Monday, December 24, 2012

Economic Growth

              By definition economic output, commonly measured by GDP, equals the number of hours worked times the average productivity of the workforce.  For the economy to grow either hours worked or productivity (or both) has to rise.  However, the simple arithmetic hides several complexities worth unpacking.  First, the standard of living in a country depends not on its GDP, but on its GDP per capita.  If all the happens is that population increases, hours worked and GDP will grow, but not on a per capita basis.  The economy will get bigger but the people will be no better off.  The best measure of growth, therefore, is the increase in real output per capita.  Unless otherwise noted, that is the measure of growth used in this blog.

              The phrase “growth” also needs to be unpacked.  Some economic innovations are one time changes that cause a burst of growth that eventually dissipates.  Women entering the workforce is an example.  As women enter the workforce, hours worked per capita rise, adding to the rate of economic expansion.  But this process is self-limiting.  Once the economy has moved to a higher plateau with more women at work, the growth spurt stops.  

              In distinction, technological innovation is an on-going process that continually increases productivity and, thereby, is a permanent source of economic growth.  This does not mean, however, that the rate of economic growth due to technology is constant.  For instance, Robert Gordon argues that the lower hanging fruit of technological innovation, such as mastering electricity, has been picked so that future growth is bound to slow.

              Whether one accepts Gordon’s pessimistic view or not, a critical question regarding economic growth is how it may be affected by government policy.  To explore that issue requires examining how a proposed policy impacts incentives that in turn affect hours worked per capita and productivity.  Unfortunately, the impact of government policies on incentives can be complex and not always directly obvious.  In future posts, I will explore some interesting examples.

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