Rethinking Economic Growth

I recently read Manfred Max-Neef and Philip B. Smith’s book Economics Unmasked. Its first half is an interesting critique on economic orthodoxy, its second is packed with ideas for positive social changes.

I want to discuss Max-Neef’s “Threshold Hypothesis” here, but first I need to talk about economic indicators in general and more specifically GDP. Now, anybody that doesn’t live under a rock will be aware that today’s economists and politicians are obsessed with economic growth (Max-Neef calls it a “fetish” in this excellent interview by Democracy Now!) and that their standard metric of growth is GDP. GDP stands for “Gross Domestic Product” – it is the total market value of all the goods produced and services rendered within a nation’s borders over the course of a year.

By recording monetary transactions, economists can keep track of that total market value. Looked at in this way, GDP tells us in some sense the “total amount of stuff being done” in the economy. For example, imagine that the “Hole-Digging Corporation” pays me a salary of £100 to dig a hole. Later, the competing “Hole-Filling Corporation” pays me a salary of £100 to fill it in! GDP, as valued in terms of my “services”, has now increased by £200. All such “stuff being done” can be beneficial, neutral or harmful; the money being transacted can represent anything, but GDP will not inform you as to what.

In my somewhat mischievous example, digging a hole added to GDP. So did filling it in. What about more realistic examples? Cleaning up pollution adds to GDP. So does polluting. Mediating negative social and health outcomes of drug abuse adds to GDP. So does the production of various harmful addictive substances. Investment in schools, hospitals and social infrastructure adds to GDP. So does the manufacture of armaments to kill and maim one’s fellow human beings. For economists to aim for growth in GDP, in monetary transactions, irrespective of what these transactions represent, is totally ridiculous!

So GDP as an economic “indicator” does not really indicate anything much. What we want to know, presumably, is the health of our economy. We want an indicator that increases when the economy is providing well for people’s needs and improving their quality of life and decreases when it is not. Seeking to increase such an indicator would be a potentially sensible economic policy. Seeking to increase GDP is an absurd economic policy, because GPD lumps together the things that add to our quality of life with the things that subtract from it, treating both as positive contributions.

Economists working outside the mainstream realised all this years ago and developed alternative metrics, attempting to put a number on “economic health”, first called ISEW  (standing for “Index of  Sustainable Economic Welfare”) and later updated to GPI (standing for “Genuine Progress Indicator”). You can read about exactly what ISEW is and how it is calculated here. When these economists started to study trends in ISEW / GPI and compared them with GDP, they noticed something interesting. In developed countries GDP has grown more or less continuously in the last 50 years, but ISEW / GPI has not. What happens in almost every case is that ISEW / GPI increases until around 1970-1980, then stalls or begins to decline. The Friends of the Earth website gives examples of ISEW / GPI vs GDP growth over the last fifty years for several countries.

Prior to the development of the ISEW / GPI measures, Max-Neef and colleagues had proposed the “Threshold Hypothesis”, stating that:

“In every society there is a period in which economic growth contributes to an improvement of the quality of life, but only up to a point, the threshold point, beyond which if there is more economic growth, quality of life may begin to deteriorate.”

The plots linked from Friends of the Earth seem to provide evidence supportive of this statement, assuming that ISEW / GPI is a sufficiently representative metric of human quality of life.

So if all of this is true, why are all nations so hell-bent on chasing perpetual growth in GDP? I will suggest that perhaps the reason is a monetary one. First though, I need to explain where money comes from. A fact many are not aware of is that banks do not lend money. When a bank makes a “loan” to a “borrower” it does not take existing money from anywhere. It simply invents a new liability on its balance sheet; new money which the “borrower” owes the bank in the future but can spend immediately. Over 97% of our money supply is created this way (the other 3% being notes and coins), meaning total debt is roughly equal to the total money supply.

In this type of “debt-money” economy, a lot of work is done simply to service the interest on our substantial debts – money has to be passed around quickly enough to make all the interest payments – the “velocity of circulation” of money has to be large enough, in economics parlance. If the ratio of debt to money increases, this velocity must increase to compensate – more stuff must be done, so GDP must increase. Has the debt to money ratio increased? It certainly did in the UK leading up to the financial crisis, as the plot below (taken from Positive Money’s submission to the Independent Banking Commission, in collaboration with New Economics Foundation and Prof. Richard Werner) proves:

Exactly why the debt to money ratio increased during a “boom” would be an interesting question to have answered. Oddly though, the economics profession as a whole seems to have no interest in answering it! Mainstream schools of economics consider money and debt to be of no particular relevance to the functioning of an economy: money is merely “a veil over barter” and moreover “including money in the models would only obscure the analysis” (!) according to a popular undergraduate economics textbook. At this point, I feel members of the public might fairly ask why they should give credence to a single utterance of the economics profession ever again. Moreover, the neo-liberal emperor is not only naked, but is now busy stealing the shirts from the people’s backs, making them naked too!

Whatever the reason for it, the above plot implies we are forced to undertake more and more economic activity during a boom, simply to service the increasing interest due on our debts, irrespective of whether such increased activity is useful, desired or indeed democratically mandated. If GDP does not grow, the economy most likely collapses in a deflationary spiral of bankruptcies, since the money needed to service the interest on debts will not be transacted with sufficient velocity.

Perhaps a reformed monetary system, one where money is not created out of commercial bank debt, is the only escape from a global economy that will try in vain to grow forever, sooner of later (if not already) resulting in a planet-wide ecological crisis?

One thing seems certain: the planet’s ecosystems cannot take another decades-long, debt-fuelled growth binge: the “cure” for the financial crisis the majority of the disgraced economics profession is currently touting. See for example the 2010 Living Planet Report, which finds we are currently using 1.5 Earths and are projected to be using 2 Earths by 2030 under “business as usual”. More economic growth in developed countries would indeed be “asking people to drink poison in order to survive” the financial crisis. The cumulative dose might be a lethal one for much of life on Earth, including humans.

To summarise then: the evidence suggests that economic growth, as measured by GDP, is no longer in the interests of developed countries, the stability of the planet’s eco-systems, or indeed the probable survival of the human race. Developing countries, having not yet reached their GDP thresholds, should be entitled to grow. However, this will only be possible on a finite planet if the developed countries consent to abandon the path of perpetual economic growth. They can only do this, without inducing domestic economic collapses, if fundamental changes are made to “our” current monetary systems.

Widespread popular recognition of this may be the only hope of a decent existence for future generations. It would also be helpful, though not critical, for the majority of the economics profession to recognise it, rather than working actively to deny or ignore it – as they currently do.