The Steady Stater

The Most Shocking Conclusion of Mainstream Economics

August 23, 2020 Brian Czech
The Steady Stater
The Most Shocking Conclusion of Mainstream Economics
Show Notes Transcript

Mainstream economics leads to a litany of bizarre beliefs and crazy conclusions. For example, the belief in perpetual GDP growth is woefully behind the times and extremely dangerous in the 21st century. However, one conclusion—straight from the leading theory of economic growth—is jaw-dropping in its departure from sanity. In this episode, we explore this crazy conclusion, expose its fallaciousness, and explain how it gained acceptance.

Richard Tibbetts:

From the Center for the Advancement of the Steady State Economy, this is the Steady Stater, a podcast dedicated to discussing limits to growth in the steady state economy.

Brian Czech:

Welcome to the show. I'm your host, Brian Czech, and today we'll be talking about the single most shocking conclusion to come out of the economics profession. I won't reveal it just yet, because where's the suspense in that, but it's a conclusion that will blow your mind. And it's not even a very controversial conclusion within the economics profession. It's standard fare, state of the art economic theory. I might add that it's Nobel Prize winning theory. But before I reveal this shocker, we need to revisit something from last week's episode on "what is a steady state economy?" And it's that phrase I mentioned "in the aggregate." Now, as I was saying, we need to dwell a little bit on that phrase from last week, "in the aggregate," we defined the steady state economy as stabilized production and consumption of goods and services in the aggregate. And so all else equal, that means a stabilized GDP. And it entails stabilize population, and per capita consumption. And then we didn't really elaborate, I didn't elaborate, upon the phrase "in the aggregate." We did talk about the structure of the economy, so it may have come out, to some degree, that way, but we need to really emphasize the phrase "in the aggregate," because otherwise, I guarantee you what you will find, especially in shallower discussions about economic growth and limits to growth, if you talk about the fact that that we need to establish a steady state economy, because growth is is causing too many problems, you're going to get people out there saying "Well, wait a minute, we can have more solar panels and less oil wells, that's economic growth. We can have more bikes and less BMWs. That's economic growth. We can have more organic vegetables and less Roundup Ready soybeans and Bt-corn, that's economic growth." Wrong. That isn't economic growth. Those are each examples of what we call a sectoral adjustment and you can have sectoral adjustments in a growing economy and in a steady state economy and in a degrowing economy. But by no means does a sectoral adjustment automatically mean economic growth. And in fact, with these examples, when you think about it a little bit, solar panels instead of oil wells, bikes instead of BMW's, it's very unlikely that those would correspond with GDP growth, it'd be just the opposite. So "in the aggregate" is a really key phrase. Now, let's go on to the big shocker from mainstream economics. I'm calling it the most shocking conclusion of mainstream economics. You might also look at, look at it as the most shocking theory in the economics profession. And let's remind ourselves that GDP is the size of the economy. And ever since the economics profession began, it's largely been about growing the economy. And when Adam Smith wrote The Wealth of Nations, it wasn't necessarily measured with GDP. But since the 1920s, it has been. And so it's all about growing GDP, and just as importantly, growing the GDP per person. And that's known to economists basically as quality of life, as standard of living. And it is important, let's face it. We need more than just subsistence to have a fully functional economy and society. If we want a military, for example, for national security, we have to have quite a bit of GDP per person. So now, here's the shocker. Because if you think about how are we going to get more GDP per person in a purely logical or very basic mathematical sense, you would say, well, there's clearly two ways that we would go about that. We can grow GDP itself and that increases GDP per person or we can lower the number of people out there and that increases GDP per person. Either one works. The shocker is that in mainstream, conventional economic growth theory, the way to get an increasing GDP per person is to have a growing population. Yes, that's right. The way to get increasing GDP per person is to have a growing population. And if it sounds crazy, well, frankly, it is. It's crazy in the sense that it's missing a big chunk of reality in the deriving of it. Otherwise, it's not at all crazy. And so let's talk about how this all came about. And some of the implications. First of all, there wasn't really a cogent theory of economic growth until the 1950s, when Robert Solow published his paper, "A Contribution to the Theory of Economic Growth." And what Solow did was, he accounted for the capital and labor stocks in the United States. And he discovered that yes, those two factors account for much of the increase in GDP, but there was one other major thing that he couldn't find explained by capital and labor. And so this so called residual, he assigned that just logically based upon his own thinking about the economic process. He said that what this residual represents is technological progress and at the time when he was writing, he favored the phrase "technical progress." Over the decades, we've come to call it "technological progress." Now, one thing about Solow was, he's starting with this landless production function. Production is a function of capital and labor. Land had been left out. It had been sort of abandoned in the economics profession, starting approximately at the beginning of the 20th century and so he didn't think to look very closely at, well, what about the rampant extraction of natural resources and the use of more and more acreage across the country and across the planet for international trade? So he was really focused on technological progress at explaining the rest of that GDP growth and the quickening in the 1950s and 60s then, as he studied growth for decades following that, the uptick in the growth rate, he focused entirely on technological progress. All right, so that went on that subset of the economics profession, dealing with economic growth, pretty much followed up on the Solow model for decades afterwards. And it's still following up on it, frankly. And I would say the two most famous names in terms of contributing to the basic model were Robert Lucas and Paul Romer, his student, Paul Romer. Lucas is at the University of Chicago. And what Lucas did is, first of all, he mathematized growth theory up and down and left and right. And it's some beautiful calculus, no doubt about it. I remember watching him give his presidential address at the American Economics Association Conference back in maybe 2003 or so and it was some spectacular calculus. But once again, he started out with the landless production function. He and many, many other students and scholars of growth, which by the way, that list includes BJ Harris, the father of Kamala Harris, the democratic VP candidate. Well, I mentioned Paul Romer, he was a student of Lucas's at the University of Chicago and he was the star student, and he actually took growth theory to the next level. And then he went on to faculty at Berkeley, and Stanford, I think, for most of his academic career, and later at New York University. And he was, for several years, I think it was about maybe 2015 to 2018 or so, the chief economist at the World Bank, so an extremely accomplished fellow. And he won a Nobel Prize, not The Nobel Prize. Maybe this is for another episode. You hear talk of a Nobel Prize in Economics. It's sort of a a copycat prize. It's the prize issued by a bank in Sweden where they use the name Nobel, it's not a Nobel Prize per se, but still it's a very prestigious award. And he won it primarily for his work on what he called endogenous technological progress. What does that mean? It's not as complicated as it sounds. When Solow was looking at technological progress, he couldn't really explain it with the model he had developed. He had focused, as I mentioned on capital and labor. And he treated technological progress as manna from heaven. He just knew it was out there. He speculated some on how it occurred and how it should be encouraged, for the sake of GDP growth, but that was about it. Romer, rather, took the concept and the process of technological progress and then he took Romer's growth model and he merged the two. So you could say he endogenized the variable, technological progress. And it is very clever, cleverly done. There's no doubt that Romer, just like like Lucas and Solow, was a brilliant mathematician and economist, in many ways, macroeconomist. And let me tell you a couple of the highlights of his theory on - his endogenizing technological progress. One thing that he did is he explained very clearly and exhaustively the importance of patenting and intellectual property in general, buffered by the process of patenting. And so what this did, the process of patenting, is it allowed for increasing returns, returns to investment and effort, because let's say, for example, that you invent a hammer. And everybody needs a hammer, so hammers are bought rapidly, making a lot of money, but you have production costs with each hammer you produce. And eventually the demand is met, so you have diminishing returns to your investment in the manufacture of hammers. Not only that, you have other firms that see this happening. "Hey, they're making a lot of money manufacturing hammers." So they start competing with you in the manufacture of hammers and so that just diminishes your returns faster. So Romer, he recognized a couple of things. First of all, if you had a patent, you could avoid that latter part of the diminishing returns, the competition, at least for the life of the patent. And so one of the implications is you have a little longer patent life. The other thing that he recognized, remember, this paper of his "Endogenous Technological Change," was published in 1990, so he was fairly prescient, he could see the information economy coming, I think, better than just about anybody else. And he recognized that intellectual property is way different than the manufacture of goods of physical goods. So for example, if you come up with some software that everybody wants, and once you produce it, there's no real additional cost of production after you've done that. So you get increasing returns to your investment and effort in software production, and then especially if you have it patented. Well, he became so enamored with this concept that he also took a look at Romer's model, and he honed in on capital and labor. And he said, and I'm paraphrasing, he said, you know, with labor, we have two basic kinds of labor. We have what we might call regular old labor, that's using the hammer or producing the hammer, you know, the all of the sectors that that we talked about in the last episode. We also have a sector that we can call research and development. And that labor is a labor of thought. It's a labor of invention and innovation. And that's how we get the products, the intellectual property like the software's such that we can have more cases of increasing returns, and especially if we stick to strong patenting law. So this is a way, if you only look at it mathematically, without considering any sorts of limiting factors, resource shortages, like the Solow model, without land in the production function, like it does, it fails to consider these types of things, you can be led to think that well, we can just start having a growing ratio of these types of activities compared to the old, you know, the farming and manufacturing, and the other types of service provision, like transportation and health services and so on. So that is how we got to the conclusion. That's how Romer got to the conclusion. And Romer I don't think ever really emphasized this too much. It was more like championing pro-growth interests I'd say, the Competitive Enterprise Institute and places like that, that really took it and ran with it and said, hey, look what this Nobel Prize winning work has to say. It's telling us that if we want a growing GDP per person, we need more and more people. Why? If you want more and more ideas, more and more invention and innovation, you need more and more labor devoted to that. You need a growing labor sector devoted to research and development, but you certainly have to have the other part of the labor force as well. Otherwise, what's gonna happen with all those ideas and inventions and innovations? You have to have the other part as well. So that means, at some point, you can't just reallocate labor from other other types of labor to the research and development sector. You have to have a growing labor force. And similarly, with the labor force, you can't just count on, on drawing people out of retirement and starting them to work earlier and working longer hours, you have to have a growing population. So naturally enough, with endogenous technological change, you come to the conclusion that in order to increase GDP per person, you must have a growing population. I know if you have some background in ecology, if you're a farmer, if you have primarily common sense as your intellectual mindset, you're thinking, what in the heck were they thinking? And you should it's, it's really crazy stuff, but I'm not exaggerating. Look it up, now. You will find examples of it all over, not only in the economics profession, but in political economy. I remember seeing a reference to a fellow by the name of, I think his name was Robert Bradley, and he gave a speech at an awards banquet. He was getting a type of economics award from the Competitive Enterprise Institute. And he said natural resources originate from the mind, not from the ground, and therefore are not depletable. That's the kind of logic we get when we take endogenous growth theory to extremes. So, I think that about wraps her up. That describes the most shocking conclusion of mainstream economics and I've been calling it a conclusion. It's a theory in conventional in conventional economics. It's so prominent, so widely accepted that we can call it a conclusion. All right, so that's it for this time. I hope you enjoyed the show. This has been the Steady Stater. I'm Brian Czech and I'll see you next time.