Michael Eriksson's Blog

A Swede in Germany

Exponential growth, the economy, and the damage of poor government

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Skimming through a recent article on UNZ, and with the topic of exponential growth on my mind through COVID-19, I cannot resist an item on my backlog: how poor politics and politicians harm economic growth—with dire long-term results.

As I try to keep my blogging down, I will not give this backlog item more than a fraction of the attention that it deserves, but:

Firstly, growth rates accumulate multiplicatively over time and, if constant, lead to an exponential growth. Ditto, if varying growth rates are replaced by a geometric* average. The implication is that even apparently small differences in growth rates can have enormous consequences over time. For example, compare two economies with a growth rate (fix or as geometric average) of respectively 2 and 2.5 percent. The yearly difference might seem like nothing, but look at the difference over e.g. 70 years, which could be viewed as more-or-less the experience span of a single individual. 1.02^70 ~ 4, while 1.025^70 ~ 5.6; giving a 4-fold “new” size of the economy compared to a 5.6-fold. The one with the marginally higher grow rates is then roughly 40 % larger than its competitor at the end of the 70 years; or, in absolute terms, 1.6-times-the-size-of-the-original-economy larger. Where would you like your grandchildren and great-grandchildren to grow up?

*As in multiply-and-take-the-nth-root, and as opposed to the add-and-divide-by-n used by the “regular” or arithmetic average.

With greater differences in growth rate, the end results explode apart. For instance, 1.04^70 ~ 15.6 or almost four (!) times as large as the “1.02 economy”. If growth rates remain even approximately as they are, originally-poor-but-fast-growing countries like the “tiger economies” will necessarily outdo originally-rich-but-slower-growing economies (like the US or Germany). The original richness can cover up the difference in growth rate for a long while, but sooner or later the advantage runs out and the tables turn.

Obviously, economies that are both poor and and low in growth will do disastrously—one reason why socialism and poverty is so dangerous, as the poverty leads to calls for socialist politics, which stunts growth, which keeps poverty going, … (cf. below).

Secondly, current economic policies in many Western countries do a lot, as a side-effect, to artificially keep economic growth back. This especially in countries that have a strongly Leftist take on policy, where the focus is on re-distributing the existing cake instead of making the cake larger. For instance, high taxes and bureaucracies keep enterprising individuals back; high employment costs* make it harder to be competitive and reduce the willingness to expand, especially taking the step from a one-man company to having even that first employee; attempts to compress differences in income/lower the GINI coefficient reduce the rewards for competence and hard work, make it harder to get the right employees in the right positions,**; etc.

*Which includes more than the actual salaries/wages/whatnot. These can be problematic enough, but then add half a fortune of additional taxes, fees, whatnot for the employer to pay …

**E.g. because someone who would have worked in field A due to a higher salary than in field B now chooses field B; because someone who would have put in extra overtime, if he kept the pay, does not when the government takes most of it; because someone would have taken extra responsibility for a significant earnings increase, but does not when the increase is small; and so on.

To this I note that there is considerable empirical evidence on this issue, as with China (discussed in the linked to article), the Venezuela of the last few decades, the old East vs. the old West Germany, etc.* Indeed, Germany’s likely greatest period of growth, the Wirtschaftswunder era, coincided with the likely most free-market-friendly politics of its history, while the current, slow growing, Germany has redistribution mechanisms, social security and health-insurance costs, whatnot, that might fit the Sweden of the 1970s.

*But I caution that looking at any given individual example is tricky, because a multitude of factors can play in, e.g. that West Germany received help from the US while East Germany was exploited by the USSR. Looking at the totality of examples, however, the picture is quite clear.

Could the current Germany or the current US reach and sustain “Chinese” growth rates? Possibly not—and even the Chinese have been having trouble doing so for quite a few years. However, they could easily do better, say in getting that 0.5 % of extra yearly growth. That they fail to do so could be seen as a crime against future generations to the same degree as undue pollution can.

In the long run, it really does pay better to get a fix proportion of the growing cake than a growing proportion of the fix cake. If in doubt, note that a growing cake can help everyone, while a growing proportion of a fix cake means that someone else has less.

Note on inflation, etc.:
Above, I have ignored topics like inflation, purchasing power, “per capita”, whatnot. They have no effect on the principles discussed, and, indeed, the exact same examples can be used if e.g. a growth rate is declared to be adjusted for this-and-that. However, they can lead to a different set of numbers that are realistic—and, in doing so, they will tend to increase the importance of higher growth (unless the higher growth is correlated with a higher inflation or whatnot). For instance, in the original economies, assume that the growth rates were “naive” and without considering inflation, and that inflation, in both cases, is 2 percent per year. The one economy will be more-or-less stagnated while the other will still grow, even be it considerably more slowly than before. In the one case, future generations are stuck on the level of past generations; in the other, they see still see significant improvement.

Written by michaeleriksson

April 28, 2020 at 11:55 am

One Response

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  1. […] on the main topics: As to the main topics of [1], and with a strong connection to e.g. [3], I note that there have been several interesting political decisions recently, e.g. the new, […]

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