Growth is the word that gets used more often than any other in economics reporting and in some respects we have lost sight of the fundamentals behind it.
It refers to GDP (Gross Domestic Product). This is the value of ‘the’ economy. Or could be compared to the turnover of a company. Growth is the annualised increase in GDP usually expressed as a %.
Although it’s a figure that is calculated and should therefore simply be a factual result of the millions of activities that make up the economy, it has taken on a much bigger meaning. Even though what happens in the past should not necessarily be a guide to what happens in the future, growth and its forecast is nevertheless considered to be THE fundamental indicator for future financial planners both individual and government as well as for assessing the general health of the economy and supporting the currency.
If we are growing, our living standard is improving or at least not declining, we can relax, maybe even invest in the future. Growth has become our comfort blanket, our security for the future, an assurance.
Western economies have apparently enjoyed almost uninterrupted economic growth certainly for living memory and even recessionary interruptions have not broken the relentless upward trend. This underlying expectation of growth remains the base assumption of economists, and most other commentators, but is it all true?
If we start to examine the fundamentals, the cracks start to appear.
Compounding theory shows that indefinite growth is not possible and that long term growth should not be expected.
If an economy has a 10% annual growth rate, after 10 years the increase in GDP would be more than one and a half times (1.59) the size of the original GDP. For a developing economy where workers are moving from agriculture to industrial production such an increase is possible but for a developed industrialised economy, most unlikely.
If that 10% year on year growth continues for 50 years, the increase in GDP would be more than one hundred and sixteen times (116.39) the size of the original GDP which if prices are consistent is clearly impossible. Most of that increase is the result of compounding and not growth. If the amount of the initial 10% is maintained, the increase after 50 years would be only five times the size of the original GDP which equates to a year on year increase of only 3.5%.
Therefore for a consistent yearly increase in GDP the growth % declines year on year according to the compounding principle. This factor rarely gets a mention by economists and statisticians who seem to assume that past growth should be the baseline for the future.
In practice the annual increment is unlikely to be consistent and an initial high growth % would naturally significantly reduce to less than 5% after industrialisation very much as we have witnessed with China over the past 20 years.
Growth is not equal to increased living standard and despite the many report to the contrary, there is no link. GDP per capita indicates living standard and of course depends on population size as well as GDP.
If the components of GDP are considered together with the propensity for change in each case, a better indication of the current and future expectations for growth can be derived.
|Component||Past Change||Expected Future Change|
|Production||Has already peaked. Scope for increase is a function of available market which is necessarily limited||Continued decline. Scope for increase is a function of available market which is necessarily limited|
|Population||Most western economies have had declining endemic populations for some years and any increase is as a result of immigration only||Unchanged trend|
|Employment||Declining employment during the past 10 years due to improved technology, automation, globalisation etc.||Unchanged trend|
|Price||Increase of approximately 5% Year on Year||Decrease|
This raises some interesting points:
Production can only seriously be considered in the context of a globalised world. Demand is finite, production is finite and individual economies are competing within a finite market.
If immigration is taken into account, population should also be considered as finite in a global sense. Forecasts of population change are robust and are very unlikely to be significantly incorrect. Western governments in some cases have allowed populations to increase possibly to boost growth, clearly this strategy cannot be sustained for the long term.
Inflation is a vital element of growth and if prices do not continue to increase it will become impossible to maintain any plausible forecast of growth. This is why all western governments hate deflation so much and are effectively still deny its existence in many cases.
So for the western economies, all things being equal, unless markets and production can be significantly increased there is no reason to expect that growth will occur, in fact based on these ‘normal’ components the prognosis for growth doesn’t look good.
Of course the situation is actually much worse, because for the past 30 years growth has been bought and paid for with debt and would not have occurred otherwise. Successive governments have intentionally induced additional growth by borrowing and spending to promote consumer demand and investment. If that artificial stimulus effect is removed from the equation GDP has remained fairly constant, any increase being one or two % only for some of that period.
This would suggest that for a developed western economy sustained growth should never have been considered as inevitable and at the present time any further growth cannot be assumed.
So to complete the exercise it should remain to consider the ongoing effect on the growth to western economies, given the reduction / cessation of artificial government stimulus and possible negative stimulus due to repayment of debt. Of course negative growth is no longer growth but shrinkage. The extent is unknown and there are no established parameters for prediction but based on the above fundamentals, and with no artificial stimulus, it would appear that GDP’s of western economies will reduce at least for a period of several years and possibly for a period commensurate with the period over which artificial stimulus has been applied.
Therefore based on the above there has been no real growth for the past 30 years and we have been lied to or misinformed by governments and economists alike who may or may not have been deluding themselves as well as us.
It is also inevitable that in the years to come, growth will be viewed increasingly as a crude and irrelevant indicator.