2
Economic Growth

Neither monetarist nor neoliberal policy prescriptions are primarily concerned with maximizing the prospects for economic growth. Their focus has always been on providing monetary stability and in maintaining a low and steady rate of inflation. Their supporters believe that a framework will then be created within which economic growth will take place at an appropriate pace, dictated by the market. The problem, however, is that the rate of growth that monetarist and neoliberal conditions have generated has been relatively low and far beneath those where other policy prescriptions much more favourable to high growth rates have been put into practice. The way ahead, therefore, is not to ignore inflation, but to understand what needs to be done to achieve much better results in the growth stakes without price rises running out of control. How can we achieve results in the West now which are comparable to those that were widely seen in Europe and North America in the decades immediately following World War II, let alone those attained more recently by countries such as China?

The way ahead has to be to build on what we can learn from the economic successes we have achieved so far and to understand how we can avoid the pitfalls which have led to disappointing performance, particularly recently in many western economies. There is plenty of evidence of success on which to draw. Between 1950 and 2018, the world economy grew to 12.1 times its 1950 size, or by an average of 3.7% per year.1 Of course, the population also became much larger too, increasing over the same period from 2.6 billion to 7.5 billion, an average of 1.6% per annum.2 Dividing the increase in GDP by the increase in population shows that GDP per head - a qualified proxy for living standards - rose over this 68-year period by a factor of 4.10, or by an average of 2.1% per annum.

Judged by anything achieved on any comparable scale previously in human history, these are astonishing figures. In 1945, only a small proportion of the world's population lived much above subsistence level, most of them in the industrialized West. Nowadays, the number of very poor people - those with incomes equivalent to $2 a day or less - has shrunk to about 12% of the world's population, down from 37% in 1990 and 44% in 1981.3 Prosperity on a scale unimaginable to our ancestors has spread to most of the planet.

This has happened because the value of the work which the world's population has done has risen exponentially, although not because - on average - the number of hours worked per person has gone up. Some people, such as those employed in industrial occupations are now working shorter hours than their equivalents were 70 years ago, while others, such as those who have moved out of subsistence farming into more productive occupations, are working more hours. The reason why so much more is achieved by the world's working population now than then is that there has been a huge increase in the value created per hour of work done. It is this increase in productivity that lifted output per head of the world's population to such a massive extent cumulatively, especially since 1945.

The key to understanding what has made the world economy - and output per head - grow like this is to appreciate what has made this miraculous increase in productivity possible. It is not that people are working harder. Nor is it, beyond a limited extent, because they are working more intelligently, although some undoubtedly are. It is because they are working more effectively, which is a rather different concept. This happens mainly because of the scope for exploiting three interrelated opportunities for increasing productivity. One is the use of machinery to do work that previously had to be done without it. The second is the application of technology to make things happen in a productive way, which would not otherwise have occurred. The third is the use of much more power than the human frame can produce.

It is these three processes that, as following sections of this chapter will show, are very largely responsible for all the growth in output which the world has witnessed. Of course, investment in other areas, such as schools, hospitals, roads and rail, is also very important from a social point of view, as is much private sector investment in, for example, property development and housing. All the available evidence shows, however, that all these categories of investment typically make a limited contribution as a direct source of increased output per hour and thus to economic growth. As we shall see when analysed in more detail, the return on this type of investment is typically low - indeed little more than the interest charges on the capital needed to finance it. It does not therefore produce enough extra gross value added to lift the whole economy very much, and sometimes hardly at all. Inputs such as improved education and training are obviously potentially also very important for raising productivity but - critically - they are not sufficient on their own. They are a vital complement to physical investment for increasing output per hour, but - as has been found almost everywhere - on their own - without acting as a complement to physical investment, especially of the most productive types - they are much less effective than most people would like to believe they are.

The key to economic growth, therefore, is to arrange economic incentives so that the maximum feasible amount of investment goes into machinery, technology - not least in in the digital and virtual world - and the power they need. Steps to achieve this goal then, of course, need to be both buttressed by other types of more socially orientated investment and complemented by appropriate education, training and other supply-side policies. Some economies have managed to do this on an extraordinarily extensive basis. The proportion of Chinese GDP reinvested in total has recently been hovering at not far off 50%,4 of which about a third goes into the kind of industrial investment that produces the huge returns which have driven Chinese growth rates. The world average ratio for gross capital formation as a percentage of GDP is about 25%.5 Some economies, however, have done very much worse than this. In 2016, the proportion of UK GDP devoted to investment, including intellectual property, was no more than about 17%. Net of expenditure on intellectual property, it was just under 13%, one of the lowest in the world.6 Much of Western Europe and the USA have done little better. In 2016, the proportion of GDP devoted to investment, including intellectual property, was 19.7% in the USA, 22.7% in France and 19.2% in Germany compared to 44.2% in China.7 This has a great deal to do with why the West's productivity and real wage increases are so relatively low and why, in consequence, the rates of economic growth of many of its economies are so poor.

Why have the Chinese devoted such a high proportion of their GDP to investment while in the West the ratio has been so much lower? As always, there are complex reasons why such different outcomes have materialized, but at bottom it boils down to economic incentives. People generally react to the circumstances in which they find themselves in ways they believe will maximize their economic advantage. If, for whatever reasons, it does not pay all those in a position to influence investment decisions to opt for expenditure on them, they will not take place on any major scale - and vice versa. The keys to achieving a reasonably high rate of growth are not, therefore, in principle difficult to determine. They involve no more than clearly identifying those sectors of the economy in which investment most readily generates increased productivity, and then supplying an environment that provides the right incentives for getting it to occur.

Why has this not happened in much of the world, particularly across much of the West in recent years, especially since the 2008 crash? This book is about searching for an answer to this question. Why have our governments apparently been so bad at identifying what needs to be done? Why have they failed to provide the right incentives to make sure that what is really needed happens, instead of relying on monetarist or neoliberal conditions, which have provided a much weaker and less well-planned environment for growth, because their focus - keeping inflation down - has been on a different set of policy goals?

The way in which this book sets out to provide answers to these questions is by a combination of analysing what plausibly generates economic growth and then seeing what economic history can tell us about what has worked and what hasn't. The remainder of Chapter 2 considers in more detail the process by which economic growth takes place and the conditions needed for it to happen. Chapter 3 then turns to economic history to see what this can tell us about why some nations - particularly the UK during much of the nineteenth century and the USA during the twentieth - grew so much more successfully than others but then slipped back. Why did Japan grow so fast for several decades after the end of World War II only to regress expanding at about 1% per annum from about 1990 onwards? Why did China, with most of its population still in extreme poverty at the end of the 1980s, suddenly start growing cumulatively at 10% per annum, setting it on course to be the largest economy in the world within a few...