Wednesday, December 31, 2008

Klaatu or Keynes? A perspective of economic growth

I must begin by disqualifying myself. I am no economist. Nor am I to be regarded as having any significant measure of expertise in economic theory or applied economics. But, I lay claim to have an insatiable curiosity about how the modern world has evolved and the values that drive our current ethos.

This little post is actually inspired by the intrepid blogger Mat Cendana who has 2 excellent blogs, Cendana and Cendana Blues, and, who made a very interesting comment to my recent post on EF Schumacher. Mat Cendana's comment was, if we accept and adopt Schumacher's proposition that each community must be self-sufficient, what happens to exports and trade?

That led me to a line of inquiry that offered a vista of key swatches of the parts of economic history that dealt with economic growth. The paradigm of economic growth is, in many ways, the basis for our preoccupation with international trade and globalisation.

The genuine economics bloggers such as Sakmongkol and etheorist are also focusing on these issues. While they get into the chemistry and alchemy of economics, I am confined to a role that is best described by a scene in the movie, As Good As It Gets, where the psychologically-challenged character, Martin Udall, played by Jack Nicholson tells the gay character, Simon Bishop, played by Greg Kinnear, I'm drowning here and you're describing the water.

http://videogum.com/img/thumbnails/photos/romantic_comedies/as_good_as_it_gets.jpg.

But, undeterred and, shamelessly so, I shall attempt to describe the water...

Ibni Khaldun and the original concept of economic growth

Perhaps the most well known Islamic scholar who wrote about economics was Ibni Khaldun of Tunisia (1332 to 1406), who is considered a father of modern economics.

Ibni Khaldun wrote on economic and political theory in the introduction, or Muqaddimah (Prolegomena), of his History of the World (Kitab al-Ibar).

In the book, he discussed what he called asabiyyah (social cohesion), which he sourced as the cause of some civilizations becoming great and others not. Ibni Khaldun felt that many social forces are cyclical despite the possibility of sudden sharp turns that break the cycles.

His idea about the benefits of the division of labor also relate to asabiyya, the greater the social cohesion, the more complex the successful division may be, the greater the economic growth.

He noted that growth and development positively stimulate both supply and demand, and that the forces of supply and demand are what determine the prices of goods.

He also noted macroeconomic forces of population growth, human capital development, and technological developments effects on development. Ibni Khaldun thought that population growth was directly a function of wealth.

Although he understood that money served as a standard of value, a medium of exchange, and a preserver of value, he did not realize that the value of gold and silver fluctuated based on the forces of supply and demand.

Ibni Khaldun also introduced the labor theory of value. He described labor as the source of value, necessary for all earnings and capital accumulation, obvious in the case of craft. He argued that even if earning results from something other than a craft, the value of the resulting profit and acquired capital must also include the value of the labor by which it was obtained. Without labor, it would not have been acquired.

His theory of asabiyyah has often been compared to Keynesian economics. Ibni Khaldun's theory clearly contained the concept of the economic multiplier. A crucial difference, however, is that whereas for Keynes it is the middle class's greater propensity to save that is to blame for economic depression, for Ibni Khaldun it is the governmental propensity to save at times when investment opportunities do not take up the slack which leads to aggregate demand.

Another modern economic theory anticipated by Ibn Khaldun is supply-side economics. He is said to have argued that high taxes were often a factor in causing empires to collapse, with the result that lower revenue was collected from high rates. He wrote that at the beginning of a dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.

Laffer Curve

As a minor aside, it is interesting to note that Ibni Khaldun also introduced the concept popularly known as the Laffer Curve that increases in tax rates initially increase tax revenues, but eventually increases in tax rates cause a decrease in tax revenues because too high a tax rate discourages producers in the economy.

Ibni Khaldun used a dialectical approach to describe the sociological implications of tax strategies in the following way:

"In the early stages of the state, taxes are light in their incidence, but fetch in a large revenue...As time passes and kings succeed each other, they lose their tribal habits in favor of more civilized ones. Their needs and exigencies grow...owing to the luxury in which they have been brought up. Hence they impose fresh taxes on their subjects...and sharply raise the rate of old taxes to increase their yield...But the effects on business of this rise in taxation make themselves felt. For business men are soon discouraged by the comparison of their profits with the burden of their taxes...Consequently production falls off, and with it the yield of taxation."

This analysis is said to bear the same principles as the modern economic concept known as the Laffer Curve. Laffer does not claim to have invented the concept himself, instead attributing it to Ibn Khaldun, and more recently, to Keynes.

Concept of economic growth

Now it is generally recognized that economic growth also corresponds to a process of continual rapid replacement and reorganization of human activities facilitated by investment motivated to maximize returns. This exponential evolution of our self-organized life-support and cultural systems is remarkably creative and flexible, but highly unpredictable in many ways. Since science still has no good way of modeling complex self-organizing systems, various efforts to model the long term evolution of economies have produced few useful results.

Classical growth theory

The modern conception of economic growth began with the critique of Mercantilism by thinkers such as David Hume and Adam Smith. The theory was that productive capacity, itself, allowed for growth. And the growth of capital to facilitate that capacity was the wealth of nations. While early thinkers stressed the importance of agriculture and saw urban industry as sterile, Adam Smith extended the notion that manufacturing was central to the entire economy.

David Ricardo later argued that trade was a benefit to a country, because if one could buy a good more cheaply from abroad, it meant that there was more profitable work to be done here. This theory of comparative advantage would be the central basis for arguments in favor of free trade as an essential component of growth.

Economic growth, income and population growth

Income per capita was essentially flat until the Industrial Revolution. This period of time is called the Malthusian period, since it was governed by the principles explained by Thomas Malthus in his "Essay on the Principle of Population." In essence, Malthus said that any growth in the economy would translate into a growth in population.

Thus, although aggregate income could increase, income per capita was bound to stay roughly constant.

The mainstream theory of economic growth states that with the Industrial Revolution and advancements in medicine, life expectation increased, infant mortality decreased, and the payoff to receiving an education was higher.

Thus, parents began to place more value on the quality of their children and not on the quantity. This led to a drop in the fertility rates of most industrialized nations. This is known as the breakdown of the Malthusian regime. With income increasing faster than population growth, industrialised economies substantially increased their incomes per capita in the next centuries.

World GDP/capita changed very little for most of human history before the Industrial Revolution.

Arguments against economic growth

Having taken a superficial tour of economic history, I wish to highlight the four major critical arguments that are generally raised against economic growth:

  • Growth has negative effects on the quality of life: Many things that affect the quality of life, such as the environment, are not traded or measured in the market, and they can lose value when growth occurs.

  • Growth encourages the creation of artificial needs: Industry cause consumers to develop new tastes, and preferences for growth to occur. Consequently, "wants are created, and consumers have become the servants, instead of the masters, of the economy."

  • The human population is now so large that the amount of resources needed to sustain it exceeds what is available. Humanity’s environmental demand is 21.9 hectares per person while the Earth’s biological capacity is, on average, only 15.7 ha/person. This report supports the basic arguments and observations made by Thomas Malthus in the early 1800s, that is, economic growth depletes non-renewable resources rapidly.

  • Distribution of income: The gap between the poorest and richest countries in the world has been growing. Although mean and median wealth has increased globally, it adds to the negative aspects of economic growth.

There is also genuine concern that the conventional narrow view of economic growth, combined with globalisation, is creating a scenario where we could see a systemic collapse of our planet's natural resources. If you look at the diagram above, you will see incontrovertibly that economic growth exploded only in the 20th century and, that growth coincided with the population explosion.

Maybe, the underlying principle of humankind destroying the world by over-growth and over-consumption, as dramatically described by the recent Keanu Reeves movie, The Day The Earth Stood Still may not be so far off-base as one would imagine. So, what's it going to be? Klaatu? Or, a new Keynes?

http://img99.imageshack.us/img99/1717/11585largetw3.jpg.

To sum up, my point is basically that surely these are good enough reasons for us to re-visit EF Schumacher's perspective of economics. The Malay idiom that still holds true is, sesat di hujung jalan kembali ke pangkal jalan.

13 comments:

Hasbullah Pit said...

I think this blog post should link to my blog post

Sistem Ekonomi Keynessian Membuatkan Kita Semua Kemaruk "Pertumbuhan"

Patricia said...

Hi CT,

All I can say to this one is to echo what Nicholson said to Kinnear about the water!

Being the last day of the year and all, I'm writing to say thank you for the 'lessons' and that I look forward to more.

May the new year ring in blessings for all of us, ya? We sure could us some ;)

Happy new year!

Pat

de minimis said...

Hasbullah

It looks like our inquiry is in the same direction. Keep going, bro. Happy New Year!

Pat

Happy New Year to you and all your loved ones.

wankongyew said...

Come on, economic growth depletes the planet's resources faster and so should be slowed down? How about reducing or even reversing population growth to achieve a total headcount that the planet can more comfortably sustain?

de minimis said...

Hi WKY

At some point, you may wish to reflect on how humankind can sustain itself at an exponential rate of economic/material and population growth. This scenario may not happen in your lifetime. But what would humankind need to do at that point? Some of us believe that this issue warrants a discussion although you appear to feel otherwise.

sakmongkol AK47 said...

bro de minimis,
long time ago, i said, the footsteps of this person, scare me. i will have to shut myself away for sometime, to go back to the basics.

as always, a very well reasoned argument. hopefully i can offer useful amplifications. that of course is the forte of our friend e theorist.
thanks for the splendid post. read it this early morning but chose to think it through first.

de minimis said...

bro Sak

Thank you. I truly am looking forward to reading more of your thoughts in 2009.

Mr. Padedoh said...

Hi CT,
I tried reading your post again and again and all that struck me was that you were advoacting another argument for birth control.

I don't want to go over that but would like to comment a bit on the per capita chart you had shown. The heading seems to be a misnomer as it suggested that the worlds per cap had not risen significantly - it did miss the point that per capita of western nations exploded post the 1st and 2nd industrial revolution. Prior to that the world was an agragrian society - and per cap was more or less flat, if a country had more fertile land, it had more people and the net effect cancelled itself out leading to no great difference between the average wealth of "rich" nations and those of poor nations. Leslie Thurow, the MIT economist more or less said the same.

I did my own research to cast some relevance of where Malaysia stands in this equation. Its about 66 - USD 17 greater than Brazil.

No its not population growth that we should be bothered about - its the growing disparity between the wealth of the rich and those of the average working man. Corporates over hire foreign labour to do most jobs, artificially creating a supply of low paid and low skilled workforce. So if we want to do right, get rid of foreign labour and start to practise not trickle down Mahatirian economics but bottom up strategy instead.

de minimis said...

Mr P

I guess this post is open to any number of inferences, population growth being one of them. I was actually (believe or not) trying to engender the viewpoints on economic growth per se. But I do see that the Malthusian observation does apply i.e. that there is a direct correlation between economic growth and population growth.

I was also alluding to the environmental degradation that comes from excessive economic growth.

I guess I have to be even more direct the next time :D

wankongyew said...

I would certainly agree that human population growth needs to be constrained, although of course I would argue against coercive means of doing so. A good question is why do governments all around the world effectively promote having children through various forms of tax breaks and subsidies when there is arguably already more than enough humans on the planet?

What I do oppose is your poor critique of economic growth. It seems to me that what you're really arguing for is that you think that people should learn to be more content with their lot in life and cease pursuing happiness through the purchase and consumption of material goods. If so, why not come right out and say that? But this of course is not an economic argument but a philosophical one.

Second, you incorrectly imply that this sort of living is "Western", as if before Asians came into contact with the West, they were uniformly peaceable, agrarian communities with no great materialistic aspirations and were content to live relatively happily with relatively little material wealth.

This is ridiculous because the desire for material wealth is a universal human condition. As my wife commented to me in private conversation, it ignores that for example, China was the greatest trading centre of the world when Europe was a backwater and plenty of people then knew how to live the good life and aspired towards luxury.

This is not to say that there are no good arguments against consumerism (to name it by its proper term). Excellent grounds for critique could be based on the declining marginal utility of money as wealth increases for example, or on the observation by evolutionary psychologists that after a certain amount of wealth, the happiness that comes from earning ever more material wealth is not based on the absolute value of that wealth, but on how relatively richer or poorer someone is relative to his or her peers.

Unfortunately, those were not the grounds on which you constructed your arguments.

de minimis said...

Hi WKY

I appreciate your critique. Your reference to dynastic China is interesting. In that era, the scholars were placed at the highest end of the social order while mercantilists were at the bottom tier just above peasants. This is just one comparative factor. There are many others.

I have suggested in earlier posts that a society that venerates scholarship and philosophy over crass mercantilism may not be a bad thing at all since more objective social values may be instituted over the materialism that prevails today.

I like the fact that you are pushing for a holistic view of modern living of which economic growth is just a facet.

As with all things, short of writing a book, one has to choose one topic at a time and run the risk that a negative critique such as yours may come about.

The key consideration that we need to re-visit is the Malthusian observation that population growth is directly proportional to economic growth and material wealth.

That is an issue that I had hoped to deal with separately. But I guess your urgent negative critique has opened this issue up earlier than I had been prepared for.

I would, however, look forward to reading your own critique of economic growth with the holistic view that (as you have pointedly remarked on) appears to be absent in this post.

wankongyew said...

A couple of important points to elaborate on:

1)

I didn't comment on the "Malthusian observation" because it is clearly wrong and didn't think that it was necessary to point out the obvious. Population growth does correlate with increases in material wealth, but only up to a point, after which childbirth rates go down sharply. This can easily be demonstrated by looking at the demographics of places like Western Europe and Japan which cannot sustain its population without resorting to immigration.

In short, I don't think this is something that we need to worry about.

2)

I fear you mischaracterize my position. I am a libertarian and as such advocate relatively laissez-faire economics. I pointed out those critiques for the purpose of demonstrating that there are good critiques against consumerism that I am well aware of. I did not mean that I would support public policy that were directed expressly towards such aims.

For the record, I am personally sympathetic to the view that human life means more than just materialistic wealth. After all, the tagline for my own blog reads "The unconsidered life is a life not worth living."

However at the same time, I am very much conscious of the fact that this is simply what the vast majority of the human race wants. It is not my place to tell anyone else what should or shouldn't make them happy.

Finally, even though I would personally welcome a world filled with more enlightened people who are interested in knowledge for its own sake, I would regard with great alarm and skepticism any attempt to bring about such a world through large scale social engineering and overthrowing of the existing order of the world.

Utopian plans do not work and humanity is not perfectible. We should all know better by now.

de minimis said...

WKY

I am glad that you have that certainty that all will be well in a laissez faire setting.

I am, however, quite perturbed by your presumption that inquiries into the nature of where we are today (which requires historical reference points) are Utopian academic exercises ("knowledge for its own sake") which may account for your usage of dismissive words like "ridiculous" to describe matters that you disagree with.

The very concept of laissez faire and libertarianism have varied histories and contexts.

I am rather perplexed by your presumptuousness in inferring that the blog posting advocates social engineering. You seem to confuse an inquiry into the human condition in order to formulate economic policies with an advocacy of social engineering.

In any case, you may be comforted to know that economic and social trends that favour unlimited economic growth and free population growth is the current status quo. I do not see that changing for the foreseeable future since the U.S., Europe, Japan and China subscribe broadly to the present value system.

It will take a cataclysmic event to change the current value system.

So you can relax and not be so testy with a small group of bloggers that wish to calmly, courteously and sincerely discuss alternate economic, developmental and living directions that may be available.