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.

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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.
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• 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."
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• 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.
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• 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?

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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.