I’ve recently started listening to a podcast about economic history called, fittingly, The Economic History Podcast, and the last episode on the “Great Divergence” was so interesting it ended up rattling around my head for a few days, and I thought I’d share a few thoughts.
What makes modern economic growth “modern?”
In the (excellent) public schools I attended in the US, we received a kind of potted history of the industrial revolution. You probably remember the broad strokes: Eli Whitney’s cotton gin, replaceable rifle parts, Fulton’s steamship, Ford’s assembly line, Taylorism, the Green Revolution, and all the rest. In this telling, technological advances (industrial, political, and sociological) led to increased productivity and freedom from the “Malthusian trap.”
In the interview I linked to, Professor Stephen Broadberry poses the interesting question: how do you know when you’ve entered a period of modern economic growth? After all, the cotton gin only needs to be invented once (and only where cotton is cultivated), so you can’t say a country starts experiencing modern economic growth when it invents the cotton gin. Instead, he suggests a very interesting definition: modern economic growth is a condition of 1) rising output (e.g. GDP) per capita and 2) a growing population.
One way of thinking about this is to imagine an entirely agricultural society with three types of soil: rich, moderate, and poor. On rich land, farmers are able to produce more food than they need to survive. On moderate land, they can produce just enough to feed themselves. And poor land is capable of producing less food than is required to feed its farmers. When you have a small population, they should try to cultivate the rich land first, and since the land produces more food than its farmers require, the population has plenty of room to grow and fill up the rich land. Of course, eventually the rich land will end up full, so the population will spill over to the moderate land. This is no great trouble however, since the moderate land is still capable of producing enough food to feed all those who work it. But note what happens in economic statistics: GDP per capita mechanically falls as population rises, since the lower-producing moderate land is now being tilled by those farmers unable to access the rich land. Finally, as the moderate land becomes fully occupied, the next generation is forced to turn to the poor land, subsisting on the starvation rations they’re able to grow for themselves and the excess they’re able to extract by politics, custom, or violence from the farmers of the rich and moderate lands. At each stage of this process population increases but GDP per capita falls, since each additional farmer is tilling less and less arable land, adding quite literally more to the denominator than the numerator.
Now consider the process in reverse: a plague blows through the rich land, killing a large portion of the population, and the farmers of the moderate and poor land claim it. Here, a fall in population is matched by a sudden rise in per capita GDP, as the poor land is abandoned and the produce of the rich and moderate land is divided over a shrunken population.
Economists have a bad habit of writing a clever mathematical model and then claiming that it is actually how events played out in human history, so to be clear, this little vignette does not describe any human society that has ever or will ever exist. It’s just an illustration of one way GDP per capita and population size can be linked: a variation on the so-called “Malthusian trap.”
The professor’s definition of modern economic growth handles this by saying that modern economic growth begins when you experience a period of both rising GDP per capita and rising population. In this definition you can’t “juke” the stats by killing off your population: you can only achieve it with an economy that supports both increasing living standards and a rising population.
Shrinkage, stocks, flows, and stocks
In the final part of the interview the professor made an otherwise bland point that got me thinking specifically about the consequences of his logic for individual investors. Societies, according to his research, have historically become rich not by maximizing their growth during periods of growth but by minimizing their shrinkage during periods of shrinkage. This jumped out at me because it’s the exact opposite of what passes these days for individual financial advice: an individual investor maximizes their returns by tolerating periods of uncertain losses of uncertain length.
An individual investor should pray for depressed stock prices the entire duration of their earning life: if each year well-diversified mutual funds trade at a lower and lower multiple of their earnings, then the same annual IRA or 401(k) contribution, and reinvested dividends and capital gains, will buy more and more shares each year. This is doubly true thanks to what economists call the “wealth effect:” when the stock market is up, your net worth looks better, so you are inclined to spend more and save less, while when the stock market collapses you tend to spend less and save more — magnifying the benefits of investing during stock market lows!
But national economies work on a different principle: GDP is a measure of annual productive activity, not a built-up stock of all previous or estimated future productive activity. And one important input into that process is the way people are, unfortunately, forced to move through the productive economy over time. While Amazon shares can drop 50% this year and then rise 100% next year, with no harm done to the individual investor, a lost year’s harvest can’t be “made up” in a future year because the farmer herself will be a year older, with one fewer year to produce anything at all.
The resulting question is simple: should the government go to extreme lengths to get an additional percentage point of growth during periods of growth, or should the government go to extreme lengths to combat shrinkage during periods of shrinkage? During the post-war economic boom, growth seemed like the “default” state of the economy, and policies like the Great Society were implemented to combat shrinkage. In the 80’s and 90’s, growth was seen at risk and increasingly intensive efforts were made to preserve it, despite the human costs in the form of austerity. And in the 2000’s, shrinkage has had equal time with growth, and western economies are struggling to settle on a solution.
What is post-modern economic growth?
If pre-modern or “Malthusian” economies faced a trade-off between GDP per capita and population, with the former rising alongside mass death events and falling during times of peace and tranquility, and modern economies embraced rising GDP per capita alongside rising population, it’s worth asking what post-modern economic growth could look like.
Countries could return to a neo-Malthusian order, where falling populations are accompanied by rising GDP per capita. Note that, as in the case of a plague in a highly-productive agricultural area given above, the falling population doesn’t have to occur in the lower-productivity part of the workforce: all that is required is that the economy be dynamic enough to shift workers from low-productivity sectors to high-productivity sectors. A common example of this model is Japan, which has accommodated a declining workforce by shifting the remaining workers into the remaining high-productivity jobs.
An alternative model is to embrace a rising population, but disregard growth in GDP per capita. This would also violate the professor’s definition of modern economic growth, since it would accommodate rising population without insisting on rising GDP per capita. If the US GDP per capita is around $60,000, we could invest in economic growth that would replicate that per capita GDP without attempting to accelerate it, alongside a growing population of Americans. Note that individuals could still experience a rising standard of living under this regime if income were redistributed over time from the highest earners to the lowest-earners, without per capita GDP either rising or falling.
I don’t have any strong feelings one way or t’other about the professor’s conclusions or his data, but I found the interview fascinating, so if you’ve got 37 minutes to spare I highly recommend the episode, and if you do end up interested, the podcast’s back catalog has some tremendous content, virtually all of which is delivered in an adorable Irish brogue.