Chapter 4: The aim of an adequate

economic growth (continuation)

Outline:

01st The distinction: nominal and real growth

02nd The distinction between gross and net domestic product

03rd The distinction: extensive and intensive growth

04th Capital gains as a scale of economic growth

05th The distinction: maximum and optimum growth

06th What does optimum growth mean?

07th The problem of the growth political situation analysis

08th The growth political aim as an end in itself

09th The distribution political justification of growth policy

10th The foreign economic justification of the growth policy

11th Growth policy utilised as employment policy?

12th Conflicts with other aims of economic policy

08th The growth political aim as an end in itself

In the following sections, we now like to consider the question for what reasons economic growth is desirable at all. First, it must be clarified whether economic growth is also granted an intrinsic value in public or whether it is only striven for economic growth, because in this way other, superordinate aims can be achieved.

It is striven for economic growth, in fact, for its own sake; to have more income is viewed positively in general.

Accordingly, the individual welfare (W_i) of every individual depends primarily on the individual income (Y):

W_i = f(Y)

But intangible values (w_im) such as leisure time also determine the welfare of the single individuals.

W_i = f(Y, w_im)

Furthermore, the environmental pollution (U_w) must be considered:

W_i = f(Y, U_w)

Despite this intrinsic value of the growth aim, it can be assumed that the growth policy in general requires economic growth mainly because other aims can only be achieved if there is some growth.

One will also have to assume that an empirical science such as the economics cannot make any significant contribution to the question of whether an intrinsic value can be attributed to economic growth. Whether or not an intrinsic value is desirable cannot be stated by the economics, according to Max Weber's principle of freedom from value judgment. Values cannot be proven empirically as right or wrong.

However, if it must be assumed that politicians justify economic growth therewith that this allows other aims to be realised, science will be able to verify whether these aims-means correlations are actually

corresponding to reality.

09th The distribution political justification of growth policy

Redistributive aims are easier to achieve as the domestic product grows. The increase in the social budget can then be financed from the income gain, so that no reduction of privately available income is necessary.

An expansion of social spending then only means that private households must be satisfied with less income gains. However, for consumers it is much easier to go without expected income growths than to go with cuts of their previous incomes. The satisfaction of individuals is namely less determined by the absolute level of their income than by the extent to which income expectations are met. However, the income expectations are more strongly determined by whether the achievements so far can be maintained than by whether it is possible to earn additional income.

However, it is important to check whether the number of social welfare recipients in fact declines due to growth. In general, as the domestic product grows, the dispersion of incomes becomes greater, and thereby the risk that the number of social welfare recipients increases. This is particularly linked to the fact that in the official calculation, the poverty line is usually related to the per capita income and is thus raised automatically as income increases.

Let us take an example. Let us assume hypothetically that the average income so far has been € 3,000 and that the poverty line has been set at 40% of the average income, i.e. the poverty line has so far been based on a monthly income of € 1,200. In the following four periods, the average income increased by a total of 20% (i.e. by 5% each year) to € 3600. This means that the poverty line has also been raised to € 1440.

Now let us look upon the situation of a worker who has just been a bit above the poverty line since he has received an income of € 1250. He also had experienced an increase in his income in the meantime and that was to 1400 €. He is much better off, since he has now at least € 150 more than before. Nevertheless, his new income (1400) is now below the poverty line (1440). Thus, he has fallen into poverty now, although he has achieved an income growth in absolute terms.

But there are also trade-offs between distribution and growth. In classical view, the following applies: A levelling by increasing the wage share (l) leads to a decrease in savings (s) and this in turn reduces growth (dY/Y). It can be assumed namely that the savings rate itself increases with the income. As employees receive a lower income on average than the self-employed, an increase in the wage share (a reduction in the profit share) leads to a decline in the average savings rate and thus indirectly to a decline in economic growth:

But if we had applied a Keynesian scale, we would have reached different conclusions. For the Keynesian view is namely valid: Growth leads by an increase in the investment (I) to an increase in the price level (p) and thus to an increase in the profit share (g) or to a reduction in the wage share (l). If the entrepreneurs ask for more investment goods, the prices are rising, at first the investment goods, but therewith also the goods which are produced at the use of these production plants. However, the price increases are reflected in profit increases in the short term (as long as the unions have not enforced wage increases).

λ: wage ratio

s: savings rate

p: price level

I: investment volume

γ: profit ratio

Poverty and unemployment may also arise due to the inability of a constantly increasing group to meet production-related quality requirements.

This relationship between poverty and growth results because growth in the sense of a welfare increase implies almost always either reducing costs by rationalisation or increasing the quality of products. The hereby required use of high-quality machines asks, however, for increasing qualifications from an ever-increasing share of employees. But some of the employees profess themselves unable to feature or acquire these qualifications. Just for these reasons, these employees lose their jobs and thus fall into poverty. This risk can be reduced, however, by making efforts to raise the educational level of the lowest income classes.

10th The foreign economic justification of the growth policy

Economic growth can also help to overcome external difficulties. One of the most serious problems of foreign trade policy is when the foreign exchange balance becomes passive over longer time, that is, when imports exceed exports in the long term. If imports exceed exports, then export earnings are not sufficient to finance import expenditures, then the economy needs a loan from abroad. However, no foreign country will grant long-term loans to the interior if the existing loans are not repaid and if it is therefore increasingly unlikely that these credits can ever be repaid.

If we now take the neoclassical balance of payments theory as a basis, the threatening foreign exchange balance deficits could be avoided or reduced by increasing the growth rate. If, according to this theory, the domestic growth rate increases more than that of foreign countries, this difference is reflected in foreign exchange surpluses, which is equivalent to reducing existing deficits in the foreign exchange balance.

The Keynesian foreign trade theory, however, concludes exactly opposite results: if the domestic growth rate exceeds that of foreign countries, then foreign exchange balance deficits are formed, which even increase the already existing deficits in the foreign exchange balance. There is then - based on the Keynesian theory - a conflict of aims between growth policy and foreign trade policy.

First let us take a closer look at the neoclassical theory. In the scope of the balance of payments theory it is argued as follows: When domestic growth rates increase, this initially leads by way of an increase in the incomes to increased demand, which - according to the luxury money hypothesis - triggers a rise in domestic money demand (liquidity preference L^I). As a result, domestic interest rates rise (i^I) if the money supply does not respond to this increased money demand.

Now if growth does not take place abroad, or the growth rate is lower, an interest differential arises, interest rates abroad will remain lower, with the consequence that capital will be imported into the domestic because of higher interest income, thus increasing capital imports (K^Im) are resulting.

This is manifested finally in the fact that foreign currency is offered to the domestic market in order to acquire capital goods domestically with this additional foreign money. The deficit of the foreign exchange balance is decreasing. Thus, foreign trade policy difficulties can be overcome - based on the neoclassical theory - with growth. The following applies:

According to the Keynesian theory, however, the opposite is true: higher domestic growth rates (dY^I) than abroad (dY^A) automatically lead to current account deficits (LB-Def). It is assumed here that always a certain percentage of the income is used for the purchase of imported goods. If the domestic income increases more than the foreign income, then the domestic-induced import increases more than our export, which - in terms of its value size - is identical to the import of foreign countries. It applies now:

Im: Import sum;

Ex: Export sum

In other words: foreign trade policy and growth policy are - following the Keynesian theory - facing a conflict of aims.

11th Growth policy utilised as employment policy?

Now let us ask ourselves whether growth policy can also be understood as a means of employment policy. At first, it seems that there is a very simple and clear link between growth and employment. Herefore, let us start out from a production function. Accordingly it is valid:

Y = f(A,K)

Y: real domestic product

A: number of employees

K: used amount of capital

Accordingly, if the real domestic product increases, employment also increases with the existing production function, since a larger product quantity can only be produced with more labour force. This means there is a clear relationship between growth in terms of an increase in the volume of goods produced and the number of workers employed. New workers are needed only when more is produced, and it cannot be produced more unless the labour input is increased at the same time.

However, a closer look reveals that these relationships are not as clear and simple as suggested by this initial consideration. First, it should be remembered that these relationships always apply only under the ceteris paribus clause. We must start out from a given technology (production function) and must furthermore assume that the employment ratio between work and capital (the so-called capital intensity) also remains unchanged.

But just these two assumptions are problematic when we deal with growth processes. Growth is actually triggered almost always because changes are made in the applied technology or at least the capital intensity is increased. Thus, it is precisely in the analysis of growth processes that one should not assume these two tacit assumptions.

Secondly, the positive relationships between growth and employment initially apply only to the extensive growth, where growth is measured in terms of the total domestic product. But we have already pointed out that mere extensive growth says actually very little about how the welfare of a population is changing. If e.g. the number of employees increases, the individual employee still receives no higher income. The larger domestic product must be distributed simply to more heads now.

So, if we take growth as a welfare indicator, then we must deal with the relationships between per capita income and employment. But here the relationships between per capita income and employment are no longer that clear. In the case of intensive growth, the employment effect depends on whether production takes place below or beyond the minimum cost. Let us look at the following graphics:

Assuming a traditional average yield curve, the average yield and thus also the per capita income rises with increasing employment. But as soon as the maximum yield is reached, the average yield decreases again. Whether an increase in production is also accompanied by an increase in employment now depends crucially on whether production lies below or beyond the yield maximum. Increased employment does not always lead to an increase in per capita income.

Thirdly, there is also a dependence of the relationship between growth and employment on the type of technical progress:

l/I → TF(labour - saving) → B ↓ with:

l/i: wage-interest ratio

TF: technological progress

B: employment

If the wage rate rises in relation to the interest rate, this will indeed lead to technical progress and thus to a growth. But if technical progress is labour-saving, the demand for at least unskilled workers will decline rather than increase. This relationship is particularly important because in the context of Keynesian employment policy an attempt is made to keep the interest rate artificially low in order to minimise public debts as much as possible. If the trade union side then tries, within the framework of an expansionary wage policy, to increase wage rates more than productivity has increased, this employment-inhibiting effect is even intensified: the wage-interest ratio (l/i) increases both because the wage rates rise and because the interest rates fall.

Furthermore, it should be considered that even if more working hours are demanded due to growth, the number of employees will not increase in every case because the increased labour input can also be reflected in an increase in the number of working hours of those who are already employed.

It must also be reckoned with the possibility that the entrepreneurs let a part of the production be carried out abroad because the wage rates are lower there. In this case again there is no increase in domestic employment.

It must also be reminded of the hysteresis phenomena. Accordingly, the growth on the goods markets will be reflected in the labour markets only with a long delay. Consequently, high unemployment remains despite the increase in growth at least in the short term.

Finally, it must be examined whether a forced growth policy according to the law named after Okun does not have to be considered indispensable for the achievement of full employment.

The law formulated by Okun states that the unemployment rate will not be reduced until a critical growth rate, the so-called employment threshold. If the actual growth rate of the domestic product is below this threshold, it must even be expected that the unemployment rate will increase despite growth.

Arthur M. Okun was an American economist and Keynesian, living from 1928-1980, addressing, among other things, causes of poverty and the mechanisms that exist between domestic product and employment.

The law named after him is based on empirical research carried out by Okun for the United States for the period 1954 to 1962, which showed the relationship between the growth rate of the domestic product and the unemployment rate as claimed in Okun's law.

In the meantime, the relationship between growth rate and unemployment rate has also been empirically tested in other countries. These studies concluded that while some relationships could be established between the two variables, the critical threshold for the overturning of the unemployment rate in the surveyed countries was located at very different values.

Even if Okun's law entered the literature, there are several significant economists such as e.g. Rudiger Dornbusch and Stanley Fischer who have considerable doubts as to whether it can really be spoken of a law here already; the empirical contexts reveal a great measure of uncertainty after all. The values of the individual parameters would vary over the years and the relations would also be partially unstable. Also, the growth of production was determined only by estimations.

So, it is quite possible that for a certain time and for a specific economic sector it can be shown that there is a high correlation between two variables (e.g. growth rate and unemployment rate). Nevertheless, it cannot be clearly concluded from these results that there is a causal relationship between these two variables; that is, when one variable reaches a higher value, the other variable also changes in a very specific way.

It would indeed also be conceivable that both variables are completely independent of each other, but that they are both directly dependent on a third unknown and therefore unrecognised variable, which has occurred for more random reasons only in this time and in this area, but will not be found necessarily at all times and in all economic sectors.

The statement of Okun's law, according to which the unemployment rate can only be reduced if the growth rate of the domestic product is above a critical threshold, can well apply if certain other conditions are met. However, this critical growth rate is neither a necessary nor sufficient condition for reducing the unemployment rate.

A certain growth rate is not necessary for a reduction in the unemployment rate, since even with a constant domestic product, imbalances in general and the number of unemployed in a specific sense can be reduced simply by increasing the flexibility of the markets.

A certain growth rate is not even a sufficient condition to reduce unemployment. It would be, for example, conceivable that the economic upturn is due to a labour-saving technical progress in which the redundancy effect overcompensates the income effect. The labour-saving technical progress causes here less labour force to be required per produced unit of goods (redundancy effect). However, since the technical progress requires investment, the demand for goods and thus indirectly also the induced demand for labour will be partially increased (income effect), although it is quite possible that this upturn will not be enough to entirely reintegrate the workers who have been made redundant due to rationalisation into the production process again. In fact, here the unemployment rate may even increase just because of a high growth rate.

12th Conflicts with other aims of economic policy

So far, we have only marginally explored the question of whether the aim of economic growth also conflicts with other economic and social aims. At the centre of the previous analyses was the hereto opposite question to what extent other economic policy aims can be supported. Only because some of these reasons have been identified as faulty it is that the additional question of potential conflicts has emerged at all.

At least at first glance, the aim of the greatest possible growth appears to conflict with the environmental aim of preserving the system of the environment and the natural resources for future generations. Just the rapid pace of industrialisation almost all over the world has contributed significantly to the fact that an overexploitation of the natural, scarce resources was operated, that also the ozone layer was damaged and that mainly due to the carbon dioxide emissions the earth was heated, which led to a melting of the glaciers and an increase in sea levels, and as a result many tracts of land, especially in East Asia, will one day sink into the sea finally.

As already shown, attempts have been made to satisfy environmental policy with growth policy by seeing the aim of growth policy less in a maximum rate of growth but in an environmentally friendly growth, and that in statistics external costs of production are deducted from the value of the domestic product. In this respect, this is only a medium-based conflict of aims which can be largely avoided, if the right means are used.

The fact that this conflict can lose its seriousness in the near future, is further associated therewith that the environmental compatibility of production depends crucially on the type of products. It is primarily the products of industrial production which have polluted the environment and will continue to burden it also in the future. Other goods, particularly the different services, could be provided largely without environmental pollution or with a significantly lower burden.

The long-term economic development of the modern states is characterised now by the fact that in the first phase the agricultural sector dominates, in the second phase the sector of industry prevails and in the third phase the service sector predominates. While in 2013 agriculture accounted for only 1% and industry together with craft 30% of total production, the share of services is 69%. This means that the long-term development leads to the economic sectors that cause a relatively low environmental impact.

But the development of the entire world looks quite different. Measured by the world population and the entire world product, agriculture still predominates there today. And the industry, which is primarily responsible for the environmental impact, will even increase worldwide in the future.

The Okun's Law thesis that we can solve the problem of unemployment only in the face of high economic growth is also questionable from an ecological point of view. If this were correct, we would be condemned to permanent growth in order to guarantee full employment. But just this is not possible at all in the very long run. We must assume that a big part of the natural resources is limited, that natural resources are consumed in the production and that these cannot be replaced unlimited and in any case.

This may still apply least to energy resources. The traditional fossil energy resources (coal, wood, oil, gas) are indeed limited and they are consumed in the production, but new energy sources can be won in the long term such as solar energy, natural gas and wind energy, especially the solar energy is still available for milliards of years. Nevertheless, significant shortages can occur for a limited but quite larger amount of time, unless it is achieved to develop the technology of massive yielding of solar energy in time and expanding the long-distance grid the way that solar energy and the energy derived from wind power can be used in the places of consumption.

We must assume here that both solar energy and energy from wind power are not produced at the consumption sites, so that it is necessary to transport the electricity via remote networks to the most distant consumption places. By contrast, the traditional power generation plants (nuclear power plants and coal and gas plants) could be built almost always in the economic regions where electricity was also in demand.

Furthermore, an expansion of the storage facilities is required. While traditional power plants have been able to produce electricity evenly in all seasons, electricity from solar and wind energy cannot be produced at all times. There are times of calm and in which the sky is clouded and therefore power generation will be significantly reduced.

Furthermore, some raw materials can be replaced by synthetic materials. Certain raw materials that are not finally consumed during production and consumption can be recovered by means of recycling. Altogether, however, it applies to raw materials that they are available only to a limited extent and therefore limit the growth opportunities.

Even the space as such is a scarce good and cannot be increased arbitrarily. Of course, earth is far from reaching the population density of a big city. Nevertheless, from an ecological point of view there are also environmental limits, since the sealing of the soil hinders the water balance and other natural processes.

It is an alarming thesis that full employment should only be possible with permanent growth. But for reasons of justice it is also hardly possible to deny today's developing countries to aim for a similar level of development as it has been achieved by the already highly developed industrialised nations. In view of the scarcity of natural resources, there is hardly room for sustained real growth also in today's industrialised nations.

Finally, the development of actual demand, that is the demand, which does not need to be artificially aroused by advertising, should decide whether and to what extent growth is needed and desirable.