No Such Thing as a Free Lunch: Principals of Economics (Part 160)

Economic growth and environmental protection are not at odds. They're opposite sides of the same coin if you're looking at longer-term prosperity.

Henry Paulson

Long-Run Growth (Part A)

by

Charles Lamson

Economic growth occurs when an economy experiences an increase in total output. The increase in real output that began in the Western World with the Industrial Revolution and continues today has been so sustained and so rapid that economists refer to this as the period of modern economic growth. These three simple words describe the complex phenomenon that is the subject of the next several posts.

It is through economic growth that living standards improve, but growth brings change. New things are produced, while others become obsolete. Some believe growth is the fundamental objective of a society, because it lifts people out of poverty and enhances the quality of their lives. Others say economic growth erodes traditional values and leads to exploitation, environmental destruction, and corruption.

The next few posts describe economic growth in some detail and identify sources of economic growth. After a review of the U.S. economy's growth record since the nineteenth century, we examine the role of public policy in the growth process. We conclude with a review of the debate over the benefits and costs of growth.

The Growth Process: From Agriculture to Industry

The easiest way to understand the growth process and to identify its causes is to think about a simple economy. Recall from the early part of this analysis, Colleen and Bill washed up on a deserted island. At first they had only a few simple tools and whatever human capital they brought with them to the island. They gathered nuts and berries and built a small cabin. Their "GDP" consisted of basic food and shelter.

Over time, things improved. The first year, they cleared some land and began to cultivate a few vegetables that they found growing on the island. They made some tools and dug a small reservoir to store rainwater. As their agricultural efforts became more efficient they shifted their resources---their time---into building a larger, more comfortable home.

Colleen and Bill were accumulating capital in two forms. First, they built physical capital, material things used in the production of goods and services---a better house, tools, and a water system. Second, they acquired more human capital---knowledge, skills, and talents. Through trial and error, they learned about the island, its soil and its climate, what worked and what did not. Both kinds of capital made them more efficient and increased their productivity. Because it took less time to produce the food they needed to survive, they could devote more energy to producing other things or to leisure.

At any given time, Colleen and Bill faced limits on what they could produce. These limits were imposed by the existing state of their technical knowledge and the resources at their disposal. Over time, they expanded their possibilities, developed new technologies, accumulated capital, and made their labor more productive. In part 7 of this analysis we defined a society's production possibilities frontier (ppf), which shows all possible combinations of output that can be produced given present technology and if all available resources are fully and efficiently employed. Economic growth expands those limits and shifts society's production possibilities frontier out to the right as Figure 1 shows.

From Agriculture to Industry: the Industrial Revolution Before the Industrial Revolution in Great Britain, every society in the world was agrarian. Towns and cities existed here and there, but almost everyone lived in rural areas. People spent most of their time producing food and other basic subsistence goods. Then, beginning in England around 1750, technical change and capital accumulation increased productivity significantly in two important industries: agriculture and textiles. New and more efficient methods of farming were developed. New inventions and new machinery in spinning, weaving, and steel production meant that more could be produced with fewer resources. Just as new technology, capital equipment, and resulting higher productivity made it possible for Colleen and Bill to spend time working on other projects and new "products," the British turned from agricultural production to industrial production. In both cases, growth meant new products, more output, and wider choice.

There was one big difference. Colleen and Bill were fully in charge of their own lives. Peasants and workers in eighteenth-century England ended up with a very different set of choices. Those who would in the past have continued in subsistence farming could make a better living as urban workers. A rural agrarian society was very quickly transformed into an urban industrial society.

Growth in an Industrial Society The process of economic growth in an industrial society such as the United States is more complex but follows the same steps we have just described for growth in an agrarian society.

Technological change, innovation, and capital production have increased productivity.

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 631-633*

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