View from Abroad: What Do We Know About Economic Growth?

Listener 22 May, 1999

Keywords: Growth & Innovation;

Even a good scientific theory experiences anomalies which it cannot explain. Resolving those aberrations eventually leads to a better theory. However ideologists prefer certainty to complexity and ignore inconsistencies. An article in the April 10 London Economist – the world’s top economics weekly and prominent upholder of “more market” – nicely illustrates the phenomenon.

Although it is not as extreme as our commercialisers, The Economist regularly praises the US economy for being more market driven and more flexible. But when it looked at actual outcomes, comparing the US with the other two big economies of Germany and Japan, to its (suppressed) horror, it found that the US performance was not superior. I have shown their figures for the last decade below. (I added New Zealand’s.) US production per head has grown more slowly than Germany despite the German’s difficulties of absorbing the shambolic East German economy, and about the same as Japan, despite everyone muttering that Japan is in permanent recession. Its labour market performance is better, with more job growth (US unemployment is down to a miraculously low 4.5 percent of the labour force), but that is because its productivity performance is miserable. (New Zealand shows the same pattern of relatively high employment growth which is offset by poor productivity and miserable per capita growth.)

does not defend the US by arguing that the most technologically advanced and highest income economy in the world suffers because others have a catchup effect, as they cheaply imitate the US. Nor does it argue that economies with large service sectors find productivity growth difficult, because the expanding service sector tends to have low productivity (the so called McJobs effect). Both are relevant, although they do not seem to explain all – or even the large part – of the inconsistency.

One answer may be that the flexibility of the market is not as crucial as is claimed. (This is a different argument from that the market outcomes are inferior: that belongs to another column.) Arguably, economic actors need some stability in their economic decision making, and an un-intervened market is too volatile. One might illustrate this on the shop floor, where the Employment Contracts Act gave managers a high degree of labour force flexibility, but the insecurity means the workers lose their commitment to the employer, which may reduce their productivity. Microeconomic policy becomes a matter of finding the right balance to allow sufficient flexibility to enable firms to seize opportunities and deal with crises, but not so much that normal performance suffers.

The article dismisses some anecdotal explanations where a special factor favours one economy over the other. Indeed The Economist – like this columnist – thinks some of recent US economic growth is based on a speculative bubble, so perhaps their US figures are misleadingly high. Instead, it argues that macroeconomic policy – monetary, fiscal (and in a small economy like New Zealand) exchange rate policy – are as important. Or even more so: the article is a vague at this point. It is not arguing that microeconomic policy is irrelevant. It would probably agree with my view that macroeconomic policy works better if there is some flexibility in the economy.

But below The Economist’s concerns of the poor productivity performance of the US economy is an unspoken question: what do we actually know about the process of economic growth? One theory says that by reducing government interventions, abolishing protection, reducing taxation, an economy will grow faster. (It is the theory that the reforms from 1984 was based on.) The supporting empirical evidence is not very compelling: much begins by assuming the theory works (the ideologists’ approach), rather than testing it (the scientists’). The more I look at the evidence the more I am struck with how little we know, especially in contrast to how confidently ideologists present their conclusions. This is not to back down from the central theme of my book, In Stormy Seas: the Postwar New Zealand Economy, which argues that the economic growth of a small open multi-sectoral economy is intimately related to the effectiveness of its export and import substituting sector. What it does not explain is the economic growth of the world economy. But neither can The Economist.

What The Economist said about New Zealand

New Zealand is only referred to twice:

“Even New Zealand’s mode, of which The Economist has been a big fan, has been looking somewhat sickly: it was the only rich country besides Japan that suffered from recession last year.”

“Radical reforms in the 1980s transformed the rich world’s most regulated and closed economy into one of the most free-market, with [one of] the lowest tax, lowest trade barriers and widespread privatisation. Bad point: a big increase in inequality.”

Most will agree an increase in inequality is bad. But The Economist overlooks that we have not done too well in the economic growth, productivity, or employment stakes either.

(percent annual growth rates)

Country GDP/head Productivity Employment
Germany 1.8 2.5 0.0
Japan 1.7 1.1 0.8
US 1.5 1.2 1.3
New Zealand 0.6 0.5 1.3