How I understand economic growth

What is economic growth? From time to time I was wandering what kind of empiric evidence may explain the changes that this world experimented in las last two centuries. Economy classes at IESE shed some light onto that matter for me.

It seems evident that we live better than in XIX century, but I was struggling to understand how to quantify that difference. There’s an additional problem – economists used to operate with relative parameters that change all the time. There are very few constants in economy and in most cases that constants are estimated and not 100% measurable. For example if we think of money as the way to explain growth. The value of money depends on currency rate, monetary policy, interest rate, inflation and many other factors. So representing things in terms of money is a tricky thing. Economists try to place some order in that variability removing many of these factors, especially inflation, and representing values in “constant money”.  Sometimes a PPP (Purchasing power parity) is also used for comparisons but my best measure is the time. The time an average worker should work in order to purchase a specific product which is similar in each and every case you compare. The most famous comparison of this kind is the Big Mac index. While you know the price of Big Mac menu virtually in each and every country and you have data of average wages, you can calculate the time an average worker should employ to gain the necessary amount of money to purchase a Big Mac menu. With similar kind of methodology you can compare wellbeing in the past and now, taking as reference product prices and salaries from the past and now. (Below an example)

Time to earn hours

Labour - time costs. De Long. The Reality of economic growth.

Although these methods do present with relative accuracy the long term trend, sometime you need to understand the exact meaning of acronyms like real GDP per capita or PPP in order to properly visualize the full picture in your head.  But once you get it (at least in my case) you get excited on how beautiful the picture is, especially because the future seems to be bright for humanity.

Why? Let’s visualize it. There are basically 3 different economic models that explain growth. The first one, Malthusian model, quite pessimistic and dated XIX century, predicts that improvements in wellbeing lead to populations growth and the latter decrease GDP per capita (by increasing “capitas”).

The second one – neoclassic model predicted by Robert Solow, consider that capital savings may boost the growth up to some point where it will stabilize and remain constant.

And finally the Endogenous growth theory say that, thanks to entrepreneurship and ingenuity of humans, the growth is steady and unlimited (given the necessary stimulus to investigation, science and technology is given). I was speaking about the bright future because, if past help us to explain future, below graph give us some hint on which model is closer to reality:

GDP per capta

Real GDP per capita from year 1. http://ourworldindata.org/

The graph is self-explanatory. From year 1 up to around 1820 the growth was kind a Malthusian model. Almost inexistent. But just as humanity started to incentivize science and progress, the growth per capita boomed. Basically, population also experiences unprecedented boost as you can see below.

Demographic boom

Population growth. De Long. The Reality of economic growth.

But ingenuity of humans were way more important than population growth so in general terms our lives improved drastically. And the best part of this story is that there’s nothing known at the moment that can stop this trend. Even more, it seems that the growth rate may accelerate.

Singularity

Taken from scientific term than describes the threshold of events near the massive black hole (I speak about Astronomy, not what you thought!), singularity is the moment when a computer get enough power not only to outperform humans, but to create more sophisticated machine than it is. This will lead to exponential unlimited growth, difficult to predict and understand now. In this case the GDP per capita will be virtually limitless. Let’s hope we will live to see this.

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