What Is Economic Growth?
We, including many economists, sometimes forget what is economic growth in a normative sense, that is, what we should count as “good” economic growth. Economic growth does not consist in producing more of this or that good (or service). It does not even necessarily consist in producing a larger quantity of all goods. Nor does it consist in producing the largest value of goods calculated by weighing the quantities produced with any set of prices. To have any normative (moral) significance, to be evaluated as good or not good, economic growth requires more than that.
It is not surprising that, in order to say something about the goodness of economic growth, we need some moral criteria. The evaluation of any policy or social situation ultimately requires the same. This is what nearly a century of “new welfare economics” and several decades of “social choice theory” should have taught economists. (I reviewed some aspects of this idea in a 2006 Independent Review article, “Social Welfare, State Intervention, and Value Judgments.”)
Define economic growth as increasing consumption and wealth; and wealth as future (discounted) consumption, which will flow from capital such as machines, factories, office buildings, cars, or houses. Nothing original in that. But is consumption anything that some political authority wants people to consume? At least if our moral criterion is individualist, consumption is instead what individuals themselves want to consume. And there is no other way to measure what individuals want, given the scarcity and cost of things, than by observing the demand they express on free markets.
This leads an economist to refine his definition of economic growth as the increase in the total consumption of goods and services by all individuals, calculated by weighting the quantities by the prices determined on free markets. (Adding up apples and oranges is impossible without weighing factors.) Together with supply and cost, market demand determines the relative prices of different things given the preferences of all individuals. When they are determined by supply and demand on free markets, prices lend normative significance to the value of the total consumption. This does not measure the elusive concept of total welfare but it is as close an indicator as we can get.
The implications of this idea are deeper than it appears at first sight (which is one reason why economic theory is useful), and a short post cannot do justice to all the related problems. But it is difficult to develop or discuss any non-arbitrary concept of economic growth without considering this starting point. “Non-arbitrary” means grounded in the preferences and consent of all individuals as when we adopt the individualist moral criterion of classical liberalism and libertarianism.
To see how this makes sense, consider the polar opposite: economic growth as the increase of the production and consumption of what is deemed to be worth more by some dictator or by some group of experts or by some elected assembly or by some mob. In such a case, economic growth has no more normative foundation than, say, the rate of growth of the wealth of Louis XIV’s family (and court). Here is a numerical example.
Assume an economy with only two goods: apples and oranges. Further assume that every individual in that society prefers apples to oranges, except those in Louis XIV’s household and court. Louis XIV (or his faithful Finance Minister, Jean-Baptiste Colbert) determines that an apple is worth one denier (a unit of currency at the time); and an orange, two deniers. He orders that, in year 1, 1000 apples be produced for his subjects and 500 oranges for his household and court, for a total “value” of 2,000 deniers ([1000 X 1] + [500 X 2]. In year 2, the king succeeds in increasing the volume of oranges produced by 10% while the production of apples remains the same, for a total production “value” of 2100 deniers ([1000 X 1] + [550 X 2]). The rate of economic growth has thus been 5%. In our individualist perspective, this number has no normative value at all.
In an individualist and classical-liberal perspective, as opposed to an absolute-monarchist perspective or an absolute-majoritarian perspective or any other dictatorial or collectivist system, the morally desirable rate of economic growth corresponds to the growth of what individuals want to consume weighed by the prices that they themselves contribute to determine on free markets according to their own preferences. Because all consumers adjust their behavior to these prices, the price of a good represents the marginal value that each consumer attaches to it: this is what gives normative significance to the growth of production.