What is economic growth?

Factual Questions
1

I have tried on several occasions to get an intuitive feel for how an economy can grow – why macroeconomics isn’t a zero-sum game. There was a nifty little thread a few months back that I can’t find in which someone invented a primitive economy between two people that demonstrated a simple sort of economic growth, but I didn’t internalize it. Does someone have a clear way to make me understand how, if I get a dollar, it doesn’t have to come either from someone else or from a printing press? Or maybe it’s the latter that basically constitutes economic growth?

Basically, I want to exploit the SDMB community to give me a crash course in macroeconomics. You’re up to it, right?

2

Imagine the following scenario:

Straightdopia has a population of two people, Alice and Bob. Alice has a hundred dollars cash, and Bob has twenty dollars worth of wood, nails and tools.

So the total amount of stuff in Straightdopia is worth $120.

Bob, through the application of skilled labor, uses his tools to turn his wood and nails into a nice dining room chair. Alice can see that the chair is clearly worth more than the raw planks of wood and nails, and gives Bob $50 for it.

So now, Bob has $50 in cash plus his tools. Alice has $50 in cash left over, and a chair worth $50. The total amount of stuff in Straightdopia is now $150! The economy has grown.

Here’s another example.

Bob decides he’s tired of construction and wants a white collar job instead, so he opens the Royal Bank of Cecil. He finds one hundred depositors, who each open a savings account with a deposit of $100. So there’s a total of $10,000 in his bank.

Then Alice comes by and asks for a loan of $100 to buy a new dining room table for all those chairs that she has. Bob gives her the $100 and charges interest. He’ll keep some interest for himself and give the rest to his depositors. But, Bob has also made the economy grow.

The depositors still each have $100 in their accounts, and now Alice has $100 in her hands. That’s a total of $10,100, even though there’s only $9,900 physically in the bank’s vault. As long as Bob’s depositors don’t try to all withdraw their money at the same time, he’ll be able to cover withdrawals. So Bob’s bank has “created” money by making a loan.

These are the two primary ways by which the economy grows: turning raw materials into valuable goods, and creating money through lending.

3

Isn’t that last example what they call the multiplication effect? Isn’t that a measure of weakness for an economy, a multiplier too high? (if you can’t tell by now, I don’t know squat about economy)

4

Let’s be careful about the money side of it - economic growth is not about having more money. If it were, you could ‘grow’ the economy by just printing boatloads of bills.

I think a lot of economic thinking gets derailed when people equate money with wealth. Money is an abstraction - a way to come up with a mechanism for exchanging goods and services in an efficient way.

The wealth of a country is not measured in how much currency it has floating around - the wealth of a country is measured by the physical infrastructure it has built, the aggregate sum of goods that exist, and its capability to build products and services that people need. Money is just the way we keep track of it all.

Here’s a good example of how trade between two people can result in economic growth:

Let’s say I’m really good at building chairs. I can build 10 chairs a day. Bob, on the other hand, is really good at building tables - he can build 5 tables a day. But I’m lousy at building tables, and he’s lousy at building chairs. If I build tables, I can only build one a day. If he builds chairs, he can only build 5 a day.

So, let’s say we don’t trade, but we each build sets of tables with four chairs. I spend four days building 40 chairs, then 10 days to build the 10 tables to go with them. Fourteen days to build 10 table and chair sets.

At the same time, Bob spends 8 days to build 40 chairs, then two days to build the 10 tables to go with them.

So between us, if we don’t trade, it takes us 24 man-days to build 20 table and chair sets. Note that Bob is better at this than I am, and if he doesn’t trade with me, he’ll eventually have a lot more than I will. So why would he trade? Let’s work it out:

Let’s say that I spend all my time building chairs - the thing I’m best at. Bob spends his time building tables. In 14 days, I can build 140 chairs. In the same 14 days, Bob can build 70 tables. So now, instead of having 20 tables and 80 chairs, we have 70 tables and 140 chairs - by trading we both benefit, even though Bob is more productive than I am.

This is the law of comparative advantage, and it drives trade. It basically means that you are better off focusing your efforts on the thing that you do best relative to everyone else, and then trading some of what you made for the other things you need.

This is why economics is not a zero-sum game, and why free trade is so important to economic growth (free trade in the macro country vs country sense, and free trade in the sense of all the little market transactions being allowed to happen without government interference).

It’s important to note that comparative advantage still works even if Bob is better than I am at making both tables AND chairs. Let’s say Bob can make five tables a day, but he can also make 15 chairs. In his 14 days, he’ll have 35 tables and 75 chairs. But if he focuses on making tables, where his comparative advantage over me is the greatest, then after 14 days he will have made 70 tables. In the meantime, I’ll have made 140 chairs. But a table to me is worth 10 chairs, because I can make 10 chairs in the time it takes me to make a table. So all Bob has to do is trade 8 of his tables for 75 chairs - I make a 5 chair ‘profit’ by trading, and Bob winds up with his 75 chairs plus 62 tables - a huge advantage for him. We still both profit from trade, even though Bob is better at making everything than I am. He’s just WAY better at making tables, so its to his advantage to focus on what he does best.

In the macro sense, economies grow for several reasons. One is rising worker productivity. If workers can learn to make more with less, then the aggregate output of goods and services grows for the same amount worked. This can happen through innovative business processes, automation, or other capital investment. Assembly line workers in auto plants aren’t worth $35/hr because they are in a union - they’re worth $35/hr because each worker has hundreds of thousands to millions of dollars worth of capital investment helping to make his labor more efficient.

Another way the economy can grow is through investment in new infrastructure - a new factory, better roads to make transportation more efficient, etc. Now the same country is making more stuff.

Another way an economy can grow is through making the entire production chain more efficient. For example, ‘just in time’ inventory practices which have reduced the amount of our wealth tied up in static inventories of goods, which has allowed that wealth to be used for more capital investment. The internet has removed a lot of barriers to trade - think of all the random stuff that gets traded on eBay - in each case moving from someone who values it less than the purchaser. This is highly efficient.

Another way an economy can grow is by removing roadblocks to trade, both internal and external. Trade tariffs distort the market and cause inefficiencies. Let’s go back to our table and chair makers. Let’s say that a politician introduces the ‘chairmakers protection act’, designed to protect me from rich Bob (he’s rich because he’s more productive than I am, and ultimately ends up with more stuff). So to protect my tablemaking, the government decides that each table sale by Bob will carry a five table duty. Now for Bob to trade me the 8 tables I asked for, he’d have to give up 48. It’s no longer in his best interest to trade with me, so the trade doesn’t take place. But we’re both poorer for it.

The same happens internally, and not just because of tariffs. It could be the government overhead in paperwork - if every trade I make with Bob costs me a half-day of form-filling, I may choose not to trade with him. Or it could be taxation. If the tax on the profit of the transaction is too high, we may choose not to trade. Or it could be other inefficiencies - I make a five chair profit from the trade, but shipping it costs six chairs. So I won’t trade. Build better roads, lower the shipping costs to 4 chairs, and suddenly the trades take place and wealth increases.

That’s how economies grow.

5

Now now, you’re delving into very debate-worthy realm, outside the scope of my question. I do understand this much: there are more important things than maximizing wealth. Like creating opportunities for those whose wealth-generation abilities are unfairly delimited by, say, racism.

6

No, it’s not debate worthy. If you increase transaction costs you get fewer transactions. This is simple economics. Taxation is a transaction cost.

Whether you feel that the social goods created by the increased taxation costs are worthwhile is a question that can be informed by economics but not made by economics. If we’re concerned with mitigating racism, an understanding of the economic impact a proposed policy might have is very useful, because it allows us to compare the costs and benefits of different policies.

So it may very well be good public policy to make employers fill out some paperwork to document their racial hiring practices because the cost is low and you believe the benefit is high. But the cost still exists. A policy that requires only a few minutes of paperwork is going to have a different impact than a policy that requires months. You didn’t ask whether there were things that were more important than maximizing wealth, you asked how economics could be a non-zero sum game.

Of course if we want government services we have to pay for them someway somehow. But it’s a simple fact that every dollar spent on taxation means a dollar taken out of your pocket and spent on something else. Of course, spending on “something else” is a non-zero sum game as well. For instance, if the government pays people to blow up houses on the other side of the world, that’s a non-zero sum game, because the net wealth of the world is decreased by one house, by the cost of the bomb used to blow up the house, by taking the soldier who dropped the bomb out of productive work, by taking taxes from everyone to pay for the bomb leading to a smaller overall economy, and by disrupting the life of the guy whose house got blown up (assuming he’s alive afterwards), now instead of working he’s scrambling to find someplace to live where he won’t get bombed.

7

  1. False Dilemma. What evidence is there to say that maximizing wealth and creating oppoutunities are mutually incompatible goals?

  2. The position being advocated by Sam Stone is the REMOVAL of artificial barriers to free trade, say, racism. So I don’t see what you are debating here?

8

Would you consider affirmative action to be removing a trade barrier?

9

What the others said.

I described how wealth is generated and why economics is not a zero-sum game. That’s the question the OP asked. Issues of social justice are outside the scope of the question. If you want to argue that it’s worth it to put up barriers to trade to achieve social goals, that’s fine. Make that argument in Great Debates. But like Lemur866 said, if you want to make intelligent decisions around where to make tradeoffs between social justice and free markets, it helps to understand what you’re giving up. So understand the market first, understand how it works and what it achieves, and then you can make smarter choices about how much of it you want to sacrifice for social benefit. Don’t let your politics get in the way of understanding how things work. If you want trade barriers, understand the cost of putting them up so you can weigh it against the benefits.

10

I’ll admit to serious naivete here but I’m willing to dive in nonetheless.

Unconstrained free trade is not optimal in the long run because of the positive-feedback effect that wealth accumulation facilitates wealth creation, with the net result that wealth continually concentrates more and more densely at the top, thereby limiting the wealth generation capacity of the entire system. This is what motivated Henry Ford to pay his workers more than the market minmum so that they could afford to buy his cars.

Please be gentle in cutting me to pieces.

11

Why does every disagreement here turn into mudslinging?

I’m not letting my politics get in the way of anything, you are, okay?

12

Trying to stay away from a political debate here and stay factual… Of course affirmative action is a trade barrier, if the effect of it is to block the hiring choices of people and induce them to hire someone else based on external ‘needs’ not relevant to the transaction. All else being equal, affirmative action would lead to less efficient hiring practices.

Of course, there are arguments on the other side. One is that racism is irrational, and that irrationality is itself a barrier to efficient trade. So putting in place a program to remove it is in fact correcting a market failure of sorts and making the market more efficient. Another is the obvious social benefit argument - regardless of whether or not it makes hiring less efficient, the loss in efficiency is more than made up by the social benefit of improving the lives of a discriminated minority.

And of course, there are counter-arguments to those arguments. But then we’d be debating, and this isn’t the forum for it.

13

Mudslinging? Where? And where are my politics entering into it? The examples I gave you are pretty much textbook Econ101 examples. If you don’t like the market, that’s fine. I’m just describing how it works. I’m sorry if that makes you unhappy.

14

Thanks for admitting that there’s room for debate rather than just saying that I must be ignorant if I disagree.

15

So you’re saying that it’s universally-agreed how markets work? Woah, and I thought economics was a big, complicated, developing field.

16

Define “affirmative action”.

Does it mean that if there is a historically disadvantaged ethnic group that makes up 10% of the general population that you are obligated to have a work force that contains at least 10% of that minority group? Or does it mean making sure you always go to the Howard University career fair? Or does it mean making sure your company doesn’t pass over the best candidate for a job of that candidate happens to be a minority?

If other companies are racist and won’t hire qualified black people, the company that does hire black people is going to have better qualified employees. Is a company that refuses to promote deserving women or black guys going to do as well as a company that always picks the most qualified candidate?

Or take examples, like the famous segregated busses in the south. The bus companies had to be forced by law to implement segregation. So here we have an example of government promoting racism AND increasing transaction costs at the same time. Lose-lose. A non-zero-sum game doesn’t just have win-win situations, it can have lose-lose, win-lose, or lose-win. It’s pretty easy to imagine lose-lose situations, like my example of expensive bombs shipped around the world at fantastic expense to kill people and break things. Lose-lose. If we didn’t have win-win situations, the existance of lose-lose situations would mean the economy would be driven to zero fairly quickly. Any time goods were destroyed in a lose-lose they could never be replaced and eventually we’d all starve to death.

But we can see that a hunter-gatherer by himself can create wealth. He can find and store food. He can build a shelter. He can build tools out of rocks and sticks. He can make clothing. So even here we have the creation of wealth, which is the foundation of the economy. But a hunter gatherer might take days to make one leather shirt. A single factory worker might create thousands of shirts at the same time. But this depends on the existance of industrial sewing machines, industrial fabric cutting, industrial weaving, industrial cotton spinning, industrial cotton ginning, industrial cotton harvesting, industrial irrigation, industrial plowing, not to mention industrial tool-making to make the above capital equipment and industrial mining to smelt the metal and industrial fuel production for the trucks and boats to ship the materials to the factory and ship the finished shirts around the world and transport the worker back and forth from his house to the factory.

So clearly, wealth can be created and wealth can be destroyed. So a shirt factory can produce more shirts than a naked guy sitting in a hut. But a shirt factory can’t exist unless that naked guy sitting in a hut can trade with other people. Even if a working shirt factory fell out of the sky it wouldn’t do that naked guy sitting in a hut any good unless he can buy and transport raw materials and sell and transport finished shirts and maintain the machinery and pay the workers. That shirt factory is impossible without thousands of trades.

17

Instead, I’d rather ask for a cite. Your notion that free trade limits wealth creation by pushing all the wealth to the top where it’s inaccessible needs two cites, actually:

  1. Show me that free trade by definition causes an increasing concentration of wealth at the ‘very top’. Especially given the history of free trade in lifting up very poor countries like Singapore, Hong Kong, and Taiwan to 1st world status with GDP’s similar to ours, even though they started out as poor 3rd world nations and were trading with much wealthier partners.

  2. Show me that even if it did, this would somehow limit the maximimum productive capacity of a country. The counter-argument is that capital flows to those who are most productive, and even if it is only the top 10% of people and tey control the lion’s share of wealth, they are the ones who are best capable of putting it to productive use. In terms of wealth creation, concentration of wealth at the top might well be more efficient than having it evenly distributed. All social concerns aside.

But this really is straying away from the OP, and turning into a debate. You should maybe start a new thread in Great Debates so we can debate it there.

18

The nature of the economic effect of AA is no different than racism, if you think about it. Both lead market players to behave irrationally in economic terms. If I refuse to buy from Chinese suppliers even though it will be in my economic interest to do so, then I am being irrational and will eventually be driven out of business by my competitors who WILL buy from them. If every single player in the market except one all refuse to buy fron Chinese suppliers, then the 1 player that DOES will be able to buy the stuff at a much cheaper cost, and eventually driver the other 99 out of business. The fundamental underlying principle here is that people are willing to do all kinds of things, including overcome their own prejudices, if there’s money involved. This may not be true for all cases, reality is messy that way, but I think you’ll agree that it is true more likely than not, in general.

19

At the level of description I gave, which is to say a description of how trade between two people can benefit both, yes, there is universal agreement. It’s MATH. The simple example was given to answer the OP’s question about why economics is not a zero-sum game.

Of course, as the transactions get more complex and the number of interactions starts to grow, there is room for debate over all sorts of things. But on the basic question of how trade works and how comparative advantage can be used to build wealth, I’d like you to show me an economist who disagrees.

Of course you can build a scenario where the rich guy does all sorts of nefarious things to thwart the poor guy, or how the rich guy will spend his money inefficiently on grapes and prostitutes whereas the poor guy, if he could keep his money, would use it to build a community and teach the children how to love and appreciate one another, and we’d all work together in harmony and peace. That’s fine. But that’s delving into the social sciences and is outside the scope of a technical description of how market transactions can grow wealth.

20

There are two main branches of economics, microeconomics and macroeconomics. Everyone so far has been describing the former, but I think you’re more interested in the latter.

Microeconomics studies how individuals (in this case, consumers or firms) make decisions on how to allocate limited resources. It’s not a closed book, but there is a large body of widely-accepted knowledge. Macroeconomics, on the other hand, is the study of how markets work on a large scale and over time. The systems being studied are complicated enough that there’s still a bit of disagreement over exactly how they work.