Economic Growth Essays

Essay: The Meaning of Economic Growth and GDP

This post contains an essay submitted as part of student course work for the Planning 100 "Introduction to Planning" course taught by me this year at Planning School, University of Auckland. The topic for the essay is: Use appropriate references to explain what is meant by economic growth and how and why economic growth has changed in the past two centuries. Explain the use of “GDP” as a measure of economic activity and discuss its usefulness. The essay explores the topic and also considers economic development in China. It is by Yin (Nikki) Hui, who has kindly given permission for it to be published here.

Economic growth is defined as an increase in the number of goods and services produced in an economy in a given time period, usually a year (Sabillion, 2007). For the majority of human history, economic growth has been so slow as to be non-existent. However, from approximately 1750, there was a “Great Divergence” which resulted in an exponential amount of growth in Great Britain, allowing the citizens of Western Europe to obtain previously unprecedented levels of wealth. Economists have largely debated over the causes of this growth and why Great Britain was the first to industrialize. (“The road to riches”, 1999). The first part of this essay will argue why the key reasons behind this growth was due to changes in political and economic institutions (Acemoglu & Robinson, 2012). The second part of this essay will discuss the usefulness of using GDP (Gross Domestic Product), as a measure of economic growth and the limitations of this measure, as well as ways in which it can be strengthened.

During the 19th and 20th century, economic growth resulted in a tenfold increase in average world income (Maddison, 2003). Some economists argue that an advance in science and technology was the reason behind this growth. Technology and knowledge tend to concur, as technology is driven by scientific knowledge. The discovery of atmospheric pressure gave rise to James Watt’s steam engine in 1744, which was the driving force behind the British industrial revolution (“The Road to Riches”,1999). However, technology does not necessarily lead to economic growth when we look to China as an example. At the start of the 15th century, China’s supremacy in science and technology was astounding, and it was on the verge of industrializing. The Chinese had already invented the compass, gunpowder and the wheelbarrow well before these ideas had had even reached the West. However, in 1400 technological process halted and by 1600, China had fallen behind Europe. If technology were the driving force behind economic growth, China would have been the first country to industrialize; yet this was not the case (Ringmar, 2007).

What fundamentally lead to Britain’s modernization was not technology, but the particular institutions that were present within British society. Institutions are defined as “formal rules, informal norms and their enforcement characteristics” (Ringmar, 2007). No two societies will have the same institutions as societies are subject to economic and political conflict that is resolved in different ways. These differences are often unnoticeable at first, but they accumulate, creating a process of institutional drift. European growth has accelerated phenomenally in the past two centuries because of two critical junctures in history. At the turn of the 14th century, Europe had a feudal order. The king owned all land and granted control of the land to the lords. Peasants or “serfs” had to perform unpaid labor on the land and were subject to taxes and fines. Then in 1348, the Black Death shook up the foundations of the feudal order. The plague resulted in a shortage of labor, and workers demanded more freedoms and higher wages. The Peasants’ Revolt broke out in 1381, and as a result, feudal services diminished and an inclusive labor markets began to rise. The second critical juncture occurred in 1600, with the expansion of world trade in the Atlantic Ocean. In Britain, Elizabeth 1 and her successors were unable to monopolize trade with the Americas. This created a group of wealthy traders who opposed absolutism and demanded changes to the institutional structures of Britain (Acemoglu & Robinson, 2012).

While economic institutions are important in determining the prosperity of a nation, it is political institutions that determine what economic institutions a nation has. The previous critical junctures gave power to the citizens who formed a coalition which was able restrict the power of the monarchy and executive, forcing them to listen to the demands of the coalition. The shift in power from the elites to the general masses sparked the Glorious Revolution of 1688. The Glorious Revolution diminished the power of the monarchy and enabled Parliament to determine the economic institutions which would foster investment, trade and innovation. These included patents, which granted property rights for ideas, the application of English law to all citizens, the ceasing of arbitrary taxation and the abolition of monopolies. Furthermore, the state promoted merchant activities and rationalized property rights to facilitate the construction of the infrastructure that would be key to economic growth. Property rights in particular are important, as they create an incentive for entrepreneurs to invest in order to increase productivity. These institutional changes underpinned the Industrial Revolution of 1750-1850 (Acemoglu & Robinson, 2012).

As a result of inclusive economic institutions, inventors such as James Watt, who perfected the steam engine in 1774, were able to become innovative because they were confident their property rights would be respected and they had access to markets where their innovations could be profitably sold. When institutionalized, technology can lead to increased productivity and growth (Sabillion, 2007). This growth greatly benefited the working class, whose living standards rose sharply from 1820 and onwards. Industrialization then spread to the United States, which became first nation to adopt the new technologies coming from Britain. The War of Independence and enactment of the U.S Constitution Act displays similar characteristics to the long struggle in England of parliament against the monarchy. The French Revolution was another critical juncture that meant the institutions of Western Europe started to converge with those of Britain, and conversely, these nations were able to industrialize (Ringmar, 2007).

Looking to the other side of the world, China had experienced great things in the past but had grown conservative over the years. China was a feudal society that was ruled by a despotic emperor and bureaucratic elite. In the 15th century, these rulers stopped long-sea voyagers, blocking trade and commerce, which meant growth stagnated (Sabillion, 2007). However, China is also one of the examples of how changes to the institutional structures of a country can send it on a different path of economic growth. During 19th and 20th century the economy was in a process of decline under the rule of the Communist Party and Mao Zedong. Consequently, the political and economic institutions created were highly extractive in nature. In the 1950s, Mao promoted the Great Leap Forward and in the 1960s he propagated the Cultural Revolution. These initiatives led to the mass persecution of intellectuals and educated people and the death of millions. However, when Mao died in 1976, Deng Xiaoping came into power and implemented several economic reforms. Economic incentives were given to farmers, foreign investment was encouraged, and state owned enterprises underwent privatization. Despite the economy stagnating changes to economic institutions meant there were reductions in poverty and income inequality from the 1970s onwards and China experienced a phenomenal growth rate of 9.5% a year (Acemoglu & Robinson, 2012).

Since historical times, growth has been commonly measured using GDP, which is the annual market value of final goods and services produced in a nation after accounting for changes in inflation. GDP is a measure of market activity, yet it is commonly used as an indicator of quality of life. However, GDP has many limitations which make is less useful as a measure of economic performance. The global economic crisis took many by surprise because of the high performance of the world economy between 2004 and 2007. During this period, temporary profits in the financial industry, increasing debt levels, and the real estate bubble painted a false picture of true economic conditions. This highlighted the fact our current system of measurement is failing us, and steps should be taken to improve GDP as a measure of economic performance and social progress (Stiglitz et al, 2010). One of the limitations of GDP is that it does not give any indication of income distribution. Although GDP may be increasing, this wealth may be only going to a select few in the economy, which decreases equity. Moreover, GDP includes expenditures that do not increase standards of living. For example, traffic congestion may increase GDP as a result of the increased fuel consumption, but this depletes air quality and time is wasted while travelling. Costs related to natural disasters and the cleaning up of pollution are also accounted for as positives in GDP (Anew NZ, 2006).

Furthermore, non-market activity is not accounted for in GDP. Many services people have received from family members in the past for free are now purchased on the market. This may translate to a rise in income and standards of living, although this is not the case. Non-monetary services contribute an important role to economic activity, yet they are not reflected when calculating GDP (Anew NZ, 2006).

More importantly, one of the most fundamental limitations of GDP is that it fails to take into account the effect economic expansion has on the environment, which has issues concerning sustainability. We live within a finite biosphere, and when growth encroaches too much on surrounding ecosystems, we will begin to sacrifice natural capital such as fish, minerals, and fossil fuels, which have more economic value than man-made goods. If we continue to deplete these resources they will no longer be available for future generations to benefit from. We are facing a looming environment crisis, especially over concerns of global warming, yet carbon emissions are not reflected in GDP. Clearly, if the environmental costs of production and consumption were reflected, measures of economic performance would look vastly different (“Economics in a Full World”, 2005).

Despite it’s limitations, GDP is hard to replace because it provides one summarized figure, which is comparable between nations. In a single number you get an idea of whether the economy is expanding or contracting, and this can be comparable over time. However, since GDP is used as a measure of people’s well being there needs to be more incorporation of quality of life factors that go beyond measuring output. These factors include health, education, political voice, social interaction and the environment (Stiglitz et al, 2010). The General Progress Indicator (GPI) is an example of an alternative measurement to GDP. It measures well being by taking into account of economic, social and environmental factors. In the GPI, the costs of pollution, the loss of natural resources, and ozone depletion are all submitted as negative (Anew NZ, 2006).

Furthermore, in order to make GDP a more useful measure of economic health and well being, focus should be taken away from production into income and consumption, as material living standards are more closely associated with these measures. In addition to this, the indicator should also reflect distribution of income. Particularly, measuring government provided services, such as education, should be improved as these contribute a vital role to economic activity and benefit society greatly. Lastly, GDP could be improved through broadening income measures to non-market activities, by showing how people spend their time over years and across countries to give a better reflection of change (Stiglitz et al, 2010).

In conclusion, economic growth is usually characterized by a rise in the living standards of people. The economic growth that occurred during the 18th and 19th century that started in Britain, and then spread to other parts of the world was a result of changes to political and economic institutions. These changes influenced the way society was governed, and thus how individuals behaved. These actions either allowed for economic growth, or stunted it. GDP is the most commonly used method to measure growth. However, GDP has many limitations, which restricts its usefulness. If GDP is used as a measure of wellbeing,

it needs to be improved or alternative measures need to be sought, as human well being incorporates various factors that are separate from material wealth. The human population is now better paid, educated and fed than his forefathers could have ever imagined. Yet this growth has been largely unsustainable, which raises the question of whether we can continue to see improvements in human standards of living in the future.

Bibliography

Acemoglu, D & Robinson, J. (2012). Why Nations Fail. London: Profile Books Limited.

Acemoglu, D., Johnson, S., & Robinson, J. (2005). The American Economic Review. Vol. 95 (3), pp. 546-579.

Anew NZ Progress Indicator Action Group. (2006). Measuring Real Wealth in New Zealand. Auckland.

Daly, H.E. (2005). Economics in a Full World. Scientific American, September, 100- 107.

Maddison, A. (2003). The World Economy: Historical Statistics. Paris: Development Centre, OECD. pp 256-62, Table 8a and 8c.

Ringmar, E. (2007). Why Europe was First. UK and USA: Anthem Press.

Sabillion, C. (2007). On the causes of economic growth: the lessons of history. New York: Algora Publishing.

Stiligitz, E.J., Sen, A., & Fitoussi, J.P. (2010). Mismeasuring our lives. United States of America: The New Press.

The Road to Riches. (1999). The Economist: Millennium Special Edition, December 31, 10-12.
Author(s):Fogel, Robert W.
Reviewer(s):Davis, Lance

Robert W. Fogel, Railroads and American Economic Growth: Essays in Econometric History. Baltimore: Johns Hopkins Press, 1964. xv + 296 pp.

Review Essay by Lance Davis, Division of Humanities and Social Sciences, California Institute of Technology. led@hss.caltech.edu

For those of us who lived through the exciting days of the “cliometric revolution,” the publication of Robert Fogel’s Railroads and American Economic Growth represented a very major milestone – it was as if we now had proof that we had left the bumpy and unpaved dirt road of the first few years and could see ahead a straight and well-paved highway into the future. (See note 1.) The roots of “clio” clearly lay in the 1956 publication of Cary Brown’s “Fiscal Policy in the Thirties: A Reappraisal” and, a few months later, in Alfred Conrad and John Meyer’s initial presentation of “The Economics of Slavery in the Ante-Bellum South.” Brown showed that, unlike the findings of the then-current historiography, government economic policy during the 1930’s was not an example of President Roosevelt’s imaginative application of the modern tools of Keynesian fiscal policy; and Conrad and Meyer demonstrated that, despite nearly a century of traditional historiography, ante-bellum slavery was profitable and, at least by implication, that, if the goal was to eliminate slavery before the 1940’s, the Civil War was not an extremely costly and totally unnecessary enterprise. However, these findings – findings that have been well substantiated by later research – while convincing to the small cadre of “converted,” were still not generally accepted by the historical profession. Thus, cliometrics did not really begin to flower until the publication of Robert Fogel’s study of the impact of railroads on American growth in the nineteenth century. Not only did it generate a spate of parallel studies (of Russia, Mexico, Brazil, England, and Scotland, to cite only five), but much more importantly, it provided a methodological foundation for the systematic study of economic history and long-term economic growth.

Despite the attention that had been paid to the construction of the Erie Canal, given the role of the national market in underwriting this country’s rise to become, economically at least, the richest nation in the world, and, given the speed with which rails came to dominate the transport network that provided the basis for that national market, it is not surprising that historians had concluded that railroads were the indispensable and driving force behind American growth in the nineteenth century. To the best of my knowledge, before the first annual Cliometric Conference (a conference held at Purdue University in 1960), few economic historians, neither those traditionally nor those cliometrically inclined doubted this fundamental tenant of American development. (See note 2.) Moreover, although some cliometricians may have been aware of the concept of social savings – a concept that was closely related to the economic literature on cost/benefit analysis – none had attempted to measure the savings attached to any specific legal or technical innovation. (Fogel had touched on a similar concept in The Union Pacific Railroad (1960), but his first published paper dealing specifically with social savings was still almost two years in the future – “A Quantitative Approach to the Study of Railroads in American Economic Growth” (1962).)

With its publication, Railroads proved once and for all that economic history, while still depending on the product of scholars “slugging it out in the archives,” could benefit mightily from the careful application of economic theory and econometrics. On the one hand, although the work immediately generated substantial controversy, and even today one might quibble about a few days or a few months, in the long run, there has been little question about the book’s major conclusion – that the level of per capita income achieved by January 1, 1890 would have been reached by March 31, 1890, if railroads had never been invented. Moreover, Fogel’s work also indicated that there was no other industry that was likely to have been more important than the railroads; and, thus, if not railroads, no other industry could have played the role that historiography attributed to the rails. On the other hand, the evidence is overwhelming that, since the publication and subsequent debate over Railroads, almost all economic history has been written by scholars who have either been trained in economics or who have found it necessary to acquire (either formally or informally) those basic economic and econometric skills. What, then, in addition to the central importance of the subject, made this such a path-breaking work? As the title suggests, the book is actually a collection of four interrelated, but really distinct, substantive essays: “The Interregional Distribution of Agricultural Products,” “The Intraregional Distribution of Agricultural Products,” “Railroads and the ‘Take-off’ Thesis: The American Case” and “The Position of Rails in the Market for American Iron, 1840-1860: A Reconstruction.” Any attempt at evaluating the contribution of the book rests on the evaluation of the methods and findings of the four.

If Fogel had limited his work to the last two essays – the two that in many ways were the most central to the then intense discussions of the “Axiom of Indispensability,” the work would have been important; but it would never have had anywhere near the impact that it actually did. In the third essay, “The Takeoff,” Fogel, although not addressing the question of whether or not there was in fact a “takeoff” between 1843 and 1860, in order to operationalize his argument, chooses the first of W.W. Rostow’s criteria for a “leading industry”: in this case, what impact did the railroads have on the “change in the percentage distribution of output among the various industries?” Then, drawing on the best available data – data reported by Robert Gallman in his seminal (1960) study of commodity output – Fogel finds that the impact of the railroads on that percentage distribution was minimal. In the case of iron, railroads, except at the end of the period, accounted for only a minor fraction of the output change (overall, including the later period, it was still only 17 percent); for coal, it was less than 5 percent; for lumber, barely 5 percent; in the case of transport equipment only 25 percent (only half of the change accounted for by vehicles drawn by animals); and for machinery it was less than 1 percent. Thus, for all manufacturing, the railroads accounted for less than 3 percent of the change – hardly a ringing endorsement for what was purported to be a “leading industry.”

In his more detailed examination of the impact of railroads on the development of the iron industry (an attempt to assess the importance of railroads to industrialization because of their alleged “backward linkages”), Fogel found it necessary to produce a new series on pig iron output between 1840 and 1860 and to revise the estimates of the consumption of railroads to account for imports and recycled rails as well as changes in the weight of rails. These new estimates represented a major contribution to our understanding of the industrial history of the period. Fogel’s primary interest, however, was not on the production of the new series, but on estimating the importance of the railroads in the development of the iron industry. His results, again, indicate that railroads did not dominate the development of the iron industry in the two decades before the Civil War. In fact, his conclusions strongly support Douglass North’s conclusion that, from the point of view of backward linkages, it would be as sensible to talk about an iron stove theory of the development of the iron industry as a railroad theory.

In these two essays Fogel demonstrates a command of what had heretofore been the best of traditional economic history, but in neither chapter are there any major methodological breakthroughs – merely a carefully constructed series of new estimates and the demonstration of an ability to bring those estimates to bear on important issues. In the first and second of the four substantive chapters – the estimate of the social savings from the interregional and from the intraregional distribution of agricultural products – Fogel’s methodological innovations do, however, play a central role. First, in both essays, he attempts to explicate and to provide estimates of the appropriate counterfactual – what the world would have been like had there been no railroads. Although historians have long employed counterfactual arguments – sometimes it seems without realizing it – to most historians the idea of an explicit counterfactual was still a very foreign notion in the early 1960s. Second, in both chapters Fogel employs the concept of social savings (the difference in social costs between the real and the counterfactual worlds) to provide a measure of the value of the introduction of the railroad. The concept of social savings is itself an important research tool; but, from a methodological point of view, it is equally important that the measure was defined operationally, so that Fogel’s calculations could be tested against alternative estimates and against possible alternative definitions. As an aside, however, it is interesting to note that, although the two studies are very very important from the view point of methodological innovation, from the point of view of traditional economic history, they are not as strong as the third and fourth substantive essays. In the second substantive essay – the social savings arising from the intraregional distribution of agricultural commodities – Fogel begins by noting that the substitution of rail for water was more rapid in the intraregional than in the interregional distribution of agricultural commodities, and, that, since the distances to be shipped in the intraregional case were only a third as great for rail as for water transport, one would expect that the social savings from the innovation would be greater. To estimate those savings he proposes two measures: alpha (a direct measure of the cost differences with and without the railroads) and beta (an indirect measure based on the difference in the value of the land that would have been economically productive with railroads and the lesser number of acres and, thus, the lesser value of land that would have been economically productive in the absence of those railroads).

Fogel then estimates alpha for a sample of counties in the North Atlantic region and concludes that the direct costs (alpha) would amount to a loss of 2.5% of GNP, and that adjustment for excluded indirect costs (alpha-2) would have increased that figure to 2.8% of GNP. Neither estimate, however, includes the potential savings that would have resulted from the construction of additional canals and better roads. He admits that the North Atlantic region may not provide an adequate representation of the entire country, but he argues that it would be too expensive and difficult to extend this direct measure of savings to the rest of the country.

As an alternative, Fogel suggests that, since water transport was available for about 76% of the land value in the U.S., since, in the absence of railroads, 75% of the loss of land value would be in the four states of Illinois, Iowa, Nebraska, and Kansas, and since all of the lost land could be brought into production with only a small extension of the canal network, a measure based on the difference in the value of arable land provides an equally good measure of social savings. He concludes that the cost of the direct loss of arable land from the absence of railroads (beta) would amount to 1.8% of GNP, and that the total loss – the sum of direct and indirect costs (beta-2) – would amount to 2.1% of GNP. Again, however, beta-2 does include the potential savings that would result from additional canals and better roads. Making further adjustments for the unbuilt canals and better roads, Fogel provides two estimates for the social savings from intraregional trade: alpha-3 equal to 1.2% of GNP and beta-3 equal to 1.0% It was, however, Fogel’s estimates of the social savings generated by railroads in interregional shipping (the first substantive essay), that really touched off the methodological revolution. As in the second essay, the use of explicit counterfactuals and the innovation of the concept (as well as his estimates) of the social savings broke new ground. In this case, however, there were also other very important methodological innovations.

Fogel begins with an operational definition of interregional distribution: “the process of shipping commodities from the primary markets of the Midwest to the secondary markets of the East and South.” While there were good estimates of agricultural production and agricultural exports, there were no data on the method and routes of shipment that were used to move agricultural commodities from producing areas to the points of domestic and foreign consumption; and it is here that Fogel introduces his single most significant innovation. He focuses of four commodities (wheat, corn, beef, and pork) – commodities that together represented 42 percent of agricultural income. He, first, estimates the export surplus at ten primary markets in the west and the consumption in the almost 200 deficit trading areas in the East and South (exports are attributed to the port from which they were shipped). The potential rail and water shipping routes from West to East were easily identified, and the costs of rail and water shipment were well known. To simplify the problem, Fogel focuses on a sample of 30 of the 825 potential routes between pairs of cities in the West and the East. Since the actual choice of routes is unknown, he very imaginatively suggests a linear programming model to estimate the routes – with and without railroads – that would have been selected had the shippers been guided by cost minimization. He then estimates the costs of the inferred shipments, costs estimated both with and without rails. Since there were also additional costs of water transport (lost cargoes, transshipment expenses, extra wagon haulage, time lost because of slower speed and because the canals and rivers froze, and the capital costs of the canals that were not included in the water rates), Fogel adjusts his original cost differentials to account for these additional expenses. His result is an estimate of the social savings in interregional shipment resulting from the innovation of railroads of six-tenths of one percent of GNP, a figure that would have increased to only 1.3%, had he assumed that rail rates were zero.

In this chapter Fogel made four important innovations that were to have a major impact of the nature of research in economic history: (1) the operational definition of social savings; (2) the use of an explicit counterfactual; (3) the use of a formal economic model to estimate what costs would have been had the decisions been made by economic man; and (4) his choice, when it was necessary to make assumptions about the actual world, of assumptions that were biased against his central findings. (See note 3.) Even more than his estimates of interregional social savings, the work in this essay completely changed the way economic historians would do business in the future. There is, however, one blemish in the story. Professor Fogel never actually solved the linear programming problem; his choice of routes was based on what he assumed the solution would have been.

Notes:

1. To give you some feeling about that first decade, one might note that the term “cliometrics” was coined by my then colleague at Purdue, Stanley Reiter – he had been toying around with questions raised by a new discipline that he called “theometrics” (for example, “how many angels can dance on the head of a pin?); and, in his joking way, he suggested that the work in quantitative history seemed to be drawn from similar academic stream.

2. Bob Fogel and, perhaps, Douglass North and Al Fishlow, were the major exceptions. Fogel, himself, has said that he began his investigation fully believing that it would confirm the importance of the railroads. Fishlow (1965) reached conclusions for the antebellum period very similar to those Fogel reached about the latter part of the nineteenth century. Not long before this, North (1961, p. 164) wrote, “While the value added of rails was approximately $6.5 million in 1860 and roughly equals to the value added of bar iron, it was dwarfed by the value added of the polyglot classification of iron castings, which was $21 million in 1860. Indeed, the value added in stove making alone was equal to that of iron rails.”

3. For example, Fogel made no adjustment for changes in non-rail transport that might have been made had there been no railroads: he holds both origins and destinations fixed despite the fact that there would almost certainly have been some such adjustments in the absence of railroads; and he assumes that, in the absence of railroads, water rates would be constant rather than declining as might have been the case had canal builders exploited potential economies of scale.

References:

E. Cary Brown. 1956. “Fiscal Policy in the Thirties: A Reappraisal,” American Economic Review, 46 (December).

Alfred Conrad and John Meyer. 1958. “The Economics of Slavery in the Ante-Bellum South” Journal of Political Economy, 66 (April). This paper was first presented at the meeting of the Economic History Association in 1956.

Albert Fishlow. 1965. American Railroads and the Transformation of the American Economy. Cambridge, MA: Harvard University Press.

Robert Fogel. 1960. The Union Pacific Railroad: A Case Study of Premature Enterprise. Baltimore: Johns Hopkins Press.

Robert Fogel. 1962. “A Quantitative Approach to the Study of Railroads in American Economic Growth: A Report of Some Preliminary Findings,” Journal of Economic History, 22 (June).

Robert E. Gallman. 1960. “Commodity Output in the United States,” in Conference on Income and Wealth, Trends in the American Economy in the Nineteenth Century, 24, Studies in Income and Wealth. Princeton: Princeton University Press.

Douglass North. 1961. The Economic Growth of the United States 1790 to 1860 Englewood Cliffs, NJ: Prentice-Hall.

Subject(s):Transport and Distribution, Energy, and Other Services
Geographic Area(s):North America
Time Period(s):19th Century

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