ECONOMIC GROWTH AND THE PARABLE OF THE TWO ECONOMISTS

Two economists, Milton and Maynard[1], are walking in the woods and discussing matters of great importance, but from very different political perspectives, when Milton sees a bunch of brightly coloured berries. He says to Maynard: “To demonstrate my point that everything and everyone has a price, I’ll offer you a hundred pounds if you will eat one cluster of those berries.” Maynard considers the matter, and against his better judgement accepts the offer and eats the berries.

Shortly afterwards, Milton regrets that he was so generous, and complains to Maynard that he will now be short of cash for the rest of the week. Maynard, who by now is starting to feel a little unwell, is not entirely sympathetic, but generously decides to make the same offer to Milton. Milton accepts, eats the berries, and gets back his hundred pounds.

At the end of the walk, Maynard says to Milton: “Well that was really stupid of us. Neither of us is any better off and we may have made ourselves ill.” To this Milton retorts: “Yes, but just think. We have just added two hundred pounds to national GDP.” Maynard considers carefully before he replies. “The only positive thing I can say about this particular addition to national income is that at least it will not have added to carbon emissions.”

On the assumption that economists are always scrupulously honest[2] and declare their income, GDP will indeed be recorded as two hundred pounds higher. Both economists also pay tax at the higher marginal rate of 40%, and tax revenues increase by eighty pounds.

That is not the end of the story. Both Maynard and Milton are later admitted to hospital with mild poisoning, and their (free) treatment results in the NHS spending an additional eighty pounds, a further addition to GDP. Milton adopts a pose of righteous indignation. “A perfect illustration of my point. The private sector creates the wealth and the public sector spends it.”

Of course, had the woods been put into lockdown, or had the consumption of wild berries been prohibited by law, then none of the above would have happened, and the economy would not have been expanded by the income generating activities of our industrious economists. However, it would have recovered very quickly once that prohibition was lifted, and other foolish economists could once again risk their lives by consuming poisonous berries, or tombstoning at Durdle Door.

There are lessons we might draw from this sorry tale, some of which, curiously, may be relevant to thinking about the shape of a post covid-19 economy?

1.    GDP is a highly imperfect measure of human well-being or of standards of living. Not all of what we choose to classify as GDP generates real wealth or contributes anything of significant permanent personal or social value. In a less trivial context gambling, tobacco, alcohol, and vice will all, debatably, and for some people, fall into this category. But GDP measures what GDP measures, including the illegal drugs trade[1]. GDP does not make moral judgements about Milton and Maynard, or tell us what activities are more or less socially desirable. It merely measures transaction volume and fails to measure valuable activities, like child rearing, that are not part of a financial transaction. If we make personal choices on consumption and lifestyle that happen to result in lower growth, that really should not matter in either the short or the long run.

2.    Essential services, in the provision of health, education and infrastructure, should be seen as an essential input to normal economic life, not as a discretionary extra whose provision is dependent on an arbitrary and inappropriate measure of wealth creation. GDP does not of itself create wealth. And building a casino or a tobacco factory is not a necessary condition for a better health service. We should ridicule ludicrous mantra such as Milton’s dogma above on what sectors create and spend wealth. They are meaningless.

3.    In the absence of significant destruction of the capital stock in the current crisis, and other things being equal, there is not necessarily any reason to suppose that the economy, and consumer spending in particular, cannot bounce back quite quickly from its big decline this year – the so-called V-shaped recovery.  Milton and Maynard can resume their walks in the woods.

4.    However, there are many reasons to be more pessimistic about recovery. The greatest is the risk that governments may fail to adopt adequate or sufficiently coordinated macro-economic policies. The most obvious mistake would be a resumption of austerity measures in a misguided attempt to “pay for” the extra costs to the government of supporting business and households through the worst of the crisis.[2]

5.    The other unknown for GDP is consumer confidence. With sensible macro policies this could return quite quickly. “But being allowed to go out and spend is less important than feeling confident about doing so.”[3] This mirrors what happened before lockdown was imposed. Numbers of institutions were already closing, and people voluntarily social distancing[4].  

6.    Some of this will also translate into what is the new normal. It is hard to predict to what extent commuting to the office will be replaced by home working, or what the impacts will be on the demand for leisure travel and aviation. A clear demand for more resilient health and other systems will almost certainly shorten global supply chains. Many people are hoping that the new normal will also accelerate a greater drive development to a Green and more sustainable global economy. All these questions are important and inter-linked, but hard to predict with confidence.

7.    The bigger threat to the future of humanity, bigger than covid-19, is that of human induced climate change. Tim Harford[5] has observed that even the dramatic recent declines in economic activity have resulted in only modest falls in carbon emissions. The reason is that many of the activities stopped by lockdown, like the transactions of our two economists, and in the service sector of the economy, were not carbon-intensive anyway. Treatment of growth as an end in itself is foolish, but restricting economic growth is not per se a plausible route to a zero-carbon economy.  Decarbonisation will in any case require a great deal of investment, manufacturing, construction, and indeed new services. 

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[1] https://www.bbc.co.uk/news/av/45104007/why-gdp-includes-the-illegal-drugs-trade

[2] Fortunately this reality seems to have penetrated even into the current political establishment, possibly with the honourable exception of old guard figures such as Ian Duncan Smith.

[3] Megan Greene, Financial Times, 9 June 2020

[4] This phenomenon was also observed in Sweden which did not impose a formal lockdown.

[5] Saving the planet demands sacrifices just as Covid-19 does, Tim Harford, 5^th May, Financial Times.