Chapter One — What is Supposed to Make an Economy Grow If you were born in Canada in the 1950’s – as I was – you pretty much took for granted that things would get better over time. I grew up in Etobicoke, a suburb of Toronto. When I was very young I remember that we bought a window air conditioner – and we were one of the first families on the block to have one. Within a short period of time, everyone did. Then about twelve years after that, we had central air conditioning put in, an astonishing and unusual luxury… until it became common place. And while the homes were getting better, they were also becoming bigger! In the 1950’s (in the United States) the average home size was less than 1,000 square feet. This grew to twelve hundred by the 1960’s, then to eighteen hundred in the 1980’s, and twenty-four hundred by the year 2000. The houses were getting bigger as families were getting smaller – the best of both worlds! But this kind of economic growth hasn’t happened all the time throughout human history. The Dark Ages, a period spanning 500 A.D. to 1500 A.D., was termed as such because there was little improvement – if any – in the lot of the average citizen. And because human DNA calls for a framework around which to understand what we empirically observe, we have to come up with a theory to explain the economic growth that has lifted the standard of living and quality of life of those in the developed world. There’s something called the Cobb-Douglas production function that is used in growth accounting, which as the phrase implies, is a way to quantify (or account for) the economic growth. I’m less interested in the fine-details than I am with the broad principles around it… and the broad principles go something like this. There are three key factors that drive economic growth: • Quantity of labour (think numbers of hours worked) • Amount of capital (think machines) • Total Factor Productivity (an all-encompassing phrase that captures technological advancement as we most frequently think about it, as well as the ability to more perfectly organize existing labour and capital to increase output) Let’s think about this intuitively. Imagine that there is a village of 200 people. About 20 are senior citizens who can’t contribute much output at this point of their lives. About 60 are children who aren’t expected to contribute much output. Which leaves 120 people to work to support everyone in the village. A further simplifying assumption: 30 of those individuals work on farms and of the other 90, 45 work in manufacturing and 45 provide various services to support village life. Doesn’t it make sense that, everything else being equal, if everyone decides to increase the hours they work per week from 40 hours to 45 hours, that economic output will increase. Assuredly so. Doesn’t it equally make sense that if there is more capital equipment – using tractors to plow the fields rather than farm animals – that wealth will increase? Finally, let’s imagine that the people who are working in manufacturing figure out how to use their time more efficiently… assuming that they work the same number of hours and their capital stock is identical, there should be a similar increase in production which means that the economy is growing in real terms. If you understand the preceding paragraph – congratulations, you completely grasp neo-classical economics and (if you ask me) are qualified to instruct in economics at the post-secondary level. One final point. Returning to the village metaphor. Now there are two villages that are identical except for the fact that Village #2 enjoys a nicer climate. The growing season is longer which means that (once again, everything else being equal) there is more agricultural output per hour worked and per unit of capital. Moreover, Village #2 has more dense forest around it, providing abundant and cheaper fuel. Under those circumstances, it wouldn’t be surprising that Village #2’s citizens enjoy a higher standard of living than Village #1’s. It’s just common-sense. Let’s summarize. According to growth accounting, there may be a different base level of wealth between two Villages/countries/you-name-it depending on resource endowment. Otherwise, neo-classical growth theory inform us that it’s about the hours worked, the amount of capital and the level of technological advancement. Right? Wrong. It seems to me that neo-classical growth theory misses the SINGLE most important driver of what leads Mankind onwards and upwards and that’s… Let me ask you a question, first. A question that I frequently pose to my students at George Brown College: Question #6: Identify the country with the higher GDP per capita? Saudi Arabia or Israel? As soon as the words come out of my mouth, I can read the different reactions. “Sir, come on! What do you think we are? Stupid? Saudi Arabia has oil… 9.5 million barrels a day… 400,000 barrels an hour…sixty-six hundred barrels a minute… over 100 barrels a second… Don’t insult our intelligence. It’s a no-brainer.” And on that last point, they are correct. It is a no-brainer. Not even close. According to the CIA World Factbook (and if you saw “Three Days of the Condor you know you don’t want to mess with or question the CIA), GDP per-capita in Saudi Arabia is $30,500 while it’s $33,900 in Israel. I let this out of the bag and my George Brown College students sit in stunned silence. They know that Saudi Arabia has oil. They don’t know what Israel has. Or at least, they think they don’t know what Israel has. Then I tell them what Israel has. Israel has…
