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Economic Growth

Subjects: Economics, Investment, Goods, Capitalism.

Keywords: total productive capacity of an economy, Economic growth, decisions of the individuals, Buechner Recording, real wage rate, United States, alternatives uses of an economies, better machines.


Economic growth is the most important study in economics today. The first book on economics was by Adam Smith The Wealth of Nations the full title was the Inquire Into The Nature And Sources Of The Wealth Of Nations. “Economic growth determines a countries future, and economic growth in the past determines a countries present as far as it’s material values are concerned. ” (Buechner Recording) So every material value of the modern world is a result of economic growth in the past, or your standard of living is the result of economic growth in the past.

Economic growth in the future will determine whether or not there is rising or falling economic wealth, and coordinated with that whether or not the standard of living in the future continues to rise or fall. For example: In 1870 England was the leading industrial power of the globe, and as a consequence it also was the leading political power of the globe. According to M. Northrup Buechner the real wage rate in England is estimated to have been about 50% higher than the real wage rate in other European countries at that time.

Recording) It was about 1870 because of the rise of statist policies and ideologies that rate of growth in England started to lag behind that of the other European Countries. It didn’t lag a lot Buechner states the statistical estimate was less than one percent a year, however for a period of 10 or 20 years that’ll make a difference hardly anybody would notice. Yes maybe so, but if you compound that interest rate over 100 years what you get is what you see today. England is essentially a third rate economic power, and the real wage rate in England today is estimated to be “about 33% less than the real wage rate in other European countries. Buechner Recording)

In 1870 the United States in 1870 was an economically backward, internationally insignificant, and unimportant country in the world with respect to matters regarding foreign affairs. According to Buechner it was about 1870 when the United States embarked on a growth rate of over 5% percent a year, which was sustained for a period of over 40 years. (Recording) No country in the history of the world matched that record. At the end of that period about the time of World War I the United States took Britain’s place as the leading industrial power of the globe.

Here is the subject, and the direction on which I would like to approach my thesis. In the 19th century the United States rate of growth was over 5% a year. According to Wayne D. Angel et al. , chief economist for Bear, Stearns & CO. it’s estimated the best we can do is estimated at somewhere between 2 or 3 % a year. (Online) The long term expected growth rate in the United States has been cut in half. What has happened? As a student of economics I have an economic answer. I’m going to be looking at this from the perspective of the material, physical, and economic means of economic growth.

That is the economic causes of economic growth or decline. I’m not talking about philosophy here I’m just looking at basic mechanics. What has to be done in reality? Well it is no surprise that the fundamental answer that question is thought; then, there is action that has to been taken based on the thought. What specific actions are required? I don’t want to be accused of ignoring philosophy so let me just state briefly the philosophical preconditions of economic growth because these are really fundamental.

Any Rand, the infamous author of Atlas Shrugged states the belief in the reality of this earth, and the world we see around us is real, not just an imperfect reflection of a higher reality. Also the belief in the power of reason to grasp the world, to know the world, to grasp reality in order to deal with the facts, and that the mind is competent to guide life. Some sanction on the pursuit of personal happiness is also a precondition. Some belief apart from the idea of that to be selfish is irredeemably evil; you can’t believe that and have economic progress. 075-84)

There has to be some degree of economic freedom, men must be able to act to some extent within some significant range. The underlying assumption for everything that I am going to write that follows is a free or at least semi-free country. If you want to push me when all is said, and done I would say if you get the philosophical preconditions you will get economic growth; not without effort but probably without any additional abstract knowledge. When you get it how do you get? So lets begin with a definition economic growth I’m defining economic growth as an “increase in the total productive capacity of an economy”.

Buechner Recording) Now what is productive capacity? Well it’s the “capacity to produce output, goods, and services”. (Buechner Recording) What does productive capacity consist of? According to Buechner these are the primary components of an economies productive capacity? 5. Parts, materials, ingredients, intermediate goods (Recording) Productive capacity consists of the knowledge and skills of the population; this of course is the fundamental productive capacity, or in more objective terms “man’s mind” is the fundamental productive capacity. Rand 1075-84)

Everything else in this paper depends on knowledge, and knowledge depends on thought. Those are the fundamentals of all productive capacity. Numbers 2-5 fall under the general heading of capital goods or producer goods. Machinery and tools economists usually put this under a triumberant of machinery tools and equipment. Plants and structures of the economy are a big category, and includes factories, office buildings, damns, highways, bridges, power lines, telephone lines, pipe lines, railroad tracks, airports etcetera.

Sources of raw materials include mines, cleared land, oil wells, lumber, fisheries, and things of that nature are what economists call intermediary goods. Intermediary goods are the parts, the materials the ingredients that are passed from stage to stage through the productive process, and are used to produce the things that come out at the other end of the factory. Economic growth means that the total quantity of these things increases, and when the total quantity of these things increases more can be produced. Now there are two essentially different ways, which they can potentially increase.

We can produce more of the same thing or we can have more of the same machines, tools, and factories of the same kind producing the same output, more raw materials of the same kind etcetera. More of the same would mean economic growth signifying that the total productive capacity of the economy had increased. But historically, and this is a crucial point “historically there has been no economic growth with out better machines and tools, better factories, better products, better goods, better sources of raw materials. ” (Buechner Recording) I am going to take that as a basic fact.

Economic growth fundamentally, and essentially takes the form of better goods and services of all kinds. I’m now going to assume that the “marginal product of capital does not decrease”(Hazlitt 40) the assumption that it does I think is clearly contrary to fact. That makes a huge difference in the theory of economic growth. Where do we start with better? We start with better know how in the means of new ideas, technological discoveries, and inventions. These ideas have to be put into a concrete material form of better machinery, plants, structures, and tools that can be classified under the general heading technological progress.

According to Hazlitt if you get that, and you get total productive capacity increasing faster than the population grows you get a rising standard of living. (90) How do we get these things? How do we get more and better? Of all of these components I have a very simple minded answer; they have to be produced. I am going to use a circle to represent the economies total productive capacity. In order to have an increase in productive capacity you have to use productive capacity to produce more capacity. Now this starts with one-man alone thinking a new idea, a new product, he or she; then, communicates this to others.

They have to figure out how the idea or product can be produced, and at the same time raise capital in order to hire the labor, buy the tools, and erect the plant. Once the structure has been created all those involved need go to work, and produce it; thus using the existing productive capacity to produce more capacity. This process becomes a reality by using your existing labor force to train, and communicate skill to other portions of the labor force; therefore utilizing men, old machines, and old factories to produce new factories, new tools, and new sources of raw materials.

This is very simple, and at every stage in this processes your using your existing productive capacity to produce more capacity. Well what else can you do with productive capacity? The alternative is to use productive capacity to produce consumer goods and services. According to Buechner for the purposes of economic growth these are the only two alternatives uses of an economies productive capacity-you can use your existing capacity to produce more capacity, or you can use your existing productive capacity to produce consumer goods and services. (Recording) So economic growth involves a trade off here is the trade off.

Each circle represents the total productive capacity in these two economies, and those circles are the same size so each of these economies have the same total productive capacity, and lets also assume they both have the same population. Now Case I is using about 1/3 rd’ of its capacity to add productive capacity, and about roughly twice as much capacity to produce consumer goods. The Case II economy is using about 2/3 rd of its capacity to add productive capacity, and roughly as much to produce consumer goods. So the Case I economy is going to have a higher standard of living.

Actually twice the standard of living because it is using twice a much of its capacity to produce consumers goods as the Case II economy is. So the people in the Case I economy are better off today, and the people in the Case II economy are poorer because they have a lower standard of living; they’re not as well off. Other things being equaled rich are better than poor, but other things are not equal. According to Buechner the Case I economy is also using less of its capacity to add capacity meaning that the economy is going to grow more slowly assuming that it’s even using enough capacity to actually grow.

Recording) So here is the Case I economy 10 years later 2009. The inner circle represents 1990’s total productive capacity the red lines branching out from the inner circle to outer circle of the pie represent the total productive capacity in the year 2009. The red lines represent the increase of productive capacity in the economy. The proportions are identical to what they were in 1990 there has been no change if we assume that the population hasn’t changed in those 10 years the standard of living has risen.

How does that compare to Case II, which was using a much larger portion of its capacity to add capacity? Here is Case II As you can see the Case II economy for 2009 when compared with Case I economy for 2009 has grown much more in course of 10 years signified by the shear size of the diagram. According to Buechner this is because in the previous diagram for the Case II economy for the year 1999 that economy was using twice as much of its capacity as the Case I economy in 1999 to add capacity, and again as a result it has grown a lot more in those 10 years.

Recording) The standard of living has raised now so much so that the standard of living in the Case II economy is now higher than the standard of living in the Case I economy. You could say big deal of course you drew it that way. That’s right I did draw that way to illustrate this elemental truth about economic growth. “A country that uses more capacity to add capacity has a higher standard of living over the long run. ” (Hazlitt 43) Attention should be paid to that difference because the more capacity that is used the shorter that long run would be.

Japan is a stunning, unavoidable, and modern example of that truth. The cause and effect relationship for economic growth is you consume less than possible today by accepting a standard of living below – collectively now, the population, the people, the economy – what it could be will result in economic growth. As a result of that economic growth your able to consume more than would have been possible if you had not consumed less. That is the essence of economic growth.

In summation the fundamental determinant of economic growth is the portion of an economies productive capacity that is used to add more capacity. Amidst an increasing mound of research the next question that came my mind is, what determines that portion. “In a free economy that’s determined by the decisions of the individuals” to consume and save thus it is a joint product of the decision of the millions and millions of people who live in the economy, and there decisions of how much to consume and how much to save. (Rand 782) According to Hazilitt savings for the individual is a decision of economic growth. 80)

Assuming here an income of 100,000 if the individual making this income spends all of it on consumption that will be the maximum standard of living he or she can achieve on that income leaving out the possibility of borrowing. If this individual decides to save there current standard of living will be below what it could be; therefore, when you save you deliberately reduce your standard of living below what you could enjoy if you spend everything on consumption. Why do people do that? This is what happens if you deliberately reduce you standard of living.

In diagram Savings and Economic Growth 1 $90,000 is spent on consumer goods and services and $10,000 is saved, however the individual could be consuming $100,000. What happens? By next year and as the result of saving – now I should let you know the assumption is $10,000 is saved at annual interest rate of 10% so over a year a period of a year the 10% interest rate will yield an additional $1,000 dollars. Now that means the income has increased from the $100,000 of 1999 to $101,000 of 2000. The red lines that extend to the outer band of the pie signify this.

That additional band represents the additional $1,000 dollars that is derived from the interest on savings of $10,000. Now additional income is available for consumption if the individual wants to spend it on consumption. I’m also assuming that the additional $1,000 that the individual gets from the 10% interest rate return on the $10,000 will continue to be saved at the rate of 10% of his income. In 2000 the individual is going save $10,000 + 10% of the $1000, which is $100. The individual now has an extra $900 to spend on consumption total spending is $90,900.

Now that’s not too impressive but it’s important to remember “savings is a stock. ” (Hazlitt 177) If you save $10,000 in 1999 and you add $10,000 in 2000 you get $20,000 you save another $10,000 in 2001 you have $30,000 together with interest the individuals total savings by the end of 2001 is $30,301. Looking out at 2009 assuming the individual’s income continues to be $100,000 each year and the individual saves 10% of it at 10% the total savings in 2009 will be $126,825. Now this individual’s wealth 10 years latter is $126,825 this is the equivalent of economic growth for the economy.

The individual’s income is $100,000 plus 10% of that $126,825 so the income including the interest on saving is $111,567. Case in point the individual is now consuming 90% of income instead of 100%; the consumption in 10 years will be higher than it could have been, and would have been if he hadn’t saved at all. Why because the individual’s income is now over $100,000 by $410 dollars, and of course as time goes by this effect just continues to multiply. So you have this same effect of saving for the individual that you have for economic growth for a country.

You have increasing wealth, and you have the ability to increase consumption over time. So what! That’s just an exact parallel that doesn’t prove a connection. What’s the actual connection? How does saving cause economic growth for an economy? There are two parts to this answer. According to Hazlitt every dollar saved is a dollar less demand for consumer goods every dollar that is saved is a dollar that wasn’t spend on consumer goods. (179) That means that the productive capacity that would have been necessary to produce those consumer goods is instead available for producing additional capacity.

Savings reduces the demand for consumer goods and releases capacity to add to capacity. The way that is brought about in reality is through financial intermediaries. This is because the money saved is not tucked in a mattress not if you’re sane. Money saved is put into a bank, a savings and loan, into an insurance policy, mutual funds and, or pension funds these institutions loan it out to business to invest in their business to add productive capacity. This I believe is the essential theory of the origins of economic growth.

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