What is economic growth and are there limits to it?

By Philip Lawn
Posted on 29 August 2011
Filed under Integrated Sustainability

Before we can consider whether there are limits to economic growth, we first need to understand what is meant by the term ‘economic growth’. In conventional terms, economic growth means either the growth in a nation’s real GDP (an increase in a nation’s output of goods and services) or the physical expansion of the nation’s economy (note: the two are not the same) (see Lawn, 2007a). So, when people refer to economic growth, what they really mean is either ‘growth of real output’ or ‘growth of the economy’.

Let’s consider the term ‘economic growth’ more closely. The word ‘growth’ constitutes a noun; the word ‘economic’ constitutes an adjective. Hence, the term ‘economic growth’ implies the growth of something that happens to be ‘economic’ as opposed to something that is ‘uneconomic’. In microeconomics – the study of individual markets and firms – the term ‘economic’ implies that doing more of something has the effect of increasing benefits (marginal benefits) faster than it increases costs (marginal costs). Thus, in microeconomics, a firm is encouraged to increase its output if the ensuing marginal benefits – which exist in the form of sales revenue – are greater than its marginal costs. This is because an increase in its output would, under these circumstances, boost profits and thus be ‘economic’.

At the same, one is taught in microeconomics that the increase in benefits gradually diminishes as you do more of the very thing that generates the benefits. This is referred to as the principle of ‘diminishing marginal benefits’. One is also taught that the rise in costs gradually increases as you do more of the same thing. This is referred to as the principle of ‘increasing marginal costs’. Thus, while it is possible for a firm’s profit to rise as it increases its output, the increase in profit is gradually squeezed as the difference between falling marginal benefits and rising marginal costs narrows. Eventually, as output grows, the difference between marginal benefits and marginal costs is completely exhausted, at which point marginal benefits equal marginal costs. At this output level, profit is maximised. The firm effectively reaches its ‘optimal’ scale of production. Any further increase in output lowers profit and is therefore deemed ‘uneconomic’ and ‘sub-optimal’.

This optimality rule in microeconomics is applied to many other areas of microeconomics, such as the utility maximisation of consumers, determining the optimal labour supply decisions of individuals, and even determining the optimal choice between consumption and environmental quality. Above all, in microeconomics, the optimality condition of operating where marginal benefits equal marginal costs constitutes a ‘when to stop’ rule. Grow while growth is ‘economic’ (marginal benefits greater than marginal costs); cease to grow once growth becomes ‘uneconomic’ (marginal benefits less than marginal costs).

Incredibly, when mainstream economists shift from microeconomics to macroeconomics – the latter involving the study of the national economy as a whole – the notion of ‘optimal scale’ and the distinction between ‘economic’ and ‘uneconomic’ growth are abandoned. Consult any first-year undergraduate textbook, where the first half typically contains microeconomics and the second half macroeconomics, and you’d be excused for thinking that the book is authored by Dr Jekyll and Mr Hyde. In the macroeconomics section, you are simply told that more national output – that is, the growth in the nation’s real GDP – is desirable. End of story. Totally absent is any notion of separating and comparing the benefits and costs of real GDP growth and ascertaining whether the additional benefits of growth are exceeding the additional costs. Totally absent, therefore, is any consideration of whether the growth in real GDP is ‘economic’ and, if not, whether it would make sense to maintain a constant rate of economic output and focus attention on: (1) producing better quality goods (which would increase the consumption benefits enjoyed from a given real GDP); and (2) producing goods more efficiently (which would reduce the environmental and social costs associated with a given real GDP).

A nation’s real GDP is revealed in the national accounts that are regularly published by national statistical agencies. These are not ‘economic’ statements. They are nothing more than ‘real output’ statements, which is all that real GDP was originally designed to measure (note: national accounts were first compiled during World War II to measure the total output of the nation and its composition – a key concern when fighting a war). Until such time as the national accounts are revised to include indicators that measure and compare the benefits and costs of economic activity, they will never reveal whether a nation is experiencing ‘economic’ growth in the true sense of the term.

Ecological economists have long recognised this shortcoming and have devised an alternative to real GDP as a measure of national progress and of ‘economic/uneconomic’ growth. Originally called the Index of Sustainable Economic Welfare (Daly and Cobb, 1989), but now referred to as the Genuine Progress Indicator (GPI) (Lawn, 2007b), this new index consists of around 25 benefit and cost items of the economic, social, and environmental kind. What do GPI studies reveal? They show that, for almost all wealthy nations, the GPI rose in line with increases in real GDP until about the 1970s/80s (Lawn and Clarke, 2008). That is, until this time, the growth in real GDP was ‘economic’. However, the GPI of these countries has either plateaued or fallen – mainly the latter – which indicates that the growth in real GDP is now ‘uneconomic’. GDP growth is still generating greater consumption benefits. It’s just that the social and environmental costs of GDP growth are rising much faster, as are our defensive and rehabilitative responses to the negative impacts of growth.

Let us now return to the original question: ‘Are there limits to economic growth?’ The economy is a subsystem of a finite, non-growing ecosphere (Earth). The relationship between the economy and ecosphere is akin to one between a parasite and its non-growing host. Since the former cannot outgrow the latter, continued growth of the economy or continued growth of real GDP is biophysically limited irrespective of whether the growth is ‘economic’ or ‘uneconomic’. So there are clearly biophysical limits to economic growth. More importantly, we need to recognise that there is an economic limit to growth. I say ‘more importantly’ because the economic limit to growth (i.e., the point where the marginal costs of growth exceed the marginal benefits) is arrived at well before the biophysical limits to growth are reached and because growth beyond the economy’s optimal scale reduces a nation’s well-being. The aim of a nation should not be to increase the scale of economic activity until it reaches its biophysical limit, but to maximise the well-being of its citizens. This requires a nation to operate a steady-state (non-growing) economy at or around the optimal scale, which is much smaller than its maximum sustainable scale. It goes without saying that a nation should do everything to avoid operating its economy beyond its maximum sustainable scale. Sadly, ecological footprint studies reveal that more than half the world’s nations are in this latter position, as is the global economy as a whole (Global Footprint Network, 2008).

Given what I believe is a more accurate interpretation of ‘economic growth’, it would seem odd that I will summarise by saying that I support economic growth. But I say this recognising that the time period over which economic growth is enjoyed is very brief. I support economic growth because: (1) as long as the net benefits of growth are equitably distributed, everyone is rendered better off; and (2) to be experiencing economic growth, the economy must be physically smaller than its maximum sustainable scale (i.e., be at a physical scale that is biophysically sustainable). I do not support uneconomic growth, which is what nations eventually confront if growth continues unabated, and is precisely what most nations are currently experiencing. The failure of nations to quell growth once the optimal sale is reached and to focus instead on qualitative improvement is not only resulting in welfare-decreasing growth but, tragically, growth beyond what the ecosphere can sustain in the long-run. Given what this ultimately implies, it is humankind’s predilection with continued growth, not the lack of growth (except for the world’s most impoverished nations), that poses the greatest threat to democracy, freedom in the liberal-democratic tradition, capitalism, and international peace (Lawn, 2011).

References

Daly, H. and Cobb, J. (1989), For the Common Good, Beacon Press, Boston.

Global Footprint Network (2008), The Ecological Footprint Atlas 2008: Version 1.0, Global Footprint Network, Oakland, CA.

Lawn, P. (2007a), ‘What value is Gross Domestic Product as a macroeconomic indicator of national income, well-being, and environmental stress?’, International Journal of Ecological Economics and Statistics, 8, pp. 22-43.

Lawn, P. (2007b), Frontier Issues in Ecological Economics, Edward Elgar, Cheltenham.

Lawn, P. (2011), ‘Is steady-state capitalism viable?: A review of the issues and an answer in the affirmative’, Ecological Economics Reviews, Annuals of the New York Academy of Science, 1219, pp. 1-25.

Lawn, P. and Clarke, M. (eds) (2008), Sustainable Welfare in the Asia-Pacific, Edward Elgar, Cheltenham.

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1 Comment


Comments 1 to 1:

  1. "The relationship between the economy and ecosphere is akin to one between a parasite and its non-growing host."

    This is a new version to me. I suppose it evokes an image of a vine strangling a tree to death, then dying itself.

    For people of an economic/business bent, I prefer "the economy is a wholly owned subsidiary of the environment". Though I suppose many with a limited economic outlook overlook that people are an integral part of that environment. (Though they do understand that an out of control 'subsidiary' can send a parent company to the wall. Thereby destroying the whole organisation.)

    Drat! Seems we still lack a vivid analogy that really covers all the angles. Oh well, the more the better.
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