Monday, March 9, 2015

Econocrats doubt our ability to grow

So, how fast can we expect the economy to grow over the next 40 years? And, more to the point, where's that growth supposed to come from? That's a doubt you expect from people without the benefit of an economics education, but the intergenerational report reveals the econocrats are going through a crisis of confidence about growth.

First, a disclaimer: not being as materialist as the economists, I don't see maximising our material standard of living as the ultimate objective. I worry more about what climate change and resource depletion will have done to the economy in 40 years' time, and the social price we'll be paying for our obsession with the material.

But back to the dominant paradigm.

The report projects that growth in real gross domestic product will slow to an average rate of 2.8 per cent a year over the next 40 years, down from 3.1 per cent a year over the past 40.

A third of this decline is explained by slightly slower population growth, leaving average growth in real GDP per person falling from 1.7 per cent a year in the past to 1.5 per cent a year in the future.

I trust you're suitably shocked and dismayed. This projected decline is explained essentially by the ageing of the population, leaving the average rate of improvement in the productivity of labour unchanged between the past and the future at 1.5 per cent a year.

So, where will the growth be coming from? Exclusively from improving productivity: from the economy's output of goods and services growing faster than its inputs of labour.

It's productivity the econocrats and other economists are so pessimistic about. So how did they estimate that productivity will grow by an average of just 1.5 per cent a year?

They didn't. They simply followed previous practice and plugged in the same figure for the coming 40 years as for the past 30. Since it's impossible to know what will happen to productivity in the future, this neutral assumption is better than any other you could make.

But that hasn't stopped some economists from claiming that 1.5 per cent a year is overly optimistic. Really? This tells you something about the reigning mood of pessimism among economists.

But if income per person is driven by productivity improvement, what drives productivity? If you rely on the things economists say in public, you could be forgiven for not knowing that overwhelmingly – and for the past 200 years – it's technological advance.

Every economist knows that's true but they rarely say so. That's partly because they know little about how technological advance works and partly because they believe there's little they can do to affect it.

But in recent years, some leading overseas economists have lost their faith that rapid technological advance will continue lifting material living standards. Two centuries of innovation have hit a dry spot, we're told.

It seems Treasury agrees. It admits a fact rarely included in economists' unceasing sermons on the evil of our low rate of productivity improvement in recent times: "Australia has not been alone among advanced economies in experiencing slower productivity growth over the 2000s, which suggests that the rate of growth in technological advance . . . may have been slower than in previous decades."

So if we can't rely on a continuing stream of new technology to keep our living standards growing at a rate economists find acceptable, what does Treasury suggest? It was hoping you'd ask because it's got just the solution we need: more microeconomic or "structural" reform.

For several years, all right-thinking economists have been badgering us to pressure governments for more micro reform. To bolster its argument that micro reform is the missing elixir, Treasury says "the increase in productivity growth rates seen in the 1990s is widely attributed to significant policy reforms of that decade and the 1980s".

But even if you believe this (I'm sceptical), it's hardly a great advertisement for the benefits of reform. You can make the most sweeping reforms – reforms which, having been made, can't be repeated – and all you get for your pains is four or five years of improved performance before lapsing back into mediocrity.

Reform, we're asked to believe, is only a fleeting fix. To maintain an acceptable rate of productivity improvement, reform must be unceasing (and defy the law of diminishing returns).

This portrays our economy as hopelessly inefficient and unproductive, despite all our efforts. Other countries can grow satisfactorily without continuous reform, but we can't.

Really? Such a view is so deeply pessimistic as to verge on economic apostasy. It's also bizarre.