Bigger or Better?

The tax rise passed last June by a reluctant Congress, five months before a presidential election, marked the end of a story that began four years ago when the previous Congress—with considerably less reluctance—voted a major tax cut in spite of an impending Federal deficit: The New Economics is now clearly having its way. Perspectives on Economic Growth is the product of the group that masterminded and guided these operations. Indeed, this collection of essays has been dedicated to President Kennedy “who initiated and inspired this volume”; they have been edited by Walter Heller, who served under Kennedy as Chairman of the Council of Economic Advisors; and one of the contributors, Arthur Okun, now occupies this post. Mr. Okun recapitulates the computations that demonstrate how the 1964 tax reduction fended off the impending recession, and he shows how fiscal policies which aim to close the gap between actual and potential capacity, employment, and consumption helped to sustain continuous economic growth. No word about the sharp price rise of 1964-1966, which is just as well, since the President’s exhortation against the wage-price spiral is the only new anti-inflationary weapon that has been unveiled in recent years. Moreover, James Tobin, the author of the central piece, “Economic Growth as an Objective of Government Policy,” served, at the time Heller was Chairman, as one of the three members of the Council. The Preface emphasizes that seven other contributors have also had “Washington experience.” Warren Smith, for example, who writes on Monetary Policies for Economic Growth,” was appointed a member of the Council after this book was published.

The collection aims to present what it calls “the latest thinking and findings among the main stream of professional economic thought.” All nine essays reflect much satisfaction with past accomplishments, as well as a readiness to face continuing responsibilities in guiding the United States toward a better, or at least a richer, future. There are solemn references to “the (economic) profession” as undertaking certain tasks. Indeed, the authors exalt “high growth” as a means to “improve the image of the US abroad whereby aiding those friendly, and confounding those hostile to America and to Western values.” The authors, then, speak authoritatively on the subject of economic growth not only as technical economists, but also as representatives of Washington thinking.

In practical terms the problem of economic growth, as Tobin says, is the question of the present versus the future. The size of the Gross National Product depends at any given time on the amounts of labor, capital, and natural resources employed, as well as on the state of the technology used in various branches of the economy to transform the so-called primary inputs into the final outputs. As time goes on, the amounts of labor and of capital (but not of natural resources) increase, and technology advances; the Gross National Product grows.

Most of the services and goods which make up the annual National Product are consumed; that is, they are used to satisfy all kinds of current private and public needs. Some part of them is, however, added to the existing stock of capital, in the form of new or enlarged factories, dams, roads, and many other kinds of facilities. This new investment leads to an increase in national income. Next year’s larger income is, in its turn, again apportioned between consumption and additional investment. And so the process of economic expansion goes on and on and on. Population growth naturally plays an important part in it, adding, however, not only to the number of hands that can be employed in production, but also to the number of consumers that have to be clothed, housed, and fed.

Far from being independent of each other these different factors contributing to growth are interrelated in many different ways. The contribution of additional manpower to increasing output depends, for example, on the amount of capital equipment with which it operates. This explains why, in underdeveloped countries that are unable to equip their additional workers with the tools they need, the rising population contributes little if anything to national income while adding steadily to the number of mouths to be fed.

Investment not only consists of new physical facilities, but also can take the form of educational and training operations that transform untrained into skilled or professional labor, in the same way as iron ore is transformed into pig iron and then into steel. In the chapter on “Investment in Human Capital and Economic Growth,” William Bowen shows that, by 1964-65, annual education expenditures were nearly one third as large as annual investment in tangible physical capital.

Technological advance itself depends to a certain extent on new investment. For example, if they are to become practically useful, new and more efficient methods of generating atomic energy must first be “embodied” in newly constructed atomic generating plants. Some of these simply replace worn-out thermal installations but most represent new investment in additional generating capacity required to satisfy additional demand. Had the demand for electric energy expanded less rapidly or not at all, the introduction of the new technology would have proceeded at a much slower pace.

CONSTRUCTION of abstract “models” intended to describe in mathematical terms the complex interrationships governing the process of economic growth has become one of the favorite occupations of economic theorists. Unfortunately, the lack of detailed factual knowledge of conditions existing in the real world forces the model builder to base many if not all of his general conclusions on all kinds of a priori assumptions, chosen for their mathematical convenience rather than for their correspondence to observed facts. James Tobin and Robert Solow, the two most distinguished theorists in Heller’s group, make, in any case, the best of it.

One theoretical conclusion, which delights the model builders so much that they refer to it as the “Golden Rule” is that, in the very long run, the highest attainable level of per capita consumption depends on technological advance, not on increased saving and investment. The argument is certainly correct. It is analogous to saying that one can accelerate a car by pressing on the gas. But the top speed that can be thus attained is ultimately limited by the design of the car’s motor. In the long run, it is the improvement of this design that counts in achieving higher speeds, not greater pressure on the accelerator.

Having explained so much, Solow with words, and Tobin with calculus, both leave the long-range considerations aside and turn to the important question, how much of its potential consumption our generation could or should be ready to sacrifice in order to increase—via productive investment—the consumption level of the next and later generations. In fact, such a choice is being made all the time by every private individual when he decides, in each stage of his life, how much to spend, and how much to put away, or possibly to borrow, and how much, finally, to leave to his children. Corporate management, being placed ahead of the stockholders on the stream of national income, diverts a substantial part of the flow into investment even before the stockholders themselves have a chance to decide what to do with it.

And still higher up, there is the government. It invests directly in education, health, roads, and “defense,” but what is also important—as Warren Smith explains in his essay—it can, by means of monetary and fiscal policies, influence the consumption and investment decisions of business and private households. Moreover, it can even affect and modify the results of these decisions after they have been already taken.

But why should this be so? Because, answer Walter Heller and his associates, as a result of individual and corporate decisions, too large a portion of current national income is allocated to current consumption, and insufficient provision is made for higher levels of income and consumption in the future.

It should be said that the authors of the Perspectives on Economic Growth do not commit the error of the unsophisticated “growth men” who favor higher incomes in the future, without being prepared to sacrifice the standard of living of the present generation. This simply amounts to saying that one would like to see the national economy be more productive in the future than it is today. Hardly anyone would disagree with that, although, as we shall see below, there still exists room for serious disagreement concerning the way one should measure “productivity” and interpret the “level of consumption.”

However, like most other proponents of faster economy growth they tend to take the desirability of a greater rate of investment for granted. They center their attention on description of the various government-saving and tax incentives to private savers and investors that could achieve it. The only specific argument which is intended to demonstrate that the prevailing rate of saving and investment would be too low if the government did not step in, is that the private individuals and the capital market reflecting their attitudes systematically underestimate the benefits that would accrue to the future generations by sacrificing present consumption. I shall return to this argument later.

The real question is whether public interest indeed demands, as Heller argues, that the present generation be made to sacrifice some of its consumption in order to enable the coming generations to have more, in the same way as the rich are now made to give up some of their income to the poor by means of progressive income tax and other measures aimed at reducing economic inequality. In an underdeveloped country like India, population growth tends to outstrip the slow rise of national income so that the standard of living of the next generation might conceivably be even lower than that of the present generation. There a policy averting such a decline through larger allocations of current output to productive investment would be justified by the principle of equalization of income. But in a developed country like the United States, continuous and possibly even accelerated technological advance alone can be expected to bring about a steady growth in per capita consumption. According to Robert Solow’s own estimates, which do not deviate in this respect very much from the otherwise quite different estimates of Edward Denison,¹ in the postwar years between three quarters and one third of the increase of the per capita income in the United States was brought about by technological advance, not by increased saving and investment.

Under these circumstances a policy designed to encourage investment would tend to increase still more the disparity between the present standard of living and the much higher standard of living of future generations. If we are consistent in applying the principle that it is desirable to have equalization of income, we should, on the contrary, favor in this case policies designed to shift income in the opposite direction. Within the limits of the existing technical possibilities, present consumption should be encouraged, and saving and investment discouraged. Economic policies that transfer income from the upper to the lower income groups by means of taxation and other methods tend, moreover, to have precisely this effect, since the poor save a much smaller part of their income than the rich do.

Does this mean that large investments should not be made in education, for example? Such investments should certainly be made. Investment in human capital constitutes in this respect a class by itself. Education is a consumer good satisfying one of the most important human needs; at the same time it is a productive social investment leading to an increase in future material output. Thus it raises the standard of living of the present generation while contributing indirectly to the income of future generations as well.

The thought that greater economic equality might be justifiably sought not only among the members of the same society, but also among the different generations, admittedly runs counter to the deep-seated drive for growth and progress. But isn’t this just another instance of a continuing struggle between atavistic, intuitive drives, on the one hand, and enlightened rational value judgments, on the other? Only a few years ago, proposals to check the natural tendency toward fast population growth had quite limited support. Now they are widely accepted.

WHILE the Perspectives on Economic Growth were under examination by Walter Heller’s group, another group—consisting of seven American and two Canadian economists—sought, at Heller’s suggestion, to find out “why the growth of the British economy since World War II lagged behind that of her North American neighbors.” (It should be noted that Britain’s two North American neighbors themselves lagged, during the fifteen-year-period from 1950 to 1965, behind Germany, Italy, France, the Netherlands, Norway, Belgium, and Denmark.) In their 500-page report on British Economic Prospects² they conclude that what Britain needs is “growth via increased efficiency rather than encouragement of investment and aggregate demands.” After spelling out in great detail the measures by which such increased efficiency should be achieved, the collective author asks in the last paragraph of the very last page: “Are we not proposing growth and change in a society where don and docker alike prefer leisure and stability?” He could have added, if he referred to the chapter on Science and Technology “and in which scientists prefer pure to applied research.” “This may be,” he answers, “but many segments of British Society have declared for growth, or at least the fruits of growth. Their aspirations can be satisfied—at a price—and they should know the price they must pay.”

Ezra Mishan, a well-known British economist teaching at the University of London, has recently attempted to demonstrate that for a reasonably affluent country such as England—and certainly for the United States—the costs of such economic growth, if one assesses them correctly, exceed by far its apparent benefits³ , long before him John Kenneth Galbraith’s sharp criticism of conventional economic wisdom put in question the values governing our attitudes toward material affluence. Galbraith’s work, however, has been dismissed by some academic economists as lacking theoretical sophistication and the professional touch. Perspectives on Economic Growth contains a slighting reference to The Affluent Society. Galbraith remarked that increased leisure should be included in the Gross National Product along with the output of material goods and marketable services; Tobin sets him straight: “The Affluent Society to the contrary notwithstanding, conventional wisdom of economics was long since liberated from the policy that only goods and services yield utility and welfare.” Nevertheless none of the many tables and graphs illustrating the growth of real income and the rising standard of living in the United States takes into account or refers to the reduction in working hours and the lengthening of paid annual vacation. Conventional wisdom dies hard.

Mishan cannot be dismissed as a journalist. A few years ago, he was commissioned by the editors of the venerable British Economic Journal to write a comprehensive survey of the present state of the branch of economic theory called Welfare Economics. In contrast with what might be called positive economic theory, which is supposed to explain economic phenomena as they actually are, Welfare Economics is intended to consider what ought to be. While the old Welfare Economics is concerned mainly with justifying laissez-faire doctrine, the new Welfare Economics sets out to demonstrate that the price mechanism, even when it is operating under conditions of unrestricted competition, does not necessarily lead to efficient satisfaction even of private, not to speak of public, needs. The reason for this is that freely formed market prices more often than not present an incomplete and, consequently, a distorted picture of the real cost of production and of the true benefits derived from the consumption of particular goods.

The market price of a car, for instance, may reflect correctly the amounts of labor, capital, and of other material resources used in its production; the price of gasoline and oil reflects the cost of running it. But the no less real costs imposed on other people by the use of a car—increased air pollution and greater congestion of traffic lanes, for example—are, as a rule, not included in the price, and thus the prospective owner does not take them into consideration when he buys the car. He might not even be aware of the existence of such “external costs” borne involuntarily by others. “External” benefits exist, of course, too. I leave it to the reader to think of some “external benefits” accruing to him from other people’s cars.

The price system that governs the allocation of resources in the modern market economy fails to take into account any of the external benefits or costs associated with production and consumption of many goods. It thus distorts the private profit and loss accounts on which all the individual producers and consumers are supposed to base their hedonistic calculus. Hence, the allocation of resources brought about by the competitive market mechanism tends to be very different from the ideal allocation, which would take into account not only the internal, but also the external, benefits and costs bestowed or inflicted on the other members of a society every time an individual producer or consumer decided on a particular course of action.

The modern theory of public finance, founded some fifty years ago in Cambridge, England, by Professor A. C. Pigou, and elaborated by modern scholars, for example R. A. Musgrave at Harvard, interprets most government interference with private enterprise—through taxation, subsidies, or administrative regulations—as a means of correcting biases inherent in the operation of market mechanisms which are controlled by competitively formed prices. Expressed in the formal terms of Welfare Economics, a government policy designed to increase the rate of growth of national income has to be based on the assumption, or the demonstration, that the external benefits from accelerated growth exceed the external costs associated with it. Most economists simply assume this to be the case, as do the contributors to Heller’s symposium, but some—and Ezra Mishan speaks for them with fervor—believe that the opposite is true. He sets out to demonstrate—citing one example after another—that the generally accepted measurements of the Gross National Income and of Aggregate Consumption do not reflect the exceedingly high external cost imposed on the defenseless public by the rapidly rising output of material goods and marketable services.

Indeed Mishan concludes that the “continued pursuit of growth by Western societies is more likely to reduce than increase social welfare.” He writes,

…man’s experience of welfare is only to a limited extent influenced by the range of goods placed at his disposal by the economy. The more pervasive influences on his welfare arise from the existing technological conditions. These affect him directly in his capacity as productive agent responding passively to the evolving machinery of industry. They affect, him indirectly, though crucially, by their ultimate determination of the matrix of society—by their impress on the shape of the environment, material, institutional, and psychological, which constrains his personality.

But the technological conditions of production are not chosen with a view to enhancing man’s experience of life. Nor has any social science the least say in their determination. They evolve solely in response to the requirements of industrial efficiency. Thus, the predominant influences bearing on man’s welfare are generated accidentally; simply as a by-product of technological advance. It may well be suspected that the human frame and the human psyche are ill-adjusted to the style of living that technology is thrusting upon us, but willy-nilly technology marches on, leaving to the medical profession the unenviable task of dealing with an increasing number of casualties that are unable to cope with the strains and stresses of a rapidly changing world.

The defenders of the system say that whether by spending or by saving his hard-earned dollars, the consumer exercises his sovereign right of economic choice in the same way as, in democratic elections, a citizen exercises the right of free political choice. To this Mishan could reply that the average American, engulfed by the rising flood of bigger and better cars and taller and taller high-rise buildings unloaded on him by private enterprise, has about as much chance to opt against the wholesale destruction of the amenities of private civilized life, as he will have to express his preference for the cessation of our military intervention in Vietnam by choosing freely between Hubert Humphrey and Richard Nixon.

What does this all add up to? The advocates of growth will prevail not only because the primitive drive for growth and expansion is on their side, but also because the commonly accepted principles of equality and justice in highly industrialized societies, where the ability to consume more—to have more income to spend on cars and rent, for example—is considered a privilege that should be more widely distributed. Even if the present population growth were to slow down, or come to a standstill, economic policies aimed at raising the income of lower-income groups “up to the average” are bound to bring about a steady expansion of aggregate demand for consumer goods and services, which is mitigated only by inflation, and thus a fast-rising volume of production. For the reasons given, technical change and innovation, rather than greater saving and investment will from now on be the principal carriers of economic growth.

Romantics with a conservative tendency, like Mishan, or with a liberal one, like Galbraith, will continue to deplore the high cost of economic growth and technical progress to human values. The representatives of the economic profession in Washington, in London, and in Moscow, shunning the “grand warfare of rival ideologies,” will continue to serve the “national interests” of their respective countries by solving more and more efficiently the “technical questions involved in keeping great economic machinery moving ahead.” ⁴

Perhaps in communication the medium is the message. Certainly, in economic growthmanship the method tends to become the goal. And if some of the human consequences of this condition are not pleasant to contemplate, if the “external costs” of growth clearly seem to pose dangers to the quality of life, there is as yet no discernible tendency among economists or economic managers to divert their attention from the single-minded pursuit of economic growth.