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What Is Supposed to Make an Economy Grow?

If you were born in Canada in the 1950s — as I was — you pretty much took it for granted that life would always get better.

I was raised in Etobicoke, a western suburb of Toronto. When I was very young, our family bought a window air conditioner. We were one of the first families on the block to have one. Within a few years, who didn’t? About a decade after that, we had central air conditioning installed — an astonishing luxury that soon became commonplace.

Progress could be measured in an even more tangible way. In the 1950s, the average North American home measured less than 1,000 square feet. That increased to 1,200 square feet by the 1960s, 1,800 by the 1980s, and 2,400 by the year 2000.1 And as the houses were getting bigger, the average family was getting smaller — the best of all worlds! Quality of life was improving.

This wasn’t always the case in the human experience. The Dark Ages, a period spanning the fifth century A.D. to the fifteenth century A.D., was termed such because there was little improvement (if any) in the lives of average citizens. Since then, economic growth has been uneven, but for most citizens in the developed world life has improved immeasurably. This was particularly true in the half-century following the end of Second World War.

Because our DNA requires a framework within which to understand what we observe empirically, we’ve come up with theories to explain economic growth, in particular what has lifted the standard of living of those in the developed world. The Cobb-Douglas production function is central to “growth accounting” and the neo-classical framework. The phrase itself implies that there’s a way to quantify (or account for) economic growth. Some of the mathematical functions operate at a high level, but I’m far less interested in the fine details than I am with the broad brush strokes … and they go something like this.

Three factors drive economic growth:

 quantity of labour (think number of hours worked productively);

 amount of capital employed (think machinery used);

 total factor productivity (an encompassing phrase that captures both technological advances and the possibility that we can organize ourselves more perfectly to produce more, given the same hours worked and the same amount of capital employed).

Let’s think about the Cobb-Douglas production function with the help of a very simple model. There’s a village of two hundred people. Twenty are senior citizens who can’t contribute much output at that advanced stage of their lives. Twenty are children who aren’t expected to work, either. That leaves 160 people to support the community.

Eighty are men and eighty are women. Eighty toil on farms and the remaining eighty are split equally between doing manufacturing work and performing various services. Everyone is productive: the unemployment rate is zero. The standard work week is thirty-five hours.

One day they come together as a community and agree that everyone will work longer. They extend the work week to forty hours.

QUESTION 8

Everything else being equal, do you think that the decision to increase the work week will increase economic output?

☐ Yes.

☐ No.

I don’t know how you answered, but Cobb-Douglas believers would have marked “Yes.”

Next question. The work week has increased. Then everyone begins buying machinery to help them do their jobs better. The farmers replace their horses with tractors. The tradesmen trade in their hand tools and buy power tools. The service sector throws out its pens and gets typewriters.

QUESTION 9

Everything else being equal, do you agree that as more machinery is used economic output will also rise?

☐ Yes.

☐ No.

I don’t know how you answered, but Cobb-Douglas believers …

The work week is longer. More capital equipment is being used. And not only is the capital equipment improving as technology advances, the townspeople are figuring out how to organize themselves better. Technicians are specializing rather than being jacks of all trades. Time-motion studies help manufacturers work more efficiently.

QUESTION 10

Everything else being equal, would you agree that the greater the total factor productivity the greater the economic output?

☐ Yes.

☐ No.

I don’t know …

There are just a couple of more things to say before leaving the Cobb-Douglas production function and neo-classical growth theory.

First, increasing hours worked can only get you so far. Yes, this year the village can move from thirty-five to forty hours and maybe next year from forty to forty-five hours. But there is only so much time in a day. You can’t grow the economy forever by continuing to increase the work week.

The next important implication is that, in the vernacular of Cobb-Douglas, capital deepening can also only get you so far. Let’s keep it simple with this example: There are three carpenters working together, framing houses. Right now, they are all using hand tools. Carpenter One buys power tools and his productivity goes up. Then Carpenter Two follows suit and ditto with his productivity. Carpenter Three is last to the party — but he joins in. It stands to reason that after capital is fully employed, they will be working more efficiently. With hand tools, each framed five houses a month. That has increased to ten … but as they upgrade their equipment with new and somewhat improved tools, their productivity will exhibit diminishing marginal returns.

Diminishing marginal returns is an important economic concept and one that every recreational runner is familiar with. It’s a nice day, so you go out for a thirty-minute run. You cover six kilometres, which means one every five minutes. If you decide to stretch your run out to an hour, it’s highly unlikely that you’ll cover twelve klicks. Rather, in that time you might run ten. That’s an example of diminishing marginal returns. As you add increments (in this case thirty-minute blocks of time), your output (distance) increases, but at a diminishing rate. In that second half-hour, it’s taking you seven and a half minutes to cover a kilometre while it took you only five minutes previously.

This teaching from neo-classical growth theory has important implications for a developed country like Canada that is already “deep” in capital. Neo-classical growth theory would predict that we can’t rely on capital accumulation alone to drive progress. It will have to be other things: either number of hours worked, total factor productivity, or some combination of both.

One final point: let’s say there are two villages that are virtually identical, except Village Two has a better climate. Its growing season is longer, which means that there is more agricultural output per hour worked and per unit of capital. Moreover, Village Two has denser forest around it, providing fuel that is both abundant and cheap. Under those circumstances, wouldn’t we expect that Village Two’s citizens would enjoy a higher standard of living than Village One’s? Absolutely. Yet, at the same time, those natural advantages wouldn’t translate into a higher growth rate. Village Two’s people would be better off, yes, but the gulf between the standard of living of the two villages would not widen over the years.

Neo-classical growth theory allows for the fact that even if hours worked, capital employed, and total factor productivity are equal, certain jurisdictions — if they’re endowed with resources — can and in fact should be better off than another locale not similarly blessed.

To summarize: according to growth accounting and the Cobb-Douglas production function, there may be a different base of wealth between two villages or counties or countries or you-name-it, depending on resource endowment. However, once that is put aside, it’s only about hours worked, amount of capital, and total factor productivity. Right?

Not exactly.

It seems to me that neo-classical growth theory misses the single most important factor that has led mankind onward and upward and that is … but before I get to it, let me ask another question, one that I routinely pose to my George Brown College students early each semester.

QUESTION 11

Which country has the higher GDP per capita?

☐ Israel.

☐ Saudi Arabia.

As soon as the words are out of my mouth, I can read the reactions of my students on their faces. “Sir, come on! What do you think we are? Stupid?!” (Some of those comments on ratemyprofessor.com were spot on!) “Saudi Arabia has oil … lots and lots of it.”

This is an indisputable point. Saudi Arabia extracts 10 million barrels a day2 … 417,000 barrels an hour … 7,000 each minute … in excess of 100 barrels of black gold every single second of every single day. Yes, the answer is clear-cut and obvious.

The country with the higher GDP per capita is, by a wide margin, Israel. According to the CIA’s World Factbook, Saudi Arabia has a GDP per capita of $31,300 while the corresponding figure for Israel is $36,200.3

When I let this out of the bag most of the students sit in stunned silence.

How can this possibly be?

They know that Saudi Arabia has oil.

But they don’t know what special resource Israel has. Until I tell them.

Israel has … Israelis.

People, properly organized and motivated, are the key drivers of both prosperity and progress.

Uh-oh. My suspicion is that I’ve already stepped on some politically sensitive toes. But I’ve got some good news. When I worked for one of Canada’s largest publicly traded financial institutions, I attended “sensitivity” training, or as they termed it, a “Respect in the Workplace” seminar.

One of the session’s key objectives was to teach me and my colleagues what was and what was not offensive. In Stalled, you will not encounter phrases like: “Another kick at the cat” (cruelty to animals is an inappropriate subject for metaphor); “Blind as a bat” (the visually impaired and/or crepuscular flying mammals might take umbrage); “It ain’t over ’til the fat lady sings” (female endomorphs have feelings, too!); or “Too many chiefs, not enough Indians” (wasn’t taking their land enough?!).

Consider yourself warned. Hands up, chin down. We’re adults and I plan to speak about all topics honestly, including values and culture. And that’s almost un-Canadian.

We’re a very polite people. We tend to be uneasy with frank discussions about culture. We’re much more comfortable when we trivialize it: “Went to a great Thai restaurant last night. Even used chopsticks instead of a knife and fork! Then to a Brazilian movie (subtitles only, dubbing is just so déclassé!). Capped it off with a cappuccino at an authentic Italian café … no Starbucks for me!”

How cosmopolitan can ya get!

I would agree that the foods we eat and our entertainments possess “cultural” elements. But the ultimate truths around culture address deeper questions and more profound issues. They may be discussed aloud around kitchen tables with families, or they may be with us in our thoughts:

 What is most important to us?

 What do we expect from ourselves?

 What do we expect from our friends and neighbours?

 What is the right way to live?

Just off the top of my head, these are some critical cultural questions. I’m sure you’ve got others. That’s the essence of this book. Stalled will be a frank discussion of values and the cultural factors that were responsible for the astonishing economic growth from 1950 to 2000. Because how our values have changed goes a very long way toward explaining why the Canadian economy has stalled in recent years.

A quick aside. To the extent that so-called polite society and the chattering classes discuss culture, it’s with an Animal Farm–like sophistication of “two legs bad, four legs good.” Developed cultures are by their very nature flawed. Primitive ones are inherently pristine. I’ve heard that argument a zillion times and it’s hogwash.

This leads us to Question 12, and I think you know how I’d answer it:

QUESTION 12

Do you think that development is a good thing, that economic growth is desirable, and that progress is something we should embrace?

☐ Yes.

☐ No.