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If we talk philosophy, this is the place to expose my not understanding of some basics of economy, and ask the question: where does (global) GDP growth come from?

I just can't figure it out.

Let's take a single company that produces with profit. Is profit wealth creation? It appears to me it isn't: profit is the difference of the company expenses and receipts, but those receipts had to be there in the pocket of someone in the first place. In an economy consisting of nothing but workers who spend wages they got from companies who invest all their profit, there would be money circulation permanent zero growth [or, more realistically, GDP reduction], with the profit of some companies balancing the loss of others.

So let's introduce capitalists into the economy. Does investing money holdings in hope of getting it back with profit constitute wealth creation? It appears to me the situation is the same as before: the capitalists' profit also comes from money received from others, be them workers spending their wages, companies buying means of production or capitalists spending or investing their money.

So let's introduce wealth and wealth pricing into the model economy. If the price of stocks or houses or land rises, it can be sold for more than bought, and used for higher investment or consumption. But I don't see how this shall lead to overall growth either: higher-priced wealth should first be made money before it enters production and thus GDP, but the purchaser's money again comes from the producing economy or another object of wealth that was made money. And price hikes are fuelled by demand.

So, thinking of foreign-credit-dependent US growth, or European colonists in prior centuries, or expanding empires, maybe growth comes from conquest and takeover of others' wealth? This is a tempting picture, but doesn't explain global GDP growth.

I have two remaining thoughts, thought through only half-way.

  1. Maybe economic growth comes not from production but from absorbing new natural resources? Maybe, as money is still needed to enter the economy, gold being the most important?
  2. As the gold standard was ditched long ago, another thought: maybe GDP growth is in truth differential inflation? Maybe it all boils down to the price of different things changing relative to each other, and the measurement of inflation being more bound to stuff with less change in value?


*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Thu Jun 29th, 2006 at 08:33:19 AM EST
Dang, I got those two points at the end garbled. I originally wanted the first to be second, because it would be a fitting end point to connect back to Jérôme's original diary. But the finished version is the logical order.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Thu Jun 29th, 2006 at 08:38:21 AM EST
[ Parent ]
Now that Migeru pointed out the loophole in my reasoning, please no more ratings & off the top spot with this...

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Thu Jun 29th, 2006 at 09:23:13 AM EST
[ Parent ]
Hey, I am not done commenting on it, and the questions are good.

In any casem now that you know better you can still ask the questions in the spirit of Socratic irony, pretending not to know to see if the neoclassical economist you're debating remembers his money equation.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Thu Jun 29th, 2006 at 09:27:50 AM EST
[ Parent ]
As the gold standard was ditched long ago, another thought: maybe GDP growth is in truth differential inflation? Maybe it all boils down to the price of different things changing relative to each other, and the measurement of inflation being more bound to stuff with less change in value?

Given a collection of goods you can choose any one you like as money, and use that as a token of exchange. This is useful because it allows people to trade unequal-value lumps of "stuff" by making up the difference with money. To be suitable as money, a good should be finely divisible, durable, relatively useless, but valuable. At various historical times and places different goods have been used as money. We are most familiar with precious metals, but a very important example is salt as money (whence comes the word salary). There is a technical term for a good used as money and that is Numeraire. Whether some qualitative relation is independent of an arbitrary change of numeraire is an importan sanity check.

In a way it doesn't matter whether you have the gold standard or fiat money: there is still "differential inflation". What happens with fiat money is that it can be created at will, so in a way there is no tradeoff between it and other goods, and so it cannot be used to price other things. The only way you can make fiat money useful is by controlling the creation of money, and that's what the [central] banking system is about.

You may remember that I once cooked an example called "gold for soybeans" where I showed that, if you are sitting at a point of the Production Possibility Frontier of Gold and Soybeans, the slope of the normal direction is the relative price of the two, and the intercepts of the tangent line with the axes are the GDP expressed in units of gold or of soybeans. Assuming that the PPF is convex (mild assumption) you get that moving along the PPF will increase one of the GDP values but decrease the other. This fails the change-of-numeraire sanity check. But if you can move the PPF outwards you can increase the GDP regardless of which numeraire you're using.

Arrgh! I'm rambling again.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Thu Jun 29th, 2006 at 03:27:29 PM EST
[ Parent ]
You may remember that I once cooked an example called "gold for soybeans" where I showed that, if you are sitting at a point of the Production Possibility Frontier of Gold and Soybeans, the slope of the normal direction is the relative price of the two, and the intercepts of the tangent line with the axes are the GDP expressed in units of gold or of soybeans. Assuming that the PPF is convex (mild assumption) you get that moving along the PPF will increase one of the GDP values but decrease the other. This fails the change-of-numeraire sanity check. But if you can move the PPF outwards you can increase the GDP regardless of which numeraire you're using.

If you keep making more stuff, GDP grows by any numeraire, but if you can not make more stuff some numeraires will show a growing GDP and some a shrinking? Would that be a fair summary?

The discussion of fiat money leads me a bit of topic: I have theory on the relatively succesful fiat moneys of today.

Sometimes you hear statements about todays fiat moneys not being based on anything tangible (at least since the Bretton-Woods collapsed), but only on how much you trust the government. I think this needs expanding upon.

Let me first start with some historical examples of fiat money. The american and french revolutions printed money to finans their wars. The trust was low and as soon as trust went away in an area, huge inflation kicked in as people started to use other numeraires.

Today you can not stop using the governments numeraire. Why? Because of taxation. Of course people payed taxes in the 18th century to, but often as work or in kind. Today you need to pay your taxes and the taxes are in the governments currency. So even if you switch to exchanging beans for gold with your neighbour, you still need some euros, dollars, renminbis to pay the government. Which means that at some point you need to accept fiat money for real products.

So the currencies of today rests on taxation and the governments ability to punish you if you do not pay your taxes.

Assuming I was right on the origins of GDP in my comment on Colmans diary the other day:

I have long suspected that GDP/capita becomes an important measure at about the same time as you can get that number from the tax offices.

Then both fiat money and GDP stems from the same source: modern taxation.

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by A swedish kind of death on Fri Jun 30th, 2006 at 07:50:21 AM EST
[ Parent ]
I have also seen it claimed here on ET that the one thing for which GDP is useful is to extimate a country's tax base.

Taxation is also the reason why barter is discouraged.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Fri Jun 30th, 2006 at 07:54:16 AM EST
[ Parent ]
So, then:

1. What does GDP measure?
Tax base.

2. Why does it need to grow?
To enable politicians to keep their promises, wheter in expanding services but not increasing taxes or lowering tax percentages while keeping services constant. Or both. Few run on a platform of increased taxes and lowered services. Or on a reality-based platform where you need to pay for what you eat. Fiscal conservative is just a oppostion position, when in power you need to keep promises.

3. Does the need for GDP growth outweigh any other policy goal?
Policy is set by politicians right? Then - almost always - yes.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Jun 30th, 2006 at 08:47:56 AM EST
[ Parent ]
If you keep making more stuff, GDP grows by any numeraire, but if you can not make more stuff some numeraires will show a growing GDP and some a shrinking? Would that be a fair summary?
Yup, thanks for putting my unreadable stuff in understandable form. It is also possible for the PPF to expand in such a way that the GDP contracts by some numeraires but expands by others while the amounts of all products also increase, but I don't know how contrived that is. It doesn't require nonconvexity so it is not too contrived.

Here is my original gold-for-soybeans example, half-way down the diary.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Fri Jun 30th, 2006 at 08:00:40 AM EST
[ Parent ]
In English, that means I can think of a situation in which more is produced of everything but the GDP still would seem to increase or decrease depending on which good is used for money, and that the situation I am envisaging is not too much of a strain.

I think what this indicates is that there must be hidden inflation in the model. I have to think about how to quantify that.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Fri Jun 30th, 2006 at 08:17:59 AM EST
[ Parent ]
I must admit I've never bought the people saying that fiat money is bad and that they prefer gold or whatever but big government curb their liberties etc...

In the current system, including for paying taxes, you can right now be practically independant from fiat money value fluctuations.

You just have to have a bank account and minimal fiat money for the day, the trick is to log on internet each evening and use all or most of the positive balance to buy gold or whatever fund you want to keep the balance near zero. You need to buy something? Just sell your whatever fund and use the fiat money immeditely to make your purchase or pay your taxes.

So no issue here, the current system allows you the freedom not to depend on fiat money value at the cost of one click per day.

Of course if everyone does that, all the private banks of the world have to change their model since the government granted priviledge of creating money is of no use anymore since all customers accounts have zero balance...

by Laurent GUERBY on Fri Jun 30th, 2006 at 02:58:47 PM EST
[ Parent ]
You might have read something which was not there.

I have no problem with fiat money and I am happy not having to carry big pieces of metal around. But I find the construction interesting.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Jun 30th, 2006 at 11:05:10 PM EST
[ Parent ]
Indeed, my note was not directed at your comment, but just to inform ET'ers on my view on the "fiat money = evil mandated by the government" things that are sometimes said in libertarian circles :).
by Laurent GUERBY on Sat Jul 1st, 2006 at 07:09:36 PM EST
[ Parent ]

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