What Went Wrong – The Failure of Economic Growth

[I used to believe economic growth was the single most important concern for society and complimentary to this, due to increased productivity/efficiency/market size, society was significantly better off than ever before. After years of trying to reconcile this view with an observed reality of people struggling and complaining about the state of the economy, I came to the realization that the theoretical economic gains in the post-WW2 era did not translate into human flourishing on the scale I expected. This article explains what I think went wrong, coming from the background of someone who loves markets and is influenced by Hayek. Typically, my writing relies on data and explores the subtlety. This article intentionally avoids both data and subtlety. This story I tell is intentionally simplified due to the complexity of the topic.]

I.

According to the economic data, we are wealthier than ever, goods cost less and our selection of what we can consume is orders of magnitude larger than what we ever thought possible. 

Yet, few feel like they’re thriving; what is going on?

I believe at some point in recent history, we became so productive, things became so cheap, we had so much choice – there stopped being a meaningful relationship between the cost of buying something and its contribution to our wellbeing. 

Instead of flourishing, changes in the distribution of wealth influenced the norms of consumption causing people to spend more money in positional arms races that left most people worse off. This created an economic growth-disillusionment, where people stopped valuing economic growth as they perceived it to have failed to enhance their wellbeing. This attitude, coupled with unparalleled wealth, enabled our institutions to become inefficient, bloated and without a meaningful pressure to perform well causing an erosion in their ambition and ability to function.

I will explain

  1. Why after becoming wealthier, people chose to spend money on things that did not make them happier.
  2. Why many people now feel like things are worse than they were before even though they are wealthier.
  3. How this contributed to the erosion of our institutions.

II.

In 1930, John Maynard Keynes argued in his essay Economic Possibilities for our Grandchildren that by 2030, our standard of living would rise by 4x-8x and work hours would reduce to 15 hours per week.

90 years later, it appears Keynes was correct in his economic forecast (our GDP increased approximately 5X over the last 90 years), but wrong in his prediction on how this would impact our lives.

Fast forward to the present day and you will often hear people prognosticate about automation taking all of our jobs. Most critically, this is seen as a threat and something to be avoided, not a wonderful opportunity to drastically reduce the cost of nearly everything in our society.

Keynes’ faulty prediction and the threat of automation are fundamentally the same problem; to understand this one must first understand how and why people spend their money.

In the past, when you spent an additional dollar, or there was new innovation or an increase in productivity, it was likely to improve the quality of your life. At some time, we reached a point of such abundance, diminishing returns became so significant that every additional dollar spent, or new innovation, hardly pushed the needle at all. 

Once society reached this point, instead of trying to spend less for the same material product or experience (enabling us to work less), we instead chose to spend at the same rate largely driven by concerns of being “better off” or at least “not worse off” compared to our peers. 

Most consumption is driven by norms. We buy not only what we need; we buy what we desire, and we desire what we think others desire. If you live in a community where everyone lives in an apartment, you will likely not feel the need to live in a house. If you live in an area where everyone bicycles rather than drives a car, you will likely bicycle. As the norms around us change, so does our consumption.

If everyone around you spends $20,000 per year – then you would likely live a good life by spending $20,000 per year. If everyone around you spends on $60,000 per year and you try to spend only $20,000, you will likely be miserable.

Imagine you are a hockey player in the 1980s using a wood stick. Everyone is using the same quality of stick and feels satisfied with it. At some point, there is innovation and hockey companies start producing better composite sticks. Even if you do not buy one, if other players do, your enjoyment of hockey will deteriorate as the other players will outperform you. At some further point in the future, as more and more people start using composite sticks, hockey manufacturers will stop producing the less expensive wooden sticks due to an insufficient market for them. In the end, you will likely be compelled to buy a composite site and despite spending more money for it, feel no happier than before they were invented.

At every point in a product’s lifespan, manufacturers have the choice of making the same product for less money or a better product for more money. In most instances, rather than making something cheaper, the consumer demand is to make the product better but more expensive. 

The new better and more expensive product gradually shifts the norms so it becomes disadvantageous or unfashionable not to upgrade, causing the whole market to move with it, often removing the cheaper, lower end options from the market. This leaves people in situations where they feel obligated to spend more money on things that do not make them any better off than before the innovation took place.

III.

A number of recent structural changes altered the perceived distribution of wealth and status in our society and drastically impacted the norms of consumption. As stated earlier, as collective consumption norms change, so does our individual consumption. 

Robert Frank created the term expenditure cascades to describe the phenomena that when one group experiences an increase in their income, they will increase consumption that will cause all other groups to increase their expenditures, even if those groups do not receive any additional income. When one group of people receive more money, they will then spend more money, often on things which impact the positional status of others; goods like larger houses, fancier weddings and nicer cars. The change in these goods for this group makes those who compare themselves to them feel worse off, causing others to increase their expenditures to keep up with them. This effect then cascades all the way down the socio-economic ladder, as everyone begins spending more to keep up with those in the group directly above them.

Some of the recent structural changes in society has made the effects of expenditure cascades more pernicious.

There is the standard narrative describing the increase in wealth inequality; economies of scale, automation and the rise of management theory, salaries at the top increased faster than salaries for most other groups. Complimentary to this, there were three other significant structural changes that contributed to the rise in expenditure cascades that go beyond the standard inequality narrative.

Families went from one income to two income earners as women entered the workforce in larger numbers. This contributed to a significant increase in family wealth inequality. Imagine that each stay-at-home parent’s work (childcare, cooking, cleaning, household organization etc) was valued as an income of $25,000 per year. This compresses the distributions of income/wealth making more families in a similar financial position. 

In addition to this, many of the high income earning women married high-income earning men, causing the distribution of wealth to become even wider.

The most important change in expenditure cascades is due to the change in our media landscape. People in the past lived much more local lives; influenced primarily by those who lived in their neighbourhood, worked alongside with or were in the same social circles. With the change in media landscape, people became much more influenced by those in communities very different from their own and often, of people higher status or wealthier than them.

These three factors caused expenditure cascades to increase, changing the norms of consumption to evolve in a way that left most people to experience perceived positional loss (via others rising), causing an increase in consumption, leading most people feeling the need to spend more money on things that did not make them feel any better off.

IV.

For most challenges in society, it is not that we do not know what policy would help, but that there is no political will to actually do the recommended policy. I believe the reason our institutions and elected officials so rarely do the “smart” thing stems from an economic growth-disillusionment that permeates through society. 

All policy choices have trade-offs and no matter how great a policy may be, it will have some cost to some group. When people do not believe the benefit of any new policy will actually improve their lives but the costs are real and can actively harm their lives, they will be very reluctant to support change.

Complimentary to economic growth-disillusionment is the reality of society being so rich and things being so cheap, it allows for significantly more bloat and inefficiency in our institutions, making it much easier for decay to go ignored.

V.

To answer Keynes, I believe we are already rich enough to work 15 hours per week [I do not believe we should do this, just that we are rich enough that we could]. I believe if society wanted to, we could change the norms so our expenditures decreased by orders of magnitude, enabling us to work fewer hours on terms much more compatible with our ideal lifestyles, without making us worse off.

The challenge is, in order for our expenditure norms to change, society needs to change collectively. Unfortunately, we have collectively chosen a pathway where consumption norms evolve to increase costs and require us to spend more money on things that don’t make us any happier, while putting us in a position where it becomes too costly for individuals to opt-out to work and spend less.

The response to this challenge is not to implement radical change. This is not about 15 hour work weeks or destroying our economic system so we can all be equally poor. Rather, this story should serve as part of the framework for evaluating how our system can be revised (on the margin) so economic growth and increases in productivity/efficiency can be perceived as being more complimentary to people’s lives. We want to live in a world where both people and governments care about progress, economic growth, innovation etc. – because they believe these advances will actually make their lives and society a better place.