Edge of Chaos Read online

  Yet Edge of Chaos insists on the promise of liberal democracy. After all, per capita incomes in liberal democracies continue to rise, albeit sluggishly. Meanwhile, the problems of growth are not confined to market capitalism—and real problems such as corruption infect state capitalist and other competing systems. Rather than turning away from liberal democracy, nascent democracies need to prioritize creating growth over the immediate devotion of some paradigm of democratic perfection. And established democracies must put their own houses in order by passing aggressive constitutional reforms.

  Above all, policymakers must face up to the facts of the twenty-first century. In an interconnected world of anemic growth, other countries’ crises will become our crises, whether they take the form of terrorism, income inequality, refugees, the resurgence of infectious diseases, or illegal immigration, and governments will grow ever more fragmented and weak, further undermining an already fragile international community. For Americans, and policymakers in the world at large, protectionism and isolationism are no remedy. Historical evidence makes clear that protectionism will be accompanied by higher unemployment, lower economic performance, and stagnating living standards in the United States and elsewhere. An economically weakened and isolationist America will call into question the Pax Americana, whereby the United States oversees international peace and security, and thus expose the world to the unpredictable whims and values of nondemocratic powers. These are not the solutions the world needs.

  Creating sustainable economic growth in the twenty-first century requires no less than aggressively retooling history’s greatest engine of growth, democratic capitalism itself. This requires a clear-eyed assessment of how ineffective the system is in its current state, politically as well as economically—and then implementing the repairs that will yield better outcomes. Too much is at stake for us to remain wedded to the status quo. The ominous rise of protectionism and nationalism throughout the world portend that the global economy and community are eroding already. The only way forward is to preserve the best of liberal democratic capitalism and to repair the worst. We cannot cling to past practices and old ideologies simply for their own sake.

  Doing nothing is no choice at all.

  1

  THE IMPERATIVE IS GROWTH

  FOR THREE SUN-DRENCHED DAYS IN April 1994, millions of South Africans formed lines that stretched for miles to participate in the first truly democratic election in the nation’s history. Children cheered from the tops of billboards that featured a picture of Nelson Mandela and his call to action: “Vote for jobs, peace, and freedom.”

  Today, more than twenty years since the end of apartheid, South Africa has changed profoundly. All citizens, regardless of race, now have the right to vote and thus help shape the country’s future. But living standards remain dreadful. Unemployment still fluctuates around the 1994 rate of 20 percent, and nearly half the population lives below the poverty line. Average life expectancy has gone from 62 to 57.4, mainly as a result of South Africa’s dubious distinction of having the world’s highest incidence of HIV and AIDS. Meanwhile, the income gap is widening. According to the Gini coefficient, a measurement of inequality in which 0 represents perfect equality and 100 perfect inequality, South Africa measures 63.38—a massive gap between rich and poor. (For comparison, Brazil and Colombia have coefficients around 53, the United States and China are at 41 and 42, respectively, and Norway and Denmark are both at 27.) Two decades after its first democratic election, South Africa ranks as the most unequal country on Earth.1 A host of policy tools could patch each of South Africa’s ills in piecemeal fashion, yet one force would unquestionably improve them all: economic growth.2

  Diminished growth lowers living standards. With 5 percent annual growth, it takes just fourteen years to double a country’s GDP; with 3 percent growth, it takes twenty-four years. In general, emerging economies with a low asset base need to grow faster and accumulate a stock of assets more quickly than more developed economies in which basic living standards are already largely met. Meaningfully increasing per capita income is a critical way to lift people’s living standards and take them out of poverty, thereby truly changing the developmental trajectory of the country. South Africa has managed to push growth above a mere 3 percent only four times since the transition from apartheid, and it has remained all but stalled under 5 percent since 2008. And the forecast for growth in years to come hovers around a paltry 1 percent. Because South Africa’s population has been growing around 1.5 percent per year since 2008, the country’s per capita income has been stagnant over the period.

  The slow-growth story we see in South Africa is common among developing countries. Even the largest and most strategically important of these economies (by population size and economic influence) are generating a meager annual growth rate of 2–3 percent a year.3 At the time of this writing, Brazil, Russia, India, and China (grouped together by the moniker BRICs) all have growth forecasts far below the “magic” 7 percent number. Brazil and Russia are expected to struggle and possibly contract, with some forecasts projecting negative economic growth.

  The virus of slow growth has spread across borders, with even the world’s richest economies falling victim. For instance, between 1970 and 1990 average growth rates in the OECD (Organisation for Economic Co-operation and Development) were consistently around 3.4 percent per annum, compared to around 2 percent today, with the Eurozone emerging from a minor recession in 2012. Moreover, in the first quarter of 2017, larger developed economies such as France and Italy posted annual growth rates around 1 percent. While economists and analysts assert that the United States may be back on a path of stable growth, for instance, as GDP has ranged between 1.5 and 2.5 percent since 2010, US GDP growth has never exceeded 2.5 percent since the financial crisis. The last time the country recorded a GDP above 5 percent was in 1984.

  Even so, the benefits of this limited growth are spread unevenly across the population. From poorly educated workers to a glaring lack of infrastructure, many of the variables that have dimmed American prospects for decades still remain unaddressed and will continue to drag growth downward in the years to come.

  This chapter reveals why the growth forecasts of many developing countries and developed economies alike are so dire. It explains why growth matters so much for living standards and human progress, and why permanently diminished growth threatens to translate into permanently lower living standards. And because we cannot understand the importance of growth without discussing how we measure it, the chapter explains GDP, its shortcomings, and why it remains the definitive tool by which economists, politicians, and policymakers gauge a country’s progress, establish new public policy, and set benchmarks for comparison and improvement.

  GROWTH MATTERS—POWERFULLY—TO ORDINARY people. When economic growth wanes, everyone suffers. Stagnation exacerbates numerous social, health, environmental, and political problems. The very essence of culture, community, and people’s individual expectations about the kinds of lives they can lead become dimmer, coarser, and smaller in the absence of growth.

  Economic growth is about satisfying the most basic of individual human needs. On the micro level, for the individual, the accumulation of money itself is pointless unless one uses it to improve one’s own station or else improve society in general. Likewise, economic growth at the macro level should translate to improvements in access to and quality of such basic needs as food, shelter, security, and health care. Stagnation at either level means these individual and societal needs go unfulfilled, often with dire results.

  The linkages among deteriorating economic growth, worsening living standards, and increasing poverty and instability are well established. A classic historical example is the 1789 French Revolution, which was touched off by rioting prompted by a decade of deteriorating living conditions, including tax hikes and food shortages. The lack of progress and ensuing economic crisis ultimately led to a political revolution.

  In the present day, Greece has exper
ienced a similar pattern. Between 2008 and 2016, the Greek economy contracted by 45 percent in GDP terms, leading to a concomitant rise in poverty. Job losses, wage cuts, and reductions in workers’ compensation and social benefits all led to Greek households becoming on average 40 percent poorer. By 2014, disposable household income had sunk to below 2003 levels. Major riots in 2010, with over a hundred thousand people marching in Athens, culminated in the election of a new far left government led by the Syriza Party in 2015.

  Growth enhances the living standards of both individuals and society as a whole in three main ways. First and most straightforwardly, growth offers the individual an opportunity to improve their own livelihood. For example, a worker who earns a bonus or extra income can use that money to obtain better health care, education, transportation, and food. Because of the growth in their income, they are able to secure goods and services that enhance their life. Conversely, if an individual loses their job or receives a reduced income, they can be forced to cut back on health care, food, and education. Growth can make an individual’s life better or worse in this simple way.

  Second, growth in income can allow an individual to have an impact on the wider community. They can hire others or invest their windfall. Through everyday purchases, the individual has the opportunity to support other businesses and individuals, and help others increase their own standards of living. By investing or making their capital available to be borrowed, they enable others to grow their incomes, improve their lives, and better society. Many small and medium enterprises in particular rely heavily on this type of individual investment. Given that over 90 percent of businesses in the OECD are small and medium-sized enterprises of fewer than 250 employees (and 60–70 percent of employment), and that in developed countries a large percentage of a nation’s overall economic growth comes from such companies, an individual’s investments can meaningfully affect the economy.4

  Conversely, the absence of growth in the wider community can have a profound effect on the individual. Economic contraction can foster political and social unrest and a breakdown in social cohesion. The town of Gary, Indiana, symbolizes this kind of industrial decline. Once a thriving steel town, it has seen its population tumble to less than 80,000 from 180,000 in the 1960s. The town’s steelworks employed 5,000 people in 2015, a fraction of the 30,000 who worked there forty years earlier.5 Gary has a poverty rate of 38 percent, high crime, and poor levels of education attainment. The lack of growth in the city’s overall economy has had meaningful negative effects on individual quality of life.

  The relationship between growth in income and human progress (or conversely between a growth slump and a reduction in living standards) is explained by the multiplier effect. Additional income earned by an individual will be transmitted across the economy in multiples of its original value. This theory was originally devised by the British economist John Maynard Keynes to show that increases in government spending would result in increased income for the population. However, the original source of new capital need not be the government.

  Say that a factory worker receives a $2,000 bonus after a successful year and that he spends it all in a lump sum. When he does so, perhaps on upgrading his home, the $2,000 becomes the income of multiple traders in his town, who in turn go on to spend it elsewhere. The worker’s $2,000 can quickly become $3,000, or $4,000, and so forth. In essence, the $2,000 enables not just one transaction (the original payment to the general contractor), but many subsequent ones, so that rather than being saved, the money is spent.

  There is a third, more complex way that growth can enhance (or by its absence diminish) the quality of life: through its role in preserving transparent political structures. Personal rights and freedoms can only exist if a society is able to hold government accountable. Growth allows society to sustain itself and to ensure accountability, but in the absence of growth, society weakens. In this way, economic stress creates the conditions for political upheaval and, at the extreme, the breakdown of liberal democratic institutions.

  Germany in the 1920s and 1930s offers the classic example of this sort of breakdown. Germany faced an enormous reparations bill from the First World War, high levels of debt, hyperinflation, surging unemployment, and the 1929 cratering of world financial markets. The country’s subsequent economic collapse enabled the rise of Nazi extremism. More recently, in the aftermath of the 2008 financial crisis, Spain’s economy faced a growth contraction of approximately 6 percent, while unemployment soared to 26 percent by 2013. Amid these conditions, momentum grew for the breakup of the country through Catalonian independence. The clamor for Catalonian secession has intensified since the end of the financial crisis and aggravated ill feelings among Catalans, who are concerned that they are being forced to pay more into Spain’s coffers than they should. An unofficial poll held by the Catalonian regional government in 2014 revealed that 80 percent of voters backed independence. The breakaway of Catalonia from Spain would be costly, as the region contributes 19 percent to Spain’s GDP, produces 45 percent of Spain’s high-tech exports, and is the gateway for 70 percent of the country’s exports. The consequences of a Catalonian secession for government revenue, jobs, and the broader Spanish economy would be considerable.

  When growth is strong, it sets in motion a virtuous cycle of economic opportunity, upward mobility, and rising standards of living. Without it, society contracts and atrophies in ways evident not merely in economic indices but more meaningfully in the lived experiences of people and their communities. Although growth alone cannot end disease pandemics, address environmental and climate concerns, improve educational outcomes, or blunt the threat of radicalized terrorism, without growth solving these problems becomes much harder.

  How does economic growth help in resolving these seemingly intractable challenges? First, it enables a government to fund and enhance public goods—education, health care, national security, and physical infrastructure. In a climate of rising economic growth, governments (and businesses through increased sales and revenues) gain marginal dollars that they can earmark for these purposes. Without economic growth, governments are forced to reduce resources in one area in order to fund budgetary needs in another.

  Second, strong economic success is a precursor to private investment and innovation that act as a springboard for improved living standards and progress. Economic growth helped drive US living standards throughout the twentieth century. Incomes rose thirty times, and hundreds of thousands of Americans were moved out of poverty. In a similar vein, China’s legendary economic expansion consisted of double-digit growth rates over three decades, helping move over three hundred million Chinese out of indigence.

  Without economic growth, the public purse faces reduced tax revenues and is unable to fund and deliver on basic human needs in the form of public goods. Essentially, a lack of success is a precursor of worsening living conditions and unrest. In periods of collapsing growth—the 2008 financial crisis is a stark example—all manner and marks of human progress, including real wages, job opportunities, life expectancy, and social mobility, suffer. A lack of economic success does far more than just diminish living standards; it promotes disaffected and destitute populations. While economic failure fuels destabilizing angst, strong economic progress should dissuade radicalization and rebellion.

  Certainly there are limits to what growth can do. It is inescapably true that certain phenomena are immune to being solved by growth. Even if economic growth can meaningfully undermine the ability to recruit for extremist movements, there will always be ideologues immune to any economic success. Terrorism thus represents one phenomenon beyond the reach of growth alone. Economic improvement can ameliorate the situation but not eradicate it in its entirety. Likewise, economic growth alone cannot solve income inequality. After all, we have seen countries where income inequality worsens even as they grow. Growth can even become a problem in its own right, as poorly managed economic growth spurts can leave a damaging legacy of debt and inflation. Eco
nomic growth alone is no panacea, but without it long-term societal progress is impossible.

  Quite clearly economic growth is utterly vital to the survival, success, and stability of a nation. The challenge of economics since its inception has been to pinpoint the key elements of growth and to navigate the maze of individuals and businesses to determine how these contribute to real, sustained growth. Before delving into the measurement of economic growth, it is important to understand the engines of growth. To that end, it is worth examining what drives growth and considering how best growth should be measured.

  Viewed through the prism of economics, growth is a function of three key factors: capital (how much money an economy has invested minus deficits and debts); labor (measurable in terms of both quality and quantity); and total factor productivity (a catchall of other factors that affect economic growth beyond capital and labor, including innovation, technology, political systems, laws, and regulations).

  Productivity is thought to account for more than 50 percent of why one country grows and another does not. Transparent and reliable laws, clearly defined property rights, and advances in technology all contribute to higher productivity and thus catalyze economic growth.6 Drags on productivity, such as debt and demographics, can limit growth. In the aftermath of the 2008 financial crisis, many developed countries have suffered under the weight of mounting debts and deficits. Demographic shifts have also proven taxing, as they have taken the form of a decline in the working-age, economically active population and a rise in an aging, economically inactive, increasingly expensive population. Subsequent chapters will analyze these factors in greater detail, but for now, suffice it to say that these levers act to dampen economic growth.