Chapter 4: The aim of an adequate

economic growth

Outline:

01st The distinction: nominal and real growth

02nd The distinction between gross and net domestic product

03rd The distinction: extensive and intensive growth

04th Capital gains as a scale of economic growth

05th The distinction: maximum and optimum growth

06th What does optimum growth mean?

07th The problem of the growth political situation analysis

08th The growth political aim as an end in itself

09th The distribution political justification of growth policy

10th The foreign economic justification of the growth policy

11th Growth policy utilised as employment policy?

12th Conflicts with other aims of economic policy

01st The distinction: nominal and real growth

In this chapter we want to deal with the aims of the growth policy. Thus it is about advancing economic growth. What is the meaning of economic growth in detail, and what variables do we use to measure the extent of this growth?

The starting point is the GDP (gross domestic product). For each individual enterprise it is determined how much value this enterprise has contributed to the entire production of a national economy in a period. The GDP is unsuitable as a growth scale, though. A mere increase in the domestic product due to price increases does not represent any welfare increase.

Therefore, it is generally proposed to deflate the domestic product. Here, the nominal domestic production is divided by the price level, which gives us the real domestic product:

Y_real = Y/ P

· Y: nominal domestic product

· P: commodity price level

02nd The distinction between gross and net domestic product

The starting point is once again the gross domestic product: (GDP). From this, we initially derive the net domestic product at market prices (NDP), which we get from deducting the depreciations δ starting from GDP:

NDP = GDP – δ with δ : depreciations

The distinction between gross and net sizes takes account of the fact that in the course of production there is a wear of the equipment in each period, which must be deducted from the total value, if by help of the concept of income one wants to determine how much the value of all goods has risen in a period. Here, the depreciations are a scale of this wear, whereas it should be noted that often this size can not be determined exactly and is therefore sometimes defined fictitiously.

Next we determine the net domestic product at factor costs (NDPF), which results thereof that we add the subsidies (Subv) to the net domestic product at market prices and subtract the indirect taxes (Tind):

NDP_F = NDP+Subv - T_ind

Subv: subsidies;

T_ind: indirect taxes

With the concept of the domestic product at factor prices raises the question of how much value can be paid out now to the production factors which have been involved in the production. This value sum differs from the sales revenue (the net domestic product at market prices) on the one hand thereby that the enterprise has to pay a certain percentage of sales taxes and excise taxes from its business volume to the state; these are the indirect taxes, which must thus be deducted from the sales revenues. On the other hand, an enterprise receives also state subsidies, which are distributed to the factors of production just like the real sales proceeds and thus increase the income sum that is to be distributed to the production factors.

In its market value equivalent to the net domestic product at factor prices is the national income (I). While the concept of the domestic product starts from the supply side, the concept of the national income shows the total production from the demand side.

The privately available income (Ipra) can finally be derived from the national income. It is calculated starting from the national income, adding the transfer payments (TR) and deducting the direct (T_dir) taxes:

Ipra = I +TR - Tdir

This last term considers that the income that is actually available to households is different from the national income for two reasons. On the one hand, households have to pay a part of their gross income to the state in the form of direct taxes, which mainly include income taxes, thus private households can not dispose over these income parts. On the other hand, many households receive further incomes in addition to their regular earned income, which in their sum are referred to as transfer income.

In principle, these different income concepts can be defined as both nominal and real sizes. But only real income concepts, as already mentioned, are suitable as a scale for economic growth.

03rd The distinction: extensive and intensive growth

Furthermore, a distinction is made in general between extensive and intensive growth. The term of extensive growth refers to the domestic product (Y) as a benchmark. The question is asked of how much goods are produced for the entire economy without asking what this means for the single individuals of this national community.

The term of intensive growth just addresses this last-mentioned difference. It is emphasised how much the individual has on average contributed to production, respectively how much income the individual in turn receives on average.

Here, this term is used in different ways. First, this term is understood in terms of productivity gains. It is asked for how many goods the individual citizens produced on average:

scale: Y_real/F F: factor e.g. labour

However, there are different concepts of productivity depending on whether the domestic product is in value terms related to the factor labour or to the factor capital:

Y_real/W, Y_real/C work productivity, capital productivity

The term: intensive growth is secondly understood in terms of increases in the per capita income:

Y/P P: population

Now, what are the different concepts suitable for? The value of the per capita income shows what the individual consumers can afford, whereby the income can be used either for the purchase of consumer goods or for savings purposes. If a household saves certain income parts, then it shifts the consumption options to future periods. But savings can also serve to pass on wealth to children or other persons.

The productivity includes, unlike the per capita income, also leisure time changes. If productivity rises, then the wage rate can be raised and thus wages can rise even if not more working hours are rendered than hitherto. Or the wage income remains constant in comparison to the previous period and can be provided with a lower labour input due to the increase in productivity, so that the individual employees have more leisure time. Both the consumption of consumer goods and the leisure activities bring benefit increases to the individual, whereby it depends on the particular needs of each individual, which of these two alternatives (more consumption or more leisure time) brings greater benefits.

04th Capital gains as a scale of economic growth

The classicists understood by growth, in contrast to the previously presented consideration, the increase of production possibilities. Possible scales were:

· the acquisition-economic assets, as well as

· the level of education

The assets and the level of education of the employees rather allow a statement about the growth opportunities than the domestic product. A part of the domestic product is indeed consumed and therefore can not be used like the savings to increase production in the following periods.

If the growth level of a national economy is measured in terms of an income concept, then one learns something about what the national community can afford in the current period. The income parts that are consumed are spent and just therefore can not be used to improve production possibilities in the future periods.

But measuring the wealth in terms of the assets of a national economy reveals something about the value of the production facilities and how much can be produced in the coming periods.

The growth opportunities of a national economy depend, however, not only on the factual production facilities. The level of education of the employees is also decisive whether production can be maintained and even increased in future periods.

Now with the concept of growth we generally less connect the question of which prosperity a population can afford in the present period. Growth means grow, and this term rather indicates that the economy can improve and wants to express that the production level will rise in future periods.

Insofar, one could conclude that asset status and education level are much more appropriate scales for economic growth than the different income concepts.

Nevertheless, the growth aim is associated generally today with the increase of income; the fact that the production capacity is more likely to say something about the growth opportunities, is at most noted in the margin.

If we ask for the reasons why the growth opportunities of a national economy are not measured on the basis of the assets concepts, this is certainly due to the fact that even the assets concept does not represent a reliable growth scale.

Firstly, the production capacity does not say anything about whether or to what extent these production capacities will be used in the future periods. Here it is only about the possibilities of production. In a market economy, however, is only produced what is demanded also. The economy, i.e. the actual production level of the coming period, can also decline, though, even if there is still so much production capacity available.

The production capacity is therefore only a necessary but insufficient precondition therefore that more is produced. But if this restriction is made, then the potential growth can be measured as well in terms of income. It is not clear from the outset how much of today's income will be consumed, an increased income also enables a national economy to save more, invest more and thus expand production capacity. Both the concept of income and the concept of assets are therefore limited to pointing out opportunities for growth. Whether or to what extent such opportunities are exercised depends on further factors.

In addition, we must also ask the question as to what determinants it depends then, to what extent production capacities are expanded. And in this context belong the today's income and today's income gain to the most important variables, which also cause an increase in production capacity in general. In this respect, the concept of income as a scale for economic growth penetrates deeper into the root cause analysis than the concept of assets.

Secondly, the indication of the size of production facilities is less suitable as a scale of future growth, since the very fact that an economy has many production facilities does not say much about how productive those facilities are. We have to reckon with the possibility that due to changes in demand, some of the production facilities will not be used at all or that due to new inventions, some of the existing facilities will be considered outdated.

Particularly, if technical progress consists in improvement of the quality of the products, there will be a lack of willingness on the part of consumers to still demand the products created with the previous systems at all. And even if technical progress consists mainly in a cost reduction, it is to be feared that existing customers will shift to the producers who use these new processes, so that in this case the existing production facilities will partly stand still, too.

05th The distinction: maximum and optimum growth

Furthermore, a distinction is made in the literature between maximum and optimum growth. Let us turn to the concept of maximum growth first: A maximum technically possible growth would be achieved if, on the one hand, only the physical subsistence level for consumption would remain and, on the other hand, only the leisure time minimum would remain for leisure.

The leisure time minimum is limited to the free time, which is absolutely necessary for regeneration. Nobody can get along without sleep in the long run, he has a minimum requirement, which fluctuates between about six and eight hours per night; and humans also require a minimum vacation time for a full development potential in the professional work, too. If employees were to spend all of their remaining time on professional work, then the maximum income could be achieved from a technical point of view.

How strong the income growth will turn out in future periods depends now crucially on how much of that income is used to buy consumer goods and how much is spent on savings. Now if these savings are used for the purchase of investment goods, the production capacity and thus the future production can be increased.

This effect does not only occur if the saver invested the savings in the own business or bought securities of an enterprise. We can assume that a large part of these savings are offered to banks and that these pass on the savings as loans to enterprises, whereas at functioning capital markets the interest rate variations are responsible therefore that supply (in savings) and demand for investment credits are approximated.

The maximum growth calculated in this way is, however, an unsuitable means as a welfare indicator, since it is only possible to speak of welfare increases if increases in consumption and leisure time are also possible in the long term.

In a diagram we want to draw the consumption of the future on the abscissa and the consumption of the present on the ordinate. On the one side, we draw a series of indifference curves in this diagram. On the other side, the production possibilities shall be considered by means of a transformation curve.

A division between present and future consumption in the tangent point of both curves would be optimal. Growth could indeed be increased (maximised) if the present consumption was limited to the subsistence level. The diagram shows, however, that this maximum growth would be suboptimal, since there is a different allocation of resources that would guarantee a higher benefit.

In a further diagram, the abscissa is used for leisure time and the ordinate for consumption. On the one side, we draw again a series of indifference curves in this diagram. On the other side, the production possibilities shall be drawn by a transformation curve.

A division between leisure time and consumption in the tangent point of both curves would be optimal. However, growth could be increased (maximised) again if leisure time was kept to a minimum. But here again it is valid that this maximum growth lies on an indifference curve, which lies below the indifference curve which guarantees an optimum.

06th What does optimum growth mean?

The term optimum growth can be understood in terms of a tautology. Optimum growth results here from the voluntary decisions of all individuals. By behaving as they behave, individuals declare that this is the way to realise their optimum.

If individuals had namely not yet reached their optimum, that is, if there where other combinations for the consumers that would guarantee greater welfare, they would not be satisfied with their previous choices and would show by way of changes in their leisure time and savings behaviour that they have not yet reached their optimum and are looking for new solutions, provided, of course, that the individuals behave rationally.

However, this definition is little suitable for scientific analyses because it can never be falsified due to its tautological (always true) content. What is always true from a tautological point of view does not bring new information and only pretends new knowledge.

The term optimum growth is therefore used somewhat differently also in the welfare theory. Here it is spoken of optimum growth if the planned investment (the investment ex ante) corresponds to the planned savings (the savings ex ante).

In the context of the welfare theory, it is indeed assumed also that it can only be spoken of an optimal solution if the needs of households are met with regard to the allocation of the scarce resources to present and future goods. But it is not taken for granted that free decisions always fulfil the optimum.

It is rather assumed that different individuals participate in the fulfilment of this task: the households determine at which savings level the future needs of the individuals or the growth aims will be met, while entrepreneurs will ask for these savings to invest them and thereby provide the conditions for the households to meet their needs in the future.

Thus, it is desirable that investments and savings correspond. But the market ensures only under very specific conditions that imbalances between investment and saving are reduced. Thus, there are real processes that ensure the optimum; here, the optimum does not result from the definition already. Rather, hypotheses must be formulated which can only be regarded as confirmed if empirical studies fail to falsify these hypotheses.

Here, the saving or consumption behaviour of the households is described with by means of the collective indifference curves; and the behaviour of the entrepreneurs is described by means of the transformation curve. These collective indifference curves summarise all combinations of present and future goods that produce an equal welfare. On the contrary, the transformation curve informs about which combinations of present and future goods are possible at a given production technique and a given stock of material resources. For reasons of simplification, we will only draw one of these indifference curves in our diagram, namely the one that is just tangent to the transformation curve.

This tangent point indicates the combination of the two bundles of goods at which the highest possible welfare is obtained. Any combination (any point in this diagram) that is above this tangent point indicates an alternative that would indeed cause a superior benefit, but which can not be realised at all. Any combination below this tangent point, however, refers to solutions that are indeed possible, but guarantee a lower welfare than the tangent point.

The term optimum growth is furthermore understood in the growth theory in the sense of maximising the consumption sum over time. Therefore, it is spoken of an optimum growth path here, if in the single periods just so much is saved that over a longer period of time a maximum of consumption options is obtained.

According to the neoclassical growth theory, optimum growth is achieved when the sum of consumption is maximised in all periods (current and future). According to the Ramsey rule, a maximisation of consumption occurs precisely when the equilibrium interest rate corresponds to the growth rate of the domestic product.

Now sums of money of different periods can not be compared easily, though. If one e.g. takes out a loan to use this money to fund purchases in future periods, then one has to pay interest in addition to the future value of this good. This means that if we use certain sums of money for the purchase of goods in the future, we can invest the money interest-bearing in the meantime, so that the value of that amount of money has risen then due to interest revenue. For the same reasons is the value of today's sum of money less valuable if I want to dispose over income of future periods already today and therefore take out a loan and have to pay interest.

Thus, because sums of money have different values in different periods, we are forced to bring them to a unitary value when we try to add values from different periods. The single welfare values of the single periods can thereby be compared and also added together by previously calculating the respective present values. The present value of an amount of money of the prior period is calculated by multiplying the previous year value by the interest factor (1+ i).

Growth problems are addressed also in the environmental theory. Here, it is spoken about sustainable growth, if the environmental damage caused by production is considered. Accordingly, growth will only be ensured in the long term if scarce raw materials are not overexploited, that means if the principle of sustainability is met. Here, a policy is considered to be sustainable if it ensures that new resources are available for the future in the amount of scarce resources consumed today.

In this context it is important that in reality at the production of goods not always all the costs are considered that incur at the production of goods of a national economy. In the welfare theory we are talking here about external costs (and also revenues). External costs arise whenever and to the extent that the costs incurred by the enterprises are lower than the costs of the entire national economy.

An enterprise releases e.g. toxic gases occurring during production, such as carbon dioxide, into the air through chimneys, thereby damaging the environment thereby that cases of disease increase in the immediate vicinity of the production site and thereby incurring additional costs for treating these diseases. Nevertheless, these costs are not credited to the enterprises without particular political measures, since air actually represents a free good.

Since the enterprise is therefore charged with too low cost, the price of these goods will no longer correspond to the scarcity situation in the case of competition; it is too small in relation to the total costs incurred by a national economy.

But since private demand depends crucially on the price level, there is too much demand for these polluting goods at the presence of external costs.

An attempt has now been made to deduct these external costs in the national accounts at the determination of the domestic product, since at the presence of external costs, the initially reported value of the domestic product will be overstated just by these external costs.

The difficulty is here that the exact market value of these external costs is unknown, though. In a market economy, the value of the individual goods is determined by the interaction of supply and demand. It is the benefits that the individual buyers of the goods achieve, but benefits are initially subjective variables that can not be compared with one another. It is due to the market that these initially subjective sizes are converted into objectively comparable variables (in prices).

But this means also that no market values are known for external costs, since free goods are not traded on markets. Approximate values are therefore necessary for the determination of the market values for external costs. According to a proposal by representatives of the property rights movement can the state, however, simulate markets through creation of pollution rights and also receive values for external costs in this way.

07th The problem of the growth political situation analysis

Statements about the desired growth of the future periods require prognoses of the economic data. However, there are no long-term secured prognoses of economic data. Even small forecast errors accumulate. Furthermore, the range of variation of possibilities increases with time. Thereby, the predictive value of a prognosis is reduced the longer the period for which a forecast is executed.

Due to the fact that our knowledge of economic relationships is always more or less imperfect, we are almost never able to indicate the exact growth path of future periods. Therefore, we are forced to define a very specific range of variation for the forecasts. In the following graphic we want to assume that the domestic product (Y) runs at best according to the drawn red line, in the worst case, however, takes the course shown in the yellow line. It is obvious that the information content of a forecast is the lower the larger this range of variation is. In the case assumed here, it can not even be said with certainty that the domestic product will rise in order that a positive growth rate could be estimated firmly. There is a risk here that the domestic product may possibly even fall.

The further graphic assumes now that indeed two different growth paths are possible for the next period. The difference in the level of the domestic product between the present and the next period may be small, as suggested in this graphic. The graphic shows, however, that the range of variation becomes ever greater the longer the period of time is for which a prognosis shall be formulated. This shows that in the context of economic sciences longer-term forecasts become more and more questionable, that their information content becomes ever smaller with the length of the prognosis period, so that only prognoses over a middle period of few years make sense at all.

Continuation follows!