A mistake in economists Kenneth Rogoff and Carmen Reinhart's influential study causes us to take a closer look at the best way to judge growth in the economy.
For the past week, the economics world has been consumed by the revelation that an influential study suggesting that economic growth slows when a country's debt levels reach 90 percent of GDP contains what Bloomberg's Clive Cook calls a "cringe-making error." Economists Kenneth Rogoff and Carmen Reinhart have admitted to their mistake -- it was an Excel coding error -- and anyone who works with mountains of data has to have some sympathy. There must be a support group somewhere for smart people who let a mistake slip by and end up being ridiculed for it and haunted by it for years.
In this case, though, there's more to be worried about than a couple of academic reputations. The Rogoff-Reinhart study was a powerful argument for austerity as the way to respond to the ballooning U.S. debt. If debt itself can slow growth, then we need to get it under control as quickly as we can.
In the better-late-than-never category, there's now a more subtle debate among economists about whether it's debt that tamps down economic growth or whether it's the slow growth that pushes up the debt. That's an important question, but it actually hides what may be an even more crucial one. Is growth in GDP really the best way to judge how the economy is doing? What does GDP actually tell us, and what does it leave out? Can an economy be growing and still be on its way off the rails?
For politicians, pundits and many economists, GDP and jobs are often coupled together like love and marriage (which go together like a horse and carriage, according to the old Frank Sinatra song). But in Gross Domestic Problem: The Politics Behind the World's Most Powerful Number, political scientist Lorenzo Fioramonti asks why we have latched onto economic growth as the number one indicator of whether a country's economy is healthy and probes its limitations. The progressive think tank Demos has a study out juxtaposing U.S. economic growth with other measures of progress and human well-being.
But isn't growth the only way to create jobs and a rising standard of living? A shrinking economy is certainly no good to anyone; it's the definition of a recession. But using growth as the sole measure of how we're doing can also hide other problems:
Growth can mask the gap between rich and poor. Economic growth measures the increase in the gross domestic product, and they call it the gross domestic product for a reason. It's an overall estimate of the value of all the goods and services in an entire economy. In some countries, a healthy portion of these economic benefits go to a robust middle class. In others, the lion's share goes to people at the top. According to World Bank assessments, Namibia has the world's largest income gap, while Sweden has the smallest. The United States is in the middle, with the incomes of the wealthiest Americans rising dramatically over the last 30 years. Economic growth only shows how much more wealth the country as a whole has -- not how well we're doing creating an equitable society.
Growth doesn't seem to spur job creation the way it did in the past. In the four recessions before 1990, unemployment started falling four to five months after the economy started growing again. In the 1990-91 and 2001 recessions, it took a year for unemployment to begin easing. Now we're in an "jobless recovery" that's been dragging out even more painfully. Job creation has been listless, and new jobs are often in low-paying fields like customer service, food service, and home health care. The economy is growing, but so far, the American work force isn't really feeling the love.
Growth doesn't measure what we're doing to the planet. Another problem is that the focus on growth doesn't take into account the degree to which we're using up the Earth's assets -- its land, water, minerals, its capacity to support human life -- in our pursuit of economic progress. Greenpeace uses the image of a hamster that repeatedly doubles in size to illustrate the problem. After about a year, you have a 9-billion-ton hamster which can eat up all the corn produced worldwide every day, and the once-cute, now enormous creature is still hungry.
Of course, the hamster analogy is a little simplistic. If productivity is also rising and the economy is becoming more efficient, you can produce the same amount of stuff without using more resources (or at least not using them up as quickly). Or if you're using renewable resources, you can also feed the hamster without running out. And if a resource is running short, the world usually finds a substitute, eventually. Still, all of those factors can be overlooked if you just focus on whether GDP is growing or not.
It's significant that while some economists question whether growth is all it's cracked up to be, hardly anyone is arguing that a recession is better. We need growth to help stabilize our debt and get the job creation engine going again, but we also need a much more vigorous and critical discussion about what growth can do, what it can't, and whether it's a strategy that simply has to be reassessed as the Earth's population has now topped even billion.
We're projected to hit nine billion people in another 30 years, and all the world's people need food, shelter, energy, and a planet that hasn't been ravaged. Without growth, we can't feed, employ and sustain those two billion additional people, but unless we're more thoughtful about growth, we could end up growing and still failing to provide for them and protect the planet. Then, it will be clear that we've been looking at the wrong number -- or perhaps, the right number in the wrong way.