By Herman Daly
The term “economic growth” has two distinct meanings. Sometimes it refers to the growth of that thing we call the economy (the physical subsystem of our world made up of the stocks of population and wealth, and the flows of production and consumption). When the economy gets physically bigger we call that “economic growth.” This is normal English usage. But the term has a second, very different meaning—if the growth of some thing or some activity causes benefits to increase faster than costs, we also call that “economic growth”—that is to say, growth that is economic in the sense that it yields a net benefit or a profit. That too is accepted English usage.
Now, does “economic growth” in the first sense imply “economic growth” in the second sense? No, absolutely not! Economic growth in the first sense (an economy that gets physically bigger) is logically quite consistent with uneconomic growth in the second sense, namely growth that increases costs faster than benefits, thereby making us poorer. Nevertheless, we assume that a bigger economy must always make us richer. This is pure confusion.
That economists should contribute to this confusion is puzzling because all of microeconomics is devoted to finding the optimal scale of a given activity—the point beyond which marginal costs exceed marginal benefits and further growth would be uneconomic. Marginal Revenue = Marginal Cost is even called the “when to stop rule” for growth of a firm. Why does this simple logic of optimization disappear in macroeconomics? Why is the growth of the macroeconomy not subject to an analogous “when to stop rule”?
We recognize that all microeconomic activities are parts of the larger macroeconomic system, and their growth causes displacement and sacrifice of other parts of the system. But the macroeconomy itself is thought to be the whole shebang, and when it expands, presumably into the void, it displaces nothing and therefore incurs no opportunity cost. But this is false of course. The macroeconomy too is a part, a subsystem of the biosphere, of the Greater Economy of the natural ecosystem. Growth of the macroeconomy too imposes a rising opportunity cost that at some point will constrain its growth.
But some say that if our empirical measure of growth is GDP, based on voluntary buying and selling of final goods and services in free markets, then that guarantees that growth consists of goods, not bads. This is because people will voluntarily buy only goods. If they in fact do buy a bad then we have to redefine it as a good. True enough as far as it goes, which is not very far. The free market does not price bads, true—but nevertheless bads are inevitably produced as joint products along with goods. Since bads are un-priced, GDP accounting cannot subtract them—instead it registers the additional production of anti-bads, and counts them as goods. For example, we do not subtract the cost of pollution, but we do add the value of the pollution clean-up. This is asymmetric accounting. In addition we count the consumption of natural capital (depletion of mines, well, aquifers, forests, fisheries, topsoil, etc.) as if it were income. Paradoxically, therefore, GDP, whatever else it may measure, is also the best statistical index we have of the aggregate of pollution, depletion, congestion, and loss of biodiversity. Economist Kenneth Boulding suggested, with tongue only a little bit in cheek, that we re-label it Gross Domestic Cost. At least we should put the costs and the benefits in separate accounts for comparison. Not surprisingly, economists and psychologists are now discovering that, beyond a sufficiency threshold, the positive correlation between GDP and self-evaluated happiness disappears.
In sum, economic growth in sense one can be, and in the USA has become, uneconomic growth in sense one. And it is sense two that matters.
Herman Daly is CASSE Chief Economist, Professor Emeritus (University of Maryland), and past World Bank senior economist.