The difference between economic growth and "economic growth"

11/03/2015 07:52:00 AM
Noah Smith has a column on a very common fallacy I see all the time in US politics where people confuse things that increase the level of GDP with things that increase the growth rate of GDP. Smith's column should be required reading for anyone making any claim about "growth."

The thing is that almost all of the ideas anyone has for "growing the economy" are actually only about static gains: tax cuts result in a one-off, static increase in the level of GDP, not a persistent, dynamic increase in the growth rate in GDP. Deregulation is the same--just a one-time reduction in some dead weight loss. Same for up-zoning. Same for free trade. Hardly any of the traditionally "pro-growth" policies actually increase the growth rate, they just transition us to higher level of GDP with the same growth rate as we have now.

This all rests on a semantic slight-of-hand. Something that increases the level of GDP necessarily increases the measured percentage growth of GDP temporarily, as we transition to the new, higher equilibrium. So technically you could say these policies increased growth. But really the "growth" there is an artifact--the policies merely affected the level, and the measured growth rate will return to what it was before.

Some of these static gains are quite substantial. Easing zoning restrictions, for example, could reduce the cost of our biggest living expense, meaning it would make us all quite a bit wealthier than we are now. But compared to a permanent increase in the growth rate, these gains are minuscule.

I'm reminded of what my international econ prof said about the tension in the room when they estimated the gains from free trade in then newly-formed European Union. Everyone was quietly praying that the result would at least be non-negative. It's not that anyone had any doubt about their theory of the static gains from trade, but they all knew that these effects are easily dwarfed by dynamic effects that would affect growth rates, about which theory is mostly silent. An imperceptibly small negative effect on growth would easily wipe out the static gains from trade many times over. There was a huge sigh of relief when the estimate came out as a small but positive gain from trade.