Reinventing Prosperity - Graeme Maxton

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history there was no economic growth at all. Nothing. Following the decline of the Roman Empire in around 400 CE, the economies of Europe shrank for hundreds of years.3 Between 1000 CE and the early 1800s, they grew by only 0.3% a year,4 practically a recession by today’s standards. There was human progress during these eight hundred years, of course. The population rose, and there were many advances in technology and science. But change was almost imperceptibly slow compared to today.

      For centuries, every generation lived in exactly the same way, unless there were wars or plagues, which there often were. Grandfather after grandfather would sit on the same wooden chair, at the end of the same wooden dining table, eating the same amount of the same sort of porridge with the same wooden spoon.

      There was no increase in production and no economic growth.

      Until the nineteenth century, it was thought that there were unbreakable laws that governed humanity. Social thinkers of the time observed that living standards stayed almost constant for centuries and believed that there was a law of nature that held the majority of people in poverty and stopped society developing any faster or getting any richer. Even when new lands were colonized or plundered, and their treasures were shipped back to Europe, the life of the average citizen did not get any better. Whenever standards of living improved just a little, the population would increase and, without any increase in food production, poverty would return. Living standards were pushed back to where they started. There seemed to be no way out of the cycle.

      Observing this, Adam Smith sought to understand how it might be possible to break the pattern and improve standards of living, not just for one generation or for one part of society but in a broader and more sustainable way for the majority. This is what his famous book, written in 1776 and generally known by its short-form title, The Wealth of Nations,5 is about.

      People were poor, he argued, because output was too low. One way to fix this was to increase productivity, or the output per worker per year. To explain his theory, he used the example of a pin factory. Rather than having one worker produce as many pins as possible, Smith saw that productivity could be increased if the process was divided into simpler stages. If workers focused on one stage, rather than trying to do every stage themselves, the number of pins produced per worker would rise. This lowered the cost of each pin, expanding the market and allowing the business to grow. This generated more income for the owner, encouraging him to boost production and employ more people. If people had the chance to work and earn a wage, Smith reasoned, average living standards would improve.

      Smith’s ideas and observations were not responsible for kicking off the era of rapid economic growth, however. That began thanks to another Scot, James Watt.

      For thousands of years, people had used various forms of energy to supplement human manpower. Water wheels and windmills used water and wind to increase the supply of grain. Animals attached to plows were used to raise agricultural production. Wood, charcoal, and coal made it possible to work hot metal.

      By the early eighteenth century, steam engines had been developed and were being used mostly to pump water from flooded coal mines. But they were very inefficient, requiring, somewhat ironically given their primary use at the time, huge quantities of coal. After many years of working on this problem, Watt managed to increase their efficiency by adding a separate condenser and rotary motion. This dramatically lowered the production cost of coal, allowing the mine owners to sell more of it.

      As with Smith’s pin factory, Watt’s steam engine increased productivity.

      Watt’s invention also made it possible for the engines to be placed anywhere there was access to water and fuel. This allowed the development of steam trains and ships, and so encouraged trade. Trade, as Smith observed, also promoted productivity growth and led to higher living standards for all.

      Thanks to Watt’s steam engine, Britain’s weavers began to manufacture cotton more cheaply than the hand-weaving Indians. This gave birth to an entirely new industry. The mills built to spin and weave the cotton gradually changed the landscape, increasing the rate of urbanization. Other industries began to emerge, and by 1870, Britain’s steam engines were generating the energy equivalent of 40 million people, allowing the country (with a population at the time of less than 30 million) to expand its output without having any more mouths to feed.

      The productivity of the nation was transformed.

      During the nineteenth century, steam power spread from Britain across Europe and to the United States, where it changed the agricultural industry and led to the creation of the railroads.

      After many years of near stagnation, the economies of Western Europe and North America gradually took off. In Europe, the rate of economic growth rose above 2% a year after 1820, and it remained at this level for the rest of the nineteenth century.6

      What does all this mean in economic terms? Watt’s steam engine increased productivity, and so output. Energy, in the form of coal, was converted into practical forms of power (force, torque, movement, and heat), which increased the output per worker. The use of machines in factories had the same effect. The energy and mass production techniques increased productivity. They generated economic growth.

      Economic growth comes mainly from rising productivity. It depends on the output per person increasing. This is important to understand, as we will come back to the issue frequently. Economic growth is not the result of rising consumption, from people buying more, despite what you might think if you read many newspaper reports. Consumption is a consequence of production. It is the increase in output that makes the increase in spending possible. Put simply, you can buy a bar of chocolate only if someone has first taken the trouble to make it.

      Economic growth also depends on the population. If the population is rising, and if people have work and a source of income, they are able to buy things. So output will rise to meet the increase in demand. With a stable or declining population, though, as there will be in much of the developed world in the coming decades, this particular source of economic growth diminishes.

      Output also increases when labor and capital are used to produce new machinery and infrastructure, and it increases when the nation produces something that other countries are willing to buy, when there is trade. We will look at this in more detail later.

      Well-being is difficult to define or measure accurately. It is perhaps best understood by people’s answer to the question: On a scale from 0 to 10, how satisfied are you with life in general? Subjective well-being is influenced by many factors, including income. Some of the factors are more measurable than others. When people are poor (for example, when GDP per person is less than $10,000 a year—as it was in the United States in 1955 or the fifteen countries of the European Union (EU) in 1965), increasing income leads to a significant rise in self-reported (“subjective”) well-being. At higher levels of income, however, the impact of higher earnings is lower, though it is still there. In rich societies, income is still important to individual well-being, but the effect is primarily relational. Middle-class people are more interested in boosting their incomes so that they keep their position in the social hierarchy and not because it allows them to buy another sofa.

      It does in poor societies. Rising output tends to improve well-being when most people have low incomes. The answer is not as clear when it comes to rich nations, unfortunately. Remember, GDP measures the level of economic activity, not the level of happiness. It increases when more people work, when they create more value per person per year. But it also increases when they work on tasks that are socially undesirable, such as repairing the damage caused by climate change, work that effectively wastes human input, energy, and resources because it only fixes the unwelcome consequences of previous activities. So rising GDP does not always lead to higher average levels of well-being.

      It is important to understand that economic growth is mostly dependent on improved productivity. Improved productivity means that fewer resources, in the form of workers, energy, and raw materials mostly, are required to generate a given level of output.

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