Browse By

Economic Growth: What do they mean?


By Heiko de Boer

When economists talk about the economy, it sounds like an abstract thing. Apparently, these days, there is a lack of demand in our economy.  What does a lack of demand mean? In the end, the economy consists of people.  What do these individual people demand and think of their economy?

People are constantly acting. The purpose of all this activity (human action) is to improve our situation and conditions. If an action is not expected to improve our situation, what’s the point of wasting energy? People set certain goals. This could be making more money, enjoying more leisure or living in a sustainable world. People’s actions are meant to accomplish these goals. However, these goals cannot be accomplished instantaneously. It always takes time. Time is scarce. The means to accomplish goals are also scarce. Consequently, people have to make choices. How do people make choices?

People choose by continuously ranking all their goals. Do I want a better job, go on holiday in France, buy a new car, retire soon, etc.? The value of all things is subjective and is different for each individual.  The goals that are valued highest will be ranked highest. The higher a ranking, the happier this person will be if this goal has been accomplished. The purpose after all is to become happier. People will strive for the highest welfare. The economic term is utility.

The maximizing of GDP growth is not a goal of individual people. However, for economists and central bankers this is a very important number. If a country produces the same number of goods this year as last year, but at a higher price, then we have economic growth! If we produce the same number of goods, at a lower price due to technology improvements, so we can enjoy more leisure, economists will talk about a recession. The people are then made to believe to having a problem.

However, it is NOT possible to measure utility. One cannot say to appreciate (value) coffee twice as much as tea (utility is ordinal). You can only say that “at this moment I prefer coffee over tea“. Values between people are also not possible to measure. You cannot say ‘I like coffee better than you do’. Values can only be ranked and compared to each other by each individual. Prices are expressed in terms of money, but money does not measure value. Value cannot be measured. Our GDP growth number is at best a bad approximation of welfare. It excludes many things that people still value highly, such as leisure, an early retirement, better quality products, a sustainable environment, etc.

Another important number to economists and central bankers is price inflation. The ECB aims for average prices to rise about 2% a year. But, people do not act on this average number. When shopping, a consumer does not say: “Oops, the Harmonised Index of Consumer Prices (HICP), an indication of price developments as measured by the ECB, with all it’s shortcomings, is nearly below 0%! Now, prices must continue to fall, let’s come back tomorrow!” People probably do not know the magnitude of this number, or possibly have never heard of it’s existence at all. People are continuously ranking their goals. People act on relative prices. People do not act on some kind of complicated average number.

For politicians and central bankers GDP growth and HICP developments determine their policies. In order to accomplish their inflation tagets, the ECB ALWAYS keeps interest rates low and money growth high. They think they know what people want and how they can improve people’s welfare.  But, this is impossible to know. Politicians and central bankers are steering on bad approximations and irrelevant numbers. There is a disconnect between the monetary and the real world. A disconnect that is getting wider and wider. The ECB does not solve any problem with their stimulating policies. Hopefully the ECB does not create any problem either.