“Five Short Blasts” Theory Explained: Part 1

This post is the first in a series of articles that will explain the new economic theory I proposed in Five Short Blasts. With readership of this blog expanding dramatically, I want everyone to have the opportunity to understand this important new theory. Do I like selling books? Sure, but that wasn’t my motivation for writing it. My primary interest is in spreading the word about this new theory and its ramifications for public policy issues that are scarcely being addressed, if at all. Nothing less than the “American way of life” is at stake. If you’re someone interested in globalization, trade, overpopulation or immigration, I think you’ll find this series most interesting. The connection may not be apparent at first, but stick with me. With that said, let’s get started!

* * * * *

Out of necessity, our nation’s economic leaders, including our top economists, put all of their focus on macroeconomic measurements. They can’t be that concerned with “microeconomics” – the economies of individual citizens – because there are over 300 million of us. You and I would be dead long before they got around to paying us any attention! So they put all of their faith into the precept that if the overall economy is growing then, on average, our citizens will prosper too. On the surface, it seems to make sense. It’s held true throughout most of human history. Notice that I said “most.” Is it possible that there could come a time when macroeconomic growth – growth of the total economy – could actually become harmful to individual citizens’ standard of living? That seems counter-intuitive, doesn’t it? Economists would sneer at such a suggestion.

But I’m already getting ahead of myself. Let’s get back to measurements of economic growth and begin with a look at economists’ favorite measurement, Gross Domestic Product, or GDP. It’s the measure of all of a nation’s economic activity. It doesn’t matter if it’s beneficial or harmful activity. The cost of educating a student gets added to GDP. So does the cost of incarcerating a criminal. The cost of building a new car is added to GDP. So too is the cost of junking it.

So how has America been doing as measured by GDP? Great! Since 1962, our economy has grown at an annual rate of 7.3%, expanding from less than $600 billion per year in 1962 to $13.25 trillion in 2006. Wow! That means that Americans are twenty-two times as wealthy as they were in 1962, right? Uh, no.

A big part of this “economic growth” is nothing more than inflation, which helps no one. Since 1962, the Consumer Price Index, or “CPI,” has risen by a factor of 6.7. Take inflation out of the equation, and we find that “chained GDP,” GDP adjusted for inflation, is about four times what it was in 1962. By the way, I should point out that CPI is a price index, not a measure of the cost of living, which it actually understates. “But still,” you’re probably thinking at this point, “that’s pretty phenomenal economic growth.” “We’re still four times richer than people were in 1962! Right?” No.

We haven’t yet taken population growth into consideration. Population growth isn’t true economic growth. It’s contributes to the size of the overall “economy” but, beyond a certain optimum level (a concept we’ll explore in more detail later), does nothing to raise individuals’ standard of living. That is, if I apply the same economy to a population that is double the size, I still have the same economy from an individual point of view. The economy will be twice as big, and it will double the sales volume and profits for corporations, but for individuals it will have no effect on their incomes. From 1962 to 2006, our population grew from 186 million people to 299 million, a 60% increase. Factor this out of “chained GDP” and we arrive at a figure known as “per capita chained GDP” which, since 1962, has actually increased by 161%, an annual growth rate that is now down to 2.2% from the original “GDP” figure of 7.3%.

Well, OK, but we’re still 161% wealthier than folks in 1962. That’s not as exciting as being 2200% wealthier, like the raw “GDP” data would have suggested, but it’s still a decent increase, right? I mean, we’ve adjusted GDP for inflation and population growth. What else could there be?

Productivity. Every bit of this 161% increase in per capita chained GDP is due to productivity improvement – the amount of economic output per person. Finally, some good news here! We all know that increases in productivity lead to higher wages. At least that’s what everyone says – our politicians, our business leaders and especially economists.

Really? Are you that much wealthier than someone who did the same job as you back in 1962? Well, if you’re a top corporate executive, almost certainly. The rest of us? Probably not. Are you any wealthier at all? Maybe. Maybe not.

That is what everyone says – that productivity leads to higher wages. But it’s not true. There is absolutely no correlation between productivity improvement and higher wages. Productivity improvement does nothing to drive wages higher. If anything, it tends to drive wages down. Something else drives wages higher. Something that we’ll explore in Part 2. Stay tuned!

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4 Responses to “Five Short Blasts” Theory Explained: Part 1

  1. While I realize that you were explaining your theory and not dwelling on inflation, I appreciate the explanation of the harm that inflation does to our long term prospects.

    Inflation is also not shared equally, the young and the old suffer mightily while those in the middle believe falsely that they are winning.

    One other factor that should be taken into consideration when attempting to normalize GDP is that ALL government services and payroll are considered in the reported annual GDP. As the government (non-productive) sector of our economy grows in proportion to the productive sector, the number becomes skewed on the positive side. This has created an ever greater need for larger and larger annual budgets that no longer possibly balance. Too many Chiefs and not enough Indians.

    I have never attempted to mathematically demonstrate the down side to the above practice of continually expanding the non-productive sector of any economy while at the same time including the same in GDP. If you have any information on a source who has, please let me know.

  2. Pete Murphy says:

    Mike, I don’t share the same view that all government services are non-productive. I see government as something that’s necessary, including many of the services they provide – national defense, police, highway construction, schools and so on. We can debate how efficiently these services are provided, but they are still products that we all consume.

    Regarding the expansion of government, I also see it as an unfortunate necessity if we continue to expand our population. I believe that increasing government control is necessary as any country becomes more densely populated in order to maintain an orderly society. That doesn’t mean it’s a good thing. On the contrary. We’d all be much better off with a less densely populated society and a smaller government.

    Whether, mathematically, the increasing role of government becomes an economically unsustainable burden at some point is a good question. Sorry. I’m afraid I can’t help you there!

  3. Pete,
    I’m afraid that you have misunderstood my comment. The basis for any capitalistic economy is productivity. Until someone either grows or mines resources and creates a product, the wheels of commerce are at a standstill. I didn’t say that government wasn’t necessary, I said that government services are in the non-productive sector, which they are.

    If my memory serves me correctly, government has grown from about 7.5 private workers for each government worker to the current 1.5 to 1. This growth in the non-productive sector is unsustainable and is a large contributor to our rising national debt.

  4. Pete Murphy says:

    We’re probably just stuck on semantics here, Mike. You’re defining a product as something tangible. I’m extending the definition to include services, including government services, that are not tangible objects but are still necessary. A teacher in a classroom, though an employee of the local school district and thus a government employee, still provides a “product” that is necessary and consumed by the community.

    Regarding the ratio you’ve quoted, I have no idea what this ratio might be. You say it’s now between 1.5 and 1.0 private workers for each government worker. So, since our total workforce is about 150 million, are you saying that between 60 and 75 million people are employed by the government (federal, state and local)? This sounds very high but I’m not saying it’s wrong. Can you point me to some source for this data? Wow, if the collective governments laid off 10% of their workers, it’d send unemployment through the roof!

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