For those of you just joining this discussion, I’ve been ruminating for the past couple of months on the nature of economic growth and its relationship to the (as it turns out, quite vague) concept we call “value.” You can read the first two essays on this topic here and here. In the first, I explained how I reached the conclusion that value is an entirely separate concept from money, even though money is often used as a proxy for value. In the second, I responded to some reader comments to clarify what I was after, and posited that value comes from two concepts: 1) productivity, and 2) happiness. When we left off last time, we were talking about the crucial role of externalities in this discussion, and as a first step toward demonstrating that any intelligent policy or strategy regarding economic growth must fully account for those externalities, I proposed to map out the way in which one of the most common measures of economic health, the volume of economic transactions, can be increased.

I’ve chosen to limit the conversation for now to transactions for goods and services, even though I think it’s a crappy measure of value, because I want to demonstrate how even in this most familiar territory to economists, externalities play a huge role. The umbrella concept of “social good,” under which concepts like environmentalism and public health reside, is usually thought of as fundamentally separate from a country’s, a system’s, a world’s economic health. But as you’ll see below and as I’ll explore in more detail in the next post, they are in fact inextricably linked.

The diagram you see above is what’s known as a “theory of change” (or, in some corners, a “logic model”), a tool commonly used in the philanthropic sector. In this case, I’ve applied it to the concept of increasing economic transactions for goods and services, which is more or less the idea behind GDP. In a policy-level theory of change, the basic process is first to identify the goal that we want to achieve, and then walk back the logical steps leading to that goal. We continue this process iteratively until we finally arrive at actions, concrete steps that we can take today or tomorrow that will set us along the path to achieving the goal. It’s an incredibly powerful tool that has uses in all sorts of contexts. In this case, I’m using it to think about the nature of value.

I’ve identified seven antecedents to increased transactions for goods and services, as follows:

More people want goods and services. Pretty self-explanatory, this is about increasing the demand for stuff by increasing the number of active buyers in the market. This could take place through a population increase, by means of people living longer (which I guess can also lead to population increase), and through bringing people in to the market who weren’t buying before, principally by activating the purchasing power of the “bottom of the pyramid” — the 40% of the world’s population that currently lives on $2 or less a day).

Greater capacity to provide goods and services. The supply-side corollary to the above. It doesn’t do much good if more people want goods and services if capacity doesn’t exist to produce those goods and services. There’s both a human dimension and a, shall we say, non-sentient dimension to this. First, we can increase capacity to produce things by putting more people to work. If there are more people in the world (because of a population increase) or more people work who weren’t working before (e.g., women, children, the elderly), that increases the world’s productive capacity. But it’s not just about humans: if we can make machines to do our work for us, or take better advantage of natural resources, or come up with new operational processes and organizational systems that increase efficiency, all of these things increase productive capacity as well.

Greater variety of goods and services available. Most consumers do not have an infinite taste for any given product, especially products that are durable and not essential necessities of life. No matter how useful they might find the product, they’re only going to want so many. But if there are new kinds of products to choose from, the consumer might well buy some of them, thus increasing the net total of transactions. New products with market appeal will generally fall into one of three categories: complements to existing products that make them more appealing or useful (think a protective case for your iPhone, or a bar to go along with a new music venue); substitutes for existing products that make the older editions obsolete (think new versions of old software, or the updated car designs that come out every year); or entirely new concepts that often feature some sort of disruptive innovation and have little precedent in previous products (think the television or the phonograph).

People buy more previously available goods and services. Sometimes increasing transactions is as simple as making sure people know that the available goods exist. That’s where marketing comes in, though at its extreme (or most professional) it can take on the more sinister role of artificially inducing demand by preying on humans’ psychological quirks. [That’s one reason why this model is incomplete: by making increased transactions the sole stated goal, it endorses several socially undesirable practices (like this one, or child labor) as legitimate intermediate outcomes. We’ll address this in the next post.] The other way in which people might buy more previously available goods and services is if those goods and services suddenly become more useful–either because someone figured out a new use for them, or because a new product, desirable in itself, uses the old product as a complement. (Think old TV shows, which found a new life because of cable television and specifically Nick at Nite.)

Buying and selling becomes easier and/or faster. Sometimes, even if there’s a buyer and a seller, making a transaction can be costly or difficult. If someone in Peoria has a copy of an out-of-print book and you’re in San Francisco looking for that book, you’re not going to find it. Or at least that was the case before Amazon Marketplace and eBay. Now, it’s a few clicks of a mouse and we’re off to the library. Technologies like these increase the velocity of money–the frequency at which transactions can happen, and thus the overall number of transactions.

People spend money instead of hoarding it. Assuming money is the currency of transactions, it doesn’t serve the goal in question when people who could engage in transactions elect not to because they are afraid of running out. When that happens, trade dries up and the possibilities start to contract, as we’re seeing in this latest recession. Clearly, confidence–on the part of consumers, investors, and firms alike–is important, as is liquidity (the ability to access quickly and easily what financial assets you do have).

Impending market disruptions are avoided. I chose my wording here carefully, because just avoiding market disruptions doesn’t lead to increased transactions. You have to avoid market disruptions that would have happened had you not taken steps to avoid them. Now, we obviously don’t know exactly what’s going to happen in the future, so the easiest way to think about this problem is in terms of risk. The list of possible catastrophes that could result in a major hindrance of market activity is endless, but some of the more obvious risks include war (including nuclear war); natural disasters such as hurricanes, tornadoes, floods, and earthquakes; terrorism (physical or electronic); environmental problems, most notably global warming; and systemic financial risk of the kind that we saw in the recent banking crisis. Taking care of (or just mitigating) a problem with a high severity and high risk will provide the greatest benefit to the ultimate goal, increased financial transactions.

This theory of change for economic growth is just a first cut – the result of maybe a couple hours’ worth of thinking about the question systematically. If you have thoughts about how it could be improved, I welcome your input. I can already name a couple of deficiencies: it only goes three levels deep, which leaves out quite a lot of detail — and even then, of course, it only considers a very narrow conception of economic growth. But you can already see how, even using pure GDP as the end goal, traditional economic growth strategies (cut taxes! deregulate!) only address a small portion of the relevant levers. Issues that we’re accustomed to thinking of as totally separate from economic development, including fighting global warming, working towards peace and security in the Middle East, increasing the life expectancy of our citizens through better health care, and extending a helping hand to the world’s poorest citizens, are all directly linked to economic growth. And if economic health is more than just the volume of transactions, if it’s in fact about improving quality of life, then these supposedly “external” considerations are all the more important.

  • Mike

    Why put this all in terms of Growth? Aren't there any other policy-motivating principles, economic or otherwise, that should impact the rubric of choices that will affect our collective future? There were an interesting series of articles in a special issue of New Scientist last fall titled "The Folly of Growth". After reading those articles I'm now more sensitive to what sometimes seems like the reflexive use of a Growth-based mindset. Of course, (extremely difficult) systematic changes in the U.S. and elsewhere would have to occur in order to topple Growth as the golden cow. (not rhetorical question:) Is there room to consider these alternatives in this discussion?

  • Ian David Moss

    Hi Mike,
    I couldn't agree with you more that growth is not an especially useful metric for economic (or societal) health. One thing I learned in business school, though, is just how ingrained growth is to economic and financial definitions of success–not just in a conceptual way, but also in terms of how incentives are structured for managerial and investor behavior. ALL of the signposts in the business world point not just toward continual growth, but toward MAXIMIZING growth ALL the time. That is how people are judged in that world. So while I agree with you that the focus on growth is dysfunctional, I've decided not to attack it directly right now because I think the non-focus on externalities, which in my opinion is equally dysfunctional, is slightly lower-hanging fruit. Let's see where we get with this line of inquiry and I promise I will not forget about the need for other ultimate measures of success than the "perpetual more, more, more."

  • Ally

    I hear a lot about 'reductionist' approaches and 'maximising growth'.

    In a business school – of course you are going to learn about maximising profits. That is the point of business. In a market economy, the pursuit of profit is clearly the dominant paradigm in the private sector. Without generating revenue, you cannot incur any costs. Without increasing revenue, you contract, become less competitive, etc.

    In economics, 'economic growth' as you describe was never discussed like many people claim.

    I am all for 'no more growth' but in a business world, this could be disasterous. Capitalism is to blame for this preoccupation with economic growth, it is for the public to decide whether that is the type of economic system we want. If it is, we have to analyse it