The Purpose of Economic Growth

An economy is meant to serve human wants. To that end it seeks to provide the appropriate mix of goods and services. Wants in turn are manifestations of more basic needs. They are a means to an end. The means can change but the wants remain the same. Economic growth arises from a number of factors. Primarily, economic growth is a measure of consumption. Greater consumption leads to greater economic growth. Growth also comes from innovation. New products and services are different methods of servicing needs which in turn create new markets.

The main concern of people lies in economic growth. Faster economic growth is good. Slower is bad. In a way this makes sense. The economy has to grow as fast as population growth in order to provide young people with the necessary jobs that they will need as they enter the work force. That at least is the theory.  However a single minded focus on economic growth essentially ignores the issue of the type of economic growth. We can have (sometimes strong) economic growth without a necessary increase in job opportunities. An emphasis on encouraging capital intensive industries will lead to economic growth but will such industries provide wide scale job opportunities? Promoting service industries will again lead to economic growth but what kind of jobs will be generated? High income? Low income? What about prospects for advancement? Also consider that focusing solely on economic growth means that we are looking at the existing mix of goods and services and the companies that provide the same. It ignores new kinds of goods and services that may develop in the future and become economically important. For example, social media as an economic activity essentially did not exist a decade ago. Today they are multi-billion dollar businesses.

Then there is the question of distributing the fruits of economic growth. In India, the BJP government oversaw 5 years of strong economic growth. Their election slogan highlighted this and emphasized the future of "Shining India". Yet they were thrown out of office. Why? The fruits of economic growth were confined to a relatively narrow segment of the Indian population. A large majority saw their lives and well being worsening in the same period. This was a case of strong but blind economic growth. Part of the roots of the recent Arab uprising in the Middle East lies in economic growth which did not trickle down. Most people assume that strong economic growth alone will result in a general improvement in living standards due to a trickle down effect. But the empirical evidence does not support this argument. Most if not all the gains of economic growth are captured by a relatively small class of people who generally speaking are not interested in much trickling down. In country after country, government intervention proved necessary in order to ensure a more equitable distribution of the benefits of economic growth.

I believe that the purpose of economic growth is not in growth by itself. Economic growth is a means to an end. The end is (or should be) minimizing opportunity inequalities. An important component of this is reducing income inequalities. Poverty not only forces people to scramble to put food on the table and a roof over the head, it also prevents people from realizing their potential. That in turn lowers long term economic growth. High levels of poverty literally act as a brake on economic growth as it limits the opportunities available. It should also be noted that very high income levels often also inhibit people from realizing their potential. This is a reverse effect of a high poverty level as very high income levels lead to a satisfaction with the status quo and the sheer number of opportunities available can have a paralyzing effect.

Related articles

• Amartya Sen on Growth and Well-Being (economix.blogs.nytimes.com)

Are Corporations Necessary?

Division of labor results in specialization. This was clearly established by Adam Smith more than 200 years ago and has been a central tenet of the modern capitalist economic system. We are all specialists. We depend on others for most of the goods and services that we need. For over a 150 years now, corporations have been the primary mechanism by which we have had access to these. Corporations made sense in the past. By pooling together large sums of money and bringing together people working towards a common purpose, corporations could lower the cost of providing us with what we (think we) need. Changes resulting from industrialization helped this process along. National markets became possible and cost effective to serve. International trade progressively became easier as international linkages increased and strengthened and the cost of transportation and communication steadily fell. Firms could become larger and larger in size and thus service their customers with ever greater cost effectiveness.

However, a funny thing has happened. The same factors which helped spur the rise of corporations kept developing and today increasingly favor alternative forms of business association. Transportation and communication links steadily strengthened, became cheaper and more importantly became more personal. National markets were woven more tightly together as internal trade barriers were eliminated. WTO was envisioned as a means of lowering barriers for corporations. It has had the effect of also doing the same for looser associations and individuals.

However, it is still difficult to answer whether corporations can be done away with entirely. It is now certainly possible to for smaller firms to compete successfully against larger ones in many areas of the economy. Many but not all. In some areas (like petrochemicals) size definitely matters and here larger corporations have a definite advantage. Even in these areas, there are niches where further development is possible and smaller, looser organizations are often better equipped to tackle such areas. Certainly, corporations as they have evolved have imposed liabilities on societies and individuals which are only now becoming apparent. But if corporations are to be done away with, what can replace them. To that, there is no easy answer.

Related articles

• Continuing the Conversation on Free Trade (economix.blogs.nytimes.com)
• "Was Adam Smith Wrong on Rising Real Wages And the Spread of Opulence?" (economistsview.typepad.com)
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Why Corporations?

In the current series of posts regarding corporations, I have asked the question do we need corporations? In exploring this question, I then looked why the need for corporations arose in the first place. Related to this is the question of what advantages and disadvantages accrue from having corporations.

Consider two things. Most products and services today require a complex interplay of multiple factors. Corporations are also essentially large groupings of people come together for a common purpose. So in order to bring a product or service to market various tasks need to be performed. In the past, the cost of doing those tasks internally was lower than having them done from the outside. This was a major advantage to forming a corporation. However, while the costs are lower, nevertheless they are present. Also, accounting systems do not capture all the costs of internal transactions. Often, the costs that are not quantized are inherently difficult (and in the past were almost certainly impossible) to do so. So corporations incur costs when going about their business. Some of those costs are quantified by accounting systems. Others are at best estimated and still others are ignored altogether.

Globalization has greatly increased the complexity of doing business. Advances in transportation and communication technologies and a concomitant reduction in the cost of the same has resulted in long, complex supply chains that are nevertheless able to supply technically advanced products at ever reducing real costs. Corporations have taken full advantage of these trends. However these same trends have also lessened the traditional advantages of corporations. If a particular product can be manufactured overseas, what prevents it from being designed overseas as well? The question then becomes can we do away with corporations altogether?

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Why Did Corporations Arise?

If we want to explore the question do we need corporations, we need to at the very least look at the origin. Why did the need for corporations arise in the first place? Corporations are a fairly recent invention. Most economic interactions in the past featured individuals and not corporations. Even the oldest of these creatures are at most a few centuries old.

The need for corporations arose due to a combination of increasing costs, risk and complexity. The combination of these factors meant that it started to become too risky for any individual to engage in transactions particularly foreign ones. The answer was to find some mechanism with which to share the risks with others. This also meant that the rewards associated with the successful completion of the project needed to be shared as well and a mechanism for that also had to be developed. This was the beginnings of corporations.

The start of industrialization provided a big boost to corporations. Industrialization enabled new, mechanized, faster processes. At the same time, it increased the rewards of meeting a market need by steadily and drastically lowering local and international transportation and communication costs. This meant that increasingly people needed to work together in larger groups to accomplish a common purpose. This provided a major impetus to formalize this arrangement; in other words, the modern corporation was born.

The new entity adopted a command and control mechanism because at that time, this was the most efficient way of lowering transactional costs. The problems of managing a large group of people focused on a common goal had first been encountered by the development of professional armed forces and the solutions these had come up with were adapted in a civilian setting. The structure thus formed has proven to be remarkably durable. It has been adopted and adapted worldwide and still continues to thrive despite major recent technological, political and social developments. The question thus arises: has this structure become anachronistic or is it still relevant to the needs of the future?

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Do We Need Corporations?

Corporation are an important facet of our existence. We depend on corporations for nearly all the goods and services that we consume. More than any welfare system, corporations envelop us from cradle to grave. The academic discipline of Business Administration emerged as a result of the rise and increasing importance of corporations. Today, it is virtually impossible to advance in an established firm without having a Business Administration degree. Corporations are so embedded into our economic system that the vast majority of trade in the world occurs within and between corporations.

Whenever there is a debate about the global economic system, there is always this unspoken assumptions that corporations are necessary, indeed vital and permanent. Individual corporations may come and go but as a system, corporations will always be there. So perhaps it is pertinent to ask do we need corporations?

The question posed above actually embeds several questions in itself. The most important of these questions is what set of circumstances are most propitious for corporations? Other questions that arise are why did the need for corporations arise in the first place?  The particular form of corporations that generally exists today has remained unchanged for several decades now. This persistence has occurred despite major political, economic and social changes in the local and global environment within which corporations are embedded and within which they operate. Is this form still the most appropriate in today's environment? If yes, will it remain so in the future? What kind of economic structure is most appropriate for today and tomorrow's environment?

I believe that these are important questions that very few people are asking. The answers are not clear but they are bound to be multi-faceted and complex. This is an exploration that needs to be taken for the sake of our future. In future posts, I will try to explore each of these ideas in greater depth.

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The Guild System

One of the many effects of industrialization was the decline and disappearance of guilds. Guilds could be found in all parts of the world during the pre-industrial era. In earlier eras, they served an important role in preserving and transmitting knowledge of their statecraft over the years. This was a necessary steps for much of history since political structures were rarely durable. In those empires that lasted for long periods of time (e.g. Rome and China), there were long periods of turbulence within the empire. Guilds were a source of stability and protection in such times. It was primarily because of guilds that rulers in many parts of the world were able to construct grandiose structures. Since the guild system was designed to preserve knowledge and transmit it to the next generation, they were inherently conservative. This was fine before industrialization since changes came slowly and practices could persist relatively unchanged for centuries.

However, with industrialization came change at an ever accelerating pace. The inherent conservativeness of guilds became obstructive to new ways of thinking and doing things that were now required. The incentive to operate outside the guild system became greater and opportunities to do so became easier. These factors among others caused guilds to decline in importance and over time they were eventually banned in most countries.

However, has the guild system actually disappeared or has it morphed into new shapes and forms? While the basic purpose of guilds was to preserve and transmit knowledge, they were also an important control mechanism. Guilds could control who entered the system and who did not. They also controlled the means by which knowledge transfer could take place as well as the kinds of knowledge that were preserved and transferred. In other words, guilds helped to enforce and transmit an orthodoxy of thought. The question is that has this basic purpose disappeared in the modern era? If anything, control of knowledge - the kind of knowledge and the mechanism of knowledge transfer - has become even more important. In that sense, guilds have not only not disappeared, they are in fact thriving as never before!

Are Markets Moral?

A market based economy is an amazing system to behold. It is capable of taking inputs that are often available at irregular intervals and converts them into outputs that are dependably available all year round. And it does this generally at an affordable price for a majority of consumers. It is no wonder that economists generally love the market mechanism and view it with a wonder which sometimes approaches awe.

Is it a moral system? Economists by and large view interventions into the market as distortions that prevent an optimal allocation of resources. Taking this argument to its logical conclusion implies that society should not attempt to intervene in any manner for any good or service. No society past or present has been willing to do this. doing this implies that services like prostitution and goods like drugs be allowed free operation. The market system as a system makes absolutely no value judgement on any activity. Instead different societies make their individual value judgements on different goods and services on offer. Inevitably these value judgements distort the free operation of the market and thereby prevent an optimal allocation of resources.

There is also a large grey area where it is not clear if there should be an intervention in the free operation of the market. Most financial services for example tend to fall into such an area. The problem is that many if not most financial products have now become so complex that understanding them is essentially beyond the grasp of any reasonably educated, reasonably intelligent person. This is where moral values come into play. Should such products be peddled to persons who will be unable to understand what they are getting into? Keep in mind that one of the assumptions behind economist's model of the free market is equality (or at least parity) of information between the buyer and the seller. In turn, equality (or parity) of information implies an equal (or roughly similar) understanding of what the information means. However such an assumption is not necessary for a market economy to work. Remember that the market system by itself makes no value judgements. No good, service, action, information etc. is inherently right or wrong, good or bad from the system's point of view. Such judgements have to be imposed by the people who live within the particular economic structure. So should complex financial products be sold to people who have no idea what they are buying? The system by itself will not prevent anyone from doing so. The classic defense of such actions is that no one is forcing people to buy such products as well. This is true enough but this argument simply highlights the amoral nature of a market based system.

So markets are amoral. They make no value judgements. Neither do they by themselves impose any. This is what makes a market based system so seductive and at the same time so dangerous.

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