Originally posted on NewDeal20.org

Underlying most debates about economic policy lurks a single question: what causes economic growth? This question is key when an economy is stagnating or declining. The answer decides the fates of Presidents, political parties, and whole nations.

In my first post in this series I argued that an economy can be usefully viewed as an ecosystem comprised of different chunks or niches. Each niche, like manufacturing, fulfills a critical function. Today I want to explain how this perspective can give us a better understanding of what causes economic growth than what’s offered by mainstream neoclassical economics. Armed with a better explanation of the dynamics of growth, we can offer better and more effective policy prescriptions than those driven by the current obsession with austerity and lower taxes.

Surprisingly, neoclassical economists have not had much luck explaining economic growth. Nobel-laureate Robert Solow, who is the most important growth theoretician, calculated in the 1950s that neoclassical economics could only explain about 20% of economic growth; the rest was “technological change,” which has been impervious to neoclassical analysis ever since. And yet, according to the economic historian Angus Maddison, between 1913 and 1989 income per person in most developed countries increased almost five times (see chapter 7 of my book, “Manufacturing Green Prosperity,” and also here). So how can neoclassical economics call itself a science if it can’t explain its single most important phenomenon in the economic universe? What if physics couldn’t explain why planets revolve around the sun?
The problem is that neoclassical economics relies on a model of reality that is similar to the model use by physicists to understand things like gases and fluids. There is no growth in a gas or fluid. When things change too fast in a gas, for instance, the system explodes –- it’s all very unstable and stressful. But neoclassical economics doesn’t have the analytical tools to explain growth because it bases its understanding of production on David Ricardo’s concept of “diminishing returns”. You can’t explain how something grows if you are using a concept that explains why something diminishes.

There is, however, a science that is very comfortable with the idea of accelerating growth – biology, and in particular, evolutionary biology and ecology. Organisms reproduce — bees do it, birds do it, and as I will argue, machinery does it, too. Reproduction leads to exponential growth, that is, steady growth that builds on itself, and that can even accelerate.

But how can we have growth forever and not destroy the planet — or, to be more precise, the biosphere? Again, ecology is comfortable with this issue, because it is a fundamental aspect of all ecosystems that there must be balanced growth. In other words, no one part of the ecosystem can run out-of-control and reproduce forever. No part of a sustainable ecosystem can produce something — like greenhouse gases or pollution — that destroys the ecosystem as a whole.

Well, then, how can we keep economic growth going and not destroy the ecological foundations of the economy? In both natural and economic ecosystems, there are two main sources of change: technological change, and change in the quantity of the output of the various parts of the system. In a natural ecosystem, technological change takes place in the form of “variations”, as Charles Darwin called them, of the offspring of organisms. We now know that DNA controls these changes. And depending on how these genetic “variations” fit into their environment, their populations may increase or decrease in size, which then feeds changes back into the ecosystem.

In a manufacturing ecosystem, the processes of change are similar. In order to understand this, we have to delve a little deeper into the “natural history” of manufacturing. The most important parts of the manufacturing system are the machinery niches, or industries. These are the ones that provide the equipment for the factories that output the manufactured goods that the society uses. When these technologies change, it becomes possible to create different kinds of goods, or to create more goods with the same resources. But how are these kinds of factory machinery made?

At the center of the economy resides a set of extremely important machinery industries –- let’s call them “reproduction machinery” –- which, if we continue with our ecological metaphor, can be viewed as collectively reproducing themselves. And since they can reproduce themselves, like birds and bees do, they can drive the economic growth of the economy, decade after decade, century after century.

Now you may be more familiar with the organisms that inhabit the volcanic vents in the deep Atlantic than you are with these kinds of machinery, but they are not that difficult to understand. There are machine tools, the machines that make parts (usually steel) that are used to produce most other machines, from cars to new machine tools. So machine tools can make more machine tools. However, they do it with help from other reproduction machinery – for instance, steel-making equipment, the huge pieces of machinery that take molten iron, carbon, and a few other elements and output the various kinds of steel that keep the current civilization running – such as the steel for the machine tools.

So we have machinery that creates the substance. We have material used for other machinery. And we have machinery that forms or shapes this material. Form and substance are two helpful categories of production that are nice to have control of if you want a modern civilization. Of course, we also need energy, and the main energy for making machinery is not oil, but electricity. We hope that machines like windmills can become the dominant way to make this electricity, but currently something called an electricity-generating steam turbine does the trick, formed out of steel, using machine tools. Once we have energy, we certainly want to be able to process information, and so we have semiconductor-making equipment, which makes the semiconductors that make all the other machinery better and better, including other semiconductor-making equipment.

When reproduction machinery gets better, everything else gets qualitatively better. When there is more reproduction machinery, there can be more of everything else – which becomes a problem if we are using everything up and destroying the environment and the climate. So we need to concentrate on making everything qualitatively better, not increasing everything quantitatively. This means living in moderately-sized living spaces, for example, and making them much more comfortable and efficient. It means using the same amount of space in a city to house more people, but making the city more comfortable and efficient. And it means using wind instead of coal, computers instead of paper, and electric vehicles that are more comfortable and efficient instead of oil-based ones. And recycling everything, just like a natural ecosystem.

The machinery industries are critical, both for economic growth in general, and in particular to create the kind of economic growth that is ecologically sustainable. They are more important for the optimal functioning of the economy than, say, the level of taxes or deficits or regulation. And yet, the United States has allowed its machinery industries to decline from 50% of world output to less than China’s 16%. Unfortunately, much of what remains is owned by foreign companies, and they do the high-value engineering outside the US. For the neoclassical economist, this is not a problem, because in the neoclassical world, the economy is global. In my next post, I will explain why economies are actually based on world regions – like the United States. And I will show why and how governments must design these world regional economies instead of relying on a simplistic model of markets based on outdated and faulty economic thinking.