Bernard Hickey: Headwinds head off further growth

Taking on debt makes sense when future income growth can pay for it. Photo / Thinkstock

Just imagine if economic growth wasn't a natural thing.

What if the extraordinary growth seen throughout the developed and developing world since 1700 ended around the turn of the century? What if the long-term growth assumption of around 2 to 3 per cent a year ad infinitum was actually wrong?

How would that change our view of our economy, our social development and our political outlooks?

That's the debate sparked internationally by a stunning academic paper from respected US economist Robert J. Gordon: Is US Economic Growth Over: Faltering Innovation Confronts The 6 Headwinds.

If proven, the implications of his thesis are sobering. Gordon argues there was very little real economic growth per capita before 1700. Since then three eras of innovation have powered amazing growth. The first, from 1750 to 1830, included the invention of steam and railroads. The second, from 1870 to 1900, gave us the internal combustion engine, chemicals, petroleum, plumbing and communications. The third era, after 1960, brought computers, mobile phones and the internet.

Gordon argues the second era created the most growth, and the third era's boost to growth was relatively short-lived, ending around 2004.

He says growth in developed economies such as the US may drop to less than half the rate seen since 1870 as innovation battles an ageing population, a low birthrate, a plateau in education, rising wealth inequality, globalisation, global warming, and debt overhangs.

Gordon's conclusion? "A provocative 'exercise in subtraction' suggests that future growth in consumption per capita for the bottom 99 per cent of the income distribution could fall below 0.5 per cent per year for an extended period of decades."

If the developed world's growth rate falls to that level for decades to come, politicians and voters would have to change all sorts of assumptions, including how much debt can be loaded on future voters, how to distribute income and how to invest in infrastructure.

Taking on debt makes sense when future income growth can pay for it. A pay-as-you-go pension and health system makes sense when economic growth in future can "overcome" the effects of an ageing population.

Widening disparities in wealth and income between the lower/middle 90 per cent and the top 10 per cent can be assumed away when there's enough future economic growth to lift everyone's boat.

Removing that assumption about 3 per cent growth changes everything. Politicians and voters have been saying for years now that innovation will solve the problems. Unfortunately, that hasn't happened for 40 years, in part because investment in new science has lagged behind the explosive growth at the turn of the 20th century.

Do we wait and hope for a growth miracle or cut our cloth to the new normal?