Why does the economy grow?
When we look at the natural world we see cycles of growth and decline. Gardens sprout in the spring, bear fruit in the summer, and die back in the fall. Populations of rabbits and deer grow until they’re everywhere and then collapse. Rivers go into flood, then slow to a trickle. Only with economies do we see steady, long-term growth. A generation ago cars only went 100 thousand miles or so, and you had to wait for weeks to get parts to repair them. Several generations ago people were just getting indoor plumbing. We’re a lot better off now. Why is this?
It’s been said that the economy is more productive now because we’re smarter than we used to be. That’s not exactly true–human nature hasn’t changed. Conflict and war is still common; leaders are still felled by hubris and overreach; education and study are still hard work. But living standards have been rising steadily for 200 to 300 years. Why?
Two centuries of economic research have shown that economies grow because they accumulate capital– human, physical, or financial–and the more flexible that capital is, the more steady that growth will be. That is, if you can shift a railroad from shipping coal to shipping oil, the line won’t go unused (and jobs lost) when the price of oil declines dramatically. Dolphins don’t build factories, and chipmunks don’t trade with field mice.
That’s why the natural world is an imperfect model for understanding the economy. And the faster the economy grows, the better-off everyone is.
Douglas R. Tengdin, CFA
Chief Investment Officer