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Productivity Is King And Why GDP Growth Is A Fallacy

As humans we tend to become obsessive, one of the more recent obsessions is our one with GDP growth. But, this perhaps is understandable given growth is desired by all and we are in a moment of respite. However, should we really be focusing on "quarterly GDP growth" and "debt to GDP" as much as we are?

Simply put; No! GDP is a generally useful measure of growth, but it is flawed.

1. Any growth in consumption, which is greater than growth in income, is growth borrowed from tomorrow's consumption. Whether that is on a governmental or private level.

2. Inventory cycles highly fluctuate GDP growth

For instance, this quarter US companies could build inventory from scarcely any to full "storage" capacity, consumers and governments meanwhile could increase their quarterly consumption by 3% through borrowing and running down of any savings while their incomes only grow by 0.5%. All of these things would have a dramatic effect on GDP growth, and probably notch up quarterly gains of close to 3-5% (annualised 13-22 %!). Now, I hear you, not all of the "borrowed" money will have to be paid back as such because of the multiplier effect. The companies who dramatically increased their inventory needed to pay workers overtime, and employ new workers and the government which went on a spending binge hired x new teachers and y new policemen - All in all income rose, greater than it otherwise would with less public spending and private inventory build. This increase in income, means households have more spend, and the debt incurred through the buying binge is less worrisome today with a higher income than it looked yesterday with a lower income.

But, all of the above is short term. It is important for cyclicality, it is important for short duration investing, however it is does not create any long term growth. Had the above just continued recklessly and not returned to normal, the gains eventually would all be marked down as inflationary as we aren't actually producing any more growth in the real sense of the word - productivity!

Productivity is the key to all economic success. History gives us an overwhelming demonstration of this. None more so that the Industrial Revolution. An industrial revolution is the process of mechanization in all sectors as to allow more efficient and greater economic output for the three economic factors of production; land, labor and capital. This process occurred in the 18-19th centuries in the western world and has in fact continued ever since. A fantastic example of this is the 1950's where the hours needed to produce a car in the United States fell by half and IBM computers sped up the services industry. To the short-term GDP fanatic, this type of innovation causes economic carnage, fewer people are needed to produce the same output, incomes will then fall thus consumption and ultimately GDP will fall. In some ways history does show this view to be partially right; the 19th century was a hotbed of recession and depression as the still immature western economies were managing large economic cyclicality and notably still a reliance on the highly seasonal agricultural sector - the pre-industrial "home" of economic growth. But for one who had got obsessed and turned bearish they would have missed the greatest period of growth in human history. One which is being paralleled today in Emerging markets, they are all having their own industrial revolutions, as labor intensive industries are replaced by automation.

So, if productivity is growth. What have we seen in the last 10 years in the western world to indicate that things are improving and we are ultimately growing? Perhaps one could look at European oil consumption, which has been gradually falling, even as miles driven have risen. Why? Engines are becoming more efficient. But for me the most obvious sign of these productivity increases are the advances in mobile phones. Companies today, both multinationals and small businesses can communicate to far branches or suppliers in seconds. Today, I can learn a language more easily than ever; through e-learning, through the app on my i-phone which allows me to create flip reminder cards and test myself - instead of endlessly writing and cutting my own and carrying round with me. Today I can check if my train has been cancelled before I get to the station on my phone and be better positioned to get where I need to be on time, and not waste my time. Today tractors can drive themselves; they can minimize the route and thus minimize energy consumption. Today as a CFO, he can more quickly and accurately use software to calculate a complex financial situation, instead of wait for human labor to do it in days. Look to Moore's law where chip speeds have consistently and continue to double approximately every 18 months.

Simply put, the world is becoming more efficient. Productivity is only going to increase over time, for technology is never forgotten only bettered. Thus do not miss the forest for the trees and be obsessed with short term GDP growth, look around you and see the 21st century technological revolution that is driving long run economic growth.