Neither Free Trade Nor Immigration, Nor Lower Taxes Causes Economic Growth
You hear it again and again from the media: “free trade causes economic growth”, or “we need more immigrants to sustain the economy”.
That’s a load of malarkey.
Free trade doesn’t always cause the economy to grow. Neither does immigration. Nor lower taxes.
Each may have its part to play, but at the end of the day, long run economic growth is caused by increasing productivity—which is itself enabled by better technology.
How do you improve technology? Black swan events.
Here’s how economies grow in language non-economists can understand. If you’re looking for something a little more verbose, then read my book on the subject.
What Is It Economic Growth? A Definition
Economic growth is best defined as an increase in output, either in quantity or quality (this is basically what GDP accounts for).
There are only 2 ways to increase output:
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Make more stuff.
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Make better stuff.
And by stuff, I mean just about anything, including goods (like crayons, movies) and services (massages, tax services).
It’s that simple. For example:
Pretend Robinson Crusoe gets stranded on (another) desert island, which he names “Sadness”. The guy just can’t catch a break.
But he’s been in this predicament before, so at least he knows what to do. He gets to work.
During the first year of his “vacation”, Crusoe grows 500 lbs of apples and makes a (crappy) raft. Not bad, but he can do better.
The next year he steps his game up, and manages to grow 600 lbs of apples and makes a (less-crappy) canoe.
Crusoe’s unlucky, but he’s certainly not lazy. Not only did he grow 20% more apples, but his canoe’s 20% more seaworthy (still not good enough to cross the Atlantic).
All totaled, Sadness’ economy grew by 20% that year, since Crusoe made both 20% more stuff (apples) and 20% better stuff (he made the same number of boats, but the canoe was better).
Good job Robinson. Don’t let the cannibals get you.
Economies Grow When Output Increases
Easy enough. Let’s dig deeper.
There are only 2 ways to make more stuff:
1. Work harder (increase the hours labored).
It’s pretty straightforward: if you want more wheat, sow more fields; if you want more bobble-heads, build another factory; if you want more legal research, work overtime. In all cases, you have to add more labor.
More work, more stuff.
This option only works until everyone has a job, and no one wants additional work. Eventually, you run out of workers.
This is how the ancient (and pre-modern) economy generally worked. The Greeks and Romans solved this problem by (i) conquering territory or (ii) buying slaves—they increased the number of workers in their state.
The modern world does this through immigration and offshoring. In both cases, this option is finite—you can only work so hard.
2. Work smarter (increase productivity).
Increasing productivity means getting more work done per hour (as opposed to working more hours). In other words, it means you’re working more efficiently.
For example: if you can make 105 widgets per hour, you’re 5% more productive than your lazy buddy who only makes 100 widgets an hour.
Increasing productivity means real economic growth. and increased prosperity, because we get more stuff with less work.
Isn’t that the whole point?
Harder or Smarter?
It’s better to work smarter. Why?
Adding labor gives us geometric gains—there’s a one-to-one correspondence between economic growth and the number of people working. Therefore, real economic growth only occurs when the country gets bigger (through things like conquest or immigration).
Furthermore, since there are only so many workers, and so many hours in a day, the economy can only get so big under this model.
It’s zero-sum. You can only get richer by making someone poorer.
Working smarter gives us exponential gains. Increasing productivity (usually through better technology) can make workers many times more efficient.
This helps everyone and hurts nobody.
For example, when Edmund Cartwright invented the power loom in 1785, his invention made British weavers 40 times more productive. This helped cause the economic boom known as the industrial revolution.
Not only that, but there’s no upper limit to productivity gains (aside from human creativity). Just consider how much more efficient today’s factories are than those in the 1970s, the 1940s, even the 1840s—the same thing goes for the economy as a whole, all throughout the Western world.
This explains why productivity is so important to actual economic growth.
Real long term economic growth is caused by productivity gains—it’s all about doing more with less.
How Do We Improve Labor Productivity?
Since increasing productivity grows the economy (which is good), the next step is to figure out how to increase productivity.
Basically, we have to get better at making stuff.
There are a few ways to do this. For example, we could focus harder at work by drinking lots of coffee—in a caffeine-infused fervor we could make 11 widgets an hour, rather than 10.
Or, we could organize our labor more efficiently, like Henry Ford did with the assembly line. We could also let people who are better at doing stuff do it for us, and trade with them (ie. maximize our comparative advantage).
The problem with these suggestions is that they have the same problem as working harder: things can only be made so efficiently with our current technology. Once we hit that peak, that’s it. No more economic growth.
Lucky for us, there’s a better option.
The Impact Of Advancing Technology On Productivity & Economic Growth
The only way to perpetually boost our productivity, and therefore get richer, is to continuously advance our technology.
Better technology allows us to make more stuff, by improving our productivity. Recall how much more productive the power loom made British weavers. The same is true of inventions like the light bulb, railways, and concrete.
The faster technology grows, and is adopted, the faster the economy grows.
History makes this clear.
For example, the economic might of Renaissance Venice was caused by an innovation in ship design, which allowed them to build the ship’s hull and frame independently. This made their port the most productive in the world.
The same is true in Britain. The Industrial Revolution, and the modern world itself, owes its existence to inventions like the steam engine and the power loom. This huge burst of real economic growth resulted in standard of living gains across the board, for rich and poor alike.
This also holds in the modern world.
Productivity-boosting inventions like the personal computer and word-processing software have been the primary drivers of actual economic growth, helping multinational accounting firms and mom & pop shops alike to work more efficiently.
Historically, long run economic growth and wealth has always followed productivity-boosting inventions—not freer trade etc.
At its heart, economic growth is no more than the story of man’s insatiable pursuit of knowledge, the record of our inventions and innovations—it is the choicest fruit of the human spirit’s infinite creativity.
Better technology is not only the key to making more stuff, it is also how we make better stuff.
TVs are a perfect example. The first mass-produced TVs were bulky boxes that radiated grainy, black and white pictures. Today’s TVs are elegant devices with massive high-definition screens that display more colors than we can imagine. Even if we got no better at making TVs, we have improved their quality dramatically, and therefore their value.
If you’re looking for some further reading on this subject, I recommend starting with How Rich Countries Got Rich… And Why Poor Countries Stay Poor. It’s written in plain English, and goes into detail on this subject.
How Does Technology Advance?
Since improving technology is the key to growing the economy, how do we improve technology?
Unfortunately, we cannot force people to invent like Thomas Edison or James Watt, any more than we can force them to act like DiCaprio or write like Shakespeare—all we can do is create the best possible conditions for minds like Edison’s to thrive.
Technological breakthroughs are unpredictable.
We do not know when they will happen, and we do not really know what they will be—just think of how many discoveries happened by accident. Even penicillin, the first antibiotic, was discovered unintentionally.
All we really know is that although technological breakthroughs are unlikely, they can change everything.
Ironically, perhaps because of their infrequency and unpredictable impacts, technological breakthroughs are largely ignored by economists, who prefer to work with known variables that they can manipulate.
This is why economists often fail. Their models ignore the true driver of long term economic growth entirely. In reference to these models, a game-changing innovation would be considered an exogenous condition (one that is beyond the model’s scope).
They are the black swan events, to borrow a term from Nassim Nicholas Taleb—if you haven’t, you should read his book Antifragile, which delves deeper into non-linearity.
Increasing the likelihood of black swans (technological breakthroughs) is the key to boosting productivity, and therefore the key to growing the economy in the long run.
Not only that, but they have the potential to create whole new businesses, sectors, and industries.
History shows us the power of black swan events, for example:
James Watt’s steam engine led to the creation steam-powered factories and locomotives, which supported investment in coal mines, iron foundries, tourism, retailers etc. Essentially, steam engines were at the center of a new economic ecosystem that both supplied, and depended upon them.
This historical black swan event transformed Britain from a European power into the lone industrial hegemon—it shifted the entire economic paradigm.
Of course, there are many more examples of black swan inventions changing the course of history, but you get my point.
We cannot force black swans to breed, all we can do is provide them with a fertile habitat.
This is the only way to create long run economic growth.
Becoming A Swan Breeder, Or How To Increase The Likelihood Of Black Swan Events
Swans are finicky creatures, to breed they need: (1) the sweet taste of freedom, (2) an ample supply of mates, (3) and an ecosystem with all the fixings.
1. Economic and Intellectual Freedom
Swans love freedom, they crave it, cherish it. Specifically, they flourish in societies that safeguard intellectual and economic freedom.
What is intellectual freedom? It’s fairly self-explanatory: the most creative societies are those where people are allowed to think freely, and to communicate their ideas. Restrictions on intellectual freedom range anywhere from outright government censorship (eg. prohibiting stem cell research) to unintentionally over-regulating businesses or universities. To create, people must be free to dream.
What is economic freedom? It’s a little more complex—sometimes restrictions on freedom can benefit an economy (like stopping the type of capital outflows that destroyed Victorian Britain’s economy).
But at its heart, a good economic system will make it easy for an inventor to turn their idea into a reality, and will ensure that they benefit from their idea.
Practically, this means that individuals should be given as much control over their finances as possible (although too much individual self-interest can undermine the nation as a whole, a balance must be struck), credit markets should be open, and taxes should be low.
Additionally, strong property rights are important for long run economic growth because they ensure inventors (and everyone else) are able to profit from their creations.
Essentially, we must make sure people have the economic ability, and incentive, to invent stuff.
2. The Bigger, the Better
Swans are also shy, sometimes it takes ages for them to breed. This is the rule of thumb: the bigger the economy, the more black swan events it is likely to generate.
That being said, it is a little more complicated than this. Not all industries are created equal—some industries have spurred economic growth more than others.
For example, say there are two equally sized countries: one grows bananas, one manufactures semiconductors. Which is more likely to make a technological breakthrough?
On the one, hand banana growing has barely changed in the last 100 years, whereas semiconductors must improve every day. To stay competitive, semiconductor manufacturers must continuously make better products, by developing new technologies and manufacturing methods. Semiconductors are clearly more valuable than bananas.
It is better to have a small slice of the cutting-edge than a big helping of yesterday’s leftovers.
America’s advanced industries (IT, pharmaceuticals, aerospace & defense, advanced manufacturing) employ our highest skilled workers, and make our most technologically sophisticated products. Collectively, they employ just 9% of the workforce, but provide 90% of private sector R&D investment (90% of firms contribute nothing), employ 80% of all engineers, and file 85% of all US patents.
At the end of the day, they invent most of our new stuff—they breed black swans.
This is why they drive long term economic growth.
This growth is often shared amongst the entire economy, since new technology often improves the efficiency of old industries. Just consider how much many more tax returns an accountant can process with a personal computer or a calculator, than with just a pen and paper. If we want black swans, we have to retain the industries that breed them, instead of offshoring them to China.
3. Creating An Economic Ecosystem
Swans need a healthy ecosystem—they need a nest, a pond, delicious food to eat, and maybe even a willow tree to curl up under.
Everything is interconnected: advanced industries are not independent, they support, and are supported by, a vast network of supply chains.
Consider the aerospace industry for example.
It was born and bred in America—our aircraft were designed and built in the USA, and they bought American-made components. Basically, companies like Boeing, or Lockheed-Martin, anchored large supply networks that employed American workers, from aluminum miners to jet turbine manufacturers.
Over time they started buying foreign-made parts—small things at first, nothing but nuts and bolts. Sure a few people lost their jobs, but they were easy jobs, jobs Americans did not want to do.
Unfortunately, the cycle did not end there. As foreign suppliers acquired more technical facility, increasingly intricate components could be imported, and this forced more American suppliers to offshore or shut down.
Today, Boeing is importing engines, and even aircraft wings from Japan. The next step is to buy entire aircraft—it would be cheaper after all. Why not just design them abroad too?
This is not an idle fear, it happened to our semiconductor industry, and it is happening to our automobile industry. If all of the components are made in China (or Mexico, or Canada etc.), what sense does it make to ship them to America for assembly?
Why design them here when China can do it cheaper?
Where the supply chain goes, the advanced industry inevitably follows.
Swans need a habitat: no habitat, no swans.
How Else Does The Economy Grow?
Technological advances cause long run economic growth, but there are other ways to skin a cat.
1. National Monopolies
Historically, most rich countries had a monopoly in a product or service. This is because when a country controls the supply of a product, it can set the price higher than the market rate, without fearing that a competitor will undercut them.
And just to be clear, I’m not talking about corporate monopolies, where one company owns the entire supply, this is solely in reference to the nation-state—it’s in a nation’s best interest to control the global supply of a resource or product, just like it’s in a company’s best interest.
For example, Medieval Venice monopolized the pilgrim and spice trades, while Britain monopolized manufactured goods within its empire (which was one quarter of the World’s population).
This meant that Venice and Britain could charge extra to other countries for their exports (just like how corporate monopolies have greater price-control). This is a good thing for the nation’s consumers (not so good for other nations). But since a nation’s duty is to its own people, this isn’t a moral dilemma—we should be profiting from other countries as much as possible.
Price-gouging makes sense, if you’re the gouger.
Elsewhere in the world, China milked its lucrative monopolies in silk and porcelain (to this day we call porcelain dishes “China”). For now, America profits from its own near-monopolies in computing and aerospace.
Why are we surrendering our monopolies by offshoring to the Third World? We are giving away the golden goose.
2. Economic Diversity
Economic diversity is another key factor.
Poor countries usually specialize in one type of product (Central America grows bananas or coffee), whereas rich countries often make a variety of products.
For example, Venice was noteworthy during the Renaissance period for making all manner of goods—everything from paint, to rope, to ships. The same was true of the Victorian Britain, which was the world’s emporium for specialized products and services. They made everything under the sun.
A good illustration of this is to compare the GDP of a developing country (Kenya) with a developed one (the UK). As you can see below, the UK make a great many more types of things, and relies less on individual sectors—you’ll also notice that the UK makes more complex stuff.
This makes the UK’s economy more robust, and more profitable. This general paradigm holds true almost without exception (countries that manufacture automobiles are almost always richer than those that grow tea).
Economic diversity is the hallmark of a healthy and wealthy economy.
America is eroding its economic diversity through offshoring.
Next stop, Guatemala.
3. Increasing Returns
Finally, rich countries usually have industries with increasing returns, as opposed to diminishing returns.
Most people have heard of diminishing returns: essentially it just means that for every additional hour of work you put in, you get less reward (after a point). For example, two lawyers researching a case might be twice as fast as one, but three lawyers may only be two and a half times as fast—each additional lawyer speeds up the process a little less than the last.
With increasing returns, each additional unit made brings the average cost per unit down (as opposed to up). This means it is more efficient to make lots of units, as opposed to a few. This is the norm in manufacturing.
For example, if I were to print 100 copies of my book America Betrayed, each book would cost $5 to print, but if I printed 100,000 copies, each book would cost $0.50 to print.
Industries with increasing returns are enormously important to the economy, because as they expand, they make more goods with proportionally less labor.
This increases productivity, and is one of the reasons Britain become so rich during the Industrial Revolution.
Industries with increasing returns are also good because the bigger they get, the cheaper they can make stuff, which helps them grow even more (people like cheap stuff). This cycle creates natural monopolies, since bigger producers out-compete smaller ones by making their products cheaper.
This ensures that local industries better withstand foreign competition, because unless the new foreigner competitor has an artificial advantage (government subsidies), they will not be able to compete against an large-scale domestic industry.
If everyone plays fair, an established industry with increasing returns locks out foreign competition from the international market.
This is why no country has ever industrialized without high tariff walls, large subsidies, or exorbitant non-momentary barriers to entry.
The issue for America is that not everyone’s playing fair, and we’re not fighting back.
Economic Growth Is Caused By Black Swan Events (Technological Advances That Increase Productivity)
It’s time to believe your eyes instead of what you heard from some economics professor with a cushy job and no skin in the game.
Free trade doesn’t cause economic growth directly. Inventing and using better technology does.
As it turns out, trade is often a by-product of surplus production (if you have extra, you trade it for something else).
Freer trade sometimes undermines America’s advanced industries by offshoring them to cheaper countries. This can only hurt the US’s long run economic growth.
There’s a reason why history’s most successful economies, including Venice during the Italian Renaissance, Britain during the Industrial Revolution, and the US until very recently, all protected their cutting-edge industries from foreign competition.
That protection, or more broadly, economic nationalism, has been the most successful trade regime historically.
PS
Thanks for reading, let me know what you thought in the comments below. I read them all & will get back to you if you have any questions.
And finally, if you liked this article, and are interested in learning more about the economic history underpinning this article, check out my book on the subject. Cheers.
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Muro, Mark, et al. “America’s Advanced Industries: what are they, where are they, and why they matter.” Brooking’s Institute, 2015.
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—The Black Swan. New York: Random House, 2007.
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