Lecture 4: Generating the wealth of nations: Explaining economic growth?


In rich countries individuals are healthier, live longer, have better access to public services and better educated. Why are some countries rich and some countries poor? Why does this even matter? Is economic growth coming to an end? What do economists mean when they talk about secular stagnation? Is economic growth a good thing?

To explain these contemporary dynamics, and to answer some of these questions, it is worth taking a longer term perspective.

The first thing to note is that measuring “growth” requires examining both population and economic growth. It is the latter (productivity growth) that tends to improve aggregate standards of living. This data shows global economic growth since the industrial revolution.

It is important to note that a small percentage change compounded over a long period of time accumulates very quickly. A generation of economic growth can spur huge social change. Just think about what Ireland looked like in the 1950’s, compared to the 1980’s and today, in 2016.

For example, an annual growth rate of 1 per cent is equivalent to a generational growth rate (30 years) of 35 per cent. An annual growth rate of 2.5 per cent is equivalent to a generational growth rate (30 years) of 110 per cent. For purely conceptual purposes, you can think of the latter as a 100% change over a generation.

In contemporary discourse, politicians and policymakers often assume that a growth rate of 2 per cent per annum is small. But when compounded over 30 years it can lead to a lot of socio-economic change. Further, economic change can spur both positive innovation and social dislocation. It can create huge problems (i.e. housing not keeping apace with demand).

All of this compound change is called the law of cumulative growth. When thinking about it in terms of capital, it basically means that the annual rate of return compounded over several years automatically results in a very large increase. Hence, if profit/rent grows faster than wages, we see a divergence in who benefits from growth.

  • Table 2.2 captures what this means in concrete terms and can be applied to anything from the rate of return on capital, population growth, household income or economic growth.

This is crucial for understanding Piketty’s argument on the inequality R>G.

An apparently small gap between the aggregate economic growth rate (which gives a sense of wage growth) and the rate of return on capital (which gibes a sense of wealth accumulation) can accumulate over many years, creating a deep structural divergence in income distribution.

Most economists in the 20th century assumed that there would be a perpetual decline in wealth and inequality, and growth would lift all boats. Economic growth was considered something that equalised standards of living, as ultimately, in the end, everyone would benefit.

This is the normative foundation of liberal-democratic market capitalism: everyone benefits, not just the elite. Piketty is suggesting this is no longer the case. Capitalism is in crisis.


Population growth

Let’s look at population growth from antiquity to get a sense of just how much has changed over time.

  • Figure 2.2 depicts the growth rate of the population from year 0 to 2100. The demographic growth rate from year 0 to 1700 was less than 0.1 per cent. But in the end, much of this growth in the population was wiped out by famine and disease.

Population growth increased significantly with improvements in medical technology and sanitary conditions. Demographic growth accelerated significantly from 1700 onwards.

But there was huge variation between countries. The USA went from a population of less than 3 million in 1780 to 300 million in 2010, whereas during the same time period in France it only doubled from 30 to 60 million.

According to UN forecasts the annual population growth rate will fall to 0.4 per cent in 2030 and then 0.1 per cent in the 2070’s.

This is not a course in demography, we are not interested in demographic growth for its own sake. We are interested in population growth because it has implications for the structure of economic growth, and wealth and income distribution. As Piketty states:

Strong population growth, as in the USA, tends to play an equalizing role in wealth distribution. It decreases the importance of inherited wealth in the sense that every society must reinvent itself

What does he mean by this? Put simply: if you are one of fifteen children it is probably not a good idea to rely on inheritance from your parents to generate income and wealth. The same logic applies on a population wide aggregate basis.

Economic growth

This observation (the equalizing role played by the law of accumulated growth) makes more sense when we extend it to economic growth.

If you live in a country that is growing rapidly, such as 4 per cent per annum (with wages growing 3 percent), over a generation (30 years), you would be wise to get working, to take advantage.

Conversely, with a stagnant population and slow economic growth, with poor employment and wage prospects, inherited wealth and capital accumulated from the past (i.e. from the hard work of your grandparents) takes on much more importance in society.

This is why people emigrate to fast growing economies.

This is the crucial point for Piketty. The data suggests that western economies are slowing down rapidly but remain rich in wealth. Hence, the past impacts on the present.

Low growth economies are societies dominated by inherited wealth, and accumulated assets from the past (think Italy or France). Private capital that is owned tends to be saved and hoarded, rather than put to productive use in the real economy (i.e. investing in infrastructure). Think about an empty building in the city centre.

  • See table 2.5 for a breakdown of per capita economic output by global regional blocs.


For Piketty, declining economic growth at the macro-level is the main factor leading to rising wealth inequality over the long-term (the inequality R>G). This is what defined the 18th and 19th century. The fast growth in the 20th century changed this. Piketty suggests it has re-emerged today in the 21st century.

It is crucial to note that it was only during the 20th century that economic growth became a tangible benefit for everyone. Access to health and education were central to this shared growth. The birth of the social state re-distributed growth to the benefit of society.

In particular, the strong economic growth that swept Europe from 1945-1975 enhanced the possibility of social mobility for those whose parents did not belong to the elite of a previous generation. It also funded the emergence of the ‘social state’ in Europe.

In these rapidly changing economies, new business models were created. New skills and capabilities were developed. Capital and labour were put to work in different ways.

Economics, however, tells us very little about the distribution of growth. This is a question of politics. Trade unions, for example, played a significant role in making sure the growth was compensated with a strong wage-productivity push, as pointed out by Larry Summers.

If societies want to ensure that the gains of growth and technological innovation are distributed fairly (i.e. not captured by the elite) then this requires an inclusive set of political institutions. Democracy enables market capitalism because it widens the opportunity space for innovation and inclusion.


What institutions and public policies are likely to lead to inclusive economic growth? Is it better to live under a dictatorship with a home and a job, than to be unemployment in a democracy?

It is this emphasis on democratic institutions, public policy and electoral choice that defines large parts of contemporary political economy. Capitalism is viewed as variegated, and subject to radical mutations and adaptations (not a deterministic techno-economic paradigm), and primarily shaped by politics.

Conversely, Marxist economists anticipate a never ending crises of capitalism (such as the great recession) that will lead to its collapse.

But what about recent events? Does Piketty’s data suggest that perhaps Marx was right? We will discuss this next week.

Labour market

The major impact of capitalist and technological growth in the 20th century has been in the structure of employment. The structure of economic growth has a huge impact on jobs.

  • See table 2.4 on changes to the labour market.

Over 70 per cent of the population in the western world now work in services; even in countries as diverse as France and the USA. This is a broad category and includes high-skill and low-skill service jobs, traded and non-traded. But the defining characteristic in all western countries is the decline in manufacturing (and low to medium skills more broadly).

What we are witnessing is a growing divide between high and low skilled jobs, with medium skilled jobs (bank clerk, manufacturer etc) in decline. For economists, this is largely driven by the impact of globalisation, and technological change.

Think about the impact of technology on the labour market. For example, consider the impact of the Uber on taxi-drivers, or robots on car manufacturing, washing machines on cleaners etc.

Here comes the bad news, most research suggests that the structural shift from ‘manufacturing to services’ has significantly slowed down aggregate economic growth rates.

Secular stagnation 

Most forecasts suggest that the thirty post-war years of strong economic and productivity growth in Europe were the exception rather than the norm.

The implication is that liberal democracies cannot rely on economic growth to realize their democratic aspirations.

Furthermore, as we will discuss in later lectures, some economists suggest that the determinants of economic growth (technology and productivity improvements) may be in decline. This is often referred to as ‘secular stagnation‘.

Capital/wealth is running out of places to invest. It’s being hoarded.

Since the 1990’s the policy response to low growth has been to remove the political constraints that inhibit free markets: liberalization, tax cuts, capital mobility, hard currency and austerity.

This is what popular commentators, such as Paul Mason, call the crisis of neoliberalism.

The golden age

  • Figures 2.3 shows the comparative evolution of economic growth rates in Europe and North America.

Per capita output surpassed 4 per cent every year in most European countries between 1950-1970. If we exclude Britain it was even higher.

Now think about this in terms of the law of cumulative growth. This was the golden age of capitalism, it’s your parent and grandparents generation.

Note the difference between Europe and the USA from 1940-1975. This difference might explain why Americans do not have the same nostalgia for the ‘golden age of democratic capitalism’, or socialist democracy, as many Europeans do (again, think France).

UN and OECD data now suggests that Europe and the USA look set to enter a new period of low-growth.


Any discussion on the history of growth must, however, include an analysis of inflation. If growth is 3% per annum and inflation is 2% then we say real growth is 1%.

Between 1913 and 1940 inflation in Germany was 17% per annum. Prices rose by a factor of 300. Inflation was widely used to reduce the public debts accumulated during the world wars.

In 1720 England the average income was 30 pounds. Fifty years later, it was barely 40 pounds. Think about the average income in France today compared to the 1950’s.

The crucial point to remember is: monetary markers are stable when economic growth is slow.

Inflation is largely a 20th century phenomenon. It can be explained by distributional politics rather than economic science. See figure 2.6. We will have more to say about this later in the course.


  • Figures 2.4 and 2.5 show that global growth over the past three centuries can be pictured as a bell curve with a very high peak.

Western economic growth peaked from 1940-1975 and then declined. With the ‘neoliberal’ revolution in the 1980’s growth picked up again in the 1990’s, and declined again.

But as we will see this “neoliberal period” was made possible by FIAT money; new credit formation and financialisation.

The question many scholars are asking today, in the aftermath of the international financial crisis and the great recession is whether we will see a new adaptation/mutation of capitalism?

If so, what will define the next 30 years? Will we see the emergence of a new economic paradigm? What will be the structure of economic growth? Will inequality continue to grow?

We have now mapped the history and explained the core concepts.

In the next lecture I will discuss political economy theories on the determinants of capitalist development, before trying to explain why inequality has increased so rapidly since 1970.

The shortened lecture slides can be viewed here: lecture-3-4


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