On Intensive Vs Extensive Growth

There might be more to be said for the government's approach to raising economic growth than we think.

To see what I mean, let's first see the criticism of its approach. This rests upon the distinction between extensive and intensive growth. Extensive growth comes from simply adding more inputs: capital and labour. Intensive growth, by contrast, comes from using inputs more efficiently. To express this in terms of the most general production function, Q = f(K, L, A) where K is capital, L is labour and A is technology, the government's focus is mainly on K and L rather than A. In her recent speech on kickstarting growth the Chancellor spoke much more about investment than productivity; planning laws are being reformed to speed up infrastructure projects; and there's talk of getting the disabled into work*. By contrast - aside from talk about reforming the NHS - the government says little about improving productivity, especially in the private sector.

All this betokens a concern for extensive growth more than for intensive growth; more K and L rather than more A, in the production function framework.

And there are obvious problems with this. One is the environmental cost, most obviously in Reeves' desire to expand Heathrow.

Another is that there are diminishing returns to extra inputs. Maybe the government could get more of the unwell into work. But a lot of these can only do part-time or low-productivity work: people with long Covid aren't going to work on building sites or in the armed forces. And there's plenty of research which shows that additional investment has only a moderate impact in raising output. Of course, it has a bigger impact when we're in a depression thanks to multiplier effects. When we are close to full employment, however, it crowds out other investments: if people are building houses they cannot build runways or railways.

Intensive growth by contrast - if we could achieve it - doesn't have these drawbacks. If we are more productive we can have more of everything - including more leisure and a greener economy. And if you are worried by an ageing population and increasing dependency ratio, intensive growth is a solution; the more that workers produce, the easier it is to support non-workers.

It seems, then, that the government is looking in the wrong direction: we need intensive growth - more A, not (just) more K and L.

But, but, but. There might be more to be said for Labour's approach. In our dumbed-down political culture, they aren't saying what it is. So I'll try.

Our story starts in the early Industrial Revolution. Many of its founders - such as George Stephenson, James Hargreaves, Richard Arkwright and others - were not greatly educated. As Joel Mokyr put it:

With some exceptions, Britain's early inventors tended to be "tinkerers" without much formal schooling, whose genius lay primarily in their mechanical ingenuity. (The Lever of Riches, p244)

But they had to have something to tinker with - that is, with primitive versions of equipment which they improved upon. Investment, therefore, caused innovation. A lot of innovation isn't the creation of something from nothing, but rather a novel combination (pdf) of existing technologies. This was the point of Jacob Schmookler's 1966 book, Invention and Economic Growth.

It's not just in the early days of the industrial revolution that this was the case. It's still true today. Igal Hendel and Yossi Spiegel have shown that in a small steel mill output doubled (pdf) in the space of 12 years without great new investment or generic technical discoveries outside the firm because managers kept tweaking machinery to eke out more output from the same inputs. The same thing happens every day: whenever you discover an Excel shortcut, you are making a productivity improvement on the back of a pre-existing investment. It also happens in more high-tech industries: it was investment in broadband and 4G that permitted the emergence of streaming services and phone apps, and investment in better semiconductors that facilitated the growth of AI.

All this means that we cannot distinguish clearly between A (technical improvement) and K (the capital stock) as conventional production functions do. Not only does investment embody new technology, but it also is a pre-condition for discovering more productivity improvements - not just big new innovations, but small tweaks and marginal gains. What's more, an environment in which there's a lot of capital spending will generally be one in which there is plenty of demand and therefore opportunities and incentives to discover (pdf) ways to produce more from the same inputs. And competition from new investments can spur the owners of older technologies to up their game: sailing ships, for example, continued to improve for decades after the introduction of steamships. 

In an unjustly neglected book in 1989 Maurice Fitzgerald Scott urged economists to ditch standard production functions and think instead of investment as driving innovation:

Scientific discovery and invention are best regarded as forms of investment, and...at least to begin with, a theory of growth can be constructed without distinguishing between them...Fresh [investment opportunities] are created by undertaking existing opportunities, since one learns from the changes made thereby. Consequently, instead of scientific discovery and invention being the creators of investment opportunities, investment itself creates them. To understand economic growth, therefore, we need, in the first place, to examine the rate, quality and determinants of investment. (A New View of Economic Growth, p 131)

If this is right, conventional economists are wrong to criticise the government for focusing on K rather than A, because K will beget A.

Now, there's an obvious objection here. Jon Elster famously warned that there are no general laws in the social sciences but only a collection of mechanisms which work in some times and places but not in others. And there is one place in which Scott's mechanism seems not to work - infrastructure investment. If this begat discovery and learning, we'd expect to see the cost of such projects decline over time as builders discovered new techniques. But this hasn't happened. Instead, as Sam Dumitriu has shown, the UK's projects cost vastly more than those in comparable countries. There's no evidence of learning there.

Or is there. We have learned something from such investments - that a lot of the extra cost is because of a hideous planning system, which the government is simplifying. The question is: is this learning - and the technical progress that will follow - sufficient to ensure that Scott's theory will apply here? Personally, I doubt it, simply because even with the most perfect planning system, infrastructure investment will be constrained by a lack of labour and machinery; we need techical progress to relax these constraints too.

This would not be so much of an issue if the government also had policies to boost private sector business investment generally. It did have one good idea - that this would be stimulated by reducing policy uncertainty. But this has been undermined by Trump; the prospect of a tariff war and higher taxes and labour reallocation to boost Europe's military have created new uncertainties, giving firms good reason to delay capital spending.

So, yes, perhaps the conventional criticism of the government's growth policies is correct: it does need to focus not just upon investment but also upon raising productivity.

Nevertheless, there are still two defences it has - not that it will say them in public!

One is simply that even the crudest forms of extensive growth generates tax revenue. Given that fixing the public services is a high priority, this is a benefit to weigh against such growth being only short-lived or having environmental costs.

Another thing to be said for extensive growth is that the alternative, raising productivity, creates enemies.

This is partly because, as Schumpeter said, intensive growth is a process of creative destruction; a lot of productivity growth occurs because new entrants displace older less efficient firms. That creates insecurity as people fear for their jobs. This is exacerbated by the fact that the government needs to destroy jobs simply to reallocate labour towards the housebuilding, social care and military sectors.

Also, even the most conventional policies to raise productivity create losers. Tougher competition policy would weaken incumbent firms; shifting taxes from income to land would hurt landlords; tax simplification would put lawyers and accountants out of work; and a return to the single market would anger Brexiters. All of which matters because, as Mancur Olson famously pointed out, losers make noise whilst winners keep quiet which means that even good policies cost political capital.

And this matters. Politics is not a seminar in which the best ideas win, but is instead about the clash of interests. For now, it is the interests of what Joel Mokyr called the forces of conservatism that are prevailing. Perhaps the government will eventually find the strength (or necessity) to challenge these. And there is a precedent for it doing so: Thatcher avoided a lot of such conflicts early in her government, only taking on the miners and doing large-scale privatizations in her second parliament. Until then, however, extensive growth might be the only option.

* Albeit belied by the government raising the cost of employing them.