How Economists Got It Wrong – An Alternative Diagnosis

Fast Finance and Slow Growth

Andrew Haldane

Consider two countries – China and Italy. As recently as 1990, these economies were equal in size as measured by aggregate GDP at purchasing power parity exchange rates. But let us now put these countries on quite different trajectories for capital accumulation. Let China begin investing at double-digit rates for 20-plus years, while Italy accumulates capital at a rate of only two per cent per year. By 2013, China is now seven times larger than Italy. Indeed, China is creating an economy the size of Italy's every two years; an economy the size of Greece's every quarter; and an economy the size of Cyprus's every week.

GDP may not be all that matters, as economists are increasingly coming to accept. But, as these figures suggest, it nonetheless matters a lot if we care about improvements in living standards over lengthy time spans.

GROWTH IN THE LONG TERM

Societies are accustomed to becoming better off, generation by generation. Yet, looking across the span of human history, this has often not been the case. Measures of global GDP have been constructed back to 1 million BC. Statistical agencies were thin on the ground back then, so these numbers need to be treated with an even greater degree of caution than today's GDP releases. Nonetheless, the secular patterns they reveal are striking.

Up to around 50,000 BC, as best we can tell, world GDP per capita was essentially unchanged. Generation after generation, there was little – if any – improvement in living standards. Things improved, progressively, after that. By 1750 AD, world GDP per capita had almost doubled, having risen at a heady rate of 0.0025 per cent per year. Today's economists would call that an anaemic recovery. But for perhaps the first time in human history, living standards were at least now rising.

From 1750 AD onwards, the world entered a third growth era; a golden era. Since then, GDP per capita has risen 40-fold, at an annual rate of around 1.5 per cent per year. On average, each generation has been perhaps one third better off than its predecessor. So what explains these phase shifts in growth?

HOW HUMANS DEVELOPED PATIENCE

There is no one explanatory factor, but one key element is what sits between our ears. Something important neurologically happened to humans around 50,000 years ago. Neanderthal man died out and homo sapiens became dominant. That meant prominent brow ridges were replaced by high, straight foreheads. And they did so for a reason – namely, to accommodate growth of the prefrontal cortex region of the brain.

Modern neurology tells us that this part of the brain is responsible for patience, the ability to defer gratification. It is the part crucial for investment. In primitive societies, this meant investment in the very basics of survival – food, water, shelter, defence – but also in the institutions which helped sustain these basics: families, communities, tribes, civilisations.

After 1750 AD, the great leaps forward were in one sense different – industrial rather than agrarian. Yet they had essentially the same mix of physical, human, and social capital accumulation underpinned by a new set of institutions – schools, governments, judicial systems, even central banks. Patience generated