Why must the rate of GDP growth be positive?

Question

There are always expectations that GDP should be growing at a certain rate. This is what I see in the newspapers. I am not an economics major and this is a very basic student question. After adjusting for level of prices, meaning that forget about inflation and price related issues, it is expected to grow at say $2\%$. Why is this a case and what should it be driven by? Assume there is an economy that only produces apples, for simplicity. So, it is expected to make $2\%$ more apples every year? So the growth would be driven by the larger amount of goods produced? Why is this economy expected to make more apples every year?

Answer 1

You would expect the rate of growth to be generally positive because inventing things or inventing more efficient ways of doing things, is generally a one way process - things don't get un-invented. So we would expect things that are made by machines to be made ever more quickly as the machines evolve and improve. Periods of negative growth are likely to correspond to some financial cock-up (e.g. asset bubbles) or increasing scarcity of some natural resources for which a replacement can not be found.

Answer 2

There is no expectation to "make more every year". There is no economic law such as GDP must grow every year. Negative growth will lead to a contraction in a country's economy, and a decrease in its gross domestic product (GDP).

According to the Department of Labor, US GDP contracted by 5.1% from February 2008 to February 2010 making the Great Recession the worst since the Great Depression in the 1930s. Check the NBER's page on US Business Cycle Expansions and Contractions and the Wikipedia's List of countries by real GDP growth rate, where you will find evidence that some countries are still contracting today.

Answer 3

Let's imagine you live in this mythical land where people need only apples to survive and live secure, healthy, fulfilling lives. You would be right to say that there is no iron law that such an economy will realize 2% real annual growth per year. However let's draw out your metaphor to understand why a positive real growth rate is ultimately a good thing, why ultra-fast rates of growth tend to produce dramatic social change, and why it is nearly impossible to invest in an economy with an overall negative growth rate.

You own an apple orchard. Since you're like every other poor bozo who didn't inherit money, you bought the orchard on credit from a bank that lent you funds at a rate of interest that not only takes into account the real growth rate, but the inflation rate and the cost of risk that you go bust and cease making mortgage payments.

If you don't produce enough apples to pay for your input costs (e.g., fertilizer, pesticide, labor to pick the apples), you won't be able to make payments on your mortgage and the bank will come and seize your orchard. So, you buy crop insurance just in case you have a bad harvest. Your insurance company, realizing that it shares an incentive with you and your bank to reduce the likelihood of a bad crop year, sends you apple trade journals to help you determine how best to fertilize your crops, plant seeds, and manage weather events.

These journals also advertise the latest and greatest machines to help you pick apples with ever lower amounts of labor. That is, they reduce your input costs. So, you go out and sign a two-year lease expecting that in another two years, technological innovation will have driven down the cost of the machines, or have increased their productivity.

With ever faster machines and crop insurance, you produce more and more apples each year with less variation in total output. You lobby the government to help you find an export market for your apples, since you (and everyone else in this ridiculous example) produce more apples than is necessary to meet domestic demand. The government gets the message, liberalizes trade with a country that produces mostly oranges, and your diet improves as you sell more apples. The workers that you laid off from your orchard over the years retrain to become bankers who manage your trade finance and distributors who ensure your apples get to ever more distant markets.

To summarize, you adopted new technology and methods of risk reduction to ensure a stable growth rate in orchard profits. Your government encouraged you to continue expanding your business by helping you find opportunities to sell to foreign buyers who love your apples. Like you, others adopted the same measures, so in aggregate, the growth rate remained positive and roughly in line with past years' growth rates.

Now imagine a shock to the system. Say your insurance company faces massive losses due to major weather events brought about by climate change. Your orchard, like so many others, is now under water at high tide, and your insurance premiums have increased. The growth rate will decline.

Or say that your major trading partner decides that it wants to start growing apples because it has many more underemployed people than you have in your country. It imposes high tariffs on your apples, and it carves out an entire section of its south sea in an aggressive attempt to slow shipments of your apples among its trade partners.

Or imagine that the pace of technological change has been so rapid that you've laid off more people from your orchard than can retrain. They lack the income to buy a full day's meal of apples, so they receive food stamps that allow them to buy 1/4 the number of apples they need to live healthy lives. Their children can barely focus at school because they don't receive lunch, and they become fat as they eat apple-tasting substitutes. Because they aren't buying apples, your total apple sales decline.

These people, out of work for many years, become disillusioned with our economic system and vote for populists on both sides of the political spectrum who promise to break up and re-regulate banks despite comprehensive bank regulation overhaul many years earlier.

It's not a big deal that they want to re-regulate banks, however, because climate change, trade wars, and declining consumption have tempered your overall economic growth rate. The real growth rate stands at -2%. Your bank, recognizing it will likely make no money by extending new loans to people who want to buy orchards, decides to distribute all of its remaining capital to its already wealthy shareholders. Income inequality skyrockets.

There are many factors that effect long term average growth rates, though none should be taken as axiomatic. I hope this example suggests some reasons why growth rises and falls due to both economic and exogenous political and social factors. It is meant to be relevant, not rigorous.

Answer 4

"There are always expectations that GDP should be growing at a certain rate"

"Should" is the critical and revealing word here. @emeryville answer clarifies that there is no economic law that says that GDP does grow without interruption year after year.

From a "political economy" perspective though, we do want to see it growing year-after-year because we acknowledge that its current level, coupled with the observed income inequality, leaves too many people truly dissatisfied with their "standard of living". Increased output creates the opportunity to improve this situation without going into issues of income re-distribution that have proven to create social tensions, frictions and even clashes.

RESPONDING TO COMMENTS

I have written in a comment exchange that a constant GDP turns the situation into a zero-sum game, something that was challenged. First, I note that we are talking about production here, not assets/wealth. So we are looking at income streams. Also, this implies that we ignore exchanges with outside the economy. Finally, we consider prices as fixed, or we consider magnitudes in real terms. Then:

A) Constant GDP in levels
Here it is meaningfull to consider a constant population also, fixed at $N$. Then if $w_i$ is income of agent $i$, constant GDP in levels means

$$\sum_{i=1}^N w_{i,t+1} = \sum_{i=1}^N w_{i,t}$$

It is evident that if for some agent $j$ $w_{j,t+1} > w_{j,t}$, then for at least one other agent it must be the case that $w_{k,t+1} < w_{k,t}$ and at an amount equal to the increase in the income of the former, so as to maintain the equality of GDP in levels. So it is a zero-sum game.

B) Constant GDP per capita
Here we have $$\frac 1 {N_{t+1}}\sum_{i=1}^{N_{t+1}} w_{i,t+1} = \frac 1 {N_{t}}\sum_{i=1}^{N_t} w_{i,t}$$

Denote $n$ the growth rate of population, and so the new comers are $nN_t$, and index them by $A$ (and the old timers by $B$) and use a bar for per capita magnitudes. Then we have

$$\sum_{i=1}^{N_{t+1}} w_{i,t+1} = (1+n)\sum_{i=1}^{N_t} w_{i,t}$$

$$\implies \sum_{j=1}^{nN_{t}} w_{j,t+1} + \sum_{i=1}^{N_{t}} w_{i,t+1} = \sum_{i=1}^{N_t} w_{i,t} + n\sum_{i=1}^{N_t} w_{i,t} $$

$$\implies nN_t \bar w_{A,t+1} + \sum_{i=1}^{N_{t}} w_{i,t+1} = \sum_{i=1}^{N_t} w_{i,t} + nN_t\bar w_{B,t} $$

$$\implies nN_t( \bar w_{A,t+1} -\bar w_{B,t}) + \sum_{i=1}^{N_{t}} w_{i,t+1} = \sum_{i=1}^{N_t} w_{i,t} $$

Now assume that for some oldtimer, we have $w_{i,t+1} > w_{i,t}$ and we are told that all other oldtimers had the same income in the two periods. Then necessarily it must be the case that

$$\bar w_{A,t+1} < \bar w_{B,t}$$

meaning that the newcomers on average had in $t+1$ lower income than the oldtimers had in $t$. Here it is in this sense that it is a zero-sum game, between the oldtimers and the newcomers.

If it is the case that $$\bar w_{A,t+1} = \bar w_{B,t}$$ then there must be another oldtimer that experienced lower income in $t+1$ compared to $t$, and so again we have a zero-sum game, here between the oldtimers. Etc

Answer 5

GDP (Expansion and/or Productivity) must always average out to at least the rate of population growth. Population growth tends to be positive (Not always like in modern Japan), so GDP should then be positive if living standards are to be maintained in the long term.

That is: If a population is growing at 3% a year--doubling every 24 years--then so must GDP average 3% growth and also double in 24 years. Otherwise reduced living standards are the result--more people chasing the same amount of goods and services.

Imagine an isolated island nation that grows its own food and has a 3% population growth rate. In 24 years they better have either increased the amount of land in production, boosted farm productivity, or both, if all are to consume the same level of calories as in prior years.

Answer 6

The expectation that an economy's GDP should grow every year is largely an extension of humans' general desire to consume more goods and services. When individuals become more productive (get a raise, grow a family business, etc.), quite frequently they choose to consume more goods and services or invest more rather than cutting back their personal production and enjoying more leisure time. This is not universally true. In fact working hours have generally decreased. But on aggregate, decreases in working hours have not kept paced with productivity gains.

There are also demographic factors.

1. Any factor that increase population such as immigration or children creates more desire for consumption. With more people desiring to produce, the expectation that GDP should grow is clear--though this does not directly affect GDP per capita.

2. If you think about a typical person in a western country, productivity tends to increase over time. However, after retirement the desire for leisure time is deemed more valuable. Production decreases (or ceases). The consumption of goods and services often goes down too.

But it is entirely possible that this preference will (in the aggregate) change at some point. Some advocate for such change using the terms minimalism or simple living; there is much variety in how the idea is promoted. If a large number of people prefer to consume less, or simply consume the same while their productivity increases, then we might not expect growth in GDP (per capita).

Similarly, if the population ceases to grow, we may expect to see lower GDP, though perhaps not lower GDP per capita.