# Where the economic growth of a society come from?

I'm thinking about value generating. I hear it a lot in a innovation context, i.e. one should create a new product that a lot of people want to buy.

I can see how a new product can value more than the sum of its parts, but I don't understand how this can increase the wealth of a society.

The point of view that raised this question for me was: let's say a person can spend only what she earn as wage, so when a new product come out, this product is competing with all the pre existing products, someone should lose to someone else to win.

Where the economic growth of a society come from?

• I would think that if we see this based on the Solow growth equation: $\ Y = A K^{1/3} L^{2/3}$. Then, the creation of new innovative products from the same pool of resources would be signified by an increase in A, the "total factor productivity". – Tan Yong Boon May 17 at 3:22
• By a quick search about Solow I can see he attributes economic growth to technology change, is that right? – Jp_ May 17 at 3:29
• Is as if everybody is producing new products nobody loses. Would be kind of a competition between old and new. – Jp_ May 17 at 3:34
• 1muflon1`s answer let me thinking: The perceive of value is more important than the production itself? Kind of the bank race: if everybody wants to withdraw, it crashs, so the system depends that people believe their money is safe there, as for economic growth people needs to believe the products worth more. Even if it's an old product that is advertised as more valuable.. – Jp_ May 18 at 13:51
• – Jp_ May 18 at 15:17

Non-exhaustive list of processes by which value/economic growth/wealth is created:

1. Trade. (Example 1. Robinson has an apple and Friday has a banana. Robinson prefers a banana, while Friday prefers an apple. They trade apple for banana. Both are made better off—value/economic growth/wealth is created.)
2. Trade with division of labor/specialization. (Example 2. Robinson and Friday are on a desert island and need coconuts and fish to survive. Initially, each plucks coconuts and catches fish only for himself. Later, each specializes in one task and trades with each other, with the result that each enjoys more coconuts and fish. Both are made better off—value/economic growth/wealth is created.)
3. Capital accumulation. (Example 3. Robinson spends a day making a fishing rod. He goes hungry that day but is able to catch many more fish in the long run. He is made better off—value/economic growth/wealth is created.)
4. Innovation. (Example 4. Robinson invents and produces a better fishing rod. He is made better off—value/economic growth/wealth is created.)

Two important spurs to the above processes are self-interest (or "greed") and competition. Institutions (rule of law, property rights, enforceability of contracts, lack of corruption, education system, healthcare system) are also thought to be important.

By the way, in your question, you commit the common zero-sum fallacy:

when a new product come out, this product is competing with all the pre existing products, someone should lose to someone else to win.

Imagine a new bakery opens and produces better apple pie than an old bakery at the same cost (also sold at the same price). People stop buying apple pie from the old bakery and exactly replace their previous purchases of apple pie from the new bakery. You view this as a complete wash. But this is the zero-sum fallacy. What instead happens is this:

1. Consumers enjoy better apple pie (and are made better off).

2. And on the producer side, the old bakery may reduce its production of apple pie and reallocate its resources to making other products that are more greatly valued by society. (Or another possibility: the old bakery may figure out how to improve its apple pie, further benefiting consumers.)

• Actually the 1. and 2 only lead to increase in the level of the output. That is desirable and the increase in the level of output that can be gained that way is for sure non-trivial but it’s not an economic growth - at best it can look like a growth due to adjustment in production taking multiple time periods. Trade can have some impact in endogenous growth theories due to knowledge spillovers but not directly. – 1muflon1 May 17 at 4:13
• Specialisation and exchange certainly increases total economic value and spurs economic growth but just trade on its own does too? I find your point with the example of two people trading apples and bananas dubious. For that, I believe clearly no value has been created. – Tan Yong Boon May 17 at 4:38
• the trade can create value that’s not incorrect. For example, if I value banana at 50e but you at 60e and if you value Apple at 50e and I at 60e and you happen to be endowed with Apple and I happen to be endowed with banana if we exchange the two value is created. Without exchange the aggregate value was 100 after 120. However, even though it’s increase in value it’s not appropriate to call it growth. Macroeconomics and even international economics makes sharp distinction between growth of output and increase in the level of output. These kind of one off efficiency gains only raise level – 1muflon1 May 17 at 5:03
• 1 is a textbook example of Pareto improvement due to gains from trade. Efficiency gains from trading are from the perspective of agent's individual preferences---definition of Pareto improvement. Pareto improvement should not be confused as growth. The aggregate stock of the economy remains the same, one apple and one banana. – Michael May 18 at 16:38
• @KennyLJ It’s not me who makes the distinction it’s all mainstream macroeconomists that do. For example, David Romer Advanced Macroeconomic says pp 21. [under figure showing savings rate can increase GDP] “change in the savings rate has a level effect but not a growth effect.” Also regarding the Shumpeter quote and Adam Smith quote there is no dispute that division of labor can produce one off increase level of output but yes that’s not an economic growth - every advanced international economics textbook will tell you that in Ricardian model there is no growth only one off efficiency gain – 1muflon1 May 19 at 7:09

I can see how a new product can value more than the sum of its parts, but I don't understand how this can increase the wealth of a society.

The wealth of society, in material sense, consists of what it can produce. Production of more products or services is the wealth. Economic growth is by definition a continuous increase in production. In fact the way how we most commonly measure economic growth is to just measure output per person by measuring GDP per capita.

Wealth is not money, money is just a measurement stick for value, storage of that value, and tool to simplify exchanges, but it’s not wealth in itself. However, because it is so ubiquitous many non economists equate it with wealth itself but that is just ‘money illusion’. If you would have billion \\$ but could not buy even a loaf of bread with it you would be poor compared to a person with 0 dollars who has access to any goods or services they wish.

let's say a person can spend only what she earn as wage, so when a new product come out, this product is competing with all the pre existing products, someone should lose to someone else to win.

In competitive market economy people earn approximately what is their marginal product. When you go to work you either create goods or services for someone directly or indirectly and in competitive market you will get for that money equal to the worth of your marginal product. If you can produce more with the same or less inputs you will also earn more money.

The reason why for example Solow-Swan model shows that economic growth depends on technology is that technology makes people continuously more productive year after year and allows them to produce more. This increases production is the real wealth, but besides that if people are more productive they also get pay more.

In real life not all markets are competitive so the above holds only approximately but empirical evidence shows that real wages indeed track net productivity over long term.

Besides increases in technology endogenous growth theory suggests that also savings rates and support for basic R\&D and human capital can accelerate economic growth. The mechanism there is different than in Solow model but ultimately again what delivers growth is how the above boosts the productivity and output.

• -1 without explanation is frivolous. Efficiency gains from trade (international micro) considerations and macroeconomic growth are indeed not the same (as the other answer seems to imply). – Michael May 17 at 18:18
• "Economic growth is by definition a continuous increase in production.". Products and services? But is not just increasing products, right? These products should be perceived as more valuable than old products, right? I'm starting to think that the perceive of value is more important than anything else. Kind of the bank race: if everybody wants to withdraw, it crashs, so the system depends that people believe their money is safe there, as for economic growth people needs to believe the products worth more. – Jp_ May 18 at 13:40
• @Jp_ it’s about both value and quantity. For example if in year t economy can produce one apple in year t+1 2 apples and in year t+2 3 apples and so on it would be considered growth. One apple may still have the same value to people but there is more apples to go around. However, also if there would be just one apple produced each year but it would be continuously improved in quality making it more valuable it would also count. – 1muflon1 May 18 at 13:50
• @Jp_ I agree that marketing adds to the GDP of country, but let me stress again just an increases in GDP is not really economic growth it’s increase in level of GDP. Also although marketing does contributes to the economic activity it’s contribution is not as high as you might think. Marketing itself is not even big enough to have its own category on most national accounts. I tried to even find its contribution to the GDP but could not in national accounts because its coupled with other industries but I found source (see end of next comment) according to which it is about 1 percent of GDP even – 1muflon1 May 18 at 15:01
• In the most service oriented economies such as UK or US. Also, even if you see contribution of marketing increase over time it’s is most often not due to marketing itself but underlying technologies such as internet etc. which allow for more efficient ‘production’ of marketing services. To the extent marketing grows GDP due to access to new technologies it’s the technology causing the growth not marketing. Promised source thecreativeindustries.co.uk/industries/advertising/… – 1muflon1 May 18 at 15:04

Growth comes from resource consumption. There are certain factors like demographics which inflate gdp. However the actual long term growth is always related to physical reality.