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Why the Standard of Living Will Improve for the Next Generation

Written by: Philip Cross

Sustained rapid economic growth following the Second World War meant that it was expected that successive generations of Canadians would achieve a higher standard of living that the previous one. It is a reflection of how ingrained pessimism about economic growth has become among both young and old  that they have come to believe that the next generation will be the first to not achieve a higher standard of living than its predecessor.

This widely-held belief shows a fundamental misunderstanding of what is meant by the standard of living, how it confuses the flow of income with the stock of wealth, and ultimately what determines our standard of living.

Real GDP measures the growth of real incomes in our economy every year. It is the annual flow of income, which contributes to our standard of living, which is more a stock of wealth concept. A simple example is the share of households owning basics such as houses, autos or cell phones. This never declines; while the rate of increase of big-ticket items such as houses and autos might slow during recessions, when sales of these items decline outright from previous highs but do not disappear altogether, it cannot turn negative.

Even the purchase of services cumulates over time. Spending more on health care is reflected in steady improvements in biomedical measures such as height and life expectancy. The level of education in the population has risen steadily over time. Environmental protection has resulted in less pollution of almost every type except greenhouse gas emissions.

Since the Great Financial Crisis, Canada has experienced slow growth of about 2 percent a year. This  seems frustratingly slow, until one realizes that growth in the 19th century in the western world averaged about 1 percent a year. At that time, the concept of any sustained income growth was so new that it was called the Industrial Revolution. Growth accelerated in the 20th century to about 2 percent a year, including a sustained period of more than 3 percent growth from 1946 to 1974.

So growth of 1 or 2 percent a year is still substantial by historical standards. Moreover, growth is multiplicative not additive. Growth of 2 percent a year sustained over a generational span of 25 years does not cumulate to 50 percent but totals 64.8%. After 35 years, incomes have doubled. Compounding turns even small growth rates into notable advances over time.

Given the close link of technological know-how and knowledge and economic growth, there are reasons to be optimistic that the annual income earned by the next generation can return to or even exceed the long-term rate of growth of 2 to 3 percent seen in most of the 20th century. Like economic growth, technology and knowledge are also cumulative. What we know today is something we can build on tomorrow rather than be re-learned; every generation does not have to reinvent the wheel. There are many areas where technology is poised for major advances, ranging from artificial intelligence to genetic editing to 3D printing.

Most importantly is that the Internet facilitates how billions of human beings around the world can network together to share information and help solve problems. Networks increase in value as the number of users expands. While there are diminishing returns for land, labour and capital, there are increasing returns to knowledge. This is Paul Romer’s explanation of why growth was not just sustained from the 19th to the 20th century, but accelerated.

All of this ignores important measurement issues for GDP, especially comparisons over long periods of time which are most relevant to generational living standards. The majority of these issues imply that the improvement of living standards over time is underestimated by the statistics on GDP. There is a consensus that price inflation is over-stated by at least 0.5 percent a year, which is trivial for short-term measurements but cumulates over 25 years to a significant understatement of real income growth. Statistics also have difficulty accounting for not just the growth in the quantity of products, but their variety. For example, one study found that the 4-fold increase in the variety of imports between 1972 and 2002 was worth 3 percent of GDP. This benefit is likely to grow as technology allows the specification of manufacturing and health care products to individual needs. We are leaving behind the era of mass standardization and entering a world of mass customization. Finally, the full benefits of production are not measured alone by the cost of production, which is what is captured in GDP, but in the total benefit to consumers which includes their consumer surplus. For example, when paid newspapers are replaced by free news on-line, measured GDP declines but the benefit to consumers may actually increase, since the news is now tailored more closely to what the individual wants. Eric Brynjolfsson and Joe Hee estimate that using the Internet free alone is worth $2,600 a year per user.

So don’t be discouraged by the widespread reports that the next generation will not achieve today’s living standard. The nature of economic growth and the cumulation of new technology and knowledge makes it almost certain they will live better lives.