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October 4, 2021 | A Step Ahead
The Perpetual Growth Machine: Is It Really That Simple?

Olga Bitel, Partner

Global Equity Strategist

Hugo Scott-Gall, Partner

Portfolio Manager,
Co-Director of Research,
Global Equity Team

Have a question for Hugo and Olga to explore on a future walk?

Send us your suggestions at astepahead@williamblair.com
 
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Can it be that economic growth is best defined as a perpetual motion machine? If so, how can we harness people’s insatiable capacity to innovate for sustained growth? And can it be that our policy prescriptions are looking at all the wrong places? Hugo and Olga delve into this all-important topic and come up with some surprising conclusions.

Hugo Scott-Gall: So, we’re growth investors. Lots of people say they’re growth investors, lots of people all around the world talk about growth. Politicians talk about growth. Economists spend their time discussing growth, trying to measure growth.

I think, however, a bigger question sits on top of all this preoccupation with growth: how and why does it happen? So the question, “Is growth a thing?” is not very important but the question, “Why does growth happen?” is often overlooked.

Olga Bitel: Well, I think at its core, economic growth is a highly diffused, organic, and continuous process. It’s sort of inherent in each person’s innate desire and need to better our condition in life and that of our loved ones. So what amounts to economic growth in aggregate is a tug of war between people. Every person has an insatiable appetite, and over time, an increasing ability to improve our lot in life. And our individual and collective appetite is bumping up against other people’s vested interests in the status quo, misaligned incentives, or just plain unwillingness to change.

And I suppose, in aggregate, all this buzzing about nets to what philosophers and economists have tried to define and quantify as economic growth. And this ongoing and ubiquitous need to improve is why, despite continuous setbacks in history and humanity’s occasional flirting with reactionary regimes in the past, people still find a way to grow.

Needs drive innovation, which creates new needs, which drive further innovation. Isn’t it beautiful?


The Perpetual Growth Machine in Motion

Humans continue to innovate, even against the strong winds of vested interests, institutional inertia, and unwillingness to change.

Source: William Blair, as of September 2021.


Hugo: I don’t disagree with your description on the face of it. You outlined two things. One is the need to improve one’s lot, and the second is the means to improve one’s lot. I guess, in terms of the need, you’re saying it’s an essential part of the human condition. It’s an existential constant through time that people have desired improvements. Yet, we observe massively different living conditions and growth around the world.

So, I want to focus a bit more on the means to improve. Specifically, I’m thinking of a book called Why Nations Fail by Harvard and MIT academics Robinson and Acemoglu. They said that nations typically fail because they have bad institutions, and nations usually succeed if they have good institutions. This is because good institutions allow for risks to be taken—risks in terms of experiments and capital at risk. And underpinning that risk-taking is the strength of institutions and property rights. So in the long run they argue democracies have been more innovative than non-democracies.

That was a brief detour but hopefully a relevant one because it leads to this central question: how do you think about the means to improve if we agree that there’s an essential human desire to improve?

Olga: I like how you decompose my perpetual growth machine into needs and means. In the book you just referenced, Why Nations Fail, the authors differentiate between inclusive and extractive institutions. Put simply, inclusive institutions promote the interests of a large majority, and extractive benefit a small group to the exclusion of everyone else.

And this ought to be consistent with our growth machine. If growth is the sum of all innovations undertaken simultaneously by millions of people, then growth-supporting institutions must address the needs of a large majority. So that’s the first point.

Economic growth is a highly diffused, organic, and continuous process. It’s sort of inherent in each person’s innate desire and need to better our condition in life.

Next, these institutions are no more than first-order principles: few would object to things like property rights, democracy, or efficient allocation of capital, which can only be measured ex-post. A critical point, as Dani Rodrik articulated exceptionally well in One Economics, Many Recipes , is that many different policies can further the development of these institutions in a society, but what matters most for the success of a particular policy is the context.

Today, much is being made of the contrast between Deng Xiaoping’s proclamation “to get rich is glorious” and Xi Jinping’s “reasonable adjustment of excessive incomes.” Of course, time will tell, but the difference in context is inescapable. Deng Xiaoping’s policy of trying to allow entrepreneurs took place in a country of almost universal poverty. Today, the wealthiest 1% holds nearly a third of China’s vast wealth, up from a fifth a decade ago. And this is at a time when hundreds of millions of Chinese citizens cannot afford basic healthcare and decent living conditions. This is the second point: The context in which policies are designed really matters.

And finally, since our perpetual growth machine operates continuously, insofar as it tirelessly creates new winners and losers, our institutions that guard its operation and our policies need to be highly dynamic and ever-evolving, too. This is what the Chinese call “crossing the river by feeling the stones.” Otherwise, we end up with wholesale regulatory capture, as in the U.S., for example, but we can come onto that another time.

To promote and sustain economic growth, we need to have institutions that address the needs of most rather than a select few, specific policies must take into account current context, and in turn, must be fine-tuned all the time.

Hugo: If I understood you correctly, you are saying that to promote and sustain economic growth, we need to have institutions that address the needs of most rather than a select few, specific policies must take into account current context, and in turn, must be fine-tuned all the time.

What about some layers down from that? Such things as education, access to capital, provision of capital. Capital goes where it’s well treated, but it also seeks out high returns. High returns often come, particularly in the modern economy, from intangible things like intellectual property. Intellectual property is more likely to be created by the educated and highly skilled. So as we think about the conditions for growth, how important are access to human and financial capital and access to all other resources?

Olga: To get specific, in a modern developed economy that is more or less on the technological frontier, a government—for lack of any other entity—must remove barriers to innovation by developing and constantly upgrading physical and social infrastructure and ensuring rational competition in most industries.

On the physical side, things that connect people and goods, like highways and wireless signals, are hugely important. On the social infrastructure side, ever-higher levels of education attainable by most, together with universal access to healthcare and pension provisions, tied to overall productive life but not to a specific employer, are keys in terms of macro policies. And, of course, any government needs to continuously ensure that rational competition prevails in most industries. Without that, any discussion of efficient capital allocation is moot.

Hugo: I hear you on removing barriers to innovation. But is that enough to ensure sustained growth? Do we also need to incentivize people?

If needs drive innovation, what happens when we get to a comfortable living standard when our needs are broadly met? Isn’t complacency the essence of the middle-income trap? History offers lots of examples of stalled or derailed economies. At the turn of the 20th century, Argentina and Russia were among the top five fastest-growing economies globally. What does that purport for China’s growth in the not-too-distant future? Beyond specific country failures, what about Robert Gordon’s argument that “you can only replace horses with motor power once”? Put differently, are we running out of innovations?

Olga: We need to extend our walks by quite a few miles to do your questions justice. Shall we pick this up next time?

Olga Bitel, Partner

Global Equity Strategist

Hugo Scott-Gall, Partner

Portfolio Manager,
Co-Director of Research,
Global Equity Team

Have a question for Hugo and Olga to explore on a future walk?

Send us your suggestions at astepahead@williamblair.com

SUBSCRIBE TO A STEP AHEAD

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