Idiot’s Guide to Natural Economic Growth

I have been noticing for quite some time now, that there are a lot of people in neoreaction, or people interested in neoreaction, who tend to have a very limited understanding of economics, either because their interests lie elsewhere or simply because they do not have the time to study the subject. This post is for those people who wish they would know more about economics, especially macroeconomics. Moldbug himself had quite a few posts on economics, and those are all very good, but in some cases I believe he sacrificed simplicity in order to be as detailed and thorough as possible. The aim of this post is exactly the opposite. Understanding how the process of natural economic growth operates is indeed somewhat complicated (although not as complicated as some ‘experts’ would like to convince you), but in this post, I will try to explain it in the simplest way possible, so that whoever is new to economics can have at least a general understanding of this topic. Keep in mind, I am not a professional economist myself, I do not have a fancy degree, but I have read quite a bit about the topic and I think I have at least a general idea of what the fuck is going on. Which should be more than enough for the purposes of this post.

The modern world has actually almost entirely forgotten what natural economic growth looks like. And this is another reason why reviewing this subject is so important. You will never hear a mainstream economist say what I am about to write in this essay (hardly surprising of course, considering that I am following the Austrian School’s account here). Through the constant repetition of boom and bust cycles, along with multiple interventions by governments in order to ‘stimulate the economy’ natural economic growth has become a thing of the past. The scientific consensus is that natural growth is evil. So it is almost an accident if it happens at all nowadays.

Now, I should clarify that what is meant by natural economic growth is growth which does not rely on the helping hand of the government with its massive stimulus programs and policies of monetary expansion. Yes, contrary to popular belief an economy can grow based entirely on private enterprise and you don’t have your government spending accounting for 40% of GDP in order to keep GDP growth positive (then again GDP is a fudged aggregate anyways, but that is another topic). Now, as every Austrian economist will tell you, governments are not better at growing economies than private businesses. In fact they are much worse. And usually when they do try to ‘stimulate’ growth, that is exactly what causes the infamous business cycle. But this is not a post about Austrian business cycle theory, so we are not going to talk about that.

However, to paraphrase Hayek, in order to know why things go wrong we should know how they go right in the first place. So you cannot understand business cycles without understanding natural growth. You can’t understand why your computer is not working without understanding how it is supposed to work, etc.
Before going into the main subject however, we will first discuss a concept which is fundamental for understanding human action. We shall begin by discussing the existence of universal time preference amongst humans.

What is time preference?

Time preference stands for the rate of preference people have for consumption of goods and services at an earlier date versus consumption of goods and services at some later date. When an individual’s time preference rises, he starts consuming more and is saving much less (if he is saving at all). He is more concerned about the present and the near-future than the more distant future. When an individual’s time preference goes lower, he consumes less and saves more, cares more about the distant future and is more concerned about the long-term than the short-term in general. The existence of time preference reveals one very fundamental fact of human action – everyone prefers to consume sooner rather than later. This is true because of the fact that time itself is a scarce good. Humans are not immortal – we all eventually die which means that we don’t have an unlimited amount of time. Because of this fundamental fact, everything else being equal, everyone prefers to acquire and either consume or in some other fashion make use of a specific good sooner rather than later.

The time preference of the population directly influences the market interest rates and most importantly the overall structure of production of the economy. For now let’s just clarify why time preference is the most important factor in determining interest rates. First of all, what is an interest rate? As you probably know, interest is the premium that the lender charges the borrower for a particular amount of money loaned for a given period. When person A lends person B a certain amount of money at a certain interest rate for, say, a year, person B, after the year has passed, must repay A the original amount of money loaned plus the interest accrued. But why do people even charge interest rates? You already learned the answer in the previous paragraph. People charge interest on loans (whether they are monetary or not) because of the existence of time preference. When people loan money they demand a higher amount to be paid back because everyone universally prefers money and goods in general sooner rather than later. So the delayed consumption that the lender has to go through has to be compensated with an extra premium amount repaid on top of the principal.

Now that we know what human time preference is and how it relates to interest rates we can finally move on to the main discussion.

To start with the conclusion, natural economic growth is driven by savings and not by consumption as most mainstream economists like to claim. For them, especially for Keynesians, it is all about demand – aggregate demand. If demand is too low according to their metrics, the government should intervene and ‘stimulate’ the economy by randomly spending money. It is not that important how the money are spent, what is important is that the overall level of demand increases so that there is no price deflation (fall in prices) and no fall in employment. This line of thinking is (you guessed it!) fundamentally misguided totally retarded.

For economic growth to be possible, first the people’s time preference has to fall. This lowering of the time preference means that economic actors are now increasing their savings to consumption ratio i.e. they consume less and save more. This of course leads to a fall in the demand for consumer goods which also eventually lowers their price. At this point Paul Krugman is already having a seizure. But this fall in demand for consumer goods is necessary for the economy to be able to grow.

Now that the demand for, and the price of consumer goods has fallen this also leads to a fall in profits from producing them which forces firms in those consumer goods industries to cut back on their costs in order to keep themselves in business (some firms might actually be completely forced out of the market). So they start producing less, leading to a fall in the supply of consumer goods and of course, they also cut back on wages and labor as they do so. Remember that this whole process was initiated by the consumers themselves when they started saving more money and consuming less. The fall in the supply of the consumer goods is a response to the earlier fall in demand. Less consumer goods are now being produced not because of some mysterious ‘market failure’, but because the consumers themselves are now saving much more because of their lower time preference.

Now we come to the most important effect of the fall in time preferences and subsequent increase of savings – this leads to a fall in interest rates. With an increasing pool of savings available for lending and therefore for investment, interest rates fall and entrepreneurs can now borrow more money and undertake more roundabout and more productive long-term projects which were not profitable before when interest rates were higher. This leads to an increased demand in the capital goods industries as more roundabout and more long-term projects require a higher amount of capital. I believe it is common sense that more productive and complicated projects do require a longer time period to finish and a higher supply of capital. Or at least it should be to everyone who is not a Keynesian.

The result of this increase in demand for capital goods is that both the price of capital goods and subsequently the profits to be made in the capital goods industries rise substantially leading to a further increase in profits to be made in those sectors of the economy. Because of this the businesses already in those sectors start expanding and at the same time whole new business ventures get started as well. Just what you would expect to happen in an industry when the demand for its goods starts increasing. This of course means that wages start rising as well, as more workers are needed by expanding and newly started business enterprises in that sector.

These higher wages, caused by the increased demand for labor, start attracting workers from the consumer goods industries where wages were actually cut (because of the fall in demand for those goods) and some labor may have even been released. So, there is a shift of labor – from the consumer goods industries to the capital goods industries. This shift of course takes some time to happen therefore a mild short-term rise in unemployment may happen after the fall in consumption. In the real world, things happen in real time. This is not a statistical simulation in which the market can equilibrate immediately. It does equilibrate in the end, but that takes some time – several months maybe a year or two. In that period, yes, there is an increase in unemployment. But always remember that this is only temporary, as this unemployed labor is now needed for the production of the capital goods, the demand for which has risen, after the increased investment by entrepreneurs in more long-term projects.

After labor starts shifting, and the capital goods sector starts expanding, soon enough, the supply of capital goods in the economy starts increasing. This of course means that now more capital can be used in production which crucially increases the capital to labor ratio. The increase in this ratio means that workers now have more capital to work with which increases the marginal productivity of their labor (the employment of increasing amounts of capital, and labor, are of course both subject to the law of diminishing returns, but as this is an introductory text, we will not go into detail about that). Of course if labor is more productive this means that more goods can be produced than before, which, in the long-term, leads to a rise in the supply of consumer goods.

(Also, remember those long-term and more roundabout and more productive projects that entrepreneurs wanted to start after interest rates went down? Exactly. Now they are successfully completed.)

As the supply of consumer goods rises, ceteris paribus, their price falls, leading to an increased (real) wage to price ratio. In order words, the purchasing power of money rises, and people can now buy more stuff with the same wages they had before, assuming the money supply has stayed relatively constant, or at least hasn’t increased to the same degree as the supply of consumer goods (money are also subject to the laws of supply and demand as is any other good exchanged in the market economy). Fluctuations in the money supply can affect this whole process very seriously, but once again, we are trying to keep it simple, so we will leave that for another time.

The modern technical term for this process of an increase in the purchasing power of money is of course (price) deflation, or more precisely, (as Austrians would put it) productivity deflation. Deflation is, of course, demonized by every single mainstream economist you can come across nowadays. But as we just saw, natural economic growth inevitably leads to deflation, assuming a stable money supply. And this fall in prices is not scary at all, as it directly results in an increased standard of living for everyone as the consumers can now by more goods with less money than before.

But to emphasize this last point some historical examples might be useful.

The most famous one is of course the period of industrialization during the 19th century. For example, in the U.S. from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75 percent per year, while real income rose by about 85 percent, or around 5 percent per year [1]. Of course deflation occurred not only in those sixteen years, but throughout the whole century accompanied by massive economic growth in both Europe and the U.S. interrupted only in times of major wars.


Of course nowadays everyone is convinced that deflation (no matter what kind, because there are several) should always be avoided because it unavoidably leads to depression. This is absolute nonsense and I hope that by now you fully understand why. But if someone keeps insisting on an undeniable deflation=depression relationship, you can always point him to this research paper (by two economists of the Federal Reserve, no less), which clearly states that:


… the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-34). We find virtually no evidence of such a link in any other period. … What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.

So that’s that. I hope this post helped clarify (at least a bit) the mystical topic of economic growth. If something is unclear, post your questions in the comments below. Once again, I am not a professional economist (although I am probably still better than some), but I will try to answer any possible queries to the best of my knowledge.

[1] Data from: Milton Friedman and Anna J. Schwartz, A Monetary History of the United States: 1867–1960 (Princeton, N.J.: Princeton University Press, 1971), pp. 94–95.

4 responses to “Idiot’s Guide to Natural Economic Growth

  1. Pingback: Idiot’s Guide to Natural Economic Growth | Neoreactive

  2. Dave February 19, 2015 at 3:29 am

    Or you could take President Harding’s approach to the 1920 depression: Cut spending (by half!), balance the budget, and let God sort out the rest. By 1921, the depression was over.

    We will eventually put the task of managing the economy back in God’s invisible hand, while the former managers in D.C. roast rats and pigeons over burning piles of $100 bills.


  3. Pingback: This Week in Reaction (2015/02/20) | The Reactivity Place

  4. vimothy February 23, 2015 at 11:36 am

    To start with the conclusion, natural economic growth is driven by savings and not by consumption as most mainstream economists like to claim.

    I realise that this article is polemical, but even so, this is a remarkably wrong-headed statement. Most mainstream economists claim no such thing, as even a minimal amount of Googling would reveal. The baseline for understanding economic growth in mainstream economics is the neoclassical Solow-Swan model. In this (simple workhorse) model, abstracting away from population growth, the drivers of economic growth are either capital accumulation or technological change (i.e., productivity growth). When taken to the data, capital accumulation was not sufficient to explain the variation in growth levels across countries, leading to the assumption that productivity growth must instead be the factor that explained the residual variation in economic growth.


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