ACTIONABLE ADVICE FOR FINANCIAL ADVISORS: Newsletters and Commentaries Focused on Investment Strategy

Follow us on
 Facebook  Twitter  LinkedIn  RSS Feed

    Last 14 days

Most Popular Articles


Most Popular Commentaries

    Last 12 Months

Most Popular Articles


Most Popular Commentaries



More by the Same Author

Economic Insights
   Employment
   Inflation
   Recession
General Advisory
   Endowments
Global Markets
   Africa
   Global
   Latin America
Specialty Investments
   Commodities
A Critique of Grantham and Gordon
The Prospects for Long-term Growth
By Laurence B. Siegel
November 27, 2012


Go to page Previous 1, 2, 3     Bookmark and Share  Email Article   Display as PDF   Remind Me Later

The true history of global growth

The idea Gordon cites that, before 1750, economic growth proceeded at the paltry 0.2% annual growth rate is also flawed (although plausible if one looks uncritically at available data).  John Locke in 1700 said that a day laborer in London lives better than a king (meaning an Indian chief) in America; Adam Smith said something similar in 1776.  These comments reflect robust economic growth in Britain before 1700.  Only a fool would suggest that Leonardo’s Florence, Shakespeare’s London, or Mozart’s Vienna were not better off – by more than 0.2% per year – than those same cities a century or two earlier.  But when growth did occur prior to the 1700s, it was quickly undone by disease, or by ridiculous and tragically destructive wars. (The Thirty Years’ War eliminated a third of the population of Germany.) The failure of then-available technology to communicate innovative techniques across space and time also helped ensure that gains were always fleeting.

So global growth really did proceed at the 0.2% annual snail’s pace. But, when and where conditions were favorable, growth was considerably higher.  People have always expended great effort to make their children’s and grandchildren’s lives better than their own, and they will continue to do so.

Jeremy Grantham’s one big headwind

The fox knows many things, said Aesop, but the hedgehog knows one big thing. (He meant it as a compliment to the hedgehog.)

In “On the Road to Zero Growth”, the quintessential hedgehog Jeremy Grantham has proposed that our depletion of easily exploited natural resources has caused the 200-year downtrend of real commodity prices to reverse itself and turn upward.  This, Grantham argues, makes it almost impossible to achieve high economic growth rates; the past history of rapid growth, according to this view, is the history of cheap energy. 

While Grantham’s commentary addresses other issues, including some of those raised by Gordon, resources and the environment, in his view, trump all the others.

Grantham notes that the cost of commodities, expressed as a share of total input costs, fell from nearly 100% in the Middle Ages to 3% in the U.S. in 2000, but they have risen to 7% in the U.S. since then.  This last increase represents a massive cost shock, and it is a good explanation for recent stagnation.  Some of the cost increase is our own fault (where are the nuclear power plants?), but if this trend continues indefinitely it will be catastrophic for global economic growth. 

The hitch is that Grantham offers no evidence that the recent upsurge in commodity prices is anything other than one of the many short-term commodity price spikes that have punctuated the centuries-long downward trend.  He just asserts that this time is different because this time it’s cost-driven. 

But, as Grantham rightly points out, the cost of commodity extraction is always set by the tension between resource exhaustion, which drives prices up, and improvement in extraction technology and the discovery of new supplies, which drive prices down.  (He addresses substitution and conservation, both of which also drive prices down, later in his commentary.) 

Now, this tension must necessarily be resolved separately for each commodity.  Even if there is a surge in demand for goods in general, driving commodity prices higher in aggregate, the rate at which resources are exhausted and the rate at which technology makes extraction cheaper are determined separately for each commodity.  There is no reason to think that a technological change that makes copper easier to mine should occur at the same time as a weather condition leading to a good wheat harvest or the discovery of a new oil field.  There is just no reason why the supply curves for different commodities (other than close substitutes) should change together.

And yet that is exactly what they appeared to do from 2000 to 2012.  Commodity prices soared together from 2000 to 2007, crashed in 2008, and then soared once again from 2009 to 2012.  This is obviously a beta effect, a common factor operating on all commodities regardless of their cost conditions.  What was the cause?  Global growth may be a factor, but growth has been modest since 2009, and it was strong before 2000.  A much more plausible culprit is portfolio flows into commodity index funds and index derivatives, driven by pensions, endowments, and sovereign wealth funds.  If that’s what’s to blame, it is unlikely to be repeated.

Thus, the evidence of a paradigm shift from a downtrend to a permanent uptrend in commodity prices, as posited by Grantham, is scant.  The future of input costs – particularly energy costs – looks much like the past.  Energy costs are likely to continue to decline in a stair-step fashion, with secular cost decreases caused by technological changes – the advent of fracking, wider use of nuclear power, innovations in alternative energy – punctuated by cyclical cost increases caused by resource depletion, wars, and rising demand.

Grantham also offers an unrealistically pessimistic forecast for the contribution of the service sector to overall economic growth.  While he acknowledges its growing importance and the problems with productivity measurement, he ascribes the role of the service sector to “luxuries or, shall we say, non-essentials, the desirability or perceived quality of which often increases with the number of attendants and personal face-to-face time.” But service sector growth will come from industries like education and health care – hardly luxuries.  Moreover, the health care industry is massively inefficient and ripe for productivity gains.  Even though some of those new efficiencies will not directly boost GDP – because of the measurement problems that Grantham cites – the inefficiencies will attract new entrants, which will boost GDP, as was the case in the manufacturing sector when it was the dominant force in the US economy.

The bullish case for growth

Consumption cannot grow forever.  Some consumption is of physical, nonrenewable resources, and the volume of cumulative nonrenewable resources consumed cannot exceed the volume that exists on Earth.  Even at a zero growth rate, resources continue to be consumed, subject to physical limits.  Thus, a worldwide slowing of growth at some point in human history is inevitable.

We are, however, nowhere near that point. 

The physical environment is in pretty good shape.  It is cleaner in developed countries than it was in those same countries when they were developing, and the same potential exists in countries that are still developing today.  While some resources have been depleted so that the easiest-to-obtain supplies are gone and what remains is costly and difficult to obtain (oil being the most prominent example), that very cost makes the discovery and development of substitutes possible, necessary, and likely.  We have barely breached the surface of nuclear, solar, geothermal, wind, and tidal power.  Recent fossil fuel discoveries have been a pleasant and unforeseen surprise (though we’d be foolish to rely on more such good fortune). People have been finding cheaper substitutes for existing resources since the beginning of human history, and there is no sign that we will stop any time soon.

We have heard concerns about the permanent slowing or stopping of global growth after every depression or severe recession.  In the 1890s, the idea was circulated that everything worth inventing had already been invented.  In the 1930s, it was popular to say that capitalism had created the mechanism of its own destruction.  In the 1970s, concerns focused on foreign competition and resource constraints, and some people forecast mass starvation. Today’s concerns are no different in principle, and they are no more realistic.

The problems we face are real, but they are hardly insurmountable.

Economic growth does not come from discoveries of natural resources (although those help), but from innovations that permit us to do more with less.  That is the economist’s definition of an improvement in technology, and it is the definition we should always bear in mind.  Thus economic growth comes from people trying to better their own lives and those of their children, and it comes from the dissemination of information on how to do so across time and space.  If we can avoid the plagues of war and disease that kept economic growth from catching fire before the 1700s, we can rely on the natural desire to improve one’s lot in life as the engine of economic growth in the future, and we can expect it to continue.


Laurence B. Siegel is the Gary P. Brinson director of research at the Research Foundation of CFA Institute and senior advisor at Ounavarra Capital LLC.  Before he retired in 2009, he was the director of research for the investment division of the Ford Foundation, which he joined in 1994 from Ibbotson Associates, a consulting firm that he helped to establish in 1979. 

Go to page Previous 1, 2, 3

Display article as PDF for printing.

Would you like to send this article to a friend?

Remember, if you have a question or comment, send it to .
Website by the Boston Web Company