Stakeholder Capitalism. Klaus Schwab

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2 Kuznets’ Curse : The Issues of the World Economy Today

There might have been no better person to piece together the puzzle of the world economy today than Simon Kuznets, a Russian-born¹ American economist, who died in 1985.

      It may seem odd at first that a man who passed away in the mid-1980s would be so relevant to today's global economic challenges, but I believe the issues we are facing today may not have become so problematic had we better heeded the lessons of this Nobel Prize–winning economist.

Indeed, Kuznets warned more than 80 years ago that gross domestic product (GDP) was a poor tool for economic policymaking. Ironically, he had helped pioneer the very concept of GDP a few years earlier and had a hand in its becoming the holy grail of economic development. He also warned that his own Kuznets curve, which showed that income inequality dropped as an economy developed, was based on “fragile data,”² meaning data from a relatively brief period of the post-war Western economic miracle that took place in the 1950s. If the period of his study turned out to be an anomaly, the theory of this curve would be disproven. Kuznets also never approved of the curve's off-shoot, the so-called environmental Kuznets curve, which asserted countries would also see a drop in the environmental harm they produced as they reached a certain state of development.

      Today we live with the consequences of not having been more rigorous in our analyses or having been too dogmatic in our beliefs. GDP growth has become an all-consuming goal, and at the same time, it has stalled. Our economies have never been so developed, yet inequality has rarely been worse. And instead of seeing a drop in environmental pollution, as one might have hoped, we are in the midst of a global environmental crisis.

      That we are facing this myriad of economic crises may well be Kuznets’ curse. It is the ultimate “I told you so” of an oft misunderstood economist and forms the root of the feeling of betrayal people have toward their leaders. But before we get deeper into this curse, let's examine who exactly Simon Kuznets was and find out what people remembered him for.

The Original Kuznets’ Curse: GDP as Measure of Progress

Simon Smith Kuznets was born in Pinsk, a city in the Russian Empire in 1901, the son of Jewish parents.³ As he made his way through school, he showed a talent for mathematics and went on to study economics and statistics at the University of Kharkiv (now in Ukraine). But despite his promising academic results, he would not stay in the country of his birth after reaching adulthood. In 1922, Vladimir Lenin's Red Army won a years-long civil war in Russia. With the Soviet Union in the making, Kuznets, like thousands of others, emigrated to the United States. There, he first got a PhD in economics at Columbia University and then joined the National Bureau of Economic Research (NBER), a well-respected economic think tank. It was here he built his illustrious career.

His timing was impeccable. In the decades after his arrival, the US grew to become the leading world economy. Kuznets was there to help the country make sense of that newly found position. He pioneered key concepts that dominate economic science and policymaking to this day such as national income (a forerunner to GDP) and annual economic growth and became himself one of the world's most prominent economists along the way.

      The economic development curve of the United States in those years was a turbulent one. In the 1920s, the country was on an economic high; it came out of the First World War swinging. The US emerged as a political and economic power and put its foot next to that of an already enfeebled British Empire. Britain had dominated the world during the First Industrial Revolution, ruling a third of the world until 1914. America instead became a leader of the Second Industrial Revolution, which really took off after World War I. US manufacturers introduced goods such as the car and the radio to the country's huge domestic market, selling them to a public hungry for modern goods. Aided also by a spirit of free trade and capitalist principles, a positive spiral of investment, innovation, production, consumption, and trade ensued, and America became the world's wealthiest country in GDP per capita terms.

      But the heady experience of the “Roaring Twenties” turned into the calamitous Great Depression. By 1929, the booming economy had spiraled out of control. Inequality was sky-high, with a handful of individuals, such as John D. Rockefeller, controlling colossal amounts of wealth and economic assets, while many workers had a much more precarious existence, still often depending on payday jobs and agricultural harvests. Moreover, an ever-rising stock market, not backed by any similar trend in the real economy, meant financial speculation was reaching a fever pitch. In late October 1929, a colossal collapse of the stock market occurred and set in motion a chain reaction all over the world. People defaulted on their obligations, credit markets dried up, unemployment skyrocketed, consumers stopped spending, protectionism mounted, and the world entered a crisis from which it would not recover until after the Second World War.

      As US policymakers grappled with how to contain and end the crisis at home, they lacked the answer to a fundamental question: How bad is the situation, really? And how will we know if our policy answers will work? Economic metrics were scarce, and GDP, the measure we use today to value our economy, had not been invented.

Enter Simon Kuznets. An expert in statistics, mathematics, and economics, he developed a standard way of measuring the gross national income (GNI) or gross national product (GNP) of the United States. He was convinced this measure would give a better idea of just how much goods and services were produced by American-owned companies in a given year. A few years later, he also became the intellectual father of the closely linked GDP, presenting the slightly different concept in a 1937 report to US Congress.⁴ (GDP takes into account only the domestically produced goods and services, while GNI or GNP include income or products produced abroad by companies owned by a country's citizens.)

It was a stroke of genius. Over the remainder of the 1930s, other economists helped standardize and popularize this measure of economic output to such an extent, that by the time the Bretton Woods conference was held in 1944, GDP was confirmed as the main tool for measuring economies.⁵ The definition of GDP that was used then is still valid today: GDP is the sum of the value of all goods produced in a country, adjusted for the country's trade balance. There are various ways of measuring GDP, but the most common is probably the so-called expenditure approach. It calculates total gross domestic production as the sum of consumption that stems from it (adjusting for exports and imports):