Satyajit Das: For growth to be sustainable, we must accept lower living standards

Midweek View: The economist Robert Gordon argues that the IT revolution created only a short-lived advance in productivity

A return to economic growth requires a return to real engineering rather than a reliance on financial engineering. This would reverse the trend to a position where the real economy simply supports trading and investment in claims on underlying resources.

But even a reversion to the real economy may not be able to address the stagnation of living standards. Traditional sources of growth include increasing population, sustainable and affordable resources, new markets, and improved productivity and innovation.

Environmental and resource constraints also limit the potential for large increases in population. With the world's population fast approaching 10 billion, agronomists estimate that food production will need to increase by 60 per cent to 100 per cent by 2050 to provide food for all, as well as more protein in the form of meat for the rapidly increasing middle classes of the developing world. But the amount of arable land has remained at around 3.4 billion acres for the last decade, and boosting crop yields has become harder.

Sustainable falls in the price of energy and other scarce resources are also difficult, and the scope for new markets is limited. Since 1989, most economies, with the exception of North Korea, have become integrated into the global trading system.

No major technological changes and innovations are not on the horizon. In his 2012 paper for the National Bureau of Economic Research, entitled Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds, the economist Robert Gordon argues that the rapid growth and improvements in living standards achieved since 1750 were driven by three phases of industrial revolution: steam engines; electricity, internal combustion engines, modern communication, entertainment, petrol and chemical, and computing.

He finds that the second phase had the greatest impact on productivity and living standards. To the consternation of the i-generation, Mr Gordon argues that the third phase, while important, created only a short-lived improvement in productivity.

The replacement of repetitive low-value tasks by technology was undertaken primarily in the 1970s and 1980s. The third phase of industrial revolution did not fundamentally transform productivity, but rather improved existing technologies, enhancing capability, power and miniaturisation. Many recent innovations also centred on entertainment and communication devices.

Mr Gordon argues that many of the achievements are non-repeatable, citing higher life expectancy, urbanisation, better food production, clean water, sanitation, faster transportation, increased female participation in the work place, and temperature control to aid productivity in challenging climates.

In recent times, productivity increases, especially the change in output per unit of combined capital and labour, have slowed. Easy gains from outsourcing production to lower-cost jurisdictions or cutting back on staff have already been achieved.

Many new products and productivity measures reduce the number of workers needed, but employment and income levels are not significantly boosted. Given consumption makes up 60 to 70 per cent of economic activity in developed economies, the impact on growth is limited.

The prospect for innovation is also affected by educational levels and funding for research. Scientific research funding has declined in real terms in many nations. As a result, the focus has shifted away from uncertain but potentially ground-breaking research towards safer proposals likely to receive funding. Heavy investment in pure research and development in basic science, such as that undertaken by the Bell Labs and Xerox's Palo Alto Research Centre, is less prevalent today.

Innovation and productivity increases will remain important, but they may not be enough to restore growth to the stellar levels of the 20th century. The challenge now is to create more sustainable growth, replacing the debt-fuelled consumption and investment that has driven global economies for the last 30 years.

The problems we face are both old and new – improving crop yields; developing cheap, sustainable sources of energy; conserving oil, water and other scarce commodities; and using what we have more efficiently. Solving them will require an adjustment in expectations as we adapt to lower growth and lower living standards.

Satyajit Das is a former banker and the author of 'Traders, Guns & Money' and 'Extreme Money'