Economic growth on a flat Earth
Our modern understanding of economic growth is a number going up. American Gross Domestic Product was $3.3 trillion in 1982 and $25.5 trillion in 2022. It grew. We then map that thinking onto businesses. The Coca-Cola Company had revenues of $6.3 billion in 1982 and $43 billion in 2022. It grew.
Both numbers grew at a similar rate. Viewed as a share of America’s wallet, which is what GDP measures, Coca-Cola revenues have therefore remained remarkably stable. They’ve been flat. That wording may seem jarring, but only because we’re used to walking to stand still. Like fish in water, we’ve been on the Fed’s monetary treadmill for so long that we forget what it’d be like stepping off.
The GDP figures we’ve used so far are all ‘nominal’, which means unadjusted for price inflation. Over time, the only thing ‘growing’ nominal GDP is monetary inflation — i.e., money printing. Measured in gold, for which supply expands very slowly, the US nominal GDP was equal to 400 thousand metric tons in 1956, 1978, 1987, 2010, and 2022. It didn’t grow. In a world without monetary inflation, nominal GDP is flat over time. Economic growth has no impact on nominal GDP ‘growth’. Monetary inflation doesn’t grow anything. That’s a misnomer. It increases nominal amounts without affecting how much we produce. Entrepreneurs produce. And great entrepreneurs produce more, causing growth.
Economic growth, or ‘real’ GDP growth, is nominal GDP increase minus price inflation. We strip out the change in price (i.e., price inflation) to isolate the change in volume (i.e., economic growth). Economic growth is volume growth. Real GDP growth is thus entirely consistent with no nominal GDP increase. It’s what happened in America under the gold standard. Total production may not increase in numerical terms under a gold standard, but it can increase in volume terms. To square that math, the price simply drops. Price deflation is the natural result of economic growth when there is no change in monetary supply. A dollar no longer loses value. Things lose value relative to a dollar.
The Franchise
Going back to the Coca-Cola Company, without monetary inflation revenues would have been flat. They held their wallet share of nominal GDP, outpacing price inflation and keeping pace with monetary inflation. Coke benefited from economic growth between 1982 and 2022 by keeping profits flat in relative terms while most other things got cheaper. That’s how the price of a Coke bottle remained a nickel for over 70 years (1886–1959). It only started increasing a little after the US came off the gold standard.
By stripping out monetary inflation, we get off the treadmill and reframe what growth means. Yes, Coca-Cola grew. Not because the numerical representation of its revenues increased, but because those revenues grew their purchasing power. Thanks to a formidable brand and competitive moat, Coca-Cola indirectly benefited from productivity gains. We may call these companies Franchises, as they extract a royalty on economic output. They’re the corporate beneficiaries of Baumol’s disease, the observation that certain wages must rise more than productivity to attract people who could otherwise work in increasingly productive sectors.
Economic growth not only benefits Franchises. It also creates room for them. As we get richer, spending shifts from needs to wants. It shifts from survival to self-actualization as Maslow would say. We spend less on food and more on sneakers, allowing Colgate or Nike to build a franchise.
The Innovators
Technology is deflationary. Innovation makes things cheaper. Railroads reduced transportation costs, allowing goods to cross continents, and lowering the price of food in cities. Computers made information abundant and affordable, disrupting entire industries like advertising and boosting productivity at large. Economic growth is deflationary, not inflationary. We equate growth with ‘making more’ and ‘spending more’. We should equate it with ‘making things cheaper’ and ‘doing more with less’. That latter framing is also why infinite economic growth is entirely consistent with environmental limits, but that’s another discussion.
These companies are Innovators. They cause broad price deflation in goods and services by offering a new or better mousetrap that lets customers increase revenues or reduce expenses. Spending a higher share of wallet on Cloud computing increases productivity, making everything else cheaper to produce. Between 2013 and 2022, Amazon Web Services increased its revenues from $3.1 billion to $80 billion — or 44% annually, far above the 5% nominal GDP increase.
But Innovators can’t grow as a share of wallet forever. Every dollar they claim must come from somewhere else. The math only works if productivity gains compensate for higher spending. We buy tractors if they lower the price of food by more than what they cost because overall we are better off. But there comes a point when spending more simply doesn’t yield a commensurate productivity gain. That’s when Innovators reach maturity. Fortunately, great Innovators can remain relevant for a long time by adapting or consolidating slowing markets.
The Deflated
Nearly everything gets cheaper relative to our income. That’s the very definition of economic growth. It’s wonderful news. We may not notice since in the modern world monetary inflation overwhelms technological deflation. We think everything is always getting more expensive. But it’s an illusion.
According to the USDA, Americans spent $209 billion on food at home in 1982. That had increased to $1047 billion by 2022, or 4% annually. That’s less than monetary inflation, which is why over that period the share of disposable income spent on food at home shrank from 8% to 5%. Nominally, expenditure has quintupled. But relative to income it shrank by nearly 40%. These companies are the Deflated. Innovation makes them cheaper and as a result, consumers reward them with a smaller share of wallet.
Given enough time, almost all sectors of the economy join the Deflated gang. Railroads once accounted for 80% of America’s stock market capitalization. Today, the entire Transportation sector is worth about a tenth of Technology Services alone. Given enough time, Technology Services will also shrink into a minnow, overshadowed by a new technology wave with its Innovator champions.
Flat out growth
By stepping off the inflationary treadmill, we see the economy and companies through a new lens. We better understand economic growth: who causes it and what it causes. We apprehend new categories of companies: 1) Franchises, which indirectly benefit from economic growth, 2) Innovators, which directly cause and benefit from economic growth, and 3) Deflated, which shrink with economic growth.
We may come to appreciate just how rare and valuable Franchises can be. It takes an incredible brand and competitive advantage to hold one’s share of wallet, thereby benefiting from everybody else’s innovation. We respect the hard work of Innovators by making it clear that they cause deflation, boosting our purchasing power. We also realize that eventually, all Innovators must join the Deflated gang. It’s bittersweet, but we salute their contribution to mankind.
Sacha Meyers
