The Great Big Misunderstanding Behind Economic Growth

Christopher Koch, Will Ritzrau and Dan Wellers

The year 1934 was a time of crisis and terrifying uncertainty. The world economy was in the midst of an unprecedented economic collapse. Almost no one was spared: Unemployment had hit 44% in Germany in 1932; in 1933 the rates were 38% in the United States and 33% in Norway.

Worse, no one could explain why the collapse had happened, or what to do about it. Modern economics was still in its infancy.

In desperation, the U.S. Congress asked one of the leading economists of the day, Simon Kuznets (a Soviet émigré and future Nobel prize winner) to create a calculation for determining national productivity so policymakers could have a standard measurement to work with. His calculation, gross domestic product (GDP) became the world standard for measuring the health of economies.

As world economies recovered after World War II, GDP got lucky. Social welfare improved in parallel with huge GDP growth. The middle class blossomed, and improvements in healthcare, schools, and infrastructure manifested into the greatest gains in human well-being the world had ever seen.

In the minds of most people, growth in GDP became synonymous with a better life.

Trouble was, it wasn’t true.

GDP was not an indicator of well-being. It was just along for the glorious post-war ride.

No one knew that better than Kuznets himself, who, when he finished creating his famous calculation in 1934, cautioned the world that “The welfare of a nation can … scarcely be inferred from a measurement of national income.”

The disconnect between GDP and well-being is evident today: It continues a nearly unbroken run of global growth, but in the United States, for example, wage growth, when adjusted for inflation, hasn’t budged for most people since the 1970s.

And GDP is also hiding a crisis that is in many ways an echo of 1934. A global shift is occurring that we have never seen before and for which we have no agreed-upon answer: climate change. It is a threat to the economic growth that we have come to take for granted, as well as our well-being.

GDP does not account for this crisis. In fact, it compounds it. For example, GDP counts pollution and carbon emissions as gains for the economy – twice.

GDP makes no distinction between economic production that pollutes and that which does not; all that matters is the market value of the goods and services produced. Meanwhile, cleanup efforts after disasters such as the California wildfires are counted as a gain. But who would argue that anyone is better off because of this kind of growth?

There are alternate formulas that incorporate damage to the environment and depletion of natural resources into a national calculation, but none of them have been able to dislodge GDP.

If we treated environmental and resource destruction as what they are – economic losses – there would be an impetus for solving the crisis we are in. Business leaders and politicians would be forced by the markets to invest in technologies for diminishing the losses. For that to happen, the losses need to show up on corporate balance sheets and GDP needs to be either corrected or replaced as the accepted measure of economic growth.

If we started measuring and holding organizations accountable for those losses, we could spark an economic expansion that would make the post-war era look weak by comparison. Building out a non-polluting energy, food, and transportation infrastructure would spark what infrastructure investment always does: sustainable and long-term economic growth. Just think of how the global investments in superhighways after World War II sparked an economic growth explosion.

Growth would be further buoyed by a shift away from the traditional make, use, and dispose mindset to a circular mindset in which we design products from the start to be taken apart, repaired, reused, or recycled. In fact, this shift in mindset is defining the next era of competitive advantage.

Sustainability has gone from being thought of like philanthropy – at the edge of what companies do – to being central to business strategy and innovation, especially in industries that rely heavily on natural resources. And just as with any business practice, companies that take the extra step and adopt sustainability practices that are truly strategic – i.e., innovative and difficult to duplicate – such as circular business models, are already creating sustained competitive advantage, according to a recent study of 3,800 companies.

Changing the way we measure growth would clarify the business advantages of circular methods and spur a new industrial revolution. Emerging technologies such as IoT, cloud, artificial intelligence, autonomous vehicles, and data analytics, are ready to support this shift through such advances as inexpensive, iterative digital design processes; greater resource and supply chain transparency; and lower-cost logistics and recycling processes. Accenture estimates that organizations could create up to US$4.5 trillion in value by 2030 from adopting circular economy principles more widely.

Meanwhile, signs are all around us that the traditional paths to economic growth are narrowing. Skyrocketing demand for consumer goods has turned finding and maintaining reliable sources for raw materials into an increasingly risky business. There was record price volatility for metals during the ’00s – greater than that of any decade of the 20th century, according to a report by the McKinsey Global Institute. Price volatility of raw materials is having a significantly higher impact on the bottom line than traditional financial measures of volatility, such as currency exchange rates. Circular business models would greatly reduce or perhaps even eliminate resource cost and volatility risk by reusing existing materials rather than relying on finding and buying new ones.

Consumers are also applying pressure to the traditional growth model. One of the most significant insights in a new study by SAP (registration required) is that, more and more, the value of a product is determined by the values of the company that makes it. And that more consumers are choosing products only from companies that align with their personal values. Indeed, Nielsen’s most recent Global Corporate Sustainability Report found that brands associated with sustainability grew three percent more in one recent year than the rest of the field.

And there are signs that if businesses don’t act soon, at least some governments will. In Europe, the regulation of single-use plastics is tightening and fast. The U.K. will enact a ban in 2021, and all of Europe will do it by 2025.

But such regulations are only partial solutions.

Despite the advances being made by many brands, most circular efforts today are still small and isolated. However, during a recent 2019 Predictions Special episode of the global thought leadership roundtable series Coffee Break with Game Changers Radio, presented by SAP and hosted by SAP’s Bonnie D. Graham, we predicted that during 2019, companies will begin to invest and partner at the scale necessary to take advantage of this huge growth potential.

They will start looking at substitutes for plastics and oil. They will pursue sustainable design, sustainable supply chains, and reintegrate used products into their production and manufacturing capabilities.

If they do this, the payback in growth from circular economy business models will be immeasurable.

SAP worked with more than a dozen industry experts to uncover five trends that will determine the customer experience over the next decade. Download the report The Future Customer Experience: 5 Essential Trends, which examines each of these trends and offers recommendations for how brands should respond now to prepare.

For insightful predictions that can impact you and your business in 2019 and beyond, listen to recordings of all six episodes of the SAP’s Game-Changers Radio 2019 Predictions Special: Part 1 |Part 2 | Part 3 | Part 4 | Part 5 | Part 6. Also, check out the regular episodes of the global thought leadership roundtable series Coffee Break with Game Changers Radio, presented by SAP and hosted by SAP’s Bonnie D. Graham.

About Christopher Koch

Christopher Koch is the Editorial Director of the SAP Center for Business Insight. He is an experienced publishing professional, researcher, editor, and writer in business, technology, and B2B marketing.

Will Ritzrau

About Will Ritzrau

Will Ritzau focuses on the circular economy and impact valuation for the Global Sustainability team at SAP.

About Dan Wellers

Dan Wellers is the Digital Futures Global Lead and Senior Analyst at SAP Insights.