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Causes of Economic Growth

Causes of Economic Growth: State of Innovation

Causes of Economic Growth: The only reason we are wealthier today than our ancestors in 1500 AD or 1900 AD is because our level of technology is greater than our ancestors. Modern economists have studied this issue and found that increases in capital goods are not nearly as likely to result in economic growth as innovation.[1] Robert Solow won the Nobel Prize in Economics because of his work on the causes of economic growth. His model suggests that fourth fifths of the economic growth of the U.S. is the result of technological progress.

Real per capita increases in income can only be the result of innovation. Adding capital without any innovation associated with the capital will result in elevating every worker to a certain efficiency level, however never above that level. Once every worker has the all the capital resources they can use in their job they have hit a maximum output without innovation.

What if we had exactly the same technology now as we did in 1800? Would we be any better off per capita than the people of 1800? You might think that we would live longer. But, why would we live longer. We would have the same nutrition, sanitation, and medicine as them. We would have no advantages over our ancestors if we were limited to their technology. Our per capita income would be the same as the people of the 1800s.

Real per capita income growth is due to innovation. This is consistent with classical economics and supply side economics but refines our understanding of growth. The sad thing is, most college economics courses do not even discuss innovation. These courses focus on static supply and demand curves. Covering up the discussion of innovation with the Latin phrase “ceteris paribus” – all other things being equal.

The process of innovation, which Joseph Schumpeter called creative destruction, has largely been ignored by economics. However, other economists who have worked on innovation economics, include Robert Solow, Paul Romer and Gregory Clark. From a fundamental point of view in order to consume something it first has to be produced. In order to produce something, it first has to be invented or discovered.

While inventions are the cause of per capita income growth, market feedback mechanisms are still necessary to determine what inventions should receive investment. Without market feedback mechanisms, we might end up in the same position as the USSR. They setout on a program to produce more steel than countries in the west and succeeded in the 1950s. This caused many pundits in the west to suggest that communism was economically superior to western capitalism. However, it turned out that much of the steel was not needed and therefore not production but waste.

The U.S. needs to adopt policies that are consistent with the Causes of Economic Growth. However, these policies should be structured to work within our market economy. Encouraging innovation that is not subject to market forces is likely to fail for the same reason that the USSR’s emphasis on production without market mechanisms failed.

Patents are the free market method of encouraging people to increase our technological level. Thus, a strong patent system is the major foundation on which innovation policy is built.

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[1] Clark, Gregory, A Farwell to Alms: A Brief Economic History of the World, Princeton University Press, 2007, p. 197.

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