What is the source of economic growth? Trying times like these make this question even more important. The chart on the left is particularly instructive about the sources of economic growth. It defines what engineers call a boundary layer condition. The chart shows per capita income from 1000 BC to 2000 AD, where income has been normalized to one for the year 1800. The part on the left where per capita income final takes off is only true for western countries. For instance, African countries still have incomes near or below one on this chart and incomes in Japan do not take off for almost another 100 years.
So the million dollar question is why does income take off around 1800 after millennia of going nowhere? Let’s examine the standard answers for getting our economy growing today. Is the reason that income takes off around 1800 because taxes suddenly get lower (or higher) around 1800? No tax levels did not change significantly around 1800 and in fact they were lower than today until around 1900. Tax levels averaged 10% or less of GDP during most of history. Is it because the size of government suddenly shrunk (or grew) around 1800? No, the size of government did not change significantly around 1800. The size of government did not start to grow until around 1900. Is it because we suddenly created the world’s greatest “cash for clunker program” – in other words was Keynes right we just had to stimulate demand? Well during the period from 1000 BC until about 1800 AD is called the Malthusian period, after Thomas Malthus http://en.wikipedia.org/wiki/Malthus. During this period humans are just like every other animal and our population expands until we are on the edge of starvation. I am pretty sure that there was plenty of demand during this period, at least for food. Does income suddenly take off because we figure out how to control our money supply just right? No the tools for controlling the money supply around 1800 were pretty crude. The only reason we are wealthier today than in 1800 or 1500 or 1000 BC is because of our technology. If we had the same technology as our ancestors we would be no wealthier than they were.
I am not the only one to point out that increases in our level of technology are the only reason for real per capita increases in income. Robert Solow won the Nobel Prize in economics for essentially this point. Other economists who have study this area include Paul Romer of Stanford, Jacob Schmookler who studied the relationship between inventions and economic growth and Gregory Clark from UC Davis. This area of economics is often called Economics 2.0 or Innovation Economics. One of the best books on this area (other than my book The Decline and Fall of the American Entrepreneur ) is a business book, entitled The Invisible Edge.
Not coincidentally 1800 is around the time the first modern patent systems are created. Patents are the only free market system for encouraging people to invest in inventions and technology. Patents are legal title to your invention. The first patent statute in the US is passed in 1790. The US becomes the economic and technological leader of the world because of our patent system, not because of some innate Yankee ingenuity. We are the first country in history to recognize that inventors’ have a right to their inventions. In fact, the only place where the US Constitution uses the word “right” is with respect to patents and copyrights.
Despite the overwhelming evidence for the connection between patents, technology and economic growth, some detractors are going to argue that this is just coincidence. The chart at the right shows per capita GDP for various countries. As already explained US per capita GDP takes off around the time we create our patent system. Japan comes to the US and studies why we are successful around the 1860s. Their conclusion is that the US patent system is why the US is a technological and economic powerhouse. As a result the Japanese copy the US patent system sometime in the 1870s, which is when their per capita income takes off. A similar situation occurs in China. On the other hand there are numerous countries with no patent system or ineffectual patent systems that are stuck in the Malthusian trap.
Patents are the free market system for conferring legal title to inventions and encouraging investment in technology. Increases in technology are the only way to increase real per capita income. A strong patent system is keystone upon which economic growth is built.
 US Constitution, Article 1, Section 8, Clause 8. Note the Bill of Rights are amendments to the Constitution.
Conservation Law of Innovation:
All innovations are combinations of existing/known elements.
Conservation of matter (and energy) means that you cannot create something from nothing. As a result, all innovations must be a combination of existing or known elements.
Causality Law of Innovation:
Invention precedes production, production precedes consumption and discovery precedes invention.
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