For all their bushels of data and their powerful econometric tools, economists still know precious little about what makes economies grow. Yes, in general it seems that having a central bank that keeps inflation under control is helpful, and it’s probably good when entrepreneurs and investors aren’t living in constant fear their assets will be confiscated. But for every theory about the sources of growth one can find counterexamples. There have been fast-growing countries with high taxes and with low taxes, with relatively equal income distributions and with income controlled by a powerful few. Some people insist on the importance of the rule of law, yet China continues to boom despite a legal system that inspires little confidence. Others emphasize democracy, but Korea grew at a rip-roaring pace for a quarter-century before its military rulers surrendered power in 1987. Still others emphasize capital formation–but if that were the key, Jordan would be growing much faster than Israel, and Vanuatu would be outpacing both.
The famed economist Edmund Phelps recently waded into this debate with a book called Mass Flourishing, which I review in the current issue of the business journal Strategy+Business. Phelps believes the key to economic growth lies in innovation. Openness to innovation explains the 19th-century growth surge in Western Europe and the United States, Phelps claims, and the United States’ openness to innovation made it wealthy. Now, a decline in the pace of innovation threatens prosperity, in the United States and other countries as well. The culprit, he asserts, is corporatism—the inclination of interest groups to use the government to block economic change. This problem has been worse in Europe, but even in the United States, he contends, “the waning of innovation was largely behind the increased joblessness and downward pressure on wages that have been endemic to the post-1972 period.”
The claim that innovation is on the wane is an interesting one. But how does one prove it? Phelps attempts to do so, in part, by measuring the market capitalization of a country’s enterprises compared to the value of the companies’ physical capital; the gap between the two, he contends, reflects investors’ view of the value of unexploited ideas for making better use of that physical capital. It’s a clever idea, but very America-centric; Phelps’s measure will make companies in other countries, notably Germany, appear less innovative than American companies simply because they make less use of stock markets to raise capital.
Another way to measure innovation is to count patents. Many patents, however, are granted for “discoveries” that are hardly innovative, and many highly innovative ideas are not patented. Some scholars have looked at R&D spending as a share of output, but what of the many innovations that never saw the inside of a laboratory? My own work on A&P, for example, has shown the economic importance of innovative methods of retailing, but the company’s rapid shift from neighborhood stores to supermarkets relied on a merchant’s well-honed senses, not on scientists or engineers.
Others who have looked at this issue, like the Northwestern University economist Robert Gordon, end up arguing that some innovations are just more important than others. The period of what he calls the Second Industrial Revolution, roughly from 1870 to 1900, brought such innovations as the telephone, the motor car, and electric generation. These technologies, Gordon says, took decades to refine, leading to an extended period of rapid economic growth. By contrast, the computer-related technologies of the Third Industrial Revolution, he says, have had a comparatively small effect in improving productivity. Gordon thinks this and other factors will lead to slower economic growth in the future.
This is an important debate. Phelps insists that the formula for growth is for government to spend more on public goods, such as infrastructure and education, while attacking regulatory barriers, business conspiracies, and labor rules that slow the pace of innovation. Gordon, by contrast, seems less optimistic about the ability of government to foster growth and drive the economy faster. His message is not a hopeful one. But the sheer number of innovations I see around us makes it hard for me to believe that the age of innovation lies in the past.