Every now and then you have one of those cross disciplinary moments when everything you think you know about a discipline is proven wrong.
I thought I had a pretty good handle on economics, but was blown away last night to find that most economists apparently think that wealth is created by savings, or efficiency gains.
This is so obviously wrong, that I was surprised Dierdre Mccloskey, a renowned American economist, would be touring Australia telling us at length that it was wrong.
But apparently there is a real debate in the economics profession, and Mccloskey is on the side that says that innovation is the main driver behind increasing wealth, and her innovation on innovation is to say that it is cultural.
Mind you, I had come across plenty of people who argue that getting the tax system right, or encouraging national savings, are the keys to national wealth, but any survey of world economies shows that this is hard to justify. If tax was the key, why is it that Sweden and Australia have very similar levels of per capita national wealth?
I’m not arguing these things don’t matter, just that if they were the main drivers, then Australia would be very much richer than Sweden, and it isn’t.
Basically wealth is a measure of the stuff that one has available, now or in the future, for one’s personal use. It can be temporarily embodied in things, such as buildings, but the measure of value of a thing is the cash flows that it can generate, and cash flows are only valuable because of what other things they can buy.
An increase in wealth occurs when we control, or have access to, more things.
In this context, looking around modern society, the harnessing of energy through electricity, steam and combustion, is probably the biggest generator of wealth ever – it gives us the slaves that allow us the time to buy access to luxuries that even top human predators a thousand years ago could only dream of.
So having social systems that encourage rather than stifle innovation is important, and according to Mccloskey (assuming I am getting this right) societies where “Having a go” is encouraged have got it right, which societies where “Having a fair go” is demanded, will get it wrong.
Which obviously feeds back into tax systems, but as a second order issue.
So technology is the main driver of economic growth – who would have thought? Apparently not economists.
I heard Mccloskey speak last night at a function jointly sponsored by the The Economic Society of Australia, Griffith University and the ALS Friedman Dinners, and know little of her work apart from this.
So perhaps her approach to savings is more nuanced than it sounded. While the innovation thesis is incontrovertible, I did think that she underplayed the role of savings.
The great powers of the world have all been great banking powers, and the reason that the US colossally bestrides the globe isn’t primarily because she has a large army, but because her financial power buys her one.
And while the US is a tremendously innovative society, others are as well, but it is easier to fund innovation in the US than it is anywhere else, and this has got to be a key to her dominance.
I often think about the information revolution and regret that I wasn’t born in the US. If I had been OLO would be quite different from what it is today. Apart from access to a huge English speaking audience, we would also have had access to Tech Bubble finances.
We’re more innovative than the Huffington Post, yet the Huffington Post is now much larger and more successful than we are ever likely to be. Why?
Innovation counts, but other things, like access to savings, count just as much, certainly in the race to get innovation to market.
Would we know who Bill Gates or Steve Jobs were if they had been born and worked anywhere else but the US? I don’t think so.
You weren’t entirely wrong, Graham- efficiency is the creator of wealth, given an energy constrained economy. But innovation is required to attain greater efficiency. Let me explain (as an ex-lecturer in innovation theory):
First, we need energy and effort to make and do the things that comprise wealth- the goods and services that we desire. If we can get more energy out for the energy we put in, we can turn it into wealth- this could be by “discovering” a big new easy to get at oil, gas or coal reserve. This isn’t happening much anymore- the EROI of carbon fuel continues to diminish.
So we need to get more efficient with the way we use our energy- this requires “innovation”- either new products that are more efficient (say transistors over valves, fluoro over incandescent globes etc) or processes that are more efficient ( say mass production over craft). The energy saved by the efficiency gained is then re- invested into more available goods and services- ie “wealth”.
A certain amount of innovation occurs “naturally” ie the “learning curve” where incidental, incremental improvements in products and skills occur almost without being noticed or consciously thought of. Increasingly, learning curve effects occur through analysis of products and processes by staff and management and then applied. This is where culture can kick in.
Then there is deliberate R&D for breakthrough or substitute products that deliver a good or service with less energy. Of course the improvement needs to be reflected along the whole value chain, not just localised – a more efficient machine that takes more energy to produce doesn’t increase globally available energy.
Lastly, for this micro- lecture, there is education. Knowing how to do things right (skills) or doing the right things ( management) enable energy to be freed up for more goods and services.
At the heart of these processes must be “innovation” in the sense of “transforming an idea into something that works” – that “something” can be a new or improved good or service.
Does saving increase wealth? It can- if that saving is thought of as the capital to fund innovation. It’s a risk, of course- the innovation may not work, or work as well as envisaged. Savings, otherwise, might be a stimulus to efficiency, by withdrawing money from a system, otherwise, it’s simply a zero sum game.
Back in the Rudd days, my recommendation for a national innovation centre to focus on innovation in an Australian context, was adopted in the Cutler report, but Carr couldn’t find the funds to do it. So we continue to have sporadic insights into the processes of local innovation or rely on visiting gurus.
(Bell rings at end of lesson)
Comment by John Barker — November 26, 2013 @ 8:44 am
Thanks for a very comprehensive comment John. Yes, efficiency, or productivity are the keys, but Maccloskey is interested in why they happen at a faster rate in some societies than others.
She associates encouragement and reward of risk-taking, or iconoclastic behaviours, with those societies who get ahead, because she believes these lead to a culture of innovation.
I’m pretty sure I agree with her.
I think that there is probably another element over and above risk taking. There is plenty of evidence to suggest that we underestimate the returns from risky behaviour and that most of us sit in a sub-optimal spot on the risk reward curve.
By moving themselves further along that curve more innovative societies are probably optimising the return on the assets that they can deploy.
I did suggest that it is not savings, but banking, that work with innovation to create wealth, and banking is an innovation in itself. So it’s not having wealth yourself, but having access to wealth that can create your own wealth.
You would say that’s another efficiency, I guess. Channeling money and assets to those with the best use of it.
Comment by Graham — November 26, 2013 @ 5:15 pm
Indeed, Graham, some cultures and countries are more innovative than others. Some are more innovative at one system level than another- Japan has been technologically innovative, but culturally conservative. And their innovation has been mainly within large corporations. All societies both encourage orderly behaviour and risk-taking- they just channel it differently, depending on resources.
Capitalism- whether it’s money, materials or manpower- is necessary to tide over the “valley of death” in the innovation cycle. Financial capital innovations like the limited liability company (Germany 1800s) help mitigate risk, but most of what we see in finance these days is zero-sum-game fiddling- locally innovative, but globally destructive.
Innovation is a multi-factor phenomenon. Beware people peddling a single -factor theory.
Comment by John Barker — November 26, 2013 @ 6:32 pm
I am with john Barker’s last post; there is no single theory that explains it all, probably never will be as too many variables.
Comment by Chris Lewis — November 27, 2013 @ 7:40 am