This year the Nobel prize in economics was awarded to Joel Mokyr, Philippe Aghion, and Peter Howitt for having explained how innovation drives economic growth. According to the laureates, Mokyr in particular, the period of Enlightenment set the foundation for the Industrial Revolution and sustained economic growth. Note that the period of Enlightenment gave birth to industrial capitalism—a social system based on the recognition of individual rights, especially property rights, in which all property is privately owned.
It is capitalism, through the free-market environment, that enabled strong and sustained economic growth. According to Ludwig von Mises,
The laissez-faire ideology and its offshoot, the “Industrial Revolution,” blasted the ideological and institutional barriers to progress and welfare. They demolished the social order in which a constantly increasing number of people were doomed to abject need and destitution.
It was not innovations as such that were the driving force of the Industrial Revolution but capitalism that imperfectly protected individuals’ and businesses’ property rights. This should be contrasted with feudalism and socialism where property rights are not protected.
According to the laureates, innovations are the key to sustained economic growth. If this was the case, why is it that the Third World economies continue to experience poverty? After all, individuals in these economies have access to the same technical knowledge of the developed world.
In Man, Economy, and State, Murray Rothbard says that technological “know-how,” while important, must always work through the investment of capital in order to generate economic growth. On this issue Rothbard, referencing Mises, says,
What is lacking in (underdeveloped counties) is not knowledge of Western technological methods (“know-how”); that is learned easily enough. The service of imparting knowledge, in person or in book form, can be paid for readily. What is lacking is the supply of saved capital needed to put the advanced methods into effect.
Hence, a key factor that drives economic growth is capitalism—private development of and investment in the capital structure under a free market—that enables economic growth. What permits the increase of capital goods is private savings.
Saving and Economic Growth
To survive and thrive, an individual must consume, however, economic goods are scarce, therefore, production is necessary for consumption. Without already-produced tools (i.e., capital goods) at his disposal, an individual is severely limited and production takes more time and more labor. In order to produce capital goods, which would make him more productive and efficient, time, labor, energy, and resources have to be devoted to these goods, which necessitates saving.
In a more advanced economy, private saving determines the quality and the quantity of various capital tools that can be produced. Some economists have called this a “subsistence fund,” that is savings that sustain producers during the period of production. On this, Richard von Strigl wrote:
Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides laborers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year.
According to Bohm-Bawerk:
The entire wealth of the economical community serves as a subsistence fund, or advances fund, and, from this, society draws its subsistence during the period of production customary in the community.
The increase and the enhancement of capital goods is a major ingredient in setting in motion economic growth. This in turn can take place because of private savings channeled into capital investment. Hence, anything that weakens this private saving undermines the prospects for economic growth.
Production and private saving enable capital investment, which leads to greater production and efficiency. The improved capital structure permits not only the increase in consumer goods but also the introduction of various goods and services that were not available before. New ideas or innovation can do little without capital investment and the savings that make it possible. Technical “know-how,” has to work through capital goods in order to generate economic growth. Further, innovations have to serve some valued end, otherwise knowledge of how to do something is economically useless. Regardless of how knowledgeable we are, and regardless of various technological ideas, without an expanding saving and capital investment, sustained economic growth is not possible.
Note that we do not say that technical knowledge is unimportant. For instance, to make a particular tool, the toolmaker must have an idea of how to make this tool. The idea alone, however, is insufficient to produce the tool. Various components to make the tool must be produced before it could be assembled, which takes time and scarce resources. To do this, one must not only have a knowledge of how to build the tool, but a subjective goal for the tool and be willing to sacrifice alternatives in order to produce it.
Intermediate Goods
An advanced economy is not just made up of final consumer goods and services, but many intermediate goods or capital goods in a structure of production that help produce either other capital goods or final consumer goods. Time and waiting are key variables in economics and especially in the development of capital goods. According to Rothbard:
Capital is a way station along the road to the enjoyment of consumers’ goods. He who possesses capital is that much further advanced in time on the road to the desired consumers’ good. Crusoe without the axe is 250 hours away from his desired house; Crusoe with the axe is only 200 hours away. If the logs of wood had been piled up ready-made on his arrival, he would be that much closer to his objective; and if the house were there to begin with, he would achieve his desire immediately. He would be further advanced toward his goal without the necessity of further restriction of consumption.
In addition, with the introduction of more advanced tools and machinery, many new consumer goods can also be produced, which—prior to the making of these new tools—were not available at all. The precondition to a sustained economic growth is capitalism, that is, a free market where private property rights are protected, freedom of peaceful, voluntary exchange is encouraged, and savings can be channeled into capital investment for the development of producer goods and the enhancement of the structure of production.
Conclusion
Contrary to the conclusions of this year’s Nobel laureates in economics, technical knowledge and innovation by themselves, without prior expansion of saving and capital investment, will not cause sustainable economic growth. The precondition for a sustained economic growth is the existence of a free market economy, which provides the basis for investment in the capital structure. Ever-increasing interference of government and central banks shrinks private saving, crowds out private investment, inhibits market-directed exchanges, and distorts the structure of production.
