Policymakers around the world, in the G20 and beyond, face the twin challenges of high public debt burdens and citizens’ decaying standards of living. For the last decade and a half, the big policy idea has been to get the economy right first and then support some social programs. But that day never comes because this approach puts the cart before the horse. Debt burdens ratchet higher in both developed and developing countries, while voters become more disaffected.
The proximate cause of these twin challenges is the strange disappearance of productivity growth. The problem is that in modern economics, we do not have a good framework for understanding productivity. The best the profession has come up with is a counsel of despair that “ideas are getting harder to find.”
This conclusion is the result of a particular mechanical way of seeing the world. In reality, we are far more resourceful.
As long as we face uncertainty and our imaginations are undiminished, there is no reason to suppose that good ideas are getting harder to find, that they are subject to diminishing returns or that there are even limits to creative growth.
Economics and Evolution: How Specialization Spurs Growth
The father of economics, Adam Smith, described in beautiful prose the source of ideas. He suggested that we have a psychological need to ease the mental disquietude that arises from unexpected events. We do so by making classifications and causal connections, which he called “connecting principles.” But because we each have limited cognitive capacity and different personal histories, we economize by exchanging ideas. This exchange allows us to deepen our own ideas and to combine ideas to generate new knowledge. Some ideas may become tacit knowledge, such as a skill. Other more formal ideas — once widely accepted —may become the basis for scientific knowledge.
In Smith’s famous book on the nature and causes of the wealth of nations, he describes how the division of labor leads to specialization and, therefore, to greater knowledge and productivity. He even makes the case that specialization leads to the invention of new machines to facilitate our tasks and reduce our labor. So-called philosophers and men of speculation combine machines from different industries to create new inventions and processes that are embedded in our goods and services. And the technology industry is subject to its own division of labor, specialization and productivity.
It was for later economists to explain how the system evolves. Alfred Marshall recognized that the dynamics of knowledge creation are to be found in the living sciences such as biology, not mechanics. By making a “connecting principle” between Smith and Darwin, he recognized that specialization creates innovation and variation, while economic competition is the selection mechanism. Ideas are transmitted over time not only through our culture and institutions, but also our art, science and technology.
Productivity growth is the growth of collective knowledge. Growth of our collective knowledge arises as we each hold ever smaller and more specialized parcels of knowledge. We are part of a distributive system where the collective can grow because of the benefits of specialization. However, each step of specialization necessarily creates an asymmetry of information, which economists have shown can lead to vanishing markets.
Exchange, Evolve, Grow: Harnessing Institutions to Create Growth for All
This suggests that productivity growth creates new problems of coordination. Indeed, if growth is an evolutionary process, then there is no reason to suppose that it always leads to an optimal outcome. Given the inherent market failures (such as the asymmetric information mentioned above), this would be an improbable outcome. But contrary to what Richard Dawkins claimed in his book on evolution, “The Blind Watchmaker,” the Watchmaker, in this case, is not blind. We solve coordination problems by creating institutions, from social norms to central banks. Marshall advised that “organizations aid knowledge” — after all, even Smith’s famous pin production took place in a factory and not among isolated workers.
Institutions support the creation, storage and transmission of knowledge. They are always context-specific. In some circumstances, they may be conducive to productivity growth, and at other times, they may suppress knowledge creation.
Restoring productivity growth is not about spending more or less money while leaving our institutional structure unchanged. It is about asking what structures ensure that all parts of society can interact and engage.
It is in these interactions that specialized knowledge is shared and combined to generate new knowledge and growth.
Over the last 100 years, many countries have created national media outlets, public health systems and integrated social housing, all with the aim of influencing how we interact and coordinate, and thus spurring the growth of knowledge. If we are to restore productivity growth, we must ask which institutions are necessary for the participation of all citizens. This puts the horse back before the cart.
Angus Armstrong is the Director of Rebuilding Macroeconomics and Professorial Research Fellow at the Institute for Global Prosperity, University College London.
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