Economists once thought that capital accumulation was the cause of the wealth of nations. It’s an ancient and obvious truth that you can be enriched by stealing from your neighbor. That’s the attraction. Even Adam Smith, who fiercely opposed stealing, enslaving, and conquering by you or by the state, believed that what made for national wealth was accumulated capital. After all, he noted, Holland in 1776 was rich and had massive amounts of physical capital, while the Highlands of Scotland was poor and had little.
It took two and a half centuries for economists to escape from this apparent truth. Marx, a follower of Smith in many ways, believed that “surplus value” extracted from the working class was re-invested by the capitalists, and thereby enriched the nation, and especially the capitalists. The French Marxist, Thomas Piketty, built his sensational book in 2013 about inequality on the belief. Yet not only Marxists continued to believe that capital accumulation—the piling of brick on brick, or university on university degree—is the source of our riches. The orthodoxy of the World Bank for decades after its founding in 1944 was the recipe, “Add capital and stir.” It didn’t work. Ghana received massive foreign aid, but did not become rich. During the 1990s, the Bank therefore shifted to its new recipe: “Add (good) institutions and stir.” It doesn’t work, either.
What the economists and their followers failed to see is that the bizarre Great Enrichment of the world since 1776 involved innovation. Innovators, I’ve explained to you, think up new ways of doing things. Railways. Electric motors. The modern university. The internet. Letting women work for pay. Ending tariffs on foreign trade. And on and on, in billions of innovations unique to the modern world. Capital was sometimes necessary, of course, especially for example in railways. But so also were necessary all manner of conditions that are not in themselves creative of new ways of doing things, such as having a labor force, or obeying laws. What’s sufficient, the secret sauce in modern economic growth, is human creativity.
In 1911 Joseph Schumpeter, in 1928 Allyn Young, and in 1933 G. T. Jones began to escape from the dogma that capital implies riches. Even many recent economists go on thinking this way, in what they call “growth theory.” But Young and Jones died early, and Schumpeter fell back into dogma. It took a paper by Robert Solow in 1957 to restart thinking about the force of ideas in the economy, what he called “technical change.“ Yet still economists clung to the Smith-Marx dogma, and the Nobel Committee has given dozens of prizes to economists elaborating on it.
Last month, the Committee finally acknowledged that ideas, not capital, made the modern world. They gave the prize to Philippe Aghion, a French theorist, and two empirical scientists, the Canadian Peter Howitt, and my dear friend, the Dutch-Israeli-American Joel Mokyr. Hurrah!
Yet when will economists realize that the new ideas came from liberating ordinary people? Let’s hope not two and a half centuries.
Weekly column in Folha de São Paulo, Brazil
Translated into Portuguese for the newspaper.
Yes, ideas, not capital. But ideas only explode when ordinary people are free to experiment under radical ignorance. Spontaneous order ( not blueprints ) turns dispersed knowledge into the Great Enrichment. Liberty is the real engine.
I posit that the ultimate irony is that only now is the first time that Marx was right because Marx couldn't have forecast the massive expansion of what was then an irrelevantly minor middle class; once it did, modern economists, especially Keynes (against the angry opposition of Classical Economist), needed to measure what got called Consumption functions, much larger than investment in "dead labor", i.e., Capital. So for roughly 80 years in the past century, educated, comfortable workers "proved" Marx wrong. However, Thatcher, Reagan, Putin, etc. allowed or even fostered monopoly capitalism, end to worker, consumer, and environmental protections, wealth inequality triple that during the Robber Barons, 4 massive tax cuts for the rich; gains in productivity, free trade, office automation, robotics, and AI mostly stolen from workers. But when Marx finally right, there are no Marxist left or Marxist Governments (China and Russia, and now Trump's U.S. are all KLEPTOCRACIES, the worst possible combination of capitalism and corruption, extorting dictatorship. Ironic!