Edmund S. Phelps (2014) - Bringing Dynamism, Homegrown Innovation and Human Flourishing into Economics

Good morning, great to see all of you. Well, now for something a little different. My talk is about how we need to change macroeconomics and in fact economics more broadly. What is the economics that we have today? I think it’s fair to say that the economics predominantly practiced today by professionals is what you might call neo, neoclassical, neo plus stochastic with an overlay of Keynesian theory from which the unknowable animal spirits and the murkiness of long term expectations have all been removed. Now some abstraction is fruitful but this standard economics which succeeded in meeting a number of earlier problems is not meeting the syndrome of problems faced by the west for some decades: lethargic growth, depressed employment levels, expressions of job dissatisfaction and in several countries continual state borrowing. Using the policy tools given us by standard economics the west may obtain symptomatic relief from the illness but not a cure. This failing of our beloved economics arises of course because it does not explain the causes of those problems. In my view and that of a number of others the symptoms I cited have their roots in the losses some decades ago of much of the innovation that for more than a century energised economic growth and economic life itself. These losses have cost us much of our prosperity. Even the recent rise of wealth inequality in some economies can be linked to those losses. In the standard economics all innovations observed in a country are exogenous to it. Innovation is the name given to a shift in some technological parameter which is unexplained. But we economists can make the effort to understand the kind of innovating that is indigenous or home grown and most of which germinates in the economy rather than being exogenous to the economy. How much indigenous innovation nations achieve is important for their performance. There’s no doubt that indigenous innovation is a real phenomenon. There appears to be a significant level of indigenous innovating going on in China today. It was largely indigenous innovation that broke out in the 1800’s first in Britain and America, later Germany and France. And it is much of this innovation that has been lost. There is also no doubt it yields, this indigenous innovation yields material benefits and its processes offer non material rewards of immense value. Increasingly the west is recognising the importance of regaining the dynamism that sparks indigenous innovation. However to understand the deep roots of such dynamism and the deep satisfaction that an economy high in dynamism offers to participants we have to have the rudiments of a theory of indigenous innovation, its nature, sources and desirability. Yet the economics taught in graduate schools does not and cannot offer such a theory. Its narrow confines leave no room for indigenous innovation. Developing a theory of indigenous innovation requires going outside standard economics. That is something that my recent book “Mass Flourishing” aims to do. So this lecture to you advanced students is an opportunity for me to discuss these issues at a somewhat more technical level. Let me talk first about the unknowns. First the issue of knowledge. Text book economics postulates so called rational expectations about the future. It goes way beyond rationality in the everyday sense, not just rational expectations about what your neighbour is up to. And that premise of RE as we call it implies that a nation’s economy will not be in the business of creating and adopting new products or methods. It will not be doing indigenous innovation. Why not? Well if the economy were found to be innovating, thus using new methods and products never conceived before, that would by definition be unexpected and that would contradict the premise of rational expectations, which says that there’s fundamentally nothing that’s unexpected. So the models using RE, rational expectations, and the phenomenon of indigenous innovation do not mix. RE models are deterministic. While any economy with the dynamism to pursue indigenous innovation is open, as Carl Pauper would have put it, open to creating its future. A dynamic economy’s future is not predetermined. Now, I hope the next couple of paragraphs are reasonably clear. But if they’re not very clear don’t worry about it. We’ll be sailing into smoother water in a few minutes. Some Neo-Schumpeterians seem to get around the problem by defining an innovation as something like stumbling on the occasional 5 dollar bill on the street. These theorists, some of them good friends of mine, describe an essentially stationary economy in the mathematical sense. Calendar time does not enter in any equation. A stationary economy in which the so called innovations are governed by a linear birth process with a known probability of birth. In this model the probability distribution of the cumulative innovation up to any specified future date could be calculated. So in that sense the future in a probabilistic sense is determined. It’s probabilistically determined. The model excludes genuine innovation by implying and making very explicit that nothing new is ever learned about the economies’ potentialities, what products could later prove producible or valuable. There is no discovery process in Hayek’s sense. There cannot be any new economic knowledge in this Neo-Schumpeterian world because the structure of possibilities and their probabilities is already known. In the innovative economies that Britain, America, Germany and France acquired in the 19th century the probabilities and even the possibilities were never really known. That’s for sure. Schumpeter himself, I mentioned the Neo-Schumpeterians, Schumpeter himself thought that he had reconciled standard economics with innovation. He saw there was occasionally new knowledge of what could be produced but he proposed or supposed that it came from outside a nation’s economy. It came with the discoveries of the world’s explorers and scientists. The guy who articulated that before Schumpeter was Arthur Spiethoff in 1904 by the way. When the scientists or navigators make a discovery, the entrepreneurs in every advanced capitalist economy jump to exploit the what he calls obvious applications of the new knowledge. Unless we don’t get it, he tells us at one point that entrepreneurs have zero creativity. Cleary this new knowledge of products and methods, this Schumpeterian innovation, is basically exogenous to a nation’s economy. It’s available to all nations, those willing and able to put together the required organisations and the required investments at any rate. But I maintain that the innovating that began shaking the world from 1815 or so to 1940 and at a reduced pace in some countries to 1965 or so was mostly indigenous. Yet most historians, even many economic historians, I think of Joel Mokyr for example, who has tangled with me in the past few months, or earlier I think Douglas North and with time I probably could think of a great many others, they go on interpreting the innovation in the high innovation economies as fundamentally Schumpeterian in attributing economic advance basically to the growth of scientific knowledge rather than a growth in the stock of business ideas which results from business people looking around and thinking and imagining and experimenting, trying things out, tinkering and so forth. Their thinking, I tried to understand what underlies this, their thinking seems to be that scientific knowledge historically always or reliably grows faster than the stock of business ideas. Or else the growth of the former scientific ideas is more effective in producing economic advance than the growth of business ideas. Schumpeter himself said that an advance in scientific knowledge... He pointed out that a discovery by scientists or explorers had to be combined with entrepreneurship. And he is evidently thinking of the knowledge that entrepreneurs have about how the economy works and what is produced and what cannot be produced. So in a way Schumpeter is introducing the point that economic knowledge matters too so that when there’s a jump of scientific knowledge the level of economic knowledge is going to matter. Likewise the modern theory that I’m proposing, which emphasises the indigenous innovation, might be formulated in such a way as to say that the advance in the stock of innovative business ideas may have to be combined with a little bit of scientific knowledge. So the symmetrical opposite to Schumpeter. So what I am calling dynamism is not just the propensity to have new ideas. The effectiveness of the new ideas matters. I think the Schumpeterians went wrong in the following way. It’s surely right that the level of knowledge possessed by business people is quite important for their capacity to innovate. Yet that should not suggest to us that the spectacular outpouring of new products and new methods from the 1820s to 1940 resulted more from the further accumulation of scientific ideas than from the accumulation of business ideas. We know almost nothing about that matter. We just know that knowledge is important in various kinds. And new ideas are important. Furthermore, while a nation’s capacity to innovate depends to an extent on knowledge possessed by producers and users that knowledge doesn’t mean just scientific knowledge. It also means industry expertise, literacy, a bit of mathematics and depending on what you’re doing musicology or painting theory or whatever. The Schumpeterians are making a fetish out of science. And the economists just sit back and accept that unquestioningly which is a colossal mistake. So, I’ve talked about dynamism. I’ve used the term several times but I haven’t really said very much about it. Dynamism is the thing that exists, that has to exist in a society for it to generate indigenous innovations. So more precisely what are the elements of this dynamism and what are their source? To be sure widespread innovative activity would not have taken place in the 19th century without a range of economic freedoms and institutions. There also had to be a commercial culture. A company depends on a general adherence to implicit typically unenforceable contracts, a culture that demands keeping ones promises. But an economy can have all the latest institutions and an enviable commercial culture without having the spark for innovation certainly on a mass scale, in other words, without having enough dynamism to generate a high rate of indigenous innovation. The elements of dynamism as I see it are the latitude to innovate and the capacity to innovate and above all the desire. To have a broad flow of indigenous innovation society has to allow businesses wide latitude to innovate. There is less leeway for innovations if society is unwilling to put up with the disruption and inconvenience that often, but not always, accompanies innovation. There is still less leeway for innovation if elites in many corporatist nations can block outsiders having new ideas from entering their industries or if the industries where start-ups could have entered are fenced off from new competition by governmental protections of the established firms. Patent claims and threats of lawsuits are daunting hazards for anyone who would start a firm in hopes of achieving an innovation. What’s this capacity to innovate? Well, one's capacity to innovate depends on one’s human personal resources, most familiarly one's knowledge. Any innovation is apt to require some special knowledge as well as adequate general knowledge. Although in the early days many innovators were notorious for their illiteracy or innumeracy. Innovators in the music business must know something about composition theory. Those in pharmaceuticals must know something about chemistry. It is widely thought that virtually all innovation these days requires knowledge of science, information technology, engineering and mathematics. But that view incorrectly assumes that the only remaining possibilities for innovation these days are in high tech areas. And that’s a totally unsubstantiated hypothesis and rather absurd I think. This capacity to innovate also requires mental resources that are rarely found all in one person. Foremost among these are imagination and creativity. Those are the 2 most important words in my talk this morning. But like everybody else in the world I don’t have an awful lot to say about imagination and creativity except that, wow, are they important to innovation. Scepticism is also important. Innovators tend to be people who readily question prevailing beliefs and are willing to think for themselves. Another rare resource needed by innovators is insightfulness. It’s not enough to create new stuff. You have to create the right new stuff. Henry Ford had a vision and it was right on the money. He didn’t just build a new car. As a matter of fact he liked to go around insisting there was nothing new in that car. Not a single thing was in that car that hadn’t been already in the cars made by competitors in Detroit. It was the conception of the demand that such a car would find. To attempt an innovation is to embark onto the unknown. To undertake such a journey aspiring innovators have to feel they have sufficient understanding to warrant making a start which may require long stretches of solitary thought and they have to feel they will be able to bear failure in the event their venture does not succeed, obviously the capabilities that are common to entrepreneurs. The hustle, the extroversion and the judgement that comes from experience that’s an entirely different kettle of fish from the capabilities of innovators. At the heart of dynamism however is the desire to innovate. Despite the obstacles or maybe in some part because of the obstacles some innovators have a deep need to show others their great imagination or rare grasp by creating something that is new, that is embraced and recognised. Stravinsky enjoyed saying that he had written his great compositions to show the friends of his parents how good he was and by the time he’d finished the friends of his parents were all deceased. Some innovators are driven by curiosity to see whether their insight is proved right whether the new thing could be made at a sufficiently low cost and whether it could win a sufficiently large market. Other innovators are driven by a need to prove themselves... to prove themselves that they can succeed, not their parent's friends. Obviously these motives and aspirations are not the work and save mentality of mercantile capitalism about which Max Weber famously wrote around 1920. These aspirations and motives underlying the desire to innovate were, I maintain, stirred by the modern values that began to immerge as early as the late Renaissance. The individualism of Pico Della Mirandola and Luther. Taking charge of one’s life which entails thinking for oneself and the willingness to break from convention. The vitalism portrayed by Cellini, Cervantes and Shakespeare relishing challenges, surmounting obstacles and making a mark and finally the expressionism or experimentalism of Kierkegaard and Nietzsche, the thrill of fascination of venturing into the unknown and the self-discovery that results. These values steered people on a course to pursue careers offering personal growth, the becoming that Montaigne and Henri Bergson wrote about famously. As people created the new, they created themselves. These modern values were in sharp contrast to the traditional values of medieval or ancient times. And what were those in particular? Materialist values undermining exploration for its own sake, communitarian values opposing new businesses and new money and family values, impeding breaking away and taking big chances, betting the ranch. After a long gestation the modern values I argue gave birth to what I call the modern economy, an economy rich in dynamism down to the grass roots of society. Massive numbers of people including ordinary people were frequently observing, exploring, tinkering, imagining, conceiving, creating, experimenting, testing and marketing. Many were examining, trying out and venturing a possible adoption as new products came out. One result was an explosion of innovation as evidenced by the unprecedented climb of productivity from around 1820 to 1940 and less steeply to around 1965 in the United States. That was one result of the explosion of innovation. Another result was the changed way of life. Now there was a guy whom you may have heard of, a lawyer who was beginning to run for office around 1858. And he’d learned an awful lot about the American people in the course of his numerous exchanges and experience. And he decided to write a lecture about it. The title is invention something or other and something or other. He should have called it innovation but that’s ok. And that man was Abraham Lincoln. And turns out the second lecture was actually the first lecture but it’s too late and everybody has called it the second lecture. And I that second lecture he says: “Young America has a great passion, a perfect rage for the new.” And one might understand him to have meant that people have a good time in the shopping mall. But I think he meant something wider. That people were just into novelty when working as well as when shopping. Now I maintain that this was a good economy. For me the lone shepherd bored by the routine and isolated from exchanges with others symbolises the stasis and stultification that was characteristic of the pre-modern economies as in mercantile capitalism. The modern economy replaced boredom with mental stimulation, isolation with interchange within companies and within cities. A new dimension of prosperity appeared, one that was experiential rather than directed to an end such as increased consumption or wealth. The journey is the reward as the adage has it. Modern people experienced broadly for the first time what is referred to as prospering or thriving. There is a material prosperity that comes from obtaining improved terms for one's work and that comes from access to this experience. There is also the non-material kind of prosperity that derives from taking on challenges and creating in the hopes of adoption and recognition. The modern people were experiencing what philosophers call the good life, a life of flourishing which philosophers now agree is the word that Aristotle should have used but maybe the word didn’t exist at that time. And Aristotle used the word happiness, unfortunately. It’s clear to me that we have to rework the standard economics if it is to be applicable to all those issues where the dynamism for indigenous innovation is a crucial consideration. For one thing bringing dynamism into the analysis will shed new light on what a nation should want from its education system. It will also shed new light on the origins of wealth inequality. I don’t want to run too much over time. So let me just jump to something that I know your itching to hear about. That is inequality. And here’s what I have to say about it. When I finished my book Mass Flourishing, the subject of inequality had not become the rage. And I don’t think there’s even, the word is not even in the index. And then Piketty came along. And everybody was reading Piketty and very few people were reading my book “Mass Flourishing”. So I decided I’ve got to write about inequality too. Well I can’t get it into the book now. I don’t think Princeton University Press is going to allow that for quite a while. But I did write something in the Financial Times about a month ago. A little bit of disguised economic theory which they allowed into the paper. New voices are calling our attention away from those problems I was talking about, the slow growth, the depressed employment, the expressions of low job satisfaction. And they’re calling our attention to inequality. In Europe they estimate one quarter of private wealth is held by the wealthiest 1%, in America one third. This wealth has ballooned relative to national income in countries where growth has slowed and the share held by the rich has risen in most nations over recent decades. Now I want to say, I have to say that I have a career long interest in economic justice and hence in unjust inequalities going back to the 1960’s and 1970’s. So I am not deaf to this new discussion. I found myself asking though is the decline of indigenous innovation in the west possibly a cause of the increased wealth inequality. I just skipped a 3 page section in which I talk about the decline of innovation. And the evidence for that is of course an abrupt slowdown in the rate of growth of total factor productivity in America in 1972. If you want further evidence you can look at the rate of return to investment. Is innovation propping up the rate of return to investment as it always has in the past? No. After 1972 the rate of return to investment fell. Now it’s interesting. The rise of wealth inequality could be viewed as another symptom of this slowdown of innovation. Let me come quickly to the point. I argue that losses of the dynamism that sparks innovation have tended to inflate wealth inequality. The big innovation falloffs in the 1960s most importantly in the US hit labour harder than the wealthy. Fewer projects to develop new products and fewer factories making capital goods that produce new products most of which are quite labour intensive means a reduced share going to labour income. Profits slid too on this account but the wealthy were partially invested overseas. However the main point I want to say is that much of the losses of innovation have come from the spread of corporatist values, particularly solidarity, security and stability. And corporatist policies protecting labour and capital through anti competition regulation, the catering after interest groups through pork barrel contracts and industrial policy, these act to block or impede those who would try to innovate or would reduce their incentive to try to innovate. Now what is the effect of that on the profit share? When established companies find themselves with less competition to fear because it’s become harder for innovators in most of the economy, established firms are emboldened to raise their mark ups and thus their profits. Competition doesn’t work to drive that share back down. That in turn raises share prices, thus the wealth of the already wealthy share owners. Let me just make 2 other very brief points. Another corporatist value, materialism, likewise increases wealth inequality. In standard economics people save out of their wages to acquire returns on wealth with which to spend more. No one is a miser in an everlasting slog to more and more wealth in the standard theory. The resurgence of materialism has brought just such a fixation on getting rich. Data now show that people save even in their retirement. They’re still saving. Like some sort of wind up dolls that can’t stop saving. Last point, materialism has also led to shortermism. It tempts CEOs to pump up share prices and fund managers to demand that CEOs hit their quarterly earnings targets which is very distracting from any long run visions they might have. Corporations raise bonuses through buy backs to pump up share prices. All this adds downward pressure on innovation and buoys up wealth inequality. After innovation gauged by productivity growth weakened in the United States between 1965 to 1975 that was the period of slowing profits as a share of GDP have climbed to record highs and price earnings ratios are well out of the normal historical range. Happily getting back our dynamism will not only increase employment growth and job satisfaction, it will also shrink wealth inequality. Thank you. Applause.

Edmund S. Phelps (2014)

Bringing Dynamism, Homegrown Innovation and Human Flourishing into Economics

Edmund S. Phelps (2014)

Bringing Dynamism, Homegrown Innovation and Human Flourishing into Economics

Abstract

The economics practiced today is basically neoclassical with an overlay of Keynesian theory from which the unknowable, animal spirits and long-term expectations have been removed. Abstraction is always fruitful. But this standard amalgamated economics, which met many earlier problems, seems not to meet the syndrome of problems faced by the West in our time; nor some old problems faced by historians. That is because the standard economics excludes the heart of these problems – the sources are hidden in some variables interpreted as “shocks” or some time trend. As a result, this economics offers us the policy tools of the standard models with which we can hope to obtain symptomatic relief from our illness, but cannot expect a cure.
In my theory, prevailing values, or felt needs, are basic to an economy. In any nation there are people who feel the need for individual expression – to exercise their curiosity, ingenuity or creativity; whose vitalism stirs them to “act on the world” and make a difference; and who need careers that are a journey into the unknown – a voyage in which, as they form ideas, create and discover outcomes, they test, discover and create themselves. Such needs fuel a desire to innovate: The extent and intensity of this desire, together with the capacity and talent of people to hit upon new products that would be adopted, and the latitude society is willing to give to innovations, constitute a nation’s dynamism – its ability, or propensity, to innovate. This dynamism largely determines the nation’s homegrown innovation – the supply of it, to be precise, while various market forces impact on the actual innovation achieved. And the nation’s rate of innovation is the main source of the prosperity there – in all its dimensions, including what is called flourishing. By the 1800s, the accretion of modern values gave birth to the dynamism sparking the epoch of innovation in Britain and America, later Germany and France. Now, losses of dynamism have cost us much of our prosperity.

Content User Level

Beginner  Intermediate  Advanced 

Cite


Specify width: px

Share

COPYRIGHT

Content User Level

Beginner  Intermediate  Advanced 

Cite


Specify width: px

Share

COPYRIGHT


Related Content