The Rational Argumentator

Here’s an observation from a recent column in The Economist magazine on “The Transience of Power”:

“In 1980 a corporation in the top fifth of its industry had only a 10% chance of falling out of that tier in five years. Eighteen years later that chance had risen to 25%.”

Competition makes it hard to stay at the top even as it offers a way off the bottom. Data on income mobility also support the idea. And despite occasional downturns (some quite large, as we well know), per-capita gross domestic product in the United States keeps rising steadily over time. These two phenomena, economic growth and competitive shaking out, are of course connected.

Different Ways of Thinking About Economic Growth

Economists in the mainstream (neoclassical) tradition are trained to think of growth mainly as raising the rate of producing existing products. For example, a higher rate of saving allows firms to employ more and more capital and labor, generating ever-higher rates of output. It reminds me of the Steve Martin movie, The Jerk, in which a man who is born in a run-down shack eventually strikes it rich and builds himself a much bigger house that is just a scaled-up version of the old shack.

But economist Paul Romer, for one, has said,

“If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking.”

So growth through innovation, technical advance, and making new products is more important than just using more inputs to do more of the same thing. The late Harvard economist Joseph Schumpeter came even closer to the truth when he famously described competitive innovation as a “gale of creative destruction”—building up and tearing down—with creation staying just ahead of destruction.

But standard economic theory has had trouble incorporating the kind of economic growth driven by game-changing innovators such as Apple, Facebook, and McDonalds. Mathematically modeling ignorance and error, ambition and resourcefulness, and creativity and commitment has so far been too challenging for the mainstream.

What’s the Source of Economic Growth?

Achieving economic growth through innovation means someone is taking chances, sometimes big chances, to break new ground. As Schumpeter put it, what it takes is finding “the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization.” Although talented people are behind this process, we sometimes put too much stress on bold “captains of industry” such as Steve Jobs, Mark Zuckerberg, and Ray Kroc. The personalities of the players are important—but so are the rules of the game.

Imagine if cars had no brakes. How slowly and cautiously we would have to drive!  Clearly, brakes on cars enable us to drive faster and safer. How? Well, brakes give us the freedom to make a lot of mistakes—entering a turn too fast or taking our eyes off the road for too long—without causing disaster. We can take more chances with brakes than without them. (Of course, good brakes can also seduce us into driving recklessly, but that’s a story for another day.) Similarly, economic development of the Schumpeterian variety presupposes lots of experimentation, and that in turn means making plenty of mistakes.

Markets Mean Mistakes

Now imagine a world in which people looked down on innovators. That’s hard to do in our time, but as Deirdre McClosky argues in her 2010 book, Bourgeois Dignity: Why Economists Can’t Explain the Modern World,  it wasn’t that long ago when most people disdained innovators who challenged established ways of thinking and doing. The result was cultural and economic stagnation. Making an innovator a figure of dignity worthy of respect, which she says began to take hold about 400 years ago, has sparked unprecedented economic development and prosperity.

But a smart, creative, ambitious, and committed person is likely to make mistakes. And so a culture that lauds spectacular success also needs to at least tolerate spectacular failure. You can’t have trial without error or profit without loss.

Let me be clear. I’m not saying that people in an innovative society should champion failure. I’m saying they must expect potential innovators to make a lot of mistakes and so have not only the right institutions in place (private property, contract, and so on) but also the right psychological mindset—which is something static societies can’t do.

Change, Uncertainty, and Tolerance

If you think you already know everything, anyone who thinks differently must be wrong. So why tolerate them?

One of the great differences between the modern world and the various dark ages mankind has gone through is how rapidly today our lives change. There’s immeasurably more uncertainty in the era of creative destruction than in times dominated by the “tried and true.”  But the more we realize how much uncertainty there is about what we think we know, the more we ought to be willing to admit that we may be wrong and the other guy may, at least sometimes, be right. And so if we see someone succeed or fail, we think, “That could have been me!” In a sense, an advancing society welcomes mistakes as much as it embraces triumphs, just as a fast car needs brakes as much as it needs an engine.

That’s not just fancy talk. The evidence—prosperity—is all around us.