Is technical knowledge the key driver of economic growth?

According to some commentators such as Nobel Laureate in Economics Paul Romer, technical knowledge is key to economic growth. We hold that if this would have been the case, why third world economies continue to experience poverty. After all individuals in these economies have access to the same technical knowledge of the developed world.

Careful examination, however, shows that a key cause that drives economic growth is the pool of consumer goods or the subsistence fund. What is it all about?

Pool of consumer goods supports economic growth

To maintain life and wellbeing, man must have at his disposal an adequate amount of final consumer goods. These goods, however, are not readily available – they have to be extracted from nature. Without tools at his disposal, man can only secure from nature minimum goods for his survival. This principle can best be illustrated in a simple example to grasp this concept.

For instance, take an individual John, stranded in a forest. In order to stay alive, he can only pick up some apples from an apple tree. Apples are the only good available to him that can sustain him. Let us say that by working 20 hours a day, he manages to secure 20 apples, which keep him alive. The 20 apples that John has secured from nature is his subsistence fund, which sustains him.

Being a sophisticated individual, John realizes that if he had a special stick this would allow him to become more productive. His daily production of apples could be 40 apples (i.e. double his current production).

The problem, however, is that the stick is not available – it must be made. To make the special stick requires two days of work. If John were to decide to make the stick, he would have a problem. By spending his time on making the stick, he would not be able to pick up the apples that are required to keep him alive.

The way out of this dilemma is for John to put aside an apple a day for the next forty days. By saving an apple out of his daily production and enduring hunger, after forty days he will have an adequate stock of apples that will sustain him while he is busy making the special stick. (We make the unrealistic assumption here that apples can be preserved in edible form for forty days to illustrate the importance of saving).

Thus, after forty days, John’s subsistence fund will be comprised of 40 apples, which will see him through while he is making the special stick. We can see here that the saved or unconsumed 40 apples enable the making of the stick, which raises the production of apples and lifts John’s living standard.

Let us slightly alter the previous example and introduce an individual Rob who specializes in making the special stick. Because he is an expert in stick making, it takes him only one day to make the special stick that John requires. Rob also has to have 20 apples a day to keep him going. Note that rather than saving 40 apples John needs to save only 20 apples now, which will enable him to hire the services of Rob.

Observe that John’s saved 20 apples sustain Rob the stick maker, while John is maintained by the current daily production of apples, which is also 20 apples.

Note that the making of the stick is a burden – John has to make a sacrifice and save 20 apples thereby endangering his health and wellbeing. However, after 20 days he will be able to use the stick, which will allow him to double his production of apples. If he continues to consume 20 apples a day, this will allow John to increase his subsistence fund.

Thus on the first day, his subsistence fund will be 40 apples, of which 20 are allocated for consumption and 20 are saved. On the second day, his fund will comprise of 20 saved apples + 40 apples from current production i.e. in his fund now are 60 apples of which 20 consumed and 40 are saved. On the third day, his fund will have 80 apples (i.e. 40 apples from the daily production and 40 from savings). Out of this John consumes 20 apples and saves 60 apples etc. As the subsistence fund expands, this allows John to hire the services of other individuals that can maintain and enhance his production structure, and thereby raise further the production of apples.

The state of the subsistence fund determines the quality and the quantity of various tools that can be made. If the fund is only sufficient to support one day of work, then the making of a tool that requires two days of work cannot be undertaken.

The size of the fund sets the limit on the projects that can be implemented. It also means that the size of the fund determines economic growth. (As the fund increases this permits a greater production of apples).

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 labourers 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……..The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be. It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices.1

The essence of the subsistence fund with respect to the individual John, can be widened to include many individuals that trade with each other. John, who produces apples, can now secure meat and clothing from other individuals. This means that the subsistence fund now comprises of a greater variety of final goods ready for human consumption. 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.2

Note again that the improvement in the infrastructure is what sets in motion economic growth. The improvement in the infrastructure in turn can take place because of the increase in the subsistence fund. Hence, anything that weakens the subsistence fund undermines the prospects for economic growth. Again, we suggest that individuals that are engaged in the various stages of production require access to final consumer goods i.e. the subsistence fund in order to support their lives and wellbeing.

Observe again that we also label the part of the pool of consumer goods allocated towards the maintenance and the expansion of the infrastructure as real savings. The improved infrastructure permits not only the increase in consumer goods but also the introduction of various services that were not available before.

New ideas without the expanding pool of consumer goods cannot generate economic growth

We suggest that new ideas can do very little for real economic growth without an expanding pool of consumer goods.

In “Man Economy and State”3 Murray Rothbard says that technology, whilst important, must always work through the investment of capital in order to generate economic growth. On this issue Rothbard quotes Mises who 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”.

So regardless of how knowledgeable we are and regardless of various technological ideas, without an expanding pool of real savings expansion in economic growth is not going to emerge.

It is through the expansion in the pool of real savings that an increase in the stock of capital goods is possible. The increase in capital goods permits the increase in economic growth to emerge. Note again that we do not say that technical knowledge is not important.

For instance, to make a particular tool the toolmaker must have an idea of how to make this tool. The idea alone however will not be sufficient to produce the tool. Various elements to make the tool must be produced before it could be assembled.

In the various stages of production i.e. intermediate and final stages, individuals that are employed in these stages must be supported by providing them with the access to final consumer goods, which sustains them.

Observe that without the allocation of consumer goods i.e. real savings towards the individuals employed in the various stages of production the tool cannot be made notwithstanding the technical knowledge of how to make the tool.

Intermediate Goods

If the subsistence fund comprises of final consumer goods, how does a producer of an intermediate goods, like a producer of tools & machinery contribute to this fund? The producer of any intermediate good does not directly supply final consumer goods. However, he does offer a means to secure these goods. Moreover, he also offers time.

According to Rothbard:

Crusoe without the axe is two hundred fifty hours away from his desired house; Crusoe with the axe is only two hundred hours away. If the logs of wood had been poled 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.4

In addition, with the introduction of more advanced tools and machinery various new consumer goods can be produced, which prior to the making of these new tools were not available at all to individuals. Obviously, if the tools and equipment acquired turn out to be useless, then the savings of purchasers of these tools and equipment are squandered. Saved final consumer goods that were transferred to the producers of tools and equipment are therefore simply consumed by them and they make no contribution to the subsistence fund. We could also say that the production of useless tools and equipment weakens the subsistence fund.

How about services such as medical services? Or what about things such as education or the services offered by music and the arts? Should we include them in the subsistence fund?

We suggest that without the availability of final consumer goods– that sustain human beings – various services such as art and medical services cannot be generated. (Various individuals that provide these services must be also sustained). Once, the pool of consumer goods increases all these things become possible to human beings.

Summary and conclusions

Contrary to popular economics, we suggest that the key for economic growth is not technical knowledge but the expansion of the pool of consumer goods, which enables the enhancement and the expansion of economy’s production structure i.e. better tools and machinery. We suggest that the technical knowledge by itself without the expansion in the pool of consumer goods will not be able to grow the economy.

1 Richard von Strigl, Capital & Production, Mises Institute, p 7

2 Eugen von Bohm-Bawerk, The Positive Theory of Capital, Book 6, chapter 5, Macmillan and Co, 1891).

3 2nd edition p.542

4 Murray Rothbard, Man Economy and State, Nash Publishing, p.45.