By Dr Frank Shostak
This year the Nobel Prize in economics was awarded to Joel Mokyr, Philippe Aghion and Peter Howitt for having explained how innovation drives economic growth. According to the Laureates, in particular Mokyr, the period of Enlightenment set the foundation for the Industrial Revolution and sustained economic growth. Note that the period of Enlightenment gave birth to Capitalism, a social system based on the recognition of individual rights, including property rights, in which all property is privately owned.
It is capitalism through the free-market environment that made it possible for strong and sustained economic growth. According to Ludwig von Mises,
The laissez-faire ideology and its offshoot, the “Industrial Revolution,” blasted the ideological and institutional barriers to progress and welfare. They demolished the social order in which a constantly increasing number of people were doomed to abject need and destitution.
It is not innovations as such that were the driving force of the Industrial Revolution but Capitalism that protected businesses property rights. This should be contrasted with Feudalism and Socialism where property rights are not protected.
According to the Laureates, it would appear that innovations are the key to sustained economic growth. We hold that if this would have been the case, why is it that the third world economies continue to experience poverty? After all individuals in these economies have access to the same technical knowledge of the developed world.
In “Man Economy and State” Murray Rothbard says that technological “know how”, 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”.
Hence on this thinking a key factor that drives economic growth is Capitalism that makes possible the increase in capital goods i.e. tools and machinery. What permits the increase of capital goods is the pool of consumer goods or the subsistence fund. What is it all about?
The subsistence fund supports economic growth
To maintain life and wellbeing, an individual must have at his disposal an adequate amount of consumer goods. These goods, however, are not readily available – they have to be extracted from nature. Without tools at his disposal, the individual can only secure from nature minimum goods for his survival.
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. Hence, the size of the subsistence fund sets the limit on the projects that can be implemented. 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 essence of the subsistence fund can be widened to include many individuals that trade with each other. An individual, who produces apples, can now secure meat and clothing from other individuals. This means that the subsistence fund comprises of a great 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.
Note again that the increase and the enhancement of capital goods is a major ingredient in setting in motion economic growth. This 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, individuals that are engaged in various stages of production require access to consumer goods i.e. the subsistence fund in order to support their lives and wellbeing.
Observe that the part of the pool of consumer goods allocated towards the maintenance and the expansion of capital goods i.e. the infrastructure is 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 economic growth without an expanding pool of consumer goods.
Technical “know how”, whilst important, has to work through capital goods in order to generate economic growth. So regardless of how knowledgeable we are and regardless of various technological ideas, without an expanding subsistence fund an increase in economic growth is not going to emerge.
It is through the enlargement of the subsistence fund that an increase in the stock of capital goods is possible. The increase in capital goods in turn permits the increase in economic growth. Note 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 components 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 consumer goods.
Again, these consumer goods are sustaining individuals in the various stages of production.
Observe that without the allocation of consumer goods i.e. savings towards the individuals employed in the various stages of production a required infrastructure cannot be made notwithstanding the technical knowledge.
Intermediate Goods
If the subsistence fund comprises of 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 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.
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.
Again, the precondition to a sustained economic growth is Capitalism that protects individuals’ rights, which includes the property rights.
Summary and conclusions
Contrary to this year’s Nobel Laureates in economics conclusions, we suggest that the technical knowledge by itself without the expansion in the pool of consumer goods will not be able to grow an economy. We hold that the precondition for a sustained economic growth is the existence of a free market economy. An ever-rising interference of the government and the central bank with the economy runs the risk of shrinking the pool of consumer goods i.e. the subsistence fund thereby setting in motion a prolonged period of stagnation.
