We live in an amazing time. As David Kotter recently noted in The Washington Times, we have flipped “extreme global poverty” in just the past 250 years: When the USA was founded, roughly 90% of earth’s population lived in—by today’s standards—extreme poverty. Today, we’re at 10%, and at least a billion people have moved out of extreme global poverty in my lifetime alone. If this weren’t stunning enough, remember that 250 years ago, the global population was likely less than one billion; today it’s a whopping eight billion.
While roughly one billion remain in global poverty—what Paul Collier referred to as The Bottom Billion—our shared progress is breathtaking. And because it happened so quickly, economists have been playing a game of catch-up in economic growth theory, searching for a model rich enough to fit these dizzying facts.
As my good friend and colleague Per Bylund likes to quip, if you’re asking what causes poverty, you’re asking the wrong question. Extreme poverty is the default. The real question is, “What causes prosperity?” And this year’s Nobel laureates in economics have added to our understanding.
Yet the contributions of the new prize winners—Joel Mokyr (Northwestern University & Tel Aviv University), Philippe Aghion (Collège de France & INSEAD), and Peter Howitt (Brown University)—to our understanding of economic growth cannot be fully estimated without first understanding a little about the beginnings of the economics Nobel, taking a survey of the “shoulders of giants” the new laureates stand upon, and, especially, examining the earlier work of Joseph Schumpeter. In many ways, this year’s prize should go to Schumpeter because, without him, none of the laureates’ achievements would have been possible.
As I have discussed in earlier reflections on the economic Nobel recipients, the prize in economics technically isn’t a true “Nobel Prize” in the sense that the others are in fields like chemistry and literature. The original five prizes outlined in Alfred Nobel’s will (physics, chemistry, physiology/medicine, literature, and peace) were funded through Mr. Nobel’s estate and first awarded in 1901.
The economics prize came much later. Officially the “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel,” the economics prize was first awarded in 1969 to economists Jan Tinbergen and Ragnar Frisch for their work in modeling dynamic economic processes.
Here’s something you may not have given much thought: None of the six Nobel prizes (either the original five or the prize in economics) can be awarded posthumously. And by the time we had something called a prize in economics, Joseph Schumpeter—the name most closely associated with “creative destruction”—had been gone for nearly 20 years. The impact of this one idea upon the trajectory of economic growth theory cannot be underestimated. In fact, when I teach economic growth theory (from a quite mainstream textbook) to my beginning students in economics, Schumpeter and creative destruction are mentioned repeatedly because the concept is essential to our understanding of both entrepreneurship and economic growth. In many ways, this year’s Nobel represents the second coming of Schumpeter. Though he wasn’t awarded the prize in life, this year’s award may owe more to him than to the economists named in the wee hours of Monday, October 14.
Note, for example, the blurbs given for the recipients on the official Nobel website: “for having identified the prerequisites for sustained growth through technological progress” (Mokyr) and “for the theory of sustained growth through creative destruction” (Aghion & Howitt—emphasis mine). Yet in the entire seven-page popular summary of the contributions of this year’s laureates, Schumpeter is never mentioned. And even in the longer, more scholarly summary, Schumpeter is scarcely mentioned in its 39 pages.
How did we get here? And why are we awarding prizes for “creative destruction” without proper attribution?
The Evolution of Growth Theory and Its Laureates
Our shared understanding of economic growth is a recent development. Again, undergraduate economics textbooks are helpful in understanding the latest consensus regarding economic growth and development. So what do they say?
The Solow Growth Model
The most influential modern model of economic growth was pioneered by the late MIT economist Robert Solow, who claimed the 1987 Nobel for his growth model, which is referred to interchangeably as either the “neoclassical” growth model or the “Solow” growth model. Solow explored three possible sources of sustained economic growth: population growth, saving, and technological advances. Solow’s work quickly eliminates population growth alone as an ongoing driver of prosperity: More people will give you more GDP, but GDP per capita will never advance that way. For sustained growth, GDP needs to outpace population growth. Solow turns next to saving as a possible driver, but ultimately eliminates it because, though increases in the saving rate can lead to one-time increases in the productive capacity of an economy, it cannot explain ongoing increases in worker productivity.
Finally, Solow turns to technological advances, finding that, as long as a society persistently arrives at new technologies, growth can be limitless. But even though technological advances were the key to ongoing growth in his model, Solow didn’t flesh out a story of the genesis of such developments. For that, we needed another Nobel laureate.
Endogenous Growth Theory
Paul Romer (Boston College) shared the economics prize in 2018 for his extension of growth theory beyond Solow. Rather than taking technological advances as given (i.e., exogenous), Romer endogenized such advances and explored how and why humans make such discoveries. In short, Romer reminded us that people respond to incentives. Wherever people are motived to make toil less toilsome, or to make money, or to solve a really cool problem, or get famous—whether as a tech entrepreneur or an academic—human creativity is limitless. We never seem content with the status quo and, as long as that holds true, we’ll always be inventing and innovating.
In addition, Romer observed that, unlike machines or labor hours that always experience diminishing marginal returns, ideas could be shared and replicated repeatedly, whether within the same company or around the world. Thus, unlike a piece of machinery, ideas had no diminishing marginal returns: Each use of an idea was at least as valuable as its last use.
Finally, it’s worth noting that new technologies alone don’t get you very far unless you invest in the new pieces of equipment that harness it. Think about that scanner at the checkout lane in your local grocery store. It doesn’t do that store any good if the UPC barcode technology exists; the store needs to invest in the equipment that can utilize it. If not, your checker is still looking at price tags and typing them into the register.
Schumpeter and Creative Destruction
Before reviewing the contributions of this year’s prizewinners, here’s a snippet from the overview found at the top of the popular summary mentioned earlier: “Sustained economic growth occurs when new technologies replace old ones as part of the process known as creative destruction.” See it? Creative destruction. But no mention of Schumpeter anywhere in the seven-page document.
Yet, in his 1942 book Capitalism, Socialism, and Democracy, it is Schumpeter who identifies creative destruction as the process that drives economic progress. In Schumpeter’s view, the entrepreneur is the driver of ideas of all kinds: whether brand-new products, new processes for making old products, or innovative uses of existing ideas and technologies. And new ideas are disruptive. Once an entrepreneur enters a market, he enjoys some degree of monopoly power and—assuming consumers appreciate the entrepreneur’s idea and reward him—he enjoys the rewards of being a disrupter, including the monopoly power that derives from being unique. In fact, it’s the enticement of monopoly profits that motivates the Schumpeterian disruptive entrepreneur. Consequently, many incumbent producers will lose market share to, or be driven out of business entirely by, the upstart entrepreneur. And over time this cycle of creative destruction continues. New jobs and industries replace the old ones. But next time around, it’s the already successful entrepreneur who is now the incumbent firm facing imminent competition from the next entrepreneur who comes along.
And This Year’s Prize Goes to … Joseph Schumpeter
It’s not unreasonable to view this year’s prize as a posthumous award for Schumpeter. For example, back in 2018, TheWall Street Journal reported that “the key to America’s success lies in its unique toleration for ‘creative destruction,’ the destabilizing force described by the economist Joseph Schumpeter in 1942.” Yet this year, three living economists were given the prize. Let’s look at their contributions, and the ways in which Schumpeter informed their work.
An economic historian, Mr. Mokyr described what growth looks like over time, why the rate of growth exploded during and after the Industrial Revolution, and what the essential preconditions are for economic growth of the sort we’ve experienced over the past 250 years. In his estimation, growth happens most rapidly when technological discovery and innovation springs naturally from our past technological discoveries. According to the popular summary, this is how we not only arrived at the steam engine but also how our understandings of vacuums and atmospheric pressure made steam engines better. But such inventions and improvements are most likely to happen where entrepreneurs have the space to try new things. Mokyr understood that the fertile soil of a free society fosters experimentation and growth, and that regulatory demands by incumbent firms are a deliberate effort to keep out or stifle likely, eventual Schumpeterian competition. Existing firms are often the champions of additional regulations because they can afford to be compliant. Upstarts can’t.
The cowinners, Messrs. Aghion and Howitt, formalized Schumpeter’s creative destruction concept with a mathematical model published in 1992. The paper extends the literature of endogenous growth theory (such as that pioneered by Romer) by modeling technological advancements as the outcome of creative destruction and entrepreneurial innovation.
Sound familiar?
It should. Aghion and Howitt explicitly augment endogenous growth theory by mathematically formalizing Schumpeter’s creative destruction. And, unlike the Nobel website, they come right out and say so. Here’s a quote from the second page of the paper: “The model assumes, following Schumpeter, that individual innovations are sufficiently important to affect the entire economy” (p. 324). Even more explicitly, the line appears just below a block quote from Schumpeter’s 1942 classic. And, if that weren’t enough, consider the title of the paper: “A Model of Growth Through Creative Destruction.” Aghion and Howitt built their prize-winning paper around Schumpeterian disruption, and explicitly said as much.
A Few Reflections
As you can gather, I think it’s unwise to give a hearty “three cheers” to this year’s Nobel. Don’t get me wrong: Mokyr, Aghion, and Howitt are stars. And we understand even more about growth because of them.
My concern has more to do with both how the Royal Swedish Academy of Sciences has framed the work of these laureates and the policy implications. As I hope I have made clear, the academy makes it sound, throughout their announcements and promotional materials, that Aghion and Howitt are the originators of creative destruction. This is intellectually dishonest.
My other concern has to do with the academy’s description of what constitutes a fertile environment for entrepreneurship and discovery. Economics textbooks usually list the following: rule-of law, private property, a well-functioning price system, openness to trade. With these in place, all of us can make better decisions—under less uncertainty—than we would without them.
But the academy has a much longer list, including “well-designed policies” to address “climate change, pollution, antibiotic resistance, increasing inequality, and unsustainable use of natural resources.” They also add that sometimes monopolies may be “too” dominant and need regulating.
The academy wants to have it both ways. It wants to celebrate our long-term prosperity and all the good things that come with it. And they want a society free enough to let entrepreneurs try the crazy things that make it so.
They just don’t want society to be too free. But who can know what a “well-designed” policy is? Or which monopolies are “too” dominant. As Bastiat, Hayek, and Hazlitt have taught us, today’s policy interventions rarely lead to outcomes we expect. And they divert entrepreneurial creativity into gaming the system.
My concerns regarding the academy and its framing notwithstanding, I have no problem celebrating the new laureates themselves. After all, they stand on the shoulders of a very important giant.
