Thursday, February 03, 2005

Understanding Economic Growth

In "More about Social Security," I wrote:

As we know well from long experience, the course of the economy isn't expressed by a smooth, upward rising curve of progress. Aggregate economic output can be thought of as a quantum phenomenon, in that it has many potential values at each point in time. Shocks and stimuli determine which of those potential values becomes reality. Shocks (e.g., the collapse of the American stock market in 1929) can lead to sharp and prolonged downturns that can be reversed only by strong stimuli (e.g., the mobilization for World War II). Despair feeds on itself, as does hope. And hope fuels the kind of creativity that we saw, for example, in the aftermath of the Civil War, when the rapid invention and adoption of new technologies and production processes took us to new heights of prosperity in the 1920s.

The same kind of creativity resurfaced in the late 1900s -- spurred by the stimulus of an inflation-busting recession and significant cuts in marginal tax rates. Will it last? Will it take us to ever-higher levels of economic output? It might, but not as a matter of historical inevitability, as some suggest. Historical inevitability is what we see in the rear-view mirror of experience. Something must happen to spur the creation and adoption of new technologies that will take us to new economic heights.
Arnold Kling points to and quotes from a relevant article by Meir Kohn:
Growth does not mean movement along an equilibrium path but rather the unfolding of a complex process. At any moment the potential of the economy is not completely realized: unexploited opportunities for mutually advantageous exchange abound. Indeed the “potential” of the economy is not defined; it depends on the initiative and ingenuity of individuals. Individuals engaging in trading, innovation, and institutional change generate the process of growth, not only discovering potential but also creating it.
The secret ingredient, of course, is purposeful human behavior. As I have shown shown elsewhere, deterministic models of aggregate behavior are woefully inadequate to the understanding of economic and social phenomena.