Smithian vs. Schumpeterian Growth

In this quote from his latest book Joel Mokyr contrasts two important views on the origins of economic growth:

“[…] The difference between “Smithian” and “Schumpeterian” growth is that for the former, exchange and cooperation based on trust or respect for the law are treated as a game between individuals whereas the essence of Schumpeterian growth is based on the manipulation of natural regularities and phenomena and thus au fond should be seen as a game against nature.”

“Smithian” refers to Adam Smith, of course, who is seen as the founding father of modern economics. In his work, Smith emphasized the role of trust, cooperation, and the rule of law as the necessary prerequisites for trade and economic activity. If you can guarantee the former, entrepreneurship (broadly defined) by free citizens will soar and the economy will flourish.

This view has always been pervasive in economics. Modern proponents are, for example, Daron Acemoglu and James Robinson who, in their book “Why Nations Fail” point to the importance of “inclusive institutions” for economic growth, by which they mean a society that allows “everyone to participate in economic opportunities”.

In contrast, you have the work by Joseph A. Schumpeter who stresses the role of new products and production techniques as a stimulus for economic growth. Clever business people will constantly look for possibilities to outsmart their rivals and make more money. As a result, what Schumpeter called “creative destruction” will occur. Old businesses get driven out of the market and replaced by new firms with better products and more efficient production techniques. The basis for this are new inventions and advances in science and technology. With their help businesses are able to serve new customer needs and operate more efficiently.

But in order to come up with such advances in science and technology we need to have a good understanding of the physical world around us. Although precise knowledge about a physical phenomenon is not always needed to put it to use, we still need to carefully investigate its regularities and discern causes from effects. That’s the origin of the term “game against nature”, as Mokyr puts it. Instead of a mere cooperation game between individuals, the challenge lies in teasing out nature’s deep secrets.

Both views have their merits and they shouldn’t be seen as mutually exclusive. Acemoglu and Robinson are right in saying that a participatory society is necessary in order to stimulate creativity and to incentivize investments in innovation. Nevertheless the Schumpeterian perspective is still kept too much at the fringes of economics (I’m still waiting for Aghion and Howitt to win the Nobel!). Despite their importance for economic growth, topics of science, technology, and innovation remain underrepresented in the literature. Especially finance people seem to have the habit to treat R&D as yet another form of investment (see this paper for a current example).

Innovation as a separate research topic figures much more prominently in the business administration literature. Fields such as strategy, corporate finance, or accounting have realized how important business innovations are for a company’s economic success. Economics should follow suit.


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How important is social mobility for innovation and growth?

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The origin of time preference

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China needs to choose

Almost recovered from a trip to China last week. Actually it was my first time in East Asia. Seeing the impressive economic growth that happened in China close-by is simply amazing. We spent most of the time in Hangzhou–a city with 8 million inhabitants. When you consider that this is a small town for Chinese standards you’re left amazed even more. Continue reading China needs to choose