Tuesday, 9 June 2015

Technology Needs Capital To Produce Economic Growth

Guest post by Frank Shostak

technologyIn his article “The Big Meh” Paul Krugman complains that despite all the information technology advances the effect so far has been negligible as far as economic growth is concerned.

Krugman writes “That the whole digital era, spanning more than four decades, is looking like a disappointment. New technologies have yielded great headlines but modest economic results. Why? ... The answer is that I don’t know — but neither does anyone else.”

Indeed if one looks at the US’s real gross domestic product as compared to the potential real gross domestic product [by it’s nature a slippery measurement, but still … ] , the economy does appear to be hovering below potential, with a ratio of 0.977 registered in Q1 this year:  

Contrary to Krugman’s own admission of ignorance on behalf of his profession, however we suggest that economists such as Ludwig von Mises and Murray Rothbard have provided a clear answer to the issue of technology and economic growth.

In a seminal article on 'Capital Supply and American Prosperity,’ [one that every “growth theorist” should read and digest] Mises points out that technology, while important, must always work through the investment of capital in order to generate economic growth. Writing in 1952, he observed:

It is not true that the economic backwardness of [many] countries is to be imputed to technological ignorance on the part of their peoples. Modern technology is by and large no esoteric doctrine. It is taught at many technological universities in this country as well as abroad. It is described in many excellent textbooks and articles of scientific magazines. Hundreds of [non-Americans] are every year graduated from American technological institutes. There are in every part of the earth many experts perfectly conversant with the most recent developments of industrial technique. It is not a lack of the "know how" that prevents foreign countries from fully adopting American methods of manufacturing but the insufficiency of capital available.1

Most modern theories that emphasise the importance of new ideas and new technologies give the impression that these ideas and technologies have a “life of their own.” Many experts hold that because of the limited amounts of capital and labour, without technological progress, the opportunities for growth will eventually run out.

We Need Funding To Implement New Ideas

Ideas, unlike material inputs, are not themselves “scarce.” Consequently, it is argued, new ideas for more efficient processes and new products can make continuous growth possible.

imageWe suggest that regardless of how many ideas people have, what matters is whether these ideas can be implemented. What always limits the implementation of various new techniques is the availability of funding. While ideas and new techniques can result in a better use of scarce resources, they can however, do very little without the pool of real savings.

So regardless of how clever we are and regardless of various technological ideas, without an adequate pool of funding nothing will emerge. It is through the expansion in the pool of real savings that an increase in the stock of capital goods is possible. And it is the increase in the capital goods per worker that permits economic growth to emerge.

To Get More Funding, We Need Savings

Obviously, new ideas and new technology can be introduced during the production of new capital goods (i.e., new technology) and will be imbedded in the capital goods stock. The crux of the matter however, is that capital goods cannot emerge without a prior increase in the pool of funding or pool of real savings.

Take, for instance, a baker John who produced ten loaves of bread. He consumes two loaves of bread whilst the other two loaves — his real savings — he employs to purchase a new part to improve his oven. With a better oven he can now raise the output of bread to twenty loaves. If he still consumes only two loaves, then with a larger savings (now stands at eighteen loaves) he can enhance further his oven by introducing new parts, which will enable the introduction of new technology. Note that all this is made possible on account of real savings.

imageWe suggest that despite new technologies, a major impediment to economic growth has been the relentless central bank tampering with financial markets.

Since 2008 this tampering was made manifest in the extremely loose monetary policy of the Fed that resulted in the massive monetary expansion of the Fed’s balance sheet and the lowering of interest rates to almost nil.

These policies have been responsible for a severe erosion of the pool of real savings and thus a weakening of the process of capital formation. This in turn has undermined real economic growth notwithstanding new information technology.

For Krugman and his followers savings is bad news — it is seen as less demand — hence one shouldn’t be surprised that Krugman is puzzled as to why new ideas haven’t manifested in a more robust economic growth.

Contrary to Krugman, boosting so-called aggregate demand whilst undermining the capital formation process, and hence the ability to produce goods and services, cannot strengthen economic growth over time. In fact this way of thinking results in the notion that something can be generated out of nothing.

Image result for Frank ShostakDr Frank Shostak is the head of Australian research firm Applied Austrian Economics Ltd, and one of the world leaders in the applied Austrian School of Economics. An adjunct scholar at the Mises Institute in the US, Dr Shostak has been an economist and market strategist for MF Global Australia (previously Ord Minnett) since 1986. During 1974 to 1980 he was head of the econometric department at the Standard Bank in Johannesburg South Africa. During 1981 to 1985 he was head of an economic consulting firm Econometrix in Johannesburg.
This post first appeared  at the Mises Daily. It has been lightly edited.

1. Noah: “This lack of saved capital in these economies comes from a lack of the legal structure of property and property rights, according to the excellent Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando De Soto”: https://mises.org/library/capi...

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