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What Drives Innovation, the Engine of Economic Growth?

Many economists today are arguing that the unprecedented era of innovation—the last 250 years or so since the industrial revolution—is going to be over soon, ending economic growth. Why should we care about economic growth? Because our well-being depends on it—the alternative is the subsistence living of the pre-industrial times. Human flourishing—nutritious food, better medicine, less illness, longevity, labor-saving technology enabling more productive and recreational activities, communications technology to conduct business and to keep in touch with family and friends—depends on economic growth.

Terence Corcoran wrote about the “peak growth theory” in the National Post last week: http://opinion.financialpost.com/2012/10/05/and-now-peak-growth-theory/.  It seems that the economists predicting end of growth are basing their arguments on analysis of trends. Economic growth rates which took off after the invention of the steam engine and industrial revolution, peaked in the mid-20th century, and have been declining gradually since, particularly in the United States. If you extrapolate from declining trend, you will come to the conclusion that economic growth will end. But in order to understand any trend and to change it, we need to look at the fundamental causes behind it.

Economists understand that innovation drives economic growth. Big innovations based on harnessing steam power, discovering electricity, the computer revolution all have spurred economic growth. But what drives innovation? That is what the “peak growth” economists are either mute or mistaken about—some blame, incredulously, neo-liberal policies of deterring innovation and economic growth. Mr. Corcoran, however, correctly identifies that we need freedom to boost innovation and economic growth. It is competition in free markets that pushes companies to outperform each other in coming up with new, better, less expensive products and services, and more efficient processes and technologies for producing them. Have you ever wondered why the rate of innovation is so much higher in consumer electronics and computer industries, than say in health care? The first two are not strangulated with government regulations, the third one is. Overall, there has been less economic freedom in the U.S. since the peak of growth and more government involvement and spending (witness the size of the U.S. deficit)—thus less innovation and growth. The economies liberalizing their markets—China, India—are witnessing growth.

But freedom, while a requirement of innovation and therefore economic growth, is not a fundamental cause. The fundamental engine of innovation—which can only run on the condition of freedom—is the greatest natural resource of all: the human mind. It is the first-handed, independent adherence to reality that enabled the creation/harnessing and commercial production of the steam engine, electricity, computers, and all the modern innovations that stem from them. Only to the extent that we continue to use reason—to adhere to reality through observation and logic, and integrate what we acquire with the rest of our knowledge—can we come up with innovative solutions that contribute to economic growth.

Based on his brilliant analysis of today’s culture (from philosophy to physics to literature to education) in his new book, The DIM Hypothesis: Why the Lights of the West Are Going Out, philosopher Leonard Peikoff observes the end, or diminishing, of reason. He predicts the decline of the Western civilization—unless we change course and embrace reason again. Choosing reason over evasion, mysticism or any other form of irrationality (and ensuring that rational education is available to the young) is our first task in encouraging innovation; fighting for freedom in every realm from education to markets is the second.