I wish to discuss what I believe to be three critically missing ideas in our understanding and current theories of economic growth. These are not merely academic issues. The world breaks into economic layers, with some living very well, others not as well. Then there are the people living at the bottom of the global economic scale, people living in poverty. Fifty years of IMF and World Bank efforts, guided by the "Washington Consensus," have failed to achieve the sought for growth to bring these people a higher standard of living.
That Consensus speaks of stable government, education, infrastructure and sound monetary policy, then growth will follow. But it has not followed, and several experts tell me the Washington Consensus is dead. Without it, they tell me, they have no guiding principles.
I very strongly believe, with positive supporting evidence noted below, that part of what is missing and urgently needed is an understanding of the structure of economic webs and how that structure can abet supracritical economic growth with an ever increasing explosion of the diversity of new goods, production capacities, and new economic niches which are, in fact, new ways to make a living.
The global economy is supracritical, as is the U.S. economy. In contrast, economies can be subcritical, and make at most a very modest diversity of goods and services. Such economies tend to become export economies tied to the global market. Examples include Ethiopia, exporting coffee, and Alberta, exporting oil, wheat, timber products and beef. Both are subcritical. They are not creating an increasing diversity of goods and production capacities.
In the past 50,000 years the global diversity of goods and production capacities has increased from perhaps 10,000 to 10 billion. Economists have NO theory of this explosion, which is obviously the major driver of the historical increase in wealth.
I note that the Washington Consensus is based on the best models of economic growth. In large measure, these models treat the economy of a nation as if it produced a SINGLE GOOD, i.e., a single-sector model. Then fine equations analyse the conditions of monetary policy, regulatory features, savings and investment, labor supply, "human knowledge" and market size that lead to growth of that single good.
But these models ignore the fundamental fact that the economy is not a single good, but a WEB of interwoven activities, goods and services. New goods and services are invented, enter the economy and thereby create new economic niches which are new ways of making a living. In turn, these can spawn yet further new goods and services that link into the existing economic web and drive its further growth. In supracritical economies, this web explodes in a diversity of novel goods, production capacities, and novel ways of making a living i.e., economic niches. In subcritical economies, this explosion does not happen.
Let me define an economic web. Screw and screw driver are complements, used together to create a valuable product. Screw and nail are substitutes, one can often be used in place of the other.
Picture a three-dimensional space, a room say. Represent the goods in the economy as nodes scattered in this space. Link complementary goods by green lines. Link substitute goods by red lines. This "graph" is an image of the economic web.
The economic niche of a good is typically its complements and substitutes. New goods and ways of making a living can enter this web. In turn the new good can spawn yet further new niches, goods, and ways of making a living: The invention of the gasoline car led to its complements, an oil and gas industry, paved roads, motels, fast food restaurants and suburbia housing people now needing cars.
In my last blog post I discussed the Japanese man in a tiny apartment crowded with 2,000 books, who used his iPad to scan the books, sold them, then realized that he could make a NEW KIND OF LIVING by providing the service to others in tiny apartments crowded by books by scanning their libraries onto their iPads, so providing them more living space. So this new "library scanning service" is the technological COMPLEMENT to the invention of iPad, and ONLY CAME INTO EXISTENCE AS AN ADJACENT POSSIBLE WAY TO MAKE A LIVING WITH THE INVENTION OF THE IPAD.
Note that there is no way to deduce this new way to make a living. We cannot MATHEMATIZE the detailed growth of the economic web, hence economists wishing to derive all from equations ignore the way this web grows historically.
I stress that new goods and production functions create new "empty Adjacent Possible" context dependent economic niches. We literally are creating the very possibilities we will/may become.
The evolving biosphere also creates the new empty Adjacent Possible niches it will/may become. We MAKE THE POSSIBILITIES we will become, far from Newton's mechanical universe.
While not mathematizable in detail, we can have statistical theory. Picture an X, Y coordinate system. On the X axis plot the diversity of renewable goods in an economy. On the Y axis plot the diversity of production capacities. A hyperbolic curve in this space divides the region BELOW this curve which is subcritical. Like Alberta, it makes no increasing diversity of ever new goods and ways to make a living. ABOVE this curve, the economy is supracritical. Given sufficient capital, and market size, the supracritical economy explodes with ever new goods and ways to make a living. These ideas are now a theorem, not mere conjecture.
More, Ricardo Hausmann at Harvard's Kennedy School has shown in cross country data that the ideas are correct. Countries with a higher diversity of goods and production capacities are both wealthier and GROW FASTER.
All these ideas need desperately to augment the dead Washington Consensus to help drive desperately needed economic growth, particularly in poverty stricken parts of the world.