A visit to San Francisco over the past few days really crystalized in my head the important distinction between increased efficiency in the allocation of resources and fundamental innovation. Either can produce economic growth, but in the long-term it’s the latter that matters most of all. But while conventional economics has a lot to teach us about efficiency I don’t think economists really know much about innovation and they end up doing the world a disservice—and ultimately discrediting their own mastery of the subject they really do know—by confusing the two.
San Francisco is a hotbed of inefficiency and what any economically literate person would recognize as bad public policy. In the Tenderloin District, for example, you have huge swathes of what’s got to be some of the most valuable land in the country occupied by low-income individuals living in dilapidated structures. A more sensible policy paradigm would allow the replacement of those structures by bigger, nicer, more modern, denser structures and by doing so would unleash a quantity of financial wealth that’s more than adequate to pay off the beneficiaries of current rent control policies. The much bigger and denser San Francisco of the future would make California in particular and the United States in general a much more prosperous place by using market forces to better allocate scarce land.
That said, while San Francisco is a hotbed of inefficiency it’s also a hotbed of real innovation. The corridor that starts in San Francisco and runs down to San Jose is the premiere cluster of technological innovation in the world and has been for some time. Digital technology has given us tools that are impressive in their own right, and its influence is spreading wide day by day. And in the long run, this is where prosperity comes from. New technologies are developed and diffused and they create high living standards wherever they go.
Economists aren’t ignorant of this fact—it’s right there as a variable in the standard growth model—but the discipline doesn’t really have much to say about it. Total Factor Productivity is the economists’ phlogiston, not a real explanation for anything.
Which is fine. Human existence is complicated and it’s no surprise that there’s a lot we don’t really understand about it. But you frequently see an effort to simply subsume the question of innovation into the question of efficiency. Like if you want a high-innovation economy you just need a lot of sound market-oriented efficiency-promoting public policies, such that true prosperity stems from Oklahoma and the Dakotas with their libertarian-approved policy frameworks. But their no reason to think that strong patents to give innovators “incentives” is really the best way to spur invention. There’s ample evidence that unregulated financial markets allocate talent to ripping off pension funds or zero-sum high-frequency trading algorithms rather than innovation. Tax policies that neoclassicial economics would condemn as destroying incentives for capital accumulation may spur investments in fundamental R&D that ultimately do more to advance the frontiers of human knowledge. Does Google with its glasses, gigabit fiber, and autonomous cars strike you as a company with unusually “sound” corporate governance and managers who are faithful stewards of their shareholders’ interests or a company where geeky managers are letting the staff run amok in pursuit of technological visions that are only loosely related to a return on investment calculus?
What’s interesting is that people take this for granted in the arts. Obviously creative people want to make money, and financial incentives are relevant to how artists spend their time and what they do. But nobody seriously thinks that the most aesthetically meritorious works come about through the efficient allocation of capital and labor to profit-maximizing uses. They happen, crucially, because of passion and inspiration and perhaps delusions of grandeur. The best novelists don’t make the most money, and there’s no particular reason to believe that designing more efficient incentive systems has ever been the path to artistic greatness. Technological innovation is more tied into the mainstream operation of the economy, and thus more closely linked to considerations of economic efficiency. But it’s still a fundamental error to confuse the two, and to think that wringing the inefficiencies out of our resource-allocation system are either necessary or sufficient for fundamental growth.