Endogenous Growth: The Future of U.S. Economic Dominance through Technology

Coming off the heels of the greatest financial crisis since the Great Depression, many policymakers, academics, politicians, business people, and everyday Americans are wondering how the U.S. economy can return to growth and more importantly, what government can do to affect future growth and productivity.  The situation is complicated by a crippling U.S. debt of more than $15 trillion dollars (usdebtclock.org, 2012) and a divisive legislative branch of government that politicizes each policy debate, rather than seeking bipartisan solutions for the restoration of long run U.S. economic growth.  How then, in this environment, does government contribute to long-run growth?  What policies will have the most affect on long-run economic growth?  The neoclassical growth model would suggest that government policy primarily has an affect on leveling out short-run variances in the economic system to optimize short-run efficiency, rather than on long-run growth (Solow, 1956). Whereas, endogenous growth models suggest that government can have an affect on long-run growth by promoting policies that contribute to knowledge, innovation, and technological progress (Romer, 2008).  “Endogenous growth analysis diverges from neoclassical analysis by making technological change a function of economic incentives and behavior” (Freeman, 2000, p. 9).  Using endogenous growth theory as the theoretical basis for recommendations, this author recommends that the U.S. government further use fiscal policy to promote education and innovation, revise the taxation system to promote national saving, and remove policies that support industry entrenchment and a maintenance of the status quo.

According to Mankiw (2012), “at the very least, government can lend support to the invisible hand by maintaining property rights and political stability” (p. 256).  While this is strictly true, the government can do much more to promote long-run growth.  Economic prosperity, measured by GDP, reflects a nations ability to produce goods and services to raise the standard of living for economic participants (Mankiw, 2012).  Determinants of productivity include physical capital, human capital, natural resources, and technological knowledge (Mankiw, 2012).  Government economic policy should help American institutions use the determinants of productivity efficiently to maximize technological progress.

As capital is factor of production, access to affordable capital is an important aspect of national economic fiscal and monetary policy.  Because government deficits reduce national saving and investment, the $15 trillion U.S. government debt serves to stifle growth.  (Mankiw, 2012) In addition, the current income tax system also encourages private debt, rather than promoting saving and investment with its system of interest-based deductions.  These policies can be considered to enhance individual quality of life by reducing the tax burden of individuals, choosing to defer tax revenue and borrow instead.  However, in the end, these policies inhibit economic growth and may trade quality of life today for future innovation and growth.  Rather, U.S. fiscal policy should place more emphasis on private savings and reduced government deficit to promote capital investment in new technologies.

Technological innovation and improvements are at the heart of endogenous growth theory.  The reduction of U.S. manufacturing jobs bears witness to the impact of technology to American industry.  While many bemoan the loss of technology jobs to outsourced, offshore manufacturing, most technology jobs have been lost to technological progress through the process of creative destruction, rather than to offshore labor (Collins & Ryan, 2007; Reich, 2009).  Manufacturing has simply followed the path of agriculture and the job destruction is the direct result of government investment in technological innovation.  Consider that automated, outsourced manufacturing is the result of information technology innovations that allow product and factory design to occur electronically, and irrespective of geographical boundaries.  In essence, without Internet technology, outsourced manufacturing and factory automation would hardly be practical.  The necessary computing technology came from DARPA, a government innovation agency; (Van Atta, 2010; Waldrop, 2010); a classic example of how government investment in technology has powered the creative destruction of manufacturing and the dawn of the knowledge economy.

Today’s economic powerhouses of the corporate world are not the manufacturers of yesteryear; rather, companies that specialize in information and knowledge are the titans that dominate the business landscape.  Energy, financial services, life sciences, telecommunication, information technology, and Internet services companies are the industries benefiting from and driving the growth of the knowledge economy.  The government should reducing barriers to innovation in these industries, considering deregulation wherever there is not a clear public interest in regulation.  For instance, the FCC is grappling with how to continue to control the airwaves, when hardly anyone is using the airwaves and when they should simply get out of the way.  New legislation is seeking to change the fundamental architecture of the Internet, when there are simpler and better ways to protect property rights online (Electronic Frontier Foundation, 2012).  Perhaps the best example of an industry where the government needs to promote rather than stifle innovation is the energy market.  U.S. interests have historically been aligned with the extraction and production of fossil fuels, most notably oil.  The U.S. government heavily subsidizes the U.S. fossil fuel companies to the point that renewable and alternative fuels cannot compete effectively (Leonard, 2011).  Rather, the government should level the playing field to allow alternative and renewable energy sources compete fairly with the fossil fuel market (Rock, 2011).  Furthermore, the government should continue to direct DARPA to invest in alternatives to fossil fuel, given the DOD’s mission could be compromised because of Middle Eastern politics.  When done right, government industry investment can enhance quality of life by helping companies bring new technologies to market.  Government fiscal policy should be carefully manipulated to reduce unnecessary government industry interference, while aligning government industry investment with the development of new technologies.

Of course, technological progress is not simply the result of government and private investment.  Technological progress requires a commensurate investment in human capital.  Mankiw (2012) notes that “education is at least as important as investment in physical capital for a country’s long-run economic success” (p. 247).  In fact, to those economists subscribing to the ideas represented in endogenous growth theory, human capital investment is perhaps the most important because of the positive externalities it creates, or simply put, the ideas created that benefit others (Freeman, 2000; Mankiw, 2012).  For example, Wikipedia is a byproduct of many positive externalities, as people the world over contribute their knowledge to the rest of humanity into a single, global, free, encyclopedia.  The knowledge economy is entirely dependent on education as the basis for its success.  Think about investment in education as an investment with limitless potential.  Physical capital is subject to the notion of diminishing returns, whereas ideas suffer under no such constraint (Cortright, 2001).  Consider the impact of a global population of seven billion people (Sanjayan, 2011), each contributing their cognitive surplus to the advancement of human progress through the physical infrastructure of the Internet (Shirky, 2010) and the idea of long-run economic growth the world over is imaginable.  Today, the U.S. government invests significantly in the greatest research university system in the world, and has policies that promote secondary education like student loans and Pell grants (U.S. Office of Management and Budget, 2012).  However, the $77 billion dollar budget is a paltry sum when considered as a percentage of either total budget or GDP.  Given the potential of ideas to create economic growth, the U.S. government should consider the diversion of budget from physical capital to human capital.

When considering the U.S. government’s policies through an endogenous growth lens, it is difficult to suggest that the government should maintain the same historical economic investment portfolio.  Rather, policymakers should make investments that further promote technological innovation and the spread, rather than the control, of ideas.  Rather than continuing to subsidize industries that represent the status quo, subsidies should be shifted to those industries with the most future potential.  Rather than continuing to promote policies aimed toward consumption and debt, those policies should be moderated with policies that encourage private and public saving, and a lower government deficit.  Rather than promoting a fiscal policy where a mere 2% of the budget is allocated education, what could happen should it be increased to 3%?  What new ideas are possible should we send twice as many students to college for science, technology, engineering, or math degrees?  In the final analysis, this author concludes that government fiscal policy should further invest in education and technological innovation, promote private and national saving, and promote industry investment in new technology, particularly in industries that make up the knowledge economy.

References

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Van Atta, R., Dr. (2010). Fifty years of innovation and discovery.  Washington D.C.: Department of Defense Retrieved from http://www.darpa.mil/About/History/History.aspx.

Waldrop, M. (2010). DARPA and the internet revolution.  Washington D.C.: Department of Defense Retrieved from http://www.darpa.mil/About/History/History.aspx.