Why Economics Can’t Explain the Modern World
Background paper for an address to
the Australian Conference of Economists, Melbourne, July 9, 2012
Deirdre Nansen McCloskey
deirdre2@uic.edu
deirdremccloskey.org
University of Illinois at Chicago
and Gothenburg University
Abstract: NNNN
A big change in opinion about markets and innovation caused the Industrial
Revolution, and then the modern world. The change began during the seventeenth
and eighteenth century in northwestern Europe, when Dutch and British and then
American and French people began talking about the middle class, high or low—the
bourgeoisie—as though it were dignified and free. The result was modern economic
growth, the jump from the long, long Malthusian handle of the Hockey Stick of $3 a day
per person to the business end of the stick, and $125 a day, and all our joy.
I am claiming that ideas, or “rhetoric,” enriched us. It was mere words, which
are the most human of our accomplishments, not mere prudent decisions, our least
human. Grass, after all, is prudent. But grass is not hopeful and faithful and loving and
courageous and just and temperate. The cause of the enrichment was not in the first
instance material change or routine incentives. It was not the rise of this or that class, or
the flourishing of this or that trade, or the exploitation of this or that group.
It was not, that is, a matter of prudence-only, which any life form has. Grass and
rats and pigeons are rational in same sense as is Max U, the strange character whom
Paul A. Samuelson taught us to admire. Contrary to such Samuelsonian economics, a
seventeenth-century change in rhetoric about prudence, and about the other virtues
exercised in a commercial society, started the material and spiritual progress. Meaning
and ethics became for the first time in history favorable to frenetic, unregulated
innovation. Northwestern Europeans began to accept the Bourgeois Deal—“You let me
engage in creative destruction and in the third act I’ll make all of you rich.” It had
parallels in scientific and artistic creative destruction, from Galileo to Charlie Parker.
The new rhetoric of bourgeois dignity and liberty has ever since been spreading
progress to the poor of the world.
I am arguing that historical materialism, unreflectively popular for nearly a
century among historians and economists and other proudly tough-minded folk, is
1
mistaken. It is mistaken whether as Marx’s “original accumulation of capital” or Walt
Rostow’s “takeoff” or Douglass North’s “institutions” or the economist’s “modern
growth theory.” Ideas radically altered tastes and technologies.
One could make the case for such an ideational explanation the modern world
positively by showing the ideology changing, as I do in a forthcoming book, The
Treasured Bourgeoisie: How Innovation Became Ethical, 1600-1848. But here, and especially
in the book published in 2010, Bourgeois Dignity: Why Economics Can’t Explain the Modern
World, of which the present paper is a desperately brief summary, the case is mainly
negative. The usual and materialist economic histories from Marx to North seem to be
mistaken—which frees space, I suppose, for ideas of dignity and liberty.
The ideational theme is old-fashioned, as old as eighteenth-century political
theory. Or it is new-fashioned, as new as twenty-first century studies of discourse.
Either way, it challenges our usual ideas about the ill-named “capitalism.” Most people
carry around ideas about the origins of the modern economy that historical and
economic science have long since shown to be mistaken. People think, for example, that
imperialism explains European riches. Or they think that the Middle Ages did not
know property rights. Or they think that foreign trade differs from domestic trade. Or
they think that markets and greed came recently. Or they think that the only large cities
in the world were European. Or they think that Europeans well before 1700 were
unusually innovative. Or they think that “capitalism” required the “rise” of a new class
(as against a new rhetoric about an old class). Or they think that economic events have
to be explained every single time by material interests. None of these is correct. And
none of the material explanations, alone or in combination, has the oomph to explain
the modern world.
We know empirically that the economistic explanations are mistaken on two
grounds. Historically, other places and times, such as China always and Europe before,
had massive trade or massive exploitation or massive investment, but did not
experience the Great Fact—a rise of income per head, if one includes improved quality
of goods and services, of upwards of a factor of one hundred, but anyway thirty or
forty. The largest international trade happened until the nineteenth century not in the
Mediterranean or the North Sea or the Atlantic, but in the Indian Ocean. The Chinese
had massive cities and stable property rights for millennia. The West Africans could
cast iron and brass in a thousand shapes for two thousand years. The South Asians
invented big-scale production of steel and the analysis of grammar hundreds of years
before the West caught on. Trade or investment, exploitation or profit, were ancient
routines everywhere. But dignity and liberty for ordinary people were unique to the
age of the Industrial Revolution and to northwestern Europe. The history makes it
plausible that it was such ideas, not material causes, that most mattered.
And economically we know that routine investment, absent innovation, rapidly
drives marginal products down to zero. We know that Harberger triangles of efficiency
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gain are small single digits when set beside the magnitudes of percentage change that
modern economic growth entails. But the factor of 100 if the improved quality of
modern goods such as lighting and medicine and, for that matter, economic knowledge
is properly accounted is a percentage change of 9900 percent; and a factor of 10
worldwide on the most conservative accounting, and including areas like Chad and
Bangladesh which have not yet joined the blade of the hockey stick, is still a percentage
change of 900 percent. Of course, if we introduce economies of scale suddenly in 1800
we can “explain” the explosion. Likewise, if we assume a can-opener we can open a can
of beans. The non-tautological, non-magic economics makes it again plausible that
radical ideas, such as electric lighting and the modern university, not routine
reallocation, are what most mattered.
Economics, whether Samuelsonian or Marxist, did matter in shaping the pattern.
It usually does. Exactly who benefited and exactly what was produced, and exactly
when and where, was indeed a matter of economics. If the historians don’t grasp the
economics they will not understand the pattern of modern history. The pattern was
shaped by the trade in cotton and the investments in seaports, by the supply of steam
engines and the demand for elementary education, by the cost of iron and the benefit of
railways, by the plantation exploitation of slaves and the market participation of
women. Economics of a material sort can surely explain why Americans and Swedes
burned wood and charcoal longer than did the forest-poor and coal-rich people of inner
northwestern Europe. It can explain why education was a bad investment for a British
parlor maid in 1840, or why the United States rather than Egypt supplied most of the
raw cotton to Manchester, or why indeed the cotton growers of the present-day African
Sahel are damaged by protection for American cotton. Economics can explain why
comparative advantage in making cotton cloth shifted from India to England and then
back to India.
Economics, though, can’t explain the rise in the whole world’s (absolute)
advantage from $3 to $30 a day and beyond. It can’t explain the onset or the
continuation, in its magnitude as against its pattern, of the uniquely modern—the
coming of automobiles, elections, computers, tolerance, antibiotics, frozen pizza, central
heating, and higher education for the masses, such as for you and me. If the economists
don’t grasp the history they will not understand this most important of modern
historical events. The economics of the conventional sort does not account for the
unprecedented size and egalitarian spread of the benefit from growth, only the fine
details of its pattern. Material, economic forces were not the original and sustaining
causes of the modern rise, 1800 to the present, accelerating after 1980. Economics does
most cleverly explain how the rising tide expressed itself in micro-geographical detail,
channeled into this or that inlet, mixing with the river just so far upstream, lapping the
dock to such-and-such a height. But the tide itself had other causes.
3
Ethical (and unethical) talk runs the world. One-quarter of national income is
earned from sweet talk in markets and management.1 Perhaps economics and its many
good friends should acknowledge the fact. When they don’t they get into trouble, as
when they inspire banks to ignore professional talk and fiduciary ethics, and to rely
exclusively on silent and monetary incentives, such as executive compensation. In
particular, three centuries ago in places like Holland and England the talk and thought
about the middle class began to alter. Ordinary conversation about innovation and
markets became more approving. The theorists were emboldened to re-think antibourgeois prejudices by then millennia old. (Sadly, the talk and thought along such
lines didn’t alter right away in China or India or the Ottoman lands; it has by now.) The
North-Sea talk at length radically altered the local economy and politics and culture. In
northwestern Europe around 1700 the general opinion shifted in favor of the
bourgeoisie, rather suddenly as such things go. There was a big change in what Alexis
de Tocqueville called “habits of the mind”—or more exactly, habits of the lip. People
stopped sneering at market innovativeness and other bourgeois virtues exercised far
from the traditional places of honor at the basilica of St. Peter or the palace of Versailles
or the gory ground of the First Battle of Breitenfeld.
We economists have recently saved our models in the face of a new realization of
how radical the alteration was by speaking of “nonlinearities” or “economies of scale”
or “multiple equilibria.” I am claiming that the economy grew far beyond all previous
expectations in the eighteenth and especially the nineteenth century because the forms
of speech about enterprise and invention suddenly changed. Technically speaking, the
new conversation caused the dimensions of the Edgeworth box to explode. Reallocation by improved exchange within a fixed box à la Harberger, or reallocations by
imperial aggression along the contract curve à la Wallerstein, was not what happened:
the production possibility curve leapt out, à la Schumpeter and more.2 The habits of the
lip changed in the seventeenth and especially the eighteenth century, for various good
and interesting reasons—some in turn material, some rhetorical. Speech, not material
changes in foreign trade or domestic investment, caused the non-linearities or (in more
conventional theorizing) the leaping out of the production possibility curve.
The change in talk and thought about the bourgeoisie was probably of greater
importance for explaining the modern world than the clerical Reformation in Germany
after 1517, or the aristocratic Renaissance during and after the Tuscan Trecento. Yet both
of these influenced the change in talk, as did more powerfully a third great R-shift of
late medieval and early modern times, the political Revolts and Revolutions which
shook Holland and Britain and America and finally France. The point here, though, is
about a fourth great and (for a while) uniquely European R-shift—the “Bourgeois
Revaluation” in Holland and Britain. An old class of town dwellers formerly sneered at
by the clergy and the aristocracy and the peasantry began to acquire a new and more
4
dignified standing in the way people thought about it and talked about it, in their
rhetoric.
Faith is the virtue of backward looking, of having an identity. Keep the faith.
Dignity encourages faith. You are dignified in standing. Hope by contrast is the virtue
of forward looking, of having a project.3 Liberty encourages hope. You are free to
venture. I claim here that the modern world was made by a new, faithful dignity
accorded to the bourgeois, to take his place, and by a new hopeful liberty, to venture
forth. To take ones place and to venture, both the dignity and the liberty, were new,
and both were necessary.
My libertarian friends want liberty alone to suffice. But it seems to me that it did
not. To be sure, from 1600 on the new dignity and the new liberty normally reinforced
each other---there is one possible source of the economist’s “nonlinearities.” Yet liberty
without dignity makes for activity without faithful self-esteem, the eager but lowly and
self-despising niggling of the marketplace. And if thus lacking in dignity the
bourgeoisie is under constant assault from politics and society and literature, assuring
bad economic politics as in Habsburg Spain, and $3 a day, or as in the sad history of
Jewish emancipation liberty without dignity leading to loss of liberty and worse.
Likewise, dignity without liberty makes for status without hope, merely another
version of the hierarchy of olden times, as in the overregulated guild towns such as
Venice or Lübeck. If the bourgeoisie were admitted into the elite but at the price of
being disabled from radical innovation, the modern world would again look a good
deal like the ancien régime of Northern Italy or the Hansa, down to the $3 a day.
All this changed in the Bourgeois Revaluation of the seventeenth through the
nineteenth century. Revaluations of the honorable transcendent, no longer confined to
heroism or saintliness or courtly grace, changed sociology and politics. By contrast,
what Tocqueville called “habits of the heart” did not change much. The initiating
change was not psychological (as for example Max Weber argued in 1905), nor
economic (as Karl Marx argued in 1848), but sociological and political. That is, around
1600 on a big scale in pioneering Holland, and then around 1700 on a bigger scale in
innovating Britain, some of the elite began to revalue the town and its vulgar and
corrosive creativity. By the 1660s the Dutch cloth merchant Pieter de la Court was
declaring that “a power of using their natural rights and properties for their own safety
. . . will be to the commonalty. . . an earthly paradise: for the liberty of a man’s own
mind, especially about matters wherein all his welfare consists, is to such a one as
acceptable as an empire or kingdom.”4 No aristocratic empires or kingdoms, please;
we’re bourgeois. In 1690 an English merchant to the Ottomans, Dudley North (himself
from an aristocratic family), wrote in an even more modern and economistic way that
“there can be no trade unprofitable to the public, for if any prove so, men leave it off;
and wherever the traders thrive, the public, of which they are a part, thrives also.”5
5
Such pro-market opinions have never become universal. The British elite took a
century or more after the age of Shakespeare to even begin speaking of commercial
creativity as O.K., acceptable, not-to-be-sneered-at. Shakespeare’s only play (partly)
about the bourgeoisie is The Merchant of Venice, in which the merchant Antonio is sad
and silly (for love, charmingly) and the other major bourgeois figure is Shylock. All his
other plays concern aristocrats or peasants or imagined shepherds, and his
contemporaries like Marlowe express similar anti-bourgeois views. Two centuries later
in England, by contrast, even the heroes in Jane Austen’s novels, though gentry and not
by any means in trade, think in terms of sense and sensibility, prudence and love; and
dear Jane herself speaks methodically in her letters of her bourgeois business,
authoring. Anti-commercial snobbery in Britain did not entirely end, ever—you see it
in Emma Woodhouse’s ill-begotten advice to Harriet Smith in Emma to not marry the
farmer Robert Martin. But 1600-1800 is a sea change.
The liberty half of the Revaluation was equally, and more famously, slow in
coming. The domination of British politics by an illiberal Establishment did not entirely
end, ever. As the historian Margaret Jacob argued long ago, and as Jonathan Israel has
confirmed lately in the history of ideas, the free-market and free-voting “radical
Enlightenment” of people like the Levellers, de la Court, Spinoza, Mandeville,
Rousseau, Paine, and the well-named Freemasons was undercut by the more
conservative and monarchical Enlightenment of Locke, Newton, Voltaire, and the rest,
in the utter liberty of trade that the radicals sometimes favored among others matters.6
(And of course the reactionary powers fought both Enlightenments, the radical and the
conservative, with galley and with rope; their descendants moved on to the gulag and
the machine gun.) But bourgeois values, and revaluation, triumphed, with startling
economic results.
Yet dignity and liberty for an inventive bourgeoisie did change enough to inspire
the Industrial Revolution. The historian of technology Christine MacLeod dates the
final apotheosis of the inventor in Britain to the early nineteenth century. Certainly the
shift in rhetoric beginning in seventeenth-century Holland needed constant tending, as
ideologies do. MacLeod tells for example of the remarkable campaign in 1834 to erect
in Westminster Abbey, among the kings and priests and poets, a big statue of the
inventor of steam engines, James Watt (1736-1819). A contemporary asked in vexation
“what this vast figure represents, what class of interests before unknown [well, hardly
‘unknown’], what revolution in the whole framework of modern society.”7 He was
behind the curve, even in his metaphorical use of the word “revolution.” MacLeod
notes that the Times as early as April 22, 1826 had declared that inventors were “the
elect of the human race.”8 She detects during the 1830s “a marked alteration in the
attitudes of judges and juries towards patentees. . . . The balance of success in litigation
shifted towards prosecutors of infringements, as patentees began to be regarded less as
6
grasping monopolists [of Elizabethan date, for example], and more as national
benefactors,” sixty years after Adam Smith had fully articulated the case. 9
Such dignity for innovation and liberty for enterprise are sometimes still
opposed—which along with a bad climate and a bad start is why some countries remain
poor. True, if supporters of subsidies to American cotton growers were capable of
shame, eastern Burkina Faso and the rest of the Sahel would do better. Ethical failures
in the global North, such as the rhetoric of zero-sum “competitiveness,” contribute in
part to keeping such places poor. Yet even with a bad climate and a bad start and an
unethical policy in the North of protecting its own rich farmers, such places do not have
to remain poor. That’s the difference on past form between Norway in 1800, whose
poverty then seemed hopeless, and Bottom-Billion Chad now. When a stable though
tyrannical country like China or a turbulent though law-governed country like India
started to revalue markets and innovation, and to give a partial liberty to commerce, the
food and housing and education for the average person began doubling every 10 to 7
years. In a couple of generations China and India, if they don’t revert to antiinnovation, will have Eva’s standard of living. Already they have entered Paul Collier’s
Top 4 to 6 Billion. An internal ethical change did it, beginning in northwestern Europe
after 1700.
It wasn’t “capitalism” that was new in 1700. Markets and non-agricultural
property and a town-living middle class to manage them are very old. Credit is
ancient.10 The market economy, contrary to what you might have heard, has existed
since the caves. The invention of full language, by some accounts around 70,000 B.C.E.,
shows up archaeologically for example in a big and sudden increase in the distance
traveled by stone for tools, such as flint or obsidian, scores of miles in trade instead of
the former few. So it went, for millennia. “Back at least as far as the third millennium
B.C.E.,” writes the economic historian George Grantham, “farmers on some islands in
the Aegean Sea were producing olive oil and wine in amounts greatly exceeding
domestic consumption requirements.”11
Nor of course was innovation entirely novel in 1700. People had always been
creative in making arrowheads or pottery. An Upper Paleolithic burst of creativity in
making tools and ornaments and musical instruments gives another possible sign of the
invention of fully modern language, as does the use of ocean-going boats to get protoAustralians across the Wallace Line before 40,000 B.C.E.12 The Taiwanese natives,
originally from China, appear to have invented the outrigger canoe around 3500 B.C.E.,
and went on to populate the Pacific. The Indo-Europeans of Ukraine appear to have
domesticated the horse around 4000 B.C.E., and went on to conquer or repopulate or
inspire Europe, Iran, and much of South Asia.
Until 1800 C.E., however, the innovations had allowed expansion of humans
merely in numbers and ecological range, or the replacement of one culture by another.
For Malthusian reasons it had done nothing to change the $3-a-day life—nothing at all,
7
from Zulu farmer to Eskimo hunter. For most people right up to 1800 a typical life was
poor, illiterate, narrow, sick, and brief.
What was different after 1800, and with unstoppable force after 1900, was a novel
and immense and sustained, almost lunatic, scale of innovation, finally breaking the
Malthusian curse. For the first time the innovations made ordinary people far richer
than the ancient routine of hunter-gatherer or nomadic herder or settled farmer, and
allowed the moderns to have smaller and more educated families. Think again on your
ancestors, and compare.
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*
The argument can be summarized in a diagram. Take it or leave it as your
intellectual tastes dictate. The diagram restates some of the points in visual terms.
(These could in turn be translated into a set of equations with time subscripts,
differential terms, and so forth. But the arrow diagram is more widely accessible, and
does not require us, as the usual mathematics does, to speak only of one sort of cause,
Hume’s billiard-ball causation.13)
In order to avoid a hopelessly confusing mass of causal spaghetti, one can as it
were subtract out two sorts of alleged causal factors (strands of spaghetti) that did not
contribute, or not much, to the Great Fact. Imagine the fullest spaghetti diagram, with
all the major events of Europe 1600 to the present included, even if they contributed
little or no oomph to explaining the Great Fact—foreign trade, for example, which
flourished outside of Europe centuries earlier, or European imperialism, mainly
providing employment for twits from minor public schools and for the painting of big
portions of the world maps in red. Omit therefore the sort of spaghetti that didn’t
matter as historical causes.
One sort omitted that mattered, but not differentially in Europe as against Asia,
are the Background Conditions. Much of Bourgeois Dignity is devoted to showing that
such factors don’t work very well in explaining the modern world, because they were
present in China and India and in the Arab and then Ottoman lands, and even in some
African and New World kingdoms, sometimes much earlier or in larger measure than
in northwestern Europe:
8
Background Conditions, Good or Bad,
of All Eurasian Civilizations before 1600,
Which Merely Intensified Later
Literary, artistic, and scientific flowering
Respect for learning; universities
Education of elite
Printing and paper
Compass
Clocks [but especially in Europe]
Monotheism [especially in Europe including Orthodoxy, and in Muslim
world]
Peace and bourgeois prosperity [less in Europe]
Urbanization [less so in northern Europe]
(-? or +?) High death rates in cities
Competent bureaucracy [especially in China]
High seed/yield ratios [not in Europe, which did not have much rice, or
any maize]
Investment capability [less so in Europe: see yield/seed ratio]
Wide long-distance trade [less so in Europe]
Slavery and its trade [especially in Middle East]
Wide and deep internal trade and markets
Good internal transportation, especially unimproved rivers, canals, and
coastal ships
Temperate climate
(-) Onset of Little Ice Age (1300-1850) after climatic maximum before 1300
(-) Malaria
(-? or +?) The Plague
Desire for profit
Rule of law
Property rights
Money [in China even paper money]
Reasonably sophisticated financial institutions
High incomes in a few favored places
Coal widely used [China, India, Europe]
9
The other sort of spaghetti omitted are Incidentals, that is, actual or supposed
events after 1600 in Europe that are sometimes alleged to have caused the modern
world but have been shown to be mostly beside the point:
Incidental Events 1600 to the Present,
Not Contributing Much to the Great Fact
Protestant ethic
Thrift
Rise of rationality
Rise of greed
Spanish and Portuguese imperialism
The Price Revolution
Dutch, British, French trade (except as contributing to bourgeois dignity)
Dutch, British, French imperialism
Slave trade
Rises in the rate of saving
Original accumulation of capital
Surplus value, reinvestment
Routine investment
Exploitation of the working class
Science (until around 1900)
(-) Sustained high prestige of aristocracy and gentry
Routine transportation improvement (canals, harbors)
English genetics
English social inheritance
Stuart missteps and taxation
The Glorious Revolution
Institutional change
If an item raises your indignation (“How can she say that British foreign trade
was ‘incidental’!”), you have not been persuaded by the arguments in Bourgeois Dignity.
You may be right. But I’d ask you to read the book and then show exactly how the
quantitative and comparative arguments it makes are erroneous, not merely to wax
wroth. And “showing it,” by the way, does not consist in proposing a model after some
light historical reading that “calibrates” with the history. That’s a six-inch hurdle, like
statistical “significance.” There are an infinite number of models that roughly “predict”
(or more exactly post-dict) the course of European history in this or that regard. The
10
argument has to be able to stand up to confrontation with all the evidence, quantitative
or qualitative. It has to make full human, scientific sense.
The upshot is (you may want to magnify the print!):
My claim, in short, is that the flow chart across the centuries is better than the
strictly materialist alternatives. A young and conventionally equipped economist will
be a little puzzled by the model, because he will think that only a model with
constrained maximization constitutes a “model.” He is philosophically mistaken, and it
is a disability of his education that he will not know that he is.
But the crux here is that a Max U model, as much as I have loved such a
Samuelsonian-Beckerian idea, and have written numerous books and scores of articles
in its praise, cannot work to explain real innovation. That, after all, is the central
point—that routine maximizations, such as by the extension of foreign trade or by
investment in routine projects of swamp drainage or canal digging, do not explain the
modern world. What explains it, as the Austrian economists would put it, is discovery.
11
And, as they (such as Israel Kirzner) argue correctly, a real discovery, Joel Mokyr’s
“macro invention,” is never an outcome of methodical investment, but always an
accident in the prepared mind and in the open conversation. There is no U to max and
no constraint to obey if real discovery is at issue, as against routine exploration for, say,
oil. About oil, the startling macrodiscovery was that you could get it in bulk from the
ground and then use it to make kerosene and then gasoline. By contrast, investing an
optimal amount in drilling for additional oil, after the discovery of the idea, is a project
of rational search. The difference is the same as between Knightian risk (which is
calculable, and therefore often insurable and therefore partially avoidable in a world of
Max U) and uncertainty (which is not). No one would have bet on Europe in 1500, or
on England in 1600, or on the factor of sixteen in 1800. It was uncertain—as in
“astounding.”
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But I can satisfy a little the thirst of my economist colleagues for something closer
to what they would consider “a model.” The function for national product could be:
Q = I(D, B, R)•F(K, sL)
in which I is the Innovation function, Solow’s A, depending on D, the dignity accorded
innovators, and on B, the liBerty of innovators (the letter L is need for labor), and on R,
the rent or profit to innovation. The Innovation function multiplies a conventional
neoclassical production function, F, depending on ordinary physical capital and land, K,
and on raw labor, L, multiplied by an education-and-skill coefficient, s.
There is of course nothing profoundly mathematical about this way of saying
what I am saying. The “mathematics” is merely a metaphorical language that
economists understand, and which allows me to chat with them about the economic
and social ideas involved without excessive confusion.
The reason to separate out the I(.) function is to stress that economic growth
depends mainly on Schumpeterian/Austrian innovation, not, as some economists and
historians still believe, on classical/Marxist/Samuelsonian accumulation. Once upon a
time the economists thought that growth depended on physical capital (here K) and
now some think that it depends on various versions of human capital (sL). Aside from
the evidence I offer from history against such capital fundamentalism (to use Bill
Easterley’s phrase), Peter Howitt has reported on a recent literature of present-day
cross-country comparisons which concludes that “more than 60 percent of the crosscountry variation of per-worker GDP is attributable to productivity rather than to the
accumulation of physical and human capital,” and over 90 percent of its growth rate.14
“Thus it seems,” he argues, “that almost everything to be explained by the theory lies in
the Solow residual,” the A term in Solow’s classic paper of 1957, here the I(.) function.
12
“This is part of the evidence,” Howitt continues, “that inclines me towards innovationbased growth theory.” That seems a sensible conclusion. It was anticipated by Smith,
whose Theory of Moral Sentiments (1759 [1790]) treats the D variable of dignity, and
whose Wealth of Nations treats the B variable of liberty (amongst a great deal also, if less
originally, about F(.)). Smith believed that the obvious and simple system of natural
liberty (B, but linked with D) was necessary and sufficient for the (modest) growth he
imagined.
Even with so vague a specification as the unspecified functional form, Q = I(B, D,
R)•F(.) some qualitative points emerge—though without actual measurement our
knowledge is meager and unsatisfactory. In the innovation function, I(.), the term R is
what economists call rent, which the rest of the world calls profit. It represents in part
the routine incentive to innovate, picking up the $100 bills. Whether routine or not, it
has two aspects, depending on when you are looking at it—whether before or after
innovation, “ex ante” or “ex post,” as the economists after Gunnar Myrdal say, “from
the before” or “from the after,” that is, from the point of view of the outset or the point
of view of the end. I say that R is sometimes “Routine” (a helpful mnemonic to
remember the contrast with the noneconomic and nonroutine variables for Dignity and
liberty). But to the extent that it depends on alertness and the ability to form an image
of the future, it is decidedly not routine. Ex ante it is precisely “the possible lives they
imagine for themselves and their children” of Robert Lucas’s formulation, expressed in
money (that is, expressed in profane terms, and not mentioning the sacred matters, the
animal spirits, such as the spiritual value of caring for one’s children—which is a
limitation on the economist’s way of thinking). Such an R viewed ex ante is in part the
routine gain hovering before the eyes of an entrepreneur in Madras imagining how
very rich he could become if he could introduce air conditioning to the standard of
Atlanta. But it is also the highly nonroutine gain of Israel Kirzner’s formulation, such as
what John Ericsson imagined would be gained from introducing screw propellers into
ships. What innovations are imaginable depend on the new devices or institutions in
the offing. The novelties floating in the offing are sometimes said to depend on relative
factor prices, but the frailties of such an argument are great. On the other hand, when
steam engines with separate condensers became common, it eventually occurred to
many people that they might be made more compact for the same power at high
pressures. It was something that Watt himself realized but was unwilling to
implement, from the fear that such engines would be subject to terrible explosions. So
they were, when applied for example to railways and steam vessels.
The private R of the entrepreneur’s ex-ante imaginings, however, dissipates ex post by competition during the third act of the social drama into a social R,
imparting an actual, nonspeculative, ex-post height to the I(.) function. If R dissipates
too soon—if it is too easily imitated, or is unpatentable knowledge—then the incentive
to innovate is attenuated. But there’s no blackboard formula for institutions or
13
parameters that optimize R. Once laboriously discovered, the marginal cost of another
person learning, say, the calculus is near zero: Newton and Leibnitz (they disagreed on
which of them) should have gotten money credit, the economist says, in order to evoke
the optimal amount of mathematical innovation (the example shows, by the way, why
macroinventions are perhaps not best analyzed as routine matters of monetary cost and
benefit). But once the job of invention is done (the economist then says, switching
sides), the optimal price for copying should be zero—and so the society should
promptly stop the checks just issued to Newton and Leibnitz. It’s a paradox, with no
general resolution; it depends. The situation is that of a bridge. The Brooklyn Bridge
was costly to build, and needed somehow to be financed. But the social opportunity
cost of people going across it was, from May 24, 1884, zero, and so charging tolls to
cross and to pay down the debt is from the economist’s social point of view irrational.
The Age of Innovation was an age of uncompensated intellectual bridge building on an
immense scale.
The other arguments in I(B, D, R), D for dignity and B for liberty, are unpaid
externalities. R is unpaid, too, after its private rewards have been dissipated. But
before that time it is paid in supernormal profits earned in excess of the opportunity
cost of the routine inputs K and sL. When being paid, the rent, R, disturbs the marginalproductivity rules for distribution, which depend solely on the routineness of the F(.)
function. The manager knows how much to pay workers or investors if she knows
what hiring them will produce; her expectation is disturbed if an R out-of-equilibrium is
present. The disturbance provides one way to measure R, by seeing what financial
return is not explained by routine marginal productivities of K and sL. The ex-post
return of R sloshes around the social classes, in other words, unsettling the routine
distribution by marginal product—early on it goes to Carnegie; later, in the third act, by
the competition of steel companies at home and abroad, it goes to hoi polloi.
If there was no dissipation, and no ultimate gain to hoi polloi, innovation would
not have a justification on egalitarian grounds—as in the historical event it surely did
have. That is why ex-post rent from land has been since Ricardo under persistent
ethical attack even from economists. The sociology is that large rents from mere
possession of land, the half of national income in the Middle Ages that went to the
dignified classes, tend to create an aristocratic or priestly society. Large (and eventually
dissipated) rents from innovation, by contrast, tend to create a bourgeois society.
Honor follows money, of course, and money honor.
The paid/unpaid distinction is why I(.) and F(.) are to be treated separately, and
it justifies at least in mere logic my talk earlier of the Great Fact being a result of great
externalities. The F(.) function is routine, and you can tell whether an economist
acknowledges the role of the nonroutine in economic life by how she treats R. The
Austrian economists treat R as unintended discovery; the Samuelsonians want to bring
R back into a routine of marginal benefit and marginal cost, that is, to force it back into
14
the economics of a routine F(.). (Both schools, incidentally, are “neoclassical,” one out
of Menger and the other out of Marshall, which shows why “neoclassical” is a poor title
for the conventional Samuelsonians.) Howitt, agin, referring to Mokyr’s pioneering
historical work on the matter, notes that “nations that experience the most rapid growth
are not necessarily those in which people have the strongest incentives to develop new
technologies [in my terms, high Samuelsonian Rs] but those which have developed the
greatest tolerance for, and capacity to adjust to, the many negative side-effects of
economic growth [namely, the high D and B that accompany a signing on to the
Bourgeois Deal]. Those negative side-effects are almost always the result of. . . the
destructive side of creative destruction.”15 The high D and B in the Netherlands (before
the regenten in the eighteenth century became a virtual aristocracy and started to close
off innovation) and Britain and the new United States made for less reaction, as in
Continental anti-Semitism or on French dirigisme protecting this or that industry of
concern to l’état.
The variables of dignity, D, and of liberty, B, have their own dynamics. When
expressed as virtue, dignity draws on faith and justice, who you are and whom you
should respect. Liberty by contrast draws on hope and courage, the courage to be (as
the theologian Paul Tillich put it) and the hope to venture. (Hope and courage do not
suffice, I say once again to the libertarians). The rent in prospect or in achievement, R,
draws on temperance (savings for investment) and prudence (rationality, picking up
the $100 bills in plain sight). The seventh of the principal virtues, love of people or of
the transcendent (science, God, the family), affects the other variables unacknowledged
and certainly unpaid, but is not therefore unimportant. John Ericsson’s great love for
the iron-shaper Cornelius H. DeLamater was important for the inventor’s life and work.
Virtues unbalanced, though, are vices. Dignity, for example, tends to
corruption—causing it then to become sometimes a negative rather than a positive
influence on the height of I(.). The corruption happens if merchants develop into a
proud aristocracy, as they did at Florence, for example, and as the left believes the
power elite of the United States has. Liberty, too, including verbal action, can be
dangerous. Liberty for example can be turned into a negative influence, a politically
expressed envy, if it seems plausible to poor people now equipped with voices and
votes that stealing from the rich is, after all, the most direct way to cure their poverty.
(A New Yorker cartoon back in the 1960s showed a bank truck pulled up to the curb with
the guards handing money out of bags to the people on the street, one of whom
exclaims, “Well, at last the War on Poverty has gotten under way!”)
Over time the I(.) variables of D, B, and R are entangled (just as K and L are
entangled in the conventional F(.) function, as in substitutability, complementarity,
specific human capital, diminishing returns). A society, like routine production, hangs
together. For example, dignity for innovation in 1900 depended on earlier liberties and
earlier rents from innovation. Dt = g(Bt–1, R t–1). Liberated people tend after a while to
15
get accorded dignity, especially if their liberty results in high incomes for themselves or,
as the acknowledged benefactors of the world, for the rest of us. The reverse causation
can happen, too, from dignity to liberty after a while, or (less pleasantly) from dignity to
high rents, as peers and baronets become the honorable chairmen of new corporations.
Likewise the variables in the innovation function, I(.), can have influences over time on
the routine variables in the production function, F(.). One conventional way to think
about it is to imagine the demand curves (the marginal revenue product curves)
derived from the entire expression Q = I(.)•F(.). The I(.) function in such a derivation
would be a multiplicative term raising the marginal product of capital and of more-orless educated labor. The point made earlier about the noninitiating character of capital
can be expressed here by saying that K and sL are elastically supplied in the long run.
Accumulation, whether in physical or human capital, will therefore depend on the I(.)altered valuation of its fruits. As I(.) rises in the Age of Innovation, savings will be
found to make the appropriate investments, because the higher productivity makes R
evident and routine. Likewise, education in technical subjects will respond elastically
in the long run to the demand for them—though what is “technical” varies with the
times, being fluency in Latin in the sixteenth century (the better to serve, say, as a
diplomat), or fluency with differential equations in the twentieth century, or fluency
with electronic simulation in the twenty-first century.
The international context in which innovation takes place matters. From the
point of view of a stagnant economy such as Russia’s in 1850, the imaginable R becomes
larger and larger as the nineteenth century proceeds, finally overcoming in some
countries their low values for D and B—this is the Gerschenkron-Pollard point. A place
with low dignity for the bourgeoisie, such as prerevolutionary France, can compensate
with high liberty for the despised class, a high level of B (though it in fact did not). And
anyway it slowly gets dragged into the modern world if it is in the neighborhood of
first a militarily and economically successful Holland and then a militarily and
economically successful Britain, which makes obvious the great magnitude of ex-ante R.
The embarrassment of the War of the Spanish Succession, 1701–1714, in which tiny
Holland teamed up with emergent Britain (and aristocratic Austria on the southern
front) to humble the great and mighty Louis XIV, taught France some of what it needed.
Some.
The advantage of algebra, though, is that one can get beyond such existencetheorem, qualitative, merely philosophical claims and counterclaims, which after all can
justify any pattern of alleged facts whatever. One can get a little scientific, and focus on
the relative importance of this or that effect. For example, suppose the I(.) and F(.)
functions were Cobb-Douglas, that is, having constant exponents on each variable (you
ask why: because it is mathematically convenient, and because starting with constants is
a wise first step if you have no a priori knowledge of how they would vary, and have
no particular reason to suppose that they vary endogenously). Then taking rates of
16
change of each variable (using an asterisk, *, to mean “rate of change of the variable
preceding the *”) and using corresponding Greek letters to mean “elasticities—that is,
exponential coefficients—of the variable following”), yields obviously:
Q* = [ δD* + βB* + ρR*] + [κK* + λs* + λL*]
If you like to think in logarithms, you can make the same expression into a log-linear
one. In either case it holds without interaction terms only for small changes in the
variables, but can be easily (if lengthily) rewritten with the interaction terms present. It
should be so written if you have an interest in a particular interaction, for example
between K* and D*, percentage changes in physical capital accumulation and the
dignity of Mr. Moneybags.
The equation can of course be expressed in per-capita form by subtracting L*
from both sides:
(Q/L)* = [ δD* + βB* + ρR*] + [κK* + λs* + (λ – 1)L*]
One can make all sorts of foxy points with such an equation. (I repeat: they are
merely restatements of what has been argued earlier and in Bourgeois Dignity, not
fascinating new insights.) If the skill variable is measured as years of education, for
example, the slope of s relative to years of education would be quite small, relative to
the massive change to be explained in the Great Fact, at any rate judging from crosssection studies of returns to education. A college graduate is not ten times better in
contributions to Q than is a high-school graduate (an insulting hypothesis anyway on
its face, and silly if you have actually known any noncollege graduates). It might work
out if college is accurately selecting for a tiny elite of geniuses. But such screening
cannot in fact be done with accuracy, as the history of Britain’s Eleven Plus examination
showed, or as Einstein’s inability at first to get an academic job showed. So the
equation makes explicit why one might doubt the force of education.
On the other hand, the innovation variables D and B and even R might
themselves be improved by education. You can see reasons for it, a higher skill level, s,
resulting in higher dignity, D, because of admiration for a skilled bourgeois, or because
of a better grasp of technical matters necessary for innovation; or indeed because
instruction in economics (my own modest contribution to s) might lead people to
admire liberty in economic matters, and achieve thereby higher B. I say again, however,
that the s effect can be and often has been perverse, corrupting good bourgeois boys by
educating them to believe that the bourgeoisie have no dignity at all, or corrupting
good bourgeois girls to become state bureaucrats devoted to believing that bourgeois
liberty is to be stamped out. Marx took a PhD degree in philosophy at Jena in 1841.
The leader of the Shining Path Marxists in Peru was a professor of philosophy. A high
percentage of the officers in Hitler’s SS had advanced degrees in the humanities.
German engineers built the gas chambers. Excellent computer engineers enforce the
Chinese censorship of the Internet.
Likewise unless one has assumed, or (unlikely thought) in fact measured,
17
economies of scale, which would make the elasticity κ large, even a large percentage
change in K cannot explain what is to be explained in the rise of income per person.
The economies of scale could explain the modern world if they actually were there in
other times and places, too. But apparently they weren’t present in other times and
places, which makes one wonder why not, if they are supposed to arrive suddenly in
England in 1700. And as actually measured (off the blackboard of existence theorems),
economies of scale prove to be modest, raising the sum of coefficients in the F(.)
variables from the 1.0 of Cobb-Douglas to perhaps 1.1. For reasons of competition and
the marginal productivity theory of distribution, the share of capital in rewards to
factors of production is the elasticity in question, here κ (strictly in the absence of
economies of scale: and if the economies are small, approximately so). The elasticity is
small in modern economies (on the order of.10 or .20), though larger when land bulked
large.
Speaking of land bulking large: when it does not, and the share of L is therefore
high, then the term λ – 1 (which is of course negative and captures simple diminishing
returns to labor applied to fixed land) is small, because λ is then close to 1.0. (Indeed,
economies of scale can tip λ – 1 into modestly positive territory, meaning that we are
enriched a bit by having more of us, even without regard to economies of scale in the
other, I(.) function). In a modern economy in which human-capital enhanced labor gets
much of national income for itself, the impact of Malthusian diminishing returns is
greatly weakened by the effect. To put it another way, when the rewards to labor get to
be a higher percentage of national income, the other labor-related term, λs*, which
measures the effect of skills, gets higher. The mathematics reflects the point that human
resources become more important than natural resources—land is buried here in K, but
causes diminishing returns only to the extent that λ – 1 is large. The term was large in
the Middle Ages, with only half of national income accruing to labor, and the rest to
land. The move to modern times reduced λ – 1, and therefore the threat from
diminishing returns, from 0.5 to 0.1. Listen up, environmentalists.
There is no reason in the facts for the coefficients in the other, I(.) function to add up to
1.0. On the contrary, a doubling of dignity might result in a far-more-than-doubling of
output, by encouraging massive innovations. You will doubt that “dignity” can be
measured, but wait until the next volume, in which I shall try: it can be measured
perhaps by public opinion polls such as the Values Survey, or from the prevalence of
merchant-innovator heroes in lowbrow literature, or in the percentage in some textual
sample of favorable mentions of innovation (such as the quotation from Samuel
Johnson earlier). Liberty is easier to measure, and has been, in the surveys of days-toopen-a-business or ease-of-dismissing-workers now conventional. It, too, need not
have a coefficient constrained by constant returns to scale: the β coefficient may by itself
be well above 1.0, for example, which is to say that a 50 percent increase in liberty
measured as book pages per capita in the vulgar languages sold uncensored, say, could
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easily result in well over 50 percent increases in national income per head.
Economists regard such sociological/political matters as those summarized in I(.)
as relatively constant (or anyway exogenous to economic matters), and so they focus on
F(.). But the larger lesson of the formalization is that F(.) is nice, and is what economists
mainly talk about. But I(.) was the maker of the modern world. F(.) was the coastline,
I(.) was the tide.
*
*
*
*
A good deal hinges on whether such a new understanding of our economic and
ethical past is true or false. If true, a finding that an ethical and rhetorical and
ideological and conjective change made the modern world would be scientifically
important. The Victorian travel writer and skeptic Alexander Kinglake suggested that
every church should bear on its front door a large sign, “Important If True.”16 So here.
Economic history faces no more important question than why industrialization and the
reduction of mass poverty first started, and especially why it continued. The
continuation made us richer and freer and more capable of human achievement than
our ancestors. The latest continuation—located most spectacularly in China and India,
of all surprising places—shows that the whole world can be so. It shows, in case you
doubted it, that Europe was not special in genetics. It shows that in a world of
innovation the curse of Malthus lacks force. As Julian Simon put it as long ago as 1981,
human ingenuity, not oil or rare earth, is the “ultimate resource.”
For instance, if ideas and ethics and “rhetoric” contributed largely to such a
happy result, then perhaps we should point our social telescopes also toward ideas and
ethics and rhetoric. Looking fixedly at trade or imperialism or demography or unions
or property law—very interesting though all of them are—will not do the whole of the
scientific job. Ideas are the dark matter of history, ignored for a century or so 1890–
1980. In those days we were all historical materialists.
To be able to detect the dark matter we will need a new, more idea-oriented
economics, which would admit for example that language shapes an economy. For
such a humanistic science of economics the methods of the human sciences would
become as scientifically relevant as the methods of mathematics and statistics now
properly are.17 Such a widened economic science would scrutinize literary texts and
simulate on computers, analyze stories and model maxima, clarify with philosophy and
measure with statistics, inquire into the meaning of the sacred and lay out the accounting of the profane. The practitioners of the humanities and the social sciences
would stop sneering at each other, and would start reading each other’s books and
sitting in each other’s courses. As their colleagues in the physical and biological
sciences so naturally do, they would get down to cooperating for the scientific task. It is
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not very difficult, as one can see in the education of graduate students. A bright
humanist can learn enough mathematics and statistics in a couple of years to follow
their uses in economics. A bright economist, with rather more difficulty, can in a couple
of years learn enough about rhetoric and close reading to follow their uses in the
English Department. What prevents such scientific cooperation is sneering ignorance,
not the difficulty of the task.
It will not have escaped you that there is of course a political moral, too. If the
economy were understood as more than Prudence Only, then we could remoralize it. If
innovation were an upshot of desirable ethical changes, then we could respect it. The
rhetorical change, after all, was itself in part a feedback from dignity and liberty.
Dignity and liberty were in turn the result in part (remember the diagram earlier) of the
long perfected property rights of Europe, the medieval liberties of the towns, the
competition among states smaller than the Asian giants, the decline of serfdom outside
sad Russia, the theory of individual dignity in Protestantism and more anciently in all
Abrahamic religions, the partial liberation of women outside the Mediterranean, the
mind-freeing shock of the Scientific Revolution to Europe’s relatively primitive science,
the uneven fall of religious and secular tyrants just when Asia was abandoning its own
traditions of toleration, the emergence of at least a tiny public sphere, the careers of
quite a few open to talents, the improvements in military technology that gave the West
and the Chinese the weapons to defeat aristocratic warriors of horse-using steppe or
elephant-using empire, the techniques of printing on paper imitated and improved
from China and the Muslim world, making possible a periodical press and reasonably
uncensored theaters and publishing houses. These all were imperfectly implemented
1600–1800, but startlingly novel, it seems, on the scale practiced in northwestern
Europe, even allowing for recent findings that Orientalist notions of Asian
backwardness are false.
If the technological change was in part a consequence of a new dignity and
liberty, then we the respected and free heirs of the Bourgeois Revaluation could be
modestly happy about it, without falling into the sin of pride. If our bourgeois building
was not raised on foundations of imperialism or exploitation or unequal trade
(excepting the brief reign of gunboats and rubber-tree slavery, which were in aid of tiny
parts of the bourgeois economy), then we could admire it, though self-critically. If
serious innovation were not immoral, then we could practice ethics more grown-up
than a right-wing Greed is Good or a left-wing Down with the Bosses. We need to get
beyond the understanding of the economic past that seemed plausible in 1848, and even
to some in 1914, before the full development of professional history—sweet peasants,
romantic Middle Ages, wicked mill owners, wretched machines, alienated workers,
irritating consumerism on the part of social classes so obviously inferior to ours. The
Marxist and the reactionary views of economic history—in many ways they are the
same view—have poisoned our political lives for a century and a half. If we’re going to
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have a future, it is desirable that we know what really happened, and listen to the
lessons derived from the actually-happened, and not go on and on getting inspiration
for our politics from historical fairy tales of left or right.
I suggest instead that we recoup the bourgeois virtues, which have given us the
scope, in Wilhelm von Humboldt’s words in 1791-92, to develop the highest and most
harmonious of our powers to a complete and consistent whole. We will need to
abandon the materialist premise that reshuffling and efficiency, or an exploitation of the
poor, made the modern world. And we will need to make a new science of history and
the economy, a humanistic one that acknowledges number and word, interest and
rhetoric, behavior and meaning: a “humanomics” founded on actual economic history.
1. McCloskey and Klamer 1995.
2. I am indebted to a conversation in August 2009 with Karl Wärneryd of the Stockholm School of
Economics for this way of putting the point.
3. A full defense of this and the other categories of virtues is given in McCloskey 2006a, especially
pp. 151-194.
4. De la Court 1669.
5. North 1691, Preface, p. viii.
6. Jacob 1981 (2006); Israel 2001.
7. Dean Stanley 1834, quoted in MacLeod 1998, p. 96.
8. MacLeod 1998, p. 108.
9. MacLeod 1998, p. 108.
10. Cohen 1992. An eloquent summary of the evidence for “capitalist” institutions in ancient
Mesopotamia is Baechler 1971 (1975), pp. 37-38.
11. Grantham 2003, p. 73.
12. Kuhn, Stiner, and others 2001: they speak of the emergence over a wide area rather suddenly of
“redundant, standardized ornament forms” suggesting communicative purposes. Earlier art
was rare, and unique item-by-item in design: it was not a result of a talking culture. The
issue of when humans acquired language, though, is fraught, and recent findings suggest
that some signs of it (anatomical and brain ability; art; burial) occurred much earlier in
Southern Africa.
13. In her elegant recent book (Cartwright 2007) the philosopher of science Nancy Cartwright
argues for a variety of causation beyond billiard balls (“assists,” “encourages,” “obviates
obstacles to,” and so forth).
14. Howitt 2005, p. 7 in the Brown University preprint.
15. Howitt 2005, p. 10; and Mokyr 1990, p. 179.
16. Tuckwell 1902, chap. 5.
17. Hirschman 1977; and recently Klamer 2003, 2007; Bronk 2009. Kenneth Boulding (1910–1993),
a leading economist and a leading Quaker, would be an older case in point. The late
Stanley Lebergott (1918–2009) of Wesleyan University was another example of someone
21
who used all the evidence—of King Lear as much as of the Department of Commerce. (He
was an example, too, of how economists at liberal arts colleges are well placed to discern a
humanistic science of economics, if they will just stop seeking approval from the MITs of
the world). Down to the 1940s one could have cited many more economists, as I have
earlier, from the sainted Adam Smith (1723–1790) to the blessed Frank Knight (1885–1972)
and the insightful Joseph Schumpeter (1883–1950) and the paradoxical Maynard Keynes
(1883–1946). The turn to specialized illiteracy among economists, fortified by a scornful
ignorance of history, philosophy, theology, and literature, happened in the 1960s and
1970s, among the students of the first generation of Samuelsonians. Bart Taub has
proposed a counter-movement, called “humanomics.”
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