Building a 21st Century Economic Framework

Indeed, three competing 20th century economic doctrines embraced by most Western policymakers today are conservative neoclassical, liberal neoclassical and neo-Keynesian economic doctrines.

One of the most important principles of neoclassical economics is that it is the accumulation of capital which spurs economic growth. On this point, people in both the conservative and liberal neoclassical economic camps agree.

But they diverge in the ways they seek to spur capital formation. Conservative neoclassicalists (often called supply-siders) advocate spurring capital formation in the private sector by cutting taxes on income and wealth.

In contrast, liberal neoclassicalists recommend spurring capital formation by having the government run budget surpluses (or reduce deficits) and/or by helping low-income people save.

Adherents of the third prevailing economic doctrine, neo-Keynesianism, stress the importance of having the federal government ensure aggregate economic demand by increasing government spending, and ensuring that the fruits of economic growth are fairly distributed.

In his classic 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith argued that there were three major inputs to the production process: land, labor and capital.

In today’s New Economy, a fourth input now significantly outweighs these other three — knowledge. The fall of the Berlin Wall in 1989 triggered more than just “a flat earth,” in Tom Friedman’s terms.

The ensuing globalization accompanied and spurred a shift from the mass production, corporate managed economy to a knowledge-based entrepreneurial economy.

As innovation and entrepreneurship replace mass-production and large capital-intensive factories as the engine of growth, jobs and competitiveness, economic policy must also shift from its old economy concern of stimulating consumer demand (while restraining the market power of oligopolies) to the new economy concern of boosting innovation and productivity.

In what has become widely known and accepted as the “new growth theory,” knowledge has been explicitly recognized as a crucial factor generating economic growth.

In the new knowledge economy, knowledgeable people, including creative entrepreneurs, skilled shop-floor workers, cutting-edge researchers, innovative managers and digital-savvy “prosumers” are the drivers of growth.

The new realities of global, knowledge-based economy in the 21st century require a new approach to national economic policy. It is based more on smart support for the building blocks of innovation and entrepreneurship — and less on capital accumulation, budget surpluses or social spending.

Without an economic theory and doctrine that match the new realities, it will be very hard for policymakers to take the steps needed to foster economic growth.

Fortunately, a new theory and narrative of economic growth based on an explicit effort to understand and model how innovation occurs has emerged in the last decade.

This new economic doctrine on the block — called “innovation economics” — reformulates the traditional model of economic growth so that knowledge, technology, entrepreneurship and innovation are positioned at the center of the model — rather than seen as independent forces that are largely unaffected by policy.

Innovation economics — also called “new institutional economics,” “new growth economics,” “endogenous growth theory,” “evolutionary economics” and “neo-Schumpeterian economics” — is based on two fundamental tenets.

One is that the major goal of economic policy should be to spur higher productivity and greater innovation.

Second, markets relying on price signals alone will always be less effective than smart public-private partnerships in spurring higher productivity and greater innovation.

If it wants to meet the challenges of the future, the United States needs an economic framework that supports the new economy — and innovation economics is it.

Leading economists increasingly acknowledge that without change, the U.S. economy cannot grow, that increases in knowledge and competition drive growth and change — and that the government has a key role to play in that process.

In short, they are saying that the best macroeconomic policies are institutional policies — support for research, innovation, skill building and digital transformation, all within an environment of competitive markets.

Editor’s Note: Part II of this Globalist Paper — in which Mr. Atkinson examines how the different economic doctrines view trade and globalization — will be published on The Globalist tomorrow.