It’s All in Your Head

Saturday, January 30, 1999
Illustration by Taylor Jones

The traffic was awful. The cabbie was rude. His radio blared music and static in equal measure. I faced at least an hour, maybe more, of jarring starts and stops. The long ride from the airport looked to be only a little less painful than spending the same amount of time under the dentist’s drill.

Then I remembered that I had my portable compact disc player with me. (I bring it with me when I travel because I sometimes want to block out the noise of conversation on an airplane.) I slumped down, put on the headphones, closed my eyes, and concentrated on the achingly clear soprano of Loreena McKennitt. Everything changed. The ride was going to be less pleasant than a good meal with friends, but not by much.

As I appreciated the music, I realized that it was fifty years to the month since the invention of the transistor. This made me think once again about the kinds of changes I have seen in my lifetime.

When I was a child, audio equipment was big, heavy, and expensive. It took forty pounds of black transformers and glowing orange vacuum tubes to amplify a high-fidelity audio signal. Now, the transistor-based amplifier in my portable compact disc player weighs less than the two AA batteries that power it and costs less than one night in my hotel room in Manhattan.

As an economist, I frequently contemplate changes like these. Smaller and less expensive amplifiers are just one example of the countless improvements, large and small, in the standards of living that we have come to expect over time. One of the great intellectual challenges of our age is to understand the forces that generate these improvements.

I study an area of economics that tries to meet this challenge. This area, commonly referred to as New Growth Theory, has grown up in the last fifteen years. It offers a perspective on economic growth that differs in important ways from the traditional view, suggesting that we cannot alter the rate of technological change. If we are even partly right, business leaders and government policymakers will need to rethink some of their basic assumptions about how they do their jobs.

In the past, social scientists and policymakers saw economic progress as the inevitable product of a small number of serendipitous discoveries. These discoveries, they believed, followed naturally from progress in science, and science itself developed according to its own logic and at its own pace. We know now that this explanation is wrong. Inventions such as the transistor radio or compact disc player do not flow naturally from basic discoveries like the transistor. Nor is the overall rate of technological progress in an economy limited or directed by the unvarying internal dynamic of the scientific disciplines.

In basic discoveries and applications alike, it is the incentives created by the market that profoundly affect the pace and direction of economic progress. When the incentives are stronger, growth is faster. When the incentives point in a new direction, both basic research and development efforts change course. As economic historian Nathan Rosenberg has shown, there are many cases in which basic science follows practical opportunities, not the other way around. The transistor caused the development of the field of solid-state physics. The steam engine led to the development of thermodynamics.

In the traditional economic view, technological progress comes in two steps: the heroic discovery and the ensuing transformation of the economy. According to this theory, once John Bardeen, Walter Brattain, and William Shockley gave us a shove with their discovery of the transistor, we just followed Gordon Moore’s famous law down the cost curve, like a skier going down a jump ramp. The digital information revolution followed automatically. There are many examples of this theory. For instance, James Watt invents the steam engine, then the industrial revolution just happens.

This account portrays key technologies such as the transistor or steam engine as scarce opportunities that are given to us by nature and are largely beyond our control. This account gets things exactly backward. It’s not the opportunities in nature that are scarce: It’s the human talent to pursue the many opportunities we face. Hundreds of examples show that we make progress in almost any area we put our minds to. Moreover, we don’t make any progress if we don’t put our minds to it.

The portable battery-powered compact disc player did not just happen. Engineers at Sony created it after the founder, Akio Morita, told them what he wanted. Improvements in computer chips don’t just happen either. Moore’s Law, that computer chips double in power every 24 months (or every 18 months or every 12 months—take your pick), hides the enormous amount of human effort required to make better chips. It also obscures the fact that the rate of progress in semiconductors varies with the amount of effort that we supply.

Across the spectrum of technologies, there will always be enormous unexploited scope for innovation. When humans do set to work in unexplored areas, important new discoveries will emerge. Some of these developments will be science based, but others will be more prosaic and will seem obvious once someone works out the details. Take overnight delivery at FedEx, just-in-time inventory management at Toyota, and discount retailing at Kmart and Wal-Mart. These examples may not seem glamorous, but in the aggregate, discoveries of this type probably account for the bulk of the increase in the standards of living that we enjoy.

In the traditional account, the flip side of the heroic discovery is the critical roadblock. This, too, is vastly overrated. If it had been impossible to build transistors, audio equipment would still have improved over the course of my lifetime. Vacuum tubes would have become smaller, cheaper, and more reliable. Without the laser, we would not have had the compact disc player. But Morita still would have introduced the Walkman portable cassette player, and by now it would rely on digital magnetic tape, be as inexpensive as a Diskman, and reproduce sound just as accurately.

Early in his career, Robert Fogel, another prominent economic historian, emphasized the implications of this point for the United States. Before he did his calculations, historians believed that the invention of the railroad fueled the rapid growth of the early American economy. Fogel showed that if there had been no railroad, North Americans would have invested more extensively in canals, wagons, and roads. But the rate of the economy’s growth, he concluded, would have been about the same.

The portable compact disc player didn’t just happen. Engineers at SONY created it after the company’s founder, Akio Morita, told them what he wanted.

There is far more scope for finding new ways to do things than any of us can imagine. When we look back, we can see all the crucial milestones along the particular path that we have followed, but we have no conception of what might have happened on the thousands of paths not taken. This does not mean that the physical world will be equally generous along every path that we explore. There are technical hurdles. For example, we have made relatively little progress improving batteries, and it’s not for lack of trying. But this example just reinforces the point that there are many alternative paths and many ways to solve any problem. To see why, turn Fogel’s exercise upside down. Instead of taking a technology that did develop and asking what would have happened in its absence, take a technology that did not develop and think about the strategies that we might have adopted to address the original problem.

Imagine, for example, that you live in a parallel universe where electric batteries are as easy to improve as transistors. Their storage capacity grows by a millionfold in a few decades. Each car, washing machine, and computer comes with its own lifetime supply of electricity installed in a tiny, lightweight battery.

If the inhabitants of this parallel world tried to imagine life in a world with batteries as crude as ours, they would surely conclude that there is no practical way to use electricity at all. They have no idea what a power line or an electrical outlet is. The idea of keeping each electrical appliance tethered to a generating station by a continuous loop of copper wire is too ridiculous to even contemplate. Because their cars and aircraft are battery driven, they believe that motorized transport is impossible. They have no conception of all the clever ways engineers have found to keep electrical consumption to a minimum in portable devices like my compact disc player.

Back now in our world, the lack of powerful batteries clearly did not bring growth to a halt. By the same token, technological successes like the railroad and the transistor did not cause growth. Our lives have gotten steadily better because something makes humans strive to make things better. That something is the marketplace and the special incentives it creates.

New Growth Theory identifies three special features that make growth possible. First, we live in a physical world that is filled with vastly more unexplored possibilities than we can imagine, let alone explore. Second, our ability to cooperate and trade with large numbers of people makes it possible for millions of discoveries and small bits of knowledge to be shared. Third, and most important, markets create incentives for people to exert effort, make discoveries, and share information.

According to New Growth Theory, all the natural opportunities available to us would lie unexplored if we could not find a system for motivating and coordinating the efforts of large numbers of people. Bardeen, Brattain, and Shockley did not set out to make life more pleasant for someone stuck on a miserable taxi ride. Nor did Morita. All they wanted to do was make a profit for themselves and their companies. Yet in so doing, they and literally thousands of people like them unwittingly collaborated to improve the quality of my life.

The key to the remarkable story linking the transistor and my taxi ride lies not in Moore’s Law or the physics of semiconductors. Nor can it be found in some set of unique abilities possessed by specific scientists or entrepreneurs. The key to the story is that humans have created a market system, supported by hybrid institutions like the university and the research and development lab. Together, these institutions turn self-interest into a powerful force for the improvement of everyone’s lives. This human invention is far more important than the transistor or the steam engine, for it gives us all other inventions.

Once this is clear, growth and progress can be seen in an entirely different light. Leaders of firms or nations needn’t just sit and wait for the next big thing to come along. They can take steps to make it more likely to happen. Nor can they presume that the last big invention will automatically cause growth to happen. They also must take the steps necessary to capitalize on previous discoveries.

We can thank the people who came before us for creating powerful institutions that motivate people to seek out big and small improvements. But we must not become complacent. At the level of the company or the nation, we need to focus less on making the next big discovery or the next sequence of little improvements. Instead, we need to think about fine-tuning our institutions so that they work their way more rapidly down a never-ending string of small and large improvements. If these changes are made, companies and nations will see faster growth. In the long run, even slightly faster growth will lead to huge differences in total profits or income.

This sounds simple. But in practice, the leaders of large organizations tend to get distracted by details and lose sight of the forces that keep the growth process going. They tend to fall back on comforting old beliefs: that the rate of innovation is not very responsive to incentives; that there is not much reason to align incentives systematically so that they speed up the discovery and communication of new ideas. This is unfortunate, but it is not fatal to the overall process of growth. One of the beauties of market competition between firms, and even of competition between national economic systems, is that we don’t need to make sure that everybody gets things right. There are a few companies that are rethinking how they manage the innovation process, challenging existing presumptions about how research and development should be managed and how it should relate to other functions within the firm. Even some researchers and politicians are beginning to ask similar fundamental questions about national systems of innovation.

If one firm or nation implements an institutional innovation that is successful, it will shoot ahead of its peers but only for a while. Eventually, its competitors catch up or at least stop falling behind. Soon, other organizations innovate and a new leader emerges. Through it all, people like me will continue to see wonderful improvements in our standards of living over the course of a single lifetime.