Knowledge and the Wealth of Nations

By Boudreaux, Donald

Knowledge and the Wealth of Nations: A Story of Economic Discovery by David Warsh Norton * 2006 * 426 pages * $27.95 hardcover; $16.95 paperback Reviewed by Donald Boudreaux

The work that launched economics as a distinct discipline is Adam Smith’s An Inquiry Into the Nature and Causes of the Wealth of Nations. Note well the title, especially the first eight words that typically are left off when people mention this book.

That great Scottish scholar inquired into the nature and causes of prosperity. Worded only slightly differently, Smith asked, "What causes economic growth?" His inquiry brilliantly identified as the chief proximate cause of prosperity the division of labor. The jack of all trades becomes a master of none. So a world full of jacks is poor. But let each of those jacks specialize at performing a distinct task, and the same number of workers can produce a much greater quantity of output than they could produce when each was a jack.

A fuller account of this wealth-creation process, of course, must be told. Smith himself told much of it, as did David Ricardo and lots of-well, some-economists over the past 230 years.

The sorry fact is that, for all its contributions to our understanding of economy and society, economics has only recently returned in a serious way to the Smithian question of economic growth. For most of its history, economics has revealed the logic of allocating a given stock of resources to satisfy a given set of consumer demands with a given stock of knowledge. The economics of growth-or what came to be called development economics-suffered. All too true was a remark I heard the late Fritz Machlup make in 1981 at New York University: "[Development economics attracts the least developed economists."

Unknown to Machlup and his students (and to most economists at the time), a turnaround was underway. Its leader was a young economist named Paul Romer from the University of Chicago. Romer (now at Stanford) is no typical Chicagoan. And what makes him least typical of that school is his recognition that externalities exist and often matter.

Externalities are effects of voluntary activities that spill over onto persons who are not party to the agreements that give rise to the activities. These effects can be negative (as when a factory dumps soot on the homes of nearby residents) or positive (as when a lighthouse guides whatever ships pass by). So-called "newgrowth theory" builds on the latter by explaining how capital goods and human capital not only increase workers’ productivity, but also that this increase in productivity often occurs at a faster rate as more capital goods and human capital come into existence. That is, the productivity of existing assets often increases as these are combined with additional assets. Such assets, then, are said to produce "increasing returns"-which means that their rate of output (say, per worker) increases when they are combined with other assets.

The story of the development of new-growth theory is not straightforward. But in Knowledge and the Wealth of Nations, economics reporter David Warsh does a fine job of telling it. Although Romer is the central character in the book, Warsh’s summary of the economic theory of growth from Adam Smith’s day to our own is wonderfully clear. Indeed, in my opinion this is the best part.

And while I heartily recommend this book to those who are curious about what economists now say about the causes of the wealth of nations, I must register a few complaints.

My biggest complaint is of Warsh’s portrayal of the economics profession. He portrays economists as being more unified in our interest in pioneering ideas than we really are. I remember well the attention Romer’s important papers of 20-odd years ago received from the profession, but no more than a tiny handful of economists eagerly awaited the next conference or paper discussing new-growth theory. Economics, for better or worse, is now a highly specialized discipline. It’s the too-rare expert in urban tax policy who has interest enough to follow exciting developments in labor economics or even the economics of growth.

Relatedly, Warsh makes the development of newgrowth theory appear to be much more self-conscious than it really was. For example, some work of my George Mason University colleague Tyler Cowenwork critical of one of Romer’s papers-is mentioned in the book as playing a noteworthy role in fashioning the emerging theory of development. When I asked Cowen his thoughts on Warsh’s description of this work, he replied that he wasn’t really aware at the time (contrary to Warsh’s suggestion) that he was helping to advance new- growth theory.

Warsh also jumps to conclusions too quickly. He writes, "The need for technology policy is the inescapable conclusion that emerges from" the newgrowth theory. Well, here’s an escape: this theory, for all of its usefulness, is not also a theory of government. To assume that politicians and bureaucrats can know enough to craft an appropriate "technology policy," and are trustworthy enough to carry it out, is a fantastic stretch-one that mars an otherwise useful book.

Donald Boudreaux (dboudrea@gmu.edu) is a professor of economics at George Mason University, a former FEE president, and the author of Globalization (Greenwood Press).

Copyright Foundation for Economic Education, Incorporated Mar 2008

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