Ideas, not labor or capital, made our modern economy


Let’s examine some popular misconceptions about work and capital and the meaning of both. If you’ve been fed a steady diet of anti-capitalist nonsense, or are a die-hard capitalist, this story is going to scramble many of your misconceptions.

I begin by noting that most American adults are actually laborers. Among those of working age, very few Americans subsist upon the accumulated capital of their ancestors. This is even though a higher share of Americans today own capital than at any other time in history. With some 60 percent of households owning some sort of retirement fund, it is fair to say that now we are all both capitalists and laborers. Ironically, labor force participation is higher among workers who possess capital than those who do not, though the direction of causation surely works both ways.

Many decades ago, economists spoke and wrote about economic growth as primarily caused by combining labor and capital. The profession acknowledged, but thought little about, the role of technology change.

That way of thinking continues to animate public policy, resulting in numerous policies designed to attract capital. For the last four decades, the focus of research and popular writing about economic growth has been almost wholly about human capital and the power of ideas. Insofar as economists write about labor and capital, it is mostly to put into perspective the much more powerful force of ideas in causing economic growth.

One startling way to think about this is through the observation that everything in the world that is required to make a Tesla, iPhone or GPS satellite has always been on Earth. The only thing missing was the ideas needed to create them. Human capital, not merely the combination of labor and capital, brought us economic growth.

This simple revelation should spawn many fundamental questions about our world, and rethinking of public policies designed to generate economic growth. Sadly, it hardly ever does. Nationally, we remain transfixed by ideas from the 1970s about the role of capital taxation and growth. Here in Indiana, our education and labor market policies have shifted towards filling jobs on the factory floor rather than investing in the growth of human capital.

The 20th century was an American century precisely because of our stunning improvements in education and science. From 1950 through 2000, the average years of schooling for an American rose by 3.7 years, or almost 40 percent. Productivity of the average worker rose by 268 percent over the same 50-year period. In 1950, it took 27 workers to produce $1 million of value in today’s dollars. However, in 2000, 10 workers could produce $1 million worth of goods.

A simple empirical study that decomposes growth resulting from capital, labor and human capital inevitably finds that human capital, more than anything else, caused this growth. There are two broad policies available to extrapolate that growth into the 21st century. Both involve people.

The first and most obvious thing is to promote educational attainment. Indiana’s workforce has suffered a profound reversal. In the 12 years from third quarter 2007 (the height of the last recovery) through third quarter 2018, the quality of our workforce has actually declined. The share of adult workers with a bachelor’s degree dropped by 0.3 percent, while the share without a high school diploma rose by 2.4 percent.

In stunning contrast, the share of workers nationally with a bachelor’s degree rose by 6.8 percent over the same time, while the share with less than a high school diploma dropped by 1.8 percent. This tragedy is due primarily to failure of Indiana’s educational and workforce policy.

The second thing we can do is to import (attract) more people. Nationally, this necessarily means more, rather than less, immigration. For states, especially those struggling to keep people, this also means more, rather than less immigration.

Here in Indiana, as with much of the Midwest, international immigrants saved many communities. Last year, 32 counties lost population and saw net out-migration of native-born Americans. Of those counties, 29 saw international in-migration. Statewide, those immigrants were better educated than us native-born Hoosiers.

These sound like simple matters. They are critical, but not simple. In particular, improving educational outcomes will be expensive and will require undoing a number of recent policies. It necessitates some very tough conversations. This begins by acknowledging a problem that, when unaddressed, risks serious long-term damage to our state’s economy.

Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected].

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