Economic Expansion Requires Saving: R & D Edition

Goldman Sachs' Robert Boroujerdi has co-authored a report "The Search for Creative Destruction" that reveals an empirical relationship between research and development spending, sales revenue growth, and stock price returns. On the face of it, these results are not surprising. With more and better technology, we can be more productive and utilize our scarce resources more efficiently.

It is important to remember however, that taking advantage of technological development requires saving. It does so for two reasons. First, as I say in my book, Foundations of Economics, in order to take advantage of technology, it must be bound up in actual capital goods, which must be produced. Such production must be funded by savings.  Additionally, investment in research and development itself must also be funded by savings. Some neo-classical growth theorists downplay the importance of saving and investment and play up technology as engines of prosperity. It is important not to forget, however, that even R & D requires savings. 

Engines of Prosperity: What About Technology?

Last week I began a series of posts discussing the sources of economic prosperity. I began the series because I think it absolutely necessary to understand these basic principles if we want to properly evaluate various policy suggestions about how to promote prosperity in less developed countries or how do we get out of the Great Recession. So far I have explained the importance of the market division of labor and capital accumulation.

Since the development of the Solow Growth Model by Robert Solow, it has been argued by many that capital is not the real source of economic expansion, but that technology is. This is so, it is argued, because capital, like labor, faces diminishing returns, so that as we increase capital investment, at some point total output reaches a maximum and then economic expansion resulting from increased capital will be exhausted. The source of sustained economic progress, therefore, must be technology, according to this view.

What are we to make of this argument? It is certainly true that new and better technology allows for more efficient production. As I note in my book, Foundations of Economics, according the the USDA, in 1987 it took the average American farmer 3 hours to produce 100 bushels of wheat, compared to 275 hours it took the average American farmer to do the same thing in 1830. Since the 1830’s there has been tremendous technological advance in the number and quality of tools, equipment, fertilizers, and pesticides available for farmers, greatly increasing farmer yields.

Is technology, then, a separate component generating economic expansion? As the knowledge regarding how to do something, technology does set a limit on our production.  As Rothbard notes in Man, Economy, and State, however, capital is a narrower limit. For technology to be usable it must be bound up in actual capital goods. It does no good for a secretary to know that he could use an electronic device to type and edit written documents if programmed correctly, if he does not have access to an actual personal computer. In order to take advantage of technology, we must, consequently, have capital investment. Rothbard summarizes,

To expand production, the important consideration is not so much technological improvement as greater capital investment. At no time has invested capital exhausted the best technological opportunities available. Many firms still use old, unimproved processes and techniques simply because they do not have the capital to invest in new ones. They would know how to improve their plant if capital were available. Thus, while the state of technology is ultimately a very important consideration, at no given time does it play a direct role, since the narrower limit on production is always the supply of capital (p. 626).

Therefore, it turns out that capital is the relevant factor for economic expansion. Without capital investment, technology is of no use. With capital investment, technology will advance as entrepreneurs continually seek to use better, more efficient, capital goods.