The Big, Positive Change Coming In Economics

Steve Forbes
Forbes Magazine
October 30, 2013
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Knowledge and Power: The Information Theory of Capitalism and How It Is Revolutionizing Our World
by George Gilder (Regnery , $27.95)

With Knowledge and Power George Gilder has produced a book that will profoundly and positively reshape economics. It will rank as one of the most influential works of our era, resetting the terms of the debate and changing how we judge the consequences of government actions on the economy. The reason may initially strike most people as somewhat puzzling, because they haven’t been aware of an astounding flaw in the discipline of economics that dates back to Isaac Newton, one of history’s true geniuses.

Newton’s discoveries made possible the Industrial Revolution and the extraordinary advances of the 18th, 19th and much of the 20th centuries. “The most astonishing intellectual achievement of the 17th century [was] the invention of the calculus,” Gilder explains. “Powered by the calculus, the new physics of Isaac Newton and his followers wrought mathematical order from what was previously a muddle of alchemy and astronomy, projection and prayer.” Newton saw the universe as a great machine that ran like a grand and immensely complicated clock. The key was to figure out what the parts were and discover what made the whole thing tick.

 

Newton’s achievements inspired not only what we call the hard sciences but also the social sciences, including the subject of Gilder’s book, economics.

 

Influenced by the scientific discipline of attempting to discover how things actually work and what laws govern them, for example, Adam Smith and his disciples demolished the false pretenses of mercantilism, an ideology that took hold in the 1500s and continued to exercise a viselike grip on European rulers for 200 years. Mercantilism purported to show how states became rich and powerful. They did this, according to the theory, mainly by piling up as much gold and silver as they could through encouraging exports and restricting imports and by micromanaging the economy through regulations and government-sanctioned guilds and monopolies. As Britain adopted the Smithian principles of free trade, property rights, low taxes and small government, it became the mightiest industrial power in the world.

But in every Garden of Eden there lurks a serpent. Underlying the then liberating social science of economics was the belief that the economy was similar to Newton’s clocklike universe. It was seen as a closed system. Mathematics took over. The byword in this discipline became equilibrium, that is, how supply and demand come into balance. There would be outside disruptions, such as earthquakes or wars, but then the economy would reach a new equilibrium and operate smoothly again.

The entrepreneur innovator and his inventions were considered exogenous factors, just like those earthquakes. The idea of the economy as a closed system, operating like a machine, was not only held by classical economics but also by its heresies: Keynesianism, Marxism and monetarism.

One infidel was Joseph Schumpeter, an Austrian, who in the early 20th century declared that the whole idea of equilibrium, of a smooth, clocklike economy, was utterly preposterous. The innovator wasn’t an outlier but was actually the heart, the driver of the system. Equilibrium was a myth; disruption was the norm. “Creative destruction” was how Schumpeter famously put it.

Schumpeter was right, and since the 1980s his viewpoint has come roaring out of the shadows. But Schumpeter had been pessimistic about capitalism’s future, which Gilder shows to have been misplaced.

The heart of Gilder’s thesis is this: There is no limit to growth, now or in the future. New players will always emerge. Why? Because the real source of wealth is new knowledge, which can come only from experiments in which you risk failure and bankruptcy. We learn from failures, as well as successes. For example, Steve Jobs’ NeXT “Cube,” a personal computer, was a commercial flop in the 1990s, but its superb operating system is the core of the Apple Macintosh. As long as the quest for knowledge is not thwarted–as it increasingly has been in recent times through government regulation, taxation and money debasement–Schumpeter’s worries about how much an economy can expand over time will be groundless.

Gilder asks: What is the difference between our present age and the Stone Age? Answer: We know more. The cave dwellers of tens of thousands of years ago “had the same set of physical appetites and natural resources that we have today. The difference between our lives and the lives of Stone Age penury is the growth of knowledge.”

Gilder cites the inspiring success story of Israel as an example of the truth that the mind is the source of wealth: “Since the state was founded in 1948, its population has grown 10-fold, its arable land 3-fold, its agricultural output 16-fold, and its industrial output 50-fold, yet its net water usage has dropped an astonishing 10%.”

Gilder tells the illustrative story of Qualcomm. In the early 1990s techies faced a seemingly insurmountable challenge: the physical scarcity of bandwidth. The laws of physics said there was only so much you could do before hitting the proverbial brick wall of limits. Qualcomm claimed it had found a way to overcome the obstacles. Critics were furious, saying, in effect, that Qualcomm’s executives were charlatans. Physics was physics. The angry skeptics were right, when it came to physics. But by employing information theory–a series of mathematical ideas put forth by Claude Shannon and the late Alan Turing, an evolving discipline that, as Gilder emphasizes, encompasses surprise, i.e., new knowledge–Qualcomm’s controversial technology triumphed. Information theory became the foundation of the miracle of wireless communications. “Physics is not the final word. Qualcomm triumphed by moving beyond physics to the new science of information, transforming the physical scarcity of ‘bandwidth’ into an abundance of wireless communications.”

The assumption since Newton that the economy is a great machine that will bring about abundance but gradually evolve into a stationary state has been blasted away by information theory.

The ultimate test of government action now becomes clear: Does it impede the creation of new knowledge? Politically this is potent—who can be against the creation of new information? Big profits are the result of the surprise creations of entrepreneurs, but the new surprise quickly becomes commonplace, and the profits from it recede.

Information theory makes painfully plain the foolishness and destructiveness of government efforts to redistribute wealth as a means of stimulating economic growth. Take capital away from capitalists and it will wither instead of multiply. Who would you rather invest your capital with, Warren Buffett or Senator Harry Reid?

Gilder’s uplifting message is that if policy becomes based on the recognition that capitalism is a system of creating new knowledge, our current malaise will quickly go away. The U.S. did this after World War II and again in the 1980s. It can do so once more, far faster than most observers think possible.