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Surprise and Creativity

Notes toward a new economics Original Article

Why in the world do we need yet another “new” economics? Jamming the libraries and the bookstores of the world are avatars of what must be every variation on the great themes of market and managerial economics. Scores of Nobel Prizes have been awarded for various nugatory refinements of the prevailing ideas.

All these schemes, however, fail to answer the key questions about any economic theory, which were posed by Irving Kristol nearly 35 years ago. Can the theory provide a moral or “transcendental” justification for its results, so that it is politically acceptable? And can it explain growth and creativity?

Kristol was cofounder and editor first of Encounter and then of the Public Interest, two of the world’s most eminent and influential publications, which had served to give me an education after four years at Harvard failed. I made reverent visits to Kristol’s luminous lair on Central Park South in Manhattan, where he held forth with his awesomely learned wife Gertrude Himmelfarb. His monthly columns in the Wall Street Journal were the most elegant and erudite ever to appear in those commercially oriented pages. Among all the supporters of supply side economics, he was the most intellectually prestigious, giving a sheen of respectable cover to untutored cohorts like me and Jude Wanniski.

By the late 1970s, Kristol was the so-called Godfather of neoconservatism, not only reigning at the top of a speculative organizational chart spread across a centerfold of Esquire but also ruling a domain of mind that reached to every aspect of the culture. Almost alone among analysts of capitalism, he grasped the centrality of the sciences — from Newtonian physics to Darwinian biology to behavioral psychology — in shaping, informing, and even stultifying economic models. Since occasionally “editing” his column at the New Leader magazine in the mid-1960s (it was always impeccable) I had been among his most devout disciples. When he issued orders, I tended to jump to attention.

Writing Wealth and Poverty 35 years ago, as in launching Knowledge and Power this season, I was consciously picking up a gauntlet from Kristol. In all his works, he fused political, economic, and religious concerns in a critique not merely of government overreach but of all modernist culture. The adversary was not merely excessive tax rates and regulation but nihilism and anomie, “a melting away of established principles of authority” in a “spiritual crisis of modernity.”

Wealth and Poverty offered an extended conversation with Kristol on these themes. But it also expressed a note of callow rebellion. In my view, in March 1978 just as I was buckling down to write my book, Kristol had stumbled. In Two Cheers for Capitalism, he had begrudged our system a full threefold ovation and thus had fallen short of my standards of contrarian optimism. In a critical article in National Review entitled “Why I Am Not a Neo-Conservative,” I wrote — with patricidal panache — “If I am found at the bottom of the East River weighed down by 15 annual volumes of the Public Interest and still able to utter no more than two cheers for capitalism, you will know who did it.”

Kristol had peered into the philosophical morass of the existing theory of capitalism and found a free market competition among barbarians. They were moved by a calculus of simple self-interest and apparently governed by no moral code. In a democratic society, he declared, no such system can ultimately survive.

Impolite and even risqué was Kristol’s public exposé of the moral nudity of capitalism. Since the days of Adam Smith, the entire economics profession had put a self-interested agent, a homo economicus appraising price signals and calculating his own utilitarian advantage, at the center of their models of a capitalist economy. Like Smith himself, most of them have assumed a moral order. But they had provided no grounds to expect that such a moral order would naturally emerge in their system. It was not their department. Some of them harbored a secret relish for the image of the capitalist entrepreneur engaged in a swashbuckling war of all against all.

More ambitious theories based the model on behavioral psychology. Generalized as a hedonic pleasure-seeker, avoiding pain and pursuing gratification in a Skinner-box scheme of stimulus and response, economic man became a mere manifestation of evolution. A function of his physical environment, he became a figment of statistical aggregates. As Kristol put it, “In such a blind and accidental arithmetic, the sum floats free of the addenda, and its legitimacy is infinitely questionable.”

Kristol saw that this vision repeated Herbert Spencer’s translation of Darwinian evolution into an economic ethic. Seen as engaged in a struggle for survival governed by the laws of the jungle, Kristol wrote, economic man could be neither a creative entrepreneur nor an acceptable vessel of a good society.

As Kristol declared in a memorable essay: “The fact that for several decades after the Civil War, the Darwinian ethic, as popularized by Herbert Spencer, could be taken seriously by so many social theorists represents one of the most bizarre and sordid episodes in American intellectual history.” So much for Spencer, but also less explicitly but inexorably, so much for all the prevailing schools of economic thought. Without exception all provide models of economic activity driven chiefly by self-interested agents responding to their environments in a process that could be well summed up as “survival of the fittest.”

At the time, I believed I had discovered a way out of all these dilemmas. I would show that capitalism is intrinsically altruistic and moral. To succeed in gaining profits, entrepreneurs must be oriented toward the needs and wants of others. Capitalists were givers, not takers, and their successes “expanded the circles of human sympathy.” I devoted several early chapters of Wealth and Poverty to an attempt to prove my case through anecdote and anthropology. Popular in the Reagan White House, this défi d’enfant attracted the attention of my target. Writing in National Review, Kristol praised the book but crisply deflated my claim that altruistic morality could be seamlessly grafted onto the body of classical economic thought.

Compounding the political problem of defending an amoral system inspired by Darwinian biology, according to Kristol, was a spurious claim of determinism inherited from physics and mechanics. Describing an “impasse” of economic theory, Kristol wrote in 1980, “The dominant ‘scientistic’ model tends to drift ever further away from economic reality. … There is not the slightest reason to think … that post-Keynesians, fiddling with their ‘cybernetic’ model [of feedback mechanisms], can do any better than Keynesians with their ‘Newtonian-mechanical’ model” or the neo-Austrians with “an anarchical (or libertarian) world that is, in its own way, a construct of a rationalist utopian vision.”

In their mimicry of physics, economic theories tended to imply the impossibility of growth. As Kristol put it, “One of the axioms of any such model is that economic growth is in principle no different from physical change. [H]uman beings could no more affect the governing laws than the activity of an atom could affect the laws of physics.” Yet physical change is neither cumulative nor progressive. It tends toward deterioration.

Thus Kristol pushed me to a second central preoccupation of my book (and of Knowledge and Power) — the sources of growth. Giving shape to my argument was an aperçu of Princeton’s Albert Hirschman in an early issue of the Public Interest in 1967. Presaging a longstanding concern of Kristol’s, Hirschman wrote: “Creativity always comes as a surprise to us.” If it didn’t, we wouldn’t need it and planning would work. Wealth and Poverty became a paean not only to altruism but also to creation and surprise.

Wealth and Poverty, I identified the error of economists as founding their theory on the mechanism of market exchanges themselves rather than on the creative activity that makes them possible. Conventional economics violates a key philosophical principle. It subordinates a higher and more complex level of activity — the creation of value — to a lower level, its measurement and exchange. In their desire to found a Newtonian science of political economy, generations of economists inflated the instrumental mechanism of trading into a complete economic universe. Newton’s “system of the world” became Adam Smith’s “great machine” equilibrating supply and demand, in which there is little or no room for creativity and surprise, for the unpredictable activities of entrepreneurs making entirely new things.

Despite these passing insights, I failed in Wealth and Poverty to respond effectively to Kristol’s challenge. There remained in my implicit model of the economy both the optimizing homunculus and the visionary creator, and no particular way to integrate their different roles in the economy.

Largely leaving economics behind after Wealth and Poverty, I began decades of study of technology, focused first in Silicon Valley and then in Israel, which is now a more fertile source of new ideas than California. I soon found myself deep in a field of study called Information Theory. On one level this theory was merely a science of networks and computers, but in its deeper implications it would sound a death knell for the rationalist materialism and social Darwinism that Kristol denounced as nihilistic in its implications.

Information Theory effectively began with Kurt Gödel’s epochal demonstration in 1930 that all logical systems, including mathematics, depend on axioms that they cannot prove. Mathematics, and hence all mathematically based sciences, from physics and chemistry to biology and economics, ultimately rest on a foundation of faith. Gödel’s proof led directly to the invention by Alan Turing of an abstract universal computer, the so-called Turing machine, which he used to show that no mechanistic system could be complete and consistent. Turing concluded that all logical systems were intrinsically oracular. Computers could not be Smithian “great machines” or Newtonian “systems of the world.” They inexorably relied upon conscious programmers or oracles and could not transcend their creators. As Turing wrote, he could not specify what such an oracle would be. All he could say was that “it cannot be a machine.” In a computer, they are programmers. In an economy, they are entrepreneurs, who launch new machines into the world.

The new economics partakes of the same movement, and the same Information Theory, that is also transforming the other sciences and revolutionizing our world through information technology. In 1948 a rambunctiously creative engineer, Claude Shannon, from Bell Labs and MIT, translated Gödel’s and Turing’s findings into a set of propositions about the nature of communications. He presented technical concepts for gauging the capacity of communications channels to bear information. Without a rigorous definition of information and communications channels, it would be impossible to build worldwide interactive networks such as the Internet, which would have to be coherently interconnected.

Shannon’s crucial insight was a clear and polar differentiation between order and information. To this day, most economists believe that order and information are essentially kindred concepts. Both are seen as patterns that can evolve or emerge spontaneously. Widespread is reliance on the concept of equilibrium, the order to which economies or ecosystems return after disruption.

To Shannon, however, order was not information but its opposite. Much like Albert Hirschman decades later in the Public Interest, Shannon resolved that information is most essentially news or surprise. If you already know the contents of a message it contains zero surprise and zero information. Information is unexpected content. It is disequilibrium and disorder, not order. An orderly and predictable mechanism — a great machine — embodies no new information.

For purposes of the new economics, I sum up Information Theory as the treatment of human communications or creations as transmissions down a channel, whether a wire or the world, in the presence of the power of noise, with the outcome measured by its “news” or surprise, defined as entropy and consummated as knowledge.

Since these communications or creations can be business plans or experiments, Information Theory supplies the foundation for an economics driven not by equilibrium and order but by surprises of enterprise. Information Theory requires that such a process be experimental and its results be falsifiable. The businesses conducting entrepreneurial experiments must be allowed to fail or go bankrupt. Otherwise there is no yield of knowledge and thus no production of wealth.

By identifying a capitalist economy as chiefly a knowledge system rather than a mechanistic incentive system, the new economics obviates all the concerns over greed and avarice as crucial to the creation of wealth. The enabling theory of telecommunications and the Internet, Information Theory offers a path to a new economics that places the surprising creations of entrepreneurs and innovators at the very center of the system rather than patching them in from the outside as “exogenous” inputs. Information Theory also shows that knowledge is not merely a source of wealth; it is wealth. Wealth is the accumulation of knowledge. As Thomas Sowell declared in 1971: All economic transactions are exchanges of differential knowledge, which is dispersed in human minds around the globe.

Information is also a measure of freedom and creativity. It is gauged by the freedom of choice of the sender of a message, which Shannon termed “entropy.” The more numerous the possible messages that can be sent, the more uncertainty at the other end about what message might be sent and the more information there is in the actual message when it is received. Thus Shannon offers a way to put human freedom at the very heart of the economic model. It addresses freedom on a new level, not only as a condition of enterprise but also as the measure of information and criterion of creativity.

Through Information Theory, we can affirm Kristol’s intuition that capitalism is neither a determinist physical machine nor a social Darwinian mechanism animated by stimulus and response or gradients of pleasure and pain. Capitalism is an information system of experimental ventures that can fail or succeed and thus yield knowledge.

 After all, as Sowell also pointed out, the Neanderthal in his cave had all the material resources and physical appetites that we have today. The difference between our own wealth and Stone Age poverty is not an efflorescence of self-interest but the progress of learning, accomplished by entrepreneurs conducting falsifiable experiments of enterprise.

Summing up the new economics of information are 12 key insights.

  1. The economy is not chiefly an incentive system. It is an information system.
  2. Information is the opposite of order or equilibrium. Capitalist economies are not equilibrium systems but dynamic domains of entrepreneurial experiment yielding practical and falsifiable knowledge.
  3. Material is conserved, as physics declares. Only knowledge accumulates. All economic wealth and progress is based on the expansion of knowledge.
  4. Knowledge is centrifugal, dispersed in people’s heads. Economic advance depends on a similar dispersal of the power of capital, overcoming the centripetal forces of government.
  5. Creativity, the source of new knowledge, always comes as a surprise to us. If it didn’t, socialism would work. Mimicking physics, economists seek determinism and thus erroneously banish surprise and creativity.
  6. Interference between the conduit and the contents of a communications system is called noise. Noise makes it hard to differentiate the signal from the channel and thus reduces the transmission of information and the growth of knowledge. A key source of noise in the carrier is capriciously activist government.
  7. To bear high-entropy (surprising) creations takes a low-entropy carrier (no surprises), whether the electromagnetic spectrum, guaranteed by the speed of light, or property rights and the rule of law, enforced by constitutional government.
  8. Money should be a low-entropy carrier for creative ventures. A volatile market of gyrating currencies and grasping governments shrinks the horizons of the economy and reduces it to short-term trading and arbitrage in a hypertrophy of finance.
  9. Wall Street wants volatility for rapid trading, with the downsides protected by government. Main Street and Silicon Valley want monetary stability so they can make long-term commitments with the upsides protected by law.
  10. GDP growth is fraudulent when it is mostly government spending valued retrospectively at cost and thus shielded from the knowledge of consumers oriented toward the future. Regardless of whether government spending is fueled by taxes or by government debt, economic “stimulus” packages necessarily substitute government power for knowledge and thus destroy information and slow economic growth.
  11. Analogous to average temperature in thermodynamics, the real interest rate represents the average returns expected across an economy. Analogous to entropy, profit and loss represent the surprising or unexpected outcomes.
  12. Knowledge is the aim of enterprise and the source of wealth. It transcends the motivations of its own pursuit. Separate the knowledge from the power to apply it and the economy fails.

The Information Theory of capitalism answers both Kristol’s questions for the current era. No business guaranteed by the government is capitalist. Guarantees destroy knowledge and wealth by eliminating falsifiability. Unless entrepreneurial ideas can fail and businesses go bankrupt, they cannot succeed in creating new knowledge and wealth. Epitomized by heavily subsidized and guaranteed leviathans, such as Goldman Sachs, Archer Daniels Midland, Harvard University, and Fannie Mae, the economic crisis of today is crony socialism.

The message of a knowledge economy is optimistic. As Wanniski wrote, “Growth comes not from dollars in people’s pockets but from ideas in their heads.” As Kristol once told me, propelling me to my dictionary, as he often did, “capitalism is a noosphere.” My dictionary was unavailing. But I figured out from the Greek that a noosphere is a domain of mind. A capitalist economy can be transformed as rapidly as human minds and knowledge can change.

As experienced in the United States after World War II when government spending dropped about 60 percent in two years, in Chile in the 1970s when the number of state companies dropped from over 500 to under 25, in Israel and New Zealand in the 1980s when their economies were massively privatized almost overnight, and in Eastern Europe and China in the 1990s, economic conditions can change over a span of months when power is dispersed and the surprises of human creativity are released.

Deeper than economics or social theory, these ideas reflect the most powerful scientific ideas of the era. Information Theory recognizes that information is not order but disorder and that the universe is not a great machine that is inexorably grinding down all human pretenses of uniqueness and free will. The uniqueness and free will of humans is indispensable to civilization.

Ever since The Wealth of Nations, economists have imagined that entrepreneurs seek equilibrium and order. Hundreds of conservative economists have followed Friedrich Hayek into the intellectual swamp of “spontaneous order” and self-organization. While respecting Hayek as an intellectual giant, Kristol brilliantly dismantled the scientistic pretensions of these theories. As Kristol insisted, the key misconception of the popular versions of libertarian and Austrian economics is that political order can be spontaneous — that capitalism can thrive in anarchy.

But central to the Austrian model is the power of prices for signaling economic conditions. Without the government’s enforcement of property rights and contracts and its maintenance of defense and a monetary system, the carrier fills up with noise. It takes a low-entropy carrier (no surprises) to bear high-entropy information (full of surprise). In capitalism, the predictable carriers are the rule of law, the maintenance of order, the defense of property rights, the reliability and restraint of regulation, the transparency of accounts, the stability of money, the discipline and futurity of family life, and a level of taxation commensurate with a modest and predictable role of government.

As Kristol observed, progress in law and order does not spring from a Darwinian process of natural selection among random mutations. Progress stems from political leadership and sacrifice, prudence and forbearance, wisdom and courage. Sometimes these must be defended by military force. They originated historically in a religious faith in the transcendent order of the universe. They embody a hierarchic principle. It is these low-entropy carriers that enable the high-entropy creations of successful capitalism.

George Gilder is a founding fellow of the Discovery Institute. His latest book is Knowledge and Power: The Information Theory of Capitalism and How It Is Revolutionizing Our World (Regnery).