10: Modern Growth: The Wealth of Nations
The author chooses 1800 AD as the approximate year in which mankind finally exited the Malthusian era, in which there was an iron link between population and living standards - in economic terms, this was the essential accomplishment of the Industrial Revolution.
He notes that the term "industrial" may be a bit misleading, as it causes focus on the manufacturing sector (cotton mills, steel works, and the like)m, whereas the most significant changes occurred in more primitive industries associated to the agrarian age: farming and herding. All the wonders of manufacturing could not have been realized if there had not first been a revolution in the production of basic necessities - chiefly food.
Most Malthusian economies devoted the vast majority of the population - 70% to 80% - to the production of food. By 1861, that share had dropped to 21% in England, which completely flipped the equation in terms of the percentage devoted to other pursuits. In present-day Britain, the ratio is about 1.2%. That is, prior to the revolution only 20% of the population could pursue anything other than farming, and afterward 80% could devote themselves to other professions. Without agricultural advancement, this would not have been possible.
Similarly, the standard of living increased significantly. Between 1200 and 1800, income per captia in England was mostly static. Between 1800 and 2000, it increased tenfold and continues to rise. (For precision, it's said the industrial revolution started in Britain in 1760, but the rate of growth was slow until the middle of the following century.) The nations that benefitted from the revolution, such as Britain, the United States, and Japan, leapt forward and have maintained a dramatic lead over nations that were slow to exit the Malthusian age, and even to the present day some nations remain left behind.
This is significant because in the present day, the gap between the wealthy and poor economies is dramatic (about 40:1) compared to the era before 1800 (in which it was 4:1). But there is also a significant difference to the lifestyle of the average person. The productivity of the working class in the present age grants them a lifestyle that is better than the richest members of most communities in the Malthusian world - and the lifestyle of the richest classes in the present age is well beyond that even of emperors in the golden ages of Greece, Rome, or Egypt.
It's also noted that when income increases, consumers switch spending between goods in very predictable ways. Food consumption ceases to increase beyond a certain level of income -calorie consumption decreases slightly (around 3%) in some instances, though people switch to more expensive foods. (EN: An example from an economics professor was spam and champagne.)
Aside of the economic impact, the migration of labor out of agriculture had a profound effect on population density. In farming communities, the acreage kept people physically separated from their neighbors and most rural settlements (towns supporting the surrounding countryside) had a few hundred inhabitants. In eighteenth-century England, towns were typically located two miles apart, each having fewer than a hundred residents - which is far denser than the countryside of the present day, as fewer people work larger farms - though in the present day, there are fewer but more populous towns and cities. There is likewise an impact on population mobility: because productivity is not tied to a specific plot of land, modern populations are mobile - both workers and business owners may choose location and change location.
Explaining Modern Growth
Modern economies seem to be highly complex machines whose harmonic operation is nearly miraculous: hundreds of thousands of different kinds of goods are exchanged, the act of production requires specialized buildings, machines, and workers, and the flow of goods is global. But in spite of its complexity, the reasoning behind its functioning remains very simple: it is merely the aggregations of decisions made by ordinary people as to where they will work and what they will buy.
The model for modern economies collapses into the three basic factors of classical economics (land, labor, and capital) - the output of a society is increased by the efficient use of each of these three factors of production. Efficiency in the use of any of them increases the total output - and where there is efficiency in two or more, the growth in output is compounded.
There is something to be said of cost - specifically that investment made to improve the efficiency of one of the factors will have a greater effect on output than investment in another, depending on the activity in question. For example, increasing the capital by 1% may result in an increase in output of only 0.25 %, whereas a 1% investment in labor may cause a 3% increase in output.
Generally speaking, land-per-person was a significant determinant of growth prior to 1800, to the extent that a person was able to make productive use of additional land. This is one of the reasons that more people on the same amount of land produced less output per person - and that a decrease in population resulted in economic prosperity. This is in stark contrast to the postindustrial world, in which the degree to which land contributes to growth in output is relatively little in most economies (though the agriculture, mining, and other industries still depend on the availability of land to increase their output). As evidence, consider that countries like Singapore and Japan can be fabulously wealthy, whereas larger nations such as Sudan and Angola are impoverished.
Consideration is also given to the return on capital investment (structures, machines, vehicles, and other assets that are used in production), which is also readily measurable. Taken together, these account for about 25% of the growth in output.
What remains, then, is the efficiency of the worker as a result of training and education, which is assumed to account for the other 75%. Granted, this is remainder and there are two assumptions: that the factors named are comprehensive, and that what cannot be readily attributed to other factors is attributed to this one, which may be incorrect, but other calculations regarding labor seem to arrive at the same percentage.
For example, the author considers the income of high school graduates, those with some college, college graduates, and graduate degree holders to show that education accounts for 70% of the differences in compensation. The underlying assumption is that educated workers earn more because they create more product (giving their employers the means and incentive to compensate them better).
Even so, the author concedes that this puts a great deal of faith in coincidence as causality - but ultimately, his position is that unless we can identify other causes for growth that have not yet been identified, it seems a plausible working theory.
Innovation Explains All Modern Growth
The author argues that the "apparently independent contribution of physical capital to modern growth is illusory" and that innovation is the explanation for all growth in the modern era. In effect, human innovation creates the physical artifacts that are purchased as capital improvements.
That is to say that there is no efficiency gain from purchasing more of the same tools, but significant gains when new tools are developed for use. Analogy: buying one worker ten more shovels is less likely to make him more productive than buying him a bulldozer - and to buy him a bulldozer, such a machine must be invented, as a result of human innovation.
This is not to say that adding more capital has no effect on output, but this may be a factor of unused capacity: a cobbler can make more shoes of more leather, but eventually reaches a point where he is making as many shoes as he is physically capable and additional materials will not increase his production further. Up to this point, more capital creates more output. To get past this point, innovation is necessary to enable him to achieve greater productive potential.
Thus considered, the effect of capital is not independent of innovation, and the degree to which capital investment can be productive is entirely dependent on it - hence, the thesis that it is innovation, not the presence of physical artifacts, that has resulted in growth in the modern era.