How to grow an economy

Finance Minister Bill Morneau’s Advisory Council of Economic Growth has held its first meeting, and the early indications are disappointing, if not entirely unexpected. In an interview with The Canadian Press, Dominic Barton, the council’s chairman, offered his views about what can be done to increase economic growth in Canada. Some of the answers were sensible enough. For example, it’s a good idea to identify and remove whatever administrative and structural barriers there might be that might prevent start- up firms from achieving their potential.

Then again, it’s not a particularly new insight, either: advisers to Canadian governments at all levels have been saying much the same thing for decades. The former Conservative government’s Venture Capital Action Plan was only one of the many recent measures introduced to deal with this problem. I thought the idea of governments acting as venture capitalists was pretty silly, but it maybe that was the best idea the Conservatives could come up with. I suppose it’s possible that this Liberal government will come up with a solution that its Liberal and Conservative predecessors have missed; we’ll see.

But some of Barton’s comments are answers to questions that governments shouldn’t really be asking of themselves. Why would he mention agri- foods as a growth sector? He may be correct in his assessment, but that’s not really a useful insight into what sort of growth- friendly policies the government should be looking at.

Economic theory tells us that growth is driven by technical progress, or innovation, or increased productivity, or however you want to describe the ability to generate more value with the same level of productive inputs: labour, capital, land and other natural resources. Economists have historically described technical progress as producing more output with the same inputs, and this has led to some confusion: more “output” sounds like more “stuff,” and since there’s only so much matter on Earth — or in the universe — the idea of sustained economic growth may sound like a physical impossibility.

A seminal contribution of the New York Univer- sity economist Paul Romer — who came to economics from physics — was to recognize that “more output” was the wrong way to think about economic growth. Instead of producing more stuff, economic growth consists of re- arranging the stuff that is already there in ways that we value more. New technology is best seen as the creation of new “recipes,” and there’s no obvious limit to human ingenuity in coming up with more of those.

Recipes — ideas — have non- standard economics, and governments play a crucial role. Recipes can be copied and used by anyone, so without some sort of intellectual property ( IP) protection, researchers will not be able to recover their costs. Ideas also generate positive spillover effects: other researchers can draw inspiration from them to create new ideas of their own. And it is these spillovers that drive economic growth.

So the challenge for governments is to strike the correct IP balance. If IP is too weak, not enough research is done and economic growth suffers. If IP is too strong, there are no spillovers and economic growth suffers. The recent Oracle-Google copyright ruling — in which it was decided that Google did not infringe on Oracle’s patents, despite using similar features in its code — is a case where the public benefits of positive intellectual spillovers were judged to be more important than the private benefits of strong IP. These issues are still far from being settled, and I would have thought that they’d be high on the agenda of an Advisory Council of Economic Growth.

Part of the problem is that the council is composed almost entirely of CEOs and investment specialists, McGill’s Chris Ragan being a notable exception. This would appear to be yet another example of the fallacy of confusing the skill set required to manage a growing company with the skill set required to formulate policy for economic growth.

Inside the breast of a CEO beats the heart of a central planner: she owes her success to her ability to identify a company’s strengths and weakness and to organize its operations accordingly. When confronted with the question of increasing the growth rate of the entire economy, her training and instinct is to look for sectors that have potential for growth — agri- foods, health care, whatever — and give them more resources. In a firm, this reorganization would be the result of direct command and control; in a market economy, it would come about with a judicial mix of subsidies and tax breaks for sectors that enjoyed the favour and protection of the central planner.

Call it the Dragon’s Den theory of economic policy — not least because this is also the approach favoured by Kevin O’Leary. The panellists on the TV show — and the members of the advisory council — can doubtlessly be trusted to identify promising investment projects, or to provide useful advice in helping a firm grow. But individual firms are not the same thing as entire economies, and little good can come from pretending that they are.

CEOs KNOW HOW TO MAXIMIZE PROFITS AND EFFICIENCY. BUT THAT’S NOT THE SAME THING AS FORMULATING GOOD ECONOMIC POLICY.