It is my contention that there is no school of economic thought that is consistent with Ayn Rand’s philosophy. By studying the question of what is the source of economic growth and the related question of what caused the Industrial Revolution, we will uncover a school of economics that is consistent with Rand’s philosophy. The Industrial Revolution marks the first time in the history of the world that large groups of people escaped the Malthusian Trap. The Malthusian Trap is subsistence level living where people are on the edge of starvation. If we can understand the causes of the Industrial Revolution, then we will have greater insight into what causes real per capita increases in wealth and what policies are necessary for this to occur. Rand often said that it was clear that capitalism is a superior economic system compared to socialism when it came to producing goods and services. However, socialism often wins out because there has never been a proper ethical system underlying capitalism. I am going to add my contention that there has never been a science of economics that is consistent with Natural Rights, which is the basis of the founding of the United States. As Rand said “Capitalism is a social system based on the recognition of individual rights, including property rights, in which all property is privately owned.” Many people will immediately state that the source of economic growth is capitalism and then point to a chart of economic freedom versus wealth. The four broad categories on which economic freedom is determined are: 1) Rule of Law, including property rights; 2) Limited Government, determined in part by what percentage of GDP the government spends; 3) Regulatory efficiency; and 4) Open Markets. An interesting historical question to ask is whether Great Britain and the Colonies in 1720 were more economically free than the United States in 2010, since the Industrial Revolution did not take off until around 1800 and the United States in 2010 was experiencing at least some growth. I think it is clear that regulatory agencies such as the IRS, EPA, BLM, FCC, SEC, and local zoning boards result in property rights in the United States circa 2010 as less secure than in Great Britain and the Colonies in 1720. As for the rule of law, more generally, the United States is undergoing numerous political scandals including the IRS targeting groups on the wrong side of the political aisle. We have the NSA spying on citizens, journalists, and even congressmen. It is clear that the rule of law was more secure in the 1720 in Britain and the colonies. When it comes to limited government, the colonies and Britain of 1720 had total government spending well below 10% of GDP, particularly in the colonies. Total government spending in the United States in 2010 was about 48% of GDP. Great Britain and the colonies in 1720 had a much more limited government. There was almost no regulatory apparatus in the colonies and Great Britain in the 1720s, except for some limitations on trading, known as the Navigation Acts. For the same reason, the United States of 2010 is narrowly more free in the Open Markets category than Great Britain and the colonies. Overall it is clear that the colonies and Great Britain of the 1720s were significantly more economically free than the United States of 2010 and yet there was no real per capita increases in wealth until around 1800. This means there must be something else that is missing for real per capita economic growth to occur. Capitalism causing real per capita economic growth is an unsatisfying answer. Capitalism is a method of organizing the rules under which men live; it cannot take any action itself, only people can. Ayn Rand wrote Capitalism: The Unknown Ideal, however she was clear that it is not a book about economic science. She explained, “This book is not a treatise on economics. It is a collection of essays on the moral aspects of capitalism.” Rand had a very tenuous relationship with the free-market economists of her time. In the first chapter of Capitalism: The Unknown Ideal Rand explains a number of disagreements with the whole economics profession. For instance, she states, “One may observe the attempt to study and to devise social systems without reference to man.” Rand’s contention with the economics profession starts with the very definition of man. The definition she attacked was essentially “Economics is the study of how society manages its scarce resources.” This is a very widely used definition. The focus on society instead of individual people showed that the profession had defined itself into a collectivist approach. It also assumes that these “scarce resources” just exist and ignore that they have to be produced by individuals. More recent economics books have made some strides in putting individuals back into the equation. For instance, one definition in a text book is, “Economics is the study of how people make choices under conditions of scarcity and the results of those choices for society.” I doubt Rand would have found this a big step forward. The definition still ignores how and who produces the scarce goods and services. In addition, the focus on society again assumes a collectivist approach to economics. A section in the first chapter of Capitalism: The Unknown Ideal tackles the economic profession’s approach to values and prices. One approach she labels the “intrinsic value” theory, wherein the value of the object is inherent to the object. One example is the labor theory of value, which was proposed by the classical economists. This states the value of a good is equal to the labor necessary to make it. Yet another approach she labels the “subjective value” in which the value is simply perceived by a person, divorced from reality. This is the position of many modern economists and the Austrian School of economics, specifically. The intrinsic and subjective theories appear to be outgrowths of the mind-body dichotomy that Rand discusses elsewhere. One is focused on the material world and the other is focused on the spiritual or psychological world. Rand’s answer is an objective theory of value that takes into account the person and how the good or service relates to them in reality. Friedrich A. Hayek is commonly considered to be one of the great free market economists during Rand’s lifetime, however Rand was clear that she did not approve of him. Hayek was a Nobel prize winning economist and perhaps his most famous book is The Road to Serfdom, which was published during the Second World War. Hayek’s greatest insight was that prices in a free market result in spontaneous order that cannot be simulated by the central planner. Hayek bases his defense of capitalism upon the limits of reason. Many people believe that Hayek was just talking about the limits of a central planner to know everything going on in the market, but Hayek was explicit that reason was limited generally. He laid out his ideas on epistemology in his theory of Cultural Evolution. This theory states that ethics, law, and political structures are random and that there is a selection mechanism for the most successful cultures, which therefore thrive while less well fitted societies wither and die. He is explicit that we cannot use reason to determine which system is best. This means that to Hayek there is nothing special about Natural Rights, or the United States or Western Civilization. The only comment Hayek thinks you can make about these is that they appear to be the most successful right now, but our reason cannot tell us why. Hayek is a moral relativist and takes a collectivist anti-reason approach to ethics. How does Hayek justify his book Road to Serfdom then? He basis his criticisms in a true conservatism. Changes to the structure of society should be undertaken slowly. He also attacks central planning as a conceit of reason. If the central planner just understood that reason was limited, they would not undertake to control the whole economy. Rand did not base freedom or capitalism on the limits of reason, but on the fact that reason is man’s main tool of survival and it can only be exercised by an individual. Rand was clear that ethics is not a random and we can use reason to determine a proper moral system, which leads to a proper political system – a system that protects man’s rights, particularly his property rights which are the result of his creative efforts. Ludwig Von Mises and Rand knew each other well, by all accounts. Mises is perhaps best known for his praxeology. “Praxeology rests on the fundamental axiom that individual human beings act, that is, on the primordial fact that individuals engage in conscious actions toward chosen goals.” This seems okay, if simplistic, however Mises says we cannot judge the individual’s chosen goal, we have to take it as a given. In fact, according Mises, ethics and values are beyond the province of reason. It follows then that values and prices are completely subjective, meaning they are divorced from reality. Some people argue that when Mises says economic values are subjective, he means that each person individually evaluates their needs. However Mises was clear that economic values and all values are disconnected from reality. He therefore thought the idea of inalienable rights was nonsense. Ayn Rand and Murray Rothbard knew each other well but had a falling out. Murray Rothbard is best known as the economist who is the father of the anarcho-capitalist movement. This movement is characterized by the desire to eliminate government altogether. Their solution is to have competing private enforcement agencies. Rand was particularly disdainful of this idea, calling it a floating abstraction or worse. Milton Friedman is another well-known free market economist from Rand’s time. He won the Nobel prize in economics and is probably best known for his book and television series Free to Choose. Friedman gave a speech about Rand and Mises and he explained his disagreements with them as:
I have no right to coerce someone else because I cannot be sure that I am right and he is wrong.
This statement undermines all of ethics. A rationally based ethics is impossible and is an attack on reason. Friedman was clear that he thought economics should be divorced from morality and it appears that he basis his defense of liberty on the limits of reason. It is clear that none of the free market or other schools of economics are fundamentally consistent with Rand and Objectivism. I propose that the outlines of a science of economics that is consistent with Rand, Natural Rights, and the founding of the United States can be discovered by investigating the question of what is the source of real per capita economic growth? Surprisingly the economics profession has spent very little time on this question. I want to provide a quick survey of economic thought on this subject before delving into my answer. Adam Smith, David Ricardo, and Thomas Malthus were three of giants in classical economics. Adam Smith is considered the father of economics. David Ricardo is best known for his defense of trade as beneficial to both parties. Malthus is best known for his statement that population will always grow faster than the food supply. Most capitalists are severely critical of Malthus, however it is important to remember that when Malthus put forward this idea he was correct for all of human history. It was not until the start of the Industrial Revolution that any large groups of people began to escape the threat of starvation or the Malthusian Trap. Even today about 14% of the world’s population is caught in the Malthusian Trap. Smith, Ricardo, and Malthus all agreed that people could not escape the Malthusian Trap, which is how economics got the moniker “the dismal science”. They all had similar ideas that economic growth was caused by increases in capital, but this would never be enough for people to escape what they call a natural wage rate, or a wage that caused most people to live on the edge of starvation. It is a common misconception that Adam Smith’s famous quote, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest” was a defense of rational self interest. Smith wrote a book on ethics entitled the Theory of Moral Sentiments, in which he makes it clear that he is not defending rational selfishness. Smith’s point in this quote is that allowing people to pursue their own economic interest will result in spontaneous order. As a result, the state need not concern itself with this. Remember that Smith wrote The Wealth of Nations, not the wealth of people. His goal was to increase the wealth of a nation and explain how that is accomplished. John Stuart Mill put forth a steady state theory of economic growth. By his time, it was clear that average people were getting wealthier. He thought this period of economic growth would be a temporary phase and then it would level out and we would all live in nirvana. He assumed that people would all be equally wealthy in this state and if not the government should redistribute wealth to ensure this occurred. Von Mises and the Austrians put forth a version of the classical economists’ idea that economic growth is the result of increases in capital or savings, only in their model they assume that people can escape the Malthusian Trap. One problem with this model is that it does not explain why the Industrial Revolution started in Great Britain and the United States and not somewhere else, or why the Industrial Revolution started when it did. Joseph Schumpeter put forward his model of creative destruction to explain real per capita economic growth. In this model, new firms are incentivized by the market to create and implement new modes of production that are more efficient than older firms. The older firms either adapt or disappear. However, when we compare this model to the facts of history it fails to explain the Industrial Revolution. Firms around the world have the same incentives, but the Industrial Revolution began in an obscure, sparsely populated part of the world and even firms in Great Britain the United States had the same incentives before the Industrial Revolution. John Maynard Keynes did not really provide a model for how real per capita economic growth occurs. He turned economics on his head by suggesting that demand was the key to economic growth or at least smoothing out the business cycle. Again this does not explain the Industrial Revolution. People living in the Malthusian Trap have huge demand for goods and services, particularly food. Robert Solow is a Nobel prize winning economist that did an econometric study of the sources of economic growth and reported his results in a paper entitled, “Technical Change and the Aggregate Production Function.” What he found was that increases in capital and workers had contributed almost nothing to economic growth in the United States over the study period. The major contributor to economic growth was increasing levels of technology and on a per capita basis only technology caused economic growth. However, Solow thought that technology was exogenous, meaning it could not be affected by economic policy and could not be understood as an economic process. He treats technology as a sort of background radiation. This does not explain why the Industrial Revolution occurred when and where it did. Under Solow’s formulation this is just a random event. Paul Romer is the standard bearer for the exogenous New Growth movement in economics. Unlike Solow, he does believe that rate of technological change can be affected by economic policy and can be part of the study of economics. He uses the analogy of recipes for his understanding of new technologies, which I believe is misleading. He points out that second and third world countries can achieve economic growth by just adopting technologies from first world countries. He shows that policies such as capital controls, tariffs, and regulations in developing countries are what inhibit their adoption of modern technologies and inhibit their economic growth. For instance, he shows that rules in India on the importing of modern automobile technology have resulted in Indians being forced to drive cars with 1950s level of technology. This insight also explains why countries with lower economic freedom indices are able to have faster economic growth than countries with higher economic freedom indices. For example, a third world country can jump from almost no telephone service to a modern digital cell phone system with a fiber optic backbone. They do not have to first install landlines with switch board operators, then upgrade to digital switches, then to analog cell phones, then install fiber optic cables and then go through several generations of digital cell phone systems. They can just skip all these steps. Romer acknowledges that first world countries are forced to create new technologies if they are to grow economically. His prescription is that we need policies encouraging people to create new technologies, but once they are created he believes that ideally the technologies should be given away for free. His reasoning is based on preserving perfect competition as an ideal economic state and on the idea that inventions are non-rivalrous. Physical goods such as land are rivalrous because only one person can farm the same land at the same time, but ideas can be shared without diminishing the value to each person according to Romer. As a result, Romer thinks property rights for inventions, i.e., patents, are great at encouraging people to create new technologies but then inhibit the dissemination of technology and therefore inhibit economic growth. He thinks a better solution than property rights are for the government to fund more research and development and then give away the technology. This is essentially the system France had at the beginning of the Industrial Revolution, while Great Britain and the United States relied on property rights. France did not create the Industrial Revolution. This is also the system under which federal research grants were operated until the Bayh Dole Act and the result was that almost none of this technology created with federal money was commercialized. Now that I have reviewed what Rand’s complaints were with economics as a science and the history of what economists have said on the question of what causes economic growth, I want to start proposing some answers and solutions. The best place to start is with the very definition of economics. My proposed definition is:
The study of how man obtains those things he needs to live.
I think this definition has the advantage of focusing on man, which is helpful in discerning the source of economic growth and avoids the collectivist assumptions that are inherent to most definitions of economics. It also makes clear that economics, like ethics applies to a person on a deserted island. It is a common mistake to think that economics and ethics only apply when there is a group of people. It also ties economics to reality by focusing on what is necessary for life. Note that I do not distinguish between surviving and thriving, because I think this is a false choice. The evidence shows that the wealthier you are the longer you live and also your quality of life is significantly better. There is not a level of income at which we have enough to survive and after that our work becomes disconnected from sustaining or improving our lives objectively. For instance, you might have a million dollars, which should provide you with enough food for the rest of your life, but you might be in a terrible accident and your medical bills might be eat up the majority or all of your capital or there might be a war that wipes out your capital. The source of per capita economic growth is inventions, i.e., new technologies. An invention is the application of human reason to the problem of survival and is a human creation with an objective result. This is not surprising as man is a rational animal and in order to change his environment he has to take action in the real world, which means creating things. Without new technologies an economy might be optimized, but it cannot increase beyond this optimum point. Ayn Rand makes a similar point in this quote:
The power to rearrange the combinations of natural elements is the only creative power man possesses. It is an enormous and glorious power—and it is the only meaning of the concept ‘creative.’ ‘Creation’ does not (and metaphysically cannot) mean the power to bring something into existence out of nothing. ‘Creation’ means the power to bring into existence an arrangement (or combination or integration) of natural elements that had not existed before.”
Conservation of matter and energy means that we have to create things out things that already exist. A creation can either have a subjective result, in which case it is art or an objective result in which case it is an invention. How does this relate to when and where the Industrial Revolution occurred? First it is important to point out that Industrial Revolution was not really about industrialization, it was about a continuous invention revolution, as William Rosen demonstrates in his excellent book The Most Powerful Idea in the World. He also demonstrates that this historically unprecedented growth in new technologies was the result of property rights in inventions. Only Great Britain and the United States provided property rights for inventions to large groups of people. The result was that the Industrial Revolution started in Great Britain and the United States, not in France, Egypt, China, or elsewhere. B. Zorina Khan, an economist who has done more research on the history of patent systems throughout the world than anyone, makes the same point as does law professor and Objectivist Adam Mossoff. William Rosen has a very interesting way of illustrating the dominance of English speaking inventors in the Industrialization. He points to a steam locomotive in the Science Museum in London known as the Rocket that was built in the 1820s to transport goods from Manchester to Liverpool. The Rocket incorporates hundreds of inventions and if you could magically edit out all the inventions created in Italy, Sweden, France or China the Rocket would still run. If you did the same thing with the inventions created in England, Scotland, Wales and America, the display would be empty. That was the overwhelming dominance of English speaking inventors having access to an effective patent system. Rocket – Science Museum in London The connection between strong patent systems and the most inventive countries holds true to this day. Below is a chart of the countries with the strongest patent system and the weakest patent systems according to a report from the University of Singapore. I think it is apparent which countries create most of the new technologies and also have the greatest dispersion of technology. Property rights for inventions are not only important for the creation of new technologies, but for the dispersion of those new technologies, at least in first world countries. One of the reasons many economists do not accept the overwhelming evidence of the importance of patents is because it does not fit their conceptual framework of property rights. Historically, in the United States property rights are tied to Locke’s Natural Rights. Under this model, property rights are the result of creation, they are the law recognizing the metaphysical fact that but for the creator this thing would not exist. Rand explained it this way:
Any material element or resource which, in order to become of use or value to men, requires the application of human knowledge and effort, should be private property—by the right of those who apply the knowledge and effort.
However, many modern economists and those economists from the Austrian School of Economics follow the Utilitarian model of property rights. In this model, property “rights” are a socially useful mechanism for efficiently distributing scare resources, which should really be called property privileges. Jeremy Bentham was a leader in this attack on Locke’s Natural Rights. He called it “nonsense of stilts.” Utilitarians substituted “the greatest good for the greatest number” for Natural Rights. Here is what Rand thought of this:
“The greatest good for the greatest number” is one of the most vicious slogans ever foisted on humanity. This slogan has no concrete, specific meaning. There is no way to interpret it benevolently, but a great many ways in which it can be used to justify the most vicious actions.
Under the Utilitarian model it is argued that inventions are not scarce and therefore proper for property rights. Of course, they ignore that it takes real resources to create inventions, they ignore that it takes real resources to distribute and market inventions, they ignore that the market for the invention is limited, but most importantly they ignore the inventor is the creator. Utilitarians would agree with President Obama that you did not build that when talking about inventions. Compare this Rand who said patents were the source of all property rights. Another reason economists ignore the obvious importance of patents is because they are wedded to the theory of perfect competition. “Perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product.” Some economists have gone so far as to define capitalism as perfect competition and our anti-trust laws and securities laws are based on this idea of perfect competition. Under perfect competition there are supposed to be a large number of buyers and sellers of homogeneous products, in which every market participant has exactly the same information, and there are not barriers to entering the market. Homogeneous products are exactly the opposite of having property rights in your invention. In fact, all property rights create a differentiating factors or as economists like to say monopoly power. As a result, economists who are advocates of perfect competition tend to want to weaken property rights with anti-trust law and other regulations. As we have seen, it was the ability to obtain property rights in one’s invention that sparked the Industrial Revolution. If the United States and Great Britain had followed these economists’ advice the Industrial Revolution would have never occurred. Perfect competition is not capitalism, it is a system in which you are denied the ability to use your property to gain an advantage, it is a system in which you are denied the ability to use your intelligence to gain an advantage, it is a system in which every person is reduced to an automaton. In short it is metaphysical slavery. It is the failed concept of perfect competition that should be thrown on the ash heap of history, not patents – property rights for inventions. Given the importance of inventions and inventing, it is surprising how little attention it has drawn by the economics profession or academia generally. However, a small number of economists have studied inventions. For instance, Abbott Payson Usher wrote, The History of Mechanic Inventions, in which he attempted to catalog most mechanical inventions and define the process of inventing. Jacob Schmookler, an economist, undertook an extensive econometric survey of inventing in his book entitled, Invention and Economic Growth. He analyzed a number of profound questions, including whether scientific discoveries proceed or precipitate inventions. His and other people’s conclusion is the relation is tenuous at best and inventions and engineering often proceed science, for example the steam engine proceeded the work in thermodynamics. Another economist who had studied the process of invention is William Brian Arthur in the book, The Nature of Technology: What It Is and How It Evolves. He makes the interesting point that invention is an evolutionary process and a hierarchical process. In my book, The Source of Economic Growth, I make the point that that invention is a continuation of the evolution process of natural selection by means of human intelligence instead of by genetics. This point is also made by Ray Kurzweil, the author of The Singularity. In my investigation of the process of inventing, I have discovered six laws of invention: 1) Conservation Law of Invention: All inventions are combinations of existing/known elements. (2) Causality Law of Invention: Invention precedes production. Production precedes consumption. (3) Set Law of Invention: The number of potential inventions is infinite. (4) Rate Law of Invention: The rate of invention is dependent on the number of inventors, the size of the set of elements (components, earlier inventions) the inventors can access, and the size of the set of goals. (5) Commons Law of Invention: Inventions are not subject to overuse. The creation of inventions is subject to under investment without property rights in inventions. The diffusion of inventions is subject to under investment without property rights in inventions. 6) Income Law of Inventions: The per capita income of a large group of people can only increase over the long term if their level of technology increases. With this I think we have the outline of a science of economics that I call Intellectual Capitalism consistent with Ayn Rand’s philosophy. It starts with a definition of the study of economics that emphasizes man and reality. Specifically, economics as the study of how people obtain the things they need to survive. It puts man’s main attribute, his ability to reason, front and center by showing that economic growth is the result of man’s mind applied to the problems of survival, i.e., inventions. All capital is fundamentally intellectual capital since man is a rational animal. It makes clear that patents, property rights for inventions, are the key economic policy for creating real per capita increases in wealth. Of course, patents cannot exist in a vacuum. They are part of capitalism as defined by Rand – the economic system that emerges when Natural Rights are protected. Our standard of living is defined by our level of technology. Technologically backward countries can achieve economic growth by just copying the technologies of more advanced countries. Property rights are founded on creation and more broadly on Natural Rights. Perfect competition is not capitalism and it is not an ideal or an economically useful concept. Without increasing levels of technology diminishing returns or entropy will degrade standards of living until man lives in the Malthusian Trap again. In any free market the cost of goods will decline over time. There are objective values in economics. They are based on fact that man has to work in order to live. An objective value takes both the good or service into account and the valuer’s situation into account, in other words they are based on reality. In my book, The Source of Economic Growth, I address these issues in much more detail. However I do not approach the issue from Rand’s or Objectivism’s point of view. In fact, Rand is not mentioned once. Part of the reason is that Rand did not attempt to develop a science of economics and it is not necessary to rely on her support. This shows that the ethical and the practical (scientific) are not at odds with each other.  Rothbard, Murray, Praxeology: The Methodology of Austrian Economics, July 4, 2012, http://mises.org/library/praxeology-methodology-austrian-economics.  Note some people differentiate between ethics and morality. I reject this and in this paper have adopted Rand’s definition, “What is morality, or ethics? It is a code of values to guide man’s choices and actions—the choices and actions that determine the purpose and the course of his life. Ethics, as a science, deals with discovering and defining such a code.”  Ayn Rand, ‘The Metaphysical Versus the Man-Made’  Rosen, William, The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention, location 225, May 2010, http://www.amazon.com/Most-Powerful-Idea-World-Invention-ebook/dp/B0036S49WS/ref=sr_1_1?ie=UTF8&qid=1406667218&sr=8-1&keywords=the+most+powerful+idea+in+the+world.  Rand, Ayn, “The Property Status of the Airwaves,”, Capitalism: The Unknown Ideal, 122.  Rand, Ayn, “Textbook of Americanism,” The Ayn Rand Column, 90.  Wikipedia