The Economics of Ideas

In our previous videos, we've covered how capital accumulation can spur catch-up growth, but capital accumulation becomes less potent as countries grow wealthier. Countries on the cutting edge grow by developing more and better ideas, but how? How do we get more and better ideas? Individually, a good idea -- it might seem sort of random. Maybe it pops into your head while you're in the shower or just before you go to sleep at night.

But when we step back and look at the creation of new ideas at a macro level, it's definitely not random. There are key ingredients that spur more ideas. Ideas don't fall from the sky like manna from heaven. They grow in the soil of good institutions. Let me give you a story to help illustrate this point. You might never have heard of the flying shuttle, but it was one of the most important inventions in the industrial revolution. The flying shuttle improved looms, making it easier to make fabric quickly and cheaply, and that made it possible for people around the world to have new clean clothes.

For the very first time, fashion became something that wasn't just for the very, very rich. The flying shuttle was invented by John Kay. And what did Kay get for his efforts? Weavers who thought that Kay's invention would put them out of work -- they smashed the new looms, and they burned Kay's house to the ground. Despite creating one of the most important inventions to launch the Industrial Revolution and improve the world, Kay, in fear for his life, fled to France, where he ultimately died a poor man. I don't know about you, but if I saw what happened to John Kay, I might not be too eager to pursue my invention.

Let's contrast Kay’s story with a great innovator from recent times, Steve Jobs. For his innovations, not only did he earn lots of money, but also cultural awards. Jobs became an icon that people want to emulate. This goes back to institutions and incentives. The institutions today in the United States have enabled an amazing environment for entrepreneurs to thrive and create new ideas. If you have a great idea in the United States, in America, American institutions create good incentives to pursue that idea. You'll find incubators and venture capitalists who can help you start your business, laws to protect your idea, a culture that idolizes innovators, and markets who will reward you handsomely should your idea be attractive to consumers. John Kay could only dream of the sort of world where he could profit from his work.

In the United States and in most of the world today, ideas are produced for profit. Seventy percent of the research and development expenditures in the United States are funded by the private sector, and an even higher percentage are funded privately in places like Japan. So, while an individual idea might seem sort of just like good luck, we see that ideas spring from places that have the right institutions in place to create new ideas and pursue those ideas.

In the next video, we're gonna look at one particular institution which is important for the production of ideas, patents. We'll also discuss the trade-offs of protection versus the sharing of ideas. And, what role can governments play in the production of new ideas?