Creative Destruction

While the latter half of the twentieth century might have seen a debate between naive economists and political realists over whether government interventions are likely to improve resource allocation, it turns out that resource allocation is not the cause of large differences in prosperity. Across time, particularly in the last 250 years, innovation has resulted in dramatic increases in living standards. Across different countries, differences in culture and institutions matter a great deal.

Economic historians estimate that average per capita incomes in the world increased only a little bit until recently, with some estimates suggesting annual income of $140 in 5000 BC, $175 in 1500 AD, and $250 in 1800. At that point, however, economic growth took off, with average incomes reaching $850 in 1900 and more than $8000 in the year 2000.

These broad estimates of income, or GDP, are only approximate, because the nature of what gets produced changes so much over long periods. But we can verify that living standards have improved by tracking particular trends.

Consider life expectancy. Inquisitive Bird writes,

In Sweden1, life expectancy at birth was 30-some years in the 18th century, and today it’s above 80 years.

Roughly half of this increase is due to reduced death during birth or early childhood, but from 1751 to 2024,

even when restricted to the subset of people who live to age 15, life expectancy has increased by a staggering ~26 years.

In terms of age-specific mortality rates,

a 30-year-old Swedish woman born in 1750-1759 was 33 times more likely to die before their next birthday than a 30-year-old woman born in 1990-1994.

Overall in Sweden,

In the 18th century, if you survived to age 10, there was still roughly 1 in 5 chance you’d die before age 40. Only about half of 10-year-olds would survive to age 60, and 1 in 3 survived to age 70. Today, 90% of 10-year-olds survive to age 70.

As another example, there is a famous paper by William Nordhaus on the decline in the cost of artificial light, as we progressed from oil to candles to kerosene to electric light bulbs. He estimates that in Babylonian times it would have taken the average worker 41 hours to be able to afford 1000 lumen-hours of light. By the 1990s, it would have taken the average worker less than one second or work to be able to afford that much light.

As a third example, economic historian Robert Fogel has estimated how average calorie consumption per person has changed over time in Great Britain. From 1700 to 1989, calories in the diet increased by 50 percent, from roughly 2100 calories to 3150 calories.

Finally, we have more than three times more leisure time than we did 150 years ago. As recently as 1870 it took the average worker 1700 hours a year just to feed a family. A little over one hundred years later, this was 260 hours.

Is it really true that much progress has been relatively recent, in the last 250 years? Think of all of the quality-of-life improvements that we take for granted that were not available to someone in 1775: indoor plumbing, mechanized transportation, antibiotics, electricity.

Until the industrial revolution, innovation happened slowly, and the gains were absorbed by population growth. Because population grew while per capita consumption hardly budged, we say that growth was Malthusian. Thomas Malthus predicted that there would be no improvement in living standards from better food production, because humans would procreate too rapidly, using up the available food. But starting in the industrial era, productivity grew fast enough to overcome the Malthusian limits.

Equally dramatic are the differences in average incomes across countries. As of 2000, 900 million people in the 28 richest countries were earning roughly $9000 per year. But there were over 1 billion people living in countries with an average income of less than $1 per day.

Across countries, institutional differences matter. For example, compare Communist countries with non-Communist neighbors. Cuba before Castro was richer than Mexico. Now their situations are reversed. Taiwan is far more prosperous than mainland China. The difference between Communist North Korea and non-Communist South Korea is especially stark, with South Koreans almost 20 times richer on average. For the forty years when the Berlin Wall separated Communist East Germany from non-Communist West Germany, East Germany fell far behind.

There are important institutional differences within the non-Communist world. For example, as of 2000 it took an average of four days to obtain a business license in the United States. In Kenya or Egypt, it took over 50 days. More recently, a World Bank study found that the cost of starting a business was 1 percent of average income in the U.S., but 11 percent in India and 26 percent in Nigeria.

Business tax compliance time is about 175 hours per year in the U.S., but over 1500 hours per year in Brazil. Contract enforcement time using the court system is about 300 days in the U.S., but over 1400 days in India.

In Western democracies, the percentage of transactions that take place in the underground economy is typically around 10 percent. In other countries, such as Bolivia or Thailand, it is more than 50 percent. In the informal sector, it is much more difficult to raise capital, and property ownership is much less secure.

Economists in the 19th century described production as using tangible resources, notably land, unskilled labor, factories, and business equipment. But by the 21st century, it was evident that intangibles increasingly matter. Human skill level, business strategy, innovation, and the institutional environment determine how wealth gets created.

Joseph Schumpeter anticipated the modern economy with the phrase “creative destruction.” It reflects how new products and processes emerge, displacing older production methods. The net effect is progress that improves the lives of many people, but other people lose their forms of livelihood in the process.

The U.S. and Asia are the leaders in innovation, particularly in computers and communications. A widely-cited study, known as the Draghi report, found that Europe is a laggard, falling well behind the United States in terms of per capita income and productivity. Draghi and others see heavy-handed regulation as a factor holding Europe back. According to Econofact, “EU GDP per capita as a percentage of U.S. GDP per capita fell from 76.5% in 2008 to 50% in 2023.”

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