31 July 2010

Bryan Caplan on the dynamics between ideas and economic growth

An interesting essay from 2004: The Idea Trap

Imagine that the three variables I just named—growth, policy, and ideas—capture the essence of a country's economic/political situation. Then suppose that three "laws of motion" govern this system. The first two are almost true by definition:
1. Good ideas cause good policies.
2. Good policies cause good growth.

The third law is much less intuitive:
3. Good growth causes good ideas.

The third law only dawned on me when I was studying the public's beliefs about economics, and noticed that income growth seems to increase economic literacy, even though income level does not. In other words, poor people whose income is rising—like recent immigrants—have more than the average amount of economic sense; rich people whose income is falling—like the Kennedy family—have less.

This bare-bones model has a surprising implication: There is more than one outcome with staying power. The good news is that you can have favorable results across the board. Good ideas lead to good policy, good policy leads to good growth, and good growth reinforces good ideas. The bad news is that you can also get mired in the opposite outcome. A society can get stuck in an "idea trap," where bad ideas lead to bad policy, bad policy leads to bad growth, and bad growth cements bad ideas.

This also predicts that economic recessions generate the spread of bad ideas which, in turn, hamper recovery.