There are four issues that matter in economics: growth, stability, sustainability and fairness. The developed world has, rightly, been engrossed with stability and sustainability of late; but we must also consider long-run growth. Growth is particularly important for Africa, where output per capita has only reached the level Britain had attained by around 1750. It matters too for developed countries, since growth ultimately reflects real material progress, and its absence causes social tension.

Understood properly, economic growth is not about money or commerce: it is about increasing the real value of goods and services produced. Money and commerce are instruments to achieve this goal. The main measure of economic output, real GDP, expresses a value of all goods and services produced, and does so in money terms simply because this is a constant standard of value (so long as we adjust for inflation).

Because people need and want material things, increasing GDP increases happiness. However, happiness is also affected by the composition of GDP (medicines are better than cigarettes), the ways in which it is produced (free labour is better than slavery) and things excluded from GDP (including environmental degradation). GDP is a useful but imperfect measure.

The Liberal model
Although growth is vitally important, economists are unsure where it comes from. The standard ‘neoclassical’ model analyses growth in terms of inputs of physical capital (productive equipment) and labour. Applied to the real world, this model shows that simple accumulation of capital and labour can explain only a small fraction of the economic growth observed. More realistic models have been constructed, but it is better to look empirically at the real world to answer the vital question of what causes growth.

The recipe for growth propounded in recent decades is economic ‘liberalisation;’ lowering burdens on business by reducing regulation, taxation and government intervention. Slashing regulation is supposed to permit ventures that would otherwise be prohibited and thus yield growth. Curtailing taxation is supposed to let entrepreneurs and investors know they will keep more of their earnings, giving them an incentive to create wealth. And abstaining from government intervention avoids the inefficiency and corruption supposedly endemic to government.

Given the assertiveness of economic liberals, it is remarkable how little evidence supports their view. World Bank data for 1,346 country-year data points from 1962 to 2007 shows no relationship, no matter what time lag is used, between growth and levels of taxation. Removal of controls on cross-border capital flow and the activities of banks from the late 1960s was accompanied by declines in trend growth rates in many places and greater volatility – not the promised balanced growth. Deregulation of transport, energy, housing and telecommunications in the 1980s and 1990s likewise did not produce the promised surge in output.

In the early 1980s, Australia had GDP per capita 30 percent higher than New Zealand. New Zealand thereafter adopted a zealous programme of economic liberalisation, while Australia liberalised less. The result by the year 2000 (before Australia’s recent mining boom): existing trends continued and Australia had a GDP per capita 60 percent above New Zealand – not what economic theory would predict. In some cases, increased competition linked to deregulation may even create short-termist incentives to erode capital and competencies, thereby slowing growth.

Industrial trends
One factor that mattered in the past was the transfer of population from low-growth sectors such as agriculture, to high-growth sectors such as industry. In the 1930s, a rapid transfer from farm to factory took place in the Soviet Union and played a part in the breakneck growth achieved under Stalin’s brutal dictatorship. Similar growth dynamics occurred in southern Europe and the ‘southern cone’ of Latin America in the decades after the Second World War, and in parts of East Asia more recently.

But such transfers cannot explain everything. Most basically, they cannot explain how industry, which people are flocking to under such circumstances, came into being in the first place. And they cannot explain the growth that continues even after the transfer is complete and farming represents just a few percent of the labour force.

Another important factor is increased use of energy. Between 1820 and 2010, global energy use increased 50-fold. This had huge impacts on the value of economic output and standards of living. Mass consumer goods, extensive air travel and abundant food production all represent expenditure of huge quantities of energy.

Today, mankind uses approximately eight exajoules (8x1018J) of energy per year just in producing nitrogenous fertiliser. This equals nearly all energy production in 1820. The area of farmland in use today feeds almost seven billion people. Without artificial fertiliser, it would feed only two billion – we would be faced with a combination of mass starvation and ploughing-up our remaining wilderness for crops (with associated environmental costs).

As well as tapping more energy, our use of energy has recently become more efficient. The equivalent of one metric tonne of oil yielded $2,500 of GDP in 1973 (in 1990 international dollars) and yields $3,800 today. So, increased energy use and increased energy efficiency can be treated as together defining economic growth. But this still doesn’t tell us where growth comes from. How did we manage to tap more energy in the first place? It didn’t just turn up on the Earth’s surface in a form that could be used efficiently with pre-industrial technology.

The impact of entrepreneurs
Business types eulogise entrepreneurship as the origin of growth. It is certainly true that, without hardy individuals taking risks to apply new ideas, we would not be where we are today. If there was no one like Christopher Columbus to strike out west for a trade route to Asia, or no one like Bill Gates or Steve Jobs to turn the microchip into user-friendly mass-market electronics, the world would be much poorer.

But the entrepreneurship hypothesis too has a problem. Where did the technology come from that these individuals developed so successfully? Without the Sagres School of Navigation, which improved European seagoing technology 70 years earlier in Portugal, there would have been no Columbus. Without the scientists who developed semiconductors and microchips in the decades after World War II, there would have been no Gates or Jobs.

Scientists, engineers and inventers peer into the mysteries of nature, develop insights that no-one spotted before, and identify practical implications. In the 1960s, futurists predicted ‘pocket computers;’ today we call them iPods. Entrepreneurs take visions like these and, through hard work, determination and business skill, make them reality. The real origins of growth are knowledge and technology.

Knowledge consists of information about how the world works and how this can be used to our advantage. This leads to technology, which consists of tools and techniques for arranging the world to our liking. New technology lets us rearrange matter in new ways and in greater quantity. It lets us harness more energy and use it more efficiently. It produces the new activities that people adopt with enthusiasm. Ultimately, it improves our lives by giving us more of what we need and want.

The story of innovation
Humans innovate because it is in our nature, and because some current challenge always provides an incentive. To grasp the power of innovation, we must take a long view. Over millennia, it has changed the human experience beyond imagining. This story shows the real material roots of economic growth. We see that proximal factors were important at each stage, but that human innovation was the constant driving force throughout.

Technological innovation and economic growth began when our ape-like ancestors produced simple stone blades, using one stone to knock flakes off another. This let them hack through flesh and fibre, access more nutrients and live longer and better. Making and using tools, passing on this knowledge and coordinating tool-based activities drove the evolution of dexterity, intelligence and communication. This led to a host of new tools, such as spears, fire, nets, clothing and canoes, and eventually to speech – permitting huge knowledge transfer. Fire and cooking let early humans pre-digest protein, facilitating brain evolution.

Discovery of seed-tending and animal-herding in the fertile conditions after the ice age ended around 10,000 BCE led to the development of agriculture, hugely increasing the quantity and stability of human nutrition. Settled living reduced homicides and permitted invention and accumulation of heavy items, including pottery for storing food, the wheel, metals, astronomy (for time-keeping) and dairy products.

Irrigation was developed to increase agricultural output. Organising irrigation and defence against nomads, combined with a food surplus to support non-farmers, led to the development of structured civilisation – a process that occurred independently in six locations around the world, starting in the Middle East. To support civilisation and trade, humans developed writing, mathematics, cities and sailing ships. Iron weapons, warhorses, chariots and warships led to the gradual creation of large empires, such as that of Rome. Huge tracts of forest were cleared with iron axes.

From the second century CE; paper, firearms, the compass and moveable type were invented in China and later improved by competing European states. Decimal numbers were adopted from India and windmills from Persia. Europe itself developed intricate water mills to power many tasks, heavy wheeled ploughs, eyeglasses, clockwork, the printing press and telescopes. After the middle ages, new designs of ship and navigational tools led to global exploration and conquest, huge trading networks and new commercial institutions. New instruments led to the formal scientific method for understanding nature.

The wealth of empire and the knowledge of science led to better farming and the industrial revolution, involving more and better iron and steel, the steam engine, mechanised factories and railways. Depletion of woodland spurred the adoption of coal and coke as fuel, a huge new energy source. Increased wealth spurred greater investment in science and education (rudimentary adult literacy in England rose from six percent in 1500 to 53 percent in 1800) and more complex innovations occurred. In quick succession, scientists and engineers discovered chemicals, electricity, sanitation, oil and gas, the internal combustion engine, flight, new medicines, nuclear energy, computers, the microchip, biotechnology, the internet and more – giving us the world of today. Since we have barely begun exploiting the possibilities of physics, even more fantastic developments await in the future.

The defining feature of innovation is acceleration. Existing tools permit the development of new ones. Fire permitted metallurgy. Metals permitted machinery. The potter’s wheel probably inspired the cart wheel. The telescope led to mathematical physics, to explain planetary motion. Mathematical physics permitted complex machines. Mechanical instruments permitted chemistry. Chemistry permitted biochemistry. Biochemistry permitted genetic engineering. And so on. The greater the stock of known tools, the more new ones can be discovered, so progress accelerates.

The benefits (and costs)
Administrative and commercial records and archaeological evidence let scholars reconstruct historical statistics. These show that, before modern industry, progress was slow. Western Europe’s real GDP per capita rose from $427 in 1000 CE, to $771 in 1500, to $1,202 in 1820. This was because technological progress was slow and population growth, spurred by more food output, tended to keep pace with it. Mankind was also plagued by diseases arising from living close to farm animals and one another, un-varied nutrition and the oppression and militarism of pre-democratic rulers.

With industry, everything changed. Progress became very rapid, and included contraceptive technologies, so that population (although growing quickly) did not keep up. Western European GDP per capita surged from $1,202 in 1820 to $19,912 in 2003. Infant mortality fell from 13 percent to 0.6 percent. Life expectancy at birth rose from 34 to 79. Breaking old bonds produced social liberalism. These benefits are now going global, while slowing population growth due to contraception and women’s liberation will make gains permanent.

Admittedly, industry led to world imperialism as some countries became much more powerful than others; mechanised slaughter in the world wars; post-colonial turmoil in Africa and global environmental destruction. But the gains, felt by almost every man, woman and child in every country that has industrialised, have far outweighed the costs – and there would have been war and killing even without industry. Continued progress is working against imperialism and war. And we can make industry sustainable with low-carbon energy and closed-loop recycling of key materials.

The questions now are how to accelerate growth and manage it under different circumstances, while avoiding pitfalls. In coming articles, I will examine these questions, looking at investment in science, the role of finance, economic planning and more.