Creativity and Capitalism

The United States has both. Is that a good thing?

Thanks to creativity, life is getting better in the United States. Today’s Wall Street Journal reports that the American economy has been an innovation powerhouse in 2023 and 2024. The authors, Justin Lahart and Lauren Weber, do a great job of explaining how this makes lives better for all of us. In the latest economic data, we see the power of creativity to improve lives. Here’s how it works.

Two foundations of every country’s economy are the number of workers plus the resources and tools available: Oil in the ground, factories, transportation networks. One way to improve lives is to extract more resources from the ground—lots of countries grow by pumping oil, for example—but that has well-known problems for the U.S. We could increase economic output by adding more workers—by having more babies or by increasing immigration—but that doesn’t do anything for you personally, because you have to share that growth with those additional people and each person still gets the same quality of life. How can we make life better for you?

The answer is innovation. Innovation is what allows you to take the same number of people, and the same natural resources, and create more value. Innovation is the third foundation of the economy. Thanks to innovation, you take the same inputs, and yet your output goes up. It’s like magic! Here’s how the magic happens.

Economists use the term “productivity” for what happens between inputs and outputs. The technical definition of productivity is “how much the average worker gets done in an hour.” The success of the U.S. economy over the past century is thanks to productivity growth, and productivity growth comes from innovation and entrepreneurship.

We now have the data through September, 2024, and it’s great news! Productivity in the U.S. increased a whopping two percent from 2023, and it’s been increasing at that rate for over a year. This is huge news because it doesn’t always happen. In the five years before the pandemic, the U.S. only hit that rate for six months. Here’s how reporters Justin Lahart and Lauren Weber put it in today’s Wall Street Journal:

“Companies learned new ways of doing things and adopted new technologies, while an upheaval in the labor market moved workers into more-productive jobs. The stakes are high. Economic growth fundamentally relies on how many people are working and how much they can produce while they are on the clock. But the U.S. population is increasing slowly, the baby-boom generation is retiring, and Trump has promised to heavily restrict immigration and deport millions of workers. Stronger productivity would help bolster the economy and support an aging population. Productivity also helps keep inflation in check: A more efficient business can be more profitable and pay its workers more without raising prices.”

Creativity is the driver, but not all productivity growth comes from inventions and ideas. A lot of it comes from making the economy more logical, more sensible, more efficient. For example, over the last year, workers moved themselves into better-paying and higher-skilled jobs. “A cashier at a poorly run store moves to a well-run store, where he might earn more money, have more responsibilities, and get more done.” In a productive economy, each person ends up working at the place that most fully realizes their potential. Economists call this labor market efficiency or matching efficiency. For you, personally, it leads to a more fulfilling life and a bigger paycheck.

Productivity is also about how the economy moves resources and money to the locations where they do the most good. A bank lends money to a company that’s making better products and they don’t lend money to a company that’s making poorer products. Investors move their money into companies developing new technologies, and they stop investing in old, unproductive companies. Economists call this allocative efficiency.

When both labor and resources are used most efficiently, it maximizes the benefits to society, because everyone and everything ends up where they’re most valued and most useful. Innovation is the engine, but how does the economy translate creativity into growth that can benefit all of us? That’s a question of efficient allocation and it’s a central topic for economics research. Creativity research shows us how the innovation engine works; economics research shows us how to translate that creativity into better lives for everyone.

Here’s why entrepreneurship is so important to the success of the United States: When people start new companies, productivity goes up. Those new businesses aren’t tied down by tradition. They can choose the most current, up to date methods. New businesses are quicker to adopt new technologies. They can do the same amount of work with fewer workers, which means they can pay those workers more, and at the same time, sell their products for less money.

The two percent productivity growth in 2023 and 2024 happened even before AI came into the picture. AI is too new to move the needle on productivity across the whole economy, but the impact is going to show up in 2025 and 2026. That means the U.S. can look forward to even more productivity growth in the coming years. I’m an optimist about America; I think 2025 is going to be a great year for creativity and innovation.

What’s missing from the article

I’m surprised that this Wall Street Journal article leaves out two very important terms: They don’t use the words “market economy” or “capitalism.” But that’s exactly what this article is about! Also, the article doesn’t mention who suffers. When the cashier leaves the poorly-run store, and customers stop shopping there, that store goes out of business and the workers are unemployed. That’s why Joseph Schumpeter called capitalism “creative destruction.” The power of a market-based economy is its ability to solve the allocation problem—how do you get people into the best jobs for them? How do you make sure that resources and money go to the companies that are doing the best job for their customers? In a centrally-planned economy, you put very smart people on top and in charge. They do their analyses and they decide where to move the people and the resources. The government is “the allocator.” But economists have proven that this type of centralized system will always be worse at allocation than a market-based system. Those government allocators might decide to keep open the poorly-run store, and then, the customers end up paying more, they can’t find the products they want, and the workers are miserable and cynical. This is why capitalism wins, every time, over central planning. It’s why I’m bearish on China in 2025 and 2026—because China has been doubling down on central planning. At least for right now, most of the people leading the U.S. still understand that productivity and innovation make lives better for all Americans (that includes both Democrats and Republicans, by the way).

I’m sure that the authors, Justin Lahart and Lauren Weber, know that their article is fundamentally about capitalism and about markets. So whose decision was it to omit those terms from the article? Did they make the decision, or did the front-page editor tell them not to use those words? If we can’t count on The Wall Street Journal to explain the power of capitalism to improve lives, then who can we count on? Capitalism has a lot of haters out there. I’m taking a risk by putting that word in the title of this newsletter. Please don’t hate me for using the “C” word that even the Wall Street Journal is afraid to use. Capitalism, capitalism, capitalism. There, I said it! Creativity is essential, but creativity alone won’t improve lives. Innovations are wasted if the economy can’t figure out a way to deliver them to more customers, and if the economy can’t figure out a way to loan money to an innovative company instead of to an old-fashioned, ineffective company. Creativity and capitalism both drive productivity; you need both to improve lives. The United States has both creativity and capitalism, and that’s why 2025 is going to be a great year for America.

Happy New Year!

Keith

A coda

I waited 24 hours to post this essay because I wanted to read the comments on the WSJ web site. I wanted to see how many capitalism haters there are. I just finished reading all 487 comments (as of 1/4/2025, 10:30am). The largest category of comments, by far, is criticism of illegal immigration. But immigration doesn’t necessarily increase productivity and that’s not the main point of the article. (Immigration only increases productivity if the immigrants are matched more efficiently to jobs than natives would be.) Of the 487 comments, only two mentioned that productivity results from innovation (Thomas Hall gets points for also mentioning Schumpeter); only William Traynor pointed out that capitalism is responsible for increases in productivity; and only HLS Nelson used the term “market economy.”

There are a lot of informed arguments against capitalism. If you’re critical of capitalism, then in your comments, I’m interested in hearing your thoughts on how an economy can incentivize creativity; how an economy can maximize the impact of each invention; and what type of economy can best translate creativity into changes that make our lives materially better. If you think capitalism is immoral or ineffective, then could you propose an alternative that might do a better job of fostering creativity and innovation?