ESSAY 2 Featuring George Gilder
By John Mauldin
Flawed from its foundation, economics has failed to improve much with time. As it both ossified into an academic establishment and mutated into mathematics, [it] became an illusion of determinism in a world of human actions. Economists became preoccupied with mechanical models of markets and uninterested in the willful people who inhabit them.
—George Gilder
Knowledge and Power is one of the most fascinating examinations of how wealth is created in a very long time. It makes the moral dimension of entrepreneurship more visible in this age of decreasing confidence in the virtues of wealth creation. Gilder’s ideas are new, yet so compelling that they simply cannot be ignored.
—Reverend Johannes Jacobse
One of the most important concepts that my mentors have drilled into my head is this simple statement: Ideas have consequences. As a corollary to that, bad ideas have bad consequences.
Let me offer a somewhat controversial statement: Economics is populated by a lot of bad ideas. Many of which have come to be accepted as the correct interpretation of how the economy functions, and thus have become the basis for economic and monetary policy.
The chief bad idea in economics today is that most economists regard the discipline as a “pure science.” Economists have succumbed to what I call physics envy: They want their less-than-precise discipline to be considered a hard science, too. Unfortunately, economics—which concerns itself with unpredictable human behavior—is fundamentally incompatible with science.
Hard science, like physics, has rules you can’t break. The law of gravity makes for very specific physical behavior that can be mathematically modeled. Economists want us to believe that their own models are as reliable as the law of gravity. But the real world is a complex, dynamic, out-of-balance mess that doesn’t fit inside anyone’s model. You can’t model a system that is as chaotic and unpredictable as an economy in an Excel spreadsheet or even in the latest and greatest statistical software.
You may say, this is all well and good, but it’s just economic theory. How does that matter to my investment portfolio? The direct answer is that these models drive the policies of central banks and determines the price of money. And the price of money is fundamental to the prices of all our assets.
Further, using models to determine policy has damaged the economy in many ways, including:
- Dysfunctional and counterproductive tax/regulatory/entitlement/trade policies
- Private-sector credit growth encouraged by central bank mismanagement, and
- A massive expansion of Federal Government power and spending
Worse again, these models are all backward looking and measure only that which has already happened. But the economy, and its millions of economic actors, are forward looking, striving to create and do things which have never happened before. Yet another reason why the models we rely on are incompatible with how the economy functions.
This is why I believe it is time for a new economics. An economics which focuses not on mechanistic models, but on the creations and innovations which have driven economic progress since the beginning of time.
The brave man who has taken on the task of crafting a new economics is my good friend George Gilder. For those who don’t know, George wrote the seminal work Wealth and Poverty, back in the early ’80s, selling over one million copies and influencing a generation. He was Ronald Reagan’s most-quoted living author.
He has written many books since then, but Knowledge and Power is, in my opinion, the most important. I did not simply read this book, I thought through it, as the core premise is truly pivotal for my own thought process.
In Knowledge and Power, George attempts with some success to turn economics on its ear. His great insights are that entrepreneurial creations are the keys to understanding economic progress, and that accumulated knowledge is wealth.
Now, entrepreneurial creativity and innovations are not going to make it into any models that economists can concoct. Because we simply do not have the tools to model that kind of complexity. Let’s dive into George’s theory of “an economics of disorder and surprise that could measure the contributions of entrepreneurs,” and extrapolate out what it means for us.
Identifying the key driver of economic progress
In Knowledge and Power, George lays the groundwork for a new economics:
Capitalism is not chiefly an incentive system but an information system. The key to economic growth is not acquisition of things by the pursuit of monetary rewards, but the expansion of wealth through learning and discovery. The economy grows by accumulating surprising knowledge through the conduct of the falsifiable experiments of free enterprises.
Conventional economics holds that it is incentives—carrots and sticks—which drive individual economic actors to do what they do, and thus leads to economic growth. Although incentives are important, they are not the main driver of growth. The Neanderthal in his cave had the same incentive to eat and access to the same raw materials as we do today. Yet, our economy is vastly more advanced, why?
George says that it is accumulated knowledge, brought about by entrepreneurial efforts, that creates growth and prosperity. I agree. Whether it’s the discovery of penicillin, the creation of the automobile or the printing press, all the “things” which make our lives better and create wealth originate in the mind of the entrepreneur.
Thus, the economy is driven not by “centralized” institutions wielding rewards and punishments, but by an ever-growing pool of knowledge. This knowledge, in a real sense, is the source of wealth: wealth that is ultimately distributed throughout an economy.
But here’s a crucial point: Entrepreneurial creations—the source of wealth—are unpredictable and always come as a surprise. George often quotes former Princeton economist Albert Hirshman on this: “Creativity always comes as a surprise to us. If it didn’t, we would not need it; we could plan it.”
So, if we recognize that entrepreneurial creations are the key driver of growth, but that economic models cannot measure or predict these “surprises,” then we must recognize that traditional economics is useless at measuring the true wealth of the economy.
Thankfully, George has a better way to measure the contributions of entrepreneurs and demonstrate how economics works in the real world.
The foundation of the internet, and a new economics
With traditional economics incapable of measuring how an economy grows, George has applied the principals of information theory to create a new economics:
[A] new economics—the information theory of capitalism—is already at work. Concealed behind an elaborate apparatus, the theory drives the most powerful machines and networks of the era. Information theory treats human creations as transmissions through a channel—whether a wire or the world—in the face of noise, and gauges the outcomes by their surprise. Now it is ready to transform economics as it has already transformed the world.
Developed in 1948 by Claude Shannon, information theory is the basis for all telecommunications and the internet. At its core, it is complex and mathematical, but its implications for economics can be expressed by how it defines information.
The fundamental principal of information theory is that all information is surprise; only surprise qualifies as information. Sound familiar? George recognized the tie between entrepreneurial surprise and information theory: “Claude Shannon defined information as surprise, and Albert Hirshman defined entrepreneurship as surprise. Here we have a crucial tie between the economy and information theory. For the first time, it became possible to create an economics that could capture the surprising creativity of entrepreneurs.
Let’s flesh out how George applies the principals of information theory to economics. At its root, information theory is about distinguishing signal from noise. In technology, a signal goes down a telephone line or through a fiber-optic cable. The challenge is to sort out the actual signal from the noise that accompanies it.
Since communications can be business ideas, information theory is applicable to anything transmitted over time and space—including entrepreneurial creations. In the economy, the entrepreneur has to distinguish amidst the noise, a signal that a particular good or service is needed. But if some force—a government or central bank—distorts the signal by adding “noise to the line,” the entrepreneur could have difficulty interpreting the signal.
It is vitally important that the entrepreneur be able to separate the “signal from the noise,” as processed information leads to knowledge. And as we established above, knowledge is wealth. If the signal cannot be separated from the noise, then no new wealth can be created.
Admittedly, it took me a while to take in the full effects of George’s information theory of economics. I really had to think through the core ideas, and the more I did, the more “a-ha” moments I got.
George lays the groundwork for an economics which places entrepreneurial creativity—the creator of prosperity—at the heart of the economy. It is an economics that appreciates the powerful connection between chaos and creativity, between the disorder and surprise which engender growth. This recognition is the first step toward changing the policies that govern our nation and affect entrepreneurs and investors.
While the information theory of economics is concerned with the forces that create growth, it is also focused on those which hinder it.
Can low-entropy carriers make America entrepreneurial again?
While the information theory of economics recognizes that entrepreneurial creations drive economic growth, it places equal importance on the environment in which they operate:
One fundamental principal of information theory distills that the transmission of a high-entropy, surprising product requires a low-entropy, unsurprising channel largely free of interference.
Another concept George borrows from information theory is entropy, which is defined as “a measure of surprise, disorder, noise, and complexity.” I think of entropy as a spectrum:
- The low end: Predictable and stable carriers. In technology, a fiber-optic cable is an example of a low-entropy carrier: a system which is largely free of interference and doesn’t cause distortions of the all-important signal it is carrying.
- The high end: Surprising and unexpected signals. In economics, new creations and inventions by entrepreneurs are examples of high-entropy signals: these signals are disorderly, always come as a surprise, and inject new knowledge into the system.
While “high entropy” signals create knowledge and drive economic growth, they cannot do so without the existence of a “low-entropy” environment or channel.
For example, the success of a radio or internet signal depends on the existence of a low-entropy channel that does not change substantially during the course of communication. If there is “noise on the line,” then the communication may be distorted.
Likewise, the entrepreneur needs low-entropy “channels” to turn the idea in his mind into a product or service. George defines these predictable carriers as “The rule of law, the maintenance of order, the defense of property rights, the reliability and restraint of regulation, the transparency of accounts, the stability of money, and a level of taxation commensurate with a predictable role of government.”
For me, this is the most important part of George’s new economics. The entrepreneur must know that if his product or service succeeds at the market, it won’t be regulated out of existence. And the profits will not be taxed away. If he doesn’t have that assurance, the likelihood of turning his idea into a product or service is greatly diminished. That results in less entrepreneurial creations, which means less knowledge and wealth in the economy.
I would argue, as George does, that the business environment in the US has moved away from being a “low entropy” carrier in the past few decades. The tens of thousands of pages in The Code of Federal Regulations and Tax Code speak to that.
In order for innovation to thrive, and living standards to rise over the coming decades, we must return to a “low-entropy” legal, regulatory, tax, and monetary policy. Too much noisy interference from governments and central banks distorts market signals. They also increase the hassles of doing business, which stifles innovation and discourages entrepreneurship. Ultimately, this makes the country less wealthy and prosperous.
Identifying both the drivers and destroyers of economic growth is what George does so well with his information theory of economics. It has changed how I think about the economy, and what policies we should pursue going forward.
My hope is that President Trump will read Knowledge and Power and give a copy to all cabinet members—as Ronald Reagan did with Wealth and Poverty. Maybe I’m too optimistic, but if we began basing economic and monetary policy on George’s information theory of economics, I believe there would be a complete revitalization of the American entrepreneurial spirit.
If this can happen, I have great hope for the future. That’s because knowledge and wealth originate in the minds of entrepreneurs. As George once said to me, “An economy is a noosphere, and it can be transformed as rapidly as human minds and knowledge can change.”
I often say that every great thinker has one “big idea.” George’s information theory of economics certainly qualifies as one of those. You’ve likely heard me mention how important exposing yourself to these big, powerful ideas is. Well, that’s exactly what I aim to do with my Strategic Investment Conference. I have invited George to speak at the SIC 2018 in San Diego, this coming March.
What a great conference it was this year: great organization and amazing speakers! I was really enthusiastic about it when I came back to the office and now I think my other colleagues want to go as well next year.”
—Herman G. (past SIC attendee)
George is well versed in several areas, so I’m sure we will get into many intense discussions on topics ranging from technology to finance to economics. Yet, George is only one of the speakers that attendees will get to hear and meet. I really hope you can be there to experience it in person, with me. If you’re ready to learn more about the SIC 2018, and the other speakers who will be there, you can do so, here.
That does it for the second installment in this five-part series. Next, you’ll get my insights into Karen Harris’ pioneering work into the declining cost of distance, and the life changing effects this trend is going to have on our lives.
What do you think?
I’d like to get your thoughts and questions regarding George’s theory for a new economics.
You can post any questions or comments about George’s information theory of economics, or this five-part series, below. I’m looking forward to hearing from you.
Your hoping Washington adopts this new economics analyst,
John Mauldin
Chairman
