Fighting Poverty With Innovation and Capitalism

Commentary, Economy, Matthew Lau, Poverty, Taxation

Yale University economist William Nordhaus was one of the winners of the Nobel Prize in economics this year for his work on analyzing the long-term economic impacts of climate change and climate policies. Quite appropriately, most media headlines focussed on Nordhaus’s contributions to climate change economics. However, Nordhaus’s work in other areas is equally instructive to policymakers and deserving of attention.

In 2004, for example, his study “Schumpeterian Profits in the American Economy: Theory and Measurement” provided a compelling answer to the question of why the after-tax rate of profit on corporate capital in the United States – averaging only 5.9 percent per year over four decades – could be so low. The answer, at least in part, was that the primary beneficiaries of technological advancement were the consumers, not the corporations.

Looking at the non-farm business economy, Nordhaus found that based on data from 1948 to 2001, producers capture only about 2.2 percent of the total benefits from their innovations. The other 97.8 percent of the benefits are enjoyed by the consumers.

If Amazon CEO Jeff Bezos is comparable to the average innovator studied by Nordhaus, economist Don Boudreaux writes, then in the course of amassing his own fortune, Bezos has enriched the rest of humanity by about $6.5 trillion so far (or about $8.5 trillion, in Canadian dollars). Even if Bezos never paid any taxes and never gave to charity, he could safely be called one of the greatest contributors in the world today to the material well-being of mankind.

The implications of this are instructive in deciding the merits of two competing views on how best to help the poor. One commonly held view is that poverty is best reduced by having the government take from the rich and give to the poor. Two problems with this are that the first part of the program (making the rich poorer) is pursued too zealously while the second part of the program (enriching the poor) is almost always a failure.

Politicians often talk about how government spending helps the poor, but many government programs do nothing of the kind. Talking about spending on the poor helps politicians get elected, but when it actually comes to spending the money, politicians get more political bang for their buck by squandering the money on special interests and targeted voter groups in the middle class – groups with more influence and political power than the poor.

Meanwhile the higher taxes used to fund this spending discourages wealth creation and productive work effort, shrinking the economic pie. High taxes drive away investment and businesses, reducing jobs and ultimately hurting everybody, especially the lowest-skilled workers who are usually hardest hit in tough economic times. In the Canadian context, with taxes consuming 43.6 percent of the national income, helping the poor by raising taxes further to fuel more government spending and more redistribution is a strategy doomed to fail.

Instead of having government take more from the rich in hopes that it will give it to the poor, a far better poverty reduction strategy is to encourage economic growth – to grow the economic pie rather than redistributing the slices, so that even those with a small share of the pie get a bigger slice. A rising tide lifts all boats. After all, according to Nordhaus’s research, for every $100 added to the economic pie by innovators, they consume only $2.20 of the benefits, leaving $97.80 of benefits for everybody else.

Since innovators who grow the economic pie leave almost all the benefits to be enjoyed by others, surely, one of the best ways to reduce poverty is to encourage more innovation, more entrepreneurship, and more capital investment. And that would mean cutting taxes, not more government redistribution.