Page 54 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE, V.79, # 1, 2022, pp. 50-68

In 1970, economist Milton Friedman said in the New York Times that a business’s
sole purpose is to generate profits for their shareholders and companies that pursued
other missions would be less competitive, resulting in fewer benefits to owners,
employees and society [Friedman, M. (September 13, 1970)]. Yet, data over the past
several decades shows that while profits matter, good firms supply far more,
particularly in bringing innovation to the market. This fosters economic growth,
employment gains and other society-wide benefits. Business school professor David
Ahlstrom asserts that “the main goal of business is to develop new and innovative
goods and services that generate economic growth while delivering benefits to
society” [Ahlstrom, D. (2010)].

It is taken as axiomatic that innovative activity has been the single, most important
component of long-term economic growth and this paper will start by drawing upon
the findings of a very influential paper published by my colleague at Stanford, Prof.
Abramovitx, back in the mid-1950s.

In the most fundamental sense, there are only two ways of increasing the output of
the economy: (1) you can increase the number of inputs that go into the productive
process, or (2) if you are clever, you can think of new ways in which you can get
more output from the same number of inputs. And, if you are an economist you are
bound to be curious to know which of these two ways has been more important - and
how much more important. Essentially what Abramovitz did was to measure the
growth in the output of the American economy between 1870 and 1950. Then he
measured the growth in inputs (of capital and labor) over the same time period. He
then made what were thought to be reasonable assumptions about how much a
growth in a unit of labour and how much a growth in a unit of capital should add to
the output of the economy. It turned out that the measured growth of inputs (i.e., in
capital and labor) between 1870 and 1950 could only account for about 15% of the
actual growth in the output of the economy.

In a statistical sense, then, there was an unexplained residual of no less than 85%.
Surprisingly enough, no economist had ever undertaken this exercise before - partly
because it was only after the Second World War that reasonably accurate estimates
of inputs and outputs for the American economy, over some very long time period,
became available. Now, in any statistical exercise in which you are trying to tease
out the relative importance of some variable, and you find yourself with a residual of
85%, you know you are in big trouble! Yet a number of other economists in the late
1950s and 1960s undertook similar exercises, using different methodologies,
different time periods, and different sectors of the economy, with roughly similar
results – they found themselves left with a very large residual that could not be
accounted for.

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