Innovation, Information and the Poverty of Nations

Robert D. Cooter, UCB

Abstract

Sustained growth occurs in developing nations through improvements in markets and organizations. Entrepreneurial innovation resembles biological mutation that is unpredictable before it occurs and understandable afterwards. It is unpredictable because it begins with the innovator possessing private information by which he earns extraordinary profits. It is understandable because it ends with the public figuring out the innovation and profits approaching the ordinary rate of return. These characteristics of innovation have important con¬sequences for law and policy to foster economic growth. Specifically, government officials who rely on public information cannot predict which firms or industries will experience rapid growth. Consequently, industrial policies that promote growth are unlikely to succeed. Proponents of industrial policy today make the same mistake as the mercantilists whose interventions Adam Smith attacked as a cause of national poverty. In contrast, secure property and contract rights, as well as effective business law (especially the laws regulating financial markets), create conditions under which competition naturally produces entrepreneurial innovation and nations become rich. The main obstacle to sustained economic growth in poor countries today is ineffective civil law.