rumblings II ( innovation and social usefulness)

So taking the story forward in the last post- what will happen if the innovation by the third person in business activity is not weaving clothes but say brewing alcohol. The third person finds out a way to produce alcohol from food produced by the other two person. The alcohol is liked by all the thriee persons and hence GDP increases which comprises of three portions of food and three portions of alcohol.

So how this situations stands vis a vis the earlier situation of three portions of food and three portions of clothes. In terms of GDP, this will depend on what is the utility value of clothes vs alcohol to people. How does one calculate utility? Well it will be the value/happiness that one will get out of consumption of alcohol/cloth? Both alcohol and cloth can keep you warm in winter but clothes can do extra in making one fashionable.

From a GDP growth perspective, does it matter? Well in short term no. In long term may be. If usage of clothes lead to better processes of weaving of clothes and people discover another profession like fashion consultant which is of higher utility, while on the other hand , usage of alcohol may lead to finding its usage in medicine and someone start producing them. So in the long term, GDP may grow differently depending on the productivity growth and the future innovation of goods.

The next question is what is socially useful. Well for that we need to get a definition of social usefulness which doesn't exist or change depending on the person that you talk to.

Lets take the social usefulness as factors that affect social structures like family, legal system etc which in long term will negatively affect the economy. On this criteria, if say alcohol consumption makes people violent and more prone to fighting , this will make it socially harmful. So clothes innovation is better than alcohol on this scale.

The other criteria is a more philosophical one. What type of society do we want. Do we want to develop a society where clothes symbolizing comfort takes precedence over alcohol symbolizing leisure or vice versa. Or to take a better example whether we shall spend money/innovate profession in finding medicine for AIDS or on space exploration. In the short term, it doesn't matter. In the longer term the results may vary.

What matters here is who are "we". Could there be political leader or social evangelist deciding what we want or is it the choice arising from trials and errors of utility functions of people, the other name of this is entrepreneurship.

This also explains the charm of planned economy vs market economy. In planned economy, the planners by their supposed "super- intelligence" decide what type of goods/profession/path that the economy shall take. So in this case, through their calculations and social judgments, the planner will decide what is beneficial and hence choose the path. This will be done through quotas on goods production in private arena and capital investment by government. Also since the goods are already planned, there is no waste in form of entrepreneurship since no experimentation on utility function of people is required.

And there lies the fallacy that someone or a group of people can know what is beneficial for others in the economy and hence make a judgment on the utility functions which is impossible to perceive for a single individual leave aside the whole country.

The "socially useful" advocates also makes implicit assumption on long term utility functions of individual while deciding on what set of professions need to take precedence. Deciding on expenditure on AIDS drugs over space exploration does have the assumption that people would have larger utility of AIDS drugs as there is fear of epidemic rising in future. What may happen that in future, space exploration may lead to discovery of alien race that has already discovered drugs for AIDS.

Financial innovations can also be thought in this framework but that will be the subject of another post.