Nobel economist Edmond S Phelps has a piece, What is Wrong with the West’s Economies?  He discusses the alarming slowdown in western economies dating back to the 1960s, a lack of what he call flourishing or a narrowing of innovation.  It’s a nice piece and I recommend reading it in its entirety.  As you might expect, he does a great job of defining and documenting the decline.

Phelps does more than that, though.  He discusses the philosophical differences between those who are most concerned with opportunity (That would include me.) and those who are most concerned with equality.

Phelps proposes two possible causes of the decline in flourishing:

The first is suppression by those with a strong interest in the status quo:

What then caused this narrowing of innovation? No single explanation is persuasive. Yet two classes of explanations have the ring of truth. One points to suppression of innovation by vested interests. Their power has risen enormously in Western Europe and finally America over the postwar decades. Invoking corporatist notions of economic control and social contract originating in the corporazioni of ancient Rome, some professions, such as those in education and medicine, have instituted regulation and licensing to curb experimentation and change, thus dampening innovation.

The second is repression by families and schools:

The second explanation points to a new repression of potential innovators by families and schools. As the corporatist values of control, solidarity, and protection are invoked to prohibit innovation, traditional values of conservatism and materialism are often invoked to inhibit a young person from undertaking an innovation. Schools are doing less to expose the young to the great books of adventure and personal development. Parents teach their children from infancy to be careful and stay close to the family. There is discussion now of the overprotected child: the need for a return to “free range” children who are allowed to explore, to try things and take chances.14 Parents urge their children upon graduating to take a secure job with high pay, not a job at a startup. Many universities are now teaching courses in “responsible investing” but nothing on venturesome investing.

I think this paragraph hints at another cause, risk aversion.  As a society, we have become increasingly risk averse over the post WWII period.  Phelps points out the change in child rearing, from free range to helicopter parents.

There is more to it than how we raise children.  Our nation, which once sent men to the moon, no longer has a large-scale public space program.  Our government has become larger and more bureaucratic.  Our business have become larger and more bureaucratic.  Even smaller institutions, pressed by regulation and potential law suits, have become more bureaucratic.

Bureaucracies tend to  crush innovation, because it’s disruptive.  They also tend to punish Type I errors and not Type II errors.

I’ll step back and give a working definition (Warning. Statisticians won’t like this, but I’m not trying to be precise or exactly correct.  I’m trying to keep it simple.):  A Type I error is one that results in an obvious loss:  A loan goes bad.  A spacecraft explodes.  A new drug kills some people.

Type II errors are not so obvious:  A loan that should be made isn’t made.  A perfectly good spacecraft isn’t launched.  A drug that could save thousands of lives isn’t approved.

In each of my Type I examples, there would be hell to pay for the error.  Lots of loan officers have lost their jobs for making bad loans.  Few, if any have lost their jobs for not making a good loan.

Because of the incentives, we minimize Type I errors and ignore Type II errors.  This shows up as risk aversion, and it limits innovation.  We probably won’t regain Phelps’ flourishing until we embrace at least some risk.