Thus far, we have focused on how technological progress can increase the growth of productivity and standard of living. But, how does technological progress come about and, specifically, can governments do anything to encourage it? During the industrial revolutions of the 18th and 19th centuries, invention and the application of new technologies were carried out by private individuals and firms, virtually without government subsidies or direction. Nonetheless, the histories of these industrial revolutions suggest that governments can have a powerful impact on growth.

Douglass North, a Nobel laureate economist at Washington University in St. Louis, argues that a nation's institutions, including its government, are fundamental determinants of economic growth. Focusing specifically on the role of government, North and his co-author Barry Weingast argue: "Successful economic performance ... must be accompanied by institutions that limit economic intervention and allow private rights and markets to prevail in large segments of the economy. ... The ability of a government to commit to private rights and exchange is thus an essential condition for growth." In his classic study of U.S. productivity growth, John Kendrick makes a similar point. Citing the importance of resources devoted to increasing scientific and technical knowledge, Kendrick contends that "the relative volume of resources devoted to research development and innovation depends on the basic values and motivations of a people and on the efficacy of the rewards and penalties provided by prevailing institutions for the success or failure in the efforts to improve productive efficiency."

In the view of North and Weingast, the "Glorious Revolution" of 1688 gave England political institutions, such as a representative parliament and independent judiciary, that produced a marked increase in the security of private rights. Secure property rights, in turn, provided the freedom and incentive to take economic risks, to invest in new technologies and to look for ways to use economic resources more efficiently. The United States inherited the English tradition of protecting property rights and, hence, the same fundamental mechanism for providing incentives for invention, investment and risk-taking that was in place in England by the early 18th century. Providing these incentives would seem to be a fundamental contribution that governments can make to encourage gains in productivity and standard of living.

In addition to enforcing contracts and limiting arbitrary confiscation of property, governments often extend special protections to inventors in the form of patents and copyrights. Such protections seem particularly important in the case of intellectual property or knowledge-based products, such as computer software. The initial development of a piece of software might be extremely costly, but the costs of producing and disseminating copies of the software are trivial. Without strong protection of intellectual property rights, such as a software developer's copyright, there will be little incentive to produce knowledge-based products. In other words, secure property rights encourage the technological breakthroughs that accelerate productivity growth and living standards. British patent law dates from 1624, whereas France and other continental European countries did not have patent laws until at least 1791. (The first U.S. patent law was enacted in 1790.) Scholars debate the extent to which patent protection contributed to the high rate of invention during the Industrial Revolution, in part because of inconsistent enforcement of patent laws by British courts. Enforcement of property rights granted by patents and copyrights is, of course, crucial to their success as stimulants to invention. Patents and copyrights can also inhibit innovation if firms are permitted to extend them indefinitely.

Well-designed patent and copyright laws, along with a legal system that protects property rights, are examples of how governments can promote economic development. Other contributions that governments can make include sound macroeconomic policies and, in the view of many economists, a strong education system. Paul Romer, a leading growth economist at Stanford University, for example, argues that "the real success of American economic policy has been to have moderately strong property rights with lots of subsidies for inputs--like research and education--that are used in the innovation process."

The United States has long supported both public and private education. In the 19th century, federal assistance to education was largely in the form of land grants used to finance the establishment of public schools and colleges. The Morrill Act of 1862, for example, provided land grants for the establishment of colleges teaching "agricultural and mechanical arts," including engineering and other technical subjects. Economists widely believe that basic and technical education enhanced the productivity of American labor and contributed to the accelerated pace of productivity growth that began in the 1920s. High school graduation rates were at high levels in the 1920s, and, as in recent decades, income growth rates were higher for more-educated workers.

Defense of property rights, sound macroeconomic policies, a strong educational system, and patents and copyrights are institutional supports that governments can use to strengthen economic growth in a market system. Such supports promote the allocation of economic resources to their most productive uses and encourage technological progress by ensuring that inventors are rewarded for developing successful technologies. Many countries, however, have pursued technological progress and economic growth by limiting, even eliminating, market forces. Although growth rates can be high for short periods under government ownership and control of economic resources, history suggests that market-based economies have faster growth rates over the long term.

Today, few observers contend that highly controlled economies will grow faster for long periods than market economies. Nevertheless, many believe that governments can do more to promote technological progress and economic development than simply providing a conducive climate for markets to work their magic. Some countries have adopted formal "industrial policies" aimed at guiding technological change by subsidizing or otherwise promoting specific technologies, industries or firms over others. Economists do not agree whether such policies can enhance economic growth, and some argue that the policies are more likely to retard growth by interfering with the efficient allocation of economic resources.

To some extent, all countries, including the United States, have used subsidies, protective trade barriers, and other direct means to foster technological development. A feature of the 18th and 19th century industrial revolutions, however, was the limited extent that governments sought to dictate or interfere with the form and extent of technological progress. The great economist Joseph Schumpeter coined the term "creative destruction" to describe how economic growth arises from the continual reallocation of economic resources as new, more productive firms and technologies replace old and inefficient firms and technologies. Paul Romer argues that America's great success comes from allowing this process to occur: "The United States has maintained a regulatory and financial system that makes it easy to create new companies, raise capital and start new businesses. We also tolerate failure." By contrast, other countries have "focused on what they call 'national champions,' which they identify as a few big firms whose monopoly positions they try to protect. That really goes in all the wrong directions."