Ever wonder why innovation policy gets so little attention in Washington? One reason is the manner in which policymakers — and the economists who advise them — conceptualize the economy.
In the conventional view, the U.S. economy is a static entity, changing principally only in size (growing in normal times and contracting during recessions). In fact, a more accurate way to view the U.S. economy is through the lens of “evolutionary economics.” For in reality, our economy is a constantly evolving complex ecosystem. The U.S. economy of 2014 is different, not just larger, than the economy of 2013. And the goal of economic policy should be to help drive this evolution.
On any given day this year, approximately 620 patents will be issued, 434 new products brought to the market and 439 new production processes adopted. Firms in some industries will get bigger, others will get smaller. Entire industries will expand and contract at significantly different rates, as well. Throughout 2012, output in the oil and gas industry expanded by 0.05 percent per day, while amid the continued shift to e-commerce and “big box” specialty retailers, output from general merchandise stores shrank 0.025 percent per day. And the economy evolves through firm births and deaths.
Evolutionary economics is grounded in the work of mid-20th century economist Joseph Schumpeter. In this view, the U.S. economy is an “organism” that is constantly developing new industries, technologies, organizations, occupations and capabilities, while at the same time shedding older ones that new technologies and other evolutionary changes make redundant (the proverbial “buggy whip” industries). This rate of evolutionary change differs over time and space, depending on a variety of factors — including technological advancement, entrepreneurial effort, domestic policies and the international competitive environment. Indeed, the last factor is critical, for the U.S. economy does not evolve alone, but in competition and cooperation with other national economies.
Economic evolution includes improvements in productivity, innovations that are welfare enhancing (such as the development of new products, services and business models), and increases in global competitiveness. As defined, evolution leads to growth, and indeed is the key driver of growth, especially over the moderate and long term. It is in this context that the central task of economic policy is not managing the business cycle, boosting freedom or spurring economic redistribution — it’s driving robust rates of economic evolution.
Given this paradigm, there are a number of principles for effective economic policy that focus on enhancing economic evolution: support for global economic integration, getting out of the way of natural evolutionary gain and loss, fostering a culture that embraces evolution, and — most importantly — accelerating technological innovation.
To maximize technology-driven evolution, nations need a proactive innovation policy. Successful innovations are based on knowledge about users’ needs and the value of the innovation to users. In this sense, smart innovation policies try to fill what is fundamentally a knowledge gap. Thus, it is difficult, if not impossible, for individuals and firms to make effective decisions under conditions of uncertainty relying only on price signals. This is why, despite what neoclassical economists believe, innovation is not something that falls out of the sky, or as economist Robert Solow once called it, “manna from heaven.” It comes from intentional human and societal action.
This is particularly true given that firms acting alone in response to price signals will not always produce the optimal rate of innovation. This is because economies are evolutionary, complex systems — not just markets. Firms and entrepreneurs cannot capture all the benefits of their own innovative activity, so will produce less innovation activity than society needs.
In addition, because of the complexity of the innovation process, especially today, firms cannot maximize innovation by working in isolation. Instead, they need to interact with suppliers, customers, competitors, universities, research institutes, investment banks and government entities to gain various kinds of technology, knowledge, information, and market access. Such interactions take time, effort, and resources, and in a fast-moving world, the pattern of cooperation between firms and other agents is far from optimal — not the least because of a lack of information about possible useful partners.
Finally, “chicken-or-egg” challenges inhibit development of technology platforms. These challenges must be overcome for innovation to occur around technology platforms such as near field communications-enabled (NFC) contactless mobile payments, intelligent transportation systems, health IT systems, digital signatures, the smart electric grid and the Industrial Internet.
This means that to maximize evolution, the critical issue of the role of the state and market should not be framed, as it is currently in Washington, as the state versus the market. Instead, as Erik Beinhocker suggests, the issue should be framed as, “how to combine states and markets to create an effective evolutionary system.” How to craft an effective evolutionary system that supports organizations in their quest to become more productive and innovative in the most effective way is largely an empirical and practical problem that cannot and should not be guided by broad ideologically sweeping statements, like “government always gets it wrong,” or “corporate profits are antithetical to the public good.”
It is beyond the focus of this post to lay out a detailed innovation agenda, but a few key areas stand out. First, the government has a key role to play in marshaling resources for innovation, particularly in funding scientific and engineering research — not just at agencies like the Department of Defense, National Institutes of Health and National Science Foundation but through incentives like science prizes and the R&D tax credit. It should also do more to support the development and international recruitment of STEM talent. Indeed, knowledge generation is a key to speeding up evolution. If mankind had perfect knowledge we would already have human-like robots, cures for all diseases, low-cost clean energy, space planes, and many other things we can only dream of.
In addition, the federal government should identify a few key challenges — like the development of low-cost, low-carbon energy sources and affordable and effective robotics — and devote significant resources to their attainment, as President Kennedy did with putting a man on the moon. This means doing things like dramatically expanding, rather than cutting, federal support for scientific and engineering research and making the research and experimentation tax credit much more generous.
But to effectively drive evolution, government needs to do more than simply fund factor inputs to organizations. It needs to engage in an active innovation policy. This includes policies to spur technology transfer and commercialization and to support pre-competitive industrial research consortia. Accelerating economic evolution also means focusing on how government and government-related industries (e.g., education, healthcare and transportation) can be transformed by technology. Indeed, these sectors are primary targets for evolution and technological innovation, but evolution will be slow unless the government actively creates policies to support and spur innovation.
Taking these steps will help maximize U.S. economic evolution to dramatically improve the standards of living and quality of life of future generations of Americans.
This post is based on the forthcoming report, “Understanding and Maximizing America’s Evolutionary Economy.”
Robert D. Atkinson is President of the Information Technology and Innovation Foundation (ITIF).