I don’t know how many of us realize that we have already lived through a fifth of this century, mired in crises of one type or another. It all began with 9/11 in America which led to a series of ill-conceived wars in Asia. Then, we had the Great Recession from 2007-8 onwards from which some parts of the world like Europe and Japan have yet to recover fully. And before we knew it, a pandemic of global proportions hit us last year. We have seen crises that are political, economic and social, all in a single generation.
Now that we are in 2021, it’s time to assess and think about what was meant to define the 21st century: innovation. Yes, I know many like to believe that the world being run by tech titans is equal to innovation, and that all the digital transformation is truly innovative. Really?
If that were really so, why is the world and especially the Western world from where much of this so-called innovation emerges, not experiencing great growth in either productivity or output? Economists have for years lamented the lack of increase in productivity despite all the great leaps being made in technology and believe that innovation too has suffered. This, even as the world has globalized and grown exponentially during the past three decades.
Edmund Phelps has written in his 2013 book, Mass Flourishing, that America in particular has suffered from lack of innovation since the 1970s. He believes that one of the main reasons is the obsession with money and a new form of corporatism in the US, by which he means the involvement of government in business and collusion between them through practices like lobbying and the like, to secure their interests. In a chapter titled Understanding the Post 1960s decline, he writes;
“The question here is whether the heightened aspirations for money or wealth help account for the economic decline that was clearly underway in America by the early 1970s: the slower growth, higher unemployment, and lower job satisfaction, as well as for the massive fiscal stimuli, dereliction of regulators, and the speculative manias. The answer is yes. Wealth seeking competes with innovation seeking, so many turned away from innovating.”
A few pages later, he adds:
“Politicians use their governmental power to dispense patronage in hope of electoral support, and political parties solicit or accept contributions from companies, unions, political funds, and wealthy individuals in return for support of their special interests… It has not been considered, however, that the politicization of government costs a modern economy some of its dynamism – even if static inefficiency and injustice have not worsened.
There has always been some degree of corporatism of one variety or another – interrelations between the state on the one hand and capital and labour on the other. By now, though, there has been a considerable broadening of the nexus between the state and the business economy, much of it in the past decade.”
This, when the focus should really have been on innovation driving free enterprise and inclusive economic growth, the kind that Paul Romer first wrote about in his 1985 paper, Increasing returns and long run growth. Here he argued that long run economic growth need not be subject to diminishing returns, if it were based on accumulation of knowledge as the form of capital employed, rather than only financial capital or technology. New knowledge being added to old, through research and development, or innovation in other words, could be the main driver of long-term growth.
For a few glorious decades post World War II, technological inventions and innovations did fire up the engine of economic growth in the US (and across the industrialised world). In an important 1998 paper by David Autor, Lawrence F Katz and Alan Kreuger, titled Computing Inequality: Have Computers Changed the Labour Market? that studied the effects of skill-biased technological advancement on labour wage differentials between 1940 and 1996 in the US, they found that the advent of computing technology at the workplace forced people to upgrade their education levels and skill sets and improve their earnings by a considerable amount. There was a significant change in the composition of the workforce at higher levels of education and income, especially after 1970. Consider this another manifestation of Peter Drucker’s “knowledge worker”.
So, why is it that technology that has an even more intrusive and pervasive influence in our lives after the 1990s, is not able to generate increases in productivity and economic growth of the same kind? What happened to the “creative destruction” that Joseph Schumpeter spoke of as being the great engine of capitalism?
Having just read Schumpeter’s book, Capitalism, Socialism and Democracy, in full where he does have a small chapter on creative destruction, I was prompted to write this piece about what ails innovation today. Of course, Schumpeter was also of the view that capitalism itself would self-destruct – though not in a Marxian way – because of monopolizing tendencies and consequent increase in bureaucratization. Could that be the “corporatism” that Edmund Phelps refers to, and could they both be describing the deleterious effects that we are seeing today?
My reading of the situation is that a variety of reasons have affected businesses’ ability to innovate in recent years.
The first is that the technology of today is quite different from what the world experienced before the 1990s. Innovations that went before had a much larger, life-changing impact on our lives and their effects were also felt more widely across society. Which explains why people felt compelled to upgrade their education and skills when computers first made their appearance in offices, so they could use information technology to improve their efficiency and productivity.
After the rise of the internet and artificial intelligence, technology is of the kind that increasingly seeks to replace man. While we had automation and robots in factories, AI is making its presence felt across a wider range of industries today, and even more so in service-sector businesses. It is an ever-present threat to people and their livelihoods if not managed and regulated properly, including not upskilling employees.
Second, the innovations seem to be incremental and not radical like the innovations of yesteryear. Despite what Moore’s law says about the pace at which technology advances, the innovations of today come in byte-sized updates and software upgrades, which lulls us into believing our lives can also progress in byte-sized steps. Think of Apple’s iPhone launches each year, with people upgrading them ever so often until they realized that the product improvements were also getting slighter and less important. Meanwhile, competition in the smartphones market was fierce with Samsung and Apple trying to outdo each other.
The third reason is that technological innovations of the future will be of an intrinsically different kind. They will not be so much in products – which is what we have been used to, all our lives – but in services. Hardly surprising that Apple itself is increasingly looking to services and apps to grow its business and its profits, a greater part of which already comes from apps. The point is how will the world measure increase in productivity when this feature takes over large parts of the economy? Will the measurement systems of the past work as well, when the nature of the economy itself has changed?
A fourth factor that has an important influence is increased concentration of market power and wealth that we have been observing in the world. And from various studies, including Thomas Piketty’s, we know that this trend has accelerated since the 1990s. It certainly seems to coincide with the growth of the internet and the modern information economy. A paper titled Return of the Solow Paradox by David Autor and Daron Acemoglu of MIT and their colleagues in 2014, that I have also written about before on my blog, found that productivity and output in American manufacturing had barely grown in the 1990s and had in fact fallen since the late ‘90s. While some of this can be attributed to changes in American manufacturing with most of it going to China and elsewhere, I am inclined to think that businesses were also willing to tolerate lower productivity and output because they might have enjoyed better pricing power as a result of increased market concentration.
In fact, a 2017 NBER paper by David Autor and his colleagues at MIT titled Fall of The Labour Share and The Rise of Superstar Firms finds a strong correlation between market concentration in certain industries accompanied by the rise of what they call “superstar firms”, and fall in the labour share in firm value-added and sales in those industries.
A fifth factor and one that began the process of globalization, has also affected companies. The growth and rise of modern finance, which globalized well before companies’ operations did. While a lot of American innovation is attributed to start-ups that are largely financed by venture capitalists, the world of finance itself has innovated and been transformed, meanwhile. Companies can generate huge profits from their financial investments and it was not uncommon even during the financial crisis to find that companies were growing their profits on the back of what is called “other income”, i.e., non-operating income. While this feature on its own might not affect innovation directly, it certainly reduces a company’s appetite or incentive to innovate.
A 2016 paper, by James Bessen of the Boston University School of Law, titled Accounting for Rising Corporate Profits: Intangibles or Regulatory Rents?, tells us more about how companies increasingly make their profits, and it does corroborate Phelp’s corporatism theory. Bessen finds that both intangibles and rent-seeking account for the rise in corporate profits, but the share of increase in profits from political rent-seeking has undoubtedly grown, since the start of this millennium.
What can we do to unleash the spirit of true innovation in business once again? I have no magic wand, but a few simple suggestions that might pave the way and create the right climate for more and better innovation to take place.
First, don’t let technology become the tail that wags the dog, but create an environment in which technology functions according to certain principles and rules. Politicians, especially those on the right love to argue that regulation kills innovation, but I think the time has come to regulate the technology industry. Not merely because of its outsized influence in every aspect of our lives, but because much of business in this century and later will be conducted on the basis of technology. It already forms the backbone of several industries, from finance, telecom and energy to education, healthcare and leisure activities.
Second, reform the rules that govern patents, copyrights and other intellectual property. The current system favours the winner-takes-all approach, and has proven to be extremely controversial in the pharmaceutical industry, for example. If you want to know why America spends 18% of its GDP on healthcare, and still gets inadequate healthcare as is being borne out by the Covid crisis, look no further than big pharma. India, with its focus on generic drugs production has managed to grow its pharmaceutical industry by supplying the world, and so is China. I believe that if patents have shorter durations, but better terms for licensing and royalties, it will spur more and better innovation.
If we look at global patent applications, we find that they rose from around 1 million in 1995 to 1.7 million in 2005, at an average annual growth rate of 7%. From 2005 to 2015, the number of patent applications worldwide grew at a faster pace, from 1.7 million to 3.1 million at an average annual growth rate of 8.2%. It’s not just the faster growth rate, it’s also the composition. According to WIPO, the share of high-income countries in patent filings has fallen from 76.4% to 49.1 between 2007 and 2017, while that of upper middle-income countries has risen from 19.9% to 48.1% during the same period. China alone accounts for almost half of the patent applications worldwide after 2015, having overtaken the US in 2011.
All these facts don’t quite add up with what we have been discussing here: the lack of innovation and growth in productivity. Which means we need to look at the kinds of innovations as well, that are submitted as patent applications, since they appear to be highly incremental in nature.
Third, incentivize companies to invest in R&D and encourage collaboration with academia. In fact, I would say go one step further and incentivize R&D by small and medium sized businesses. There are many more of them and by sheer force of their numbers, innovation will catch on. Think of all the small, highly innovative companies in Israel, a country that is often called the Start-Up Nation.
It is in this context, that I would like to mention the importance of building brands as well. Brands are not merely intangible capital, they ought to form the very basis on which business operates. They help to encourage innovations of all kinds – product, process, delivery systems, and work as well in services as they do in products. Because brands are about companies and products’ affinity with people, they tend to be democratizing in nature and the world could do with more of that.
And finally, though easier said than done, disincentivize short-termism. In financial markets, in measuring profits and return to shareholders, and in gaining market shares, governments should do whatever they can to discourage short-term gains and create preference for long-term benefits. Perhaps it is this, more than anything else that has dampened businesses’ need to innovate, especially when the high-flying executive’s pay structure is closely aligned with the company’s stock performance and its gyrations.
The Western model of innovation has had its day and sadly seems to be on the wane. Will a new kind of innovation arise in the East, one that is more enduring, impactful and long-term in its effects? Looking at the surging numbers of patent applications from China and South Korea, we can perhaps look forward to such a development in Asia.
Whether it is based on technology or not, whether it is financially profitable or not, it ought to create a marked improvement in people’s lives and boost economic growth.
The featured image at the start of this post is by Sunbeam Photography on Unsplash