Unblocking the arteries of innovation

Just when we need it most, innovation is suffering a market failure of world-endangering proportions

As if we weren’t in enough trouble, among the wreckage thrown up by the still-receding economic tide is a crisis of innovation. It may be hard to credit in an era of apparently ubiquitous technology, but the innovation that has powered the rise of the western economies has stalled. Tyler Cowen in his 2011 book called it ‘The Great Stagnation’. ‘The American economy has enjoyed… low-hanging fruit since at least the 17th century, whether it be free land,… immigrant labor, or powerful new technologies’, he notes. ‘Yet during the last 40 years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognise that we are at a technological plateau and the trees are more bare than we would like to think’.

Robert Gordon’s provocative paper, ‘Is US Economic Growth Over?’, goes over similar ground. In Gordon’s account, growth and progress have been driven by the pervasive uptake of General Purpose Technologies, or GPTs, that have fuelled three ‘industrial revolutions’ based on respectively steam and the railways, then electricity, the internal combustion engine, chemicals and petroleum, and finally, already 50 years old, communications in the shape of semiconductors, computers and the internet.

But productivity growth in the third wave has been much lower than in the second industrial revolution which reached its apogee in the decades after the Second World War. Both Cowen and Gordon attribute this to the fact that many of the advances in the first two rounds were one-offs, the magnitude of whose effects become progressively harder to reproduce. This may be true. But the incidence of innovation is also falling. Not only is the effort less effective, there is less of it about. Why should this be?

One important clue is in the dates. To anyone approaching the problem from the corporate end, the fact that the innovation began to falter in the late 1970s is a tell-tale sign. To see why, we need to look at the ecology of innovation, which is much more complex than the conventional picture of a couple of nerds tinkering in a garage allows.

Entrepreneurial inventors – Steve Jobs, Jeff Bezos, Sergey Brin and Larry Page – are the photogenic face of innovation. But iPhones, Amazons and Googles don’t spring from nowhere. For innovation to have systematic effect, would-be innovators need two other elements to be in place. With the great corporate labs (AT&T, Xerox) a thing of the past, one is state support for the fundamental blue-skies research that provides the seedcorn for long-term innovation. It is well known that the internet came out of the US Defence Research Projects Agency (DARPA); perhaps less so that Google’s search algorithms, some of Apple’s iPhone technologies and the whole US biotech industry also emerged from publicly funded research. Historically the US administration has been responsible for 60 per cent of the country’s R&D effort, and particularly the fundamental part.

The second element is finance. As Gordon Pearson notes (see his excellent The Road to Cooperation), the modern finance sector and the public limited liability company developed together as a means of managing the risks of bringing innovations to market. Finance supported corporate innovators by raising the capital necessary for the uncertain process of exploiting technological development, benefiting the economy as a whole.

But in a triple whammy, over the last three decades all three of innovation’s components have broken down, and for the same reason – the cult of shareholder primacy. In the corporate sector, innovation is a prominent victim (along with pensions, wages and long-term investment generally) of the ‘downsize and distribute’ policies that have been adopted since the 1980s to maximise short-term gains for stockholders (and thus also CEO bonuses). Companies are more concerned with protecting and extracting rents from existing positions than developing new ones. At the same time, finance has turned from means to end, and a predatory end at that. The roles have been reversed. Instead of supporting industry in the patient work of real-world value creation, finance has dedicated itself to value extraction. Instead of creative destruction, taking economies to a higher plane of efficiency, finance has pursued destructive creation, in Mariana Mazzucato’s phrase. Companies that innovate and invest for the long term are particularly vulnerable to the City and Wall Street raiders. For their part, governments in thrall to the same benighted notions of efficiency as the private sector have cut back on support for long-term research in favour of more applied projects. Austerity has just reinforced this tendency.

The result is a monument to perversity, a market failure of world-endangering proportions. On the one hand sits a financially and environmentally overheating real world in desperate need of a bundle of green GPTs to drive a fourth industrial revolution centred on sustainability. On the other are corporates stuffed with cash that they don’t know what to do with, while capital markets not only do nothing to connect the two but actively siphon off for their own ends the money that governments have printed to kickstart their economies. Thus the phenomenon noted by Mazzucato of ‘poverty (underfunding) in the midst of plenty (tens of trillions of dollars of wealth in search of high returns)’; venture capital retreating progressively from innovative startups; and b-school graduates whose entrepreneurial ambition is limited to founding social-media firms that can be flipped to Google, Facebook or Microsoft without the bother of establishing a business model capable of making money from real customers.

Instead of handing out yet more money to an unreconstructed finance sector, governments should be looking to unblock the arteries of corporate innovation by protecting companies from financial predation, speeding up City reform and setting careful incentives for long-term investment in green technologies – preferably before rather than after the lights go out.

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