Tuesday, November 25, 2014

The Innovation Enigma

NEW YORK – Around the world, there is enormous enthusiasm for the type of technological innovation symbolized by Silicon Valley. In this view, America’s ingenuity represents its true comparative advantage, which others strive to imitate. But there is a puzzle: it is difficult to detect the benefits of this innovation in GDP statistics.

What is happening today is analogous to developments a few decades ago, early in the era of personal computers. In 1987, economist Robert Solow – awarded the Nobel Prize for his pioneering work on growth – lamented that “You can see the computer age everywhere but in the productivity statistics.” There are several possible explanations for this.

Perhaps GDP does not really capture the improvements in living standards that computer-age innovation is engendering. Or perhaps this innovation is less significant than its enthusiasts believe. As it turns out, there is some truth in both perspectives.

Recall how a few years ago, just before the collapse of Lehman Brothers, the financial sector prided itself on its innovativeness. Given that financial institutions had been attracting the best and brightest from around the world, one would have expected nothing less. But, upon closer inspection, it became clear that most of this innovation involved devising better ways of scamming others, manipulating markets without getting caught (at least for a long time), and exploiting market power.

In this period, when resources flowed to this “innovative” sector, GDP growth was markedly lower than it was before. Even in the best of times, it did not lead to an increase in living standards (except for the bankers), and it eventually led to the crisis from which we are only now recovering. The net social contribution of all of this “innovation” was negative.

Similarly, the dot-com bubble that preceded this period was marked by innovation – Web sites through which one could order dog food and soft drinks online. At least this era left a legacy of efficient search engines and a fiber-optic infrastructure. But it is not an easy matter to assess how the time savings implied by online shopping, or the cost savings that might result from increased competition (owing to greater ease of price comparison online), affects our standard of living.

Two things should be clear. First, the profitability of an innovation may not be a good measure of its net contribution to our standard of living. In our winner-takes-all economy, an innovator who develops a better Web site for online dog-food purchases and deliveries may attract everyone around the world who uses the Internet to order dog food, making enormous profits in the process. But without the delivery service, much of those profits simply would have gone to others. The Web site’s net contribution to economic growth may in fact be relatively small.

Moreover, if an innovation, such as ATMs in banking, leads to increased unemployment, none of the social cost – neither the suffering of those who are laid off nor the increased fiscal cost of paying them unemployment benefits – is reflected in firms’ profitability. Likewise, our GDP metric does not reflect the cost of the increased insecurity individuals may feel with the increased risk of a loss of a job. Equally important, it often does not accurately reflect the improvement in societal wellbeing resulting from innovation.

In a simpler world, where innovation simply meant lowering the cost of production of, say, an automobile, it was easy to assess an innovation’s value. But when innovation affects an automobile’s quality, the task becomes far more difficult. And this is even more apparent in other arenas: How do we accurately assess the fact that, owing to medical progress, heart surgery is more likely to be successful now than in the past, leading to a significant increase in life expectancy and quality of life?

Still, one cannot avoid the uneasy feeling that, when all is said and done, the contribution of recent technological innovations to long-term growth in living standards may be substantially less than the enthusiasts claim. A lot of intellectual effort has been devoted to devising better ways of maximizing advertising and marketing budgets – targeting customers, especially the affluent, who might actually buy the product. But standards of living might have been raised even more if all of this innovative talent had been allocated to more fundamental research – or even to more applied research that could have led to new products.

Yes, being better connected with each other, through Facebook or Twitter, is valuable. But how can we compare these innovations with those like the laser, the transistor, the Turing machine, and the mapping of the human genome, each of which has led to a flood of transformative products?

Of course, there are grounds for a sigh of relief. Although we may not know how much recent technological innovations are contributing to our wellbeing, at least we know that, unlike the wave of financial innovations that marked the pre-crisis global economy, the effect is positive.

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    1. CommentedG. A. Pakela

      Does Stiglitz own a smart phone or even know what one is? Is he still pining away for a Sony Trinitron? How many lives have been saved by the dozen or so airbags, anti-lock disc brakes, traction control and AWD in autos? How about the ability to be able to source almost any material good on the internet with transparent pricing that renders his Nobel in asymmetric information obsolete?

    2. CommentedSuhayl 53

      It all depends how one perceives the word "innovation". Important professions, such as lawyers, accountants and marketeers, are innovating all the time but their purpose is solely to improve the advantage of their client against the public. The innovation of technology is dwarfed and/or hijacked by the innovation of business, where the sole objective is to seek a higher "rent" from the invested capital. Innovation is like beauty - it is in the eyes of the beholder.

        CommentedSuhayl 53

        The temptation to be greedy dominates the desire to do good, especially in a society where money is held as a moniker for success.

    3. CommentedJose araujo

      I think it’s evident that the first order impact of innovation is many times the destruction of value. You do more with less, so the intrinsic value of the goods you produce is lower, but the second order movement is positive because not only you produce more of the goods but because it makes resources available for other uses.
      I also have don’t see any problem with bull/bear markets not being reflected on GDP, after all stock value should reflect the stream of future cash-flows, so if the stock prices are increasing due to future cash-lows or growth option value, then you shouldn’t see this value in the present GDP.
      Innovation also impact the wealth of a nation, i.e. the value of its existing stock of goods so in that sense the value it destroys many times surpasses the value it creates, and for sure it’s one of the prime causes of redistribution of value, where the value of old industries is transmitted to the new ones, and many times the sum of the two is negative.
      Finally, Innovation impacts directly on our perception of value, so what can explain the case the we cannot see the effects of innovation on GDP is because we don’t redo the books, and value past GDP at the current values.

    4. CommentedNathan Coppedge

      Re: (the primary article), I was amazed at the insights coming from framing parts of this work as a bulleted list. It brings up such ideas as how to market the consumer to the corporations ('infra-marketing'), how persistent are past ideas of innovation? / persistent systems, how does the government lubricate all major forms of economy simultaneously / or does it? should it?, how do we maximize the consumer without consuming the consumer?, how to not stimulate, but simulate innovation?, how to market economics itself, rather than just economic variables?, how to modularly expand concepts of economic growth / how to expand conceptually, rather than just materially? / Does this ever occur rationally / rational economics?, what policy satisfies the largest consumer with the best agenda / paradigmatic economics, what is the ideal economic infrastructure informationally, politically, or socially? etc. I don't find any of these quandaries anti-economical, at least. There should always be incentives for products, regardless of income. But sometimes it is necessary to extend incentives regardless of output, regardless of timeframe. Therefore, although the primary value is efficiency, that is not how it looks except at a complex scale (if it could be called complex when it fails is another question).

    5. CommentedNathan Coppedge

      Re: Kavvadias: "80's any day of the week" and Soffer "digital age": I think that although youth may believe the past is authentic, and the older adults may think the future is interesting, the immortal part of us favors some of both. It favors the persistence of the past, as well as the future that seems forever new. The archetypal things that are considered "ageless" as well as the dynamatrix of inherent potentialities.

    6. CommentedStamatis Kavvadias

      In a second thought, the author talks about two different kinds of GDP-related benefit and demines one of them. It is certain that Apple contributes to US GDP, doesn't it? How is it that "it is difficult to detect the benefits of this innovation in GDP statistics"?

      Otherwise, because these technology innovations are based on economies of scale, the advantage they provide is, more or less, uniformly distributed across the world, and can be exploited by competing international agents at the same time. This leaves little room for relative improvement in competitiveness. Well, except for competitiveness against the developing economies that cannot widely benefit and have to leave behind large parts of their population. So, it should appear in dollar exchange rates against developing markets and, in result, it would appear --which it definitely does-- in investment preference in the US.

      So, is the US stock-market a result of work of Wall Street or is it the indirect effect of US innovation?

        CommentedStamatis Kavvadias

        Btw, does prof. Stiglitz imply that, historically, Apple, or IBM before it, did not contribute much to US GDP growth? I would find that hard to believe...

        There is also the question, "what about Google and Intel?"... Here the answer is globalization. There are "better" taxation regimes than the US, so, the US is not "competitive" enough for these companies. (That's what prof. Stiglitz usually calls a "race to the bottom".)

    7. CommentedVS Aditya

      True to the mindset of oneself - INnovation can be considered as a myth constituing myriad ways of deception. Hard to ignore that these innovative methods mostly result on two things: One they do reduce the unwanted waste there-by focusing more on productive functions. Secondly, they do tend to acclaim the privilages to the dezerving by simply ignoring the others. It does provide the questions on what about others ?

      Often debated, the myth of innovation can also be linked to the management way of getting this done in a smart way. This can be possible only by relaxing the definition of what exactly constitues Innovation.

      Indeed most of the innovations mean a new invention of a idea/application of existing applications to generate better solutions. Having a proper statistic might view this perspective in a diff way.

    8. CommentedDonald Lee

      I want to offer a different perspective on this topic. I think many Americans take Silicon Valley for granted. If one just looks at macroeconomic figures, the overarching effects of technology could often lead to colossal dismissal because of its obscurity in the figures; but this should not be the case. If one looks at it from the angle of the corporate-side, everything becomes much apparent. If the U.S. companies still generated most of its corporate profits and growth mainly from the companies that were at its helm in the 70’s or 80’s, for example IBM or GE, what would have happened? These corporate giants plateaued after the dawn of the Internet era, and many jobs were created from Silicon Valley companies like Apple or Microsoft. This vibrant disruptive innovation is the cornerstone of the U.S. economy, and without it, the U.S. would have been in big trouble. To offer an opposing example, look at what’s happening in countries like Japan or South Korea. While there were many things in play owing to its decades-long recessionary spiral, one thing that is often overlooked is the fact that many corporate conglomerates experienced slowdowns in its businesses. Still, Japan managed to sail along quite well due to its strengths in various industries and SMEs’, but countries like South Korea has a disproportionate amount of economic concentration in only certain sectors and conglomerates, making them vulnerable if one of these companies such as Samsung or Hyundai fails. What these all illustrate is that, it is no doubt good to have an ever-changing corporate climate that embraces change and innovation. Japan and South Korea is experiencing a lackluster growth, and therefore insufficient job creation, because there are very little entrepreneurial activities happening there. The same old companies in the 70’s and 80’s are still dominating most of the countries’ economic activities, and this is stymieing their growth. The U.S. is not one of those, and Silicon Valley plays a central role in that.

    9. CommentedROBERT BAESEMANN

      Solow only said you can't see the computer age in the statistics. If GDP had ever included household services and personal services individuals performed for themselves, then some productivity gains in these areas might be showing up. Also, when I walk around a college campus these days, I see students walking between classes and talking on the phone. Fifty years ago, I saw students walking between classes and occasionally talking on the phone, but not at the same time. So small things like walking and using the phone were once substitutes but are now compliments. Likewise, commuting and working on a spreadsheet on a computer. For many years, FedEx drivers had computerized schedules and routes. Since the telephone became a portable computer, pizza delivery kids have vastly superior systems to guide them through a set of drop-offs. These days, an APP will give you direction to any address in your immediate vicinity or to one in Kiev. How are we supposed to account for the time and energy saved because people are not getting lost?

    10. CommentedProcyon Mukherjee

      The yardsticks we have used so far to measure the impact of innovation, needs to change; the innovator of laser, transistor or the Turing machine made not even a fraction of what the current innovators of the world are making. The consumers on the other hand of these earlier innovations received several hundred times the benefits that have flowed from the current innovations, of the likes of Facebook or Twitter.

      The way to judge an innovation is not by the how much the horde of investors are willing to pay, but by the sum total of the benefits that flows to the consumers of such innovation. Economics of this in the past actually balanced each other, but now it does not and the asymmetric system of pay-offs are so designed that the investors get benefited by several times of what the consumers can realize.

        CommentedStamatis Kavvadias

        But, if market investment does not reflect the social/consumer value of an innovation, then what are markets good for??? :-)
        What is it that markets really price, if it is not social/consumer value?

    11. CommentedJoshua Soffer

      "The contribution of recent technological innovations to long-term growth in living standards may be substantially less than the enthusiasts claim." Yes, measuring quality of life is tricky, especially when we attempt to understand it through the lens of monetary wealth.

      For instance, let's say I time travel back to 1790's Paris bringing with me a fortune in gold. As stimulating an environment as I may find there, think of what my wealth would not buy me: modern medical care, electric lighting and central heating and cooling, motion pictures, television, photography, musical recordings, telephones, motorized travel, not to mention all of the intellectual and artistic content that had not yet been made available in 1790.

      Now fast forward to 2014, and put me in a cheap rental with food stamps , medicare and an iphone. I now have access to advanced medical care, instant 24 hour worldwide social interaction, shopping and gaming, a near infinite selection of music, movies, video, photography, books, magazines and blogs, and much of this free or very affordable. There is no question in my mind that this constitutes a quality of life revolution for all who have been immersed in the digital age.

      The way we talk to each other, the way we think, have been profoundly affected by these innovations. I know that there is a wealth of new music, literature, movies, social contacts and intellectual exchanges that I continue to be exposed to on a daily basis, and that I never would have been had it not been for today's technologies. The fact that it has not made most of us wealthy yet is a problem, but how many of us would be willing to to trade a struggling middle class existence in 2014 for a time machine filled with gold bound for the year 1980?

      I'm an optimist, and believe that, with the assistance of government working in conjunction with the private sector to boost skill levels, the middle class will again be prosperous. But even if I'm wrong about this, can you imagine what might be possible, in terms of quality of life, in a cheap rental 30 years from now with only the money to purchase the latest technology? IT might be enough to tempt a 1-percenter to leave his gold behind and point that time machine for 2044.

        CommentedEric Gullicksen


        You raise an interesting point, in an orthogonal sort of way. You say that "measuring quality of life is tricky, especially when we attempt to understand it through the lens of monetary wealth."

        Indeed, but your counter-example is measuring it through material well-being. This is one way to look at monetary wealth: as a placeholder for material well-being.

        From another perspective, say that of an 18th century French nobleman, it is more fundamentally POWER (which affords, as a side benefit, material well being, the dignity of not having to labor, etc).

        If you asked him if he would trade his ancestral estates, his voluminous library, servants, the artists and scholars he sponsors, personal musicians and court position for Netflix, foodstamps, and a drywall box, you might find yourself laughed back to the time machine.

        SImilarly with the 1%: I think after your first $100 million or so, you tend to stop making money for material well-being. I mean, how much more comfortable are you at a billion than you are at 100 million. It's doubtful you're going to convince a fabulously rich person manipulating the financial and political strings of a country to trade their position for any increase in material well-being.

        A thought experiment. Take two groups of people, each with an equally high level of material well-being and even monetary wealth. Now, one group has complete self-determination and the other group doesn't. How would you rate their living standards?

        If you say "the same, because living standard is a measure of material well-being," maybe that narrow perspective (not to single you out) is what lead you to your conclusions in RE the 1% and travelling back to 1790 to become an aristocrat.

        CommentedStamatis Kavvadias

        Let me add one more thing, which I did not think when answering before. As you get older, it makes more sense to travel forward in time, but the younger you are, life is much more interesting, sincere, and essential in the past.

        CommentedStamatis Kavvadias

        Well, it's obvious that you are very young! Anyone that has lived the 1980's would go back easily (unlless he had a personal bad story back then); that is even without the gold!!!

        To reverse it, do you really think that the choices of your example person "in a cheap rental with food stamps , medicare and an iphone," are more because of the iphone? I can understand the increase in choices because of food stamps and medicare, but access to world markets is a fallacy for someone on food stamps, and all the low cost accessibility to art and entertainment are substitutes for life.

        Go to 2044? I 'll take 1980 any day of the week!

    12. CommentedStamatis Kavvadias

      Maybe --I say maybe-- the world economy is already facing diminishing returns from its persistence in bank- and debt-funded economic growth. Maybe the age of the consumer is dying, not so much because of the consiousness reset that emerged from the financial crisis, but, before that, because of increased inequality (at the global level) and the resulting reduction in the ability of people to exploit or even access technological or other innovation.

      It would not be inaccurate at all, to blame the level of inequality, for partitioning and fracturing social structure and disintegrating social cohesion. Putting aside the (decade or more running) effects that created the financial bubble --which have been masking the actual economic situation by allowing people and nations to live beyond their means-- this has been taking place a long time now.

      As a result, quantifying competitiveness itself, in a diminishing or even decreasing scale of output returns, becomes exceedingly dificult through simple historic comparison of the metric. This is because the largest fraction of nominal agregate demand (GDP) is directed to subsistence and quality-of-life preserving (or substituting) activities. In other words, innovation that targets industrial goods and economies of scale, has limited exploitation and mostly to the extend needed for self-preservation, and its benefits can only be found in the domain of resilience instead of the expected growth effects.

      Possibly, the financial bubble was not accidental at all, since diminishing returns from innovation require a larger return on investment, reasonably directing banks to property investment and financial "innovation", and outside the real economy.

    13. CommentedMichael Nikolaou

      Thought provoking.
      Conspicuously absent, though, is an important and highly consequential recent technological innovation, namely unconventional (shale, tight...) oil and gas production through combination of massive hydraulic fracturing and horizontal drilling - fracking, for short. The Economist wrote "George Mitchell, the Texas oilman who pioneered fracking, did as much to change the world as anybody in the [Silicon] Valley" (July 20th, 2013. shortly before Mitchell's death). And the NY Times, not averse to alerting on the risks of fracking (also addressed by Mitchell himself, http://www.washingtonpost.com/opinions/fracking-is-too-important-to-foul-up/2012/08/23/d320e6ee-ea0e-11e1-a80b-9f898562d010_story.html) has extolled the tangible benefits of the fracking revolution on US employment, energy security, and power-generation related greenhouse gas emissions.

    14. CommentedSegun Zack

      Thoughtful article though with limited coverage of social innovation - from financial services to health to technological end of its spectrum. For us in developing nation, I believe social innovation is key to completely reversing socio-economic profile with significant proportion of the population living on less than two dollars a day. This I believe can significantly improve our nations rating on the Human Development Index (HDI) scale and also impact the prosperity of the people. Innovation that facilitates financial inclusion as seen in Grameen Bank's model and Safaricom's M-Pesa has made significant impact in the live of the people. So for us in developing nation, innovation that significantly impact the bottom of the pyramid and enhance their ability to comfortably meet their basic needs (re Maslow classical hierarchy of needs) is critically to our future.

    15. CommentedC Jared

      It's minus 11 this morning in march in Toronto. Yesterday I had a conversation with a grocer who was complaining about the quality of the kale. Can you imagine? In march, minus temperatures, and his expectation was for perfect kale on the shelf?

        CommentedEric Gullicksen

        They promised us jetpacks, but I guess winter kale is like the "participation medal" for our once bold excursion into the future.

    16. CommentedPaul Daley

      Economists might want to take some lessons from the Olympic judges who are asked to judge sports like ice dancing. The old centimeter, gram, second measures have very little meaning there, but the combination of compulsories, long and short programs and whatever else they use seems to produce pretty fair judgments most of the time. What would be the "compulsories" for an economy that sought to lead the world?