Innovation and the Investor State

The lagging growth of productivity despite enormous advances in information technologies remains the wonderful conundrum of economic life in the West through the previous 20 decades. This is the most pressing issue of the time. Disappointing productivity growth translates into insufficient expansion in family income and the marginalization of once-prosperous parts of the American population. It also renders the West losing ground to China, with possibly dire strategic and economic effects.
Philippe Aghion, CĂ©line Antonin, also Simon Bunel have achieved an important service by building a corpus of study on economic development in a single volume, The Power of Creative Destruction. This dense, chart-filled tome will be heavy going for the normal reader, but it belongs on the bookshelf of every public policy adviser and every member of Congress involved with economic policy. It summarizes the important data and relevant research on a vast range of problems with clarity and common sense, with no tripping on ideological stumbling-blocks.
America has a lengthy if limited tradition of state intervention into public life. “Limited” is the key phrase: By focusing government spending on infrastructure and fundamental R&D, the United States avoided several of the cubes of government interventionism. We haven’t gotten the formula very perfect.
The authors assert that the solution to stagnation, when there’s one, will need more government intervention, but of a highly selective kind, including subsidies for key industries and anti-trust measures contrary to the dominant technological monopolies. Their philosophical qualifications are impeccable. (Prof. Aghion is a part of The Center on Capitalism and Society at Columbia University, headed by Edmund Phelps, the 2006 Nobel Laureate in Economics.) But they see that capitalism requires government actions under particular conditions.
The Schumpeterian Contradiction
Creative destruction, clearly, was the watchword of the Austrian economist Joseph Schumpeter (1883-1950). The authors distill Schumpeter’s complex thinking into three straightforward statements. The first is that”innovation and the diffusion of knowledge are in the core of the growth process.” The next thing is that”innovation depends upon incentives and protection of intellectual property” The third is that”new inventions render former inventions obsolete… growth by creative destruction sets the platform for a permanent conflict between the old and the new” They mean by this “creative destruction thus makes a dilemma or a contradiction in the heart of the growth process. On the 1 hand, rents are essential to reward innovation and thereby motivate innovators; on the flip side, yesterday’s innovators must not use their own rents to impede new inventions.”
Schumpeter’s limit, as Edmund Phelps finds in his book Mass Flourishing, proceeded from the view of the German Historical School that”all material improvements in a country [are] driven by the power of mathematics.” He”added just one new wrinkle into the school’s model: the need for an entrepreneur to develop the new approach or homemade possible by the new scientific understanding.” What Phelps calls”mass-produced” appears when people all across society are ready to innovate. Under these circumstances, the”contradiction” mentioned by Aghion will vanish.
As an instance, American venture capitalists include successful innovators who have an interest in shielding the rents in their previous inventions, but who nonetheless invest in new businesses which may replace their earlier, effective ventures. In actuality, Aghion et al. include an superb chapter about the significance of venture capitalists which highlights the decisive purpose of economic culture.
In the United States, the typical venture capitalist started out as an innovative entrepreneur who received venture capital financing. The royal street is to get the entrepreneur to market her company by way of an IPO. Her personal experience as an entrepreneur has supplied her with the expertise and know-how required to choose the most promising projects and also to advise newer entrepreneurs pursuing these jobs.
One might add that the huge majority of venture capital yields accrue to a small proportion of VC investors. According to one poll, half of all venture capital funds eliminate money, an extra 35 percent of capital return 1 to 2 times investors’ money, and 15 percent return double or longer. This lopsided distribution of results underscores the significance of entrepreneurial expertise.
Instead of a virtuous cycle arising from Ricardian comparative advantage, since free-trade dogma predicted, the US entered a vicious cycle of falling incomes and reduced innovation.The writers add,”By comparison, In France, venture capitalists are often fund professionals whose career was in banking or insurance and who, therefore, have the practical entrepreneurial expertise nor the technological knowledge to advise a startup.
What Phelps calls economic dynamism avoids the so-called Schumpeterian contradiction because the owners of rents generated by preceding innovation spend the profits in future inventions. That is a cultural and political entity; France lacks the venture capital culture that predominates in the United States and Israel, for instance.
Schumpeterian antagonism involving owners of previous rents and prospective challengers has reappeared with a vengeance in the Information Technology business. Aghion and his coauthors cite studies that attribute the”decline in dynamism of the American economy as the beginning of the 2000s” to”an increase in industrial concentration and also at markups.” The dominant companies,”having already accumulated the most patents, are those that continue to file the most patents. These very same firms purchase the best amount of patents for defensive purposes, that is, to dissuade new creation by prospective entrants within their respective sectors.” That makes it harder over the years for the laggards to catch up with all the leaders” Therefore,”production ends up becoming more concentrated in the hands of these leaders, whose rents thus increase”
They conclude,”It is thus critical to rethink competition policy, particularly governmental policy regulating mergers and acquisitions, and to ensure technological revolutions, like IT and artificial intelligence, boost growth in both the short run and the long run.”
An October 2020 report by the House Subcommittee on Antitrust, Commercial and Administrative Law saw the Identical problem:
Although these companies have delivered clear benefits to society, the dominance of Amazon, Apple, Facebook, and Google has come at a price. These companies typically operate the market while at the same time competing in it–a situation that allows them to write 1 set of rules for others, even while they play by a different, or even to take part in a form of their very own private quasi regulation that is unaccountable to anybody but themselves. The impacts of this significant and durable market power are costly. The Subcommittee’s series of hearings generated significant evidence that these companies revamp their dominance in a way that erode entrepreneurship, degrade Americans’ privacy online, and endanger the vibrancy of their diverse and free media. The outcome is less innovation, fewer alternatives for consumers, along with a diminished democracy.
The contemporary equivalent of starvation in the midst of lots is stagnant productivity in the existence of fundamental technology shift driven by the IT sector.
Targeted Intervention
Public policy might help, and not simply in the kind of anti-trust measures against monopolistic and Big Tech. Republican dogma in the time held the cheap imports from China profited Americans by reducing the expense of consumer products. That isn’t the situation, according to studies cited by the writers. The more complicated the penetration of Chinese imports in any particular region of the United States, the more industrial jobs have been lost. Nor was the loss of industrial jobs the inescapable consequence of labor-saving investments. Over a fifth of manufacturing job loss may be attributed to the China jolt. And worst of all,”The loss of industrial jobs wasn’t the only consequence of the Chinese export shock. Wages also fell. Hence the negative effect of Chinese imports on regional economies was even worse, because the fall in wages decreased the demand for neighborhood services while raising the supply of work available for service-sector jobs”
Innovation also suffered: US patent applications fell when Chinese imports into the US hastened following China’s admission into the World Trade Organization in 2001. Instead of a virtuous cycle arising from Ricardian comparative advantage, since free-trade dogma predicted, the US entered a vicious cycle of falling incomes and reduced creation.
America’s tech industry has largely abandoned production in favor of software, which includes inherently greater profit margins, devoting the hardware into Asian manufacturers. That’s given Americans cheap way of entertainment but fewer industrial jobs.The question, then, is how to react to trade shocks. “There are two strategies to manage foreign competition: one is to raise import duties (tariffs): the other would be to segregate domestic companies to innovate more, especially with subsidizing investments at R&D,” the authors observe. Tariffs attempt to defend existing industries against fluctuations in the world economy, while service for R&D encourages domestic companies to leapfrog the competition and gain international market share. Citing studies by Marc Melitz and others, the writers note that tariffs suppress production by eliminating the incentive for national firms to boost productivity so as to deal with overseas competition. Subsidies for research and advancement, though, help domestic companies to compete against markets, and help”expansionary creation” on the part of companies that want to export more.
This general rule”doesn’t signify that protectionist policies always have to be rejected,” the writers allow. However,”tools such as public investment in the information economy, infrastructure, and industrial policy are more inclined to yield productivity gains and long-term wealth than a drastic increase in export duties.”
America’s high-tech business is one of the beneficiaries of these subsidies; it has largely abandoned production in favor of software, which includes inherently greater profit margins, devoting the hardware into Asian producers. That’s given Americans cheap way of entertainment but fewer industrial tasks. R&D subsidies encourage innovation, as Aghion et al. see, but it’s also true that Asian capital subsidies suck production jobs from the United States. The obvious solution is a shift in the tax structure to favor capital-intensive investment (rather than equity buybacks, which in 2019 surpassed total capital investment one of the S&P 500).
Immigration policy is also important, as qualified immigrants contribute disproportionately to American creation. One analysis of the period 1976-2012″reveals that foreign-born individuals who came in the United States after the age of twenty were responsible for 23 percent of total [creation ] output, which was more than their demographic weight of innovators (16 percent).” Immigration between 1995 and 2008″accounted for some 29 percent gain in the proportion of the US working population with a college diploma,” especially in STEM fields.
The writers draw a bright line between the”customer state,” which supports innovation, and also the”insurer state,” which utilizes state funds to maintain the status quo. European welfare state and industrial policy is a baleful instance of the policy condition. As an exemplar of their investor state, Aghion and his coauthors cite the Defense Advanced Research Projects Agency (DARPA), which”demonstrates a well-managed industrial policy can successfully nurture rather than inhibit innovation”
DARPA was created at the Sputnik Moment of 1957, when Russia beat America into space. “The DARPA model, they watch, is especially fascinating because it”unites a top-down approach using a half-dozen approach. On top-down side, the Department of Defense funding the applications, selects the application heads, and hires them to get a three-to-five-year period. On the bottom-up side, the app heads, who come from the private business… have full latitude to specify and manage their applications.” They notice “DARPA has played a decisive part in the development of high-risk projects with high social value, such as the net… and GPS.”
That is exactly right, but doesn’t quite catch what DARPA accomplished. Two things characterized every one of those signature creations of the electronic age, from integrated circuits to the web to optical networks.
The semiconductor laser that powers optical networks along with a huge number of different applications began with a Signal Corp job to illuminate battlefields through the nighttime. CMOS chip fabricating (mass production of light, fast, and energy-efficient custom processors ) began with a DARPA request to permit fighter pilots to run weather predictions in the cockpit but ended up trapping lookdown radar. Famously, the net began as a way to secure communications in wartime and became the most worldwide medium of info.
The authors say the hope that peaceful economic competition rather than war will inspire rivalry among nations, and in doing so they miss a vital stage about DARPA’s efficacy. Even the United States had to compete with Soviet discoveries, starting with Sputnik but including surface-to-air missiles that displayed devastating efficacy throughout the 1973 Arab-Israeli war. By supporting research at the frontiers of mathematics and computer engineering, DARPA motivated scores of corporate laboratories and several thousands of scientists to push the envelope of mathematics fiction.
Regrettably, peacetime industrial policy is subject to the whims of governmental constituencies who want to procure jobs and profits to existing industries. Defense R&D requires investigators to handle problems without any known alternatives and make technologies whose peacetime software cannot be predicted. However, the push to acquire wars has generated virtually all of the technologies that altered civilian life through the last generation. Our great bursts of innovation happened not because the right number of dollars came from Washington and also the right number of graduates came from universities, but because presidents like Eisenhower, Kennedy, and Reagan put good challenges before us, such as the Apollo Program and the Strategic Defense Initiative. Political leadership supplied not just the resources, but the inspiration and dynamism to perform things that nobody had envisioned before.