Innovation isn’t dead – but we mustn’t forget why the profit motive matters

 
Ryan Bourne
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ECONOMISTS have long realised that sustained improvements in GDP-per-capita and welfare are achieved through productivity growth, driven by innovation. Over the past 250 years, a raft of technologies, including electricity, sanitation, fossil fuel extraction and internal combustion have revolutionised agriculture, facilitated the industrial revolution, and slashed transportation and communication times. Following 700 hundred years of stagnation, we saw an explosion of new wealth and improved well-being.

But is the continuation of this innovation-fuelled growth inevitable? Last year, professor Robert Gordon claimed the gains from established technologies have now been fully-exploited, with recent IT developments not having the effect on productivity we once thought. Perhaps, he posits, the last few centuries were unique, and now we’re likely to return to a slow growth trend. Tyler Cowen’s 2011 book The Great Stagnation suggested that the US had largely exhausted gains from the “low-hanging fruit” of extensive land, life-changing technologies and widening education.

Both economists use a thought experiment to make their point. How willing would you be to give up the technologies developed in the past 10 years compared to losing, say, clean water or the aeroplane? Most people suggest “not very”. Likewise, travel speeds, having increased rapidly in the twentieth century, appear to have plateaued. According to some, this shows that innovation growth is diminishing over time.

Or does it? New innovations tend to stand on the shoulders of existing technologies because, in response to human challenges, there is an incentive (and larger pay off) to solve needs before wants.

But the most important innovations from the ongoing IT revolution will likely come from the way we organise existing activity, rather than through physical inventions. This makes the thought experiment difficult. Though air travel speeds may not have increased over the past 30 years, for example, online face-time conference calls have rendered a proportion of business travel unnecessary.

There are also time lags involved in the pass-through of new technologies to productivity gains (Capital Economics estimated the delay for James Watt’s steam engine was 60 years). Writing off the potential benefits of modern IT seems premature. At the very least, the modern internet means the diffusion of ideas from a larger population will occur more rapidly than ever before.

The policy danger is that the perceived inevitability of slower growth will lead to the role of the market being forgotten. The magic ingredient that has meant capitalism has generated sustained innovation is competition, or contestability, in the pursuit of profit. It comes as no surprise that the sectors of our economy most lacking in innovation seem to be the most heavily regulated and devoid of market pressures, with high levels of government subsidy and/or crony-capitalist relationships between government and firms.

Ryan Bourne is head of economic research at the Centre for Policy Studies.