OVER the last five years, the British economy has experienced its worst growth since the 1920s. Yet, in important respects, the economy is faring far better than it did back then. Part of the reason lies in low interest rates and forbearance on the part of lenders, which have both helped to soften the damage to the economy in this cycle.
The UK has also escaped Great Depression levels of unemployment. Indeed, employment has risen for the last three years, as job growth in the private sector has outstripped public sector job losses. This is obviously welcome. But, the combination of an expanding workforce and a shrinking economy has meant that productivity, or output per worker, has dropped.
The causes of this so-called productivity puzzle remain obscure, though there are plenty of competing explanations. We are on stronger ground in analysing what, over time, makes economies grow. Here technology and innovation are clearly vital. But, in understanding the role of technology, what does history show?
Firstly, the application of new technology in an economy is at least as important as innovation. It is not necessarily ground-breaking inventions that matter to an economy as much as the ability to realise the potential of new ideas, wherever they come from.
Harnessing technology effectively requires a skilled workforce, and systems which facilitate the diffusion of new techniques. Within Europe, countries vary enormously in their capacity to exploit new technologies. The World Economic Forum ranks Ireland first out of 144 countries in its ability to absorb new technologies through foreign direct investment. Italy, by contrast, is ranked 122nd.
Secondly, the lag between invention and application has historically been long. It takes us time to work out how to get the most out of new products and ideas. The leading economic historian, professor Nick Crafts of Warwick University, has observed that electricity made a big impact on American productivity in the 1920s. US factories became organised around electrical power 40 years after the pioneering experiments of Thomas Edison. The Wright brothers’ aircraft first took off in 1903, but it was not until the 1970s and 1980s that air travel became an affordable mass form of travel. The implication of these long and continuing lags is that there is still huge benefit to be reaped from past inventions and discoveries.
Thirdly, the good news is that the lag between invention and exploitation seems to be shortening. It took 150 years for the full effect of steam power to be felt on UK productivity. The information, communication and technology revolution of the last four decades has marked its mark far more swiftly.
And, fourthly, markets often find new and unforeseen uses for technologies, creating more pervasive economic effects than were originally envisaged by their inventors. The initial application for radio, one of the transformational technologies of the twentieth century, was for ship-to-shore communication. Global Positional System (GPS) technology was created for military use, but has become a ubiquitous and productivity-enhancing civil technology. The market’s frenetic search for improvements squeezes the maximum value from new products and inventions.
Fifthly, consumers, rather than inventors or companies, tend to be the principle beneficiaries of innovation. Crafts estimates that only around 2 per cent of the total social gain from technological progress accrues to the innovators. Railways were a revolutionary form of travel in the nineteenth century but proved a poor investment. Mass air travel has changed the world in the last 40 years but, for much of this time, the airline sector has faced weak profitability.
Innovation is vital and widely seen as such. Yet history shows that it is the application and testing of new products and processes in the market that boosts growth. Growth-enhancing innovations work fastest in those economies that have the flexibility and capacity to exploit them.
Innovation is worth celebrating. But let’s not forget the less glamorous – but equally important – business of putting ideas and inventions to work across the economy.
Ian Stewart is chief economist at Deloitte.