CAN you have too much innovation? You might be forgiven for thinking that you can, given that the financial meltdown was caused, in large part, by overenthusiasm for financial innovations such as collateralised debt obligations and credit-default swaps.

Paul Volcker, the former chairman of the Federal Reserve, says he thinks the greatest financial innovation of the past two or three decades was the ATM, because it actually provided benefits to people. Financial innovation will continue – it always does – but it’s hardly surprising that it has a bad name at the moment.

Yet an economic crisis, whatever its causes, is when innovation of all kinds is needed most, because innovation is an important driver – perhaps the single biggest driver – of economic growth. Innovation need not simply mean new technologies or inventions; Paul Romer, a guru on the economics of innovation, likes to point out that it simply means discovering better ways to do things, whether low-tech or high-tech.

How can such discoveries be encouraged? The usual answers are investment in education, research and development, so that there is both a constant stream of new ideas and a workforce with the skills to exploit them; and the right business climate, with a minimum of red tape, to encourage entrepreneurs. But there are also other, more unusual ways to provide incentives to innovators. In recent years one of these ideas has been dusted off and reinvented for the modern age, with great success: the idea of offering prizes.

The most famous historical example was the British government’s Longitude prize of 1714, which offered a cash reward to anyone who could figure out a reliable way to determine longitude at sea; it was eventually claimed by John Harrison, inventor of the marine chronometer. In 1927, Charles Lindberg was motivated to make his historic flight from New York to Paris after a rich hotelier offered a prize to the first person to do so.
This changed the way people saw air travel and paved the way for the rise of commercial aviation.

But the idea of prizes to spur innovation had fallen from favour until it was revived in 1996 by Peter Diamandis, who offered a $10m prize for the first privately funded reusable spacecraft. The prize was claimed in 2004 by an American firm. (It is now testing a larger version of its spacecraft for Virgin Galactic, which plans to offer space tourism flights from 2011.) Diamandis’s X Prize Foundation has since offered prizes in many other areas, including medical research and energy-efficient transport. The great thing about prizes is that a relatively small reward can encourage a much larger investment in a particular field, as multiple teams compete for the prize.

This week Diamandis was presented with an innovation award by The Economist for his work: a prize for his innovative use of prizes to encourage innovation, in other words. That may sound like a brain-teaser. But, particularly in times like these, the world needs more innovation, not less.

Tom Standage is digital editor of The Economist

The Economist Innovation awards were held on 21 October; the accompanying Innovation Summit is taking place today at the British Library.