Wednesday, December 10, 2008

"Innovation Economics"

Will innovation economics provide the theoretical foundation for a 21st century entrepreneurial liberalism?

While the U.S. economy has been transformed by the forces of technology, globalization, and entrepreneurship, the doctrines guiding economic policymakers have not kept pace and continue to be informed by 20th century conceptualizations, models and theories. Without an economic theory and doctrine that matches the new realities, it will be harder for policymakers to take the steps that will most effectively foster growth.

Fortunately within the last decade a new theory and narrative of economic growth grounded in innovation has emerged. Known by a range of terms – “new institutional economics,” “new growth economics,” “evolutionary economics,” “neo-Schumpertarian economics,” or just plain “innovation economics”: – collectively, this new economics reformulates the traditional economic growth model so that knowledge, technology, entrepreneurship, and innovation and are now positioned at the center, rather than seen as forces that operate independently.

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This new doctrine of "innovation economics" reformulates the traditional model of economic growth so that knowledge, technology, entrepreneurship, and innovation are positioned at the center of the model, rather than seen as independent forces that are largely unaffected by policy.

Innovation economics is based on two fundamental tenets. First, innovation economists believe that what drives growth is not capital accumulation, as neo-classicists claim, but innovation. They argue that the major changes in the U.S. economy of the last 15 years have occurred not because the economy accumulated more capital to invest in even bigger steel mills or car factories, but because of innovation: the creation and adoption of new products, services, and business models. The economy developed and deployed a wide array of new technologies, particularly information technologies. Although capital was needed for these technologies, capital was not the driver. And it’s clear from the current financial crises, in which capital was chasing bad deals, that capital was not a commodity in short supply. Thus, the primary goal of economic policy should be to spur higher productivity and greater innovation.

Second, markets relying on price signals alone will always be less effective than smart public-private partnerships in spurring higher productivity and greater innovation. That’s because innovation and productivity growth take place in the context of institutions. In turn it is the "social technologies" of institutions, culture, norms, laws, and networks that are so central to growth. Innovation economists view innovation as an evolutionary process, where organizations act on imperfect information and where what economists call "market failures" are in fact actually the norm. But these are precisely the sorts of social systems that are so difficult for conventional economics to model or study.

As a result, innovation economics holds that the critical issue of the proper role of the state and market should not be understood, as it is currently by policymakers and others in Washington, as the state versus the market. Rather, as Beinhocker suggests, the issue should be seen as "how to combine states and markets to create an effective evolutionary system." And this is largely an empirical and practical problem–to which neo-classical economics, with its focus on prices and mathematical models, is particularly unsuited.

Over 70 years ago, as policymakers struggled to escape the grasp of outmoded economic doctrines that hindered them from effectively responding to the Great Depression, John Maynard Keynes famously stated, "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." Today, the challenge is for Washington’s practical men (and women) to stop being slaves of defunct economists–including Keynes–and start being followers of the kind of innovation economics that Beinhocker, Heller, and others so compellingly articulate.

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