Growthology

Growing Pains

My inaugural column for Forbes.com, "Avoiding the Coming Growth Slowdown," is now up.  Here's a teaser:

Consider this puzzle. Compare economic performance in two periods: 1973-1990 versus 1990-2007. Both periods are 17 years in length; both begin and end with the last year of an economic expansion. In the earlier period, the U.S. economy weathered oil shocks, stagflation, and a punishing recession in the early ’80s, and growth in labor productivity in the nonfarm business sector limped along at a dismal 1.33 percent a year. In the latter period, prosperity was interrupted only by a pair of brief, mild recessions, and the IT revolution led a dazzling rebound in productivity growth up to 2.33 percent a year. Yet in 1973-1990, real gross domestic product per capita rose at an average annual rate of 1.93 percent – better than the 1.85 percent average annual growth rate during 1990-2007. How could that have happened?

Check out the whole thing.

Raising Productivity Growth

Courtesy of the McKinsey Global Institute, here is an interesting new contribution to the debate kicked off by Tyler Cowen's The Great Stagnation. This new MGI report -- entitled "Growth and renewal in the United States: Retooling America's economic engine" -- doesn't mention Tyler's book, but it offers evidence that supports his argument -- as well as that of his critics. On the one hand, MGI makes a strong case that we are facing strong headwinds when it comes to prospects for future growth. On the other hand, contrary to Tyler, the report points out that there's plenty we can do about it.

The MGI report singles out demographics as the main obstacle to future growth, and it makes a strong case. Think about per-capita GDP growth as a function of two variables: growth in output per worker-hour (i.e., productivity growth) and growth in total worker-hours per capita. If the latter slows down, the former has to speed up for growth to stay on trend. According to MGI:

Today, however, the contribution from labor is slowing down as baby boomers retire and the female participation rate has plateaued. In the next ten years, the proportion of working-age Americans will decline from 67 percent to 64 percent. By the 2020s, the contribution of labor to US GDP growth rates is expected to decline to just 0.5 percent from a peak of 2.0 percent in the 1970s.

Accordingly, to avoid a dropoff in the long-term growth rate, labor productivity growth needs to compensate for the unfavorable demographic situation. Specifically, the MGI report says that output per worker-hour would need to increase by nearly a quarter to maintain the historical average of 1.7 percent annual growth in real GDP per capita.

Unlike Tyler, though, the folks at MGI don't think the orchard of "low-hanging fruit" is bare.  They see plenty of opportunities to boost productivity: diffusion of existing best practices, implementation of the next wave of emerging business innovations, and restructuring of low-productivity and highly regulated sectors (namely, education and health care) all offer promising gains. 

In addition, the report helpfully points out that our demographic situation is not unalterable. If the United States could achieve the same labor force participation rates for women and workers 55-64 as Sweden, the same youth unemployment rate as the Netherlands, and the same immigration rate as Australia, it could expect to add a full percentage point to its real GDP growth rate over the next 10 years. 

On a critical note, the MGI report is sometimes frustratingly short on specifics. In particular, it's much too vague in addressing what needs to be done to boost the abysmal productivity record of the health and education sectors. Nonetheless, it does frame the issue well -- and points the discussion in a more constructive direction than Tyler's fatalism.

The Great Stagnation?

That's the title (sans question mark) of a new e-book by Tyler Cowen, economics professor at George Mason University and blogger extraordinaire at the wonderful Marginal Revolution. The thesis is summarized by the book's fashionably prolix subtitle: "How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better."

Tyler argues that, ever since colonial times, the American economy has benefited from "low-hanging fruit" -- i.e., bountiful opportunities for growth. He singles out three in particular: free land, technological breakthroughs, and smart but uneducated kids. "Yet during the last forty years, that low-hanging fruit started disappearing, and we started pretending it was stil there. We have failed to recognize that we are at a technological plateau and the trees are more bare than we would like to think. That's it. That is what has gone wrong." Tyler identifies the exhaustion of easy opportunities for growth as the main culprit behind the slowdown in growth over recent decades, rising inequality, the nastiness of our present-day politics, and even the recent global financial meltdown.

It's a wonderful book: provocative, clever, full of surprises, accessibly written, and mercifully brief. And most of the constituent elements of his argument I wholeheartedly endorse. Indeed, in a weird coincidence, I have a new Kauffman paper in the works that touches on very similar themes. I agree with Tyler that growth has gotten a lot harder since the early '70s. And I agree that a great deal of political mischief has been caused by our collective failure to grasp this important truth.

But, at least for now, I can't buy into the idea of a "Great Stagnation." I just don't think the evidence supports Tyler's sweeping historical narrative that centuries of easy progress are now over. A lot of the force of his argument comes from contrasting the United States' glittering economic performance in the decades following World War II with the decidedly less impressive record in recent decades. But if you zoom out and look at the larger historical record, Tyler's Great Stagnation more or less disappears. And if you zoom in and examine recent trends in detail, the numbers likewise belie the claim that we have hit some "technological plateau."

Tyler correctly points out that median family income rose smartly after World War II only to fall off sharply in the '70s. GDP per capita figures reveal the same trend, albeit a little less dramatically (because of the rise in income inequality). Between 1950and 1973, the average annual growth rate of real GDP per capita was 2.5%; for the period between 1973 and 2007, the corresponding figure was only 1.9%

But look what happens when you put these figures in larger historical context (note: I'm using calculations by Angus Maddison for earlier periods and Census figures for post-WWII periods):

1820 - 1870            1.3%

1870 - 1913            1.8%

1913 - 1950            1.6%

1950 - 1973            2.5%

1973 2007              1.9%

From this broader perspective, what Tyler calls the Great Stagnation looks like a return to normalcy after the "Great Boom" of the post-WWII decades. Indeed, recent growth rates are better than those of all other earlier periods. So yes, growth has cooled down since the postwar "Golden Age," and that fact poses real economic and political challenges. But the Golden Age was the outlier, not our present era; it just doesn't make sense to talk about the present period as stagnant after centuries of easy growth.

Now let's focus on trends in recent decades -- in particular, productivity growth. If we've reached some kind of technological plateau, that should show up most clearly in a fall-off in the growth of output per worker hour.  But look at the actual BLS labor productivity figures for the nonfarm business sector:

1947 - 1973            2.8%

1973 - 1995            1.4%

1995 - 2007            2.7%

Once again, there was a big dropoff after the postwar boom. But then look what happened: beginning in the mid-'90s, fueled by the IT revolution, productivity growth came roaring back, nearly equaling the record of the Golden Age. It's hard to look at these figures and conclude, with Tyler, that the trees in the orchard are becoming bare.

Granted, the productivity comeback offers no ground for complacency. The productivity figures look better than the per-capita GDP figures, in large part because the labor force participation rate peaked in the late '90s, fell during the dot-com bust, and only recovered to early '90s levels by 2007 (superior growth in output per worker was thus partially cancelled out by sluggish growth in the number of workers). Meanwhile, the per-capita GDP figures look better than the median income figures cited by Tyler because of the rise in inequality -- that is, because income growth has been concentrated at the top of the socioeconomic spectrum.

These facts point to real challenges for future growth. One reason the labor force participation rate has stalled is the aging of the population -- a trend that is going to cause all kinds of economic and political headaches in coming years. And rising income inequality is due in significant part to slumping human capital formation: we reaped big gains from sending Tyler's "smart but uneducated kids" to high school, college, and grad school, but educational attainment at both the secondary and postsecondary levels has stagnated since the '70s even as the demand for highly skilled workers has continued to climb.

I've focused on criticisms here, but I want to close by reiterating what an interesting, intelligent, and thought-provoking book this is. Growth has gotten harder, and there are mounting obstacles ahead. For pointing out these sobering facts, and doing so in such an engaging manner, The Great Stagnation deserves a wide readership.

"Wrongology"

Immediately drop everything you are doing and read this article. Then, shove aside the growing pile of books on your nightstand and read this book this weekend (doing so will also deflate any tension with your spouse over the appearance of your nightstand). Discussion questions:

1. How can we really "know" anything? These pieces only reinforce my belief that one of the most profound philosophical statements in all of history comes to us courtesy of Bill & Ted: "The only true knowledge consists in knowing that you know nothing. That's us, dude!" (And, yes, I know I have written about this before, but really, is there anything more fundamental than the question of how we can know whether we're right or wrong?)

2. Where is the John Ioannidis of economics or social science more broadly?

3. I often think that a helpful research strategy would be to write a "bizarro" paper for every "real" research paper that we do. But I can't decide if that would have any merit or even feasibility. As Being Wrong details in such a lovely way, the most pernicious and persistent type of confirmation bias is the failure to seek out contradictory evidence--omission rather than commission. If anyone tells you how open-minded and open to criticism they are, they're probably wrong. It would seem to be much safer and saner to walk around with the presumption that you are wrong about everything until proven otherwise, but this strategy would clearly strain the limits of human identity and, thus, plausibility. 

4. If much of our conscious identity (the stories we tell ourselves) is composed of memories, but if those memories turn out to be mostly mis-remembered, what does that mean?

Finally, out of sheer coincidence, I also happened to stumble across this terrific sentence earlier today: "Both rationalism and functionalism grossly exaggerate the capacity of actors to know what they are doing before they have done it." (See question 2 above.) (HT: Rogers Hollingsworth.)

Why Not a Market for Advancing Innovations out of Universities?

Yesterday I had the privilege of delivering testimony on behalf of Bob Litan in front of the Joint Economic Committee. The subject of the hearing was how the United States could maintain its position on the global frontier of innovation, with a specific focus on universities and federal funding of research and development. Most of the Members of the Committee were in general agreement with the panelists: innovation is key to economic growth, universities are important to R&D and innovation, and the United States needs to make some changes if we are to remain an innovative economy.

On one particular point, however, there was a considerable degree of contention. Congresswoman Carolyn Maloney (D-NY) inquired as to the state of technology commercialization in higher education. Can it be improved? Is everything peachy-keen? 

The Kauffman Foundation takes the position that all is not well in the land of technology commercialization. There are success stories, to be sure: Gatorade, Vitamin D, Netscape, MRIs and so on. And there are star performing universities--Stanford, WARF (the Wisconsin system), and the University of California system do a phenomenal job of moving innovations out of campus buildings and into new (and existing) companies. But universities, on the whole, appear to be under-performing relative to what they could be contributing to economic growth. The Bayh-Dole Act of 1980 allowed universities to hold the intellectual property rights to innovations and discoveries that result from federally-funded research. The result was a wave of university innovations as well as a wave of attempts to move university innovations into the marketplace. Most universities receiving federal R&D dollars established technology licensing or transfer offices (TLOs or TTOs) to manage the intellectual property and serve as the liaison for faculty members seeking to commercialize their innovation. As noted, many universities have managed to successfully commercialize new technologies.

As with anything, however, the structure that was set up in response to Bayh-Dole has now run into problems. The productivity of federally-funded research at universities has been declining for a number of years. Technology transfer offices are typically understaffed and unable to manage their university's stream of innovations--innovations, moreover, that often span a wide diversity of disciplines. At the same time, however, bureaucracy has grown up around the process of technology commercialization and dramatically slowed, if not stalled, the process in many places. Anecdotal evidence abounds of faculty members running headlong into bureaucratic drywall at their licensing office. Furthermore, as a result of the outstanding success of a handful of universities with a handful of innovations, many TTOs and TLOs have implicitly or explicitly adopted a home-run mentality, chasing the next big hit at the expense of many smaller innovations. 

Finally, many universities have latched onto the most easily measured outputs of R&D, patents and licenses. But, there is little correlation between federal research funding and the returns (in patents and licenses) on that funding. Maybe we shouldn't expect there to be such a correlation, of course, but the race by universities in the wake of Bayh-Dole to establish commercialization offices and the drift of research spending toward a more political rather than scientific distribution have raised the implicit promise that there is such a correlation. The wonderful historian Roger Geiger has documented such drift: at one time, the distribution of university innovations and federal R&D money to universities both followed a Pareto distribution, with a handful of institutions far outdistancing everyone else in terms of inputs and outputs. Over time, however, while the distribution of innovative outputs remains skewed, the distribution of research dollars has gradually gotten flatter. We expect proportional output in terms of innovations but don't receive it.

There is no magic solution to these bottlenecks, but my colleagues Lesa Mitchell and Bob Litan have come up with a fantastically simple and novel idea: open up technology transfer to market competition. That is, allow a professor from University X with a potentially breakthrough innovation to go outside his or her university's TLO and use that of University Y, if University Y happens to be more skilled at commercialization in this particular discipline. University X would not be required to relinquish IP rights, and of course the professor is not required to do anything. The idea is simply to bring more openness and competition into a process that has become muddled and distorted. Where else in society do we tolerate such artificial monopolies with public research dollars at stake? This idea, in fact, perfectly carries forward and extends one of the primary motivations behind Bayh-Dole--to smooth the commercialization process. Bayh-Dole was enacted in part to construct a platform upon which faculty and professors could more easily interact with companies (new and existing). Allowing universities to hold IP rights was meant to remove one of the legal entanglements in this process.

Who could oppose such openness? Who could oppose competition when competition has been shown repeatedly to be the best avenue toward maximizing innovation and social welfare? Not to sound trite, but follow the money. Most universities and TTOs and TLOs vehemently oppose this idea. In fact, you can scroll through the webcast of yesterday's hearing to the very last question and witness the animation with which Dr. Samuel Stanley opposes the mere mention of this idea. Basically, the opposing arguments boil down to these: (a) there is no evidence that the current licensing process is dysfunctional; (b) allowing such "free agency" would give rise to all the legal problems that predated Bayh-Dole and were put to bed by that legislation; (c) no professor and no university wants to do this; (d) technology commercialization is a delicate art that cannot be commoditized; and (e) the current system is working fine as it is--as proof, look at all the great innovations universities have given us.

Unfortunately, I did not get a chance for a counter-rebuttal, so I offer it here. First, Dr. Stanley (and others) confuses an absence of evidence with evidence of absence. The absence of overt dysfunctionality does not imply the corollary, that things are hunky-dory. In fact, the arguments I've mentioned above regarding research productivity and returns to patents and licenses would seem to indicate something is amiss, as would the growing stock of anecdotes from frustrated professors and companies. It is of course nearly impossible to prove that something like a university is not living up to its perceived potential in terms of commercializing innovations, but the inability to prove that there is room for improvement is not an argument against opening up the process. That, in fact, is the nub of the free agency proposal--just open it up. No one would be forced to operate as a free agent or to contract with a free agent, as Dr. Stanley seems to think we are suggesting. This is entirely optional, as is any competitive market. It could even be optional at the level of the department or school of any particular university, with one department perhaps choosing to work with ABC agent while another chooses XYZ agent.

Dr. Stanley also predicts that such openness would instigate a return to those dark days before Bayh-Dole when legal machinations corrupted every attempt at commercialization--contract disputes, broken agreements, etc. Oddly, however, technology commercialization at universities is still plagued by these problems--Bayh-Dole did not banish legal disputes, and I'm not sure how Dr. Stanley manages to pull off such cognitive dissonance.

By opening up the technology commercialization process, we would likely see the development of completely new organizational forms to facilitate the process. No one can predict what will happen--and that is exactly the point. Maybe free agency will flop; maybe it won't. But there is no (or shouldn't be) single model when it comes to technology commercialization: free agency would encourage experimentation as a way to lower transaction costs, which was precisely the idea behind Bayh-Dole. In fact, many professors are already finding their way around the TLOs and TTOs, doing "end-runs" around the bureaucracy and finding their own commercialization routes. Rather than see this perversion as a defense of the status quo we should encourage free agency as a way to promote the development of more such alternate pathways. In their promotional materials and commencement speeches, university administrators consistently trumpet the glories of diversity and self-actualization and intellectual experimentation--except, it seems, when it comes to their own operations.

That seems to be a running theme of opposition: technology commercialization is special and cannot be subject to the rules of the market that govern the rest of the economy. Dr. Stanley is far from alone in asserting that each particular innovation is unique and must be granted its own customized commercialization process that can only be run through a TLO. Undoubtedly, there is some truth to this. Just as clearly, however, there is plenty of room to lower transaction costs by standardizing some portions of the commercialization process. This is precisely what UNC-Chapel Hill has done with the Carolina Express License Agreement; we will keep you posted as to whether or not the world ends as a result of this dangerous experimentation with technology commercialization.

Finally, we come to the tried and true defense that everything is fine. Universities have, after all, contributed enormously to economic growth and human welfare. Why mess with success? The real message, however, is: don't mess with us! This is the completely predictable and understandable response of any institution when its monopoly is threatened and should, in fact, serve as a reason to promote more experimentation. Just because universities have contributed much in the past does not mean they are performing optimally today (research is only one of many fronts on which we could have this discussion) and does not guarantee that they will continue to do so in the future. If bureaucracy keeps building up around the discovery and innovation process, it is almost guaranteed that they will not.

Field of Dreams is an Awesome Baseball Movie, not an Economic Development Strategy

By some estimates, the United States currently has vacant office space running into the hundreds of millions of square feet: law offices, Fortune 500 companies, cookie-cutter glass boxes constructed on sandpiles of debt, etc. And, as discussed previously, commercial real estate (CRE) could very well be the next economic shoe to drop, dragging down whatever economic recovery is materializing. 

At the same time, it's increasingly clear to more and more people that recovery and expansion simply won't happen without entrepreneurs: new companies that bring innovations to market. Entrepreneurs are not the silver bullet solution, yet growth will not occur without them. 

So let's see: how could we possibly address a looming CRE problem as well as encouraging incipient and potential entrepreneurs? Got it! Construct completely new science parks! Ignore both problems and travel a well-trod path that, if not inspired by Field of Dreams, at least follows the same blueprint: Build it and they will come. 

Oh, wait, hold on a second, I'm being told that this idea is already being pursued--it seems that Congress has taken time from its time-consuming BCS debates to pass legislation that will ostensibly "spur innovation [and] economic with development" by building science parks. And wouldn't you know it, the bill miraculously finds empirical support from the Association of University Research Parks. This is a page right out of the NVCA's playbook.

Not that science parks are necessarily bad, but evidence on their effectiveness appears mixed and, in any case, the concept would seem to contradict, you know, the entire history of innovation.

The bill's title is "The Building a Stronger America Act," which should not be confused with Build a Stronger America, an entrepreneurs' movement that seeks, inter alia, to expand the popular notions of entrepreneurship and innovation beyond science parks and venture capital, beyond the idea of walling off our "innovators" from the huddled masses of ordinary humans.

One of the absolute best pieces to read on how innovation happens is J. Rogers Hollingsworth's chapter on "High Cognitive Complexity." Synthesis, not separation, is the key.

Update: Kedrosky has written a wonderfully scathing post focused on the CRE part of this issue.

Breaking Through Barriers to Innovation

The search is on for ideas that will stimulate short- and long-term economic growth in the United States without further adding to the budget deficit. Here's a no-brainer: allow university researchers with innovations that are ready to be commercialized to shop around to different technology licensing offices. 

That's the idea advanced by Kauffman Foundation vice-presidents Lesa Mitchell and Bob Litan in the forthcoming issue of the newly revamped Harvard Business Review. This issue features the top "Breakthrough Ideas for 2010" and, happily, this idea comes in at number 6!

Currently, if you are a professor with a new technology or innovation, you typically must work through your own university's technology licensing office (TLO). This is inefficient for a variety of reasons. For one thing, not all TLOs are created equal: some have greater skill than others, while a handful excel. Several decades ago, federal funding of academic research was dramatically skewed toward those universities that engaged in the most commercialization: patents, licenses, spinoffs, etc. In the last twenty or thirty years, the distribution line of federal funding has flattened considerably, with a greater number of schools receiving money than before. This is not to say that the distribution is equal, but it's much less skewed than before.

Here's the kicker: the distribution of innovation output--patents, licenses, startups--has not changed. It's still skewed toward a handful of schools despite the huge increase in the number of universities receiving federal R&D money. We are not reaping the benefits of innovations that are presumably emerging from all that research and development. 

While some TLOs are more competent than others, moreover, it's also likely that such competence varies by area: one TLO may excel at commercializing life science discoveries while another may have a comparative advantage in computer science. Opening up the market for discoveries and commercialization should help iron out the inefficiencies and barriers that exist.

Kudos to Lesa and Bob for a fantastic article and for advancing a top Breakthrough Idea of 2010.

Wired Looks Into Craigslist's Refusal to Innovate

Guest post by Charles C. Johnson

In the latest issue of Wired, Gary Wolf takes Craigslist to task for failing to iterate upon its 1999 website design. In an age of apps, why doesn't Craigslist make itself more user-friendly? Wired investigates. [Emphasis is mine.]

 Each of these sites, of course, is merely one of the many sections of craigslist, which dominates the market in facilitating face-to-face transactions, whether people are connecting to buy and sell, give something away, rent an apartment, or have some sex. With more than 47 million unique users every month in the US alone—nearly a fifth of the nation's adult population—it is the most important community site going and yet the most underdeveloped. Think of any Web feature that has become popular in the past 10 years: Chances are craigslist has considered it and rejected it. If you try to build a third-party application designed to make craigslist work better, the management will almost certainly throw up technical roadblocks to shut you down.

Most baffling about the article was just how lightly Craigslist is staffed, reflecting, no doubt, founder Craig Newmark’s fascination with creating online public goods.

Craigslist gets more traffic than either eBay or Amazon .com. eBay has more than 16,000 employees. Amazon has more than 20,000. Craigslist has 30. Craigslist may have little to teach us about how to make decisions, but that's not the aspect of democracy that concerns Newmark most. He cares about the details, about executing all the little obvious things we'd like government to do. "I'm not interested in politics, I'm interested in governance," he says. "Customer service is public service."

Craigslist, though, might be onto something in its refusal to innovate.

. . .  craigslist is old-fashioned in any number of ways. It relies on email and the telephone in an era of SMS and social networks. It sticks to traceless transactions in an industry that makes its living collecting data from every touch. And just as people who run technical companies are reaching an apex of confidence in their ability to invent new forms of community based on sharing everything, craigslist still treats social life as dangerously complex, deserving the most jaded caution. Corporate isolation, user anonymity, refusal of excessive profit, glacial adoption of new features: These all signal Newmark and Buckmaster's wariness about what humans, including themselves, might do if given the chance. There may be a peace sign on every page, but the implicit political philosophy of craigslist has a deeply conservative, even a tragic cast. Every day the choristers of the social web chirp their advice about openness and trust; craigslist follows none of it, and every day it grows.

The Distinct Dystopian Possibility

Tim posted two interesting entries in recent days, both touching on the recurrent question of whether or not we are entering an extended period of Dystopia. Given that it's been just over a year since I happily discounted the possibility of American Dystopia, I thought I might weigh in here. I won't keep you in suspense: I dramatically downgrade my optimism.

There are two related questions here, one pertaining to recent history, the other toward future projections. The first is whether or not the United States economy has really performed as well as we all like to think it has over the past two or three decades. This is a contentious issue among economists and I have nowhere near adequate space to address it, so I'll confine myself to Tim's point:

". . . the existence of the pernicious Dystopian Myth that middle class incomes are stagnant. The Dystopian Myth is social poison, a fiction shouted by the negative nabobs that convinces voters the American economic system is failing them."

Say it ain't so . . . but I will: it's sort of true. In June, Monthly Labor Review published this article, the abstract of which reads:

"OES [Occupational Employment Statistics] data from 2002–2007 reveal that an overall shift in employment towards occupations with lower mean wages hindered growth in the U.S. real average wage and that wage growth was concentrated in higher paying occupations; the data also show a shift in employment from the middle-paying occupations to the highest and lowest paying occupations."

The gist, as you can tell, is that real wage growth in this recent five-year period was basically stagnant overall because of the large growth in jobs paying the lowest wages--which actually appears to have come at the expense of better-paying jobs. The MLR article conveys the image, though not in so many words, of an emerging barbell-shaped wage distribution. Heartening. (I should just point out that Tim's characterization of the myth as a ploy to fool American voters is actually somewhat true--because voting participation follows income. Self-flattery as political vote-buying.)

Onto the larger point: is the United States now entering a Dystopian period of slow or stagnant growth, marred by class conflict, a dysfunctional national legislature (oh, wait, we already have that), and a "new normal" of diminished living standards? Again, this is a subject for a much longer disquisition, but for what it's worth, some recent reading I've been doing--and too many conversations with Paul Kedrosky--has me convinced that we are in for some very trying times ahead. We will see a short-term bounce in GDP growth here in the next quarter or two, but possibly 2010, and more likely 2011 and beyond, will bring discord, precipitated in large part by not only a higher "normal" of oil prices but also the realization that we are about to enter, prepared or not, a serious energy transition. Oh, and China's entire economy might be a bubble and we might be on the brink of having a failed state on our southern doorstep--because of plummeting oil production, not drug lords. (But they don't help; of course, if California legalizes marijuana to deal with its fiscal problems, this would be a boon for Mexico. Wouldn't it be ironic if the United States, irrespective of what party is in power, supported drug legalization because it would forestall the development of a basket case next door?)

OK, so I sound semi-apocalyptic. Don't get me wrong: I don't expect (at least, I don't think I expect) a Joseph Tainter-esque societal collapse. But there is a worrying disconnect between everyone who claims to see "green shoots" around every corner, even those who foresee a longer recession but eventual "normal" recovery, and the reality of long-term energy trends. Look, there is a reason why the Industrial Revolution has been more aptly named the Promethean Revolution (one of the best books on it is Landes' The Unbound Prometheus): humans harnessed inorganic energy. Our entire economic model is based on the premise of cheap coal and cheap oil: techno-utopians consistently ignore the inconvenient fact that much of that computing power they love to tout runs on such energy.

The obverse is that our economic model is not premised on permanently higher oil prices, whatever climate feedback loops we may be instigating, and the nontrivial risk of geopolitical instability. (The U.S. military, by the way, has little room for anything but a realistic appraisal of the future.)

Little of this will be new to readers: we all know we have energy issues to deal with. And, sometimes it's much easier to be pessimistic than optimistic about the future. To be sure, there are a few reasons for optimism. One is that humans are adaptive and we will likely find a way to adapt to the energy challenge. The profit motive will, or should, play a key role in this transition--this doesn't mean there is no role for government. Obviously, there is and should be: federal labs will be critically important going forward, but we need to unlock the innovations in those labs more efficiently. But government's role will be to do what it always does when it acts as facilitator, viz. frame incentives. In this case, it seems that a carbon tax would be an almost no-brainer. Then again, the fact that a carbon tax is treated like a shoot-the-moon option simply reinforces the pessimistic outlook. 

A key piece to moving forward through the next energy transition--and to possibly suppress or at least mitigate whatever geopolitical unpleasantness arises therefrom--is the supply of entrepreneurs. I don't just mean clean tech. We're talking about wholesale economic and social changes here--let's hope in slow motion, rather than abruptly. Don't just take it from me. At the recent World Economic History conference, Robert Ayres presented this wonderful presentation on the relationship between energy and economic growth, concluding that only entrepreneurs can take us forward. How's that for framing a policy debate?

(This pessimistic outlook, of course, will bring some amusement, namely, the perpetual cognitive dissonance of so-called conservatives and liberals as they endlessly bloviate in endless legislative fights. Rightward-leaning folk don't really seem to have dealt with the inherent tension between their Edmund Burke impulse and their defense of free-market capitalism as a ceaseless source of creative destruction. You can't sanction one type of change and seek to prevent the other. And liberals--or in today's parlance, progressives--haven't reconciled the exact opposite dichotomy: their embrace of "social change" as an all-encompassing yet vacuous strategy, but their readiness to preserve nostalgic remnants of the mid-twentieth century economy.)

The most frustrating thing about such a discussion is that it's quite difficult to talk about an alternative future because all we have to structure our imagination of that future is the present state of affairs. When we're trying to imagine what the next economic model will be, and how it will differ from the one that has carried the world forward for the last century and a half, we have little to draw on by way of reference points. But this, oddly, might be the strongest case for optimism: human knowledge always advances in a desultory fashion. We adapt by trial and error and adoption. The potential for future innovation and new knowledge creation shouldn't be in doubt--it's the institutional response, the adoption and absorption, that should be of concern. 

What's important is that we stop discounting the very real possibility that the future could be anything but bright: the fact that the last two hundred years have seen more or less upward progress in terms of human living standards, steadily spreading over the entire globe, is not a reason to believe that the future will simply be a continuation of this. Believing so is the mistake made by Taleb's "turkeys."

The sources of innovation are ...

 

The chart above comes from our recent survey of economics bloggers. For me, the results showed what I hope but were disappointing in that every source of innovation that we listed got a "Gentleman's B" or higher. 

The good news is that all of our policymakers think innovation is a good thing, growth is a good thing, and so on. The bad news is they still act on that instinct with classic "spend more" solutions. Innovation is not a rope that can be pushed. If it was, then funding more R&D would make sense. But in isolation, R&D spending won't get an economy very far.

Our panel of experts believes that the most important source of innovation is the "small start-up firm" which is in contrast to the venture-financed firms. In all fairness, the panel did not rate users, tinkerers, and garage entrepreneurs very highly either. That viewpoint is epitomized by the excellent research from Eric Von Hippel, and my guess is that still not enough people are familiar with it. Here's a quote from his 2005 book (which is freely available as a PDF at the link above):

The manufacturer-centric model does fit some fields and conditions. However, a growing body of empirical work shows that users are the first to develop many and perhaps most new industrial and consumer products. Further, the contribution of users is growing steadily larger as a result of continuing advances in computer and communications capabilities.

Innovation by Inches and Decades

A handful of interesting points on innovation this morning. First up is a link (via Tyler Cowen) that describes the Depression years of the 1930s as the most innovative in recorded history, a conclusion from Alexander Field's September 2003 paper in the AER:

The hypothesis does not imply that all of the effects of the advances registered in the decade were immediately felt in the productivity data .... Rather, it draws our attention to the probability that progress in invention and innovation in the 1930’s was significant, in ways not well appreciated ....

This is not as surprising as it seems, given that progress is defined as the growth rate of MFP (multi-factor productivity). One should expect that a severe reduction in output would cut the least productive capacity (labor and capital) first. A more severe downturn yields a more severe MFP increase. Likewise, you might think that the most booming of years would reflect low MFP growth. The paper includes data tables on compound MFP growth rates which indeed show this:

The weakness of growth in 1972-79 is well known, and explanations for it range from critical (new regulatory burdens hampered GDP growth) to apologetic (quality improvements in safety and the environment resulting from 1970s regulations are unmeasured output).

Measuring Innovation

A new line of research is exploring if GDP has been correctly including intangible value in a broader sense. Fields comments on this, but the "innovaion metric" movement is bigger still. Ed Prescott, for example, believes the intangible value of things like brands deserve much more attention. A commission created by the Commerce Department and headed by Kauffman's Carl Schramm explored the measurement of innovation with recommendations for improving such, published in this 20-page report in January 2008.

It must be said that the economists and staffers at the Bureau of Economic Analysis are constantly improving the measurement of GDP. Our thanks to them. In fact, I discovered today this study: "Toward Better Measurement of Innovation and Intangibles" of measuring innovation, published in January 2009 by BEA and published on its main page:

Expenditures on software, for example, have been treated as investment in the core accounts since 1999. And in 2006, BEA launched a research and development (R&D) satellite account, to explore investment in R&D and its larger economic effects.

My prediction: the measure of R&D will be extremely helpful, but will also reveal that the bulk of growth is still mysterious. Growth by innovation may itself be intangible and far deeper in human creativity than can be captured by research budgets.

So does all this mean the depression of 2007-2017 will be perversely good for the long-term economy. It would be nice to think so, wouldn't it?

Innovation, yes, but a Culture Receptive to it?

Michael Martin over at Broken Symmetry has a very good post on the requisite elements for a culture of innovation. His ideas are far better than the usual ideas floating around the political world.

ALERT: Americans to Secede from Humanity

This just in:

After three or four centuries during which citizens of the United States partook in that great narrative of innovation known as human civilization, Americans have suddenly stopped innovating. Biologists and anthropologists, anachronistically noting that innovation is a defining human characteristic, have duly concluded that Americans have thus effectively ceased to be human.

What are the causes of this crisis, in which the United States' "position is slipping" relative to the rest of the world? Laziness? Ignorance? Short-sightedness? Dastardly foreigners stealing our humanity? Yes, yes, yes, and yes!

The propensity to panic, of course, is as innate as the creative impulse. Two observations:

Am I naive to observe that many of those calling for a government-led national innovation strategy are--sometimes, not always--the very people who would benefit from, say, increased R&D funding or a more central role for venture capital?

It is striking that most of the recommendations for spurring American innovation, while claiming to be future-oriented, actually look backward. Imagine if, in the wake of World War Two, the U.S. had decided that future prosperity depended not on federal R&D funding, but a greater stress on prewar research modes, mostly privately funded. Or if, in the 1980s and 1990s, we had collectively decided that large corporate research labs were our only hope--forget start-ups, forget university spin-offs, forget entrepreneurs not dependent on R&D. Likewise today: is it really that clear that a return to prior modes of innovation--more federal basic research money, more venture capital--is the only way for us to innovate? (One of the biggest changes in the nature of innovation often seems to pass unremarked: the end of the Cold War. The Cold War was a huge spur to government (defense) research as well as large numbers of students majoring in engineering.)

I'm not saying that the long-term prospects for the U.S. economy are in tip-top shape, or that our innovation ecosystem lacks room for improvement. (Marc Andreessen makes a compelling case that innovation is "alive and well.") But, given the continuing shift of the American economy into knowledge-intensive services (not well captured by traditional measures of innovation), the rising importance of social production, and the more nebulous (and numerous) pathways of innovation outside VC and R&D, the panic seems overblown.

Can a State be Schizophrenic?

Apparently so. Florida, which has basically functioned as a giant pyramid scheme, is as a result ground zero for the housing bust.

Yet, as William Haseltine noted yesterday, Florida has shown incredible gumption in recruiting some of the top research centers in the world to set up camp there. Scripps, Burnham, Max Planck, Torrey Pines--these are far from insignificant institutions. The famed innovative organization, SRI, has set up a satellite operation in Florida, as has the Oregon Health & Science University.

Can a real estate Ponzi scheme turn out to be the most dynamic and innovative region of the country?

Genius Need Not Apply; We’ll Take the American Guy Instead

The Kauffman Foundation released a report today that challenged recent restrictions on H-1B visas.

The findings are summarized here, but here are the essential paragraphs

Immigrants have contributed disproportionately in the most dynamic part of the US economy - the high-tech sector - co-founding firms such as Google, Intel, eBay and Yahoo. In addition, immigrant inventors contributed to more than a quarter of US global patent applications. Immigrant-founded US-based companies employed 450,000 workers and generated $52 billion in revenue in 2006.

"Losing these skilled immigrants is an economic catastrophe that will hurt US competitiveness for decades to come," said [Vivek] Wadwha.

I can’t help but notice that the deficit in California alone is around $42 billion. Hmm….

Steve Lohr of The New York Times has more on the brain drain.

Economics, not visa headaches, is the main engine of the shift, according to the two-year research project, which surveyed 1,203 Indian and Chinese workers who had studied or worked in the United States for a year or more before returning home. Growing demand for their skills and shining career opportunities back home were cited by 87 percent of the Chinese and 79 percent of the Indians as the major professional reason for returning. Most also cited the lure of being close to family and friends.

Most of the returnees were young –- in their early 30s -– and nearly 90 percent had master’s or doctorate degrees. And 66 percent said that visa considerations were not a reason for returning home. “Addressing this issue is going to entail more than solving the visa problem,” said Mr. Wadhwa, referring to the waiting list of 1 million H-1B visa holders and their families who are seeking longer-term work visas.

Instead of permitting skilled immigrants to enter the United States, Mr. Wadhwa insisted, the country has to start wooing them by creating “fast-track” immigration policies and incentives to stay, as nations like Singapore and Australia have done.

The Obama administration and the Democrat-controlled House and Senate should take note. But unfortunately, they just passed a bill that bans companies that receive stimulus money from hiring any foreign workers. What a message to send to some of the foreign workers in our universities!

Technology Transfer and Beyond, Way Beyond

Universities have long been cited as an important source of innovation and, more recently, a key cog in the American entrepreneurial ecosystem. Much of the attention has focused on intellectual property that a university licenses, including to start-up companies that take technology out of the university and into the marketplace. (Hence the moniker, technology transfer.)

This, however, is only one mechanism by which university innovations have an economic impact--in fact, it may not even be the most important avenue of advancing innovations. This is one of the conclusions to be drawn from a new Kauffman Foundation study officially released this week by Edward Roberts and Charles Eesley of the Sloan School and MIT Entrepreneurship Center.

A conservative estimate is that, "if the active companies founded by MIT graduates formed an independent nation, their revenues would make that nation at least the seventeenth-largest economy in the world. A less-conservative direct extrapolation of the underlying survey data boosts the numbers to 25,800 currently active companies founded by MIT alumni that employ about 3.3 million people and generate annual world sales of $2 trillion, producing the equivalent of the eleventh-largest economy in the world."

These are astounding numbers and highlight the absolute centrality of universities to entrepreneurial capitalism. This in itself is probably not a new revelation for many readers, but this study brings to the fore the much wider impact that is often hidden beneath numbers that focus solely on licenses and patents. Innovation and entrepreneurship are much broader than that.

Why is MIT so successful at producing high-impact entrepreneurs? Culture, according to the authors:

"Rather than any single or narrow set of influences, the overall MIT entrepreneurial ecosystem, consisting of multiple education, research, and social network institutions and phenomena, contributes to this outstanding and growing entrepreneurial output. This ecosystem rests upon a long MIT history since its 1861 founding and its evolved culture of 'Mens et Manus,' or ' mind and hand' . . . [a] tradition of valuing useful work."

It has become fashionable to speak of national and regional economies as ecosystems, a salutary development that (hopefully) underscores the subtle and fragile connections among institutions that as a whole drive economic development.

But what this report makes clear is that such an entrepreneurial culture is usually not something that can simply be decreed de novo. What is interesting is that the universities that top the innovation tables today--MIT, Stanford, Wisconsin, Berkeley--all date to a period during which utility was a guiding principle of higher education. Laurence Veysey's fabulous book, The Emergence of the American University, is a great history of this period. The entrepreneurial cultures from which we benefit today have been developing for a very long time, something to remember as we search for ways to generate new innovation ecosystems today.

Our Debt to Darwin

Last Thursday marked the 200th anniversay of Charles Darwin's birth, and this year marks the 150th anniversary of the publication of his most famous work, On the Origin of Species. There have been plenty of books and articles commemorating the occasions, and there will undoubtedly be more throughout the year. But even on a blog dedicated to economic growth, we shouldn't let this pass unremarked. 

Darwin's primary intellectual contribution, after all--the evolutionary mechanisms of variation and natural selection--is one of the greatest and most influential ideas of all time. It is difficult to imagine a more fundamental and revolutionary change in human thought and perception than the teasing out of natural selection's implications over the last century and a half. (The shift, helping to spark the Renaissance and Enlightenment, from a closed to an open worldview in the late Middle Ages may be comparable.)

And economics has not been immune to this: "Ideas about 'rational' economic man are being overturned by new ones from a discipline called behavioural economics. . . . What is surprinsg is the degree to which human beings ar enot rational, and how the reasons for this are likely to involve Darwinian explanations."

More than that, an entire sub-field, evolutionary economics, has grown up in the Darwinian shadow. (The institutionalist school in the late 19th and early 20th centuries was also heavily influenced by Darwin.) I don't presume to be an expert on this, and much of the work in evolutionary economics strikes me as interesting but often of marginal relevance. (There are, of course, exceptions.) 

But the core of the idea, variation and selection, is unbelievably powerful and seems like an almost-perfect description of the intricate patterns of economic change. As applied to economics, that is (or should be) rather non-controversial. It is the larger implication of natural selection--the necessary lack of foreknowledge and the absence of a teleological end--that is apt to cause a stir. 

So any innovation, for example, can be called a variation. The fact of variation, however, does not presuppose merit or, importantly, success. As to the first, we need look no farther than the innovation of, say, collateralized debt obligations or subprime mortgages to understand that "innovation" is not necessarily synonymous with progress. Regarding the second, the inability to foresee success, we can all think of innovations--eight tracks, the Pinto, laser discs--that are now either ridiculed for their inanity or failed to really catch on. It is only in the messy process of selection--an economic as well as social phenomenon--that innovations are retained and propagated. Both--the generation of the new knowledge and their interaction with the environment--are crucially important.

I'm not smart enough to be able to say how the variation and selection model should reshape economic thought. (And many have already sought to apply it to various fields.) But, when we all seem to flailing about in the face of a severe recession (Gregory Clark says there has been no advance in economic knowledge in seven or eight decades), we could do worse than seek insight and understanding from one of history's most brilliant ideas.

Wiki-Limits

"Einstein could not have posted his theory of relativity on Wikipedia. Wikipedia is not the place for novel theories and ongoing work. Wikipedia is here to consume new material only after it has found its way into the 'mainstream' via multiple reliable secondary sources."

This unremarkable statement comes from one of the self-appointed volunteers who help police Wikipedia to ensure accuracy and objectivity. It's what we all expect from something purporting to be a reliable repository of knowledge, and anyone who has ever contributed to a Wikipedia entry knows how strictly they are monitored. On one level, this is very reassuring and makes me wonder why "professional" publications and associations refuse to accept Wikipedia as a citation source. 

Yet on another level, the above statement belies, in part, the lofty claims attending Wikipedia and its cousins, "crowdsourcing" and "folksonomy." (And yes, I have no compunction about linking to Wikipedia; I use it quite often, as I imagine most readers do as well.) 

In Wikinomics, Don Tapscott and Anthony Williams review the explosion of mass collaboration and peer production, from open source software to Wikipedia. These are supposed to lead to more participation and, ultimately, greater levels of innovation. Wikipedia founder Jimmy Wales calls Wikipedia a "Darwinian evolutionary process, where content improves as it goes through iterations of changes and edits."

As the Einstein statement above makes clear (and this particular volunteer is quite prolific in his or her monitoring--hundreds of revisions a day), places like Wikipedia are not always synonymous with innovation and we shouldn't make the mistake of assuming that mass collaboration always generates more innovation. Places like InnoCentive have a different structure, but when many organizations talk about collaboration and peer production, they often mean a model along Wikipedia's lines, with multiple people contributing to a single project.

For one thing, as we've noted elsewhere, innovation frequently, if not always, means an idea that is initially quite marginal. It is absolutely true that Einstein's theory of relativity would not pass mass collaboration muster. The structure of Wikipedia, as ingenious as it is at soliciting self-organization and self-regulation, is somewhat antithetical to innovation. And that's OK.

But it means mass collaboration as a phenomenon to be applied everywhere to stimulate innovation is a bit misguided. We're all familiar with human dynamics: any group of people, no matter how diverse, often gravitates toward a consensus view of things. Few people enjoy being the odd one out, or want to risk fraying a relationship over opposing viewpoints. And consensus, as valuable as it may be in some arenas like politics, is an antonym for innovation. Wikipedia and other peer production ventures may be seen as evolutionary, but variation and adaptation (non-teleological, by the way) do not have to meet a consensus standard to survive. And "spandrels," the nooks and crannies of natural selection, are often fertile sources of variations. 

I don't doubt the potential for innovation out of some models of peer production--creative thought, after all, springs out of the recombinations of existing ideas. The coming together of different people can be an efficient way to do that. If we want an economy based on innovation, we need as much variation from as many people as possible. Mass collaboration, depending on how it's done, can as easily stimulate that as it can stultify it.

The Bizarro Bailout

The ongoing sagas of the stimulus bill and financial bailout are, understandably, dominating headlines and online chatter. In no way do I intend to belittle the severity of the current recession and the overall gravity of the situation but, if history is any guide, these policy debates run in parallel to a bizarro world in which a separate economic future is developing.

In this bizarro world, the high-growth companies of tomorrow are just coming into existence, and innovations we cannot even imagine are in their infancy. A few years ago in the American Economic Review, economist Alexander Field declared the 1930s to be "the most technologically progressive of any comparable period in U.S. economic history."

In the bizarro spirit, then, I spent part of the morning canvassing what I like to think of as the frontiers of economic growth--the spaces where our future is being made right now. The stimulus and bailout matter to these frontiers, of course, but it's important to note that the as-yet-imagined future is materializing without word from Washington or Wall Street or anywhere else.

This is just awesome.

Stem cells are key.

The stimulus is apparently directed toward "shovel-ready" projects, but instead of shovels, what about nano-particles?

And this just sounds crazy, but still awesome.

Emergent Innovation: interview with Nathan Myhrvold

This is what makes Joel Achenbach special -- a fantastic interview with Microsoft's genius behind the throne, Nathan Myhrvold, written for the Princeton Alumni magazine and titled:

Inventing the future

The very cool world of Nathan Myhrvold *83

All of which raises a rather profound question: Were teeth inevitable? And what about the innovations in our own world — are they the result of carefully orchestrated projects, schemes, and hard work, or do they tend to bubble up from a million accidents and casual inspirations?  

“Broadly, overall, the way society works is emergent, and it is built on progress — it generally runs downhill toward something better,” Myhrvold says as we get deep into the philosophical weeds on all this stuff. The world is a better place now than it was 500 years ago, he declares. Driving that improvement is, he believes, technology. He’s an unabashed technophile. And he seems to have a strong libertarian streak.

“Creating new technology through invention is the single biggest value driver that our society has,” he says. “Humans grabbed the tiger by the tail when we invented agriculture, and it was one of the best and one of the worst things we ever did.”