Innovations Tuesday, Mar 16 2010 

There’s been some talk about innovations recently. “Innovation” is defined as “The act of introducing something new” by the The American Heritage Dictionary. Not only are innovations new things, but they are also useful things. Innovation is one of the greatest sources of wealth creation and increased productivity. Thus, the importance of innovation is critical to the study of economics. In fact, there is an entire doctrine of economics, called innovation economics, that explores the relationship between innovation and economic growth. The pioneer of this doctrine was Joseph Schumpeter, author of Capitalism, Socialism and Democracy. According to innovative economics, the primary source of growth is not the accumulation of capital, but rather innovation, particularly innovation that increases productive efficiency. Thus, the incentivizing of innovation is what’s critical for an economy. In this sense, Schumpeter thought capitalism was the best mode of production because it incentivized innovation the most. Today, several prominent economists have used the theories of innovation economics to explain the growth of economies.

What is absolutely clear is that innovations are beneficial. How beneficial they are compared to other sources of growth could be debated, but it’s generally widely agreed upon that innovations provide a benefit to society. For example, King Banaian, the chairman and a professor of the economics department at SCSU, says entrepreneurship, which is a major source of innovation, is a positive externality and “may do more to relieve poverty than social organizations.” It’s a positive externality because “the value of this is not captured as much by entrepreneurs themselves as by society at large.” For example, with the invention of Windows, society was benefited far more than Bill Gates was benefited. (In other words, the price one pays for innovations does not reflect the true benefit it brings.) Basically everyone agrees innovation is great for society.

However, there are also problems with the current system of innovation, or the environment in which innovation occurs. One issue that I’ve highlighted on this blog before is that of copyrights and patents. Patents and copyrights are tools used to incentivize innovation and entrepreneurship. However, as I mention in the post, patents and copyrights create what are basically government-granted monopolies. As very elementary principles of microeconomics show, monopolies are economically inefficient. This can have significant impacts in the real world. For example, “economic inefficiency” might be translated into “hundreds of thousands of Africans dieing.” That’s precisely the consequence of patents in the medical industry, which keep prices high and poor people out of the market for life-saving drugs. Thus, I think it’s important to keep in mind the real world implications when we use technical and theoretical jargon like “market inefficiency”; it has real effects.

Essentially, the argument I made in that previous post is that government interference in the market creates an inefficiency (one that has dire effects) and that government-granted monopolies are not the solution for incentivizing innovation, particularly in the medical industry. I raised this point in Dr. Banaian’s post, and I got derided for it. I was told I was “only looking at one side of the issue.” After all, there’s a benefit that patents and copyrights bring, in that they do incentivize innovation, which we’ve all agreed is a positive thing. I’ve acknowledge that. If patents and such do lead to the creation of innovation and entrepreneurship, then that is a positive thing. We might even agree that the positives of this “intellectual property” outweigh the negatives of them. But that still doesn’t mean that patents and copyrights are the best option to choose. That’s an important point to keep in mind.

What I believe is “only looking at one side of the issue” is ignoring the more harmful consequences of this type of government interference. If some of the consequences of patents truly are harmful, even if there is a net benefit, we should ask ourselves if there is a way to mitigate the harmful aspects of our incentives for innovations without mitigating the positive aspects of our incentives. If there is, then we ought to choose that option.

Even though I do believe government-granted monopolies (i.e. the result of patents and copyrights) are quite harmful, that doesn’t mean government should necessarily get out of the way. I still agree innovation and entrepreneurship should be incentivized and rewarded. After all, if we accept the arguments coming from innovation economics, innovation is the key to economic growth. So how do we incentivize innovation without the harmful effects of patents and copyrights? There are different ways, but one idea that is proposed by Joseph Stiglitz, a Nobel laureate at Columbia University, is what he calls “prizes, not patents.” One of the problems with the current system (what I call the “profit motive“) is that it does not incentivize the allocation of scarce resources into areas that are not profitable for private, profit-maximizing firms—even when there’s a tremendous social benefit in doing so. (In other words, public goods are underproduced in free markets.) One example is in the production of life-saving drugs for illnesses and diseases that afflict much of the Third World. A majority of the populations that are afflicted by these life-threatening conditions are poor, so there’s not a lot of profit to be found in selling them drugs. A prize system, which is discussed in more detail in Stiglitz’s book Making Globalization Work, would help mitigate this problem by offering a reward or financial incentive to those who produce important innovations, like life-saving drugs. Not only would it incentivize innovation, it would direct resources into areas that would otherwise would not be profitable but are still a great benefit to society. Explains Stiglitz, “Since governments already pay the cost of much drug research directly or indirectly, through prescription benefits, they could finance the prize fund, which would award the biggest prizes for developers of treatments or preventions for costly diseases affecting hundreds of millions of people.”

There are other ways governments can be (and, in fact, are) critical in the introduction of innovation, which is through development that comes straight out of the state sector. CNN has an interesting article about the three most important “innovations that changed America.” The reader is asked to pick the most important of three, which are “1. The building of the interstate highway system, 2. The blanketing of the United States with coast-to-coast television, 3. The introduction and spread of the Internet.” Voting is now over, but 58% of readers chose the Internet, 29% picked television, and 14% picked the interstate system (numbers were rounded). I would agree, the introduction and spread of the Internet was the most important innovation that changed not only America but also the world. But where did the Internet come from? It came out of the state sector. The Internet was developed by the public, and it was later transferred to the private sector so that private firms could make a profit off it (that’s why we pay for Internet today). What about the interstate system, which is “often said to be the biggest public works project in the history of the world,” according the CNN article? It’s basically the same thing. This great innovation in logistics was created by the state, as I was quick to point out in a previous post on transportation subsidies. In television, it may be less clear, but the government still played an important role, particularly in broadcast television and the introduction of communication satellites. What this suggests is that, while (private) entrepreneurship is an important source of innovation, so too is the public sector.

In fact, a great deal innovation comes from the state sector. The Internet and the interstate system are two very important examples, but there are many others. In particular, high technology either comes from or is critically supported by the state sector. Science and innovation are symbiotic, and a lot of science is funded by the public. MIT, for example, is a source of great innovation; while a private university, MIT receives are great deal public subsidies, particularly through grants under the guise of military contracts. Public universities are also responsible for a great deal of innovation in both technology and ideas. This is what we should expect. If entrepreneurship and innovation is a positive externality, as Dr. Banaian contends it is, then we should expect that it would be underproduced in a free market. This image from Wikipedia shows this concept graphically. If private markets underproduce important innovations, then it suggests the state could play (as it currently does) an important role in either producing or incentivizing these innovations, e.g. through Pigouvian subsidies.


Globalization. What’s in a name? Saturday, Oct 24 2009 

Today, what we call globalization has become ubiquitous. Needless to say, “globalization” has fierce and unrelenting critics; perhaps chief among them is Joseph Stiglitz. Dr. Stiglitz, a professor at Columbia University and the former Chief Economist at the World Bank, won the Nobel Prize in economics in 2001 with two others for his contributions to our understanding of asymmetric information in markets. He has also made what I feel are important contributions to our understanding of the inequities that “globalization” bring about around the world, particularly with his two books, Making Globalization Work and Globalization and Its Discontents. While people like Thomas Friedman may write that “The World Is Flat,” in reality, we know that the playing field is not even but is tilted.

But how can we talk about globalization without first knowing what it is? So, what is globalization? Being an international business major, a lot of my courses have dealt with defining and discussing globalization. Probably the most common definition I hear is “the integration of businesses into world markets,” or something along those lines. That’s one particular way to define it. Used neutrally, however, the term globalization means international integration (that is, of any form). The term is not used neutrality, though. The term, in its current usage, “has been appropriated by a narrow sector of power and privilege.”

The term, as appropriated by the neoliberals, is meant to describe an economic order that favors investor rights over the rights of people. Some people refer to it as market fundamentalism, but I disagree. What is being advocated under this appropriated term really has nothing to do with free markets and is, frankly, and affront to markets. In fact, in incorporates very little of what Adam Smith advocated in The Wealth of Nations, the seminal work that neoliberals are always quick to cite. Take, for example, the free circulation of labor. It’s impossible to talk about free markets without the free circulation of labor. Smith wrote, “the policy of Europe, by obstructing the free circulation of labor and stock both from employment to employment, and from place to place, occasions in some cases a very inconvenient inequality in the whole of the advantages and disadvantages of their different employments….Whatever obstructs the free circulation of labor from one employment to another obstructs that of stock likewise.” This is part of the “perfect liberty” that Smith said would lead to “perfect equality.” Instead, there has been great work to limit the free movement of labor. In fact, in 1994, President Clinton went so far as to militarize the border in what was called “Operation Gatekeeper.” Why 1994? Because that was the year of NAFTA.

What is NAFTA? It is touted as a “free trade agreement” between Canada, Mexico, and the United States (it got the “NA” part correct) whereby barriers to trade and investment are eliminated. What does NAFTA really mean? It means Mexico opens it borders to highly subsidized U.S. agribusiness. This drives the peasants off their land because they cannot compete with this U.S. taxpayer-funded agri-exports. Consequently, they flee to urban slums (what’s called urbanization), driving down wages, allowing for large multinational corporations to exploit their cheap labor. That produces what’s called an “Economic Miracle,” where typical economic indicators like GDP, FDI, and corporate profit soar but the masses approach pauperization. That’s what America means by “free trade.”

What has this particular form globalization brought us? In what is hailed as the era of liberalization and globalization, world GDP growth rates have decreased by nearly 38% over the past 24 years (using the 2003 as the latest year with available figures) compared to the 24 years prior to that (the Bretton Woods era), according to data provided by Angus Maddison. Likewise, Americans have seen stagnated wages. The inequality of distribution of wealth has been simply remarkable, everywhere. Poverty in the U.S. saw a steady decline through the ’60s and ’70s; the ’80s, however, saw an incline in poverty and it has remained relatively unchanged since. Meanwhile, speculative capital flows have erupted, bringing with them destabilization, as Stiglitz has argued. It has also had the effect of wiping out domestic production for domestic needs, as we’ve seen in Mexico. Because local producers cannot compete with U.S.-subsidized agribusiness, many Third World nations must rely on what are called cash crops (as opposed to subsistence crops): bananas, cotton, coffee, sugar, etc. But not all the export crops are as innocuous as bananas; they also include coca, marijuana, poppy, and other drugs that fuel the current-day drug war, with Peru’s president calling the cocaine business the “only successful multinational to emerge” from Latin America in the face of globalization. It has certainly only given more credence to dependency theory.

Naturally, anyone that opposes this particular form of globalization gets called “anti-globalization.” It’s unfortunate because it’s not true, with the exception of very tiny minority who are truly anti-globalization, in the neutral sense of the word. International integration is, in fact, a great thing, as the people at the World Social Forum and other places have been espousing for years. It, however, should not be based on the blind faith in the religion of neoliberal markets, but rather should include more awareness for the rights of laborers, corrections for obvious market failures, and environmental protection as proposed by the adherents of alter-globalization.