China had the largest economy in the world by 1500. By the end of the 19th Century, the U.S. and Western Europe had surpassed China in production and service.
Why? Some economists claim that the West’s unfettered innovation and free markets in China led to this shift. What is the link between innovation, markets, productivity, and inequality?
Panelists discussed how to measure innovation, the role of market forces, and which types of companies are most likely to innovate. The panelists examined the impact of productivity on wages, skills, and social inequality. They also considered how policies could be implemented to ensure innovation is accelerated.
How do you measure innovation
Amit Seru says that, like art, everyone can recognize innovation when they see it. But defining it and measuring it is “a holy grail for researchers.” Patents could be the key to answering this question.
Seru and his co-workers used big data techniques to analyze 9,000,000 U.S. Patents filed during the past two centuries. Researchers found that although Silicon Valley believes that startups are at the heart of innovation, established firms also showed high levels of innovation, as evidenced by their patenting activities. Researchers also found that private and public companies contributed to the creation and that universities and some government agencies were quite innovative.
To do this, the first step was to create a measure for high-quality innovations. Researchers compared the text of all patents in the database and tabulated the frequency of keywords. The patent would be considered novel if there was little or no overlap between its text and that of its predecessors. If the terms of subsequent patents are similar, then it is likely that the patent in question was an important innovation on which other patents have been built. Seru, a Stanford GSB finance professor, says that patents that met both criteria – i.e., novel and essential – were considered “high quality.” To check their findings, the researchers compared the list of high-quality patents with those already regarded as significant by economist historians. They found that the two lists were very similar. The researchers used this measure to examine which entities were responsible for breakthrough innovations and what patterns they consistently associated with them.
Seru says that “what is consistent” is the idea of creative destruction and the rational reallocation of resources around such events. Profits increase when firms innovate. Labor and finance flow towards them, away from competitors affected by this creative destruction. To achieve this, the labor and capital markets must function efficiently. Creative destruction and its associated patterns are nothing new. What is different is that today, innovation can occur between separate entities – such as the government and public or private companies – and inventors who work across geographical boundaries. Seru says that innovation is still brisk but could be hindered if the U.S. markets, functioning efficiently for centuries, were to become less efficient.
What happened to China
Stephen Haber, along with his colleagues, also used big data for the analysis of economic growth. They geocoded all significant cities in the world and then, based on various sources, looked at the level of economic growth every 100 years. The study took three years.
During a period when China had surpassed the West in economic advancement, it exchanged goods such as tea, spices, and silk for silver. Haber says that the West did not have much else to offer the Chinese at the time. By 1800, the West was able to gain an advantage. The difference was innovation — modern chemistry and steam power in transportation. Interchangeable parts were also important. But not only innovations in technology. Haber says that current economic growth was also a result of organizational innovations in the military, transportation, legal, and financial worlds.
A significant example is the idea of a patent as a property right that can be traded.
Haber says that “places where people could experiment freely, compete simultaneously and work together through a marketplace where no one decided which technologies were to be accepted, rejected and forbidden” flourished.
China, historically, took the opposite approach. The state had the power to reject specific technologies. Haber says that the Chinese emperor slowed down the development of railways because he was afraid they would undermine the agricultural system and threaten his power.
He says that today’s leaders should never forget this lesson. “If there’s a threat to the prosperity of our country, it comes from those who think they’re doing something good by using state power to decide what innovations are fair and which ones are not.”
How are productivity and inequality linked
Edward Lazear is a Stanford GSB professor of economics. He says that there are two ways to increase economic growth. The 20th century had tremendous economic growth. The standard of living doubled about every 33 years. This was a difficult target to achieve in the 21st century. Slower population growth and today’s aging population mean that productivity must increase.
Lazear says that productivity is a significant factor in wage growth. However, as productivity has declined over the past few years, wages have also decreased. Productivity grew about 3% per year in the late 1990s; today, it is only one-third that. It’s not surprising that wages are also flat. The pain of flat wages does not affect everyone equally.
Over the past 30 years, the pros highly educated workers’ productivity and wages increased. The opposite is true of less educated sections of the population.
The industries with the most growth are those that have the highest level of education, and the industries with the lowest levels of education are the ones that have seen the most significant decline.
Lazear argues that artificial intelligence and other technologies are irresponsible and won’t put everyone out to work. Jobs as a group, measured by the participation in the workforce, do not disappear when new technology changes the nature of the work. He notes that the Industrial Revolution was less radical, but the labor force grew.
The concern isn’t that people won’t work. Lazear says the problem is not that people won’t work but will do crappy jobs instead. It will be necessary for the government to rethink job training and education to alleviate this problem. Lazear explains that the key is to “lower the skills gap.”
