Monday, May 16, 2011

More on innovations and the role of governments

This is revisiting an old debate, thanks to the excellent Chris Dillow. Daron Acemoglu re-examines the classic claim that producers capture only a tiny fraction of the full benefits of any innovative activity and research and development activity should therefore be catalyzed by governments.

Analysing the incentives that drive investments in innovative activities by private firms and the direction (or areas) of those investments when the market is dominated by a particular technology or strategy, he writes,

"This paper... shows that equilibrium technological progress may exhibit too little diversity (too much conformity), in particular, foregoing socially beneficial investments in 'alternative' technologies that will be used at some point in the future. The presence of future innovations that will replace current innovations imply that social benefits from innovation are not fully internalized. As a consequence, the market favors technologies that generate current gains relative to those that will bear fruit in the future; current innovations in research lines that will be profitable in the future are discouraged because current innovations are typically followed by further innovations before they can be profitably marketed...

The recognition that there will be further innovations (in the prevailing technology or strategy) will discourage research in areas that will generate new products or technologies for the future relative to improving currently used products, processes, or technologies. Consequently, in equilibrium, too much research will be devoted to currently successful product and technology lines...

A social planner would choose a more diverse research portfolio and would induce a higher growth rate than the equilibrium allocation. The diversity of researchers is a partial (imperfect) remedy against the misallocation induced by the market. Researchers with different interests, competences or ideas may choose non-profit maximizing and thus more diverse research portfolios, indirectly contributing to economic growth."

In this context, Chris Dillow points to three reasons why this finding assumes even greater significance. He writes,

"1. If there is a danger of catastrophic climate change, then there is a need for new green technologies. But the danger that producers won’t get the fruits of such innovations - as they’ll be usurped by future better innovations - can lead to under-investment in them.
2. Capital spending and productivity growth have been weak for years. This might be a symptom of a decline in useful innovations. Maybe capitalism has picked the low-hanging fruit.
3. Many innovations (pdf here) since the 1980s have had the effect of increasing inequality. They’ve benefited capitalists and/or bosses at the expense of workers."

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