Thoughts on innovation

John Cassidy credits the Nobel Prizes in Economics to William Nordhaus and Paul Romer as an acknowledgement of market failures (it is deeply disturbing that it required Nobel Prize worthy works for economists to realise this!).

He writes,

Take the development of transistors. Scientific researchers at Bell Labs invented them in the late nineteen-forties, and Western Electric started manufacturing them for commercial use in 1951. The customers who purchased the products that incorporated these early transistors, such as hearing aids and radios, presumably got their money’s worth. But that was only the beginning: once the basic knowledge of how to create a transistor existed, other businesses could use it to make different and better products, a process that Romer likened to creating new recipes. “By now, private firms have developed improved recipes that have brought the cost of a transistor down by a factor of 1 million,” he noted in a 1993 essay. “Yet most of the benefits from those discoveries have been reaped not by the innovating firms, but by the users of the transistors. Just a few years ago, I paid a thousand dollars per million transistors for memory in my computer. Now I pay less than a hundred per million, and yet I have done nothing to deserve or help pay for this windfall.”

Implicit in this line of reasoning is at least the following assumptions

1. It is private firms and markets which drive innovations,

2. therefore innovators deserve the high mark-ups they charge, 

3. innovators also deserve to appropriate all (or at least the major share of) the benefits from an innovation,

4. but innovators cannot appropriate benefits since it is relatively easy to copy innovations and commercialise them,

5. those who follow reap most of the benefits from those discoveries and the innovators reap disproportionately lower benefits, 

6. in the absence of such incentives businesses would not innovate, whereas presented with them they would do so, and 

7. consumers deserve nothing for the lower prices.

It is indeed striking that none of the seven assumptions would hold in many, if not the vast majority, of the cases involving commercial innovations. Marianna Mazzucato has documented it here and here. 

But the hegemony exercised by this narrative is striking. How about the following alternative narrative?

1. Private firms and markets drive commercial innovations which are built on decades of fundamental research financed largely by governments. Innovations are generally built sequentially on each other.

2. It is therefore only appropriate that the benefits of the commercial innovations that emerge from the foundations of public financed R&D be distributed proportionately and not allowed to be privately appropriated by just the last innovator. 

3. Very few innovations are truly path-breaking in so far as they emerge from first principles - general purpose technology innovations. It would be a mischaracterisation to claim that Facebook or Google or Amazon or Uber or AirBnB would not have emerged without those respective entrepreneurs. In each of these cases, a correct characterisation would be that each of those enterprising entrepreneurs and their respective companies were lucky enough to be at the right place at the right time in the path of technological evolution to be able to seize the breaks that came their way. 

4. Innovators are incentivised by a patent regime which is increasingly skewed in their favour. This allows them a monopoly market power which translates invariably, even in the hands of the best intentioned people, into high mark-ups and even price gouging. 

5. There are considerable entry barriers into copying - not only do you need to copy the innovation itself, it also necessary to copy/develop a business model. In case of knowledge innovations, barriers like network effects can be almost insurmountable. And now with the political capture of the institutions that makes the rules of the game, the entry barriers are institutionally entrenched. 

6. There is now a growing pile of evidence that businesses, despite sitting on massive cash surpluses, prefer not to invest in R&D and spend money on share buy backs and the like. 

7. Consumers are also taxpayers who underwrote the overwhelming share of the ultimate cost of bringing these innovations to them.