Citizens in the world’s richest countries have come to think of their economies as being based on innovation. But innovation has been part of the developed world’s economy for more than two centuries. Indeed, for thousands of years, until the Industrial Revolution, incomes stagnated. Then per capita income soared, increasing year after year, interrupted only by the occasional effects of cyclical fluctuations.
The Nobel laureate economist Robert Solow noted some 60 years ago that rising incomes should largely be attributed not to capital accumulation, but to technological progress – to learning how to do things better. While some of the productivity increase reflects the impact of dramatic discoveries, much of it has been due to small, incremental changes. And, if that is the case, it makes sense to focus attention on how societies learn, and what can be done to promote learning – including learning how to learn.
A century ago, the economist and political scientist Joseph Schumpeter argued that the central virtue of a market economy was its capacity to innovate. He contended that economists’ traditional focus on competitive markets was misplaced; what mattered was competition for the market, not competition in the market. Competition for the market drove innovation. A succession of monopolists would lead, in this view, to higher standards of living in the long run.
Schumpeter’s conclusions have not gone unchallenged. Monopolists and dominant firms, like Microsoft, can actually suppress innovation. Unless checked by anti-trust authorities, they can engage in anti-competitive behavior that reinforces their monopoly power.
Moreover, markets may not be efficient in either the level or direction of investments in research and learning. Private incentives are not well aligned with social returns: firms can gain from innovations that increase their market power, enable them to circumvent regulations, or channel rents that would otherwise accrue to others.