Innovation - Econlib (original) (raw)

• Home /

ECONLIB CEE

Corporations and Financial Markets , Economic Regulation, Economics of Legal Issues

“
Innovation”: creativity; novelty; the process of devising a new idea or thing, or improving an existing idea or thing. Although the word carries a positive connotation in American culture, innovation, like all human activities, has costs as well as benefits. These costs and benefits have preoccupied economists, political philosophers, and artists for centuries.

Nature and Effects

Innovation can turn new concepts into realities, creating wealth and power. For example, someone who discovers a cure for a disease has the power to withhold it, give it away, or sell it to others.1 Innovations can also disrupt the status quo, as when the invention of the automobile eliminated the need for horse-powered transportation.

joseph schumpeter
coined the term “creative destruction” to describe the process by which innovation causes a free market economy to evolve.2 Creative destruction occurs when innovations make long-standing arrangements obsolete, freeing resources to be employed elsewhere, leading to greater economic efficiency. For example, when a business manager installs a new machine that replaces manual laborers, the laborers who lose their jobs are now free to put their labor into another enterprise, resulting in more productivity. In fact, in many cases, the number of jobs available will actually increase because the machinery is introduced.

Henry Hazlitt provides the example of cotton-spinning machinery introduced in England in the 1760s.3 At the time, the English textile industry employed some 7,900 people, and many workers protested the introduction of machinery out of fear for their livelihoods. But in 1787 there were 320,000 workers in the English textile industry. Although the introduction of machinery caused temporary discomfort to some workers, the machinery increased the aggregate wealth of society by decreasing the cost of production. Amazingly, concerns over technology and job loss in the textile industry continue today. One report notes that the introduction of new machinery in American textile mills between 1972 and 1992 coincided with a greater than 30 percent decrease in the number of textile jobs. However, that decrease was offset by the creation of new jobs. The authors conclude that “there is substantial entry into the industries, job creation rates are high, and productivity dynamics suggest surviving plants have emerged all the stronger while it has been the less productive plants that have exited.”4

According to Schumpeter, the process of technological change in a free market consists of three parts: invention (conceiving a new idea or process), innovation (arranging the economic requirements for implementing an invention), and diffusion (whereby people observing the new discovery adopt or imitate it). These stages can be observed in the history of several famous innovations. The Xerox photocopier was invented by Chester Carlson,5 a patent attorney frustrated by the difficulty of copying legal documents.6 After several years of tedious work, Carlson and a physicist friend successfully photocopied a phrase on October 22, 1938. But industry and government were not interested in further development of the invention. In 1944, the nonprofit Battelle Corporation,7 dedicated to helping inventors, finally showed interest. It and the Haloid Company (later called Xerox) invested in further development. Haloid announced the successful development of a photocopier on October 22, 1948, but the first commercially available copier was not sold until 1950. After another 16millionwasinvestedindevelopingthephotocopierconcept,theXerox915becamethefirstsimplepush−buttonplain−papercopier.Animmensesuccess,itearnedCarlsonmorethan16 million was invested in developing the photocopier concept, the Xerox 915 became the first simple push-button plain-paper copier. An immense success, it earned Carlson more than 16millionwasinvestedindevelopingthephotocopierconcept,theXerox915becamethefirstsimplepush−buttonplain−papercopier.Animmensesuccess,itearnedCarlsonmorethan150 million.8 In the following years, competing firms began selling copiers, and other inventions, such as the fax machine, adapted the technology.

Schumpeter limited his analysis of innovation to its economic aspects, but Friedrich Hayek pointed out that the same process takes place at the level of social mores and political philosophy. Hayek and his contemporary Karl Popper developed the political theory of the “open society,” stressing the importance of innovation for the discovery and testing of social values.9 In Hayek’s words, “the existence of individuals and groups simultaneously observing partially different rules provides the opportunity for the selection of the more effective ones.”10 This process, however, creates discomfort as well.

Reasons for Opposing Innovation

The discomfort that innovation generates has led many people to condemn it outright or to try to regulate it. Reasons for opposing innovation range from the practical concern that unforeseen consequences of untried innovations might cause disaster—as when a new drug causes unpredicted side effects—to immediate self-interest of those who benefit from the status quo—as when film studios sought to stifle the development of the home video recorder, which, they thought, threatened their profits.11 Likewise, dictatorships bar demonstrations and elections to prevent the dictator from losing authority. More theoretical concerns that, by altering the state of affairs, moral and social rules will also be upset can lead to regulation of innovation. Leon Kass, for example, argues that innovations in medical science will destroy important social and moral values such as respect for nature.12 In The Republic, Plato declared that in the ideal commonwealth, governing authorities would “be watchful against innovations in music and gymnastics counter to the established order, and to the best of their power guard against them . . . [f]or the modes of music are never disturbed without unsettling the most political and social conventions.”13 Opponents of innovation are frequently motivated by a desire to preserve a stable social order, often on the grounds that permanency is the essential goal of political society.

Innovation in technology upsets established orders no less than innovation in social mores does because technology and social mores are often intertwined. The introduction of steam power, firearms, and alcohol to Native Americans during the nineteenth century severely disrupted their ancient traditions. The introduction of technology into the workplace has often been a target of anti-innovation criticism. Household tools that reduced the amount of housework traditionally done by women enabled them to leave the home and enter the workforce in competition with men.14 One result was the passage of legislation barring women from certain professions, supposedly to protect them but in reality because, as the president of the International Cigar Makers Union admitted in 1879, “We cannot drive the females out of the trade, but we can restrict this daily quota of labor through factory laws.”15

Reasons for Innovation

Defenders of innovation, whom Virginia Postrel calls “dynamists,”16 argue that innovation is essential for solving problems that impose significant social and personal costs. For example, humans lived with disease and starvation for most of recorded history, but technological advancement has led to cures for many of these diseases and improved the production of food, with beneficial consequences for a great many people. The introduction of labor-saving technology was essential to this process even though it initially caused disruption by costing the jobs of manual laborers.

Moreover, some defenders of innovation point out that some of what opponents see as “costs” of innovation are in reality benefits. C. P. Snow, for example, argues in The Two Cultures that opponents of innovation tend to overlook the suffering of disenfranchised groups, or even to romanticize it. Postrel criticizes Leon Kass’s views on medical science on these grounds, arguing that it is morally wrong to regard suffering and illness as essential parts of human experience that ought to be preserved.17 By contrast, defenders of innovation often see it as beneficial for innovation to disrupt social orders they see as unjust; in The Hunchback of Notre Dame, for example, Victor Hugo dramatizes the importance of the printing press in disrupting the unjust social order of the middle ages.18

As with social disruption, dynamists regard the economic disruption caused by innovation as a benefit to the consumer and as an important step in the pursuit of economic efficiency. In short, dynamists tend to favor innovation out of a humanistic concern for the survival and flourishing of individuals.

Requirements for Innovation

There are two common sayings about innovation. The first is that “if you build a better mousetrap, the world will beat a path to your door.” In a seminal work on innovation, economist Jacob Schmookler gave credence to this view when he compared the rates at which patents were issued with the amount of investment in new technologies. Schmookler concluded that innovation is driven almost exclusively by economic demand: people engage in innovation out of a belief that the economic returns will be greater than its costs.19 But some economists criticize his approach as overly simplistic, particularly for ignoring factors independent of economics that heavily influence how innovation happens.20 Mere demand for a new product or service is not enough to bring an innovation about.

The other common saying holds that “necessity is the mother of invention.” But the reality is that leisure is the mother of innovation. In economic terms, surplus capital provides the necessary time and startup costs for implementing a new idea (see investment).21 Because a new product or service, or even a new social more, might not succeed, a potential innovator must assemble the resources to permit him to begin implementation without a guaranteed return on the investment. The ability to assemble and invest capital is therefore indispensable for innovation of any sort, and capital is available only when some people have enough wealth to permit innovators to spend their time thinking creatively.

But the mere availability of capital is not sufficient for innovation. Capital must also be mobile and stable (see property rights). Hernando de Soto explains that even in places where entrepreneurship is strong and capital is available, capital cannot serve the needs of potential innovators unless it is in a mobile form that allows various types of wealth to be converted into credit. This mobility includes “property document[s]” such as title deeds, which “represent the invisible potential that is locked up in the assets we accumulate.”22 Stability of capital is provided by the rule of law,23 by which the use of coercion in society is made regular and predictable. If investments cannot be insured against expropriation, possessors of capital are less likely to take the risk of investing in an innovation. Nations lacking a stable rule of law, including property rights, tend to be less prosperous and to have less innovation.24

Paul Romer, a leading scholar of economic growth, has explained that innovation results from a combination of growth-fostering social institutions and new ideas.25 Because ideas, unlike objects, can be shared by many at the same time, they greatly increase the speed of technological advancement. Capital, social institutions, and new technology, therefore, do not alone cause growth; they must be combined with the ability and willingness to think and act creatively (see entrepreneurship), which in turn means that innovation has philosophical and psychological requirements.26 The ability to think creatively requires epistemological tools such as the scientific method, by which an innovator can approach a problem and begin the process of solving it. Philosophies that have not produced such tools, such as dogmatic religions, tend to retard technological innovation. As Nathan Rosenberg and L. E. Birdzell note, the scientific method provided Western civilization with an indispensable tool in its creation of prosperity.27 David Landes’s book The Wealth and Poverty of Nations emphasizes that, in addition to geographical and other circumstantial causes, innovation has important ethical and metaphysical foundations. Societies in which innovation is seen as a sinful disruption of the proper cosmological order, or in which individuals are punished or shunned for thinking differently than others, are also unlikely to experience innovation. On the other hand, early America, for example, prospered in large part because it was “a seed bed of democracy and enterprise” wherein “equality bred self-esteem, ambition, a readiness to enter and compete in the marketplace, a spirit of individualism and contentiousness.”28

Some economists argue that larger firms have an advantage in introducing innovative goods and services, as they can afford to invest in developing a possibly fruitless new idea—which can be very expensive.29 RCA, for example, invested more than sixty-five million dollars in the color television, a lot of money in mid-twentieth-century dollars, before it became commercially successful. Also, some economists argue, larger firms can attract more talented employees to devise new ideas. But market dominance may not be as important as these economists suppose. Frederic Scherer notes that of sixty-one important twentieth-century inventions, more than half were devised by people who were independent of any formal research organization or who were college professors.30 Private research and development is responsible for the telephone, the lightbulb, paper matches, and even the baby incubator, which was introduced as a carnival attraction at Coney Island.31 Also, established firms are sometimes slow to introduce new creations: Gillette took its time introducing the stainless steel razor in the 1960s, partly out of fear that it would be so efficient that Gillette sales would decrease. (As with English textile machinery in the eighteenth century, this fear proved groundless.)32 And IBM delayed production of the personal computer until small upstart companies such as Apple and Commodore had introduced them successfully. Nor do long-established, wealthy firms necessarily have greater access to talent. Some Silicon Valley software companies have created workplaces designed to foster innovative talent, providing beds, foosball and Frisbee games, and snack rooms full of free food.33 Employees of the film company Pixar work not in cubicles but in “cottages” they design themselves, so as to create an ideal environment for creative thinking.34 An individual’s willingness to entertain unorthodox ideas and confront those who oppose his innovation as immoral or unwise will also determine his ability to innovate. The creative process often involves potential embarrassment and financial ruin. In extreme cases, it may mean conflict with family, friends, and religious or social leaders. Innovation is therefore related to the psychological phenomenon of self-esteem.35

Political freedom is also an important ingredient. Because innovation often requires the exchange and expression of ideas, the freedom to dissent is particularly important. Also, since innovation is often encouraged by a desire for profit, secure property rights serve as an incentive by ensuring that innovators are secure in the fruits of their labor. Scientific, as well as artistic or philosophical, innovation tends to be greater in countries with greater political freedom. Moreover, political freedom requires an innovation to satisfy the consumer, rather than the political authorities, if it is to succeed. Although economist Kenneth Arrow argued in the 1960s that free markets tend to underinvest in innovation out of fear of the risk involved, Rosenberg and Birdzell contend that Western nations prospered precisely because “the response of the market was the test of the success or failure of an innovation,” an effect that “was intensified by the Western practice of leaving the losers to bear their own losses, which were often substantial. This use of a competitive spur to stimulate change was a marked departure from tradition, for societies and their rulers have always strongly resisted change unless it enhanced the ruler’s own power and well-being.”36 In Rosenberg and Birdzell’s view, the potential risks of innovation help to ensure that capital is more wisely invested in a free economy than it would be in a command economy.

The prospect of monopoly profits is a particularly important incentive to innovation. A “new mousetrap” gives its producer an advantage against competitors, at least until the competitors imitate the innovation. As Schumpeter writes,“Every successful corner may spell monopoly for the moment.”37 One example of how innovations often begin with a desire for monopoly profits is the movie industry. In the early days of motion pictures, entrepreneur Adolph Zukor began Paramount Pictures. Like many other movie studios, Paramount integrated the entire film production process, from script writing to filming to distribution to movie theaters owned by the film company itself.38 Because motion pictures were still a relatively new idea, it made sense for a single firm to both produce and show movies—just as broadcast television networks were sometimes owned by the same companies that manufactured televisions.39 An antitrust lawsuit ended the movie studios’ ownership of theaters in 1948,40 but actual monopolies have also assisted innovation in some cases. One legal device designed to encourage innovation is the patent, a legal monopoly giving the holder the exclusive right to profit from the implementation of an idea. Any person who attempts to profit from the sale of something covered by another’s patent can be prosecuted and forced to disgorge his profits.

Yet, while the possibility of temporary monopoly may attract innovation, a permanent monopoly can stifle it. “A company which already dominates the market it supplies has little to gain by speeding up the introduction of product improvements,” writes Scherer. Hence patents are granted only for a limited time. This ensures that firms must continue to satisfy the consumer if they are to maintain their market dominance: “If their market position is threatened by the introduction of the smaller innovator, they have a great deal to lose by running a poor second: the larger share they would otherwise enjoy.”41 Besides IBM and Apple, the history of innovation is replete with examples. Henry Ford’s failure to introduce the electric starter gave the Dodge Brothers an opportunity to compete against the Model T. When the management of Ben Franklin thrift stores rejected the marketing ideas of employee Sam Walton in the 1960s, he went on to found Wal-Mart on his own.42

About the Author

Timothy Sandefur is the lead attorney in the Economic Liberty Project at the Pacific Legal Foundation in Sacramento, California. He is also a contributing editor of Liberty magazine.

Footnotes

See, e.g., Jane S. Smith, Patenting the Sun: Polio and the Salk Vaccine (New York: Anchor, 1991).

Henry Hazlitt, Economics in One Lesson (New York: Three Rivers Press, 1979) chap. 7.

See Frederic M. Scherer, Industrial Market Structure and Economic Performance (Chicago: Rand McNally, 1970), chap. 15.

On Popper, see http://www.eeng.dcu.ie/˜tkpw/; also see Karl Popper, The Open Society and Its Enemies, 5th ed. (Princeton: Princeton University Press, 1966).

Friedrich Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960), p. 63.

See, e.g., Leon Kass, The New Biology: What Price the Relief of Man’s Estate? (American Association for the Advancement of Science, 1971); online at: http://www.alteich.com/links/kass.htm.

See Virginia Postrel, The Future and Its Enemies (New York: Free Press, 1998).

Jacob Schmookler, Invention and Economic Growth (Cambridge: Harvard University Press, 1966).

See further Hayek, Constitution of Liberty, p. 205–233.

Nathan Rosenberg and L. E. Birdzell Jr., How the West Grew Rich: The Economic Transformation of the Industrial World (New York: Basic Books, 1987), pp. 250–257.

David S. Landes, The Wealth and Poverty of Nations (New York: Norton, 1999), p. 297. See further Jacob Bronowski, Science and Human Values (New York: Harper, 1965); W. J. F. Jenner, The Tyranny of History: The Roots of China’s Crisis (New York: Viking, 1992).

See, e.g., Kenneth Arrow, “Economic Welfare and the Allocation of Resources for Invention,” in Richard Nelson, ed., The Rate of Inventive Activity (Princeton: Princeton University Press, 1962).

Scherer, Industrial Market Structure and Economic Performance.

Nathaniel Branden, Self-Esteem at Work: How Confident People Make Powerful Companies (San Francisco: Jossey-Bass, 1998), p. 69.

Arrow, “Economic Welfare and the Allocation of Resources for Invention”; Rosenberg and Birdzell, How the West Grew Rich, p. 23.

Schumpeter, Capitalism, Socialism, and Democracy, p. 102.

Kevin Starr, Inventing The Dream: California Through the Progressive Era (New York: Oxford University Press, 1985), pp. 312–333.

Scherer, Industrial Market Structure and Economic Performance, p. 368.