Wednesday, June 18, 2014

On Innovation

Two articles in the Wall Street Journal this week have got me thinking about the subject of innovation, or the lack of it, in Western economies today. The first was this article in the Wall Street Journal quoting molecular geneticist Jan Vigj in his book The American Technological Challenge who said that the number of inventions in America has dropped markedly since 1970 [and hat tip to Mark Steyn who said a similar thing in his book America Alone]. The second article was this one about Uber, the Internet-based taxi booking service that is challenging regulators and established taxi companies in 100 cities and 36 countries around the world.

To understand why the West is not innovating, we need to go back to the Renaissance to appreciate why the West has been so economically successful in the first place. Economic historian Niall Ferguson has identified six 'killer apps' that he believes underly the enormous growth of Western economies over the past 500 years, viz. political and economic competition, the scientific revolution, the rule of law, modern medicine, education and the work ethic. Ferguson expounds on his theory in his book, Civilization, and goes on to say that the erosion of these achievements is responsible for the decline of the West in recent decades relative to emerging economies such as China, which have increasingly adopted these values.

In my view Ferguson's six killer apps can be further reduced to just three things - individual rights, capitalism and the rule of law. In other words, the classical liberal values that became entrenched in the political and economic systems of Britain and the Netherlands in the 17th Century through the writings of John Locke, and that were picked by in the 18th Century in America by the likes of Alexander Hamilton, Thomas Jefferson and James Madison.

The innovative human mind is like a packet of dried seeds - without the right soil, water and sunshine, they will either remain inert or any shoots that do sprout will soon wither and die. The environmental conditions in which the human mind flourishes are the freedom to live and work as one chooses (subject only to the right of others to do the same), the freedom to enjoy the fruits of one's labour, and the protection of laws that guarantee these freedoms for all people. These are the classical liberal values mentioned above that we have so abrogated in the West today. It is little surprise, therefore, that we are losing our innovative edge.

The exception over the past decade or two has been in the realm of information technology and the Internet. Often compared to the 'Wild West', the on-line world has remained lightly regulated with few barriers to entry or innovation. On-line businesses like Uber are able to innovate precisely because they sit outside the highly-regulated traditional markets they are challenging. In the West we have in effect two parallel operating environments - the traditional political and economic environments in which innovators face huge regulatory hurdles in getting their products and services to market, and the on-line environment in which heavy-handed government involvement has been largely absent until now.

The United States provides the starkest example of this dichotomy. Traditional 'bricks and mortar' markets such as banking, manufacturing, transportation and medicine are subject to overbearing bureaucratic control and as a result American companies in these sectors are struggling to maintain their global leadership. Most economic growth in the United States in the last couple of decades has come from lightly-regulated 'digital' sectors such as software, entertainment and on-line services. But this is starting the change. The desire of Western governments to heavily regulate even the on-line world is starting to choke innovation in these sectors.

Western governments, including that in my own country, New Zealand, like to think the answer is more government. They like to think they can pick winners and encourage innovation through government investment and subsidies to certain industries. But history shows us that governments are poor gamblers when it comes to innovation. The clearest example of this in recent years is government investment in so-called 'green' businesses such as solar panel manufacturers. In the United States and Europe in particular, such investments have been disastrous.

Governments have a role to play in providing the fertile environment for innovation, i.e. in maintaining the institutions that uphold the classical liberal values that are responsible for Western political and economic success, but the most important thing they can do to encourage innovation is simply to get out of the way.

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