Column: Can America innovate its way to growth?

Wed Oct 23, 2013 6:23pm EDT

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(Reuters) - America is banking on economic growth. Its ability to pay debts, lower unemployment, and provide better living standards all depend on growth returning to its pre-recession levels and staying there. But what if it doesn't?

Several economists are worried it won't. Growth can come from three sources: more labor, more capital, or more innovation. The 20th century was remarkable because each of these factors grew. America's final push to manufacturing, and away from agriculture, increased the use of capital. The volume and quality of labor also increased. More people than ever finished high school and went on to college, and many women joined the labor force. But we can't repeat these events. Not only that, future demographic trends are not favorable. American education isn't giving many young people the skills they need to be competitive in the global economy. An aging citizenry means a smaller share of the population will be working to support everyone else. Lower rates of economic growth will make it harder to repay America's debt - both entitlements and outstanding treasury bonds. Servicing debt will take more resources from the economy, creating a vicious cycle of high rates and low growth.

But not all hope is lost; there's still innovation. Innovations make existing resources more productive. Productivity is measured by calculating how much output (GDP) increased or decreased given the inputs (capital and labor) used. If you get more output for the same amount of inputs, productivity has increased. That means if western economies innovate more, and thereby constantly increase productivity, they will still grow. If productivity outpaces the economic headwinds, America can still grow at the pace it used to. But that's easier said than done.

In his new book, Nobel Prize winner Edmund Phelps frets that the culture of dynamism that leads to innovation has dwindled. He recently hosted a conference on the future of innovation where Robert Gordon of Northwestern argued, using results from a paper he wrote last year, that the pace of innovation has slowed because all the big and important things (electricity, indoor plumbing, cars) have already been discovered. Tyler Cowen argued a similar idea, with his book The Great Stagnation. He also believes all the low-hanging fruit has been picked; there isn't much left to innovate that will have a notable increase in living standards. That suggests we've not only run out of new labor and capital but ideas, too.

This view seems to be confirmed by recent productivity estimates. Productivity increased by 2.3 percent, on average, each year between 1891 and 1972, but only by 1.33 percent from 1972 to 1996 and 1.33 percent between 2004 and 2012. Gordon believes the heady days of full integer growth are behind us. Between 1871 and 2007 GDP per capita grew 2 percent a year, on average; this meant living standards doubled every 35 years. But between the slower pace of innovation, changing demographics, debt and the environment he anticipates the American economy will only grow at 0.2 percent a year in the future.

But the future may not be as bleak as Gordon and the others suggest. First, it's too soon to judge the impact of recent technology. Economic historian Joel Mokyr, also of Northwestern, points out that it took 50 years to realize the impact of the steam engine; we can't count out new technology just yet. The infrastructure to deal with innovations often lags behind their creation. Take high-speed trains. They exist, yet America still doesn't have the tracks to accommodate them. We still may not have realized the true potential of recent innovations.

Also, the purpose of growth is improvement in living standards. But GDP per capita is not an adequate metric to capture changes in living standards. It fails to consider all the changes in quality of life. Mokyr said, in response to claims that innovation is no longer radical, "you may want a flying car, but wait until you need an artificial hip."

Cars provide an example of how innovation has changed to improve quality of life in ways GDP doesn't capture. The household adoption of cars in the 20th century does not seem to be matched by recent innovation. Cars still are cars; they don't fly or drive themselves (or at least not yet for the general public). But that undercounts some very important technologies that have transformed many lives. Things like anti-lock breaks and four-wheel drive means cars are much safer to drive. Between 1994 and 2011 the number of drivers killed in car accidents fell 24 percent. That's even more impressive if you consider that the number of miles driven increased 25 percent and the number of licensed drivers increased 20 percent. Not dying in a car crash is surely important to quality of life, even if it's less flashy than a flying car. The success of a car not killing someone is hard to fully capture in traditional productivity measures.

Mokyr also makes an interesting point regarding who benefits from innovation. New technology is associated with the young. But many recent innovations benefit the old. Old age and retirement look very different than they used to. Well into their 70s, many people are vibrant and mobile. Retiring baby boomers are becoming a desirable demographic who demand products and technology - especially medical innovation that enhances the quality of their lives. Technology that benefits the elderly won't have the same impact on traditional productivity.

Changing demographics also require us to redefine what we mean by increased living standards. We normally associate it with what more wealth buys, but that fails to capture leisure. Retirement used to consist of getting increasingly sick, feeble and dying. Retirement has gotten longer and more active: in 1970 the average retirement lasted 13 years, in 2010 it was over 18 years. People live longer and (up until the Great Recession) retired younger. This trend is not sustainable because it undermines growth by shrinking the labor force. But to some extent, longer and fulfilling retirements are not completely unreasonable. Increased prosperity means consuming more goods and leisure. The concept of modern retirement is one of the fruits of increased wealth.

An aging society may mean less growth and, just like more growth is presumed to benefit everyone, less growth is expected to be bad. But when you consider different demographics there are winners and losers. Japan has suffered from low growth since 1990, but the deflationary environment and long retirements meant good times for the Japanese elderly.

We don't know what the future holds. The latest revolution in technology may be sowing the seeds of something profound that benefits everyone. But, so far it seems we are on a path where more gains go toward the elderly. A more balanced and higher growth path will involve improving education and encouraging people to work longer. Though even a low growth future doesn't spell all doom and gloom, it shows traditional ways of measuring growth and innovation are aging too.

(Allison Schrager)

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