In the year 1500, China stood as the leading economic powerhouse globally. However, by the 19th century, the United States, Western Europe, and Japan had surpassed China, surging ahead with significant production of goods and services, while China seemed to have hit a standstill. So, what led to this shift? Some economists argue that China’s constrained markets and lack of unhindered innovation compared to the West played a pivotal role. But how do innovation and markets intertwine with productivity and inequality? Recent discussions at a forum held by the Hoover Institution delved into these questions on the correlation between innovation and economic growth. Three Hoover fellows who are Stanford professors — Stephen Haber, Edward Lazear, and Amit Seru — shared insights on a panel moderated by Jonathan Levin, Dean of Stanford Graduate School of Business. The panelists explored the measurement of innovation, the role of markets, and which types of firms are prone to innovating. They scrutinized how productivity impacts wages, skills, and societal inequality, along with considering what policies might sustain a lively pace of innovation.
Measuring Innovation: A Challenge
Amit Seru likened defining and measuring innovation to a “holy grail” for researchers. His team utilized big data techniques to scrutinize 9 million U.S. patents filed over two centuries. Despite the prevalent belief in Silicon Valley that startups are the core of innovation, the researchers found established firms to also be highly innovative, as evidenced by their high-quality patents. They concluded that innovation came from private and public firms, universities, and certain government entities. The researchers first crafted a gauge for high-quality innovation. They achieved this by comparing the texts of all patents in the database, noting the occurrence of crucial words. If a patent’s text showed minimal overlap with previous patents, it was likely a novel innovation. Conversely, if subsequent patents used similar language, the original patent was deemed an essential innovation that others built upon. Patents meeting both criteria — novelty and importance — were dubbed “high quality.” Seru, a finance professor at Stanford GSB, mentioned that they cross-checked their list of high-quality patents with those recognized by economic historians, finding significant similarities. Using this measure, they studied which entities contributed to groundbreaking innovations over time and identified consistent patterns.
The Constant of Creative Destruction
“What remains consistent is the concept of creative destruction,” Seru remarked, highlighting the rational reallocation of resources around such innovative events. When firms innovate, profits soar, attracting labor and financing away from competitors who face the brunt of this creative destruction. For this dynamic to occur, efficient labor and capital markets are imperative. While the idea of creative destruction isn’t new, the modern twist lies in innovation sprouting across diverse entities — including governments, public, or private firms — and inventors collaborating across borders. Seru emphasized that while innovation continues to thrive, any hindrance to the historically efficient U.S. markets could jeopardize this progress.
China’s Historical Shift
Stephen Haber and his team, mirroring Seru’s approach, employed big data to analyze economic growth. To map out economically robust regions geographically, they geocoded major cities worldwide and tracked economic activity at 100-year intervals, a study spanning three years. During the era when China eclipsed the West economically, it traded prized commodities like spices, silk, and tea for silver, as the West lacked offerings of similar appeal, Haber explained. However, by 1800, the West surged ahead due to innovation — advancements such as modern chemistry, steam-powered transportation, and standardized parts. Yet, this innovation wasn’t solely technological; it also stemmed from organizational breakthroughs in military, transportation, and legal and financial realms, Haber elaborated. A prime example was the concept of patents as tradable property rights. “Regions where people had the freedom to experiment, to compete and cooperate simultaneously through an uncontrolled market, flourished,” Haber noted. Historically, China adopted the opposite stance: state intervention to reject certain technologies. For instance, the growth of railroads was significantly hindered by China’s emperor, fearing their spread would disrupt the agrarian society and his rule.Haber stressed this historical lesson should resonate with today’s leaders. “If there is a threat to prosperity, it comes from people who believe they are doing good by using the power of the state to decide which innovations are just and which are unjust.”
Linking Productivity and Inequality
Edward Lazear, an economics professor at Stanford GSB, outlined two pathways to economic growth: increasing population or enhancing productivity. The 20th century saw tremendous economic growth, with the standard of living doubling every 33 years. However, this poses a formidable target for the 21st century, given slower population growth and an aging demographic that necessitates productivity boosts for future progress. Productivity directly impacts wage growth, yet with recent productivity slowdowns, wages have also stagnated, Lazear pointed out. In the late 1990s, productivity surged by about 3% annually, now reduced to roughly one-third of that rate. Consequently, wage growth has also plateaued. However, this stagnation isn’t uniform across the populace. Over the last three decades, the productivity — and consequently wages — of highly educated workers have soared. Conversely, the trend is reversed for less educated segments of society. Compounding this, the industries witnessing growth predominantly employ highly educated workers, while those shrinking typically hire less educated individuals. Nevertheless, Lazear dispelled concerns that artificial intelligence and new technologies would eliminate jobs entirely. Looking at labor force participation, he emphasized that as technologies evolve, jobs as a whole don’t vanish. Even during the Industrial Revolution, which brought substantial change, the labor force expanded. “The concern isn’t the disappearance of jobs but the potential for ‘crummy jobs,'” Lazear emphasized. Addressing this issue, he advocated for a reevaluation of education and job training strategies, pinpointing the need to “close the skills gap” as pivotal.
