State of Innovation

Patents and Innovation Economics

The Science of Economic Growth: Part 3

This is a multi-part post on the science of economic growth.  Standard economic theory has failed miserably to define the source of economic growth, which means it is impossible for it to provide rational policies to restore economic growth.  This series of posts defines a scientific theory of the source of economic growth.

Part 1 

Part 2 

Part 3 

Part 4 

Part 5 

Exogenous vs. Endogenous

            Robert Solow assumed that inventions were exogenous and therefore the most important factor in economic growth was essentially out of the reach of economic policy.  The exogenous model of growth has been refined by Michael Kremer[1] and more recently by Klasen and Nestmann.[2]  These models start with the assumption that inventors (brilliant or lucky) are randomly distributed through out population.  As a result, high population rates will lead to higher rates of invention, which will lead to increases in population (Malthusian Assumption).  This assumption works reasonably well throughout history, until the Industrial Revolution.  There have been attempts to refine the exogenous theory by adding population density.  However, none of these adjustments to exogenous theory can explain whyEngland was the epicenter of Industrial Revolution. France had a larger population by a factor of three and larger GDP and equally talented scientists.  Why did the U.S. overtake England’s GDP by the 1850s or why the overall GDP per capita and level of technology of the West grew so much faster than the East?  The one factor that is consistent is the rate of invention.

A number of economists have shown that inventors are motivated by financial return.  For instance, Jacob Schmookler, in Invention and Economic Growth, shows that demand or expected return is the biggest factor affecting the number of inventions in a particular industry.[3]  He also examined the role of scientific advances in the creation of new inventions and found that these had minimal effect on the number of inventions.[4]  His results were echoed by economic Historian Zorina Khan.[5]  She provides extensive evidence that the US patent system and economic forces affect both the level and direction of invention.  She shows that the US created the first modern patent system and the patent system provided the major incentive that caused the US to grow from an agrarian economy to a world economic and technology power in just 70 years.[6]  Note there was very little government sponsored research and development at the time.

Perhaps the best known endogenous growth theory economist is Paul Romer.  Romer makes the distinction between physical property, which is rivalrous, and ideas or recipes as he calls them, which are non rivalrous.[7]  He claims that:

With ideas, you have this tension: You want high prices to motivate discovery, but you want low prices to achieve efficient widespread use. You can’t with a single price achieve both, so if you push things into the market, you try to compromise between those two, and it’s often an unhappy compromise.[8]

Romer is ambivalent about patents for this reason.  He likes the incentive they provide for creating new inventions.[9]  However, he believes that it slows down dissemination of new technologies and results in monopolistic competition.

He further states: “Because everybody can use the idea at the same time, there’s no tragedy of the commons in the intellectual sphere.  There’s no problem of overuse or overgrazing or overfishing an idea.”[10]

This statement is misleading as applied to inventions and patents.  As soon as the invention is realized in a physical form, then the invention is subject to the same scarcity issues  as any other good or service.  The total market for an invention is limited (scarce) at a particular point in time and the goods and services necessary to realize an invention in its physical form are also scarce.[11]  When the infringer of a patent makes the invention, he reduces the market value of the invention to the inventor.  Patent law not only recognizes that ideas cannot be overused by too many people knowing about them, patent law actually encourages the spread of ideas.  A primary goal of a patent system is the spread of technical information.  Before modern patent systems, people and companies kept their inventions trade secrets, which inhibited the spread of information.  In theU.S., our patent system created a number of patent depository libraries to encourage the spread of technical information.  It is one of the requirements of patents that the information on how to “practice the invention” is part of the quid pro quo for receiving a property right in your invention.  Specifically, 35 USC 112 states:

The specification shall contain a written description of the invention, and of the manner and process of making and using it, in such full, clear, concise, and exact terms as to enable any person skilled in the art to which it pertains, or with which it is most nearly connected, to make and use the same, and shall set forth the best mode contemplated by the inventor of carrying out his invention.

Romer’s statement that ideas are not subject to the tragedy of the commons is misleading in another sense also.  One of the problems with commons is that when no one owns a resource, no one invests in the resource – or at the least they under-invest in the resource.  A system of limited term property rights for inventions is not the unhappy compromise that Romer suggests.  It encourages the spread of information about the invention and it provides incentives to both create new inventions and to invest in the dissemination of inventions.  Romer implies that it takes no resources to disseminate new inventions and others explicitly state this, but they are incorrect.  Inventing the electric light bulb did not allow instantaneous use by people throughout the World.  It required investment in manufacturing plants, distribution, an electrical power system, etc.  Without secure property rights in the invention, there would have been no incentive for anyone to invest in this dissemination of technology.  This was clearly shown in a study by Professor Hughes.  The study, British Electrical Industry Lag:1882-1888, examined how limitations on the rights (profits) of British companies attempting to provide electrical lighting resulted in the British lagging significantly behind the United States.[12]  Without the incentive of ownership, the British were unable to provide electrical lighting to their country.  Lack of strong property rights resulted in under-investment in the electrical industry inBritain.  Professor Hughes examines a number of other potential explanations.  Differences in technological talent between theU.S. andBritain? The British had more and better trained engineers.  The effect of economic downturns?  Both countries suffered economic downturn at the same time.  Interestingly enough, no other explanation  accounts for the difference in the dissemination rates of electrical technology in theU.S. andBritain.

Romer’s emphasis on scarcity and rivalrous vs. non-rivalrous goods, leads to a number of errors.  Entropy explains not only why goods are scarce, but why diminishing returns exist and why inventions are how humans overcome entropy and diminishing returns.  First, scarcity does not imply diminishing returns.  A scarce resource might be as easy to extract the first time as the last.  In this case, the resource’s cost would be exactly the same until we ran out of the resource.  Scarcity does not explain the ultimate struggle of all life – namely the need to extract more energy than one uses in order to stay alive.  Secondly, the nonrivalrous nature of ideas does explain how humans overcome diminishing returns.  The emphasis on rivalry leads to the idea that there is some sort of conflict between systems that encourage inventions but supposedly restrict the dissemination of inventions (production).  This conflict is also rooted in the idea that we want to maximize the production of goods today (existing inventions).  Humans’ long term struggle is to overcome entropy, not to maximize goods today.  In order to maximize goods today, we have to devote all resources to production and none to invention.  This means we are in a technologically stagnant situation.  As explained earlier, this is not sustainable because of diminishing returns and will result in a return to the Malthusian Trap.  Our ability to survive and thrive is based on maximizing inventions.  This results not only in more of the same goods in the future but a greater diversity of goods.  Diversity of goods may be more important than increasing the production of existing goods.  For instance, when we find that we are running out of coal we can switch to oil or nuclear power; when we find that one antibiotic is not effective against a new strain of bacteria, we can switch to a different antibiotic.  Diversity of goods allows us to withstand external shocks to our economy better than maximizing production of existing goods.

A system that only incentivizes inventions but not dissemination will result in  producers  that do not focus on either creating or disseminating new inventions.  Introducing an invention to the market is a huge risk.  Retailers do not know if the product based on the invention will sell.  The manufacturer often has to spend money establishing new channels of distribution and investing in new manufacturing facilities.  In fact, venture capitalists often estimate the cost of introducing an invention to the marketplace at ten times the cost of inventing.  It is always less cost and less time for a manufacturer to simply wait until a product is proven successful and then introduce a copycat product.  This allows them to freeload on the marketing, sales, distribution, and inventive efforts of the first mover.  There have been a number of business books on this exact point, see Getting to Plan B: Breaking Through to a Better Business Model, by John Mullins and Randy Kosimar[13] see also Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge[14]  Without incentives for both creation and dissemination of new technologies, we will have underinvestment in dissemination.  Smart companies know that the cost of introducing a new product is expensive and fraught with risk.  This is why most large companies focus most of their research and development on line extensions.  A Small Business Administration study, An Analysis of Small Business Patents by Industry and Firm Size, found that most emerging technologies are developed by start-ups and individual inventors.[15]

Invention is an endogenous process that is heavily affected by policy decisions.  In theUnited States, our unique patent system provided an incentive to invent and to invest in the dissemination of inventions.  The patent system also encourages the dissemination of information on which other inventors can build.  Because of the high risk of inventing and marketing emerging technologies, most of this effort is undertaken by start-ups and individual inventors.  Direct government support for inventive activities in the United Statesin the 19th century was minimal.  Despite this, the US went from a mainly agrarian nation at the time of the American Revolution, to the leader of the Industrial Revolution by 1850.

 

 


[1] Kremer, Michael, Population Growth and Technological Change: One Million B.C. to 1990, The Quarterly Journal of Economics, Vol. 108, No. 3. (Aug., 1993), pp. 681-716, http://links.jstor.org/sici?sici=0033-5533%28199308%29108%3A3%3C681%3APGATCO%3E2.0.CO%3B2-A.

[2] Klasen, Stephan; Nestmann, Thorsten, Population, Population Density, and Technological Change, CESifo Working Paper Series No. 1209, 2004, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=558105.

[3] Schmookler, Jacob, Inventions and Economic Growth, Harvard Press, 1966, pp 104-164.

[4] Schmookler, Jacob, Inventions and Economic Growth, Harvard Press, 1966, pp 57-86.

[5] Khan, Zorina B., The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920, Cambridge  University Press, 2005, pp. 50

[6] Khan, B. Zorina. “Technological Innovations and Endogenous Changes inU.S. Legal Institutions, 1790-1920.” NBER Working Paper No. 10346.Cambridge,MA: March 2004.

[7] Romer, Paul M., “WHICH PARTS OF GLOBALIZATION MATTER FOR CATCH-UP GROWTH?”, p. 7, NBER Working Paper 15755, Cambridge, MA, February 2010, http://www.nber.org/papers/w15755.

[8] Bailey, Ronald, “Post-Scarcity Prophet: Economist Paul Romer on Growth, Technological Change, and an Unlimited Human Future”, Reason, December 2001.

[9] Romer prefers the word “recipes” to “inventions” perhaps because he believes the word invention implies all the complex definitions of patent law.  However, I believe this leads to confusion.  An invention that is never realized in physical form is meaningless.  Once it is realized in physical form it has at least some of the rivalrous features of physical property.

[10] Bailey, Ronald, “Post-Scarcity Prophet: Economist Paul Romer on Growth, Technological Change, and an Unlimited Human Future”, Reason, December 2001.

[11] Even software inventions are subject to scarcity.  It takes energy, transmission capabilities, and computers to recreated a software invention.

[12] Hughes, Thomas Parke, British Electrical Industry Lag:1882-1888, Technology and Culture, Vol. 3, No. 1 (Winter, 1962) , pp 27-42, http://www.jstor.org/pss/3100799.

[13] Mullins, John and Kosimar, Randy, Getting to Plan B: Breaking Through to a Better Business Model, Harvard Business Press,BostonMA, 2009.

[14] Shenkar, Oded, Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge, Harvard Business Press,BostonMA, 2010.

[15] Breitzman, Anthony; Hicks, Diana, An Analysis of Small Business Patents by

Industry and Firm Size, Under contract no. SBAHQ-07-Q-0010, November 2008, http://archive.sba.gov/advo/research/rs335tot.pdf.

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December 24, 2011 - Posted by | -Economics, Innovation | , , ,

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