In the last couple of months, I wrote three posts [1,2,3] that tried to explain our recent economic experience as a consequence of the increased rent-seeking that goes along with a prolonged period of stabilisation. My analysis was restricted to the post-2008 period which has thrown up some anomalous patterns that cannot be explained by conventional macroeconomic theory (Keynesian or Monetarist). In particular, I focused on two patterns: the disconnect between corporate profitability and unemployment (highlighted by the rapid rise in labour productivity), and the fact that this increased profitability has so far only led to increased corporate cash balances and not to increased investment. Both these patterns, although unique, still possess an ancestral lineage that can be traced back to the Great Moderation. Recoveries have been becoming increasingly jobless since 1991 and the “corporate savings glut” has been a common feature since atleast the 90s in the United States, Europe and Japan. To some commentators (notably Michael Mandel and Peter Thiel) our current problems are the result of a prolonged innovation deficit, a view that has been expanded upon by Tyler Cowen in his excellent new book ‘The Great Stagnation’. In my opinion, this innovation deficit is atleast partly driven by increased Olsonian rent-seeking.
It’s difficult to prove that innovation has fallen due to increased rent-seeking. How can we measure the innovation that could have been in the absence of special interests? One approach is to look for industries where the developed economies of the United States, Europe and Japan are not at the forefront of innovation. Tyler Cowen correctly notes that much of the growth in developing economies comes from “catch-up” growth but this is not always the case. As the Economist notes, some of the best innovation in frugal healthcare is now coming out of China and India and much of this innovation has been slow to make its way into the developed economies. The Economist identifies the price-insensitivity of developed markets and regulatory red tape as reasons but this is an incomplete explanation. The same dynamic is visible in financial services where almost all the genuine innovation is taking place in developing economies (e.g. mobile banking in Africa and India), and although financial services has its share of regulatory red tape, it is certainly not price-insensitive.
A hint as to the real problem can be found in the unusually honest comment from a GE executive in the Economist article who admits that “the sales and distribution systems at firms like his, set up to sell $100,000 scanners, are ill-suited to sell versions at a tenth of that price”. As [amazon_link id=”0060521996″ target=”_blank” ]Clayton Christensen[/amazon_link] and James Utterback identified long ago, incumbent firms are almost never responsible for disruptive product innovations. These are inevitably originated by new entrants into the industry. As Christensen noted, disruptive innovations often result in worse product quality in the short term and drastically reduced profit margins that cannot sustain the incumbents’ cost structure. To expect an incumbent in this situation to take a leap on an uncertain innovation that at best will result in dramatically reduced profits is unrealistic. This highlights the damage done by the pervasive presence of special interests in any industry. Rent-seeking becomes the dominant niche that outcompetes all exploratory innovation by new entrants.
Despite this rather gloomy analysis, there is a silver lining. In the long run as the disruptive innovation becomes established, it is inevitable that the technology will spread even to the most rent-infested economies. This highlights the benefits of nation-level diversity in the global economy and the folly of pursuing homogeneity in global regulatory regimes. As Kenneth Boulding said: “If you have only one system, then if anything goes wrong, everything goes wrong.” As long as the “Olsonian cycles” of the major economies are not perfectly synchronised, the global economy may be able to maintain a healthy pace of innovation albeit in a stop-start manner.