The Information Technology & Innovation Foundation

Economic Doctrines and Policy Differences: Has the Washington Policy Debate Been Asking the Wrong Questions?

by Robert D. Atkinson and david b. audretsch | september 2008

While the U.S. economy has been transformed by olicymakers and economic scholars around the world agree the forces of technolog y, that the primary source of economic growth, competitiveness, globalization, and entre- and increases in standards of living in a globalized economy preneurship, the doc- P is innovation in the form of new products and services, more efficient trines guiding economic production processes, and new business models.1 Moreover, as oil policymakers have not and food prices escalate, the need for innovation across the economy kept pace and continue to be informed by 20th becomes even more pressing. Yet even in an election year when both century conceptualiza- presidential candidates in the United States are confronted with a trou- tions, models, and theo- bled economy, the current U.S. political dialogue is giving scant atten- ries. tion to innovation and policies to promote innovative activity.

Innovation policy has gotten short shrift As described in this policy brief, the in the U.S. political dialogue largely be- three competing 20th century econom- cause the three dominant economic pol- ics doctrines embraced by most Wash- icy models advocated by most economic ington policymakers today are conser- advisors – and implicitly held by most vative neoclassical, liberal neoclassical, Washington policymakers – ignore the and Neo-Keynesian economics doc- role innovation and technology play in trines. One of the most important prin- achieving economic growth in the glob- ciples of neoclassical economics is that al, knowledge-based economy of the 21st it is the accumulation of capital which century. Unfortunately, while the U.S. spurs economic growth. On this point, economy has been transformed by the people in both the conservative and lib- forces of technology, globalization, and eral neoclassical economics camps agree. entrepreneurship, the doctrines guiding But they diverge in the ways they seek economic policymakers have not kept to spur capital formation. Conservative pace and continue to be informed by neoclassicalists (often called supply-sid- The Information 20th century conceptualizations, mod- ers) advocate spurring capital formation Technology & Innovation els, and theories. in the private sector by cutting taxes on Foundation ITIF income and wealth, whereas liberal neoclassicalists rec- The keys to growth are in some ways profoundly sim- ommend spurring capital formation by having the gov- ple. Nobel Prize-winning economist Douglass North ernment run budget surpluses (or reduce deficits) and/ summed it up as follows: “We must create incentives for or by helping low-income people save. Adherents of people to invest in more efficient technology, increase the third prevailing economics doctrine, neo-Keynes- their skills, and organize efficient markets.”4 As Paul ianism, stress the importance of both having the fed- Romer, former Stanford University economist and a eral government ensure aggregate economic demand leader in the field of innovation economics, states, the by increasing government spending and ensuring that conservative “save-more” and liberal “spend-more” the fruits of economic growth are fairly distributed. approaches are not the answer:

In his 1776 book, An Inquiry into the Nature and Causes of [Such] policy prescriptions miss the crux of the the Wealth of Nations, Adam Smith argued that there ex- matter. Neither adjustments to monetary and fiscal ist three major inputs to the production process: land, policy, nor increases in the rate of savings and capi- labor, and capital. In today’s New Economy, a fourth tal accumulation can by themselves generate per- input now significantly outweighs these other three – sistent increases in standards of living … the most knowledge. The fall of the Berlin Wall in 1989 trig- important job for economic policy is to create an gered more than just “a flat earth,” in Tom Friedman’s institutional environment that supports technologi- terms; the ensuing globalization accompanied and cal change.5 spurred a shift from the mass production, corporate- managed economy to a knowledge-based entrepre- The new realities of a global, knowledge-based econ- neurial economy. As leading Stanford economist, Ed omy in the 21st century require a new approach to Lazear, observed, “The entrepreneur is the single most national economic policy based more on smart sup- important player in a modern economy.”2 port for the building blocks of innovation and entre- preneurship and less on capital accumulation, budget surpluses, or social spending. Without an economic The central goal of economic policy should be to spur higher pro- theory and doctrine that match the new realities, it will be very hard for policymakers to take the steps needed ductivity and greater innovation. to foster economic growth.

Fortunately, as described in this policy brief, a new To be sure, such entrepreneurship does not have to be theory and narrative of economic growth based on an reflected in individuals starting new companies; it can explicit effort to understand and model how innova- be reflected in larger organizations acting more nim- tion occurs has emerged in the last decade. This new bly. But in either case, it is innovation and organiza- economics doctrine on the block – called “innovation tions doing new things that now spurs growth. As economics” – reformulates the traditional model of innovation and entrepreneurship replace mass-produc- economic growth so that knowledge, technology, en- tion and large capital-intensive factories as the engine trepreneurship, and innovation are positioned at the of growth, jobs, and competitiveness, economic policy center of the model rather than seen as independent must also shift from its old economy concern of stimu- forces that are largely unaffected by policy. Innovation lating consumer demand while restraining the market economics – also called “new institutional econom- power of oligopolies to the new economy concern of ics,” “new growth economics,” “endogenous growth boosting innovation and productivity. In what has be- theory,” “evolutionary economics,” and “neo-Schump- come widely known and accepted as the “new growth ertarian economics” – is based on two fundamental theory,” knowledge has been explicitly recognized tenets. One is that the central goal of economic policy as a crucial factor generating economic growth.3 In should be to spur higher productivity and greater inno- the new knowledge economy, knowledgeable people, vation. Second, markets relying on price signals alone including creative entrepreneurs, skilled shop-floor will not always be as effective as smart public-private workers, cutting-edge researchers, innovative manag- partnerships in spurring higher productivity and great- ers, and digital-savvy “prosumers” are the drivers of er innovation. growth.

The information Technology & Innovation foundation | sep tember 2008 page 2 The United States needs an economic framework that economy, what they see as important and not impor- supports the new economy – and innovation econom- tant, and most importantly what they believe is the ics is it. Leading economists increasingly acknowledge correct public policy and what is not. that without change, the U.S. economy cannot grow, that increases in knowledge and competition drive Moreover, it’s not just Ph.D. economists working at growth and change, and that the government has a key the Federal Reserve, with Congressional committees, role to play in that process. In short, they are saying or in think tanks that subscribe to particular econom- that the best macroeconomic policies are institutional ics doctrines. Virtually all policymakers involved in policies – support for research, innovation, skill build- economic policy subscribe to a particular econom- ing, and digital transformation – all within an environ- ics doctrine, even if they may not be aware of which ment of competitive markets.6 camp they are in. The economics doctrine guides their thinking and deliberations and helps them make sense This policy brief succinctly explains the three prevail- of an incredibly complex, rapidly-changing economy. ing economics doctrines, as well as the newer doctrine Indeed, as John Maynard Keynes himself once stated, of innovation economics, that are competing for the “Practical men, who believe themselves to be quite ex- attention and allegiance of U.S. policymakers. In ad- empt from any intellectual influences, are usually the dition to discussing each doctrine’s principles, goals, slaves of some defunct economist.”10 and what each believes about the economy, it discusses the advantages and limitations of each economics doc- As noted, there are three main economics doctrines trine. Finally, it examines how each doctrine views and a fourth, new, economics doctrine competing for particular real-world economic challenges and ex- the attention and allegiance of Washington policymak- plains the different types of policy prescriptions that ers (Table 1, page 13). It is important for these policy- result from each. makers and others to understand these economics doc- trines so that they can more self-consciously choose the doctrine they believe is most effective in producing ECONOMICS: A SCIENCE OR AN ART? the kinds of economic outcomes they support – and Economics prides itself on being a science, closer to ultimately so that they can become liberated from be- physics than to sociology. But as David Colander notes, ing the slaves of some defunct, or in some cases, some 7 the art of economics has been lost. Although supply current, economist.11 and demand curves and other aspects of economics do approach being a science, much of economics is actu- Economics doctrines don’t emerge and become adopt- ally based on frameworks, paradigms, and doctrines. ed on the basis of intellectual arguments alone. The Thus, noted tax economist Joel Slemrod observes, “It economic and social structures of an era profoundly is a troubling fact for the aspirations of economics to shape not only what economics doctrines emerge as be a hard science that our values about equity end up dominant but also which policies stemming from eco- being so correlated with our beliefs about what kind of nomics doctrines are effective. Thus, for example, fiscal, or tax policy works best for the economy.”8 Lar- the dominant economics doctrine before World War ry Lindsey, former head of President Bush’s National II was classical economics, which supported the pri- Economic Council, agrees, noting, “In part, the con- macy of markets and a limited role for government. In tinuing argument [among economists] is a product of the 1940s, with the Great Depression and the emer- philosophical disagreements about human nature and gence of large corporations and large government after the role of government and cannot be fully resolved by World War II, Keynesian economics emerged as the economists no matter how sound their data.”9 dominant paradigm. Keynesianism emphasizes us- ing federal government spending and other policies to People’s beliefs about what policy works best for the spur economic demand and manage the business cycle. economy are not simply random thoughts; rather such Its dominance through the early 1970s was confirmed beliefs make up coherent world views or doctrines, in 1971, when Republican President Richard Nixon which, in turn, profoundly shape how they view the proclaimed, “We are all Keynesians now.”

The information Technology & Innovation foundation | sep tember 2008 page 3 Keynesian economics doctrine held center stage in the way on adjusting the demand or supply of capital and United States until the stagflation of the 1970s led to labor to keep the economy in equilibrium. All three neoclassical economics – a modification of classical focus on macroeconomic factors, particularly prices, economics – taking center stage as a reaction against it. rather than on the institutional factors and technologi- The reaction against Keynesian economics was espe- cal change that really drive growth, albeit in different cially notable among conservatives, who crafted a neo- ways in different countries and times.13 And none of classical alternative to Keynesian economics known the three prevailing doctrines have much to say about as “supply-side economics,” which remains the domi- the complex process by which technological innova- nant economic paradigm for many conservatives to tion occurs, preferring instead to dwell largely in the this day.12 At the macroeconomic level, monetarism, a world of mathematical models, not in the messy and close cousin of supply-side economics, held that rather complicated world of firms, industries, and national in- then applying fiscal policy to respond to business cycle novation systems.14 troughs as Keynesianism proposed, the government should manipulate the money supply. More politically- Fortunately, a new theory and narrative of economic moderate neoclassical economists embraced many of growth – innovation economics – has emerged in the the same principles as supply-siders but developed a last decade through the work of a wide range of schol- neoclassical economics doctrine that incorporated ars.15 Understanding innovation economics is particu- their own values of a belief in a stronger role of gov- larly important for Washington policymakers because ernment and greater economic equity. Meanwhile, a the playbooks (economics doctrines) most of them are group of neo-Keynesian economists on the left devel- using today – conservative or liberal neoclassical, or oped ideas that they hoped were better able to explain Keynesian – severely limit the plays they can call. Call- current economic events than the original Keynesian ing a play not in the official playbook is a particularly doctrine. risky thing to do unless perhaps the team is down by 40 going into the fourth quarter, so it is very impor- tant for Washington policymakers to have the right Since the 1980s, three prevailing economics doctrines have been playbook. Unlike the United States, the policymaking communities in many other countries around the globe competing for dominance in the United States: conservative neo- have already recognized the primacy of innovation and classical economics doctrine, liberal neoclassical economics doc- developed a rich and nuanced set of institutions and policies to make their economies innovation-based. trine, and neo-Keynesian economics doctrine. Thus, policymakers in many other countries have the advantage of operating from the right playbook: inno- vation economics.16 In sum, since the 1980s, three prevailing econom- ics doctrines have been competing for dominance in the United States: (1) conservative neoclassical (often THE DOMINANT NEOCLASSICAL ECONOMICS DOCTRINE called “supply-side”) economics doctrine; (2) liberal Each economics doctrine has its bible, and the bible for neoclassical economics doctrine (sometimes called neoclassical economics is Adam Smith’s classic 1776 “Rubinomics,” referring to the policies of President book entitled An Inquiry into the Nature and Causes of the Bill Clinton’s Secretary of the Treasury Robert Rubin); Wealth of Nations. Although the neoclassical economics and (3) neo-Keynesian economics doctrine. Each of doctrine embraced by most economists in Washington the three prevailing economics doctrines today pro- today has evolved significantly since Smith wrote his vide important insights into the economy and offers book, both the conservative and liberal versions of the important guides to policymakers. doctrine are based on many of the same insights and principles he outlined. Unfortunately, however, none of the prevailing eco- nomics doctrines offer the kind of economic policy Conservative neoclassicalists – supply-siders – find framework that fits the new economic realities of the their institutional home in places like the American 21st century. All three focus in an almost Newtonian Enterprise Institute, the Heritage Foundation, the Cato

The information Technology & Innovation foundation | sep tember 2008 page 4 Institute, the Competitive Enterprise Institute, and a eas of technology…They grudgingly acknowledge the host of other conservative think tanks. Liberal neo- importance of technological change, but they don’t un- classicalists – proponents of Rubinomics – find their derstand it or trust it.”19 homes at a host of politically moderate think tanks like the Brookings Institution, the Peterson Institute, Economic growth is achieved by maximizing al- the Center for American Progress, and the Council on locative efficiency. Neoclassical economists have one Foreign Relations. 17 overarching principle that guides their thinking and shapes their advice: Maximize “allocative efficiency.” Principles Guiding the Neoclassical Economics Doctrine Allocative efficiency is the market condition whereby resources are allocated in a way that maximizes the net Neoclassical economics doctrine is guided by at least benefit attained through their use; and the quantity of five key principles, outlined below: goods produced is that which is most beneficial to so- ciety. An allocatively efficient market is one in which The accumulation of capital drives economic scarce goods and services are consumed on the basis growth. Perhaps the most important principle of neo- of the prices consumers are willing to pay for them and classical economics is that the accumulation of capital scarce goods and services are produced on the basis of is what drives growth. Massachusetts Institute of Tech- marginal costs equaling the prices charged for them. nology (MIT) economist Robert Solow was awarded the Nobel Prize for empirically linking two explicit factors – labor and capital – to growth.18 While Solow is noted for acknowledging the importance of technol- Neoclassical economists – whether conservative or liberal – see ogy in growth, he did so by calling the unexplained their ideal tax code as one with low rates and few distortions. residual in the model “technical change,” and seeing it as still exogenous, that is, lying outside of the model, therefore outside of economic inquiry. In other words, From the standpoint of a neoclassical economist, it in the neoclassical model capital is at the center. would be a cardinal sin to propose a policy that would alter the “natural” allocation of factors – that is, capi- The belief that capital drives economic growth leads tal, labor, and goods and services – produced by mar- neoclassical economists to recommend a set of poli- ket price signals determined by individuals and firms cies designed to spur private savings (for supply-siders) making free choices not distorted by regulations, taxes, or public and private savings (for liberal neoclassical- market power, or other “distortions.” Both supply-sid- ists). The policy implication that flows naturally from ers and liberal neoclassicalists believe that any policy the neoclassical model is clear and unambiguous: Fo- that distorts allocative efficiency harms growth. cus public policy on ensuring high levels of savings (public and/or private) because high levels of savings (mechanically) create the capital pools to support in- Nevertheless, liberal neoclassicalists will sometimes vestment, which in turn drive economic growth. accept policies that harm allocative efficiency (and by extension growth) if they lead to greater economic fair- ness. As liberal neoclassical economist Alan Blinder Although the accumulation of capital is at the center of states: “We need not summarily reject a substantial re- the neoclassical model, technology is outside the mod- distributive program just because it inflicts some minor el. Indeed, as BusinessWeek chief economist Mike harm to economic efficiency…Policy changes that pro- Mandel notes, neoclassical economists are “capital moted equity (such as making the tax code more pro- fundamentalists who believe that savings and invest- gressive or raising welfare benefits) would often harm ment in physical capital and (sometimes) human capital efficiency.”20 Liberal neoclassicalists are particularly are the only forces driving growth. [They] generally strong in their opposition to policies that distort the ignore or minimize the role of technology.” For the economy and potentially hurt equity, even if they lead most part, therefore, neoclassical economists “remain to higher growth. Gene Sperling, former head of Pres- profoundly ambivalent or even hostile toward most ar-

The information Technology & Innovation foundation | sep tember 2008 page 5 ident Clinton’s National Economic Council, argues, ing to the same principles: individuals and firms re- “New technology will always make it more efficient sponding to price signals. It is for this reason that to replace workers with machines or computers, but neoclassical economics largely overlooks factors such decisions should be based on relative economic costs, as economic history, culture, norms, and institutions, not a tax code that tips the balance against workers.”21 preferring instead to dwell in the more universal world But overall, their view is consistent with supply-side of prices, costs, and mathematical models. It is also for economics in that it holds that markets acting on price this reason that most neoclassical economists reject the signals alone get most things right, with the exception notion of a new economy emerging in the last decade, of things like public goods and equity. because for them, the economy is still based on price signals and supply and demand. Neoclassical economists believe that any violation of this principle of maximizing allocative efficiency leads The economy tends to equilibrium. Related to neo- to what economists call “deadweight loss” – a loss of classical economists’ focus on allocative efficiency is economic efficiency that occurs when people buy too the notion that the economy is simply a large market of much of one product (if it is priced lower than it costs) goods and services that is generally in equilibrium and or buy too little of a product (if it is priced higher than usually best left to itself. Equilibrium occurs when a cost and a market clearing profit.) Taxes, by their very market price is established through competition such nature, neoclassical economists argue, distort alloca- that the amount of goods or services sought by buy- tive efficiency, and taxes that favor or burden particu- ers is equal to the amount of goods or services pro- lar activities distort it even more. For that reason, neo- duced by sellers. Because the economy tends toward classical economists – whether conservative or liberal equilibrium in the neoclassical view, the main task of – see their ideal tax code as one with low rates and few economic policy is simply to reduce artificial barriers distortions. Such a tax code, they claim, allows deci- and impediments to market equilibrium, particularly sions by economic actors to be driven by the market by ensuring that prices are aligned with costs. and not by the tax code. Similarly, most neoclassical economists assert that proactive policies to spur firms’ productivity or innovation are inappropriate because Individuals and firms are rational maximizers and they “distort” the market. respond to incentives. Neoclassical economics holds that individuals act in response to incentives to ratio- The focus is on markets and prices. If there is nally maximize their own self-interest and that indi- one defining factor that determines whether someone viduals’ pursuit of their own self-interest generates the is a neoclassical economist, it is a predominant focus public interest. Indeed, according to Adam Smith, the on the economy as a market determined by price sig- individual who “intends only his own gain” will, in the nals. Indeed, allocative efficiency revolves around the course of maximizing his needs, be “led by an invisible responsiveness of economic agents – firms and con- hand to promote...the public interest.”23 As supply-side sumers – to price signals.22 Consequently, neoclassical guru Arthur Laffer notes, supply-side economics “is a economists tend to rely on mathematical models rather recognition that people change their behavior when than on actual studies of how businesses, industries, marginal incentives change.”24 One of the biggest in- and national economies work. And their emphasis is centives, supply-siders claim, is taxes – particularly top more on factors like interest rates, currency values, in- marginal tax rates on individual earnings, savings, and flation, and other monetary factors than on factors like investment which limit work and investment. Thus, the rate by which firms are developing and adopting supply-siders’ recipe for boosting productivity is to new technologies or the effect of culture on entrepre- cut tax rates on individuals, especially high earners. neurship. Similarly, liberal neoclassical economist Alan Blinder argues: “[E]very tax influences incentives, as supply- Neoclassical economists see few differences between siders correctly emphasize…Unless the market is mal- economies, whether over space or over time, because functioning, such tax-induced redirections of resourc- they view all economies as operating largely accord- es reduce economic efficiency. They are therefore to

The information Technology & Innovation foundation | sep tember 2008 page 6 be minimized.”25 And the hurdle for establishing that The fundamental benefit of higher national savings a market is malfunctioning is quite high for neoclassi- – achieved by preserving a substantial portion of cal economists. the projected budget surplus – is that it will expand economic output in the future. Higher national Conservative Neoclassicalists vs. Liberal Neoclassicalists saving leads to higher investment, which means Although conservative and liberal neoclassicalists that future workers have more capital with which agree on many key economic principles, they also dif- to work and are more productive as a result.28 fer in some important ways. Thus, for example, al- though both camps of neoclassicalists hold that capital Government spending policy is another area where accumulation is the key to growth, the two have a dif- supply-siders and liberal neoclassicalists differ. Sup- ferent focus on where that capital should come from.26 ply-siders view lower taxes as the key to growth but Supply-siders argue that the accumulation of private also see reduced government spending, even if taxes capital is the key to economic growth; hence lower remain the same, as a stimulus to growth. They be- taxes on income and wealth are the keys to spurring lieve that many government expenditures, including more capital accumulation. Supply-side economist both direct spending and tax expenditures, have a host Larry Kudlow states, “Tax-cut incentives will promote of pernicious effects.29 In contrast, liberal neoclassi- capital formation, productivity, jobs, and growth.” calists worry about government spending not because The logic of supply-siders is rather straightforward. In they believe it is harmful but because of its supposed the neoclassical model, if you want more of anything, effects on fiscal discipline and public savings. Liberal you lower its price. If you want more savings, you neoclassicalists are also more willing to support pub- lower the price – in this case, tax rates on capital. But lic spending if it is focused on helping economically- supply-siders’ focus on private capital accumulation is disadvantaged individuals, but they would usually see naturally oriented to wealthier individuals, the reason decisions about such spending as involving a tradeoff being, according to them, that the disincentive effect between growth and fairness. of taxes on savings is greatest for those with the high- est marginal tax rates. Even though cutting taxes on The extent to which economic policy can influence higher earners leads to a less progressive tax code, sup- long-run growth is yet another area where the two ply-siders are willing to make that tradeoff because for camps of neoclassicalists differ. Like innovation econ- them economic growth is more important than fair- omists, supply-siders believe that economic policies ness. Some supply-siders in fact believe that greater can influence the long-run rate of economic growth. equity actually limits the incentives for growth. For example, supply-sider Greg Mankiw, who headed the Council of Economic Advisors in the administra- Liberal neoclassicalists also believe in the primacy of tion of President George W. Bush says, “In the long capital and savings to growth, but they differ from run, lower tax rates expand the supply side of the econ- supply-siders in being strong supporters of greater omy by enhancing the incentives for work, saving, and income equality. Consequently, liberal neoclassical- investment.”30 ists advocate increasing capital accumulation either by having the government run budget surpluses (or re- Liberal neoclassicalists, in contrast, believe that at duce its deficits), and/or by helping low-income people some point, it will become impossible to spur further save more, in part by giving low-income citizens tax in- growth because capital will be exhausted and there will centives.27 The liberal neoclassicalists’ approach aims be, in the words of economists, diminishing returns. to spur capital accumulation in ways that are more fair Adding the first machine tool to the economy will con- than tax cuts on high earners. Perhaps the best sum- tribute to economic growth, but adding the billionth mary of liberal neoclassicalists’ beliefs comes from Pe- will contribute eventually nothing to such growth. In ter Orszag, formally at the Brookings Institution and fact, the original (Robert) Solow growth models pre- now head of the Congressional Budget Office: dicted that we would reach a steady state where capital intensity could not grow and productivity would stag-

The information Technology & Innovation foundation | sep tember 2008 page 7 nate. As economics journalist David Warsh describes in at least some circumstances. And indeed, both con- it, in the neo-classical Solow model “there was little or servative and liberal versions of the doctrine contain no room for policy to affect growth rates.”31 It is for key insights. Markets are important, especially at the this reason that most liberal neoclassical economists microeconomic level (e.g., markets for electricity, for are profoundly pessimistic about long-term growth – gasoline, for “widgets” generally). Helping to ensure and perhaps one reason why economics is known as that prices usually match costs can be important to “the dismal science.” For even among those who be- promoting allocative efficiency, especially when there lieve that economic growth and improved productiv- are little or no compensating benefits to productivity ity are important, many liberal neoclassical economists or innovation. It’s possible that tax rates at too high believe that there is nothing economic policy can do a level can limit incentives (the key question is what to positively influence growth, except perhaps to in- that level is). Budget deficits at too high a level can fluence short-term growth on the consumer demand limit capital availability (again, the key question is what side, as Keynesian economics suggests, or to reduce al- the level is at which this becomes a problem). The locative inefficiency to let the economy operate a little evidence suggests that modest increases in personal closer to its growth frontier, as neoclassical economics tax rates or budget deficits have no negative effect on suggests. economic growth.35 Individuals and organizations are rational and respond appropriately to incentives (but not necessarily all the time). Certain markets, espe- Many liberal neoclassical economists believe that there is nothing cially those characterized by stability and slow rates of change, do tend toward equilibrium (but many other economic policy can do to positively influence growth. markets do not).

Liberal neoclassical economist Alan Blinder argues: Areas Where the Neoclassical Economics Doctrine Is a “Although economics can tell the government much Flawed Guide to Policy about how to influence aggregate demand, they can tell Notwithstanding its positive contributions, the neo- it precious little about how to influence aggregate supply. classical economics doctrine is a flawed guide to eco- Let no supply-sider tell you differently.”32 Blinder goes nomic policy in the global, knowledge-based economy on to claim, “Nothing – repeat, nothing – that econo- of the 21st century. The neoclassical economics doc- mists know about growth gives us a recipe for adding trine gets it wrong on a number of key points. a percentage point or more to the nation’s growth rate on a sustained basis. Much as we might wish other- 1. Innovation is a much larger driver of growth than wise, it just isn’t so.”33 Paul Krugman, another liberal capital. In the old economy, where large amounts of neoclassical economist, offers the same refrain, pro- capital were needed to construct an embryonic factory nouncing: “Productivity growth is the single most im- economy, and before the emergence of the kinds of portant factor affecting our economic well‑being. But sophisticated global capital markets of today, neoclas- it is not a policy issue, because we are not going to do sicalists’ overriding focus on capital accumulation may anything about it.”34 These views aren’t outliers. The have made some sense. But in today’s economy, trying dominant economic thinking embodied in the liberal to stimulate the supply of an item that the economy has neoclassical economics doctrine minimizes the role plenty of – investment capital – does not make much of innovation in growth and government’s capability sense. The problem in the new economy is not a lack to spur innovation and largely counsels policymakers of investment capital but a lack of good investment op- to manage the business cycle, reduce allocation inef- portunities. Supply-side tax cuts on individuals do not ficiencies, and support greater fairness. make much difference in the availability of capital; and even if they did, the supply of capital is not the key Areas Where Neoclassical Economics Doctrine Is Useful factor driving economic growth in today’s knowledge- and Generally Accurate based economy. The neoclassical economics doctrine would not have obtained such a large following and dominant position The liberal neoclassical focus on government savings in the United States if it were not accurate and useful is equally misplaced. In an era of global capital mo-

The information Technology & Innovation foundation | sep tember 2008 page 8 bility, the relationship between higher budget deficits efficiency. Without the tax credit, though, firms would and an increase in interest rates is less strong than it conduct less R&D and produce fewer innovations, and once was. Moreover, as we have seen so clearly in re- the economy would grow more slowly.37 The key point cent years, lower interest rates don’t necessarily spur is that the gains in innovation and productivity spurred more capital investment. Indeed, even with the very by the increased R&D that the tax credit produces low interest rates of the first half of this decade, capital vastly exceed any minor losses from “misallocation” of investment rates fell, and people used the low interest economic resources. rates to increase capitalized spending, particularly on housing, which does nothing to increase innovation As discussed in detail below, innovation economics or productivity. Yet many liberal neoclassical advo- has found that the lion’s share of growth is achieved cates of fiscal discipline would oppose measures such not by simply allocating existing goods and services as more liberal expensing of machinery and equipment in the most efficient way, but by increasing productive on the grounds that this would increase the budget and adaptive efficiency.38 With their focus on getting deficit, thereby increasing interest rates and in turn re- prices right, neoclassical economists assume that mar- ducing investments. But lower interest rates are a very kets get prices right most of the time; and that even blunt tool – possibly boosting investment – but also when markets don’t get prices right, government inter- boosting capitalized spending, whereas expensing of vention in response will be wrong. But as innovation machinery and equipment or investment tax credits or economists Phillipe Aghion, Paul David, and Domi- research and development (R&D) tax credits are much niqu Foray note, “The empirical foundations for such more targeted tools that directly spur innovation. It sweeping statements remain remarkably fragile.”39 is in this sense that MIT professor Lester Thurow ar- gued: “Like having a better CFO in a company, hav- Neoclassicalists also assume that the pretax marketplace ing a better minister of finance is not going to yield a is efficient and that taxes, regulation, and spending dis- future competitive advantage. Having a national chief tort the “invisible hand” envisioned by Adam Smith. knowledge officer who understands where the knowl- But the neoclassical model, as innovation economist edge-based economy is headed is where the future is to F.M. Scherer explains, “assumes perfect competition, be found.”36 constant returns to scale, and the absence of externali- ties. All three assumptions have been questioned, of- 40 2. Productive efficiency and adaptive efficiency ten convincingly, by new growth theorists.” are much more important to economic growth Finally, with its focus on allocating existing scarce re- than maximizing allocative efficiency. Neoclassi- sources, the neoclassical economics framework gives calists also get it wrong by stressing the importance of short shift to innovation. The neoclassical model as- maximizing one factor – allocative efficiency – to spur sumes that firms have static production functions that economic growth and giving short shrift to two other respond to changes in input prices. If prices of one key factors: productive efficiency and adaptive efficien- input go up, firms will use less of it and more of an- cy. Productive efficiency is the ability of organizations other. Indeed, a textbook by Paul Samuelson and Wil- to produce in ways that lead to the most amount of liam Nordhaus, two leading neoclassical economists, output with the fewest inputs, including labor inputs. defines economics as “the study of how societies use Adaptive efficiency is the ability of economies and in- scarce resources to produce valuable commodities and stitutions to change over time to respond to succes- distribute them among different people.”41 But as not- sive new situations, in part by developing and adopting ed innovation economist Joseph Schumpeter stated, technological innovations. “Add successively as many mail coaches as you please, you never get a railway thereby.”42 In short, simple and One can easily envision a host of policies that, while minimal polices are nice and provide a certain amount distorting allocative efficiency, would boost produc- of intellectual comfort, but they are means not ends, tive efficiency and adaptive efficiency. The R&D tax and if they come at the expense of economic growth, credit, for example, undoubtedly “distorts” allocative such policies are not pro-growth.

The information Technology & Innovation foundation | sep tember 2008 page 9 3. The economy increasingly doesn’t tend to one Complexity theory and the mathematical modeling equilibrium. The neoclassical economics doctrine related to it show that many systems act less like well- holds that the economy is a large market of goods and structured equilibrium systems and more like chaotic services that is generally in equilibrium. But in a world complex systems. The new behavioral economics is of rapid technological change where innovation drives finding out that, in real life, people consistently make change, market equilibrium is almost never achieved. what are – at least from the perspective of econom- The reason is that some new product, service, business ics – irrational decisions all the time. In The Origin model, or new market is always emerging, disrupt- of Wealth, Eric Beinhocker explain that people’s deci- ing existing products, services, business models and sions are affected by a host of “problems,” including markets. As Eric Beinhocker, author of The Origin of framing biases, difficulties judging risk, superstitious Wealth states, “Equilibrium systems by definition are reasoning, and other “human” biases.48 Often, for ex- in a state of rest, while growth implies change and dy- ample, people tend to overestimate the likelihood of namism.”43 low probability events. Finally, research on the process of organizational change and innovation increasingly shows that the process is path dependent, locationally The problem in the new economy is not a lack of investment capi- specific, and institutionally shaped. New discoveries in the realms of behavioral economics and complex- tal but a lack of good investment opportunities. ity theory such as these are calling into question the “Newtonian” simplicity of the neoclassical worldview. Some economists, disputing the neoclassical view that the economy tends toward one equilibrium, have ar- THE NEO-KEYNESIAN ECONOMICs DOCTRINE gued that economic systems can have multiple equilib- As noted earlier, the dominant economic doctrine be- ria, with significant consequences for economic welfare fore World War II was classical economics, which sup- and that government policy that moves an economy to ported the primacy of markets and a limited role for the more productive equilibrium can spur growth.44 government. Keynesian economics first emerged dur- A number of trade scholars, for example, have argued ing the Great Depression, when British economist John that in the new world economy, more industries are Maynard Keynes published his theories in The General characterized by increasing returns to scale; hence, na- Theory of Employment, Interest, and Money in 1936. Keynes tions that start to produce first in such industries can maintained that the government could help maintain acquire comparative advantage. This means that there economic growth by instituting counter-cyclical fis- exist multiple possible equilibria.45 Moreover, it means cal policies, especially through government spending. that government policy that moves an economy to a Keynesian economics doctrine gained wide acceptance higher output equilibrium can spur growth.46 Innova- after World War II and was the dominant economic tion economists believe that the market is characterized paradigm in the United States until the 1970s. not by equilibrium or multiple equilibria but instead In the economic doldrums of the mid-1970s, when is roiled by constant change. Consequently, a quest to conservatives and many moderates moved to replace ensure that prices align with costs and drive towards Keynesian economic thinking with what subsequently equilibrium is a quest that can never be achieved. became the dominant neoclassical economics doctrine 4. Individuals and firms are not necessarily ra- of today, many liberals remained firmly committed to tional actors. Neoclassical economics doctrine holds the Keynesian economic doctrine. Even today, as the not only that the economy is an equilibrium system economy has become more global, dynamic, and tech- but that individuals operating within that system have nology-driven, a large group of liberal “neo-Keynes- full information and act rationally to maximize their ians” – so called because they have attempted to revise own self-interest. Without this basic assumption of Keynes’ ideas in response to new economic conditions rationality, modeling economic behavior mathemati- and new research – continue to base their policy recom- cally would be much harder. Recently, however, the mendations on Keynesian ideas. Most neo-Keynesians emerging fields of behavioral economics and complex- are on the left side of the political spectrum, with in- ity theory have called this and other assumptions that stitutional homes in places like Demos, the Economic underlie neoclassical economics into question.47 Policy Institute, the Center for Economic and Policy

The information Technology & Innovation foundation | sep tember 2008 page 10 Research, the Levy Economic Institute, the AFL- Former Democratic House leader Dick Gephardt CIO, the Center on Budget and Policy Priorities, and echoes the neo-Keynesian view: the Center for American Progress (also home to some liberal neoclassicalists.) [R]aising wages does more than help someone buy food or pay for shelter. Remember the Republican Principles Guiding the Neo-Keynesian Economics Doctrine nostrum of the 1980s, supply-side economics? I’m Neo-Keynesian economic thinking is guided by at least a believer in demand‑side economics. Raising wag- three key principles, outlined below. es increases the buying power of American workers and that’s good for the entire country.54 1. Demand drives economic growth. Neo-Keynes- ians have long held that it is the demand for goods and 2. Equitable distribution of wealth is critical. services – coming from business investment, govern- Neo-Keynesians see most economic issues as boiling ment spending, and consumer spending – that drives down to a question of who gets the benefits: working growth.49 In recent years, though, neo-Keynesians people or rich people and corporations. Consequently, have tried to update the liberal demand-side story for neo-Keynesians – even more than liberal neoclassical- the new economy. Thus, some neo-Keynesians now ists – focus on ensuring that the fruits of economic acknowledge that investment is the key to productivity growth are distributed fairly. but claim that consumer spending drives investment.50 Instead of claiming that aggregate consumer spending MIT neo-Keynesian economist Frank Levy argues: leads to more jobs, they now tell a more nuanced, and “We cannot legislate the rate of productivity growth... what they hope is a more compelling, story about how That is why equalizing institutions are so important.” consumer demand is the fuel that induces companies Since there is not much that can be done to increase to invest in new machinery and equipment. Accord- productivity growth, there is no reason, they argue, for ing to neo-Keynesians, if companies think consumer tax policies to spur productivity and innovation, such demand is increasing, they will have an incentive to as accelerated depreciation or R&D credits. Moreover, invest more. There are many adherents to this neo- because neo-Keynesians view increased spending (as Keynesian story. The Center for American Progress’s opposed to savings) as the key economic growth, they Christian Weller, for example, explains the modest generally want tax cuts to go to lower income individu- slowdown in productivity growth between 2004 and als and households, arguing that they are more likely early 2007 as stemming from slow consumer income to spend the money from tax cuts than wealthier indi- growth that, “provides business with fewer incentives viduals and households. to invest at an accelerated rate.”51 3. Managing the short-term business cycle is the Because of neo-Keynesians’ focus on aggregate de- primary objective. In part because Keynesianism mand, many neo-Keynesian economic policies revolve was largely a response to the Great Depression, neo- around increased government spending to keep the Keynesians focus predominantly on the short-term economy growing. As former Economic Policy Insti- business cycle, usually at the expense of a focus on tute President Jeff Faux writes, a core tenet of Keynes- long-term growth. In The General Theory, Keynes re- ian economics is that a key role of the federal govern- flected this view when he wrote: ment is “to jump-start consumer demand and through its spending keep it up.”52 Similarly, neo-Keynesian If the Treasury were to fill old bottles with ban- economist James Galbraith argues: knotes, bury them at suitable depths in disused coal-mines which are then filled up to the surface Consumption is also an important and much ma- with town rubbish, and leave it to private enterpris- ligned policy objective. People should have the in- es on well-tried principles of laissez-faire to dig the comes they need to be well fed, housed, and clothed notes up again (…), there need be no more unem- – and also to enjoy life. Public services can help: ployment and, with the help of the repercussions, day care, education, public health, culture, and the the real income of the community, and its capital arts all deserve far more support than they are get- wealth also, would probably become a good deal ting.53 greater than it actually is. It would indeed be more

The information Technology & Innovation foundation | sep tember 2008 page 11 sensible to build houses and the like; but if there are ics is still a demand-side story that doesn’t adequately political and practical difficulties in the way of this, get at the real factors driving investment and produc- this above would be better than doing nothing.55 tivity growth. Neither is there now nor has there been in the past much of a relationship between consumer Neo-Keynesians are more focused on ensuring that spending and productivity growth. Between 1990 and the economy does not tilt into recession (in large part 1995, for example, consumer spending in the United through countercyclical fiscal policies) than on policies States increased just 13 percent, yet productivity surged to spur productivity and innovation. One problem is in the late 1990s. In contrast, consumer spending grew that many neo-Keynesians think that the economy is at essentially the same rate in the second half of the always on the verge of a recession, or even worse, a 1990s (20.4 percent) as in the first half of this decade 56 replay of the Great Depression. As a result, they of- (19.2 percent), but productivity growth rates were ten have a tendency to favor public spending that may somewhat lower recently.59 produce short-run economic results – and give less em- phasis on investments like support for innovation that can potentially lead to longer term results. Innovation economics makes an explicit effort to understand and Areas Where the Neo-Keynesian Economics Doctrine Is model how innovation occurs, seeing such advances as a result of Useful and Generally Accurate intentional activities by economic actors, including government. Like neoclassical economics, neo-Keynesian econom- ics contains important core insights. First, fairness is an important goal. Fairness and equity are corner- To be sure, during periodic economic slowdowns, stones of the sustainability of western democracies, the U.S. government can use temporary increases in and societies in which income inequality is too high spending or cuts in taxes to help boost spending and experience lower economic growth than more equi- 57 get the economy back to operating close to full capac- table societies. ity. But such government “pump-priming” policies do little to boost economic growth through higher pro- Second, when it comes to determining employment ductivity. Keynesian demand-side economic policies levels, neo-Keynesians are right in believing that mac- can make sure the “economic car” is going at its top- roeconomic factors (e.g., fiscal and monetary policy) rated speed of 60 mph instead of chugging along at an are more important than microeconomic ones (e.g., anemic 40 mph. What such policies can’t do is build a minimum wage.) They are also right in believing that faster economic car that can go 70 mph. Yet building full employment has beneficial effects on productiv- a faster economic car is critical to boosting incomes of ity and innovation. During the 1990s, full employ- all Americans because, despite what many liberal neo- ment helped to boost the real wages of many workers, 58 Keynesians have claimed about the supposed large and particularly those at the lower end of the wage scale. growing gap between productivity growth and median Tight labor markets mean that companies must bid income growth, changes in wages have been tied to up wages, leading to more equal growth in incomes. changes in productivity over the moderate and long Furthermore, in addition to being a tool for a fairer term – and continue to be so today.60 distribution of the fruits of growth, tight labor markets are a spur to growth. When companies must compete INNOVATION ECONOMICS — THE RIGHT ECONOMIC more to attract scarce workers, in part by paying higher DOCTRINE FOR THE NEW ECONOMY wages, they are more likely to invest in new technology If Adam Smith is the patron saint of neoclassical eco- and automation as a way to cut costs and produce more nomics and Keynes of neo-Keynesian economics, it is output. Joseph Schumpeter who is the patron saint of innova- tion economics. Indeed, if there is a “bible” for in- Areas Where the Neo-Keynesian Economics Doctrine Is a novation economics it is perhaps Joseph Schumpeter’s Flawed Guide to Policy classic 1942 book Capitalism, Socialism, and Democracy. Although the neo-Keynesian doctrine acknowledges Writing around the same time as Keynes, Schumpeter the importance of private sector actions to boost pro- had a decidedly different take on the economy and on ductivity, at the end of the day neo-Keynesian econom- economics. For Schumpeter it was institutions, entre-

The information Technology & Innovation foundation | sep tember 2008 page 12 Table 1. Comparison of the Three Prevailing Economics Doctrines in the United States with Innova- tion Economics

Neoclassical Economics Doctrine

Factor Conservative Neoclas- Liberal Neoclassical Neo-Keynesian Innovation Economics sical Doctrine Doctrine Economics Doctrine Doctrine (“supply-side”) (“Rubinomics”)

Locus of economic Supply-side Supply-side Demand-side Supply-side growth (individuals and (individuals and (organizations, organizations) organizations) entrepreneurs, and “prosumers”)

Source of economic Accumulation of Accumulation of Spending Productivity and growth capital capital innovation

Ultimate objects of Consumers Consumers Workers All residents122 policy

Principal economic Growth and managing Efficiency and Fairness and managing Growth and policy goal the business cycle managing the business the business cycle innovation cycle

Key economic Allocative efficiency Allocative efficiency Consumer demand, Productive efficiency process full employment and adaptive efficiency

Principal means Lower top marginal Fiscal discipline, Public spending, Tax, expenditure, and tax rates and lower reformed economic progressive taxes, regulatory policies rates on capital; reduce regulation stronger regulation to boost innovation, regulation skills, investment in new equipment, competition, and entrepreneurship

Trade theory Free markets boost Free markets boost Trade can hurt workers Trade can bring gains, allocative efficiency allocative efficiency and lower consumer principally through and consumer welfare and consumer welfare, demand competition and but government learning, but for it policies should to be most effective compensate those hurt policy must fight by trade mercantilist distortions and actively promote innovation at home

Organization of Limited Focused on the basics Large and powerful Reinvented government government government and increased reliance on quasi-public organizations and public-private partnerships

Locus of activity Markets Markets Institutions and Institutions and organizations organizations

The information Technology & Innovation foundation | september 2008 page 13 preneurs, and technological change that were at the innovation economics makes an explicit effort to un- heart of economies and economic growth.61 Schum- derstand and model how innovation occurs, seeing peter explained: such advances as a result of intentional activities by economic actors, including government.63 Today, in- The essential point to grasp is that in dealing with novation economists find their home mostly in the capitalism we are dealing with an evolutionary academy, sometimes in economics departments that process...the fundamental impulse that sets and are willing to buck conventional thinking, but often in keeps the capitalist engine in motion comes from Schools of Management, Public Policy, and City and the new consumers’ goods, the new methods of Regional Planning.64 Some also find their home in production or transportation, the new markets, think tanks, such as the Information Technology and the new forms of industrial organization that capi- Innovation Foundation, the Economic Strategy Insti- 62 talist enterprise creates. tute, the Woodrow Wilson Center, and the Council on Competitiveness. But because of the dominance of the Keynesian doc- trine over the next 40 years, the insights of Schum- Principles Guiding the Innovation Economics Doctrine peter were never really fully appreciated until more Innovation economics is guided by at least six key recently. Indeed, it is only within the last 15 years principles, outlined below. that a theory and narrative of economic growth fo- cused on innovation and grounded in Schumpeter’s ideas has emerged. 1. Innovation drives economic growth. Innova- tion economists believe that what primarily drives economic growth in today’s knowledge-based econ- omy is not capital accumulation, as claimed by neo- If there is any ideolog y governing this, it should be that smart classicalists, but innovation. The major changes in the public-private partnerships can play a key role in helping non- U.S. economy of the last 15 years have occurred not governmental organizations become more innovative and pro- because the economy accumulated more capital to in- vest in even bigger steel mills or car factories; rather ductive where there are significant market failures limiting their they have occurred because of innovation. The U.S. own action. economy developed a wide array of new technologies, particularly information technologies, and used them widely. Although capital was needed for these tech- Indeed, a new theory and narrative of economic nologies, capital was not the driver; nor was capital a growth focused on innovation has emerged in the commodity in short supply. last decade. This new economic doctrine – known as “innovation economics” – or by a range of other As William Baumol emphasizes, the most striking as- terms, including “new institutional economics,” “new pect of capitalism is not its capacity to generate alloca- growth economics,” “endogenous growth theory,” tive efficiency, but rather its remarkable propensity to “evolutionary economics,” and “neo-Schumpertarian drive economic growth through innovation, in what economics” – provides an economic framework that he terms as the “innovation machine.”65 Several re- explains and helps support growth in today’s knowl- cent studies that have attempted to explain the sources edge-based economy. of economic growth agree. According to University of California/Berkeley economist Brad Delong, “growth Unlike any of the three prevailing economics doc- accounting studies have found that capital deepening trines in the United States, innovation economics is responsible for only a small part of advances in labor postulates that innovation drives economic growth. productivity.”66 After reviewing an extensive and ex- Thus, innovation economics, unlike the three eco- haustive literature, Richard Nelson concluded that the nomics doctrines currently prevailing in the United research, “provided evidence that neoclassical vari- States, does not treat knowledge and technology as ables do not account for all of the differences among something that happens outside economic activity firms in productivity.”67 (exogenous factors in the economic model.) Instead,

The information Technology & Innovation foundation | sep tember 2008 page 14 Robert Hall and Charles Jones studied 127 nations to tive. From the standpoint of innovation economists, if determine why some grew so much faster: “[O]utput government policies to encourage innovation “distort” per worker in the five countries in 1998 with the high- price signals and result in some minor “deadweight” est levels of output per worker was 31.7 times higher loss to the economy, so be it, because allocative efficien- than output per worker in the five lowest countries.” cy is not the major factor in driving economic growth These researchers found something else that would in the 21st century knowledge-based economy. probably come as a surprise to neoclassical economists who see more saving as the key to economic growth: Innovation economists believe that the primary driv- “Relatively little of this difference was due to physical ers of growth are what economists call productive ef- and human capital.” Far more important than how ficiency – the ability of organizations to reorganize much capital a nation had in economic growth – 4.6 production in ways that lead to the most amount of times more important in fact – was how a nation used output with the fewest inputs, including labor inputs – its capital. and adaptive efficiency – the ability of economies and institutions to change over time to respond to succes- Other studies have come to similar conclusions. Kle- sive new situations, in part by developing and adopting now and Rodriguez-Clare decomposed the cross-coun- technological innovations. As innovation economist try differences in income per-worker into shares that Douglass North explains: could be attributed to physical capital, human capital, and total factor productivity. (Growth in total factor Adaptive efficiency...is concerned with the kinds productivity represents output growth not accounted of rules that shape the way an economy evolves for by the growth in inputs like physical and human through time. It is also concerned with the willing- capital). They found that more than 90 percent of the ness of a society to acquire knowledge and learning, variation in the growth of income per worker was a re- to induce innovation, to undertake risk and creative sult of how effectively capital is used, with differences activity of all sorts, as well as to resolve problems in the actual amount of human and financial capital and bottlenecks of the society through time. We accounting for just nine percent.68 Not all studies have are far from knowing all the aspects of what makes found such a large share, but almost all find that in- for adaptive efficiency, but clearly the overall in- novation and how capital is used is the main driver, stitutional structure plays a key role to the degree with the expansion of capital accounting for a much that the society and the economy will encourage smaller share.69 the trials, experiments and innovations that we can characterize as adaptively efficient. The incentives 2. The major drivers of economic growth are embedded in the institutional framework direct If productive efficiency and adaptive efficiency. the process of learning by doing and the develop- the focus in neoclassical economics is “the study of ment of tacit knowledge that will lead individuals how societies use scarce resources to produce valu- in decision-making processes to evolve systems that able commodities and distribute them among differ- are different from the ones that they had to begin ent people,”70 the focus in innovation economics is the with.71 study of how societies create new forms of production, products, and business models to expand wealth and In the neoclassical economists’ world where allocative quality of life. efficiency is all that matters and where market failures are few, one can make a compelling case for limited In contrast to neoclassical economics, which is fo- government, except perhaps to address issues of equity cused on getting the price signals right to maximize and areas of core government concern, like national se- the efficient allocation of scarce resources, innovation curity. This is because the key to economic prosperity economics is focused on spurring economic actors – is to reduce price distortions. But in a world in which from the individual, to the organization or firm, and productive and adaptive efficiency is what matters and to broader levels, such as industries, cities, and even where market failures are more the norm, the role for an entire nation – to be more productive and innova- the government to institute explicit and effective in-

The information Technology & Innovation foundation | sep tember 2008 page 15 novation economics policies is more compelling. This ments. Thus, innovation economics shifts the focus is because innovation and productivity depend not just of economic policy toward creating an institutional on the workings of individual firms acting alone, but environment that supports technological change, en- on a wide array of supports, such as a strong research trepreneurial drive, and higher skills. Because of this base, skilled workers, networks, standards, and a host conceptualization, innovation economics focuses not of other factors that public-private partnerships can just on macroeconomic and monetary issues like prices play a key role in helping to provide. but also on microeconomic and institutional issues.

3. Spurring evolving and learning institutions is When examining how the new economy creates wealth, the key to growth. Neoclassical economics, which fo- innovation economists give answers that are strikingly cuses principally on markets and individuals and firms different from those offered by neoclassical or neo- acting in them as atomistic particles responding pret- Keynesian economists; they also ask questions that are ty much exclusively to price signals along supply and strikingly different: demand curves, does explain a share of the economy. But innovation in the neoclassical economics model is  Are entrepreneurs taking risks to start new an exogenous process – a black box, if you will, that ventures? works its magic solely in response to price signals. In this sense, the neoclassical model sees innovation as  Are workers getting skilled, and are companies falling like “manna from heaven,” not something that organizing production in ways that utilize can be induced by proactive economic policies. those skills?  Are companies investing in technological In innovation economics, innovation is central. In- breakthroughs, and is government supporting novation economists recognize that innovation and the technology base (e.g., funding research and productivity growth take place in the context of insti- the training of scientists and engineers). tutions. Indeed, it is the “social technologies” of insti- tutions, culture, norms, laws, and networks that are so  Are regional clusters of firms and supporting central to growth, yet are so difficult for conventional institutions fostering innovation? economics to model or study. Innovation economists  Are research institutions such as universities view innovation as an evolutionary process in a market transferring knowledge to companies and indi- where firms act on imperfect information and where market failures are common. viduals?  Are trade policies working to ensure a level Innovation economists also view innovation as an evo- playing field for domestic companies free from lutionary process that takes place through the interac- mercantilist distortions? tion and learning of firms, industries, and other orga- nizations that collectively make up an overall national  Are policymakers avoiding imposing protec- innovation system. National innovation systems are tions for companies against more innovative institutional arrangements that facilitate learning and competitors? innovation among economic actors – and a robust na-  Do individuals and firms have the right incen- tional innovation policy facilities innovation. National tives and tools to adequately invest in new innovation systems differ significantly from country to ideas and commercialize them? country, depending upon culture, history, attitudes, in- stitutions and laws.  And, perhaps most importantly, are govern- ment policies supporting the ubiquitous Innovation economics is based on the notion that the adoption of advanced information technolo- economy’s productive and innovative power is en- gies and the broader digital transformation of hanced only through actions taken by workers, compa- society and the economy? nies, entrepreneurs, research institutions, and govern-

The information Technology & Innovation foundation | sep tember 2008 page 16 So is innovation economics a demand-side or a supply- When the economy is characterized by uncertainty – as side economics doctrine? Innovation economics it is today, for example, with respect to energy prices focuses on supply-side factors like knowledge, skills, and the environment – price signals alone are not the and investment. But innovation economics is also fo- best guide to decision-making. In this sense, when cused on the demand-side of the equation in the sense much more of the economy is in disequilibrium much that it seeks to increase the demand by organizations more of the time, the old allocation models no longer for the factors that boost growth and innovation – provide adequate guidance, and relying on price signals namely, new knowledge, new skills, and new capital alone to drive innovation is not enough. The Internet, equipment. for example, might never have been developed with a reliance on price signals alone because it was impos- 4. The new knowledge-based economy tends to- sible to model the risk-reward ratio of investments in ward change rather than toward equilibrium. In- the Internet. novation economics holds that although there is equi- librium in some markets at some times, in a growing share of markets in the new knowledge-based econo- Neo-Keynesians see most economic issues as boiling down to a my, equilibrium is a fleeting moment. The reason is that markets are constantly roiled by entrepreneurial question of who gets the benefits: working people or rich people entry, disruptive technologies, political and social up- and corporations. heavals, changes in trade patterns, and more, never set- tling down into equilibrium. The lack of equilibrium is especially common to industries characterized by Innovation entails an information challenge, not just a higher levels of change and innovation. Moreover, in- supply and demand challenge. Innovation economist novation economists believe that market disequilibri- Allan Naes Gjerding has observed that although neo- um is responsible not for economic inefficiency but for classical economics doctrine holds, “that the market growth and progress. As innovation economist Joseph mechanism represents the most effective way of co- Schumpeter pointed out over half a century ago: ordinating economic activities, innovation economics argues that the market must be endowed with inter- A system which is efficient in the static sense at ev- organizational arrangements in order to achieve coor- ery point in time can be inferior to a system which dinative efficiency in cases where there is not complete is never efficient in this sense, because the reason knowledge about the characteristics of new products for its static inefficiency can be the driver for its and processes.”73 Successful innovations are based on 72 long-term performance. knowledge about users’ needs and about the value of the innovation to users. In this sense, smart innovation 5. Individuals and firms are not rational maxi- policies try to fill what is fundamentally a knowledge mizers. Rationality has generally been understood gap. Thus, it is difficult, if not impossible, for individu- to involve consistency across decision-making based als and firms to make effective decisions under condi- on measurable calculations. Decision-making involv- tions of uncertainty relying only on price signals. ing risk can be made using rational decision-making. Decision-makers judge costs, revenues, and the risk Decision-making under uncertainty requires elements involved in each and then make decisions. Innovative not commonly included under risk calculations.74 As activity, particularly if it involves a high degree of nov- the venture capitalist T. Boone Pickens explained how elty, typically involves uncertainty, where the outcomes he selected venture capital investments, “I sit him [the and their associated probabilities are not known at all, entrepreneur] down and look in his eyes…if I like what rather than risk, where the outcomes are known with a I see, I lay the dough down.” Innovation economics, calculable probability. As a result of such uncertainty, rather than being a theory that can be applied to all innovative efforts will meet with many failures, as well situations for all time (e.g., have markets set prices), as some great successes. is based on a set of practical guidelines that change

The information Technology & Innovation foundation | sep tember 2008 page 17 depending on the context. It is for this reason that sweeping statements, like “government always gets it adherents of innovation economics focus not just on wrong,” or “corporate profits are antithetical to the economics but also on technology, business, regional public good.” development, culture, and law. It is also why adherents very much look to a pragmatic and empirical analysis Neoclassicalists will point to examples where govern- of what has worked and is likely to work in the fu- ment did get it wrong, while neo-Keynesians will point ture. To be sure, innovation economics offers a num- to cases where there was corporate excess and wrong- ber of guidelines to policy makers, including to focus doing. But decisions about where to draw the line be- on innovation and productivity; to spur public-private tween what should be public, what should be private, partnerships; when appropriate to support competitive and what should be public and private should be guid- markets; and to embrace change and dynamism. But ed by actual experience, data, research, and logic.76 To these guidelines are not and should not be reified into say that decisions in Washington, D.C. are not today rigid rules. guided by these factors is indeed an understatement. If there is any ideology governing this, it should be that smart public-private partnerships can play a key role in helping non-governmental organizations become more As John Maynard Keynes himself once stated, “Practical men, innovative and productive where there are significant who believe themselves to be quite exempt from any intellectual market failures limiting their own action. influences, are usually the slaves of some defunct economist.” Areas Where the Innovation Economics Doctrine Is Useful and Generally Accurate 6. Smart public-private partnerships are the best Much like Einsteinian physics built on Newtonian way to implement policy. Innovation economics re- physics, innovation economics builds on the economic jects the almost exclusive reliance of many neoclassi- models preceding it. In this sense, innovation econom- cal economists on markets (an exception being liberal ics recognizes that many markets are characterized by neoclassical economists’ willingness to intervene to more or less stable supply and demand factors with few improve fairness). Because firms and individuals are market failures, and in these markets the neoclassical not rational maximizers responding like automatons guidance to just get the prices right might be an ad- to price signals, markets sometimes underperform, equate framework. But in markets that are character- particularly with regard to innovation. But innovation ized by high levels of dynamism and uncertainty, as economics also rejects neo-Keynesians’ suspicion of many markets are in today’s global, knowledge-based the corporate sector and their belief that “what is good economy, innovation economics provides a more ac- for GM is probably not good for the country” – some- curate guide to policy than the neoclassical or Keynes- times it is good, and sometimes it isn’t. ian models. The focus on spurring innovation on the supply-side of the economy has been shown to be the Innovation economics suggests that the critical is- right focus by a large number of growth accounting sue of the role of the state and market should not be models. framed, as it is currently by policymakers and others in Washington, as the state versus the market. Instead, Areas Where the Innovation Economics Doctrine Is a as Beinhocker suggests, the issue should be framed as Flawed Guide to Policy “how to combine states and markets to create an ef- Innovation economics can be a flawed guide to policy fective evolutionary system.”75 How to craft an effec- if it used as a crutch by policymakers to intervene in tive evolutionary system that supports market organi- markets (or to fail to remove barriers in markets) in zations (including commercial enterprises, non-profit ways that reduce productivity and innovation, or if its organizations, and government entities) in their quest use is motivated by political factors instead of using the to become more productive in the most effective way doctrine to intervene in ways that are beneficial and is largely an empirical and practical problem that can- grounded in sound analytical reasoning and evidence. not and should not be guided by broad ideologically Innovation economics also does not excuse economic

The information Technology & Innovation foundation | sep tember 2008 page 18 policymakers from the important tasks of making sure described below, these four doctrines often lead to that markets are open and generally free and that both quite different policy advice for general economic pol- macroeconomic conditions and the financial system icy issues in the United States, as well as for specific are stable and healthy. Open and free markets and a economic policy issues. stable macroeconomic environment are necessary con- ditions for robust innovation and growth; but they are General Economic Policy Issues not sufficient conditions. The four economics doctrines’ approaches to dealing with general economic policy issues – tax policy, public Yet many neoclassicalists persist in labeling innovation expenditure policy, trade policy, antitrust enforcement, economics with the pejorative “industrial policy” label and regulation – are quite different, as explained be- meant to imply inappropriate meddling in the market. low. In dismissing the need for action by the federal gov- ernment to help boost U.S. competitiveness in the face Tax Policy. Perhaps no issue is more central to con- of new challenges, for example, supply-sider Gregor ventional economic policy than tax policy, in part not Mankiw framed the choice this way: only because of the focus of neoclassical economics on monetary factors but also because tax policy is di- Policymakers should not try to determine precisely rectly under the control of policymakers. Adherents of which jobs are created, or which industries grow. If conservative and liberal neoclassical economics, neo- government bureaucrats were capable of such fore- Keynesian economics, and innovation economics have sight, the Soviet Union would have succeeded as a very different approaches to tax policy. centrally planned economy. It did not, providing the best evidence that free markets are the bedrock of economic prosperity.77 Proponents of innovation economics want the tax code to be used But this kind of “black and white” framing poses a as an explicit tool to spur business investments in innovation and false choice. It does not follow that any kind of nation- al innovation economics based strategy, even if done productivity. in ways that foster competition, relies on market tools, supports firms to be more efficient and innovative, and For both supply-siders and liberal neoclassicalists, is industry-led, is “industrial policy.” But when your the best tax code is the one that distorts allocative economics doctrine places the top priority on ensuring efficiency the least. Neoclassical economists gener- that markets set prices, any policy doctrine that seeks ally believe that any tax distorts prices from what the to intervene is by definition harmful. “market” would naturally produce and therefore leads Finally, with its focus on institutions, entrepreneurs, to economic welfare losses. Both supply-siders and and technology, innovation economics is not a sub- liberal neoclassicalists would deal with this situation stitute for effective fiscal and monetary policy or for by making the tax code as simple as possible, elimi- ensuring that the financial system operates effectively. nating most deductions and exemptions, and using the 78 Rather, it should be seen as a complement to good fi- savings to pay for a lower statutory tax rate, because nancial system policies. even though both camps believe that taxes distort the economy and economic decision-making, they believe that differential tax rates applied to different activities APPLYING THE ECONOMICs DOCTRINES TO REAL- distorts it even more. Supply-siders would go further WORLD POLICY ISSUES and cut taxes, especially on high marginal rates since One way to appreciate the differences between the these, they argue, distort the market the most. Liberal four economics doctrines – conservative and liberal neoclassicalists would be torn, on the one hand want- neoclassical economics, neo-Keynesian economics, ing the growth that lower taxes bring but at the same and innovation economics – is to consider how the time wanting higher taxes, especially on high earners, doctrines lead to particular policy recommendations in order to increase public savings and foster economic for a variety of real-world economic policy issues. As fairness. 79

The information Technology & Innovation foundation | sep tember 2008 page 19 Neo-Keynesians generally don’t worry that higher wary of significant increases in public investment. taxes distort growth. In their view, because individu- They generally prefer to use money to pay down the als with higher incomes have a lower propensity to national debt. consume than individuals with lower incomes, high- er taxes on such individuals, used then to support Proponents of innovation economics distinguish be- public spending, would drive economic growth. The tween spending and investment as well. However, be- reason is that almost all of the money collected as cause they see the economic benefits from increased taxes from such individuals would be spent on public public investment as usually significantly outweigh- projects, instead of a large portion of it being saved, ing the economic benefits of deficit reduction, they thereby driving growth. favor significantly expanding investments in innova- tion (e.g., direct public expenditures on research, or Proponents of innovation economics would want indirect public investments like an expansion of the the tax code to be used as an explicit tool to spur R&D tax credit), skills, and infrastructure. business investments in innovation and productivity. Thus, they would advocate tax policies that stimulate One can see the differences between the four doc- more investment in the kinds of business activities trines by examining how each economics camp would that spur growth and innovation, such as first year recommend what the federal government do if it had expensing of investments in broadband and other an extra $50 billion. Neo-Keynesians would probably information technologies, a more robust R&D tax support spending the money on activities that would credit, and a workforce training tax credit.80 give more purchasing power to lower- and middle- income Americans in ways that would also address Public Expenditure Policy. Adherents of con- economic challenges facing working-class Americans servative and liberal neoclassical economics, neo- (e.g., expanding health care coverage, unemployment Keynesian economics, and innovation econom- insurance, low-income housing). In contrast, supply- ics also have very different views when it comes to siders would return the money to taxpayers through public expenditure policy. Supply-siders want public tax cuts for individuals, particularly higher income expenditures to be limited to the essential activities individuals. Liberal neoclassicalists would likely that the market and individuals cannot easily pay for advocate that government use the money to reduce on their own, like national defense and the legal sys- the budget deficit, or if in surplus, to pay down the tem, in part because they believe most government national debt. Finally, innovation economists would spending is inefficient. probably invest most or all of the money in innova- tion – a more generous R&D tax credit, more federal Neo-Keynesians, on the other hand, want to expand support for research and development, incentives for public expenditures, in part because they see them companies to invest in new technology, infrastruc- driving demand and thereby spurring economic ture, etc. growth, but also because they see public spending as helping low- and moderate-income individu- Of course, the real issue is achieving the right balance. als. The distinction between spending and invest- Raising the top marginal tax rate to very high rates in ment (the latter being an expenditure that produces order to pay down the debt, as some neo-Keynesians returns long after the initial investment is made) is propose, would be counterproductive, just as cutting one that neo-Keynesians typically do not make. For marginal tax rates to less than 20 percent while ex- neo-Keynesians, spending on low-income housing panding the debt and shrinking public investment, as or Medicare is in the same category as investment many supply-siders propose, would be. in broadband in terms of its impact on the economy. Both create jobs in the short term. Trade Policy. There is perhaps no more contentious economic issue in the United States than trade. Ad- Liberal neoclassicalists, on the other hand, do dis- herents of the four economics doctrines have dramati- tinguish between investment and spending. They cally different approaches to trade and fundamentally generally favor the former, but because of their over- different beliefs about its efficacy. riding emphasis on fiscal discipline, they are usually

The information Technology & Innovation foundation | sep tember 2008 page 20 Supply-siders and liberal neoclassicalists, with their benefit.81 The same motivation underlies neo-Keynes- overriding focus on promoting allocative efficiency ians’ support for demands to have nations like China and consumer welfare, strongly favor free trade; they increase their currency values vis-à-vis the U.S. dollar. oppose tariffs or other restrictions in large part be- cause they see them as reducing allocative efficiency. Adherents of innovation economics are generally sup- Neoclassicalists believe that if each country specializes portive of globalization and unimpeded international in what it supposedly is good at (has a competitive ad- trade, but their support for trade is not based on in- vantage in), efficiency is increased (just as it would be if creasing allocative efficiency the way neoclassicalists’ prices are not distorted at home). Moreover, neoclassi- support is. Instead, they support global trade for three calists largely focus on the benefits to consumers from main reasons. First, the increases in competition can low-wage production overseas and ascribe the costs to spur companies to be more innovative and productive. workers as just the natural results of market forces that Second, the natural evolution to a global trading sys- are only resisted at the cost of economic peril. The only tem should naturally benefit high-wage countries by real difference between the two neoclassical camps is creating a new global division of labor where the in- their difference in what to do about workers who are dustrial base of these economies evolves toward more hurt by trade. Supply-siders generally argue that there high value-added and innovation-based goods and ser- are significant risks from more generous policies to vices. Third, they see globalization as increasing in- help those who are hurt by trade, including increas- novation in the sense that it spurs greater learning and ing government spending and blunting incentives for collaboration across borders. workers to work and take risks. In contrast, liberal Yet adherents of innovation economics temper their neoclassicalists argue for helping workers who are hurt support for global trade with the concern that manipu- by trade, in part because they believe that by doing so lation of the trading system by countries embracing they can limit political opposition to trade. mercantilist policies (e.g., tariffs, unfair taxes, currency manipulation, discriminatory standards) that favor ex- ports, coupled with disregard of intellectual property With its focus on allocating existing scarce resources, the neoclas- standards, not only can hurt richer nations’ productivi- ty and innovation but potentially can also lead to lower sical economics framework gives short shrift to innovation. levels of global growth as companies make investments in places and in types of production that they would 82 Because neo-Keynesians are concerned first and fore- not make absent these mercantilist policies. This is most with workers’ welfare, they are more skeptical of why people who subscribe to innovation economics trade, seeing that it leads some workers to lose their advocate concerted international efforts to move the jobs. They also focus not on the benefits to consum- global trading system away from national economic ers from low-wage production overseas but on the policies that promote exports in a beggar-thy-neighbor costs to workers. Neo-Keynesians believe that many fashion (as is currently the case today in most nations) and toward policies that support domestic innovation U.S. workers see their wage increases restricted be- 83 cause of pressures on production wages from low- and productivity. wage workers in developing nations. For that reason, Like neo-Keynesians and liberal neoclassicalists, in- most neo-Keynesians favor limiting steps to open new novation economists do favor policies to help workers markets, particularly with countries with lower wages and communities adjust to trade-related dislocations; and weaker labor and environmental standards – and however, they would generally oppose policies to pro- neo-Keynesians sometimes even favor reversing past tect domestic companies from legitimate impacts from market-opening steps. Because they want to blunt trade (as opposed to protecting them from the impacts low-wage competition, neo-Keynesians’ preferred so- of foreign mercantilist policies). Finally, innovation lution to globalization is to push for stronger labor and economists argue that for trade to be effective, it must environmental standards, assuming that if corporate be complemented with domestic innovation policies to costs go up in other nations, American workers will help the economy move up the value chain and take

The information Technology & Innovation foundation | sep tember 2008 page 21 advantage of global economic opportunities and re- ally favor weak antitrust enforcement, assuming that spond to global challenges. For unlike neoclassical the market will adequately deal with any issues arising economists who believe that trade simply allows na- from market power or market abuse. In contrast, the tions’ competitive advantage to be “revealed,” inno- liberal neoclassicalists’ more favorable view of govern- vation economists believe that competitive advantage ment leads them to favor more aggressive antitrust en- has to be created and continually recreated. forcement. Indeed, the focus of liberal neoclassicalists is almost exclusively on consumer welfare, often lead- Antitrust Enforcement. How to deal with competi- ing them to oppose mergers that lead to net societal tion in the marketplace has been a concern of poli- gains (e.g., greater efficiencies, more innovation) if the cymakers for over 100 years. As U.S. Senator John mergers also increase prices for consumers. Further- Sherman, who argued for passage of his 1890 antitrust more, unlike supply-siders, liberal neoclassicalists wor- bill, warned: ry about buyers’ power, not just sellers’ power. Thus, for example, some liberal neoclassicalists worry that If we will not endure a King as a political power the power of companies like Wal-Mart will be unfairly we should not endure a King over the production, used to hurt business suppliers, thus hurting allocative transportation, and sale of the necessaries of life. If efficiency.86 we should not submit to an emperor we should not submit to an autocrat of trade with power to pre- Neo-Keynesians are likely to favor strong antitrust en- vent competition and to fix the price of any com- forcement, but their motivation is different from that modity.84 of liberal neoclassicalists who want to use antitrust policy to favor consumers. Neo-Keynesians want to Not surprisingly, there is little agreement among the use antitrust enforcement to favor workers by favor- conservative and liberal neoclassical economics, neo- ing producers that might be hurt by other competitors. Keynesian economics, and innovation economics We see this in the approach to antitrust in many re- camps on the proper approach to antitrust enforce- gions of the world, particularly the European Union. ment. Neoclassicalists of both camps favor competi- Moreover, like Senator Sherman, neo-Keynesians also tion – the more, the better. With their emphasis on see antitrust enforcement as a political tool to limit the allocative efficiency, neoclassicalists worry that undue political power of large corporations they fear have the market power will lead to inefficient prices and harms potential to subvert democracy. to the consumer. Thus, for example, the legal scholar Robert Bork is convinced that allocative efficiency was Innovation economists, because of their focus on pro- not just the dominant but the sole consideration of ductivity, view mergers and market power in the con- Congress in enacting the antitrust statues: text of how they affect company efficiencies and inno- vation.87 Even if a particular merger might lead to an My conclusion, drawn from the evidence in the increase in market power and a concomitant reduction Congressional Record is that Congress intended the in allocative efficiency and/or hurt other companies in courts to implement only that value we would today the marketplace, such a merger might expand economic call consumer welfare…Though an economist of welfare if it leads to even greater efficiencies from con- our day would describe the problem of concern to solidation – particularly in industries with declining (Senator) Sherman differently, as a misallocation of marginal costs, where added scale can drive significant resources brought about by a restriction of output cost savings. In addition, innovation economists are rather than one of the high prices, there is no doubt less concerned with buyer power, because the effects that Sherman and he would be thinking the same of this are largely to pressure other businesses to be- thing.85 come more innovative and competitive. Moreover, in- novation economists recognize that markets in which But the two camps of neoclassicalists differ on the there is no market power, and hence low levels of prof- role of government in enforcing competition. Because its, are markets where there is not much innovation supply-siders are skeptical of government, they gener- because firms in such markets do not have the surplus

The information Technology & Innovation foundation | sep tember 2008 page 22 to invest in R&D.88 In addition, because innovation Neo-Keynesians worry less than neoclassical econo- economists look at evolutionary dynamics rather than mists about effects of regulation on economic growth static efficiency, they are more prone to consider how – believing that the costs of regulation are simply borne disruptive technologies and new entrants might pose a by corporations, and by extension wealthy shareholders challenge to firms with market power. – and more about making sure that regulation achieves its purposes. Consequently, neo-Keynesians are gener- Finally, adherents of innovation economics see inno- ally skeptical about means of regulation that might be vation as involving a learning and coordination chal- more efficient than command and control, preferring lenge and therefore see inter-firm collaboration related mandates and stricter top-down regulation in order to to learning as a good thing to be encouraged, not a be assured that intended goals are achieved. bad thing to be prosecuted, as neoclassicalists and neo- Keynesians might see it. Adherents of innovation eco- nomics might also see collaboration among producers to fight restrictions among middlemen and distribu- Innovation economists, because of their focus on productivity, view tors as a good thing, particularly if such collaboration mergers and market power in the context of how they affect com- leads to companies being able to bypass protectionist pany efficiencies and innovation. restrictions.89 In sum, innovation economics focuses on the pragmatic issues surrounding each issue, and judges it based on the extent to which it spurs innova- Innovation economists place a particular emphasis on tion and productivity. Granted, these do not always crafting regulatory systems that go beyond achieving generate the kind of clear and easily understood guide- their immediate objectives to explicitly help spur inno- lines that the neoclassical and Keynesian doctrines vation (including digital transformation). Innovation generate, but good economic policy is not necessarily economists and liberal neoclassical economists alike easy or simple. worry that regulations that are too blunt and inflexible Regulation. Adherents of conservative and liberal could create additional costs that other measures might neoclassical economics, neo-Keynesian economics, avoid while still achieving the goals of regulation. In and innovation economics have different approaches addition, both groups tend to view social regulation to economic regulation (e.g., regulation of prices and as a mechanism for providing investments in human entry) and social regulation (e.g., labor market, health capital that are a crucial input to creating new knowl- and safety, and environmental regulation), both of edge and ultimately innovative activity. which have impacts on the U.S. economy. Specific Economic Policy Issues Conservative and liberal neoclassicalists alike worry As described below, the four economics doctrines lead that economic regulation distorts price signals and to quite different prescriptions for specific economic leads to allocative inefficiency. Yet the two groups’ policy issues confronted by U.S. policymakers, includ- views on social regulation differ. Supply-siders gen- ing: the design of an economic stimulus program, erally work to keep social regulation to a minimum, competitiveness and innovation policy, telecommu- arguing that it limits economic growth (and personal nications policy, the U.S. housing crisis, government freedom) and that other means (such as contracts) are 90 entitlement programs, energy prices, and surface trans- more appropriate for dealing with these issues. Lib- portation policy. eral neoclassicalists, on the other hand, are more likely to support social regulation, arguing that it is key to Economic Stimulus. The recent and current de- creating a better society. At the same time, liberal neo- bate in the United States over the national economic classicalists (like adherents of innovation economics) stimulus package was reflective of the current division want the goals of social regulation to be achieved in among adherents of conservative and liberal neoclassi- the most efficient and cost-effective ways (e.g., rein- cal economics, neo-Keynesian economics, and innova- venting government, using industry codes of conduct, tion economics. harnessing information tools, and disclosure).

The information Technology & Innovation foundation | sep tember 2008 page 23 Among neoclassicalists, supply-siders argued that the Many, but not all, liberal neoclassicalists are more will- best stimulus package was permanent cuts in indi- ing to admit that there is a competitiveness challenge, vidual marginal tax rates.91 Liberal neoclassicalists ar- at least in terms of its affect on some American work- gued that any stimulus package should be targeted and ers. Liberal neoclassicalists don’t reflexively question temporary, for they did not want to boost the budget government support, but because of their general faith deficit over the long term.92 Some even went so far in the marketplace and their fear that government ac- to argue that any stimulus should be paid back when tion will distort allocative efficiency, they often limit times got better. their solutions to ones that help foster general factor conditions to make it easier for companies to be com- Neo-Keynesians used the need for a stimulus package petitive. In this regard, liberal neoclassicalists’ favored to support a package of spending increases, including solutions are to boost human capital (e.g., improve K-12 support for expanded unemployment insurance, aid to education, help more people go to college, boost high- local government, and assistance to low-income work- skill immigration), increase support for basic research, ers.93 and create a regulatory climate that is supportive of in- novation.95 Both conservative and liberal neoclassical If innovation economists had engaged in the stimulus economists are prone to view any more-targeted gov- package debate, they would have likely focused not just ernmental efforts to help business become more inno- on the amount of stimulus but on what kind of stimu- vative and productive as unwarranted industrial policy, lus was being offered. In particular, they would argue even if such efforts are strategic and done in partner- for at least a part of the stimulus to be invested in areas ship with industry. Both groups of economists believe that would boost productivity or innovation while also that government is inherently incapable of implement- getting spending ramped up in the short run. Innova- ing an effective innovation policy. tion economists might, for example, have advocated a To the extent that neo-Keynesians focus on the com- multi-billion grant program administered through the petitiveness issue at all, it is generally to propose poli- National Science Foundation to help research universi- cies to create “good jobs” for workers (as opposed to ties upgrade their undercapitalized research infrastruc- policies to help companies be more innovative and ture. Such a package could be spent relatively quickly productive) through such means as instituting univer- but, unlike checks to consumers, would have long-term sal health insurance, funding infrastructure, and spur- growth benefits for the economy. ring the creation of new “green” jobs.96 Neo-Keynes- ians are also often somewhat supportive of efforts to Competitiveness and Innovation Policy. As global help individual firms become competitive, particularly economic competition has increased, the U.S. econ- if they are targeted to small firms. But they are more omy has come under increasing economic challenge. skeptical of policies that might provide financial in- And on this critical issue, adherents of conservative centives to larger corporations, for example, by letting and liberal neoclassical economics, neo-Keynesian them expense investments in equipment in the first economics, and innovation economics propose quite year. They are however, sometimes willing to use the different policies, and even have quite different views tax code to give companies incentives to create good of the nature of the challenge. jobs at home and otherwise act in “socially responsible ways.” Neo-Keynesians also worry that efforts to re- Supply-siders, because of their overarching belief in form regulation (e.g., tort reform) to boost innovation the primacy of the market, are generally skeptical that will work to the detriment of working people. there even is a competitiveness challenge, for in con- servative neoclassical economics doctrine, it is axiom- Innovation economists would argue that the innova- atic that market outcomes are not a problem. To the tion process is rife with market failures (e.g., the in- extent that there is any competitiveness problem, its ability of firms to capture all of the benefits of their sources must lie squarely with government – in par- innovation activities, high levels of uncertainty, coor- ticular, excessive government regulations and taxes.94 dination failures, etc.), and for that reason, the market

The information Technology & Innovation foundation | sep tember 2008 page 24 left to itself will produce less innovation and produc- Telecommunications Policy. As the digital economy tivity than is economically rational. Consequently, al- has emerged, telecommunications policy has become though people who subscribe to innovation economics not just more complex, but more important. Telecom- support policies to ensure that there are adequate in- munications policy is viewed differently by adherents puts into the innovation process (e.g., an ample sup- of conservative and liberal neoclassical economics, ply of scientists and engineers and expanded funding neo-Keynesian economics, and innovation econom- for basic research) and a better regulatory climate, ics. they would go further and advocate for policies that help organizations become more innovative and pro- For conservative neoclassicalists there is little need for ductive. Such policies would include tax policies to a telecommunications policy (as telecom in their view spur companies to invest more in innovation (e.g., the is no different than any other industry), and many favor R&D tax credit); new institutional forms to help spur abolishing or radically reducing the role of the Federal innovation (e.g., a National Innovation Foundation97); Communications Commission. Supply-siders see tele- more targeted R&D funding, especially to industrial communications services as a private good (with no consortia; and efforts to spur digital transformation in public goods aspects or externalities) and are therefore particular industries, like health care. Moreover, un- largely content to let the market decide how to pro- 100 like neo-Keynesians, adherents of innovation econom- vide service. They believe that markets are generally ics would have no specific preferences for small firms, competitive and are not in need of prescriptive regula- arguing instead that the goal should be to spur innova- tions – and that where markets are not competitive, tion and higher productivity and that policies should new entrants will come in if incumbents abuse their be neutral with regard to firm size. market power. Finally, they believe in strong property rights and generally oppose a balancing between fair Finally, adherents of innovation economics would use and the rights of content owners.101 make a distinction between policies that help compa- nies do something socially beneficial that they would not otherwise do or not do as much of (e.g., training Virtually all policymakers involved in economic policy subscribe workers in broader skills, spending more on research and development) and programs and policies that of- to a particular economics doctrine, even if they may not be aware fer subsidies but do nothing to help make companies of which camp they are in. more productive or innovative. Examples of policies that would help companies do something socially beneficial that they might not otherwise do or do as In contrast, adherents of the other three doctrines do much of include programs that: 1) raise the capacity of worry that telecommunications markets are not fully companies to be more productive and innovative, like competitive; they also believe that telecommunications the National Institute of Standards and Technology’s has inherently public aspects (e.g., with respect to use (NIST) Manufacturing Extension Partnership (a pro- of the electromagnetic spectrum) and that there is a gram to provide technical assistance to help small and role for telecommunications policy to ensure access medium-sized manufacturers), or that 2) help compa- to telecommunications services by all. Nevertheless, nies develop new technology, like NIST’s Technology the three camps differ significantly in how they would Innovation Program.98 Examples of programs and craft telecommunications policy. policies that offer subsidies but do not make companies more productive or innovative include those that give Liberal neoclassicalists and neo-Keynesians would use money to companies with no increase in productive or telecommunications policy to help create more com- innovative potential, such as agricultural subsidies and petitive markets, but for different reasons. Liberal price supports that postpone needed market adjust- neoclassicalists, reflecting their overall belief in com- ments while propping up inefficient farm producers. petition driving allocative efficiency, support policies In contrast to innovation economists, both conserva- to increase competition in telecommunications, believ- tive and liberal neoclassical economists would tar all ing that this will drive down prices and help consum- such interventions, whether investments or subsidies, ers.102 Neo-Keynesians, reflecting their general wari- pejoratively as “industrial policy.”99 ness of large corporations, also support more competi-

The information Technology & Innovation foundation | sep tember 2008 page 25 tion, particularly if it comes from government-owned tions services. In contrast, neo-Keynesians are much telecommunications providers (e.g., municipal provi- more supportive of an expansive role for government sion of broadband) or small companies.103 In addition, to ensure telecommunications access for all and likely neo-Keynesians would use the power of government to propose measures such as creating a robust univer- to limit the market freedom of large telecommuni- sal service fund paid for by taxes on telecommunica- cation providers, for example, by crafting strict “net tions services.109 neutrality” mandates and banning or severely limit- ing circumstances under which telecommunications The Housing Crisis. With the dramatic fall in U.S. providers can deploy network management technolo- housing prices and the increase in mortgage foreclo- gies.104 In addition, neo-Keynesians see the telecom- sures, many of them involving subprime mortgages, munications industry as a key anchor of democratic policymakers are looking to solutions to the crisis. discourse and would impose regulatory requirements Again, the differences among adherents of conserva- (e.g., minority ownership rules) on the industry to tive and liberal neoclassical economics, neo-Keynesian further these goals.105 Finally, they believe that there economics, and innovation economics in terms of their should be a very weak copyright regime, with individu- approach to the housing crisis are notable. als free to download and copy virtually all content, all Both conservative and liberal neoclassicalists focus on in the name of “fair use.”106 the impacts of the housing crisis on markets, the impact of the fall in prices on homeowners, and the potential In contrast, innovation economists believe that some limiting of credit due to the crisis’ impact on banks. telecommunications markets are characterized by sig- Supply-siders generally believe that market forces will nificant economies of scale (especially in providing lead to the right outcomes and worry that any kind of “last mile” services) and that increased competition, intervention, either to bail out lenders or borrowers, especially that promoted proactively by government, will create moral hazard.110 Liberal neoclassicalists are could result in excessive and duplicative investments, less worried about creating moral hazard and more thereby lowering industry productivity and ultimately willing to intervene in order to ensure that markets raising consumer prices.107 In addition, because inno- vation economists see telecommunications infrastruc- work in the present. ture as a “general purpose technology” that drives in- Neo-Keynesians worry even less about moral hazard novation and productivity, most tend to favor explicit than liberal neoclassicalists but would focus their ef- policies to give incentives to private providers to invest forts more on helping borrowers who have been hurt, more, particularly in higher speed broadband and in even if the borrowers provided inaccurate informa- getting broadband to more areas and more people. tion in order to obtain their loans. In addition, neo- Thus, adherents of innovation economics would sup- Keynesians would seek to institute new regulations port a national policy with measures to spur not just limiting what lenders could do in the future.111 more access to broadband networks but the develop- ment of better networks – for example, through tax Adherents of innovation economics focus less on the incentives to broadband providers to deploy very high- impact of the housing crisis on markets (which they see speed networks.108 as simply impacts on prices) and more on the impact on real output – in this case, the lost economic output With respect to fairness, both liberal neoclassicalists of having large numbers of houses vacant due to fore- and innovation economists believe that telecommu- closure. For them, the fall in housing prices is simply nications access for all is an important goal, but they a transfer of wealth from owners to buyers (as housing would not make universal access the primary goal of prices fall owners lose but new buyers gain). The real telecommunications policy. Part of the reason is that loss to society is from falling housing output. As a liberal neoclassicalists and innovation economists be- result, people who subscribe to innovation economics lieve that doing so could create tradeoffs with econom- would press for policies that would reduce foreclosures ic growth, particularly if the monies for the expendi- and get homes that have been foreclosed back on the tures are derived from higher taxes on telecommunica- market as quickly as possible.

The information Technology & Innovation foundation | sep tember 2008 page 26 Government Entitlement Programs. With an ag- in the stock market, equity prices would rise as the de- ing population and increases in the cost of health care mand increases. But as soon as baby boomers begin to exceeding inflation, government entitlements – Social retire and start selling their stocks to pay their mort- Security and Medicare in particular – are expected to gages, medical bills, and other expenses, stock prices grow significantly. Each of the four economics doc- would begin to fall as the number of sellers exceeds buy- trines look at this problem differently and propose dra- ers. At that point, the real return to the stocks would matically different solutions. fall and the supposed miracle of higher returns would have evaporated. Shifting Social Security payments to Both conservative and liberal neoclassicalists look to the stock market confuses real wealth that society can the market, in this case the financial market, for part draw upon with asset prices that reflect supply and de- of the solution. Supply-siders argue that letting people mand factors. To address the Social Security entitle- put their money in the stock market instead of in the ments problem, innovation economists would instead Social Security trust fund would solve the problem, focus relentlessly on boosting productivity so that in since over the long term the stock market has out- later years relatively fewer workers would be able to performed other investments.112 Even though liberal produce enough to meet their own consumption needs neoclassicalists generally oppose using Social Security and the consumption of the increased number of re- funds to create personal private retirement accounts tirees. Even though relatively fewer U.S. workers will (because of fairness concerns), some embrace the same support more retirees, if these workers produce much logic and embrace a version of privatization that would more, they could maintain or even increase their after- have the government invest at least a portion of the tax income while enabling Social Security payments to trust fund assets in equity markets.113 retirees to not fall.

Conservative and liberal neoclassicalists alike argue Similarly, with respect to health care costs, innovation for cutting entitlement spending now in order to have economists stress spurring innovation and productiv- enough money in the future. They propose cutting ity in the health care system so that society can con- entitlement spending now to save for the future in a sume more health care (as people get older) with the variety of ways – for example, indexing increases in same or even lower costs.115 Finally, to the extent that benefits to inflation rather than wage rates, which go cost savings and productivity improvements do not get up faster because of increases in productivity, and ra- us all the way, innovation economists would still focus tioning health care. Liberal neoclassicalists are more on the real economy and favor people working longer, likely than supply-siders to support what is called pro- both by reducing the incentives for individuals to re- gressive indexing, in which higher income individuals tire early and by increasing the retirement age. see benefits indexed to inflation and lower income in- dividuals see benefits indexed to wages (which histori- Energy Policy. With the rise of gas prices to about cally have gone up faster than inflation). $4.00 a gallon, pressure for some kind of public policy response are growing. Adherents of conservative and In contrast, most neo-Keynesians minimize the extent liberal neoclassical economics, neo-Keynesian eco- of the entitlements problem, arguing that it’s over- nomics, and innovation economics would again re- stated. Moreover, even if the problem is real, they spond with different solutions and approaches. argue that cutting needed benefits would hurt those who need government’s help the most.114 To the extent Among neoclassicalists, supply-siders assume that in- there are shortfalls, neo-Keynesians believe that they creasing market prices for oil will spur people to con- should be made up by raising taxes (e.g., increasing the sume less oil and, more importantly, spur producers (oil taxable base of income subject to Social Security taxes companies) to produce more, especially if they are not and/or dedicating estate taxes to Social Security). hindered by regulations (e.g., restrictions on offshore oil exploration or expanded drilling in Alaska). But in Innovation economists tend to be skeptical of asset- line with their faith in markets, supply-siders generally based approaches to save Social Security. The reason oppose the government favoring any particular energy is that they believe that if payroll taxes were invested technology, even a technology that has significantly

The information Technology & Innovation foundation | sep tember 2008 page 27 fewer environmental impacts than current technolo- consumers to shift to. Without viable electric cars, for gies.116 Liberal neoclassicalists similarly believe that example, people will still drive gasoline-powered cars, higher energy prices will lead to more supply and less albeit slightly more fuel-efficient ones. Consequently, demand, but they are less willing than supply-siders to adherents of innovation economics would address the eliminate regulatory protections (i.e., permit offshore challenge of high oil prices by significantly expanding drilling) to expand supply, while somewhat more will- federally-supported R&D efforts (including R&D tax ing to consider government support for particular en- credits) focused on developing cost-effective and vi- ergy technologies, especially if the support is limited to able technological alternatives to oil consumption. basic research. Likewise, neoclassical economists (and innovation economists) would use price signals to spur Surface Transportation Policy. The availability of alternative energy production by having some kind of surface transportation – road, rail, transit, bike and pricing of greenhouse gas emissions. walking – is an important driver of economic growth (and quality of life). Not surprisingly, adherents of conservative and liberal neoclassical economics, neo- Keynesian economics, and innovation economics have In markets that are characterized by high levels of dynamism very different views when it comes to surface transpor- and uncertainty, as many markets are in today’s global, knowl- tation policy. edge-based economy, innovation economics provides a more accu- Supply-siders generally support reducing the role of the rate guide to policy than the neoclassical or Keynesian models. government in the provision of surface transportation infrastructure and relying more on the private sector to provide it (e.g., private toll roads). Toward that end, Neo-Keynesians worry most about the impact of oil supply-siders often oppose raising the gas tax, fearing prices on low-income individuals, and many of them that a higher gas tax would simply perpetuate the gov- favor subsidies to individuals most affected by high ernment-dominated system.119 Liberal neoclassicalists energy prices. In addition, in line with their focus on similarly favor increased use of pricing and privatiza- economic redistribution, many favor an excess profits tion where it makes sense; and they also worry about tax on oil companies,117 while others would limit oil increased reliance on the gas tax and other indirect tax- futures trading based on the belief that speculators es, believing that the more prices for using the system and other monied interests are artificially bidding up are tied to costs imposed on the system, the more effi- the price of oil in pursuit of short term profits. For cient the system will be. Liberal neoclassicalists differ the longer term, they would favor regulations to spur from supply-siders, however, in that they believe that energy efficiency (e.g., stronger corporate average there is a stronger role for government in supporting fuel economy, or “CAFE,” regulations on vehicles equity and access to surface transportation, whether by and “smart growth” development patterns) and large subsidizing transit or subsidizing low-income users of new federal investments in R&D directed at develop- the road system if road pricing is introduced.120 ing cost-effective alternatives to oil consumption (e.g., electric or fuel cell cars), in part because of the eco- Neo-Keynesians emphasize that transportation policy nomic stimulus effect such federal investments would can be used as a means to create jobs, and argue for 118 create. increased transportation infrastructure spending as a way to spur demand and higher-paid jobs.121 For this Innovation economists see the challenge of oil prices reason, they are much less concerned about how the as essentially a long-term challenge, particularly given revenues are raised and are more supportive of using the emergence of large numbers of middle-class con- general funds revenues, even though this reduces the sumers in developing nations and a potentially dwin- link between system use and price paid. Because of dling known supply of oil. But they are less sanguine their focus on fairness, many neo-Keynesians would than neoclassicalists about the power of price signals invest a larger share of system resources in transit and alone to bring about a solution even if supplemented oppose greater reliance on user charges (e.g., tolling), by carbon pricing. They believe that price signals believing that such charges hurt lower income users work only when there are adequate alternatives for most.

The information Technology & Innovation foundation | sep tember 2008 page 28 People who subscribe to innovation economics, eral neoclassical economists advocate, or simply redis- because of their focus on technology and institu- tributing resources to the needy (or even the middle tions, believe that the government should play a role class), as neo-Keynesians advocate. in spurring the adoption of new technologies in the transportation system (e.g., “intelligent transportation To effectively foster an innovation economics agenda, systems”). They also believe that the federal govern- Washington policymakers must understand the limi- ment should use its powers to spur innovation in the tations of today’s prevailing economics doctrines and provision of transportation services by state and local appreciate the potential offered by the emerging doc- governments. trine of innovation economics. In addition, they must embrace an innovation economics agenda that places CONCLUSION spurring organizational innovation and productiv- In the 21st century global economy, innovation and ity at the center of U.S. economic policy. For unless knowledge are the most important factors driving eco- the current playbook of economics doctrines changes, nomic growth. The U.S. government can no longer the plays available to U.S. policymakers will remain view its role in the economy as one of driving capital the same. Given the new challenges facing the U.S. accumulation and ensuring a more efficient allocation economy, we need both new plays and a new playbook. of scarce economic resources, as conservative and lib- This report is intended to help guide the way.

The information Technology & Innovation foundation | sep tember 2008 page 29 ENDNOTES

1. For example, with the 2000 Lisbon Proclamation, Romano Prodi, President of the European Commission, committed the European Union to becoming the world’s innovation leader to ensure prosperity and a high standard of living in the EU. Similarly, in 2006 the National Governors Association in the United States named Innovation as the number one priority in its mandate for Innovation America.

2. Ed Lazear, “Entrepreneurship,” National Bureau of Economic Research Working Paper 9109 (2002).

3. Paul M. Romer, “Endogenous Technological Change,” Journal of Political Economy, Vol. 98 (1990): 71-102.

4. Douglass C. North, “Poverty in the Midst of Plenty” (Stanford, CA: Hoover Institution, 2000) (accessed November 23, 2005).

5. Paul M. Romer, “Beyond Classical and Keynesian Macroeconomic Policy” Policy Options (July-August 1994): 21.

6. See for example William Baumol, Free Market Innovation Machine: Analyzing the Growth Miracle of Capitalism (Princeton, New Jersey: Princeton University Press, 2002).

7. David Colander, “Retrospectives: The Lost Art of Economics,” Journal of Economic Perspectives, Vol. 6, (1992): 191-198.

8. Joel Slemrod and Jon Bakija, Taxing Ourselves: A Citizen’s Guide to the Debate Over Taxes (Cambridge, Massachusetts: MIT Press, 2004): 141.

9. Lawrence B. Lindsey, The Growth Experiment: How the New Tax Policy is Transforming the U.S. Economy (New York: Basic Books, 1990), 12.

10. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt Brace and World Inc., 1936).

11. See “Find Your Economic Type” for a test to determine one’s economic doctrine.

12. Robert D. Atkinson, Supply-Side Follies: How Conservative Economics Fails, Liberal Economics Falters, and Innovation Economics is the Answer (Lanham, Maryland: Rowman Littlefield, 2006).

13. Economist Robert Solow found that only 19 percent of long-run change in labor productivity was due to increased capital intensity; the remainder was due to what he called “technical change.” See Robert Solow, “A Contribution to Theory of Economic Growth,” Quarterly Journal of Economics, Vol. 70 (1956): 65-94. Based on a review of most growth accounting models, Boskin and Lau (1992) estimated that half of economic growth comes from technical progress. See Michael Boskin and Lawrence Lau, “Capital, Technology, and Economic Growth,” in Nathan Rosenberg, Ralph Landau and David C. Mowery (eds), Technology and the Wealth of Nations (Stanford, CA: Stanford University Press, 1992). Jones comes up with a similar estimate for the period of 1950 to 1993, with an additional 30 percent stemming from higher levels of education. See Charles I. Jones, “Sources of US Economic Growth in a World of Ideas,” American Economic Review (2002) vol . 92. (1): 220-39.

14. Mandel documents this, illustrating that most economics classics completely overlook technology. For example, the term does not appear in the index of Milton Friedman’s 1979 bestseller, Free to Choose. Michael Mandel, Rational Exuberance: Silencing the Enemies of Growth (New York: Harper Collins, 2004).

15. For a list of materials on innovation economics, see: .

16. See for example, OECD Science, Technology and Industry Scoreboard 2007: Innovation and Performance in the Global Economy (Paris: OECD, 2007).

The information Technology & Innovation foundation | september 2008 page 30 17. The Brookings Institution is actually home to two camps. The liberal neoclassicalists largely inhabit the Economics Studies Program, while the innovation economists reside in the Metropolitan Studies Program.

18. Solow, op. cit.

19. In the famous Solow growth model, technological change was interpreted as being represented by the unexplained residual. It was often pointed out this meant that technological change was important but exogenous and fell like “manna from heaven.”

20. Alan S. Blinder, Soft Hearts: Tough-Minded Economics for A Just Society (Reading, MA: Addison-Wesley, 1987).

21. Gene Sperling, The Pro-Growth Progressive (New York: Simon and Schuster, 2005), 85.

22. Allan Naes Gjerding, Innovation Economics: Part I: An Introduction to Its Birth and International Context (Aalborg, Denmark: Center for International Studies, 1998).

23. Adam Smith, The Wealth of Nations (New York: Penguin Classics, 2000), 32.

24. Arthur B. Laffer, “The Laffer Curve: Past, Present and Future.” Laffer Associates, January 6, 2004. (accessed September 11, 2008).

25. Alan S. Blinder, op. cit., 162.

26. William A. Niskanen and Stephen Moore, “Supply Tax Cuts and the Truth About the Reagan Economic Record,” Cato Policy Analysis No. 261 (Washington, D.C.: Cato Institute, 1996).

27. Sperling, op. cit.

28. Peter R. Orszag, “Marginal Tax Rate Reductions and the Economy: What Would Be the Long-Term Effects of the Bush Tax Cut?” (Washington, D.C.: Center on Budget and Policy Priorities, March 2001): 1.

29. Heritage Foundation economist Dan Mitchell asks, “Is spending hindering economic performance because of the taxes used to finance government? Would the economic damage be reduced if government had some magical source of free revenue?” He concludes that even if somehow government programs could be implemented at no cost, they would still harm economic growth. Daniel J. Mitchell, “(Supplement to) The Impact of Government Spending on Economic Growth” (Washington, D.C.: The Heritage Foundation, March 15, 2005).

30. Gregory Mankiw, “Ask the White House,” October 8, 2004 .

31. David Warsh, Knowledge and the Wealth of Nations (New York: WW Norton and Company, 2006), 266.

32. Blinder, op. cit.,107.

33. Ibid., 58.

34. Paul Krugman, The Age of Diminished Expectations (Cambridge, MA: MIT Press, 1990), 18.

35. Atkinson, 2006, op. cit.

36. Lester C. Thurow, Fortune Favors the Bold (New York: Harper Collins, 2003), 279.

37. Robert D. Atkinson, “Expanding the R&D Tax Credit to Drive Innovation, Competitiveness and Prosperity”

The information Technology & Innovation foundation | september 2008 page 31 (Washington, D.C.: Information Technology and Innovation Foundation, April 2007) .

38. Elhanan Helpman, The Mystery of Economic Growth (Cambridge, Massachusetts: Belknap Press, 2004).

39. Phillipe Aghion, Paul A. David, and Dominique Foray, “Linking Policy Research and Practice in STIG Systems: Many Obstacles, but Some Ways Forward” CEMI Working Papers, Working Paper 2007-002 (Paris: Ecole Polytechnique Federale De Lausanne, Chaire en Economie et Management de l’Innovation, June 2007): 13.

40. Jonathan Temple, “The New Growth Evidence,” Journal of Economic Literature, 37 (March 1999): 112–156.

41. Paul A. Sameulson and William D. Nordhaus, Economics (New York: McGraw Hill, 1998), 4.

42. Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper Perennial, 1942, 1975), 37.

43. Eric D. Beinhocker, The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics (Boston, Massachusetts: Harvard Business School Press, 2006), 39.

44. Ibid., 31.

45. See Ralph Gomery and William Baumol, Global Trade and Conflicting National Interest (Cambridge, Massachusetts: MIT Press, 2000). See also Elvio Accinelli, Silvia London, Edgar J. Sanchez Carrera, “Complementarity and Imitative Behavior in the Population of Firms and Workers,” 2008 (accessed on February 28, 2008).

46. For example, research by economist Elvio Accinelli has shown that there is strategic complementarity between the per­ centage of high-skill workers and high value-added, innovative firms in an economy. Accinelli finds that economies can be in perfect neo-classical equilibrium at either high levels of innovation, or in a “poverty trap” of low skills and underinvestment in innovation. Since the poverty trap can be avoided if the number of innovative firms in an economy exceeds a threshold level leading to an increased number of skilled work­ers, there is a role for public policy to move economies to a high-level equilibrium on innovation. Accinelli, op. cit.

47. Brian W. Arthur, “On the Evolution of Complexity” (Sante Fe, NM: Santa Fe Institute, 1993).

48. Beinhocker, op. cit., 122.

49. Jared Bernstein and Dean Baker, “The Benefits of Full Employment: When Markets Work For People” (Washington, D.C.: The Economic Policy Institute, 2003), 2.

50. Liberal economists Barry Bluestone and Bennett Harrison argue that, “what initially energized the post‑WWII economy boom had less to do with supply‑side factors [like technology] and more to do with extraordinary buoyant demand.” Barry Bluestone and Bennett Harrison, Growing Prosperity: The Battle for Growth with Equity in the Twenty-First Century ( New York: Houghton Mifflin, 2000).

51. Christian E. Weller and Amanda M. Logan, “Ignoring Productivity at Our Peril: Slowing Productivity Growth and Low Business Investment Threaten Our Economy” (Washington, D.C.: Center for American Progress, August 2007), 20.

52. Jeff Faux, “You Are Not Alone” in The New Majority. ed. Stanley Greenberg and Theda Skocpol (New Haven, Connecticut: Yale University Press, 1997).

53. James K. Galbraith, “The Surrender of Economic Policy,” The American Prospect (March 1, 1996).

54. Richard Gephardt, An Even Better Place: America in the 21st Century (New York: Public Affairs, 1999), 73.

55. John Maynard Keynes, op. cit.

The information Technology & Innovation foundation | september 2008 page 32 56. Democracy Now, “Economics Journalist Robert Kuttner on the “Most Serious Financial Crisis Since the Great Depression: This is the Result of Rightwing Ideology and the Political Power of Wall Street” January 23, 2008 (accessed August 28, 2008).

57. Alberto Alesina and Dani Rodrik, “Distribution Politics and Economic Growth,” Quarterly Journal of Economics 109 (1994): 465-90 and Willi Leibfritz, John Thornton, and Alexandra Bibbee, “Taxation and Economic Performance,” (Paris: Organization for Economic Co-Operation and Development, 1997): 16.

58. Jared Bernstein and Dean Baker, “The Benefits of Full Employment: When Markets Work For People” (Washington, D.C.: The Economic Policy Institute, 2003), 2.

59. Bureau of Economic Analysis, U.S. Department of Commerce, National Income and Product Accounts Tables, (Washington, D.C.: U.S. Department of Commerce, 2007) .

60. Stephen Rose, “Does Productivity Growth Still Benefit Working Americans?: Unraveling the Income Growth Mystery to Determine How Much Median Incomes Trail Productivity Growth” (Washington, D.C.: Information Technology and Innovation Foundation, June 2007) .

61. Schumpeter, 1942, op. cit.

62. Ibid., 82-83.

63. One of the first articles articulating the new growth theory was Paul Romer, “Endogenous Technological Change,” Journal of Political Economy, Vol. 98 (1990): 71-102.

64. For a list of readings based on innovation economics see: .

65. Baumol, op. cit.

66. J. Bradford De Long, “Productivity Growth and Investment in Equipment: A Very Long Run Look,” Sept. 1991: 4 (accessed November 24, 2005).

67. Richard R. Nelson, “Research on Productivity Growth and Differences: Dead Ends and New Departures,” Journal of Economic Literature, Vol. 19: 1029-1064.

68. Peter J. Klenow and Andres Rodriguez-Clare, “The Neoclassical Revival in Growth Economics: Has It Gone Too Far?,” NBER Macroeconomics Journal 12 (1997): 73-103.

69. William Easterly and Ross Levine, “It’s Not Factor Accumulation: Stylized Facts and Growth Models,” World Bank Economic Review 15 (2001): 177-219.

70. Sameulson and Nordhaus, op. cit., 4.

71. Douglass C. North, Institutions, Institutional Change and Economic Performance (Cambridge, Massachusetts: Cambridge University Press, 1990), 80-81.

72. Schumpter, 1950, op. cit.

73. Allan Naes Gjerding, op. cit., 16.

74. The distinction between risk and uncertainty is explained by Frank Knight, Risk and Uncertainty (Boston, Massachusetts: Houghton Mifflin, 1921).

The information Technology & Innovation foundation | september 2008 page 33 75. Beinhocker, op. cit., 427 (emphasis in original).

76. For example, Lipsey et al. have studied cases of successful and unsuccessful cases of government innovation policy around the world and identified 15 lessons that can be drawn from these experiences. Richard G. Lipsey, Kenneth Carlaw, and Clifford Bekar, Economic Transformations (New York: Oxford University Press, 2005).

77. Gregory Mankiw, “Remarks at the Annual Meeting of the National Association of Business Economists Washington Economic Policy Conference,” March 25, 2004, (accessed December 2, 2005).

78. For example, the Treasury Department recently issued a report calling for the abolition of the R&D tax credit and the use of the savings to help pay for a lower overall corporate rate.

79. Sabastian Mallaby, “McCain’s Convenient Untruth,” The Washington Post, September 8, 2008 (accessed September 8, 2008).

80. Robert D. Atkinson, “Expanding the R&D Tax Credit to Drive Innovation, Competitiveness and Prosperity” (Washington, D.C.: Information Technology and Innovation Foundation, April 2007) .

81. Economist’s View, “James Galbraith on Progressive Alternatives to the Hamilton Project,” 2007 (accessed August 29, 2008).

82. Julie A. Hedlund and Robert D. Atkinson, “The Rise Of The New Mercantilists: Unfair Trade Practices in the Innovation Economy” (Washington, D.C.: Information Technology and Innovation Foundation, June 2007) .

83. Robert D. Atkinson, “Why China Needs to End Its Economic Mercantilism,” Huffington Post, January 30, 2008, (accessed August 29, 2008).

84. Cited in David B. Audretsch, Isabel Grilo, and Roy Thurik, Handbook of Research on Entrepreneurship Policy, (Northampton, MA: Edward Elgar, 2007).

85. Robert H. Bork, “Legislative Intent and the Policy of the Sherman Act,” Journal of Law and Economics, Vol. 60, (1966): 7-48.

86. Albert Foer, “Mr. Magoo Visits Wal-Mart: Finding the Right Lens for Antitrust,” American Antitrust Institute Working Paper, No.06-07 (November 30, 2006) (accessed August 28, 2008).

87. See for example David B. Audretsch, Andrew Burke, and William Baumol, “Competition Policy in Dynamic Markets,” International Journal of Industrial Organization, Vol. 19, No. 5 (April 2001): 613-634.

88. Richard R. Nelson, Technology, Institutions and Economic Growth (Cambridge: Harvard University Press, 2005), 21.

89. Robert D. Atkinson, “The Revenge of the Disintermediated: How the Middleman is Fighting E-Commerce and Hurting Consumers” (Washington, D.C.: Progressive Policy Institute, January 2001) .

90. Quoted in R. Glenn Hubbard, “A Framework for Economic Policy,” Remarks at the Ronald Reagan Presidential Library, February 15, 2002, (accessed November 22, 2005).

The information Technology & Innovation foundation | september 2008 page 34

91. Jim DeMint, “An Honest Stimulus: Tax Cuts Instead of Rebates,” Real Clear Politics, January 26, 2008, (accessed August 19, 2008).

92. Lawrence Summers, “Why America Must Have a Fiscal Stimulus,” Financial Times, January 6, 2008, (accessed August 19, 2008).

93. John Podesta, Laura Tyson, and Sarah Rosen Wartell, “A Practical and Progressive Economic Stimulus and Recovery Plan,” Center for American Progress Action Fund, January 17, 2008, (accessed August 29, 2008).

94. Michael Franc, “U.S. Tax Code Hampers Competitiveness” (Washington, D.C.: The Heritage Foundation, November 3, 2007) .

95. Titus Galama and James Hosek, “U.S. Competitiveness in Science and Technology” (Santa Monica, California: RAND Corporation, 2008) (accessed August 29, 2008).

96. Robert Kuttner, “Good Jobs in a Global Economy,” The American Prospect, (January/February 2008): 22-36.

97. Robert D. Atkinson and Howard Wial, “Boosting Productivity, Innovation, and Growth Through a National Innovation Foundation” (Washington, D.C.: Information Technology and Innovation Foundation, April 2008) .

98. The Manufacturing Extension Partnership is a highly effective program that was a semi-finalist for a 2004 Innovations in American Government award sponsored by Harvard University’s Kennedy School of Government. Likewise, the ATP program has been shown to be a highly effective program. See Charles W. Wessner, Ed. “Government-Industry Partnerships,” (Washington, D.C.: Board on Science, Technology, and Economic Policy, National Research Council, 2001).

99. Robert J. Shapiro and Chris J. Soares, “Cut and Invest to Grow: How to Expand Public Investment While Cutting the Deficit” (Washington, D.C.: Progressive Policy Institute, July 1997) .

100. Thomas W. Hazlett and Anil Caliskan, “Natural Experiments in U.S. Broadband Regulation” (Arlington, Virginia: George Mason Universtiy School of Law, George Mason University Law and Economics Research Paper Series 08-04, November 29, 2007) .

101. Thomas D. Sydnor II, “Tragedy and Farce: An Analysis of the Book Free Culture” (Washington D.C.: The Progress and Freedom Foundation, April 2008) .

102. Robert D. Atkinson, “The Role of Competition in a National Broadband Policy” (Washington D.C.: Information Technology and Innovation Foundation, October 2007) .

103. Art Brodsky, “Connect Kentucky Provides Uncertain Model for Federal Legislation,” Public Knowledge, (January 9, 2008) (accessed August 29, 2008).

104. George Ou, “Beyond the Hype: Agencies can gain efficiencies and save money through monitoring and managing IT power use, so find your patch of green,”FedTech (accessed August 29, 2008).

105. Media Access Project, “Issues: Media Ownership,” (accessed

The information Technology & Innovation foundation | sep tember 2008 page 35 August 29, 2008).

106. Yochai Benkler, The Wealth of Networks: How Social Production Transforms Markets and Freedom (New Haven: Yale University Press, 2006). Lawrence Lessig, Free Culture: Big Media Uses Technology and the Law to Lock Down Culture and Control Creativity (New York: Penguin Press, 2004)

107. Atkinson, “The Role of Competition in a National Broadband Policy,” 2007, op. cit.

108. Robert D. Atkinson, “Framing a National Broadband Policy” (Washington, D.C.: Information Technology and Innovation Foundation, 2007) .

109. Frank G. Bowe, “Universal Service and the Disability Community: The Need for Ubiquitous Broadband Deployment” (Washington, D.C.: Benton Foundation) .

110. Conn Carroll, “Common Sense on Housing” (Washington, D.C.: The Heritage Foundation, April 2008) .

111. Joint Economic Committee of the United States Senate and the United States House of Representatives, Testimony of Jared Bernstein: How Much More Can Consumers Be Squeezed by Stagnant Income, Skyrocketing Housing Costs, and Falling Home Prices? (July 2008) .

112. For example, the conservative Heritage Foundation claims that if an average 30-year-old could invest their Social Security taxes in a mutual fund instead of the Social Security fund, by the time they retire they would have $500,000 more than if they kept paying Social Security taxes.

113. Peter G. Peterson, Running On Empty: How The Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It (New York: Farrar, Straus and Giroux, 2004).

114. Nancy J. Altman, “Protecting Social Security’s Beneficiaries: Achieving Balance without Benefit Cuts,”The Economic Policy Institute, November 20, 2007, (accessed August 19, 2008).

115. Daniel Castro, “Improving Health Care: Why a Dose of IT May Be Just What the Doctor Ordered” (Washington, D.C.: Information Technology and Innovation Foundation, October 2007) .

116. Ben Lieberman and Nicolas Loris, Energy Policy: Let’s Not Repeat the Mistakes of the ‘70s (Washington, D.C.: The Heritage Foundation, July 2008) .

117. Dean Baker, “The Meltdown Lowdown (No. 16),” The American Prospect, August 8, 2008, (accessed August 19, 2008).

118. Apollo Alliance, “Comparing Energy Plans: The New Apollo Program, New Energy For America, The Lexington Project,” 2008 (accessed August 19, 2008).

119. Ronald D. Utt, “How States Can Improve Their Transportation Systems and Relieve Traffic Congestion” (Washington, D.C.: The Heritage Foundation, July 2008) .

120. David Lewis, “America’s Traffic Congestion Problem: Toward a Framework for Nationwide Reform” (Washington, D.C.: Brookings Institution, July 2008) .

121. The Economic Policy Institute, “Investing in U.S. Infrastructure,” 2008 (accessed August 28, 2008).

122. In this regard, corporations are not the ultimate objects of policy in any of the doctrines. Rather, corporate well-

The information Technology & Innovation foundation | sep tember 2008 page 36 being can be a means to promote the ultimate goals of either improved conditions for consumers, workers, or all residents.

The information Technology & Innovation foundation | sep tember 2008 page 37 About the authors Dr. Robert D. Atkinson is President of the Information Technology and Innovation Foundation. He is also author of the The Past and Future of America’s Economy: Long Waves of Innovation that Power Cycles of Growth (Edward Elgar, 2005). Dr. David B. Audretsch is a Distinguished Professor and the Ameritech Chair of Economic Development and Director of the Institute for Development Strategies at Indiana University. He is also the Director of the Max Planck Institute of Economics in Jena, Germany. Audretsch’s research has focused on the links between entrepreneurship, government policy, innovation, economic development, and global competitiveness. Professor Audretsch is ranked as the 21st most cited scholar in economics and business, 1996-2006, and has been recognized as being among the 60 most important economists of all time. Dr. Audretsch is the author of Entrepreneurship and Economic Growth and The Entrepreneurial Society. He is also the co-founder and co-editor of Small Business Economics: An Entrepreneurship Journal.

About the Information Technology and Innovation Foundation The Information Technology and Innovation Foundation (ITIF) is a nonprofit, non-partisan public policy think tank com- mitted to articulating and advancing a pro-productivity, pro-innovation and pro-technology public policy agenda inter- nationally, in Washington and in the states. Through its research, policy proposals, and commentary, ITIF is working to advance and support public policies that boost innovation, e-transformation and productivity.

Acknowledgements The authors wish to thank the following reviewers: Pierre De Vries, Steve Rose, and Rick Whitt. In addition, the authors thank Scott Andes, Stephen Ezell, Priscilla Jang, and Kerry Kemp for editorial and research assistance efforts.

For more information contact ITIF at 202-449-1351 or at [email protected], or go online to www.innovationpolicy.org. ITIF | 1250 I St. N.W. | Suite 200 | Washington, DC 20005

The information Technology & Innovation foundation | september 2008 page 38