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

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 entrepreneurship 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 doctrines 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

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