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Home Opinion Falling behind in the innovation race
Innovation • Growth • Productivity

Falling behind in the innovation race

Robert D. Atkinson - 06 May 2014

Innovation is the prime driver of growth yet both the United States and Europe have fallen behind.  By embracing policies to drive innovation and productivity, both can ensure that they see the 21st century as better than the 20th

Innovation – the development and adoption of new products, processes, services and business models – is the prime driver of growth.  Unfortunately both the United States and Europe have fallen behind.  The United States runs a significant trade deficit in high technology products and Europe lags in building future industries and growing productivity.  Yet, the reasons for their suboptimal performance are distinct.

1. American short-termism
America’s problem stems from the pressure for short-termism.  Neither US business nor the US electorate adequately focuses on the long term; preferring gains today at the expense of greater gains tomorrow.  Companies in America invest 36 per cent less (as a share of GDP) in workforce training and 13 per cent less in R&D as they did a decade ago, and 30 percent less in new equipment and software (compared to three decades ago).  Why invest in training, equipment, and R&D, especially basic research, when the payoffs are risky and won’t accrue for years?  

This reluctance to invest for the long-term stems from financial markets demanding short-term profits. As the Business Roundtable, the leading association for large American corporations, reported, “The obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value.”

Not surprisingly short-termism has come with rising financialisation. The financial industry’s share of the US economy has grown at least four-fold over the last forty years while financial sector profits increased from just 20 per cent of manufacturing profits to 145 per cent today. Combine this with what Andrew Smithers calls the “bonus culture” where corporate leaders managers seek to maximise their bonuses and stock option values, and you get a system where the share of after-tax US profits being paid to shareholders through dividends and stock buybacks has increased more than 150 percent since the 1970s.

At the same time, US public investment is lagging. Since the early 1980s, Americans have violated the pact by which current generations invest to make the future better than the present. An ever-expanding backlog of investment needs is the price of our failure to maintain funding, as the average age of the government capital stock (which includes assets such as roads, bridges, and water systems) has increased by almost 50 per cent since 1970.  Likewise federal investment in R&D as a share of GDP is just 44 percent of 1960s’ levels.  

And US politics shows no easy way out. The Left rejects cutting entitlements – including to people aged sixty-five to seventy, most of whom could work – as a way to pay for needed investments, while the Right rejects increasing taxes on individuals. What they have in common is an orientation of “me, now!” As James Lincoln Collier wrote in The Rise of Selfishness in America, “A nation in which most people cannot even occasionally put the good of the whole society above their own immediate gratification is bound to grow steadily worse.”

2. European risk aversion
If America suffers from short-termism, Europe suffers from risk aversion.  We only have to look at the EU’s embrace of the “precautionary principle” to understand how. According to the European Commission, where scientific data do not permit a complete evaluation of the risk, recourse to this principle may… be used to stop distribution or order withdrawal from the market of products likely to be hazardous.  If the precautionary principle were in place when the automobile was developed, a technology that kills tens of thousands of people a year, would the Commission have approved it?

By definition, innovation leads to what noted economist Joseph Schumpeter termed “creative destruction.”  But too many in Europe want the creation without the destruction.  Emblematic are comments from French Economic Minister Arnaud Montebourg who recently stated that when it comes to innovation that can destroy existing companies, “well, we have to go slowly.”  Yet “going slowly” means “growing slowly.”  

This explains the overriding focus in Europe on job creation and the concern that productivity growth will conflict with job growth.  For example, European officials look to the green economy for jobs, even though it will likely mean higher energy costs and lower productivity.  But the view that productivity is the enemy of job growth has been thoroughly discredited both by history and economics.

This matters because since 1995 US productivity growth rates have been significantly higher than European.  And productivity is how nations get richer and how they can afford to pay for the high dependency ratios that Europe faces.

Some Europeans understand the cul de sac they are in.  As Paul Giacobbi, a centre-left member of the French Assembly, states: “The idea that nothing will change, no factory will ever close, and restructuring will not be a permanent feature is contrary to everything that the direction of the world tells us every day.” Unless Europe can accept that innovation entails plant closures and job losses, new technologies with uncertain social or environmental impacts, and new kinds of business models that will lead to business bankruptcies, it’s not likely that it will be able to keep up in the race for global innovation advantage or grow productivity enough to pay for growing entitlements.

3. Embracing policies to drive innovation and productivity
So what does this mean for the centre-left in both regions?  For the US it means that policy must focus on better aligning the interests of companies with the interest of the US economy. This involves rolling back the financialisation of the economy; expanding, not cutting incentives for companies to invest in the US in the building blocks of growth (R&D, skills, new equipment and software, and digital and non-digital infrastructures); and cutting entitlements to the elderly to free up budget space for sorely needed public investments.

For Europe it means putting productivity and GDP growth first, even if some firms and workers may be hurt. This will require a faith that jobs will follow. It will also need to be coupled with a continent-wide expansion of the Scandinavian “flexicurity” system that focuses on helping workers, not by preventing change, but by maximising ability to adapt.  

In a world with rapidly growing economies in the low-cost developing nations, the challenges facing old, developed regions like Europe and the United States are large.  But by embracing policies to drive innovation and productivity, both can ensure that they see the 21st century as better than the 20th.

Robert D. Atkinson is president and founder of the Information Technology and Innovation Foundation, a Washington DC-based innovation policy thinktank

This is a contribution to the “Making Progressive Politics Work” publication ‒ ideas and policy proposals from 40 leading international experts.

This is a contribution to Policy Network's work on Progressive Capitalism.

Tags: Robert D. Atkinson , Robert Atkinson , Opinion , Progressive Governance Conference , Progressive Governance , Growth , Social stability , Living standards , Policy Network , Global Progress , Competitiveness , Growth , Solidarity , Globalisation , Centre-left , Centre-left , Europe , EU , European Union , Eurozone , Southern Europe , Northern Europe , Production , Productivity , Growth , Wages , Investment , Jobs , Globalisation , Equality , Pre-distribution

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The Policy Network Observatory promotes critical debate and reflection on progressive politics. It is centre-left orientated but determinedly challenges social democracy. It is pro-European but restlessly questions EU institutions and practices.

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