Over the past 75 years, economists have learned much about managing a market economy. They've mastered policies for avoiding depressions and ameliorating recessions; they've plotted strategies for keeping inflation under control and for responding to financial crises. Yet when it comes to encouraging innovation -- one of the most essential ingredients for economic growth -- there still is little consensus about what to do. Some economists say that the key is to cut the nation's budget deficit to unlock more funds for private-sector research and development, while others favor slashing taxes to provide more incentives for entrepreneurs. Some advocate strengthening patents and copyrights to give innovators a good payoff on their ideas. Others worry that too much protection of intellectual property will increase litigation and slow innovation.
Part of the difficulty in identifying the right policy is that the innovation economy has many moving parts. The government, universities, big companies, small startups, venture-capital firms, stock market investors -- each has a distinct role. And innovation has gone global, bringing in even more players.
There is one guidepost amid the confusing trends: the enormous and surprising success of the American innovation machine in recent years. In the late 1980s and the early 1990s, virtually all economic forecasters wrote off the U.S. as a mature, slow-growth laggard that eventually would be passed by more vibrant economies in Europe and Japan. Yet when the Internet revolution arrived, it was U.S. entrepreneurs who proved far more nimble and adept in converting ideas into products. The result was a productivity boom that is still barreling forward.
Governments around the world should be able to build on the successes of the 1990s. Here are some ideas for spurring innovation:
INVEST IN RESEARCH AND EDUCATION Innovation depends on good ideas and smart people. So, to encourage innovation over the long run, the best course is to increase government funding for basic research, which is not profitable for most companies, and to spend more on graduate education in science and engineering.
In recent years, the U.S. has had a reasonably good record in these areas. Since 1997, federal government contributions for basic research, adjusted for inflation, have risen at a 6.8% annual rate, outpacing the growth of the economy as a whole. And graduate enrollment in science and engineering rose by 12% from 1997 to 2002, the last year for which data are available.
But more is needed. In the aftermath of September 11, there's been understandable pressure to shift resources towards defense and homeland security. Real federal spending on basic research has stalled out, with no rise likely in fiscal year 2005. And tighter security procedures have made it much harder for foreign students and researchers to get visas, with no sign yet that Americans are making up the slack.
That's why putting more financial muscle behind basic research and education in graduate science and engineering is essential, not just in the U.S. but around the world. "Most governments should do more to encourage investment in R&D," says Elhanan Helpman, a Harvard University economist and growth expert. "Sometimes simple things do a good job."
GET THE MAXIMUM BENEFIT FROM GLOBAL INNOVATION For the first time ever, innovation is spreading from a few large industrial countries to a broader stage. That's good news: The rise of higher education and R&D spending around the world can create a global division of labor where the U.S. specializes in areas such as biotech and advanced software while South Korea and Taiwan focus on areas such as flat-panel displays and chips.
Countries have to take two steps to fully participate in the new global innovation economy. First, they need to be willing to engage in collaborative research across national boundaries, and allow the free movement of ideas and people. Building up walls around intellectual property is simply a bad idea.
Second, to make the best use of innovations elsewhere, a country, including the U.S., has to spend enough on R&D and education to maintain a substantial presence in critical fields of research, including the ones where it is not the leader. That's the ante to get into the global game.
SUPPORT THE PATENT OFFICE A well-functioning patent office is key in an Innovation Economy. In the U.S., however, it's not working very well. Since 1997, the number of patent applications has risen by 50%, but the backlog of patents waiting for action by a patent examiner has quadrupled. Moreover, Congress, desperate for funds to reduce the budget deficit, has not allowed the Patent & Trademark Office to spend all the money brought in by application fees. "The patent office has been transformed into a profit center," says Josh Lerner, a professor at Harvard Business School.
Faced with a mountain of applications, patent examiners are compounding the problem by approving patents too quickly, and giving protection to far too many broad or mundane ideas. The result, says Lerner, is a "litigation tax" on innovation, which forces new companies to spend time and money wending their way through a forest of existing patents before they can launch a new product.
The right level of protection for intellectual property is a divisive subject. Perhaps the simplest fix is to give the patent office more funding, including allowing it to tap its own funds. More examiners, and more time to look into what has been done before -- "prior art" -- may improve the quality of patent grants.
BETTER NUMBERS ON INNOVATION An Innovation Economy requires political support to prosper. Politicians have to speak in favor of investments in new technologies that may not pay off for years.
It's easier to muster support for innovation with concrete evidence of its positive effects. Unfortunately, the government's statistical system typically does a much better job measuring old technologies and industries than it does measuring new ones, so it can take years before an innovation is fully reflected in the data.
For example, the first single-chip microprocessor was introduced by Intel Corp. (INTC ) in 1971, triggering a period of rapid decreases in the price of computing power. But that wasn't measured by the government until 1985.
Today, the statistical system needs to be retooled again to better quantify the impact of such health-care innovation as new drugs and surgical techniques. The cost of the health-care sector today is well counted, but there's no good measure of its true output, which is years of good health. That makes it much harder to assess the payoff from the billions of dollars spent on medical research.
MAINTAIN FREE MARKETS The rapid innovation of the past 75 years has been accompanied by the spread of the market-based economic system around the globe. In terms of innovation, this is no coincidence. "The historical record shows that this is the one system that has worked," says Northwestern University economic historian Joel Mokyr.
It is far easier to protect the status quo than it is to adopt the policies that promote change and innovation. Yet in the end, it is competition and free markets that spur innovation -- and that is what will make the next 75 years as fruitful as the past 75.
By Michael J. Mandel