October 2004
By Robert R. Ebert, Ph.D., Buckhorn Professor of Economics
Innovation is the answer! But what is the question?
The question might well be: "When will we have another sustained super-boom like we had in the 1990s?" The short and honest answer is that I do not know. However, an educated guess can be made that when it occurs, it will be driven by some new innovation.
The idea that innovation is a dynamic force in the business cycle is not new. Joseph Schumpeter, an influential Austrian-born, Harvard economist from the mid-20th century, described the essential element of capitalism as the process of "Creative Destruction." To Schumpeter, innovation - in the form of new consumer goods, new production methods, new transportation methods, the creation of new markets and new forms of industrial organization - is "the fundamental impulse that sets and keeps the capitalist engine in motion" (Schumpeter 83).
Creative Destruction is the process that from time to time revolutionizes the economic structure from within. An innovation comes along that changes the economic system and in the process destroys the old ways of doing things. Schumpeter saw waves of Creative Destruction and innovation occurring periodically. After a while, there is a period of comparative quiet in which the results of the revolutionizing development are absorbed. Then, once again, as still another innovation comes along, the cycle starts all over again. The process of revolution and absorption are what Schumpeter believed to be the fundamental cause of the business cycle (Schumpeter 83).
Certainly, as we reflect on the 19th and 20th centuries, it is possible to identify waves of innovation. In the late 1800s, steel and railroads created an economic transformation of the United States. In the early to mid-20th century, it can be argued, the automobile and aerospace industries played a similar role.
Absorption of the development of the automobile industry occurred in the post-World War II era as the industry matured in the 1950s and 1960s. Likewise, by the early 1970s the aerospace industry entered a quiet phase as the technological advances in space exploration of the 1960s were absorbed and built upon. It is true that in analyzing the economy of the 1970s, the economic picture was clouded by the advent of the energy crisis. However, it is not unreasonable to argue that a lack of specific and major new innovation in the 1970s and early 1980s was a contributing factor to the stagnant economy of the times. It may have not been an accident, therefore, that the stock market as measured by the Dow Jones Industrial Average was in a "holding pattern" and fluctuated in a very narrow range for over twenty years from the mid 1960s to the mid 1980s.
Three key characteristics must exist for significant innovations to have a major impact on the economy. First, they must have a generality of purpose and, as such, affect a wide range of industries and activities within industries. Second, the diffusion and dynamic effects of these general-purpose technologies may take as long as several decades before they have dramatic effects on the macroeconomy. Third, these new technologies must act as engines of growth (Petsas, 579).
A persuasive argument can be made that semiconductor-driven "high-tech" innovations led to the boom of the 1990s. The stock market and economic growth of that decade were manifestations of the expansion phase of an innovation cycle. In fact, in his 2001 presidential address to the American Economic Association, Dale Jorgensen presented evidence that American growth resurgence in the 1990s was a result of the development and diffusion of semiconductor technology. Jorgensen pointed out that intensifying competition in the market for semiconductors led to shortened product cycles and lower prices - all of which helped the diffusion of the technology through the economy. The result of this diffusion of technology was accelerated growth in output, labor productivity, and total factor productivity (Jorgensen, 1, 2, 15).
A half-century after Schumpeter's death, economists continue to be intrigued by the implications of his ideas on innovations and the economic cycle. For example, in his work on the dynamics of general-purpose technology, Iordanis Petsas of the University of Scranton confirms that the long-run growth rate of the economy depends positively on the magnitude of quality innovations (Petsas, 598).
The work of Masaaki Hirooka, formerly of Ryutsu Kagaku University in Kobe, Japan, also supports the notion that there is a strong link between innovation and economic development. Masaaki's research found that growth bubbles burst at the peak of an innovation wave at a point where there is actual saturation of the market. Then, before there is another innovation wave with diffusion of the products of that innovation, there is a rather long period of technological development (Hirooka 571-574).
One theme of this issue of our Business&Economy@B-W newsletter is innovation and what it might mean to the Northeast Ohio region. Schumpeter's theories and more recent scholarship confirm the link between innovation and economic growth. Therefore, a reasonable policy recommendation would be to structure incentives (whether tax, infrastructure development, educational support, etc.) in a manner conducive to incubating innovation within the region. However, that incubation period may be prolonged, which then suggests incentive policies should also be tailored to recognize and entice to the region those individuals and firms who may be in the later stages of development and diffusion of innovation. Success may well be dependent on an intentional partnership of business, government and academic institutions. While the challenges of such an effort should not be underestimated, the results could be exciting and enable the region to ride the crest of the next innovation boom.
Works Cited
Hirooka, Masaaki. "Nonlinear dynamism of innovation and business cycles." Journal of Evolutionary Economics 13 (2003): 549-576.
Jorgensen, Dale W. "Information Technology and the U.S. Economy." American Economic Review 91 (2001): 1-32.
Petsas, Iordanis. "The dynamic effects of general purpose technologies on Schumpeterian growth." Journal of Evolutionary Economics 13 (2003): 577-605.
Schumpeter, Joseph A. Capitalism, Socialism, and Democracy. New York: Harper & Brothers Publishers, 1950.
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