Changing Models when the Current Model is “Broken”

If there is one thing we can agree upon, it’s that there is little agreement about the nature of the current global economic crisis.  Everyone has their own view it seems.  Case in point is yesterday’s op ed in the Washington Post by columnist Robert Samuelson.  When looking to spur recovery, Samuelson points out, "we live in a world of broken models;” a statement perhaps everyone can agree with.

Based upon this statement, it would seem that a logical response would be to actually change the model when proposing solutions to our current economic problems.  Unfortunately, the rest of Samuelson’s piece is centered upon a model of the economy from the 1960s that has proven quite inadequate in explaining sustainable growth as well as job creation (along with numerous other flaws).

Samuelson goes on to summarizes that since consumption is down, government can’t increase spending, the private sector won't invest and we can’t export, we are doomed to stagnation.  His “three possible solutions” are derived from the “broken model” itself.  It’s no wonder that he is left without a viable solution and claims that “there is no longer a large source of strong economic growth in the world to stimulate and support struggling economies.”

Samuelson explains GDP growth as derived from the following equation:

So, instead of using a “broken model,” let us do what is necessary and change the model with which we confront the current economic slump.  What will work is looking at the real long-term cause of growth and increased living standards: innovation and the related increases in productivity.  It is a test of human-ingenuity versus ever tightening constraints, and we must face the fact that the “new model” must be one where innovation is key driver of growth.  If and only if we as a nation face this fact, will we ever truly tap into the engines of growth and start moving forward rather than stagnating or slowing.  Today, we are moving beyond the time when short-run topical solutions (trying to use monetary and fiscal policy to direct markets when the markets themselves are what is broken) can conceal the real problem: slowing innovative productivity (See Figures 1 and 2 for an illustration of the recent trends in patenting by U.S. firms).

Though patent application rates were growing through the 1990s; since then they have declined.  Samuelson, with his focus on traditional macroeconomic management, ignores the fact that we are no longer innovating at an increasing rate.  Rather, the number of new utility patents filed by U.S. firms has stagnated. Samuelson states that “finding a path forward could be time-consuming, tortuous and, possibly, inconclusive.”  ITIF does not believe so, and the right model is not difficult to understand at all.

The “new” model is actually rather simple and comes with it, a simple solution: spurring innovation.  Increasing innovation will fundamentally change how we produce goods, relax current constraints, increase standards of living, and is the only sustainable source of growth.  As innovation economist Paul Romer rightly points out:  “The challenge now facing all of the industrialized countries is to invent new institutions that encourage a higher level of applied, commercially relevant research and development in the private sector.”

So, getting the model right at a theoretical level is not as hard as it seems.  So-called “New-Growth theory” has been around since Joseph Schumpeter in the 1940s and developed further in the early 1990s by Romer and since then by other prominent growth-economists.  Rather, where the real difficulty lies is in convincing those who use “broken models” to seriously reconsider how they look at the world.  Convincing policy makers to pay attention, and then attack the problem head-on by introducing a comprehensive innovation policy at the national level is exactly what is called for, and what could lead to the recovery we all seek.

Figure 1: Velocity of Innovation from 1981-2001

Figure 2: Velocity of Innovation from 2001-2011

Data Source for Figures 1 and 2: USPTO Patent count data available at http://www.uspto.gov/web/offices/ac/ido/oeip/taf/cbcby.pdf