Looking back on Equilibrium 2012 I find that yes, it is a review of ESSA’s year and yes it is a memoir, a keepsake, a gift to our members. It is also, more than anything a celebration of economic thought. It is about the thinking and sharing of ideas, which has been what ESSA is about all along. In light of the imminent launch of Equilibrium 2013, I look back on our inaugural publication and pull out some examples of our writers’ ideas. The ingenuity of some of these propositions makes for a riveting read, as is the captivating nature of all good ideas.
Economics is often regarded as the study of scarcity: when there isn’t enough to go around, we have to watch the way we spend. But what if the opposite was true: there was too much to go around. Would there still be a need to study economics?
Turns out, there are situations where plenty is the norm. Information stands out as one of the common ‘goods’ available to us which is non rivalrous and non excludable. The internet has allowed information to be shared virtually free, resulting in an abundance of information ‘consumption’. So against the backdrop of plenty, how do such economies organise themselves? The traditional exchange model of goods breaks down because there is so much quality content available for free. Before you buy a subscription to a paper, you would google it, for free.
One of the ways people react to abundance is to start ‘giving’. When quantity no longer matters it’s the quality of the good that’s important – indicated by the amount that someone is able to ‘give away’. Two closely related but distinct examples of groups in the information economy – where someone’s ‘value’ is measured by the amount of quality output they produce – is in academia and the start-up music scene. This is what anthropologists, and only in recent years economists, describe as the gift economy, a way for societies to determine the value of individuals in situations of abundance. A type of place where your worth is determined by what you give away as opposed to what you’re able to accumulate for yourself.
For Australia, promoting innovation is particularly critical in the context of our poor productivity outcomes in recent years. Nevertheless, innovation will never receive the public attention so eagerly lavished on the “standard measures” of economic performance: GDP, unemployment, and inflation. Yet if sustainable long-term economic growth is the aim and innovation is indeed the catalyst for productivity growth, it is necessary for discourse on innovation policies to transcend the boundaries of heterodox (or non-mainstream) economics.
The benefits of innovation are manifest at both the firm and economy-wide levels. Firms reap the benefits of innovation by gaining a competitive advantage and in improved profitability. Innovation, and its consequent diffusion and application, creates spillovers that may help economies achieve productivity improvements and greater productive capacity. As producers, firms develop innovations in-house, either alone or in collaboration with external partners. As absorbers, they adapt innovations developed by other firms or institutions. Data reveals that Australian firms are predominantly absorbers rather than producers, with a majority of firms innovating by adopting or modifying existing foreign innovations.
The key corollary of innovation is the production of knowledge, which can be subsumed as a public good owing to non-excludability and non-rivalry properties. Furthermore, innovative activities create positive externalities that are not considered by individual firms when making resource allocation decisions. These factors are the crux of the market failure argument, implying that firms allocate fewer resources toward innovative activities than is socially optimal.
The obvious concern when applying market failure theory to policy is determining the optimal subsidy. How do we estimate the extent to which the market- produced level of innovation is ‘socially inefficient’?
Given these caveats, policymakers have recently directed their attention towards an alternative rationale for innovation policies: building and sustaining the national innovation system. This interest arose in light of recognition of differences in innovation systems and the influence of external actors. The literature identifies several types of system failures, including infrastructural, institutional, interaction, capability, and transition failures. The systems failure approach to innovation policy seeks to identify where these failures, or bottlenecks, lie in the innovation system, and use policy intervention to rectify them.
In the eyes of economists, the patent system is a double-edged sword. To justify the system we consider the problem of appropriation. Appropriation is the act of using something for one’s own use, typically without the permission of the owner. Although it could spark new innovations, the innovators that strive to make money from the function of the innovation suffer. This is because of the curious nature of innovation. Innovations are a black box in economics: sometimes they are modelled as random shocks, sometimes they are thought of as the result of some prior accumulation of knowledge. At other times, innovation is attributed to the right combination of the right factors at the right time, whereby we observe innovation but do not know the inner workings of the phenomenon. However, on the contrary to innovation, appropriation is quite a simple procedure. Shortly after a spark of innovation, the market is almost sure to be flooded by generic substitutes of the original product, driving the innovators’ profits down to marginal cost after all that hard work! Ultimately, we have a situation where there are no incentives to innovate even if the social benefits are significant, since the innovator will reap close to no rewards for his/her hard work.
The treatment for the appropriation problem in the world we live in is the patent system. It does set up the incentives for firms to invest in research and development for new technologies, but how does it affect society at large? For the individual firm or inventor, the patent is favourable because it assures them a fixed benefit from research and development; however the monopoly power granted to the original innovators may actually impede new ideas and inventions. It will raise transaction costs and inhibit cumulative invention. Also, the existence of this pot of gold at the end of the rainbow (the end of ‘this’ rainbow may or may not exist) creates the environment for a patent race. This occurs when multiple firms invest in a very similar or identical technology in order to win the patent before the others. For a simple illustration assuming risk-neutral firms, a firm would enter the race if his expected payoff (‘present value of the power granted by the patent’ x ‘probability of developing technology first’) is greater than the expected cost of the investment. This may induce a more than ideal number of firms investing in identical research and development, obviously giving rise to some dead weight loss.
Over the years, many economists have proposed various indicators to measure the health of the economy and predict it future. Since the economy is influenced by many factors making it hard to read, most economists have had to conjure up some creative solutions.
An indicator that is growing in popularity is Google. By tracking the incidences of key search terms using Google’s powerful Trend Analytics, Israel has been able to gauge consumer demand for its government statistics. For example, more people browsing for cars might suggest that there is an automotive boom presently, or on the horizon. Besides Israel, the Federal Reserve and the central banks of Britain, Italy, Spain, Turkey, and Chile have expressed great interest in this potentially useful indicator. One advantage is that the statistics are measured by a third party and updated regularly, with information released one to three days after the queries. This means that governments can keep a close-to real-time eye on the status of the economy. In a paper released in mid-2009, Tanya Suhoy, a senior economist at the Bank of Israel, found that Google-mined information helped predict a slowdown in economic activity in Israel. Due to the variation in search terms that could be monitored, it is impossible to broadly categorise this indicator by its direction with the economy. Since the data reflects current trends, this would be a coincidental indicator.
Want to revisit these articles and more from Equilibrium 2012? You can find them here.
Equilibrium 2013 will be released at the ESSA Year in Review on October 10. Register for the event here.
The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.