How to evaluate the value of innovation

All around the world, there is vast enthusiasm for the type of technological innovation symbolized by Silicon Valley. In this view, America's originality represents its true comparative advantage that others strive to imitate. Other than there is a puzzle: it is difficult to detect benefits of this innovation in GDP statistics.


What is happening today is equivalent to developments some decades ago, early in the era of personal computers. In 1987, economist Robert Solow awarded the Nobel Prize for his pioneering work on development lamented that "You can see the computer age everywhere however in the productivity statistics." There are numerous possible descriptions for this.

Possibly GDP (Gross domestic product) does not really capture the improvements in living standards that computer-age innovation is engendering. Perhaps this innovation is less important than its enthusiasts believe. As it turns out, there are a number of truths in both perspectives.

Remind how a few years ago, just before the collapse of Lehman Brothers, financial sector prided itself on its innovativeness. Given that financial institutions had been attracting the best and brightest from around the globe; one would have expected nothing less. Although, upon closer inspection, it became clear that most of this innovation involved devising better ways of scamming others, manipulating markets without getting caught and exploiting market power.

In this stage, while resources flowed to this innovative sector, GDP growth was markedly lower than it was before. Still in the best of times, it did not lead to an enlargement in living standards and it eventually led to the crisis from which we are only at the present recovering. The net social contribution of all of this improvement and innovation was negative.

Likewise, the dot-com bubble that proceeded this period was marked by innovation - Web sites through which one might order dog food and soft drinks online. As a minimum this era left a legacy of efficient search engines and a fiber-optic infrastructure. Although it is not an easy matter to assess how the time savings implied by online shopping or the cost savings that might result from increased competition affects our standard of living.


Two things must be clear. First, the productivity of an innovation may not be a good measure of its net contribution to our standard of living. In our winner takes all economy, an innovator who develops a better Web site for online dog-food purchases and deliveries could attract everyone around the world who uses Internet to order dog food, making enormous profits in the procedure. But without the delivery service, much of those profits just would have gone to others. The Web site's net contribution to economic growth might in fact be relatively small.

Furthermore, if an innovation, for example neither ATMs in banking, leads to increased unemployment, none of the social cost, neither suffering of those who are laid off nor the increased fiscal cost of paying them unemployment benefits is reflected in firm's profitability. Similarly, our GDP metric does not reflect the cost of increased insecurity individuals may feel with the increased risk of a loss of a job. Evenly important, it frequently does not accurately reflect the improvement in societal wellbeing resulting from innovation.

In a simpler world, where innovation simply meant lowering the cost of manufacture of, an automobile, it was easy to assess an innovation's value. However when innovation affects an automobile's quality, the task becomes far more difficult. This is even more apparent in other arenas: How do we exactly assess the fact that, owing to medical progress, heart surgery is more likely to be unbeaten now than in the past, leading to an important increase in life expectancy and quality of life?

Yet, one cannot keep away from the uneasy feeling that, while all is said and done, the contribution of recent technological innovations to long-term development in living standards may be substantially less than the enthusiasts claim. Lots of intellectual effort has been devoted to devising better ways of maximizing advertising and marketing budgets, targeting customers, particularly the affluent, who might actually buy the product. But standards of living might have been raised even more if all of this innovative talent had been allocated to more fundamental research or still to more applied research that might have led to new products.

Yes, being better linked with each other, through Facebook or Twitter, is valuable. But how can we evaluate these innovations with those like the laser, transistor, the Turing machine and mapping of human genome, each of which has led to a flood of transformative products?

Naturally, there are grounds for a sigh of relief. Though we may not know how much recent technological innovations are contributing to our wellbeing, as a minimum we know that, unlike the wave of financial innovations that marked the pre-crisis global economy, the effect is positive.

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