Innovation, the Best Investment

By Chris Farrell Thrift is a virtue, according to economists, policymakers, philosophers, and parents. We recite Ben Franklin's aphorism, "A penny saved is a penny earned," and believe the exhortation of Poor Richard's Almanac that "The art of getting rich consists very much in thrift."

Yet we've become incurable spendthrifts. We're far too eager to take on massive debt to own big houses and the latest computer to qualify as virtuous. The national data show that consumers are barely saving. From 1980 to 1994, the personal savings rate averaged about 8%. By the early 2000s it had dropped to the 1% range, and it has recently declined to 0.4%.

Savings scolds such as investment banker Peter Peterson and economist Laurence Kotlikoff warn that a profligate society faces an unhappy future and economic disappointment. Jeremiads against our spendthrift ways resonate because most of us struggle to save. Who doesn't worry that they aren't putting enough money aside to handle a short-term emergency, let alone their golden years? What's more, it has been drilled into us that private savings is the main source of funds for investment in new capital goods and is the wellspring of higher productivity and living standards.

With that in mind, a number of recent major fiscal policy initiatives have been put forward. Boosting personal savings was the main economic justification behind slashing the effective tax rate on capital income, and the same is true of President Bush's push to eliminate the estate tax.

THE INTERNET'S EXAMPLE. The President has also expressed interest in abandoning the current income tax system for a consumption tax, which would tax spending and exempt savings. And one promised benefit from the partial privatization of Social Security would be the eventual increase in national savings and, therefore, the economy's prospects. As Peter Bernstein, the eminent financial economist quips, the "assumption is that savingsandinvestment is one word."

Yet the focus on boosting private savings is misplaced, and the gloomy forecasts of inevitable catastrophe are wrong. (Public savings is a different matter, and the federal government could boost the economy by getting its fiscal house in order.) When it comes to economic growth, creativity, innovation, and risk-taking matter. Growth isn't spurred by saving or a lack of spending. What moves an economy forward is the discovery of new ways of organizing business and finding new consumer desires to satisfy. Case in point: the Internet. Another example: The biotech revolution. How about securitized mortgages?

So, if you're really interested in gauging the economy's long-term outlook, perhaps you should look at the research and development data published by the Nation Science Foundation instead of the personal savings rate published by the Bureau of Economic Analysis. (The lag in the data from the NSF is disappointing, however. The Foundation only recently published its estimates for 2003 R&D spending.)

PRODUCTIVITY REVOLUTION. While the personal savings rate declined from nearly 6% in the beginning of 1993 to 1% in early 2003, the total spent on research and development in the U.S. jumped 44% to a record $253 billion over the same time period, after adjusting for inflation.

"If enterprise is afoot, wealth accumulates whatever may be happening to thrift; and if enterprise is asleep, wealth decays whatever thrift may be doing," wrote John Maynard Keynes, the leading 20th century economist.

The economic payoff from innovation is improved productivity. To be sure, learning how to exploit frontier technologies takes years of experimentation and organizational reshuffling. But over time management and labor move up the experience curve, even as additional innovations make technology easier to use and price drops make the innovations more affordable. Thus, it's no coincidence that the high-tech ferment of the past quarter century eventually paid off in higher productivity. Since 1995, productivity has been running at around a 3% annual rate, about double the pace of the preceding two decades.

NOT WELCOME. Believe it or not, we can do even better. What we need is a public policy that focuses on nurturing technological innovation and scientific breakthroughs. Clearly, putting more money to work in basic research and development is key, as is increased investment spending on pre-K through PhD education.

The government could also try harder to get out of the way of innovation. For instance, legislators should stop trying to put up barriers to the offshoring of services, a remarkable organizational and technological innovation that is bringing huge efficiencies to the information and service sector industries.

The federal government is also throwing up worrisome barriers to the free flow of scientific information. And it is making it harder for skilled immigrants to come here to live and work. Both initiatives are part of the war on terror and while they are well-intentioned, they threaten to do far more harm than good. After all, America's high-tech industries, from semiconductors to biotechnology, depend on immigrant scientists, engineers, and entrepreneurs to remain competitive.

THE SEEDS OF INNOVATION More than half of the engineers and 45% of math and computer scientists with PhDs now working in the U.S. are foreign born. The U.S. government's Trends in International Mathematics and Science Study published late last year said 60% of the top science students and 65% of the top math students in high schools are children of immigrants.

So, when policymakers put forward legislative initiatives that they claim will boost economic growth, we should ask whether the legislation will cultivate an environment that rewards innovation and creativity. The mantra should be unleashing innovation, not raising savings. A penny saved may a penny earned, but money well invested can bring dividends too great to measure. Farrell is contributing economics editor for BusinessWeek. You can also hear him on Minnesota Public Radio's nationally syndicated finance program, Sound Money, as well as on public radio's business program Marketplace. Follow his Sound Money column, only on BusinessWeek Online

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