Acemoglu on Growth and Innovation

Posted by: Michael Mandel on January 14

Daron Acemoglu, whom I identified here as one of the leaders of innovation economics, has written a paper titled The Crisis of 2008: Structural Lessons for and From Economics. It’s being widely quoted and criticized. Mark Thoma has a post titled Acemoglu: The Models are Broken. Arnold Kling likes Acemoglu’s essay, calling it “highly recommended”. But Yves Smith calls the analysis in the essay “shallow and profession serving”.

I’m going to focus on a different part of the Acemoglu essay than these commentators. I’m going to focus on his analysis of growth and innovation, as it relates to the crisis. Acemoglu writes:

Barring a complete meltdown of the global system, even with the ferocious severity of the global crisis, the possible loss of GDP for most countries is in the range of a couple of percentage points, and most of this might have been unavoidable given the overexpansion of the economy in the prior years. In contrast, modest changes in economic growth will accumulate to much larger numbers within one decade or two. Thus, from a policy and welfare perspective, it should be self-evident that sacrificing economic growth to deal with the current crisis is a bad option.

followed by

Recent events have not shed doubt on the importance of innovation. On the contrary, we have enjoyed prosperity over the past two decades because of rapid innovations quite independent from financial bubbles and troubles. We witnessed a breakneck pace of new innovations in software, hardware, telecommunications, pharmaceuticals, biotechnology, entertainment, and retail and wholesale trade. These innovations are responsible for the bulk of the increases in aggregate productivity we enjoyed over the past two decades. Even the financial innovations, which are somewhat tainted in the recent crisis, are in most cases socially valuable and have contributed to growth. Complex securities were misused to take risks with the downside being borne by unsuspecting parties. But when properly regulated, they also enable more sophisticated strategies for risk sharing and diversification. They have enabled and will ultimately again enable…firms to reduce the cost of capital. Technological ingenuity is the key to the prosperity and success of the capitalist economy. New innovations and their implementation and marketing will play a central role in renewed economic growth in the aftermath of the crisis.

I think this point is being dramatically overlooked in the rush of today’s crisis. Innovation is essential, and probably the only way out of the mess in the long run.

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Reader Comments

CompEng

January 15, 2009 10:18 AM

I'm not sure technology is the solution to all our problems. I see how technology increases the effective productivity of each person. I'm just not sure how technology necessarily enables more people to profitably participate in an economy. I mean, to an extent this happens because things like the internet lower geographic barriers, but do they fundamentally make more workers necessary are useful, or is that effect weak compared to simply adjusting the geographic dispersion?
To some extent technologies do provide a forum for new goods and new markets (and thus more participation by more people), but that effect may be overrated.

Don't get me wrong. I'm not against technology, I'm just not sure it solves all our problems. Wiping out the mountains of investment and debt and making work pay may be more important than new technologies in getting the economy up again. The "2 billion new capitalists" effect still trumps the incremental gains of technology.

Joseph T

January 15, 2009 01:49 PM

Perhaps their needs to be a period of time where change is digested. Too much innovation and change leads to imbalances and dislocations like we have experienced with this financial meltdown and unemployment from global labor arbitrage. Maybe the dust needs to settle before the next wave of innovative change can come about.

Rycoka

January 15, 2009 05:22 PM

Mike,
I think the point about innovation is well made. The probem for the future may be the stifling effect on innovation of taxes and burdensome compliance regimes required by governments overloaded with debt.

Ajay

January 16, 2009 08:08 PM

Innovation, or more appropriately the lack of it, has played a key role in the recent bubbles and busts. The dot.com boom spurred giant bursts of economic activity as everyone assumed big changes were coming. Unfortunately, all the micropayment systems that were being built in the '90s ended up imploding and when the dot.coms could never monetize, the bust came. The last 9 years have been a technological ice age, as economically illiterate engineers and tech investors never got a micropayments system going, relying instead on the unimaginative and weak solution of transitioning advertising online. With no place for investment money to go, it went into housing and then briefly into commodities. Now, we have a fair amount of technology waiting to be used, only it's all sitting fallow because very few online transactions can be monetized, with the lone exception of the WSJ subscription website. The missing link is micropayments. It is the match to the firewood and gasoline of the PC and the internet, it will light the blaze. Mark my words, I will make it happen even if nobody else does. Once micropayments are here, information work booms and this current rough patch becomes a bad dream. I mentally snickered when Acemoglu talked of the breakneck pace of tech that he has seen so far, he hasn't seen anything yet. What's coming might make him want to throw up and get off the ride. ;)

Devin

January 18, 2009 01:24 PM

Acemoglu is referring to "technology" in the strict economics sense, which is more like "innovation"--ie, essentially anything which improves the productivity of a worker (not including increases in the level of capital per worker). So, beyond things like email, it also includes improvements in management, and also a "catching up" effect where there is a lag between the introduction of a technology and the time when the best use of that technology is really figured out. Basically, no one knew what to do with a fax machine when it was first produced--just like know one knew what to do to make money online when the internet first started catching on. So, given this definition, technology is the ONLY way to increase the level of production in a country and thus increase the standard of living. Without technological innovation, workers will never be able to produce more than they can right now--and how could they? Presumably they are already working hard, so it isn't a matter of working harder--the only other way would be working more, like in the 1800s, when 60-, 70-, 80-hour workweeks on farms were the norm. In that regard, technological innovation is the only explanation of long-run growth in living standards. The "two-billion new capitalists" is nice for us now, but what happens when they've caught up? All they are doing is racing through the last two hundred years of industrialization in the west to realize their potential at our current levels of tech. progress. Once China is producing at the same level as us per capita, what then? They won't have us to piggy-back off of, and it will be down to technological growth again.

Obviously, that will be a while, and it will be a useful period where growth can be driven in part by the rapid rate of advancement in China, India, and elsewhere, but it still leaves the question of how America can increase its living standards. And that is where Acemoglu's (and really economics') view of technological innovation is crucial.

rayman

January 18, 2009 03:38 PM

Innovation and technology are fine, but only if it equates to products or services which the U.S can produce and consume itself, without this, America will continue to cede power and it's living standards to other countries. Rather than a synchronized global economy, one where countries compete against each other for growth is more likely.

CompEng

January 19, 2009 01:30 PM

I agree with Ajay that technology has not really advanced all that much in the last 9 years, it's mostly been the rollout of existing technology and tuning for the market. Micro-payments are indeed a part of the business solution, and that's cultural as much as anything. There's a local area paper that has an internet paper subscription for essentially $3/month. I imagine that eventually you'll get bundles of subscriptions much like you pay for bundles of channels. Verizon and co. seem to be trying to rework the laws and make a killing, here. Watch for things like a "middle ground" on net neutrality to make a big difference for the monetization of content. But it's not really about new technology right now: it's about business models for rev N of the basic technologies that have been around for 30 years or more.

Just the way we refer to "tech" makes this obvious. Technology used to refer to the pinnacle of the application of all sciences: Physics, Biology, Chemistry, Material Science, Geology, and all the applied fields like Electronics, Pharmacology, and Aerospace Engineering. Now people only use it to refer to Information Technology. IT is far from dead, but so are the hard sciences, and the manufacturing arm of these things is potentially spectacular and yet mostly undervalued. I would love for Science and Technology to really be backed again and become a new fount of jobs and inventions. Most CEOs seem to think sticking an antenna and a keyboard on the same device is a great innovation. Right...

Mike Reardon

January 21, 2009 02:32 PM

We will get no bubbles from finance for some time, so what is in your post above is all that we will have to raise GDP from now on.

I caught the press conference on the Royal Bank of Scotland on Bloomberg Cable, it was especially chilling because both Gordon Brown and Treasury Chief Alistair Darling had a fair amount scorn for the lack of any real valuation being inside almost any investment vehicle. Both went on about the total toxic assets that had not yet been seen and that were still the center of the problem going forward.

Browns vent went to RBS’s excessive investment for greater return outside Brittan. The message He was giving banks was, move investment into the Nation, and stop putting money into self inflating bubble silos and help restart the economy with needed lending.

I got the impression Brown and Alistair Darling felt Obama’s administration was going to be supportive of something very similar.

I think the best we will get to is a flat banking system with growth coming from direct federal deficit investment that drags private investment in its wake. Requires private investment.

I would push more service infrastructure because it cost less and has a direct effect on quality of life. But it is still all about what innovation can add to the reduction in costs and increases in productivity. From here out you have it right.

Econdogg

January 23, 2009 02:07 AM

Interesting essay. I like the part where he says lowered gas prices will stymie green investments. Isn't $2.00 the breakeven point for alternative fuels? Try passing a gasoline tax to raise it back to $2.50... Or for that matter, try getting overleveraged consumers to purchase innovative products such as smaller tech toys (nanotech). We're in debt because of our financial ingenuity. I agree that innovation is key and yes, deregulation was good (underfunding oversight was bad). Although innovative leveraged finance and capitalism took it on the chin, overregulation and porkbarrel spending is not the solution. Acemoglu says this. My point is that everyone in America is spent: consumers, businesses and government alike. GDP increases when innovation is produced and consumed - i.e. buy my new pacemaker... but leveraged debt can't pay for it anymore....

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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