Mere innovation is not enough


On Feb 10, Apple’s stock market value touched US710.7bil, making it the most valuable US company ever. – AFP

On Feb 10, Apple’s stock market value touched US710.7bil, making it the most valuable US company ever. – AFP

IT is dogma that innovation is key to raising worker productivity – the single most important determinant in driving economic growth and hence, living standards.

The practical logic is simple: whenever innovative products or services come to market, productivity rises and the economy gets wealthier. That’s what happened in the past two centuries. As a result, living standards had risen dramatically. Nobel laureate economist Robert Solow demonstrated that up to 40% of all productivity and growth gains in the United States during the first half of the 20th century came from “technical progress.”

In other words, learning and innovation that led to gains in productivity. For more, read my column “Schumpeternomics: Gotta’ Keep On Learning” (July 12, 2014).

Venturesome society

First, I should clear a widespread myth – that innovation needs government to direct and promote domestic creativity. China targets “strategic industries;” India wants to be “self-reliant” in electronics. Many major emerging economies provide preferential treatment to their own enterprises to create national technology champions. Even the US does it – for clean energy projects. Ample studies have shown that the biggest benefits from innovation don’t come from state policies or state owned enterprises (SOEs).

Favouring key sectors or projects with taxpayer money appeals to politicians. But it does more harm than good. It crowds out enterprising competing private investment. Worse, it warps bureaucratic decisions and brings on political cronyism.

Harvard’s Larry Summers calls government a “crappy venture capitalist.” Markets function best when risks are borne by private capital and enterprise. Sure, governments have a responsibility to fund pre-competitive, generic research and development (R&D) and basic defence initiatives (e.g. in basic science and technology from nanoscience to clean energy), but only when they pass vigorous cost-benefit tests and keep the playing field level among alternative commercial pursuits.

The computer-linking technology that created the Internet was funded by the US for defence purposes. But the numerous defence technologies wound-up with many commercially valuable civilian applications. By the same token, it is not in order for the government to fund a particular search engine or social networking platform. US industrial policy failed in the 1970s and 1980s and thereafter.

Letting government instead of the market-place pick “winners” is a bad idea. The lesson: it’s far better to focus on harnessing the gains in productivity than on where the innovation comes from.

Don’t expect new discoveries in technology every day. The optimal benefits from innovation come from enterprises that effectively use innovations (old and new). They will come from the application and adoption (and adaptation) of technological breakthroughs, regardless of where those creative breakthroughs were achieved.

The world wide web (www) was discovered in 1989 at Cern (a particle-physics lab near Geneva). But its biggest beneficiary wasn’t Switzerland, but enterprises around the world which learned to harness its power for wide-ranging purposes. The policy moral: (1) public policies affecting the use of innovations are as important as any investment in creating new technologies. For more than 10 years since the 1990s, Europe invested in as much hardware and software as the US, but with lower productivity gains (annual productivity rose an average 1.1% in France and 1.5% in Germany from 1995-2000, but up from 2% in the United States).

Productivity up

This reflected inhibiting anti-competitive regulations in Europe, while widespread use of IT-based tools and networks drove-up productivity in the United States; and (2) counter-productive discriminatory public policies in selecting national champions have led to capital misallocations and market distortions. Classic examples include the expensive Anglo-French government “hobby” (the Concorde supersonic aircraft), and Barack Obama’s clean-energy programmes (Solyndra, Ener1 and Beacon Power).

Nevertheless, the United States’ catalytic role in funding basic R&D and its flexible labour market, skilled labour supply, freer business regulations, strong property rights, and efficient and deep capital markets have combined to create for entrepreneurs a “venturesome” ecosystem that encourages both businesses and consumers to use innovations and to invest in the world’s best new ideas.

Implications

Innovations have strong implications. Creativity brings forth network effects or externalities. Today, most PCs use Microsoft’s Windows operating system. And because of its popularity, everyone else use Windows to drive their PCs. The more people use Windows software, the more Microsoft dominates. This creates externalities (benefits) for the majority of PC users. Similarly, peripheral devices are designed to work with PCs driven by Windows. A convenient network of externalities based on Windows is thus created – which becomes self-perpetuating. Microsoft’s dominance is locked in.

> Monopoly: So, network externalities make Microsoft a monopolist. According to Harvard’s Joseph Schumpeter, competition for markets drives innovation and this can (and do) create monopolies. Apple has since become a monopolist in mobile devices (there are now more Apps for iOS than others), similar to Microsoft’s position with Windows operating system for PCs. However, monopolies can inhibit innovation. Creative destruction means monopolies eventually get beaten down. It’s happening to Microsoft; it can well happen to Apple, Google, Amazon (and others like them).

> Stymie job growth: The spread of automated processes and robots has acted as a drag on job creation. As Schumpeter had anticipated, technological progress routinely disrupts. Airlines and highways decimated rail passenger service; air-conditioning drew people to the warmer US south; supermarkets displaced small grocers. But empirical studies showed that overall, real productivity enhancing technologies usually created more jobs than they destroyed, through: (i) lower prices leading to consumers buying more; and (ii) higher wages and profits enabling more spending on healthcare and education. Still, the process is slow and long. But the growth of start-ups (and their hires) has slackened. However, recent pick-up in employment growth is encouraging. It is still possible for US to reach full employment by 2017.

> Frugal innovation: Frugal “how to do more with less” innovation has arrived. It started with some multinationals designing no-frills products for emerging markets (General Electric’s affordable medical devices in India and China; and Renault-Nissan’s no-frills cars in Indonesia and Romania) as well as for advance nations where recession has left incomes stagnant in the face of high unemployment (American Express marketing Bluebird, a low cost account through Walmart). Similarly, “crowd sourcing” product development schemes (Ford’s innovation centre where employees can spend spare-time experimenting with new technologies) and “crowd funding” outfits (Kickstarter, KissKissBankBank provide frugal sources of financing for frugal-investors) are opening-up the innovation space to all sorts of possibilities (including 3-D printing) to raise productivity.

> Workers on tap: Today, a growing group of entrepreneurs is striving to bring together IT power with freelance skills to provide personal services once reserved for the wealthy: Uber provides chauffeurs, Handy supplies cleaners, SpoonRocket delivers restaurant meals, Instacart keeps the fridge stocked, etc. They now go beyond to provide smart medical and legal services, office workers, as well. This “on-demand” economy is growing; it connects people with freelancers to solve problems. Like mass production, such new innovative services have profound implications from the organisation of work to the nature of social contract. It will change social habits. It just imposes more risks on individuals.

What, then, are we to do

Innovation matters. Its benefits are optimised when effectively used, regardless of where it is discovered.

On Feb 10, 2015, Apple’s stock market value touched US$710.7bil, up two-thirds over the past year and up 50,600% over its IPO value in December 1980. It became the most valuable US company ever – double each of the next three largest companies in the S&P 500 index: Exxon Mobil (2nd), Bershire Hathaway (3rd) and Google (4th); it’s 2.5x Walmart, 4x Bank of America and 12x GM. It’s 30x Maybank, Malaysia’s largest.

It also beats the “law of large numbers” (the idea that growth slackens as companies grow bigger). It’s significant that at this time RadioShack filed for bankruptcy – joining the list of famous US companies capsized by waves of creative destruction.

Of the companies on the first Fortune 500 list in 1955, 88% don’t exist today or have fallen by the wayside. The lesson: no business triumphs forever. The same can’t be said of SOEs – where failure is often rewarded with more money (e.g. Proton, MAS and many more). What a shame!

Obiter dictum

Person-to-person (P2P) payments are in. Using mobile smartphones to pay and transfer cash is nothing new. The granddaddy being Kenya’s M-PESA; US market leader is PayPal through its P2P start-up Venmo. It’s catching – Facebook is joining the fray, so is ApplePay. Big banks are also in, through Popmoney in US and Paym in Britain.

What’s moving is that such “cashless” transactions are getting ever easier and faster to use. Snapcash even allows users to flick cash to friends by dragging images of banknotes across the screen of smartphones.

Venmo now makes mobile payments “social” (allows splitting bills and sharing such information among friends). But there are concerns about security and data sensitivity. So far, all offerings are known to be loss leaders.

Still, it’s the new fad and poses a grave threat to banks. In some US circles, “Venmo” is fast becoming a verb (as in, “can you Venmo me some money?)

What’s next?

Unfortunately, we remain the faddish laggard.

Former banker, Tan Sri Lin See-Yan is a Harvard educated economist and a British chartered scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: starbiz@thestar.com.my

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