For 250 years, technological innovation has driven economicdevelopment. But the economics of innovation are very different for those atthe frontier versus those who are followers striving to catch up.
At the frontier, the innovation economy begins with discoveryand culminates in speculation. From scientific research to identification ofcommercial applications of new technologies, progress has been achieved throughtrial and error. The strategic technologies that have repeatedly transformedthe market economy – from railroads to the Internet – required the constructionof networks whose value inuse could not be known when they were first deployed.
Consequently, innovation at the frontier depends on fundingsources that are decoupledfrom concern for economic value; thus, it cannot be reduced to the optimalallocation of resources. The conventional production function of neoclassicaleconomics offers a dangerously misleading lens through which to interpret theprocesses of frontier innovation.
Financial speculation has been, and remains, one requiredsource of funding. Financial bubbles emerge wherever liquid asset marketsexist. Indeed, the objects of such speculation astound the imagination: tulip bulbs, gold and silver mines, realestate, the debt of new nations, corporate securities.
Occasionally, the object of speculation has been one ofthose fundamental technologies – canals, railroads, electrification, radio, automobiles, microelectronics,computing, the Internet – for which financial speculators have mobilizedcapital on a scale farbeyond what “rational” investors would provide. From the wreckage that hasinevitably followed, a successionof new economies has emerged.
Complementing the role of speculation, activist states haveplayed several roles in encouraging innovation. They have been most effectivewhen pursuing politically legitimate missions that transcend narrow economiccalculation: social development, national security, conquering disease.
In the United States, the government constructedtransformational networks (the interstate highway system), massively subsidizedtheir construction (the transcontinentalrailroads), or played the foundational role in their design and earlydevelopment (the Internet). Activist states around the world have funded basicscience and served as early customers for the novel products that result. For aquarter-century starting in 1950, the US Department of Defense – to cite onecrucial example – combined both roles to build the underpinnings of today’sdigital economy.
For countries following an innovative leader, the path isclear. Mercantilistpolicies of protection and subsidy have been effective instruments of aneconomically active state. In the US, the first profitable textile mills blatantly violatedBritish patents. And ferociouslyentrepreneurial private enterprise was supported by a broad array of stateinvestments, guarantees, and protective tariffs, in accordance with the“American System” inspired by Alexander Hamilton and realized by Henry Clay.
The great, neglected German economist Friedrich List, astudent of Hamilton’s work, laid out an innovation roadmap for his own countryin 1841, in his
NationalSystem of Political Economy. It has been used repeatedly: byJapan beginning in the last decades of the nineteenth century; by the AsianTigers in the second half of the twentieth century; and now by China.
List noted how Britain’s emergence as “the first industrialnation” at the end of the eighteenth century depended on prior state policiesto promote British industry. “Had the English left everything to itself,” hewrote, “the Belgians would be still manufacturing cloth for the English, [and]England would still have been the sheepyard for the [Hanseatic League].”
Coherent programs to promote economic catch-up arerelatively straightforward. But the transition from follower to leader at the frontier of theinnovation economy is more challenging and elusive.
The US managed the transition roughly between 1880 and1930, combining the professionalization of management with a speculative tastefor new technologies – electrification, automobiles, and radio – and statetolerance of the Second Industrial Revolution’s great industrial monopolies,which invested their super-profits in scientific research. The post-World WarII invocation ofnational security as the legitimizingrationale for an economically active state extended America’s leadership.
It is not yet clear whether East Asia’s economicpowerhouses will succeed in making the transition from follower to frontier. Tobegin, the “national champions” of the catch-up phase must be rendered accessibleto competitive assault. More generally, the state’s role must shift fromexecuting well-defined programs to supporting trial-and-error experimentationand tolerating entrepreneurial failure. And the debilitating “corruption tax” that seems inevitablyto accompany economic revolutions must be curbed, as it was in Britain during the nineteenthcentury and America during the twentieth.
Here is the moment of strategic uncertainty. The “made inAmerica” digital economy exhibits ample momentum in the private sector. But leadership ofthe next new economy – the low-carbon economy – is open. America is sufferingthe consequences of a generation-long effort to render the state illegitimate as aneconomic actor. Europe is miredin its oxymoronic commitment to “expansionary fiscal austerity.”
Can China manage the economic, cultural, and politicaltransitions necessary to assume the leadership role now up for grabs? I find it intriguing to go backalmost 200 years and consider Britain’s political economy when the First IndustrialRevolution was gathering steam.
England in 1820 was governed by a corrupt oligarchy that exercisedpower in intimatecollaboration with a national religious establishment. Political legitimacy wasvalidated by fearof anarchy, theterrifying reality of which had been observable across the Channel withinliving memory. Arbitrary, draconian repression was the rule: under the “BloodyCode” of criminal justice, more than 100 felonies were punishable by death or transportation. The patentsystem was notoriously expensive and inaccessible.
England’s rulers sought in vain to keep a lid on the greatest explosion ofeconomic energy and financial wealth in human history. Over a long generation,England was transformed. From the Great Reform Act of 1832 to the repeal of the Corn Lawsin 1846 – and on to the civil-service reforms initiated in 1853 and the Representation of thePeople Act of 1867 – Britain pursued its unique path toward a relatively stableand sustainable democratic capitalism.
No doubt China’s own path will be as distinctive as theprocesses by which it has reached its current moment of opportunity. Whether ornot its path proves to be as progressive as England’s may determine who assumesthe mantle ofglobal economic leadership.
加JingGuanBbs
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