Competitiveness

Innovation, including the diffusion of information technology throughout the economy, is key to boosting productivity, which in turn is at the heart of increasing living standards.

Innovation and Productivity: What’s the Relationship and How Does it Happen?

November 11, 2011
| Presentations

In a featured presentation at the ATSE Forum, Rob Atkinson stresses the relationship between innovation and productivity. All nations need an innovation-productivity strategy because addressing complex and systemic challenges–such as achieving affordable health care, combating global climate change, achieving sustainable energy production, deploying digital infrastructure, etc.–requires coordinated strategies leveraging the resources of firms, government, academia. And, in contrast to what the conventional neo-classical economic doctrine holds, markets alone will produce societally sub-optimal levels of innovation.

The Impact of Regulation on Innovation in the United States: A Cross-Industry Literature Review

November 14, 2011
| Reports
Through a high-level, multi-industry review of the literature this paper describes how regulation can both stifle and encourage innovation. The impact of regulation on innovation depends largely on the breadth and type of the regulation.

Innovation—the commercially successful application of an idea from invention, the initial development of a new idea, and the widespread adoption of the innovation—is classified by whether the innovation benefits the market or social welfare. Market innovation typically benefits producers, consumers, and society at large, although there are cases where it may only benefit producers at the expense of social welfare. Social innovation refers to product and process innovations that create social benefits, such as cleaner air, which firms cannot directly capture through market sales.

Firms can also choose to innovate incrementally or radically. Incremental innovation occurs when firms make relatively minor improvements to existing products and processes to comply with regulation. Radical innovation occurs when a firm replaces existing products or processes to comply with regulation. This type of innovation is costly and risky; however, it can yield greater benefits than incremental innovation. 

Like innovation, regulations can be economic or social in nature. Economic regulation sets market conditions; it often changes the market efficiency and potentially affects the equality and fairness of the market. Social regulation, on the other hand, seeks to protect the welfare of society or the environment. When the scope of regulation is narrow, firms may choose to change their products or processes so that they are no longer within the scope of the regulation, also known as circumventive innovation. When the scope of the regulation is broad, firms may prefer to change its product or process to adhere to the regulation—otherwise known as compliance innovation. A regulation’s stringency, flexibility, and effect on available market information—collectively known as innovation dimensions of regulation—can have drastic impacts on innovation. Stringency is the degree to which a regulation requires compliance innovation and imposes a compliance burden on a firm, industry, or market. 

Generally, the more stringent a regulation is, the more radical compliance innovation is required. Thus, stringent regulation increases risk,cost, and the chances of “dud” products or processes. Flexibility describes the number of implementation paths firms have available for compliance. Information measures whether a regulation promotes more or less complete information in the market. Although flexibility and increased available information generally aid innovation (see Table D-1), regulation or the possibility of regulation can induce two types of uncertainty—policy and compliance uncertainty. Policy uncertainty occurs when a firm anticipates the enactment of a regulation at some time in the future and may cause firms to divert resources in preparation for future compliance. The degree of resources diverted depends on the anticipated stringency of the future regulation. Policy uncertainty may cause firms to innovate, even if regulations never become enacted. Compliance uncertainty is uncertainty caused by an existing regulation. This generally occurs when a firm does not know whether a product or process will comply with preexisting regulation or how much time is needed for the product or process to comply.

Productivity, Innovation and Prosperity - The Great Australian Challenge

November 11, 2011
| Presentations

ITIF president Rob Atkinson will be giving the keynote presentation "E-Transformation for Competitiveness" as part of the conference Productivity, Innovation and Prosperity - The Great Australian Challenge, sponsored by the Austrailian Academy of Technological Sciences and Engineering. Other notable presenters inculde Senator the Hon. Stephen Conroy, Australian Minister for Broadband, Communications and the Digital Economy and the Hon. Gordon Rich-Phillips MLC, Minister for Technology and Assistant Treasurer, Victoria.

Technological Breakthroughs the Key to Our Future Prosperity

November 9, 2011
| Blogs & Op-eds

In this Op-Ed for The Australian, Rob Atkinson stresses Australia has an opportunity to lead the world by crafting a national strategy focused on driving productivity through IT innovation. Australia’s national science agency, CSIRO, is already doing leading-edge work to develop an IT-based digital technology strategy. But if these and related efforts are to be successful,they’ll need to be fully supported by government

Innovation Deficit Disorder: A Diagnosis For a Sick Economy

November 8, 2011
| Blogs & Op-eds

Writing for The Atlantic, Rob Atkinson argues the economic recovery theories of many economists and policymakers miss the essential point: the loss of U.S. innovation, competitiveness leadership and the origins of the devastating decline in the U.S. manufacturing sector in the last decade. Between 2000 and the peak of employment in January 2008, the number of jobs grew just 5.4 percent, while manufacturing jobs declined by a whopping 32 percent.

Despite these alarming trends, too many policy elites have urged us not to fret, arguing the United States is still strong in "innovation." But manufacturing and innovation are linked. Much of manufacturing (think semiconductors, drugs, medical devices, aerospace, and instruments) is high tech. Moreover, losing high-tech industry (the U.S. has run a trade deficit in high technology since 2000) leads to the loss of the upstream R&D and design jobs as well.

Congress should take a more nuanced approach to budget cutting that addresses the budget deficit while simultaneously reducing the investment and trade deficits.

Instead of focusing solely on the budget deficit, Congress should take a more nuanced approach to budget cutting that addresses the budget deficit while simultaneously reducing the investment and trade deficits. The only way to do this is to increase targeted investments that spur innovation, productivity, and competitiveness while cutting budgets elsewhere. Increasing these productive public investments will close the investment deficit, boost U.S. competitiveness and exports, and generate higher economic growth, which is the single best way to close the budget deficit. The CBO estimates that an increase of just 0.1 percent in the GDP growth rate could reduce the budget deficit by as much as $310 billion cumulatively over the next decade. For example, an increase in the real rate of GDP growth from the CBO projection of 2.8 percent over the next decade to 4 percent—the U.S. growth rate from 1993 to 2000—would, all else equal, cut the cumulative budget deficit in half, or by $6.8 trillion, over the next decade.

The budget, trade and investment deficits, if left unchecked, could reach $41 trillion over the next ten years.

As the Congressional super committee edges up to its deadline for submitting a proposal to reduce the nation's long-term debt, what is being ignored is the fact that we have three interrelated deficits to overcome: budget, trade and investment. If we cut investments in R&D, education, and innovation in the name of fiscal austerity today, we will impede growth and set the stage for even larger budget and trade deficits tomorrow. Read more »

Taking on the Three Deficits

November 7, 2011
| Reports
The battle over how to reduce the federal budget deficit is simultaneously consuming and paralyzing Washington. As the President’s National Commission on Fiscal Responsibility and Reform noted in its final report, “America cannot be great if we go broke. Our economy will not grow and our country will not be able to compete without a plan to get this crushing debt burden off our back.” But this report by ITIF and the Breakthrough Institute explains the focus almost exclusively on the budget deficit has obscured the fact that America actually faces three deficits—the budget deficit, the trade deficit, and the investment deficit—that, if left unchecked, could total over $41 trillion in the next 10 years. The report explains the interrelationship between the three deficits and offers a guide to help policymakers reduce wasteful government spending but preserve or increase federal investments in areas like research, technology, education and infrastructure that are essential to economic growth and long-term prosperity.

America faces three cumulative deficits, each of which must be addressed to ensure continued economic prosperity:

The Budget Deficit is the difference between federal revenues and spending. The budget deficit for FY2011 stands at over $1.2 trillion, and the cumulative national debt will reach $10.4 trillion this year. The debt may rise to more than $18.3 trillion by 2021, according to Congressional Budget Office (CBO) estimates.

The Trade Deficit is the annual difference between U.S. exports and imports. For years, the United States has imported more than it exports, leading to large and persistent trade deficits. In 2010, the United States generated a $500 billion trade deficit. Since 1975, the United States has accumulated a total trade deficit of $8 trillion, and the cumulative trade deficit could grow to $18 trillion in 10 years. The trade deficit creates a drag on economic growth and represents a hidden tax on future generations of Americans who will have to pay it off by running trade surpluses that stem from expanded exports and/or reduced consumption of goods and services.

The Investment Deficit is the shortfall of investments in scientific research, education, productive infrastructure, and new technologies that are needed to maintain our current standard of living and provide a critical foundation for long-term economic prosperity. These investments drive economic growth by accelerating innovation and boosting productivity, yielding positive returns on investment for the entire economy. Yet public investment in these building blocks of national prosperity has declined for decades, leading to stagnating growth and a widening investment deficit that may increase to over $5 trillion in the next decade.

Overall, America’s three deficits total almost $21 trillion and are projected to grow to over $41 trillion in 10 years. The budget deficit alone makes up less than half of the total combined deficit, and both future economic growth and government revenues are influenced by the magnitude of the trade and investment deficits. Thus, addressing all three growing deficits is critically important to ensuring continued economic prosperity.

Estimate of America's three deficits in 2011 and 2021 projection graph

Figure 1: Estimate of America's three deficits in 2011 and 2021 projection

Right Way and the Wrong Way to Close the Three Deficits

The Wrong Way

Most policymakers in the budget debate are ignoring the trade and investment deficits, and as a result risk making all three deficits worse. The predominant approach in Washington is to “put everything on the table” and pursue across-the-board budget cuts to reduce the level of public spending. Such a strategy makes policymakers appear bold in their approach to the national debt, but would actually be counterproductive, since it would simply transfer some financial debt to investment or trade debt. Take, for instance, the impact of a 10 percent cut in funding for research and development spending over the next 10 years. This would nominally reduce the budget deficit by $150 billion over 10 years, but would increase the investment deficit by the same amount. Moreover, it would actually increase the trade deficit as well, by slowing the pace of innovation and making U.S. exporters less competitive. In turn, both factors in turn would reduce economic growth, ultimately leading to a higher budget deficit (see Figure 2 below).

Estimated net impact on the three deficits of a 10 percent cut (relative to 2010 government investment level) in R&D investments portioned equally over 10 years Graph

Figure 2: Estimated net impact on the three deficits of a 10 percent cut (relative to 2010 government investment level) in R&D investments portioned equally over 10 years. See Appendix A for a brief description of our estimation methodology.

The Right Way

Instead of focusing solely on the budget deficit, Congress should take a more nuanced approach to budget cutting that addresses the budget deficit while simultaneously reducing the investment and trade deficits. The only way to do this is to increase targeted investments that spur innovation, productivity, and competitiveness while cutting budgets elsewhere. Increasing these productive public investments will close the investment deficit, boost U.S. competitiveness and exports, and generate higher economic growth, which is the single best way to close the budget deficit. The CBO estimates that an increase of just 0.1 percent in the GDP growth rate could reduce the budget deficit by as much as $310 billion cumulatively over the next decade. For example, an increase in the real rate of GDP growth from the CBO projection of 2.8 percent over the next decade to 4 percent—the U.S. growth rate from 1993 to 2000—would, all else equal, cut the cumulative budget deficit in half, or by $6.8 trillion, over the next decade. Indeed, gaining control over the nation’s debt without an increase in economic growth and therefore tax revenues will be extremely difficult, if not impossible.

Productive Investment vs. Consumptive Spending

The challenge, then, is to identify those programs that spur innovation, productivity, and competitiveness, and therefore drive economic growth and competitiveness. In particular, policymakers should distinguish between productive investments—expenditures that expand the productive capacity of the country, drive economic growth, and increase future incomes—and consumptive spending—government expenditures that finance present consumption of goods and services.

This critical distinction is often lost on both sides of today’s budget negotiations. Many on the left do not distinguish between the two, either because they are unconcerned about the budget deficit or because they believe spending and investment have the same economic impact. Many on the right paint all federal investments as “spending” that should be cut, even though investments like scientific research yield large returns for both society and the federal treasury that other spending, including subsidies to farmers and oil companies, do not. There is a similar lack of clarity on tax policy, with some on the left opposed to more tax cuts for businesses and some on the right in favor of any and all tax cuts, regardless of merit. The truth is that some tax expenditures, like the ethanol tax credit, are wasteful and do not increase productivity or growth, while tax incentives, like the R&D tax credit, encourage activities that foster growth, innovation, and job creation.

Furthermore, policymakers from both the left and right limit their framing of the federal budget to either discretionary or non-discretionary programs. The fact is, the entire federal budget consists of government expenditures. The key difference between programs should really be whether a program is considered consumptive spending or productive investment, not whether the expenditure is mandatory or not. Breaking from this old framing would create a more robust and effective budget policy debate.

Productive public investments will help reduce the three deficits and should be strengthened, while consumptive spending will likely add to the three deficits and could more justifiably be cut. Some consumptive spending programs may still be important, but each should be judged on their own merits. In general, targeted cuts could be made to consumptive spending to reduce the budget deficit without exacerbating the other two deficits. Meanwhile, agencies, programs, and policies with some connection to productive investments—e.g., R&D, education, and infrastructure programs and policies—collectively take up a relatively small portion of the budget picture—likely less than 10 percent of all expenditures. Increasing high-impact productive investments, including pro-growth tax expenditures, can therefore be accomplished without adding significantly to short-term debt, while generating economic returns that reduce all three deficits over the medium to long term.

To distinguish between investment and spending, policymakers should consider three criteria:

1. Innovation. Does the program or policy help spur innovation to create new products, processes, technologies, or knowledge that in turn adds value or creates new industries?

2. Productivity. Does the program or policy increase the productivity of organizations and the economy as a whole?

3. Competitiveness. Does the program or policy help close the trade deficit by making U.S. firms more globally competitive, thereby increasing exports or reducing imports?

By using these three metrics as a guide, policymakers can make better budget decisions that spur economic growth and simultaneously close all three deficits, even as they cut spending elsewhere in the budget. By increasing productive public investments to spur innovation, productivity, and competitiveness, America can begin closing its three deficits and once again become the most competitive and innovative nation in the world.

 

This report was named a "must read" by The Council on Foreign Relations.

Taking on the Three Deficits

November 3, 2011
| Blogs & Op-eds

In this National Journal Energy and Environment Expert blog post, clean energy policy analyst Matthew Stepp discusses how policymakers can reframe the budget debate and have a more nuanced discussion about how America can address all three deficits through targeted investments and spending cuts. As the U.S. economy continues to struggle through an anemic recovery, politicians in Washington are consumed by a debate over how to drastically reduce the nation’s debt. But in their zeal to close the budget deficit, policymakers are ignoring that America is actually challenged with three deficits: budget, trade, and investment estimated to grow to $41 trillion by 2021.

As a result, policymakers are "putting everything on the table" and aiming to cut not just wasteful government spending but also federal investments in areas like energy research, technology, education and infrastructure that are key to economic growth, competitiveness, and long-term prosperity. 

China compelled high-speed rail manufacturers, including Japan's Kawasaki and Germany's Siemens, to offer their latest designs and produce 70 percent of each system locally.

The example cited in the article by Thomas M. Hout and Pankaj Ghemawat illustrates that something close to extortion is a core element of China's economic development strategy. China is employing this same strategy of divide-and-conquer with Boeing and Airbus as those companies compete for China's huge commercial aircraft market. Of course, China is not alone. As ITIF has documented, "innovation mercantilism" is on the rise. Many countries are willing to bend or ignore the rules of global commerce and fair competition to gain an advantage in key industries. Read more »

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