The Economist Flunks The Innovation Test

The lead article in The Economist this week is on innovation, the pace of which appears to have slowed in recent decades. The article draws on Robert Gordon’s work and is insightful up until about the last few paragraphs, where the article takes a sharp turn toward finger pointing, effectively blaming government for stifling innovation.

Specifically, the article notes that:

“The biggest danger is government … When government was smaller, innovation was easier. Industrialists could introduce new processes or change a product’s design without a man from the ministry claiming some regulation had been broken. It is a good thing that these days pharmaceuticals are stringently tested and factory emissions controlled. But officialdom tends to write far more rules than are necessary for the public good; and thickets of red tape strangle innovation.”

The article then goes on the assert that governments should “get out of the way of entrepreneurs, reform their public sectors and invest wisely.”

This is the sort of editorializing that only an unserious magazine would engage in. After all, fans of history will recall that the last time the government “got out of the way” of the private sector and deregulated financial markets, the end result was economic ruin.

Now, that’s not to say that too much government isn’t currently a problem. The article correctly notes that “[t]he West’s intellectual-property system … is a mess”; however, this is a point that the article could have elaborated on with several paragraphs, rather than with just one sentence.

Americans currently pay an extra $270 billion per year on prescription drugs due to patent monopolies in the pharmaceutical sector. In addition, the public spends an extra $100 billion per year due to copyright protection on creative work, such as recorded music, books, and software. (Both figures come from Dean Baker’s book, “The End of Loser Liberalism: Making Markets Progressive.”) Without these giveaways to the corporate sector, you can bet your butt that there would be more money to go around for entrepreneurs to use to innovate.

The article also stresses the need for more innovation from government in the healthcare sector. Yet, amazingly, the article never once mentions the possibility of invoking more free trade. On average, Americans spend more than twice as much on health care as do citizens of other wealthy nations, with little to show for in the way of health outcomes – life expectancies in the US are no better than in most other OECD countries. This suggests that huge gains could be had from more international trade. For example, if Medicare recipients were permitted to purchase foreign medical care, the gains could be enormous. In addition, if our trade policies were redesigned in such a way that allowed more foreign doctors to enter the country, then the salaries of US doctors would be brought down from their artificially inflated levels – after all, on a purchasing-power-parity basis, salaries for general practitioners in the US are nearly twice as high as the average GP salary in other OECD countries. Such an effort would inevitably place more money into the pockets of American consumers, meaning, again, more money to go around for entrepreneurs to use to innovate.

The final issue, which the article fails to mention, is that the inability of government to effectively limit intergenerational wealth transfers has undoubtedly led to less innovation. When children are given multimillion-dollar estates, they will clearly have less of an incentive to produce than if they had to work for those estates themselves. (This is, after all, the exact same argument that was used to decry “welfare queens” in the late-1970s.) The prime example here would be Paris Hilton, who would probably be living on the streets right now if her great grandfather didn’t found a multibillion-dollar hotel chain.

The point is that we need much higher estate and gift taxes, perhaps approaching 100 percent for very large bequests. The recent budget deal, which raised the estate tax to 40 percent for bequests over $5 million, is basically a joke. Innovation will pick up only when handouts are rightly taxed at extreme levels and when the associated revenue raised is rightly used to improve the terrible educational opportunities for the millions of unfortunate children who are born into poor neighborhoods each year. Maybe then will we start to see the data on social mobility make a turnaround.

In short, The Economist needs to take off its ideological blinders to see why the pace of innovation has slowed. If anything, less government in the way that the magazine envisions would almost inevitably lead to less innovation and more economic injustice.

2 Responses to “The Economist Flunks The Innovation Test”

  1. The Arthurian Says:

    Hi Joe. I always like your articles. Usually you write about things I’ve not thought much about (so I have little to offer in response that might be at all interesting:) but I always like your articles.

    “we need much higher estate and gift taxes”

    Alexis de Tocqueville said the same thing, more or less. He said all the Americans need is an estate tax to prevent the accumulation of wealth over generations.

    I’m paraphrasing. One of these days I’ll look for the the quote (in Democracy in America). But I know for sure he didn’t call it a death tax!

  2. JSeydl Says:

    Thanks, Arthurian. I like the quote by Tocqueville. This is actually the topic of a dissertation that I’m currently working on. I’ll be sure to post the whole thing when it’s done, which won’t be until Septemberish.

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