Innovation Matters: Reviving the Growth Engine

I have had the pleasure of working with McKinsey who have done  a report that was presented at the G8 innovation summit 14th June 2013 last week.

The webpage is here.
The report is here.
The YouTube video presentation is here and the program of presenters, including David Willetts and the PM is here. 

Infrastructure

To those who think that infrastructure spending will solve our problems, today's FT suggests, to me at least, how hard the politics around this are. Here's then minister Peter Mandelson,

"In 2010, when the then Labour government decided to back HS2...We were focusing on the coming electoral battle, not on the detailed facts and figures"

Even then the facts and figures are pretty hard to sort out:

" The cost-benefit analysis for the rail scheme assumes that faster trains will produce £21bn of economic benefits simply because passengers will spend less unproductive time.

 Hilary Wharf, director of the HS2 Action Alliance, said £21bn of the £48bn of forecast economic benefits from HS2 depended on the assumption that people did not work on trains.

Philip Rutnam, permanent secretary at the Department for Transport, admitted that the modelling was based on a survey that was now “a decade old” – before the era of handheld devices.

A report for the DfT in 2009 found train journeys had become much more productive. “The obvious causes of this trend are in the general availability and use of mobile phones and laptop computers,” it said.  Yet the HS2 analysis has not taken this change into account. “We are seeking to revise that,” Mr Rutnam told the public accounts committee of MPs, revealing that an altered business case would be published in the autumn.

Can governments use procurement to boost innovation? The US story.

Many have argued that governments can improve growth by procuring “well”, that is to say, in such a fashion that will promote innovation.  In Europe there is a lot of romance about some US examples like DARPA or the SBIF or Apollo/Manhattan programs.   But what are the facts?  David Mowery gave a wonderful presentation today on lessons of procurement from the US. Here is my take on it.

1.     1.  US public procurement is separated in the data from R&D. Federal procurement is actually 63% military.  The non-defense part of procurement is mostly energy, federal housing and veterans admin (mostly drugs and hospital equipment).

2.      2. Note that DARPA and SBIR are not, in the data, procuring.  They are under separate accounts, but besides the accounting point, the important point is that there is an R&D and a procurement program i.e. two instruments.  The former might be used for R&D and the latter for buying the cheapest regardless of innovation.  Or the latter might be used to complement the former.   But with two instruments its not necessarily the case that not using procurement for innovation is missing a trick.

3.      3. The Apollo and Manhattan projects were designed deliberately not to be adopted in the private sector.  So that is very different to e.g. using procurement to trying to find a solution to a grand challenge, like health.   

4.      4. Procurement can take many firms

a.      Paying just for the prototype.   That might encourage innovation just up to an early stage.

b.      Requiring, as in the case of semiconductors, more than one supplier when procuring.  That helps competition and information sharing between the two suppliers.

c.       Paying for the whole project but not promising to then buy the final product.

d.      Paying for the whole project and also buying the final product perhaps from one supplier

5.      some practical details.

a.      Most procurement can be thought of as demand pull.  It procures a product for a particular government missions.

b.      Less common are policies to specifically encourage particular new technologies e.g. deliberately buying innovative energy products to push a green agenda.

6.      How might benefits to innovation from procurement come via the demand pull mechanism?

a.      A lead customer who buys the product might helps firms learn, give them scale economies etc.

b.      Procurement contracts might require new suppliers  or might legitimize standards.

7.      Perhaps most interesting are some cases.  

a.      The big success is IT.  In the 1950s the US military procured  a lot of e.g. software and semiconductors.  This helped Texas Instruments for example to develop semiconductors and seems to have crowded in other suppliers.  Note that one provision of this program was that more than one supplier was needed and this made sharing of information and common standards in the industry a common practice. But note that by the late 1960s, the military was buying a very small share of IT products, so exit by the public sector was important.  In addition, the projects were, in fact, highly complementary to private sector needs.  Indeed, they are the victims of their own success: the military now buys software from the private sector since it’s more advanced.   An attempt by the military in the 1980s to have its own software was a failure.  So ultimately the success was to develop something that was very complementary to private sector needs and the private sector just took over the lead.

b.      Perhaps less well known are some failures.  For example, in the 1970s/80s the USAF tired to develop CNC machine tools but they were a failure: the Japanese did much better.  Another example was civilian nuclear power.  This program focused on PWRs since they were going to be used by nuclear subs.  They were a failure, unsafe and became unused etc.

8.      so what are the lessons?

a.      If the project is aligned with civilian needs, then more chance to be widely adopted.  Very hard to say ex ante: indeed totally impossible.   Components will have more chance rather than a whole system perhaps.   Or maybe the link is endogenous, maybe procurement can try to encourage sharing etc.

b.      There’s a natural tension between wanting to get the lowest price and wanting to support innovative products which might be expensive.   But when there are two targets you need two instruments and you have this: an R&D and a procurement budget.

c.       The Apollo and Manhattan projects highlight that the purpose of the project has to be clear: they were never intended for public use, so aren’t good examples of encouraginginnovation.  Indeed, that is case where the procurement project was a different instrument to the R&D budget.

d.      Supporting prototypes might be good since they don’t mean lock into a whole project. But prototypes are impossible in some technologies e.g. nuclear submarines.

Finally, in the discussion, David Mowery made some other very interesting points.  My interpretation of them are:

1.              the romance with SBIR is misplaced.  There are very few rigorous studies of its effectiveness and what studies there are show very mixed results

2.              Much of venture capital in the US does not just supply money.  It also provides managers, help with business plans etc. that’s why some of them are very local, since they are tailor to local labor market needs.   So it may not be something that the EU can imitate by just providing money if the EU cannot also supply the other skills and advice.

3.              Regarding tech transfer, everyone seems to concentrate on the gross return that universities make from ownership of IP.  The net return, aside from some very few top universities, is very modest, because it costs a lot of money to run the office and do the work.  In particular, it costs a lot for patent attorneys (although these costs might be reduced by universities sharing facilities).

Various teaching links

1. Supply curves slope upwards.  An illustration from the housing market.  

2. India to send the world’s last telegram on July 14th.  

From Tyler Cowan.  A nice example of creative destruction

3.  A great music post following our discussion in class this weekend on the future of the industry

'David Bowie once predicted that “music itself is going to become like running water or electricity,” and, that as a result, artists should “be prepared for doing a lot of touring because that’s really the only unique situation that’s going to be left.'

read more from the wonderful Tim Taylor here.

4. and from Shane Greenstein following our class discussion of two-sided markets on competition between platforms. 

5. Fiscal transfers in a monetary union again, Florida versus Spain.   It just seems to me like the Euro is doomed unless this kind of transfer can be hardwired in.  Feyer and Sacerdote is the key paper here, showing how in the US transfers are huge. (Feyrer, James, and Bruce Sacerdote. 2013. "How Much Would US Style Fiscal Integration Buffer European Unemployment and Income Shocks? (A Comparative Empirical Analysis)." American Economic Review, 103(3): 125-28.  Link

DOI: 10.1257/aer.103.3.125)

Climate change and discounting the future

Last week in class we studied discount rates.  Here is Martin Weitzman on climate change and discount rates. 

Discounting the Costs of Climate Change in the Future

To add to the complexities and uncertainties, there is the fact that long periods of time are involved. The really high temperatures would likely materialize, if at all, only in the course of centuries. The worse the magnitude of the climate disaster, the more likely is it to occur at a further-off future time.
One premise of modern economics is that we humans discount the future. This simply means that we value something that happens in the here-and-now -- the present -- more than we value it, right now, if we will only get it in the future. A dollar today is worth more than a dollar a year from now, for example. And that means that a dollar a year from now is worth less, in today's money, than the dollar today.
We use a discount rate to compare the two -- which is, in the case of money an interest rate. So if the discount or interest rate were 3 percent a year, a dollar a year from now would be worth 3 percent less -- only 97 cents -- than a dollar today. At a 3 percent discount rate, that is the so-called "present value" of a dollar you wait a year to get and spend. And indeed, 3 percent a year is a commonly used discount rate for rewards in the future compared to rewards today.
It's important to notice that if an ordinary interest rate like 3 percent were used to discount the distant future, the power of compound interest is such that the present value of even very large damages could be made to appear small. A dollar today is worth 3 percent less than a dollar a year from now: 97 cents. Discount that 97 cents by another 3 percent to wait yet another year, and so on, and by the time you repeat the process for about 24 years, a dollar is worth just half what it is today. Wait 50 years and it's worth 22 cents. Wait a hundred years and a 2113 dollar would be worth barely 3 cents to someone living in the present.
There is a vigorous debate among economists about what interest rates should be used to discount the inter-generational damages from climate change. If we value highly the climate-associated welfare of future generations then we should be using low discount rates -- say 1 percent or less -- which would register the present value of their catastrophic damages as if it were equivalent to a very high level of present damages -- something that must be avoided by action now. If we used market interest rates, which are usually much higher, it could still be the case that catastrophic damages should be avoided by action now if the magnitude of the future catastrophic damages were high enough. So time and discounting introduce new wrinkles, but it could still be the case that what is most worrisome about climate damages is not their average or expected or most-likely mid-range value, but the extreme upper-end values associated with various sorts of catastrophe.
Once it is in the atmosphere, CO2 remains there for a very long time. Even if CO2 emissions were cut to zero at some point in the future (a very drastic assumption), about 70 percent of CO2 concentrations over the pre-industrial level of 280 ppm would remain in the atmosphere for the following one hundred years, while about 40 percent would remain in the atmosphere for the following one thousand years. This, along with the possibility of bad outcomes, is the argument for keeping CO2 concentrations from reaching very high levels.

Growth, Innovation and Intangible Investment.

Growth, Innovation and Intangible Investment.  
My evidence to the LSE Growth Commission, June 2012.

Inequality, health and the Spirit Level

I am at Sussex university discussing a paper by Richard Wilkinson, author of the Spirit Level.  His main point is that many outcomes, notably health are not correlated with GDP per head, but with inequality.  So for example,

 

is the relation between life expectancy and GDP per head i.e. declining.  But

is the relation between inequality and life expectancy. 

So Paul Stoneman asks a nice point.  He can see that making a poor person richer might riase their life expectancy.   But the logic that inequality matters says this:  making a rich person poorer, raises the life expectancy of the poor person.  This seems to me a substantial objection to the theory that inequality determines life expectancy and health. 

Patents and innovation

This seems like a very interesting paper:

DP9458 Patents and Cumulative Innovation: Causal Evidence from the Courts

Author(s): Alberto Galasso, Mark Schankerman

Abstract: Cumulative innovation is central to economic growth. Do patent rights facilitate or impede such follow-on innovation? This paper studies the effect of removing patent protection through court invalidation on the subsequent research related to the focal patent, as measured by later citations. We exploit random allocation of judges at the U.S. Court of Appeal for the Federal Circuit to control for the endogeneity of patent invalidation. We find that patent invalidation leads to a 50 percent increase in subsequent citations to the focal patent, on average, but the impact is highly heterogeneous. Patent rights appear to block follow-on innovation only in the technology fields of computers, electronics and medical instruments. Moreover, the effect is entirely driven by invalidation of patents owned by large patentees that triggers entry of small innovators, suggesting that patents may impede the ‘democratization’ of innovation.

UK Productivity

Update.  The new data were encouraging, +0.3%.  I discussed them in advance on Radio 4 Today,  from 23 mins in: http://www.bbc.co.uk/programmes/b01s0qmg …

The UK awaits the 2013Q1 GDP numbers release on Thursday. Meanwhile more parts of the productivity puzzle feature.

1.  Public Service Productivity Estimates: Total Public Services, 2010 is released today.  Key points.

a. Total public service productivity has remained broadly constant between 1997 and 2010, with an
annual average growth rate of 0.0% i.e. outputs matched inputs.
b. The two most recent years, 2009 and 2010, showed modest productivity growth rates of 0.3%.

Here's the picture
 



And the per year data are




So the current economy looks like the public sector over the last 13 years.

2. The IFS Green Budget had a great chapter on productivity.
An interesting graph is






which shows that
1. the aggregate fall in labour productivity is the result of falls within sectors, with some sectors experiencing larger falls than others.

2. The figure shows that the fall of productivity within the finance industry alone would have reduced the aggregate productivity by 1.2% (i.e. a quarter of the total 5.0% fall caused by within-industry effects). The mining and quarrying industry also saw a large fall in productivity, which accounts for about a third of the absolute fall.