How Policymakers Best Support Innovation?

Under the assumption that regulations place an unnecessary strain on the innovative free-market companies that create the jobs and industries needed to drive the economy, liberalization is oftentimes the go-to policy prescription for states or countries hoping to spur innovation. Although proponents of deregulation cite incidents of government overreach and inefficiency as evidence of the state suppressing the market’s innovativeness, the government does not always hinder innovation, according to articles featured in the January 2015 issue of Foreign Affairs. By making the strategic investments the private sector is often unwilling to make, the state can play a major role in providing the necessary infrastructure needed for prosperity generating innovation.

Mariana Mazzucato, a professor of the Economics of Innovation at the University of Sussex, makes a plea for the innovative state. In countries that have traditionally grown their economies through innovation, she argues, the state does not serve as a meddler in the private sector but as a partner of it, making the necessary (and risky) investments in areas such as basic research that prove pivotal in the creation of entirely new markets. The role of regulations, according to Mazzucato, should not solely be to address market failures as traditional economics suggests. Instead, she argues that the state can foster innovation by investing in the long-term, risky, and gap-filling projects often neglected by the private sector, helping to create new markets like clean energy or nanotechnology.  

The notion of “market-creating innovation” is described in depth by Bryan Mezue, Clayton Christensen, and Derek van Bever, three Harvard Business School professors also writing in this month’s Foreign Affairs. Market-creating innovation occurs when technological advancements allow for products or services to reach entirely new populations of customers at low costs. Examples of market-creating innovation range from mobile banking in Africa to the Model T – innovations that target the general public’s non-consumption. Since more people can now buy these products, innovators need to hire more people. And, in addition to creating a new market, since these innovations are lower cost, they also lead to new supply chains and distribution networks. As a result, the authors state that “only market-creating innovations bring the permanent jobs that ultimately create prosperity.” Throughout their article, the authors make clear that, at the end of the day, it is the firms that create these jobs. But, sprinkled across their examples are further instances of public policy playing a role in market-creating innovations, especially in their early stages.

The state plays a pivotal role in establishing both the hard and soft infrastructure necessary to drive market-creating innovations. Basic research (theories and studies) and applied research (the ensuing patents and commercialization) that stem from federally funded research at universities, labs, and other institutions, provide one example of the soft infrastructure that serves as the foundation of market-creating innovations. Mazzucato points to a handful of these cases, with ARPANET, the Department of Defense-funded early version of the Internet, as the most notable. As soft infrastructure, public policy also plays a critical role in market-creating innovations. For example, policies that promoted highways and the sprawl that followed promoted the consumption of automobiles and large-lot single-family homes.  

Hard infrastructure refers to the construction of critical components of the economy often taken for granted, and often paid for by the government. Examples of hard infrastructure include those same federally funded highways in the 1950s and 1960s, or the large-scale laboratories at universities and federal labs where a lion’s share of basic research takes place.  In the early 1980s, The Computer Science Network (CSNET) was funded by the NSF as a means of connecting computer science departments at academic and research institutions.  To expand on that, NSFNET, established in 1985, initially linked researchers at NSF-funded supercomputing centers. Through additional private and public backing, these networks became the backbone of our Internet infrastructure, which in turn serves the information technology industry.

Market-creating innovations require infrastructure to be put in place before they are able to provide widespread access to new technologies, create jobs, and deliver on prosperity. When the government originally began building out this infrastructure, it wasn’t necessarily with spurring innovation in mind. Instead, the government was focused on strategic investments in the pursuit of global competitive advantages.  This was true with the development of telecommunications technology and is true today with the cleantech industry. Although competitiveness or national security may drive initial infrastructure investments, the job of the private sector in advancing market-creating innovations is made considerably easier by their development.

When deregulation proponents criticize the government’s impact on innovation, they oftentimes fail to recognize the state as the important provider of infrastructure – both soft and hard – that it is. Furthermore, contrary to the widespread claims that liberalized product markets foster innovation and growth, recent research calls this and the policy actions that typically follow into question. In a sample of 13 manufacturing industries for 17 OECD countries during the 1977-2005 periods, researchers from the University of Paris find no evidence supporting a positive impact of liberalization on the technical progress of manufacturing industries operating at the leading edge of technology. Instead, they find, “most estimation performed on leaders show a significantly positive impact of traditional forms of product market regulation on productivity channeled through the innovative process.” Because of this, the researchers argue, policy prescriptions that liberalize industries with the hopes of increasing competition and fostering innovation are increasingly misguided.

The triple helix model of innovation, pioneered by Henry Etzkowitz and Loet Leydesdorff in the mid-1990s, posits that in a knowledge society, the potential for innovation and economic development relies heavily on the hybridization of elements from industry, government, and academic institutions. Assuming this pervasive model holds true, the role of the government must constantly change, but it must also maintain its role as a driver of innovation. 

Speaking at the 50^th anniversary of ENIAC, the world’s first programmable computer, in 1996, Vice President Al Gore commented on the already amazing growth of the Internet: “That's how it has worked in America. Government has supplied the initial flicker -- and individuals and companies have provided the creativity and innovation that kindled that spark into a blaze of progress and productivity that's the envy of the world.” For governments hoping to promote innovation, they themselves must be innovative, forward in their thinking, and willing to make the long-term investments others are unable or unwilling to make. They should avoid meddling and tampering, and instead focus on how they can best partner with both industry and academia. At the very least, the state is worthy of recognition for its role in driving market-creating innovation. Just like innovation, infrastructure doesn’t happen on its own.