Focusing on Innovation

The first step in treating a severe illness is making the correct diagnosis.  Since passing the stimulus package in early 2009, President Obama and his economics team have groped for a good explanation of why the economy remains stuck in a long-term slump, and in particular, why job growth has remained so slow.  The answers have variously been high health care costs, fiscal profligacy by the Bush administration, recklessness on Wall Street, excess dependence on foreign oil,  and a poor education system.  And while President Obama’s heart is clearly in the right place, the lack of focus has made it difficult to come up with the right remedy to treat the sluggish economy and the weak job market.

Now Obama is proposing a new plan for stimulating the economy.  It appears to contain some good ideas, including sharp short-term tax incentives for capital spending, making the R&D tax credit permanent, and more infrastructure spending. But it still feels like a hodgepodge still hasn’t offered a clear explanation of what’s wrong with the economy, and how he plans to fix it. 

To come up with a much more focused policy for addressing our economic problems, we need a much sharper diagnosis for why the U.S. shifted from the great “job machine” of the 1990s—with 20 million private-sector jobs created—to the great job crunch of the 2000s. From 2000 to 2010, we lost more than 3 million private-sector jobs, even though we still had the same basic economic and political institutions, with all their strengths and flaws, as we did in the previous decade.

I’d like to suggest that the main difference between the two decades lies in the speed and amount of successful innovation.  In the 1990s, there was a very rapid pace of change in information technology equipment and software, which created a demand for all sorts of educated and skilled workers who could quickly adapt to rapid changes in work requirements.  By itself, the computer systems design and software industries roughly tripled in size in the 1990s, adding more than 1 million jobs. 

By comparison, successful innovation slowed to a crawl in the 2000s, outside of communications (think wireless and Internet). Think first about the computer on our desk and the software you use on a daily basis. In the 1990s, the hardware and software changed at a rapid pace. But in the 2000s, the change has been incremental rather than revolutionary—the computer is faster with more hard drive capacity than it was ten years ago, but you are still likely spend most of your time using word processing, spreadsheet and database software which is not that much different than it was in 2000, provided by most of the same companies.

Partly as a consequence of the innovation slowdown, job growth in IT-related occupations fell way off in the 2000s.  That was a big surprise to employment experts:  In 2001, the Bureau of Labor Statistics projected that the top seven fastest growing occupations in the 2000s would all be IT-related, with applications software engineer topping the list.  All told, computer and mathematical occupations were projected to add 2 million workers in the 2000s. The actual gain in those occupations?  Closer to 500 thousand.  

Of course, the jobs shortfall in information technology occupations can be partly attributed to offshoring.  There’s no doubt, though, that it’s far easier for companies to move jobs to other countries when change is slow, incremental and predictable. 

What about the innovation slowdown in other parts of the economy?  Over the past decade, innovation in the US biosciences sector—which includes pharmaceuticals, medical devices, and broader applications of biotech—ran into some unexpected problems.  The science progressed rapidly, driven by large amounts of government and industry research spending.   Breakthroughs such as the sequencing of the human genome carried the promise of revolutionary treatments for a variety of medical ills, ranging from gene therapy to faster development of new drugs.  

However, turning science and early stage development into successful breakthrough products has been much more difficult than expected.  The reasons are not yet clear, but seem to include a combination of government overregulation, short-term pressures from Wall Street, and industry difficulties managing research. 

But even if we don’t yet know the causes of the innovation slowdown in biosciences, the consequences are clear.  Employment in pharma, medical devices, and biotech has grown, but at a very slow rate. Over the past ten years, these industries have added only 30 thousand jobs—which is better than nothing, but far less than they would have generated if they had been able to produce the sort of successful breakthrough innovations that were expected.

It’s worth noting that some parts of the communications sector, which has been garnering all the headlines for being innovative, have managed to create jobs over the past year despite the weak economy. Notably, the industry called “Internet publishing and broadcasting and web search portals”—think Google—has seen employment rise by 10% in the year ending July 2010. Jobs in the wireless industry, too, are up slightly.  Innovation creates jobs.

So if the diagnosis is a lack of successful innovation, what would a good jobs policy look like? The first step: President Obama would have to make it clear that innovation is critical to his economic plan.  Right now, it keeps falling to the bottom of the laundry list.  One example: The White House report on the innovation impacts of the stimulus package was released on August 24, the dog days of the summer when Congress was not in session. And it was presented by Vice President Biden, not by President Obama.

Second, the federal government needs to make a serious investment in R&D.  Proposing to make the R&D tax credit permanent is nice. However, Obama’s 2011 budget actually called for a slight decrease in federal research and development outlays as a share of gross domestic product.  In his first four years, President George W. Bush increased federal R&D’s share of GDP by roughly one-quarter of a percentage point. Obama should aim for that as well, which would be equivalent to adding about $40 billion to the annual federal budget.

Third, and most important, the federal government has to seriously consider whether an excess of regulation is impeding innovation, especially during this downturn.  Over the past ten years—since the tech bust and 9/11—the country seems to have encumbered itself with layer and layer of rules and regulations that didn’t exist before.  Companies have put in whole new layers of management to deal with Sarbanes-Oxley, the 2002 legislation that was supposed to protect us from any further financial crisises.  The supposedly deregulated airline industry is now completely enmeshed in security measures, so we put up with more and more bureaucratic procedures each time we fly.  And financial and healthcare reform seem certain to add even more regulations to the mix.

That’s why I’ve previously suggested countercyclical regulatory policy as an adjunct to countercyclical monetary and fiscal policy.  (See, for example, my July 20, 2010 piece, The Coming Communications Boom? Jobs, Innovation and Countercyclical Regulatory Policy, published by the Progressive Policy Institute).  Countercyclical regulatory policy would take a careful look at proposed regulations, to see if postponing them would encourage innovation and entrepreneurship during the downturn. Existing regulations, too, would be scrutinized to see if any could be temporarily relaxed during the downturn, to give the economy and hiring a quick added boost.

The White House already has an Office of Information and Regulatory Affairs, which issues an annual report on the benefits and costs of federal regulation. However, that report barely mentions the impact of regulation and innovation, and certainly does not address the interaction between regulation and the business cycle.

So the remedy I’m suggesting consists of one part more money for R&D, one part better focus by President Obama, and one part an acknowledgement that the federal government may sometimes be making things more difficult for innovators and entrepreneurs, especially in the downturn.  Taken together, this package could help move the US in the right direction.