Throw Out Your Economics Textbooks

In “The Race to the Top” (Issues, Summer 2020) David Sainsbury succinctly summarizes the United States predicament: it is destined to lose technological and market leadership in the industries of the future unless it can implement innovation-friendly structural changes and dramatically increase private and public spending on R&D and related support infrastructure. The nation must also increase the flow of graduates into the workforce who can support technological innovation through excellence in science, technology, engineering, and mathematics. Effectuating such change is no longer just “good to have”; it’s now “must have.”

Sainsbury is rightfully critical of the US economics profession where too many talented graduates are steeped in theories that subtly deflect them from understanding the “productivity puzzle.” The profession has steered policy-makers wrong for far too long, to the delight of American strategic rivals. Innovation scholars are well aware that it is business firms that do most of the innovation (albeit with considerable financial assistance and institutional support from government), yet textbook economic models fail to understand the firm-level factors so critical to understanding innovative success.

Sainsbury makes a clarion call for an explicit industrial policy that focuses on supporting generic R&D. The United States has an industrial policy (though seldom admitted), but it needs to be improved. Economists’ knowledge of how government can provide strategic help is blunted by the fear that entertaining the idea of industrial policy will encourage the government to try to “pick winners,” a task that, of course, should be left to the market.

Sainsbury makes a most useful contribution to improving the quality of discourse on this topic by proposing that industrial policy be seen as improving firm-level capabilities, not the particular product development strategies of individual firms. For example, the government shouldn’t have bankrolled the now-bankrupt solar manufacturing company Solyndra, but should be helping to create ecosystems that can provide support to battery start-ups that are doing promising research.

If adopted, Sainsbury’s ideas would improve the debate and stimulate smart, transparent, and coherent industrial policy—and banish the clumsy, obscure, poorly articulated, and often poorly implemented policies of the kind seen too often. It will of course require economists and policy analysts to understand firm-level capabilities—what they are, how they are built, and how they can be used to support firm-level innovation and competitive advantage. This will require boning up on, and hopefully contributing to, the vibrant scholarship in technology management. Ideas and intellectual frameworks matter a lot in industrial policy formulation, and America does not at present score high in this regard.

In short, new circumstances require new mental models. It’s time to follow Sainsbury and throw away the intellectual baggage of the past and rapidly develop and implement new frameworks that can help rescue the United States, the United Kingdom, and many other advanced countries from economic malaise and associated inevitable social unrest.

It’s also time for chief executives and boards (and regulators) to stop incentivizing share buy-backs and reallocate available funds to investments for the future. This is little more than asking business leaders and boards to be good stewards of their businesses. We have seen too little of this. We can no longer remain complacent.

David J. Teece

David Sainsbury firmly knits together four nation-specific economic outcomes and policy actions that often pass like ships in the night in neoclassical economic analysis: 1) trade performance in R&D-intensive goods; 2) the “productivity puzzle” (slowing growth); 3) government research and education investments and policies; and 4) differences in firm-level performance and national difference in corporate governance and behavior.

We know these outcomes and actions to be real because national differences are revealed in data or other comparative analyses. Similarly, simple logic tells us that there are multiple interactions among these phenomena, and overlapping time lags, some as long as a decade, between action and outcome. The baseline international economic concepts of “natural” comparative advantage and free trade ignore important national differences and assume away time lags.

The power of neoclassical economics is that by making a few assumptions, it is possible to reach conclusions about interactions and outcomes in a complex system of consumer preferences, firm behavior, government policy, and gains from competition and trade. It is a simple but powerful model that has come to dominate policy advising—and it is incredibly useful. Except when it is not. Usually because it is applied to situations where large aspects of reality do not align with the model’s assumptions.

The modern world of international trade in services, trade in high-tech or R&D-based goods, national differences in how multinational corporations behave, and national industrial policies is dramatically different than the world in the early 1800s when the British political economist David Ricardo created the theory of comparative advantage. And the pace of divergence from the international economy of the early 1800s is accelerating due to the globalization of science and engineering (S&E) knowledge and expertise.

Over the past several decades the divergence from the world of David Ricardo has become even more pronounced, driven by four main forces: 1) the widespread global dispersion of S&E applications capability has increased the difficulty of a nation capturing value from its government’s investment in basic or applied research; 2) the emergence of global labor markets for S&E (and especially research-capable) talent has increased the difficulty of capturing value from investments in education; 3) global supply chains are increasingly an industry’s innovation ecosystem, which challenges the idea that exceptional domestic performance in several segments of the supply chain translates into a sustainable national competitive advantage; and 4) “national” S&E assets are increasingly held by footloose multinational corporations.

A journey of a thousand miles—even one chasing a horizon that moves away from us—begins with a compass and several steps in the right direction. Sainsbury points in the right direction by setting aside doctrinaire thinking in favor of a direct policy-relevant and fact-based struggle with the reality of national differences and policy actions. Sainsbury’s national policy prescriptions regarding the importance of government investment in R&D for generic technologies and in education, as well as attending to corporate time horizons, are spot on. These are certain to bring benefits to both the investing nation and the world. However, given that national innovation systems are increasingly components of a single global innovation system, a sustainable national approach needs to manage, perhaps with new guardrails, the balance between capturing value from innovation for domestic benefit and sharing the results of taxpayer-funded advances or education with global competitors that may be pursuing zero-sum (beggar-thy-neighbor) economic policies.

Bruce Guile

Given the real financial insecurity that millions of people endure in the United States—exacerbated by a pandemic but clearly driven by the decades’ long rise in inequality—I find David Sainsbury’s perspective to be almost entirely wrong.

He starts by taking aim at neoliberal economists, but truthfully, it’s hard to see how his own point of view stands apart. He seems to have absolute faith that high-tech competition among firms and among nations will enhance livelihoods around the world. I am no economist, and maybe that’s why I find it difficult following this “race to the top” or “rung on the ladder” argument to any sort of logical conclusion. Will every nation eventually manufacture only quantum computers? Where will one buy underwear?

Sainsbury decries the increase in “low-value-added” jobs such as health care services, as if to suggest that the nation can simply swap these out through skill development initiatives. It seems we need more engineers and scientists, but fewer home health care aids and food production workers. I don’t think that’s how a real economy works.

Sainsbury’s main argument seems to be that firms in the United States and the United Kingdom are uncompetitive and falling further behind. But he offers no firm-level evidence, only pointing out that other countries, too, have learned to manufacture high technology products and improve schooling for their citizens. Good.

If we are truly losing a race to the top, he needs to do more than observe that the United States isn’t alone in this supposed race. Macro measures of gross domestic product growth and national R&D intensity do little to convince me that individual US firms are ill equipped to compete internationally. And if these firms are in such a weakened position, where do they get those billions of dollars in revenue to buy back their own shares year after year?

I agree that we should reconsider the governance of share buybacks. But if the aim is to elevate economic well-being, why shouldn’t those dollars instead support higher wages and full-time employment? On one hand he warns against influencing firm strategy; on the other he wants firms to redirect more of their revenue to R&D. Most importantly, Sainsbury doesn’t explain how public policy intent on strengthening the performance of high technology firms will do anything to help the millions of Americans who work in essential but low-wage jobs now—and will for the foreseeable future. No matter how big Google grows, we will still have teachers, waiters, nurses, plumbers, custodians, writers, and welders.

None of this is an argument against R&D. I agree with Sainsbury that fostering innovation remains a crucial role for government, and one that is historically underappreciated. However, he seems to cast aside the essential public good aspect of effectively managed R&D efforts. He instead frames R&D as primarily a means to bolster US businesses. His discussion of US clean energy technology sees a failure to win market share and jobs, not a failure to mitigate climate change. Technologies such as jet engines may look “generic” in retrospect, but they emerge and evolve as part of some larger public good, such as enabling national security through air dominance.

We take for granted phrases such as “innovation is the engine of economic growth.” Yet we know from the past several decades that growth alone does not ensure shared prosperity. A race to the top is still a race, and it is the multitudes who will remain working outside high tech that are falling behind—not entire nations and not the vaunted technology firms that sometimes pay taxes.

Travis Doom