What Future for the Innovation Driven American Economy?

Last week, I wrote about a David Brooks column that argued that the next great debate in American society is going to be about the best way to promote innovation in the economy. Indeed, innovation has been the lifeblood of the American economy, and it's heartening to see that much of the national conversation has turned to promoting innovation. But not all innovation is beneficial to society. Indeed, one of the sectors that has seen a great deal of innovation recently, some of which created sub-optimal results, was the financial sector. Calvin Trillin, writing in the New York Times, explains, in a sentence, why:

The financial system nearly collapsed…because smart guys had started working on Wall Street.

What Trillin goes onto explain is that smart people, instead of going into for example physics, started going into finance and started innovating. A lot - and much more than their less talented predecessors. (James Kwak at the Baseline Scenario says that this actually is probably true.) But, as Simon Johnson and Kwak have explained, much of the recent innovation in the financial sector hasn't necessarily been beneficial to anyone other than those doing the innovating. They differentiate between innovation that has made things better for consumers – the ATM for example – and innovation that involves easier access to credit, which isn't always as good:

In short, financial innovations whose sole function is to increase access to credit do not in and of themselves make the world a better place. They can help by providing the credit that people need to make the world a better place, but they can also make it possible for people to do irrational and economically destructive things. So when people say that innovation is the source of all progress, that may be true – but not all types of innovation are equal.

In the most recent Democracy Journal, which features a whole series of articles on innovation (incuding one by Johnson and Kwak), NDN's Dr. Rob Shapiro criticizes a proposal promoting the idea of utility capitalism, essentially government regulated monopolies or cartels. Michael Lind, the proponent of utility capitalism, argues that this framework would encourage innovation, which Shapiro debunks by explaining how, according to Nobel Laureate Kenneth Arrow, innovation really works:

Large, incumbent firms try to enhance the efficiency and reduce the costs of what they already do well. Younger firms have to establish a new place in the market, and since their size precludes competing on price, they have to compete in some area of quality, which often means innovation. [Cartels and monopolies, which preserve the incumbent status of large firms, therefore do not lend themselves toward innovation.]

Most of us can agree that for America to maintain its economic standing, our edge in innovation and the modern idea-based economy is crucial. Unfortunately, maintaining an edge in something so inherently dynamic as generating the ideas that create new and powerful companies, products, and services is difficult, and our ability to innovate is certainly not unlimited. 

Most would agree that it was a mistake in recent years to focus so much innovation on the financial sector as opposed to science, medicine, and making people's lives better, and Trillin's point paired with Shapiro's are crucial: America needs to create the incentives that move talented people into socially useful professions (like center-left Washington think-tanking) and create the economic incentives to produce socially useful innovation.