A Definition for Innovation Economics

unimotocycleInnovation economics is an economic doctrine that reformulates the traditional model of economic growth so that knowledge, technology, entrepreneurship, and innovation are positioned at the center of the model rather than seen as independent forces that are largely unaffected by policy.

Innovation economics is based on two fundamental tenets. One is that the central goal of economic policy should be to spur higher productivity and greater innovation. Second, markets relying on price signals alone will not always be as effective as smart public-private partnerships in spurring higher productivity and greater innovation. This is in contrast to the two other conventional economic doctrines, neoclassical economics and Keynesian economics.

A Definition for Innovation Economics

Innovation economists believe that what primarily drives economic growth in today’s knowledge-based economy is not capital accumulation, as claimed by neoclassicalists, but innovation. The major changes in the U.S. economy of the last 15 years have occurred not because the economy accumulated more capital to invest in even bigger steel mills or car factories; rather they have occurred because of innovation. The U.S. economy developed a wide array of new technologies, particularly information technologies, and used them widely. Although capital was needed for these technologies, capital was not the driver; nor was capital a commodity in short supply.

The major drivers of economic growth are productive efficiency and adaptive efficiency. If the focus in neoclassical economics is “the study of how societies use scarce resources to produce valuable commodities and distribute them among different people,” the focus in innovation economics is the study of how societies create new forms of production, products, and business models to expand wealth and quality of life.

In contrast to neoclassical economics, which is focused on getting the price signals right to maximize the efficient allocation of scarce resources, innovation economics is focused on spurring economic actors – from the individual, to the organization or firm, and to broader levels, such as industries, cities, and even an entire nation – to be more productive and innovative. From the standpoint of innovation economists, if government policies to encourage innovation “distort” price signals and result in some minor deadweight loss to the economy, so be it, because allocative efficiency is not the major factor in driving economic growth in the 21st century knowledge-based economy.

Spurring evolving and learning institutions is the key to growth. Neoclassical economics, which focuses principally on markets and individuals and firms acting in them as atomistic particles responding pretty much exclusively to price signals along supply and demand curves does explain a share of the economy. But innovation in the neoclassical economic model is an exogenous process – a black box, if you will, that works its magic solely in response to price signals. In this sense, the neoclassical model sees innovation as falling like “manna from heaven,” not something that can be induced by proactive economic policies.

In innovation economics, innovation is central. Innovation economists recognize that innovation and productivity growth take place in the context of institutions. Indeed, it is the “social technologies” of institutions, culture, norms, laws, and networks that are so central to growth, yet are so difficult for conventional economics to model or study. Innovation economists view innovation as an evolutionary process in a market where firms act on imperfect information and where market failures are common.

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