It is not surprising that economists raise a cynical eyebrow at corporate-speak-filled innovation reports. Last week we had the IDA’s Horizon 2020; this week it was the turn of the Innovation Taskforce with its Innovation Ireland. But it would be a mistake for Irish economists to disengage from the debate given the impressive body of literature on the economics of innovation we have to draw on.
Market failures—part of our stock and trade—are pervasive in innovation-intensive industries. The failures largely stem from externalities—both technological (e.g. knowledge spillovers) and market-mediated (e.g. the local availability of specialist input suppliers). These externalities give rise to the system effects that are at the heart of the Taskforce’s report. Shamelessly resorting to our own jargon, the elements of the innovation system are strategic complements: an increase in the level of one element (e.g. venture capital) increases the profitability and levels of other elements (e.g. private R&D) and vice versa. This gives rise to positive feedback loops that can explain the clustering of innovation industries. One unfortunate consequence it is very hard to do cost-benefit analysis of particular government policies, which goes a way to explaining our reticence and cynicism. Just because it is hard does not mean these effects are unimportant, however. And we may have to rely on theory and macro-based evidence in addition to more standard evaluations.
Another reason that economists should not disengage from the debate is that government failures are pervasive in innovation policy. While government policies can play a critical supporting role in building the innovation system, international evidence shows they get it wrong much more often than they get it right. These failures are well documented by Josh Lerner in his recent Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed–and What to Do About It (Princeton University Press) [Economist article here]). The evidence would suggest, for example, that government-directed angel funds are a bad idea. On the other hand, policies that go with the grain of the market, such as government matches for international venture capital fund investments, stand a better chance of success. Economics has a central role in indentifying policies that work.
Paradoxically, the fear of government failure can sometimes lead to demands for self-defeating forms of accountability. The provision of incentives for innovation often takes the form of a multi-task principal-agent problem. Demands for accountability can lead to an excessive focus on the tasks most easily quantified. Thus we get the innovation output of universities being measured by crazy indicators such as the number of patents, or the number of spin-outs, or even the number of PhDs. Taking patents, we know that the distribution of value is fat-tailed—a large majority of patents are close to valueless. A measure that simply counts is likely to be misleading and distorting. In a different context, Declan Kieberd quotes Einstein in today’s Irish Times; the quote seems apt here also: “What counts can’t always be counted and what can be counted doesn’t always count”.
Armed with our tools for studying both market and government failures, economists should be at the forefront of the innovation policy debate.