Around the world, there is enormous enthusiasm for the type of technological innovation symbolized by Silicon Valley. In this view, the US’ ingenuity represents its true comparative advantage, which others strive to imitate. However, there is a puzzle: It is difficult to detect the benefits of this innovation in GDP statistics.
What is happening today is analogous to developments a few decades ago, early in the era of personal computers. In 1987, economist Robert Solow — awarded the Nobel Prize in Economics for his pioneering work on growth — lamented that: “You can see the computer age everywhere but in the productivity statistics.”
There are several possible explanations for this: Perhaps GDP does not really capture the improvements in living standards that computer-age innovation is engendering. Or perhaps this innovation is less significant than its enthusiasts believe. As it turns out, there is some truth in both perspectives.
Recall how a few years ago, just before the collapse of Lehman Brothers, the financial sector prided itself on its innovation. Given that financial institutions had been attracting the best and brightest from around the world, one would have expected nothing less. However, upon closer inspection, it became clear that most of this innovation involved devising better ways of scamming others, manipulating markets without getting caught (at least for a long time) and exploiting market power.
In this period, when resources flowed to this “innovative” sector, GDP growth was markedly lower than it was before. Even in the best of times, it did not lead to an increase in living standards (except for the bankers) and it eventually led to a crisis from which we are only now recovering. The net social contribution of all of this “innovation” was negative.
Similarly, the dot-com bubble that preceded this period was marked by innovation — Web sites through which one could order dog food and soft drinks online. At least this era left a legacy of efficient search engines and a fiber-optic infrastructure. However, it is not an easy matter to assess how the time savings implied by online shopping, or the cost savings that might result from increased competition (owing to greater ease of price comparison online), affects our standard of living.
Two things should be clear. First, the profitability of an innovation may not be a good measure of its net contribution to our standard of living. In our winner-takes-all economy, an innovator who develops a better Web site for online dog-food purchases and deliveries may attract everyone around the world who uses the Internet to order dog food, making enormous profits in the process. Without the delivery service, much of those profits simply would have gone to others. The Web site’s net contribution to economic growth may in fact be relatively small.
Moreover, if an innovation, such as ATMs in banking, leads to increased unemployment, none of the social cost — neither the suffering of those who are laid off nor the increased fiscal cost of paying them unemployment benefits — is reflected in firms’ profitability. Likewise, our GDP metric does not reflect the cost of the increased insecurity individuals may feel with the increased risk of a loss of a job. Equally important, it often does not accurately reflect the improvement in societal wellbeing resulting from innovation.