Innovation and the Economy

Continuing with Noah Smith’s Bloomberg article, yesterday I praised him for his insights.  But now, I’d like to point out some of his errors and discuss them, namely how technology and economics interact.

First off, he states:

Economists often treat technology as if it just appears out of nowhere, but in fact it comes from the innovative efforts of companies and researchers.

I do not know of a single economist who treats technology as something that just appears.  I know the Austrians (of which I am a follower) do not.  In fact, we see innovation and entrepreneurial spirit as the key to economic growth.  I know the Keynesians (the dominant school of thought in modern economics) do not.  They recognize the importance of saving to fuel loanable funds and drive innovation.  The Neoclassical, Chicagoians, and yes even the Communists do not.  So I’m not sure what economists he’s referring to here.  Sure, we all may have our own prescriptions on how to drive innovation, but I do not know of a single school of thought that treats technology as something that just happens.

Second, he says:

Why do companies innovate? You might think that companies invent any technology that will make them more productive, but this isn’t actually true, for a number of reasons. First of all, innovators don’t know ahead of time which things they will be able to create — trying to innovate is risky, and companies are usually risk-averse.

Some companies are.  Many companies are not.  That’s how we ended up with the Googles, Ubers, Wal-Marts, JC Pennys, Fords, etc etc.  Those who are risk-adverse tend to disappear (absent of any government support).  Those who innovate become the new cream of the crop.  Should they stop, they’ll die.  Circle of life.

Second, companies may be focused on the short term, and may thus be unwilling to shell out cash for research and development that would only pay off years later.

This is about as popular a myth as can be, but it’s also been busted countless times.

Finally, companies may simply get comfortable with what they have, and fail to engage in innovation unless they feel sufficiently intense pressure to do so.

This statement I actually don’t have any problems with, but it emphasizes the need for competition.  That “intense pressure” is applied by competitors breathing down their necks.  Like Uber and the taxi companies.  When firms are protected, whether by regulation, protectionism, or legal monopoly status, they are shielded from this intense pressure and innovate less.  This is a major reason why I support free markets.

With the above paragraph, I did also notice he tries to have his cake and eat it, too: companies do the research and innovation, but then they don’t do the research and innovation (or too little of it).  I’m not sure what he means by this seeming contradiction.

So what happens if a company suddenly finds that it has to pay higher wages? It might just take the hit to its profit margins and continue operating as before. It might decide to downsize, laying off workers and shrinking its operations.

Or, it might decide to invest in labor-saving technology.

This is a wonderful paragraph.  When individuals or firms face higher costs, they adjust their behavior as necessary.  Absolutely, 100% correct.  In fact, he goes on to cite a few more examples:

McDonald’s is installing a line of automated kiosks where people can create their own burgers.

Economic historian Robert Allen has argued that the Industrial Revolution began in Europe, rather than in China, because European employers were forced to pay more for labor. Since labor was more expensive, companies invested in technology, which then raised productivity so much that it boosted wages even higher, forcing companies to invest more in technology, even as their increased incomes allowed them to make those investments. A 1987 theory by growth economics pioneer Paul Romer operated on a similar principle — expensive labor causes an upward spiral of technological improvement.

Absolutely correct.

But let’s talk about artificial increases in wages vs natural increases.  Remember that prices are signals: they tell us which resources are relatively more scarce, which are more abundant, and we can adjust as necessary.  When the price signal is disrupted, or manipulated, then it gives off incorrect information and causes people to adjust in undesirable ways.  Using the natural price rises of the Industrial Revolution and using it to call for artificial rises in 2015 is misapplying the lessons.  For whatever reason, labor was getting more expensive in Europe and the US, forcing the increase in new machinery (as an aside, this kind of kills the whole “slavery built capitalism” argument).  These innovations were necessary; they represented a shift in the demand curve for labor.  Conversely, a price floor will not have the same effect.  A price floor is movement along a demand curve, not a shift of the curve itself.  This still results in shortages (fewer low skilled workers are demanded and more are supplied).

There is also the question of “how much is too much?”  As with anything in life, there is an optimal amount needed for any given time and place.  Water is good for you, but drinking too much can cause you to get sick or die.  Low interest rates can be good, until a housing bubble builds and bursts.  If minimum wage drives an artificial increase in demand for technology, and more resources are devoted to this, then it could potentially lead to an oversupply of capital goods in the market and eventually lead to a tech crash (for the record, I think this scenario is highly unlikely as minimum wage is such a small sector of the economy.  But I’m doing the cereal box thing: making the size larger to enhance the texture.  However, it is likely such a thing would happen at a small scale).

As with anything, there are pros and cons to Smith’s minimum wage speculative benefit.  But these items must seriously be considered, especially if intended to become national policy, as there will be very real consequences.