On Sunday this week, there was an interesting article on the Opinion pages in New York Times, about why the private sector is stagnating and getting increasingly less prone to succeed with breakthrough innovations. The article was written by the 2006 Nobel prize winner in Economics, Professor Edmund S. Phelps and is titled “Less Innovation, More Inequality”.
In the article Professor Phelps argues that America’s peak years of indigenous innovation ran from the 1820s to the 1960s. There were a few financial panics and two depressions during this time, but in this period, there was also a frenzy of creative activity, economic competition and rapid growth in national income provided widening economic inclusion, rising wages for all and engaging careers for most.
Innovations gave workers better tools to work with and better products to make, thus lifting their wages. Then this innovation began to retreat, most of it to an area of land along the West Coast. In the early 1970s the rate of indigenous innovation (as measured by its estimated contribution to the rate of growth in labor productivity) dropped by about half.
Professor Phelps writes that innovation in United States has declined in the everyday processes that businesses tinker with incrementally as they try to become more productive over time. This decline of innovation across many fields, with notable exceptions like Silicon Valley, biotechnology and clean energy, has set back much of the earlier gains in productivity in American history.
He also says that a return to the productivity growth and broad economic inclusion of the past will require nothing less than a revival of the high dynamism that underpinned that performance. What to do then? To quote Professor Phelps:
“The needed revival will require a reform of the financial sector and of the business sector. In the financial sector it is necessary to put an end to the short-term thinking that unduly focuses on hitting quarterly earnings targets instead of aiming for long-range profitability and growth.
Financial institutions’ addiction to liquidity has made lending to business less attractive, while an addiction to diversified investments has left very few financial institutions willing to make money the old-fashioned way — by lending, or investing in projects for new products and methods.”
“In the business sector, it is necessary to put an end to infighting in established companies and the shortsightedness of chief executives who know they have only a few years in which to haul in some big bonuses. Better corporate oversight by boards and by government regulators is also essential.”
The problem is that the big and global multinational firms, particularly US corporations, today focus on pursuing short-term shareholder value along with providing massive short-term executive incentives.
In the process of acting so short term, they have lost the capability to innovate.