Why Innovation Does Not Equal GDP Growth

We are an inherently optimistic species. We prefer to look forward and to believe in the possibility of a better tomorrow. Our embrace of technology reflects this hope for the potential  perfectability of almost everything we do.

Which explains why so many of our incentives and strategies are designed to encourage innovation. It is the key to the future and we have come to an agreement that it should be nurtured and supported.

But, as the following article explains, there can often be a disconnect between our faith in innovation and the reality of how it actually influences the outcomes on which we rely to chart our progress.

This gap can be explained by a great degree by our lagging approach to the rising importance of intangibles and the wholly inadequate set of metrics that have been jury-rigged to decipher their impact on the economy.

GDP offers an understanding of short term developments. It is, to some extent therefore, a perfect reflection of the outlook preferred by the drivers of the financialized economy. It does not, however, take much account of the investment in thought, time and effort from whose fruits the economic system will benefit, often far into the future.

The problem, as the article states, is with GDP, not with innovation. But to the extent an entire panoply of policies has been structured to build on this connection, results may continue to understate and possibly mislead until we have designed measures to accurately capture their potential as well as their immediate impact. JL

Dietz Vollrath comments in the Growth Economics Blog:

Lots of current innovations are like making Diet Coke for free, but owning the recipe. They are worthwhile despite the fact that they do not necessarily contribute much to GDP, and might even detract from it.
Joel Mokyr posted an op-ed in the Wall Street Journal about being optimistic regarding growth. I liked this particular passage:

The responsibility of economic historians is to remind the world what things were like before 1800. Growth was imperceptibly slow, and the vast bulk of the population was so poor that a harvest failure would kill millions. Almost half the babies born died before reaching age 5, and those who made it to adulthood were often stunted, ill and illiterate.

I’d like to think that growth economists are also here to spread this message. It’s easy to be pessimistic about the near-term economic future when we are slogging our way slowly out of a terrible recession. But extrapolating from the current situation to say that long run sustained growth is over is taking it too far.
Mokyr (and us mere growth economists) are more optimistic about things. Why? [Because we're tenured professors who can't be fired. But that's only part of it.] Because the ultimate source of economic growth over history has been technological innovation, and there is still an essentially infinite scope for this to continue. Mokyr lays out a long list of innovations that are coming down the pipeline: driverless cars, nanotechnologies, materials science, biofuels, etc. etc. We aren’t running out of ideas, and just because you or I can’t think of what they could possibly invent anymore doesn’t mean that other people aren’t busy inventing things.
But will these new innovations really provide a boost to GDP? Maybe not, but that’s a failure of GDP, not of innovation. Let’s give the mike to Mokyr:

Many new goods and services are expensive to design, but once they work, they can be copied at very low or zero cost. That means they tend to contribute little to measured output even if their impact on consumer welfare is very large. Economic assessment based on aggregates such as gross domestic product will become increasingly misleading, as innovation accelerates. Dealing with altogether new goods and services was not what these numbers were designed for, despite heroic efforts by Bureau of Labor Statistics statisticians.

We measure GDP because we can, and because it gives us a good indication of very short-run variations in economic activity. But it is only a measure of “currently produced goods and services”. That is, GDP measures the new products or services provided in a specific window of time (e.g. the 3rd quarter of 2014, or all of 2013). If all the effort in producing a new product comes in development, but it is then copied for free, this means that there is a one-time contribution to GDP in the year it was developed, and then nothing afterwards.
Things like refrigerators, Diet Coke, and cars contribute to GDP every period because we have to make new versions of them over and over again. But in one sense that is a bug, not a feature. Imagine if, having invented Diet Coke, you could make copies for free. That would lower GDP, as Coca-Cola would drop to essentially zero revenue from here forward. But it’s demonstrably better, right? Free Diet Coke? Where do I put in the IV line?
Diet Coke is a good example here. Let’s say that you could replicate the physical inputs of Diet Coke for free, but that Coca-Cola still owned the recipe, and you had to pay them to use it. This would still lower GDP, as Coca-Cola would no longer be earning anything from the physical production of Diet Coke, only from renting out the recipe each time you wanted a Diet Coke. This is still a win, even though GDP goes down. Lots of current innovations are like making Diet Coke for free, but owning the recipe. They are worthwhile despite the fact that they do not necessarily contribute much to GDP, and might even detract from it.