NBER Reporter: Summer 2001

Innovation Policy and the Economy

The NBER's second annual Conference on Innovation Policy and the Economy, organized by Research Associates Adam Jaffe of Brandeis University, Joshua Lerner of Harvard Business School, and Faculty Research Fellow Scott Stern of MIT, took place in Washington on April 17. The following papers were discussed:

David S. Evans, National Economic Research Associates, and Richard Schmalensee, NBER and MIT, "Some Economic Aspects of Antitrust Analysis in New-Economy Industries"

Nancy Gallini, University of Toronto, and Suzanne Scotchmer, NBER and University of California, Berkeley,

"Intellectual Property Rights: An Efficient Mechanism for Rewarding Innovation?"

Manuel Trajtenberg, NBER and Tel-Aviv University, "Government Support of Commercial R&D: Lessons from the Israeli Experience"

Timothy Bresnahan, NBER and Stanford University, "Prospects for an IT-Led Productivity Surge"

J. Bradford DeLong, NBER and University of California, Berkeley, "Do We Have a 'New' Macroeconomy?"

Competition in many important industries centers on investment in intellectual property. Evans and Schmalensee note that sound antitrust economic analysis of such industries involves explicit consideration of dynamic competition. Most leading firms in these dynamically competitive industries have considerable short-run market power, for instance, but may be vulnerable to drastic innovation. Similarly, conventional tests for predation cannot discriminate between practices that increase or decrease consumer welfare in winner-take-all industries. Finally, innovation in dynamically competitive industries often involves adding to the set of features a product provides or improving its existing features.

Intellectual property (IP) is not the American economy's only mechanism for rewarding R and D. Prizes and various types of contract research are also common. Given the controversies that swirl around policies regarding IP, in particular whether it is justified, Gallini and Scotchmer review the economic reasoning that supports patents (or other IP) over funding from general revenue. For those economic environments in which IP is justified, they review some of the arguments for why it is designed as it is, especially with regard to breadth of protection, and especially where innovation is cumulative. The patentee's ability to reorganize rights through licensing and other contractual arrangements should be taken into account in designing the property system, they conclude.

Israel's R and D policies have been highly responsive to changing circumstances, including instituting innovative programs such as a government- sponsored fund to jump start the venture capital market: the "Incubators" program, supporting generic projects conducted by consortia of firms and academic institutions. The Israeli high tech sector has grown remarkably fast since the mid-1980s, and government policies contributed significantly to its success. It seems that the key has been both the willingness of the government to take substantial risks in allocating resources, and flexibility and creativity in responding to rapidly changing needs. Trajtenberg reviews these policies and the challenges that confront them. He also lays out the more general issues and possible lessons for other countries that arise from the Israeli case: how many resources should be devoted to R and D? Is it better to target supply or demand in the market for R and D inputs? What types of support exist for R and D policies, and what is the effect of international spillovers?

Advances in information technology (IT) shift the invention-possibility frontier of the economy, permitting users of IT to invent new and sometimes highly valuable applications. IT is also general purpose technology, shared across a wide variety of uses. Therefore, new advances in IT can have an economy-wide impact which will be larger or smaller according to the degree of sharing. Finally, IT has the possibility of substantial network effects. Together, these three features of IT mean that advances in it can have very substantial effects on long-run growth. The pace of arrival of that growth varies across types of IT according to the value of the enabled applications, the difficulty of the enabled invention, the ease of sharing advances, and the mechanisms for turning network effects into a force for advance rather than for inertia. Analytical studies of earlier IT advances, together with a new model that Bresnahan introduces, suggests that there are two main patterns of the pace of uptake. Current IT advances connected to the Internet seem highly likely to set off both patterns.

DeLong notes that the IT revolution is the prime candidate for driving the acceleration in aggregate labor productivity growth in the 1990s, and the boom in IT investment promises to pay dividends in the form of accelerated aggregate labor productivity growth for at least a decade to come. It is also a credible candidate for driving the reduction in the natural rate of unemployment, the NAIRU. Finally, it may diminish the aggregate economy's vulnerability to inventory fluctuations, which for more than a century have been a principal driving force behind the business cycle.

These papers will appear in an annual volume published by the MIT Press. Its availability will be announced in a future issue of the Reporter. They can also be found at Books in Progress.


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