The Innovation Dividend: Efficiency Isn't Growth

Much of the innovation we’ve seen lately hasn’t led to growth but instead to efficiency - that is, shrinkage.

I’ve been mulling over Mike Mandel’s cover story in last week’s BusinessWeek, in which he tried to puncture another bubble: the belief that we’ve had a rich decade of American innovation. He argues that there’s actually an “innovation shortfall” and he uses economic stagnation to plead his case. Now I’m not economist (that’s a straight line) and so I won’t argue about the impact of other events on growth - starting with the so-called financial crisis.

But as I thought through the major innovations of the last decade, many of them have not led to economic growth; they haven’t added money to the economy but left it in the economy. Thus measuring innovation’s impact in the revenue, growth, productivity, and market cap of large companies may not be valid. Instead, we are seeing innovation take money out of their pockets, leaving it with their customers. What they, in turn, do with that extra money and what impact it has on the economy is an entirely different question - and that impact is likely seen in any case not in large companies but in individual consumers and in small businesses. But I think the proper measure of the changes in the last decade is the innovation dividend. See:

• Craigslist is blamed for destroying (that’s from the publishers’ perspective) $100 billion in classified ad value, replacing it with its reported $100 million revenue. Newspapers act as if that was their money - as if they had a God-given right to it - but, of course, it wasn’t. When Craig Newmark spoke with my students at CUNY, and they asked him why he didn’t maximize revenue at craigslist and sell it for billions and then use that money for philanthropy, he told them that he thought he was doing more good for the country and the economy by leaving more money in the pockets of the people who were doing the transactions he now enabled. He cut out a gross inefficiency born of the monopoly that newspapers held over the means of production and distribution. If you try to measure his innovation’s impact on the economy with old methods and metrics - built on the assumptions of the old economy - you can’t see it. He didn’t make companies grow or become more productive. He added efficiency.

• Amazon (AMZN), eBay (EBAY), and the internet as a whole are blamed for destroying large swaths of the retail marketplace. But again, they brought efficiency in a number of ways: price transparency, which leads to lower prices for customers; critical-mass efficiency; the reduction of brick-and-mortar and staff costs; and I’d imagine a reduction in distribution and warehousing costs. The net result is fewer jobs, less rent, less waste (that is, books on shelves that get pulped; now they’re made just in time), and lower prices. Again, more money is left in the pockets of the transcators. The impact of innovation on retail is seen in shrinkage and efficiency, not growth.

• Google (GOOG) is blamed for destroying media but, of course, all it did was give advertisers a better deal. It dared to compete. Google did this not just by creating abundance rather than selling scarcity born of control of those means of production and distribution. This created a more efficient - read: less expensive - marketplace for advertising. More important, Google revolutionized advertising by selling performance, proving a return on investment. So the money that didn’t stay in the pockets of people buying and selling cars and homes, thanks to Craig, now stayed in the pockets of retailers and manufacturers thanks to Google. More efficiency. In What Would Google Do”, I argue:

We have shifted from an economy based on scarcity to one based on abundance. The control of products or distribution will no longer guarantee a premium and a profit. . . . We are entering a post-scarcity economy in which Google is teaching us to manage abundance, challenging the bedrock rule of economics, first written in 1767: the law of supply and demand.

Old rules and measures and analyses can’t track that.

• Web 2.0 is credited with making it much faster, easier, and far less expensive to start new companies. That is the other innovation dividend - the innovation that happens on the back of innovation. But this is happening, again, not at a large-company level but at a small-company level. Measuring spending on innovation, then, becomes another unreliable metric. The economics of innovation itself have changed.

The reliability of the standard metrics and analysis matters greatly because profound - and expensive - policy and economic decisions are being made on the basis of them and I’m not at all sure they’re valid anymore, or at least as valid. They miss too much of the change and impact and value and dynamics in this new economy. They lead us to bail out GM (GMGMQ.PK) and Chrysler. One could argue, as George Will did in yesterday’s Washington Post, that that the bailout violates even old rules:

The administration’s deepening involvement in designing and marketing automobiles through two crippled companies ignores this truth: Capitalism is a profit-and-loss system, and the creative destruction it produces is supposed to clear away failures such as Chrysler, freeing capital for more productive uses.

But that capital, once freed, may not go to building huge new ventures. It may go to building small new ventures. It may stay in the pockets of people doing transactions and now instead of spending it on Toyotas (TM), it may go to banks. You won’t see all the impact - except negatively - on the Dow Jones Average and the Fortune 500; those were the measures of the old economy. We need new measures.

Comments

[sportsguy:]

capitalistic efficiency leads to a larger gap between haves and have nots, and technological efficiency leads to an automated economy which will eat its young! or its customer base. . . the downward spiral to socialism continues until the US wage structure equals the chinese age structure + shipping. . . with a growing population, social unrest will be the first sign that socialism on the backs of corporate taxes will be necessary. . .

Jun 13 07:34 PM

[derryl:]

Jeff Jarvis and sportsguy are right:

'Productivity' is measured as output per worker. If a factory replaces 100 workers with one machine that factory has enjoyed a huge 'productivity' gain. Probably the factory owner can increase his profits and maybe lower his prices so ultimately the consumer will enjoy lower cost products. But 100 former consumers now have no jobs or income so they cannot participate in enjoying lower prices because they have no money.

The Luddites solution to job loss during England's industrial revolution was to wreck the machines that had replaced their labor. Now we have unemployment insurance and welfare, paid from taxing the still-employed. Theoretically the unemployed will find new jobs in the 'new industries' that progress creates. New industries include services like washing rich people's dogs for $10/hr.

Capitalist progress invariably increases wealth disparity via the very increases in 'productivity' that are supposed to provide everyone with a higher material standard of living. This ruse is perpetuated by reporting economic data in aggregate as GDP growth. So if in a nation of 300 million people one guy increases his income by a trillion dollars (by monopolizing agriculture and replacing all agriculture workers with robots) and everyone else's income collectively declines by $900 billion, the data shows GDP growth of $100 billion and a massive increase in agricultural 'productivity'. Even though 300 million people (less the one trillionaire) have on average lost $3000 dollars of annual income per man, woman and child. These people are NOT going to be enjoying the lower food prices that productivity gains make possible. They will be economizing by consuming less.

I've quoted this in a previous comment, but in 1848 Karl Marx observed that 'capitalism tends inevitably toward monopoly'. In the 1920s CH Douglas, who invented the 'social credit' monetary system, observed that while productivity gains were making employment redundant, the only way people could get incomes to consume the output was by working at production (or services). Douglas saw that full employment is not necessary in an advanced productive economy. But employment is the only way most people have to earn money to live.

Especially with billions of BRIC peoples increasing their production, incomes and consumption, we are running into a host of 'peak resources' problems where all the easy commodities have been mined and converted to capital plant and consumer goods. So continuous economic growth, in order to create new productive jobs for those laid of due to mechanization, is not going to be viable.

Jun 14 12:42 AM

[derryl:]

oops-I hit Publish before I was done my long-winded comment.

I have advocated a guaranteed annual income (GAI) as a solution to this work-income problem, which is similar in principle to Douglas' 'social dividend' cheques that are given to everyone. But no kind of GAI will work as long as we retain our debt-money financial system, where all money in the economy originates as 'loans' at interest.

The federal government is constitutionally required to provide the country with money sufficient for the needs of the economy. I say the 1913 Federal Reserve Act is an illegal act of federal abrogation of this core constitutional duty.

Until we institute some kind of system of sound, non-debt money; and until we figure out how to equitably get incomes to people in an increasingly mechanized and low-labor economy, the rest of our troubles are mere symptoms and cannot be cured without addressing the underlying diseases.

Jun 14 12:54 AM

[Alphameister:]

When Marxist meets Luddite it should surprise nobody that the focus is all about differences (envy) than about the "rising tide of affluence that lifts all boats." We are rapidly approaching the point of guaranteed annual incomes for all.....much to the detriment of economic progress. Better to have equality in an impoverished socialist society than to have dramatic differences in a prosperous capitalist society in the envious eyes of those unable to comprehend "the invisible hand".

GNP and GDP are admittedly deficient measures of a society's economic progress and even worse measures of a society's well being.

The law of supply and demand is immutable. It can be found operating even in the depths of a Soviet prison where free markets are dressed in black.

Jun 14 10:16 AM

[TonyCinTX:]

Personally, I think the best measure that would capture this a median discretionary income of people. Or at least say a 10% trimmed average (i.e. not counting the bottom 5% or top 10%) of discretionary income, either way inflation adjusted against a basket of staple items that have been around for centuries (like bread).

If Craigslist or Google or eBay are leaving money in people's pockets, that should be reflected in greater discretionary income. Ignore businesses altogether; if people have greater discretionary income, that will flow to savings or purchases or investments.

The basic idea is that lower costs for consumers produce higher profits for consumers, but since they aren't selling anything we can't measure "profit" in a traditional sense. Their top-line revenue (a salary) may not change at all. What changes is the amount left over after a basic average allowance for food, shelter, transportation and insurance; that is their discretionary income.

Jun 14 11:15 AM

[TonyCinTX:]

Oops, I meant not counting the bottom 5% or top 5%, I mistyped. We trim a total of 10% off the population to keep outliers from skewing the stats.

Jun 14 11:16 AM

[notsosmart:]

as long as the beer swillers fill the stadiums( some now owned by tax payers) there are no worries.when the cameras no longer show the crowds(or lack of) thats the time to worry.

Jun 14 12:50 PM

[Danny Newton:]

I have also noted that per capita income is sometimes a poor indicator of economic well being when the population in a county declines because of recession or even depression. Usually, per capita income goes up as people leave.

I fear that trying to move to a perfect economic system may result in unintended consequences if we already have the optimum system that our total circumstances will allow. Karl Marx also said that the government would wither away but failed to explain exactly how that could work. Maybe that is what happened to the Soviet Union.

I don't think that an economic system can be perfected much beyond the morality or depravity of the people engaged in it. It is a shame that hard working and desperate people come to the US, many of them fleeing economic systems that we seem to be trying to emmulate. Poor countys are always countrys that have little or no concept of property rights and are in no way dedicated to protecting such rights. A country can be an island of diamonds floating on a sea of oil but without property rights it will descend into chaos.

Jun 14 04:03 PM

[SpinWatch:]

Society has been though this many times. Every innovation that produces major gain also produces major pain for those working in that sector. In the transportation sector during the early 1900’s horses were replaced by automobiles. This was devastating for ranchers, blacksmiths, and feed producers. We have now forgotten the massive ranch unemployment generated by the horseless carriage as we merrily get in our cars and drive off. The reason change feels different now is because those hurt by Internet innovation are currently visible to us. Several decades from now when visions of the unemployed have dimmed, the Internet period of commerce will be viewed as a highly productive period in which unnecessary “fat” was trimmed.

Jun 15 12:18 AM