The Economics of Innovation

August 6, 2001

Originally published October 1991. Published on August 6, 2001.

With a new Russian revolution, we are once again distracted from contemplating our most strategic question. Not that the consequences of this latest drama are unimportant; it just does not represent the most critical issue we face. The collapse of the Soviet Union picks up where other distractions left off, such as the war with Iraq and the end of the Cold War. And those were important issues, too.

Our most crucial challenge, one that will determine the quality of our lives in the coming decade and decades, our wealth, and our power, is economic competitiveness. It is easy to see why this subject attracts so little attention. First of all, it sounds like economics, and a lot of people find economics confusing. I am reminded of the economics professor who explains why he is not upset that his students keep stealing the questions to his final exam. The questions are always the same anyway, he points out, it’s the correct answers that keep changing.

Furthermore, the issue of economic competitiveness sounds dull. This is primarily because our challengers are not our enemies, they are our friends. A story about enemies is a lot more interesting than a story about friends. It certainly makes for better television. Tom Brokaw in Moscow and dogfights in the Persian Gulf attract more viewers than coverage of our laboratories, factories, and classrooms.

Yet we should keep in mind that it was the bankruptcy of Communism as an economic strategy that caused its demise. Communism was indeed viable during the late stages of the first industrial revolution (the one hat expanded our physical capabilities), but became irrelevant as we entered the second (the one that is expanding our mental horizons). But lest we become too smug in this victory, we should recognize growing signs of weakness in our own industrial base. Since World War II, it has been taken for granted that we were the wealthiest nation on the planet. Yet several of the business magazines last year ranked us second in value of total assets to Japan, a country with only half our population. With the fall of the Japanese stock market over the past year, we are now slightly ahead again, but that still puts Japan significantly ahead of us in per capita wealth.

The changing nature of wealth

Perhaps of greater significance, total capital investments for new plants, equipment, and research and development in Japan was $750 billion in 1989–50 percent higher than the comparable figure in the United States. Thus on a per capita basis, Japan invests three times as much as we do in its future. While the United States leads the world in total debt, Japan is a net creditor to the tune of over $300 billion (in all fairness, the United States does have substantial foreign investments that help to offset its debt). We continue to lead in total gross national product (GNP), but Japan leads in per capita GNP and, if current rates of growth hold up, may eventually surpass us in total GNP.

The sky is not falling, however, and we still have considerable economic strength. The success of Japan and our other trading partners (like Germany) is not the cause of American economic problems. We reap what we sow, and we will continue to do so. We can emerge into the 21st century with enormous economic momentum or in decline. Achieving the former requires us first of all to put this dull subject at the top of our agenda. It also requires us to understand the changing nature of wealth.

Prospecting for knowledge

As I discussed in last month’s column, the industrial revolution of the past two centuries was an age hungry for natural resources, one in which our bountiful supply stood us in good stead. We are now entering a second industrial revolution, one based on machines that extend and leverage our mental capabilities. This age, rooted in a nation’s intellectual resources, has enabled Japan, a country with no natural resources to speak of (not compared to the United States), to approach dominance in economic affairs.

In the present era, we prospect not for iron or oil, but rather for intellectual property. Let’s examine a quintessential example of the creation of intellectual property: the process of invention. Inventing today is increasingly interdisciplinary. The development of speech recognition technology, in which I have participated, requires linguists, speech scientists, signal-processing experts, psychoacousticians, circuit designers, programmers, and other specializts who can work together and, perhaps most importantly, understand each other’s terminology.

The importance of this last point was first recognized by Norbert Weiner in his 1948 classic Cybernetics, in which he writes,

Since Leibniz there has perhaps been no man who has had a full command of all the intellectual activity of his day . . . There are fields of scientific work . . . which have been explored from the different sides of pure mathematics, statistics, electrical engineering and neurophysiology; in which every single notion receives a separate name from each group, and in which important work has been triplicated or quadruplicated, while still other important work is delayed by the unavailability m one field of results that may have already become classical in the next field.

From my own experience. this meshing of diverse disciplines is perhaps the most crucial element in developing interdisciplinary technology, which is becoming most of technology. A useful technique is to spend time merging the individuals into a single problem-solving group by bringing all of the members up to X working level of current knowledge in each field of study. This cross fertilization has a number of advantages. Aside from the rich yet focused intellectual strength of such a group, one can encourage “thinking outside the box” by allowing, say, a signal processing problem to be solved by the linguists, or vice versa. Such experiments are not always successful, but it is possible to achieve creative solutions to problems that could hardly be attained in any other way. We also generally develop our own terminology to refer to many of the phenomena we encounter. This has advantages in terms of proprietary technology protection. If anyone overhears our conversations they have no idea what we are talking about.

The Gordian solution

Once developed, the technology (and technologists) must be further integrated into the equally well-developed disciplines of a modern corporation. As Akio Morita, the chair of Sony, points out in his book The Japan That Can Say No, there are three equally important areas of industrial creativity, of which technological invention is but one. The second is marketing, and he provides an instructive example. The transistor, invented in the early 1950s at Bell Laboratories, certainly represented a primary technological breakthrough and today fuels a revolution that has transformed multiple industries. A transistor has two properties: it amplifies electrical signals, and it is small. So obviously, according to its American inventors, it was perfect for hearing aids. And equally obvious, there was no reason to suppose that one could do anything else of value with it. Or at least that was the prevailing view at the time. Sony thought otherwise and became the first Japanese company to license the patent in 1953 with the idea of developing a transistor-based radio.

“Why bother with that?” they were asked. After all, you will still have a very large speaker, not to mention all that furniture. But maybe you can replace the big speaker with a little speaker. But with a little speaker, all the people gathered around the radio won’t be able to hear it. But maybe it is good enough to have one person use it at a time.

But a radio is too expensive to devote to just one person. Sony applied a Gordian solution to this knotty and circular thinking and brought the transistor radio to market. Its motto became “one person, one radio.” Junior may not want to listen to the same music as Grandpa.

The transistor radio was a hit, and the transistor was off and running. The marketing creativity involved in rethinking the purpose of a radio in light of new technological capabilities provided by the transistor was as important as the technology. It involved considering several variables at the same time, not just the single issue of the transistor’s size.

The importance of manufacturing

The third area of business creativity cited by Morita is manufacturing. He states that “America has stopped manufacturing things.” While this is an exaggeration, in all too many industries (the entire area of consumer electronics being just one) it is, unfortunately, all too true. We do not adequately respect manufacturing. It is not the area to which our “best and brightest” are attracted. But this is not the case in Japan and other countries. As I toured a modern Japanese factory on a recent trip, I was impressed with the amount of intellectual property that has been devoted to this aspect of business.

Another theme that Morita develops in his book and in speeches is the nature of a Japanese corporation, contrasting it to the American version. A Japanese corporation is a “community bound together by a common destiny.” If this sounds like a platitude, there is an important concept here. A Japanese manager, according to Morita, is primarily responsible to his employees and their long-term welfare. Other constituencies, such as stockholders, are secondary. In our society, as any business school graduate will tell you, management is responsible to the stockholders.

It sounds different, but an enlightened analysis would show that the two approaches should be equivalent. An American platitude is that the best way to serve the stockholders is to serve the customer. The only l constituency in a position to serve the customer, however, is the employee, and obtaining the loyalty and devotion of the work force is the only way to achieve the consistent quality necessary for an effective customer franchise. Indeed some of the most successful American companies have provided just such a community of shared interests, including lifetime employment.

Theory vs. practice

Although equivalent in theory, there is a real difference in practice. Japanese corporations do hire their workers for life. At least this is true of the prosperous first tier of industrial corporations.

It is often not the case in the many small assembly companies and cottage industries that handle the ebb and flow of demand in the Japanese economy. A common American system has workers forced to seek protection from an insensitive management through unions, thus creating an adversarial environment with obvious loss of motivation.

The Japanese approach to the nature of a corporation works well. To the extent that it has been tried in this country, it has worked well here, too (e.g., by Japanese companies). The idea seems very Japanese: devotion of family and to the extended family represented by the larger institutions of company and country. But the originator of this concept of the Japanese corporation was an American: General Douglas MacArthur.

Finally, we come to the issue of education. If knowledge and its creation are the cornerstones of wealth in the age of knowledge, then we need to equip our emerging generations with the intellectual tools to create intellectual property. It is still people who will create our intelligent machines, at least that will remain the case for the next several decades.

The age of knowledge will be hungry for learning, while at the same time providing tools that can assist in the process of education. How will our schools change with their increasing importance to our national destiny? What about libraries? What will the impact be of emerging communication technologies such as the fiberoptic-based information super-highway now being installed in Japan? How do we compare to our Asian and European competitors? Can we catch up? We will examine some of these questions in next month’s column.

Reprinted with permission from Library Journal, October 1991. Copyright © 1991, Reed Elsevier, USA

Other Futurecast columns