The Lost Decade?

Dr. Michael Mandel recently gave a talk at MIT called "Innovation and the Financial Crisis." Mandel, author of Rational Exuberance, suggests that the economic meltdown respresents the symptom of an underlying disease in the American economic model and not the cause.

In "Innovation and the Financial Crisis," Mandel argues that Americans borrowed piles of money and moved production overseas under the assumption that we would make it back in innovation. The U.S. is the innovation powerhouse, after all, and innovation tends to account for about 85% of GDP growth.  But according to Mandel, most innovation occurred in finance and not where it's supposed to--extracting value from production inputs.  Money that should have gone to R&D went instead to real estate under the assumption that housing involved less risk than innovation.

To prove his point, Mandel points to stagnation in the S&P in real dollar terms. The "money chart" is this one:
GDP growth went nowhere because big company stocks went nowhere.

Don Dodge, a director of business development at Microsoft, looks at Mandel's chart and tries to argue that innovation will lead us out of the recession.  He advocates for innovation in information technology because "it saves us money and increases productivity." After all, if there's one thing we all know about Microsoft, it's that they innovate exceedingly well, they try to save us all piles of money, and their products are flawless examples of productivity-enhancing goodness.  (My biggest quible with Dodge's post, though, is his effort to equate innovation with information technology when they are not the same thing.)

...but I digress.  It's interesting that Mandel chooses to rely upon the S&P to prove his point. A broader macroeconomic viewpoint shows that annual real GDP growth, while slowing since the 1940s, is doing okay.  So I have to wonder if there's more innovation going on in the small- and medium-sized enterprises. After all, SMEs comprise about 50% of the businesses in the United States.  And if big companies were such great innovators, then most economists would tell Schumpeter where to shove his theory of creative destruction.

What does this have to do with China?  Well, Mandel alludes to the fact that we've outsourced production to other locales and sent our business expertise along with it.  But I am not so sure.  After all, China's still in the middle of the smiley curve, and they haven't yet figured out how to move up the value chain.  Moreover, they still underspend on basic research, which is where the disruptive innovations often come from, and their patents are not yet up to snuff.  The real question for the U.S., I think, is whether we can maintan our dominant innovation position in the long run, given China's hunger for innovation-growth.