The Innovation Paradox

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The Innovation Paradox

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Bibliographic details

• Authors: UFUK AKCIGIT
• Published: September 3, 2024

Summary

• Investing more in research and development has not led to expected productivity and growth gains in the United States despite a large increase in R&D spending.
• Over recent decades, innovation, productivity gains, and economic expansion have slowed even as total R&D investment rose.
• The allocation and behavior of large incumbent firms are central to explaining the paradox: resources and inventive talent have reallocated toward large, older firms that are more likely to defend market positions than to pursue disruptive innovation.

Key empirical findings

• Total US R&D investment:
  • "In the 1980s, total US R&D investment represented 2.2 percent of GDP. Today, that figure is 3.4 percent."
  • "Private R&D spending by businesses more than doubled, to 2.5 percent of GDP from 1.1 percent."
• Productivity growth:
  • "Productivity growth between 1960 and 1985 averaged 1.3 percent."
  • "Over the subsequent three and a half decades, gains in productivity fell below that average."
• Inventor employment and concentration:
  • "At the beginning of this century, roughly 48 percent of American inventors worked for these big incumbent companies—those that are more than 20 years old and employ more than 1,000 workers. By 2015, that figure had surged to 58 percent."
• Wage and innovativeness changes after 2000:
  • "The pay differential widened by 20 percent, prompting many innovators to switch jobs and join larger, well-established companies."
  • "These inventors’ innovativeness dropped by 6 percent compared with that of their peers who joined younger employers."

Mechanisms identified

• Leadership paradox and defensive behavior:
  • Large enterprises often shift focus from innovation to protecting market position as they grow.
  • Larger enterprises "tend to innovate less and instead engage in activities that limit competition," including hiring politicians.
• Innovation-stifling hiring:
  • Large incumbents offer higher salaries to hire key employees from younger competitors.
  • Hired inventors are frequently placed in roles that "do not fully leverage their skills," reducing their subsequent innovativeness by 6 percent.
  • This practice weakens rivals and reduces the economy’s overall capacity for disruptive innovation.
• Policy interaction—R&D tax credit effects:
  • The R&D tax credit (introduced federally in 1981; first adopted at the state level in Minnesota in 1982) was intended to encourage R&D investment.
  • Research shows "large businesses are much more likely to benefit than smaller ones," suggesting the policy disproportionately favors incumbents.
  • Firms claiming R&D tax credits are "more likely to engage in" innovation-stifling hiring and related defensive practices.

Consequences

• Despite higher absolute R&D spending, diminishing returns to productivity growth have emerged because:
  • Inventive talent and R&D resources concentrated in large, old firms are being used less effectively for disruptive innovation.
  • Defensive allocation of R&D resources and strategic hires reduce overall innovative output and productivity gains.
• Aggregate increases in R&D spending do not automatically translate into economic growth if allocation and incentives favor incumbency and market protection.

Policy implications and recommendations

• Shift focus from solely increasing R&D spending to improving allocation of R&D and inventive talent:
  • Design policies that support smaller businesses and start-ups, which "often have a greater capacity for disruptive innovation."
  • Consider targeted tax credits for small businesses and grants for early-stage innovation.
  • Promote policies that "encourage competition and reduce barriers to entry for new players."
• Reconsider traditional industrial policy tools:
  • Evaluate how existing incentives such as R&D tax credits may unintentionally favor large incumbents and create perverse incentives.
  • Craft industrial policy to balance support for R&D with measures that discourage market-consolidating, innovation-stifling practices.
• Encourage dynamic, risk-taking behavior by making the innovation ecosystem more inclusive of young firms and entrepreneurs.

Source: "The Innovation Paradox," UFUK AKCIGIT, F&D Magazine, September 2024.

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