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The Hidden Puzzle of Innovation

Updated: Dec 30, 2022

Innovation is the concept of creating new ideas, processes and methodologies, and this spectacle is a key component in achieving economic prosperity. The importance of innovation was famously highlighted by Steve Jobs, who noted “Sometimes when you innovate, you make mistakes. It is best to admit them quickly and get on with improving your other innovations.” [1] This importance to perpetually innovate is ultimately what is said to ensure success in a prosperous world, and is valued highly by economists globally. However, to fully understand the sentiment of innovation, it is important to grasp how this is driven, and what causes such events to occur. Furthermore, what challenges surround this seemingly wonderful notion must also be considered, and whether this can manufacture more harm than good for the economies of the world on the most macro-sized level.

Quintessential to economic growth?

The ideas of innovation dating back to the industrial revolution of the late 18th century, notably in the United Kingdom, have been said to be the main reason why the UK was able to grow to where is now, as the world’s 6th largest economy. The same idea is also used to analyse why many countries in Latin America and controversially China have been unable to escape the so-called ‘Middle-income trap’. This ‘trap’ has fascinated economists over the reasons behind this, and lack of innovation in these labour-intensive economies has been said to be the main contributor to stagnation in this middle-income status. To drive productivity and technology, particularly promoting an increase in TFP (total factor productivity) within the economy, for resources to be effectively allocated and the informal sector in these economies is a major issue for this wastages. This encourages investment from more developed nations such as the neighbouring USA to the north in the form of FDI and entices the need to innovate with the abundance of resources available. This has been particularly apparent also in Venezuela where old technology from the 1980s is still used to this day as issues surrounding corruption and hyperinflation have caused depopulation and a lack of investment over recent years. This is another key reason why economists use innovation as their main reason why an economy either succeeds or fails on the global scale and the significance of this too.

Japanification. A bizarre outlier to innovation?

Although innovation has proven to be the main driver of growth and prosperity, especially in under-developed/emerging economies, why has the economy of Japan failed to rival global economies on the development scale over recent years? Japan currently has an economic growth rate of -1% and has experienced rates of negative and positive rates of high volatility since the early 1980s, after it took off as a rapidly emerging economy. However, the general stagnation of back and forth growth is mainly due to its massive 266.2% of GDP debt levels, as well as an ageing population. Therefore, although Japan continues to be a leading innovator, especially in the automotive and robotics sector, this does not allow economists to explain why an economy like Japan would fail to grow over the past 30 years. However, this could be considered to be a rare outlier in terms of why economists can't use lack of innovation as a reason for no growth, especially when analysing markets on the smallest of scales, in which innovation is at the forefront of all market competitors' ambitions.

Microeconomic innovations

Technology plays a monumental role in allowing companies to thrive in extremely competitive market conditions and can save time, money and many other valuable resources that occur in the production process of a firm, allowing them to gain an enterprise advantage over other competitors. The thirst to be the best, typically in free-market systems where state intervention does not occur, allows innovation to thrive and prosper, which is a major grantor for large businesses such as Tesla to develop a new product which is adopted by other firms and leads to an environmentally friendly ethos, especially under current affairs to promote the fight against climate change. This in turn can produce many positive externalities, especially if the innovations are in green technology, as fewer people will be admitted to hospital with pollution-related diseases and waiting times are shorter, as a result, allowing the labour in the economy to stay productive, and able to contribute to the workforce. This has been particularly apparent in places such as the UK where 36,000 people die every year due to pollution-related diseases, posing a massive issue for an already weak labour force post-COVID-19. These benefactors are all reasons why innovations, especially in the ever-changing environmental world are vital, and highly valued by many leading economists.

However, innovation in a firm can result in disruption, especially to the business cycle. A very topical example of this is Tesco’s supermarkets in the UK, where self-service checkouts are rapidly replacing many checkout workers. This innovation will lead to vital cost-saving practices for the firm, allowing them to charge lower prices, but in the short term, the investment in automated technology will lead to unemployment. This can be a problem as these workers are typically low-skilled and therefore will find it harder to find another job with a similar skill set requirements and could be unemployed for extended amounts of time. This will require more state funding to be issued into the welfare system and as a result, place an opportunity cost on governmental budgets, which is why innovation needs to be carefully assessed before it is implemented into the market.

Innovation on the macroeconomic scale

Despite the potential for disruption, innovation ultimately has many benefits, directly speaking to the economy. The decrease in production costs and therefore increase in productivity matches favourably with Keynesian economics, allowing the economy to use a large number of its resources, and thereby create efficiency. The boost in economic growth from an increase in investment from the firms in the economy, therefore, encourages further government spending because of an increase in tax revenues. This will be spent on services such as education and healthcare, and also produce more job opportunities for work through government spending, such as the 127,000 jobs from the £106 billion HS2 investment. The decrease in unemployment will also increase the labour force of the UK, boosting productivity even further. Innovation can also be protected in some cases regulated by public policy through rule of law, patencies and even free trade and SEZs (special economic zones) like those in China, and encourage more innovations and competition in particular markets too. Ultimately, the effectiveness of innovation is strong. From the smallest of markets to those on an international level, innovation spurs success. This ensures that we as a global economy are always pushing for the best results, and in doing so improve living standards and qualities of living, most needed in developing economies. This is why economists all see innovation as the vehicle for prosperity, and the tool to change the world as we know it.



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