The Rate and Direction of Inventive Activity Revisited


While the importance of innovation to economic development is widely understood, the conditions conducive to it remain the focus of much attention. This volume offers new theoretical and empirical contributions to fundamental questions relating to the economics of innovation and technological change while revisiting the findings of a classic book. Central to the development of new technologies are institutional environments, and among the topics discussed here are the roles played by universities and other ...

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While the importance of innovation to economic development is widely understood, the conditions conducive to it remain the focus of much attention. This volume offers new theoretical and empirical contributions to fundamental questions relating to the economics of innovation and technological change while revisiting the findings of a classic book. Central to the development of new technologies are institutional environments, and among the topics discussed here are the roles played by universities and other nonprofit research institutions and the ways in which the allocation of funds between the public and private sectors affects innovation. Other essays examine the practice of open research and how the diffusion of information technology influences the economics of knowledge accumulation. Analytically sophisticated and broad in scope, this book addresses a key topic at a time when economic growth is all the more topical.

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Meet the Author


Josh Lerner is the Jacob H. Schiff Professor of Investment Banking at Harvard Business School, with a joint appointment in the Finance and the Entrepreneurial Management Units, and a research associate and codirector of the Productivity, Innovation, and Entrepreneurship Program at the NBER. Scott Stern is the School of Management Distinguished Professor of Technological Innovation, Entrepreneurship, and Strategic Management at the Massachusetts Institute of Technology Sloan School of Management and a research associate and director of the Innovation Policy Working Group at the NBER.


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The Rate and Direction of Inventive Activity Revisited

The University of Chicago Press

Copyright © 2012 National Bureau of Economic Research
All right reserved.

ISBN: 978-0-226-47303-1

Chapter One

Panel Discussion The Impact of the 1962 Rate and Direction Volume, a Retrospective

Why Was Rate and Direction So Important? Nathan Rosenberg and Scott Stern

One is tempted to start by saying: In the beginning was Simon Kuznets. We will not in fact start that way, because Kuznets would be more likely to point to larger social forces or institutions rather than specific individuals—he would have been more likely to point to the National Bureau of Economic Research (NBER)—where much of his early research was conducted, and where he trained and worked with his coauthors, colleagues, and former students, including Schmookler, Kendrick, Abramovitz, Fabricant, Denison, and others.

But our immediate task today is to understand how the 1962 conference volume has ended up playing such an important role in the development of the economics of innovation and technological change over the last half century. The volume includes an extremely diverse range of essays, from case studies of the organization of R&D to careful measurement studies to conceptual and theoretical papers, most notably Ken's paper on the nature of invention as an economic good. On their own, many of the papers would stand as important contributions to the field, and any assessment of their impact will necessarily be incomplete due to their diversity. However, our contention is to argue that the Rate and Direction volume had a separate and independent effect. Dick used the opportunity of the Rate and Direction Conference to bring together an extraordinary and diverse group of scholars, and focused those scholars on identifying a systematic research program to evaluate (a) the nature of innovation as an economic good, (b) the organization of research and development organizations, and (c) the interrelationship between innovation and the dynamics of industry structure. The volume initiated a systematic research program that offered a timely counterpoint to the macroeconomic approach that equated technological change to "the residual" and treated innovation as exogenous to the economic system. The 1962 volume served a decisive role in establishing the microeconomics of innovation and technological change.

To understand this contribution, it is worthwhile to take a brief but informative review of where the field stood in the late 1950s and how it had come to that place. Kuznets (working in large part through the NBER) began, first in the 1930s and then after the war, to systematically undertake a research program focusing on the measurement of economic inputs and outputs with the objective of relating them in some fashion. While measurement had always been a part of economic science, the efforts spearheaded by Kuznets and others involved a very significant increase in the sophistication and comprehensiveness of measurement. Indeed, it is no surprise that the first chapter of the 1962 volume is by Kuznets and is entitled "Inventive Activity: Problems of Definition and Measurement." It is also unsurprising that the commentary is by Jacob Schmookler.

Most importantly, this measurement work demonstrated that the relationship between measured economic inputs (capital and labor) and outputs (gross domestic product [GDP]) was changing dramatically over time and that there was no easy explanation for this. Simply put, the measurement program spearheaded by Kuznets at the NBER illuminated the central economic fact of US economic history.

Of course, the explanatory framework for understanding these empirical findings only emerged in the mid-1950s with the seminal studies of Moses Abramovitz ([1956], reprinted in 1990) and Bob Solow (1956, 1957). Both Abramovitz and Solow highlighted that, over time, the amount of inputs required to produce a given level of output had dramatically increased (an upward shift in productivity of 2 percent per year). Simply put, they had independently discovered—or more accurately, rediscovered—the residual (Copeland 1937; Griliches 1996).

Of course, the interpretation of this increase in total factor productivity (TFP) was more controversial. In 1956, Solow introduced a simple and tractable neoclassical equilibrium growth model. The Solow model simply stated that the relationship between inputs and outputs at a point in time can be described as the "level" of technology; as such, the changing relationship between inputs and outputs can be described as "technical change." While Solow was of course aware and recognized that technical change may itself be endogenous, the model took the growth rate in technology—A—to be exogenous. As Solow describes explicitly in his 1957 paper "Technical Change and the Aggregate Production Function," "It will be seen that I am using the term technical change as a short-hand expression for any kind of shift in the production function" (Solow 1957, 312).

Importantly, Abramovitz was less sanguine. Abramovitz memorably dubbed the residual "a measure of our ignorance." For example, in Abramovitz's review of Edward Denison's 1962 book The Sources of Economic Growth and the Alternatives Before Us. Abramovitz sharply comments that "as a residual, it is the grand legatee of all the errors of estimate embodied in the measures of national product, of inputs conventional and otherwise, and of the economies of scale ... classified under productivity growth" (Abramovitz 1990, 162). Abramovitz notes that the original estimates of the residual—with more than 85 percent of the increase in income per capita unexplained—can be attributed to various sources, including changes in the intensity of work (i.e., reduction in work hours per worker), education, appropriately measured capital inputs, and changes in technology and organization. For Abramovitz, to understand the sources of growth is not simply a measurement exercise but requires an understanding of the economic forces inducing growth, including the determinants of investment toward invention, and the relationship between those forces and measured economic aggregates (Abramovitz 1990).

Ultimately, to understand the role of innovation in economic growth, it was necessary to move beyond a "black box" approach and build a meaningful microeconomics of technical change. Dick Nelson emphasizes this point exactly in his introduction to the volume, particularly in a section entitled "The Classical Economics Approach and the Black Box." While there had been earlier attempts to make progress—for example, a 1951 Social Science Research Council meeting at Princeton University, and the impactful publications arising from Zvi Griliches doctoral dissertation, it is fair to say that the microeconomics of innovation was at that time in an embryonic state. What was missing was an economics of technical change and innovation grounded in the microeconomic, historical, and institutional environment in which invention and innovation occur. The 1962 volume was in large part the first and a particularly important salvo in that cause.

Spurred by an initiative headed by Charles Hitch, then Chairman of the Economics Department at RAND, Dick Nelson brought together a group of junior and senior scholars to focus on the rate and direction of inventive activity as a key for understanding technological change as an economic problem. The volume takes an eclectic approach, with different papers offering different methodologies—from highly descriptive papers to systematic measurement to theory. How, then, does it "hang together" and what factors made the volume so influential?

Three distinctive areas are useful to highlight:

1. The nature of innovation as an economic good 2. The economics of the organization of research and development organizations

3. The industrial organization of innovation-intensive industries and sectors, with a particular focus on dynamics and evolution

Each of these areas is not only a central element of the microeconomics of innovation, but also one in which the 1962 volume serves as the essential starting point (or, more accurately, the starting point after Schumpeter) for the large literature that has been spawned since that time.

The Nature of Innovation As an Economic Good

The 1962 volume was a milestone in articulating how the nature of inventions and innovations as economics goods raise fundamental issues regarding appropriation, indivisibility, and uncertainty. Of course, Dick had raised these issues in his seminal 1959 paper, and issues regarding the nature of ideas as economic goods were an important area of contention among classical economists (see the penetrating summary and history of economic thought on the topic provided in Fritz Machlup's 1958 report for the US Congress, "An Economic View of the Patent System").

With that said, it is useful to consider Ken's distinctive contribution in his paper "Economic Welfare and the Allocation of Resources for Invention." Before diving into the substance, it is perhaps useful to note that, according to Google Scholar, this is Ken's third most highly referenced paper, with more than five thousand citations. Here is where Ken clearly articulates the disclosure problem: "there is a fundamental paradox in the determination of the demand for information; its value for the purchaser is not known until he has the information, but then he has in effect acquired it without cost." (Arrow 1962, 615). The traditional microeconomic notion of "willingness-to -pay" is undermined when one cannot formulate a willingness-to-pay. One cannot do so prior to having information about the idea. Most importantly, in the absence of enforceable intellectual property, once the potential buyer has the information that allows her to formulate a willingness-to-pay, the willingness-to-pay drops to zero.

Interestingly, though Machlup mentions in his 1958 essay that "Indeed, if one always cites only the 'fist and true inventor' of an argument concerning the patent system, one will rarely be able to cite an author from the 20th century" (Machlup 1958, 22), the distinctive role for intellectual property rights in enhancing the ability to negotiate and trade inventions is noted only obliquely (under the general rubric of appropriability issues).

A related contribution of the 1962 volume is the inclusion of early, persuasive empirical studies of appropriability. For example, Enos's careful study of invention and innovation in the petroleum refining industry offers sharp, early insights into the nature of innovation (see Rosenberg 1982, 8; Enos 2002). Enos carefully emphasizes the importance of incremental process innovations, and provides reasonable estimates of the private rates of returns (which he estimates to be quite high). The volume additionally provides evidence about the gap between the private and social rates of return. As Dick notes in the introduction, "A third major problem is that of external economies. Arrow, Kuznets, Machlup, Markham, Merrill, and Nelson all present argument or evidence that, given existing institutions, inventive activity generates values which cannot be captured by the inventor" (Nelson 1962, 14). Indeed, Arrow draws out these implications clearly in terms of the economywide incentives for research: "we expect a free enterprise economy to underinvest in innovation and research ... because it is risky, because the product can be appropriated to only a limited extent, and because of increasing returns in use" (Arrow 1962, 619). This simple statement has certainly kept us busy.


Excerpted from The Rate and Direction of Inventive Activity Revisited Copyright © 2012 by National Bureau of Economic Research. Excerpted by permission of The University of Chicago Press. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

The Rate and Direction of Inventive Activity Revisited Josh Lerner and Scott Stern, editors

Introduction Josh Lerner and Scott Stern

I. Panel Discussion: The Impact of the 1962 Rate and Direction Volume, a Retrospective

Why was Rate and Direction So Important?
Nathan Rosenberg and Scott Stern

Some Features of Research by Economists on Technological Change Foreshadowed by The Rate and Direction of Inventive Activity
Richard R. Nelson

The Economics of Inventive Activity over Fifty Years Kenneth J. Arrow

II. The University-Industry Interface

1. Funding Scientific Knowledge: Selection, Disclosure, and the Public-Private Portfolio Joshua S. Gans and Fiona Murray
Comment: Suzanne Scotchmer

2. The Diffusion of Scientific Knowledge across Time and Space: Evidence from Professional Transitions for the Superstars of Medicine Pierre Azoulay, Joshua S. Graff Zivin, and Bhaven N. Sampat
Comment: Adam B. Jaffe

3. The Effects of the Foreign Fulbright Program on Knowledge Creation in Science and Engineering Shulamit Kahn and Megan MacGarvie
Comment: Paula E. Stephan

III. Market Structure and Innovation

4. Schumpeterian Competition and Diseconomies of Scope: Illustrations from the Histories of Microsoft and IBM Timothy F. Bresnahan, Shane Greenstein, and Rebecca M. Henderson
Comment: Giovanni Dosi

5. How Entrepreneurs Affect the Rate and Direction of Inventive Activity Daniel F. Spulber
Comment: Luis Cabral

6. Diversity and Technological Progress Daron Acemoglu
Comment: Samuel Kortum

7. Competition and Innovation: Did Arrow Hit the Bull’s Eye?
Carl Shapiro
Comment: Michael D. Whinston

IV. The Sources and Motivations of Innovators

8. Did Plant Patents Create the American Rose?
Petra Moser and Paul W. Rhode
Comment: Jeffrey Furman

9. The Rate and Direction of Invention in the British Industrial Revolution:  Incentives and Institutions Ralf R. Meisenzahl and Joel Mokyr
Comment: David C. Mowery

10. The Confederacy of Heterogeneous Software Organizations and Heterogeneous Developers:  Field Experimental Evidence on Sorting and Worker Effort Kevin J. Boudreau and Karim R. Lakhani
Comment: Iain M. Cockburn

V. Panel Discussion: Innovation Incentives, Institutions, and Economic Growth

The Innovation Fetish among the Economoi: Introduction to the Panel on Innovation Incentives, Institutions, and Economic Growth Paul A. David

Innovation Process and Policy: What Do We Learn from New Growth Theory?
Philippe Aghion

VI. The Social Impact of Innovation

11. The Consequences of Financial Innovation: A Counterfactual Research Agenda Josh Lerner and Peter Tufano
Comment: Antoinette Schoar

12. The Adversity/Hysteresis Effect: Depression-Era Productivity Growth in the US Railroad Sector Alexander J. Field
Comment: William Kerr

13. Generality, Recombination, and Reuse Timothy F. Bresnahan
Comment: Benjamin Jones

VII. Panel Discussion: The Art and Science of Innovation Policy

The Art and Science of Innovation Policy: Introduction Bronwyn H. Hall

Putting Economic Ideas Back into Innovation Policy R. Glenn Hubbard

Why Is It So Difficult to Translate Innovation Economics into Useful and Applicable Policy Prescriptions?
Dominique Foray

Can the Nelson-Arrow Paradigm Still Be the Beacon of Innovation Policy?
Manuel Trajtenberg

Contributors Author Index Subject Index

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