Like most people, I believe Hong Kong’s long-term economic growth depends critically on the creativity and innovation of its people. The question is whether there is a role for government to promote policies and build institutions to foster creativity and innovation? This article presents the intellectual case for selective intervention towards that end. It proposes a general approach that might have the highest chance of economic success in the Hong Kong context.
Positive non-interventionism has long been the guiding principle in managing Hong Kong’s economic affairs, so naturally there is some hesitation about a new positive interventionist role. It is not easy for institutions and people to simply reverse gears on this issue. Moreover, the necessary political support to develop institutions and people to foster creativity and innovation will not be easy to sustain as these investments are unlikely to yield instant success. Nonetheless, there are economic reasons why some positive intervention could be good for Hong Kong.
Ideas as Causes of Economic Growth
Economic growth is about increasing income per capita so that over time the standard of living improves. When income per capita rises continuously, its growth rate must be positive and this means labor productivity defined as output per worker will rise without limit. It also means the law of diminishing returns ceases to apply and the economy experiences increasing returns.
Per capita income may rise in three ways. First, one can increase labor productivity by increasing the stock of capital per worker. The mechanism for this is to lower consumption, which raises savings, produces more investment, and drives up per capita income. Growth continues as long as savings and investments can be increased. However, the amount one can save is limited by one’s income and willingness to lower consumption. Once savings-driven investment ceases to increase, the growth rate will fall to zero. So investment alone cannot lead to continuous growth.
Second, labor productivity can be increased if the economy has access to better technology. Poor developing economies with lesser technology can catch up with rich developed economies by learning or acquiring their better technology. Catching-up is of course a one-off technological improvement and leads to a one-off increase in per capita income. Unless technology can improve continuously, its effect on per capita income, like that of investment, will run out and the growth rate will then fall to zero.
Third, per capita income can grow continuously if technological progress can be sustained continuously. Chicago economists Paul Romer and Robert Lucas have worked out what it takes to achieve this using a model of endogenous growth. For them, economic growth arises from new ideas invented by people. They see the world as being divided into “ideas” and “things”.
Output, labor, capital and human capital are “things”. These are scarce resources and subject to the law of diminishing returns. Alone they cannot produce continuous economic growth. But “ideas” can because human beings possess an infinite capacity to discover better ways to do “things”. The application of “ideas” is not subject to the law of diminishing returns. Investing in human capital enhances the chance for discovering new “ideas”, while new “ideas” in turn enhance the stock of human capital. The iterative positive interaction between “ideas” and human capital therefore produces increasing returns.
One can think of “ideas” as pure public goods and “things” as private goods. The value of a pure public good is not diminished by more people using it, but this is not true of a private good because anyone who uses it denies its use to another person. The pure public goods nature of “ideas” makes it fundamentally different from the private goods nature of “things” and this is the source of increasing returns.
For example, the “idea” of standardizing units of measurement was an important productivity-enhancing discovery and had numerous applications. Similarly, the idea of making coffee cups of different sizes that use the same size lid in coffee shops is also a productivity-enhancing discovery. The paper that makes up the coffee cup is a “thing” and typically only one person can use one paper cup at a time. In other words, a paper cup is like a private good; when one person uses it others are deprived of its use. The insight that you could design standardized small, medium and large cups that all use the same sized lid is an “idea”. Ideas can be used by many people at the same time without its value being diminished.
Transforming “Ideas” into “Things”
Classical economics claims that in competitive markets suppliers are prevented from charging higher prices than what consumers are willing to pay. This understanding of the market pricing system provides the ideological basis for positive non-interventionism. Market economists have admonished governments to focus only on setting property rights and let the market determine prices freely. Capitalism will then take care of itself. However, while this works well in markets for “things”, it’s not ideal for “ideas”.
If continuous economic growth depends on the discovery of new “ideas” and not merely the efficient allocation of scarce “things”, then we must set very high prices to encourage discovery. But then what is the right price to make sure the new “idea” is efficiently used? Since the new “idea” is a pure public good then anybody in the world who can benefit should be free to use it. So the right price is zero because this would encourage maximal use and thus economic growth.
The difference between setting prices for “ideas” and “things” is that for “things”, a single price mediated through competitive markets can determine both what and how much to produce and also who will get to use it. In other words, both supply and demand can be cleared through markets. For “ideas” the correct price to encourage discovery is not the same as the correct price to encourage maximal use of what is a pure public good.
A deep and difficult problem is how to organize economic activity when it is necessary to set a high price to encourage research but a low price to encourage use. The economic problem is how to configure our institutions so that we are able to discover better “ideas” and at the same time provide appropriate incentives to transform these “ideas” into “things”. Companies must derive some monopoly profits for taking risks to develop new “ideas”, otherwise they would not engage in research.
Patent and copyright laws serve this purpose, but to encourage wider dissemination the laws must limit the control that companies can exert over their technologies.
Governments must therefore pursue intelligent policies – there is a role for them to create and foster conditions and institutions that would effectively transform “ideas” into “things”. Governments also have a role in subsidizing research and education to encourage the discovery of “ideas”. This is not to imply that only governments can do this. Companies and individuals undertake research and learning on their own, but there is a role for governments where decentralized and individual efforts are inadequate.
In the market, which is the realm where “things” operate, the fundamental underpinning notion is that of private ownership, where an individual who owns some resource typically possesses almost unlimited scope to decide how it should be used. In science, the process of technological discovery is supported by a very different and unique ethic. When somebody discovers something like the double helix structure of DNA, the convention is that the discoverer does not control that “idea”. It is given away through publication. Science rewards the dissemination of “ideas” by conferring the most prestige and respect to those who first publish an “idea”.
However, this means that usually only governments are willing to become engaged in making the huge investments required for discovery as there is no opportunity for private firms and individuals to recoup their investments. This can lead to the undesirable consequence that only ideas deemed interesting by governments will receive investments. The economic case for protecting academic freedom rests ultimately on the superior ability of the unregulated discovery process in promoting economic growth.
Taking “Ideas” to the Market
“Ideas” still have to be transformed into “things” that can be used by clients before their value can be realized, which means they often require further refinements and investments in application that cannot be supported by public funding alone. This is where the market comes in. Silicon Valley is the best known example of a successful marriage between private and public institutions.
However, the conditions and ways of making science and the market work together are still imperfectly understood. Attempts to clone Silicon Valley elsewhere have not met with much success. The former Soviet Union had very strong science in some fields but it was not coupled with strong institutions in the market. As a consequence, the benefit of discovery was very limited. The United States has created strong institutions of science and the market so that the benefits of discovered “ideas” can be brought to the marketplace as “things”.
Patents, copyrights and secrets are mechanisms in the market for creating quasi-property rights for “ideas”. They exclude other people from using an idea that is inherently a pure public good and in so doing they make use of the market to create incentives to transform “ideas” into valuable “things”. Virtually all ideas that benefit consumers have been picked up by for-profit firms, which commercialize the ideas, tailor them to the market, and deliver them. This is the best and only reliable way to take free floating contentiously discussed ideas from the realm of science and into the market.
If “ideas” are not well protected then there will not be any incentive to make “things” out of ideas and mankind will not reap the benefits of discovery. The Soviet Union wasted a lot of good discoveries, which interestingly were captured by Israel after Soviet Jewish scientists and engineers fled there following the collapse of the Soviet Union. These immigrants created new innovation and technology driven industries.
On the other hand, if “ideas” are too well protected then the benefits to society are restricted to the few and not distributed widely. Where to draw the line between science and the market has to be experimented with again and again until the right combination is found.
When that combination works, innovation can lead to the development of new products or processes and the know-how that begets them. For example, in the finance field it can lead to high-level building blocks such as information and computer engineering, mid-level intermediate goods such as financial computational models, and ground-level final products such as derivative securities.
In addition, new know-how and products require interconnected, non-technological innovations, such as those in marketing and organizational set-ups. Innovations that sustain economic growth involve a vast array of contributions. The key point is that different innovations all play necessary and complementary roles.
Innovation and the Venturesome Spirit
Innovation has always been associated with the discoverer, inventor or entrepreneur. The role of the consumer is too often neglected, yet the willingness of consumers to assume the risk of trying out new products is just as important in making innovations succeed. Without the “venturesome” attitude of risk-taking consumers, emphasized by Professor Amar Bhide, there would be little incentive for the entrepreneur, inventor or discoverer to take the gamble and create new products or processes.
The willingness to be “venturesome” is positively related to human capital. Better educated women were the first to use birth control devices and better educated farmers were the first to adopt new hybrid seeds. A venturesome consumer also needs to be open-minded. Young people are often more avid consumers of new products than older people.
Norway may not have the cutting edge of technology of Sweden, but it has the highest labor productivity per hour in the world. This is because its service sector is great at using technologies to improve its productivity. Developed economies tend to have large service sectors and they need to use technologies intensively or fall behind. Japan and Germany are technological powerhouses in manufacturing, but their service sectors are incredibly backward. They lag behind in appealing to venturesome consumers and producers, who want technologies that support increasing specialization in new niche areas and that offer supreme customized service globally.
Innovation is a whole chain of organizations, arrangements, processes and pursuits that leverage on scientific discoveries and technological inventions to produce new goods and services to meet the needs of venturesome customers, who have a taste for trying out new things. The value creation-innovation-technology nexus work best when there are policies that create better incentives for scientists, inventors and entrepreneurs to discover new ideas, and for customers to try new things.
These policies are sometimes understood narrowly as science and technology policies to encourage research and development, but they also embrace rules and laws to protect intellectual property rights that facilitate the transformation of ideas into commercially valuable things. There can also be policies to promote competitive markets that are instrumental in allowing new things to enter the marketplace, where customers are free to discover them. And at the end of the day customers must want to try them for otherwise the virtuous circle of the value creation-innovation-technology nexus cannot be completed. Success depends on all these factors coming together and being put into action.
What Hong Kong Can Learn from Route 128
On the supply side, Hong Kong has many pieces of the infrastructure in place for the value creation-innovation-technology nexus to thrive and promote sustained growth. These pieces include its legal institutions, competitive markets, business and financial infrastructure, research and training capacity in its universities, mid-stream and down-stream applied research, and development capacity. The supply side infrastructure is there.
Hong Kong’s weakness, though, is in the linkage of the value creation-innovation-technology nexus to market demand. Hong Kong is too small to realize the full benefits of investing in science and technology and research and development. It is vital that it reach beyond its borders in search of demand so that the advantages of scale and complementarities could be exploited more fully. Our mid-stream and down-stream applied research and development operations have yet to be effectively linked up with the demand that exists across the border and beyond.
Unless this happens, the “ideas” we produce cannot be transformed into “things”.
To be tied to genuine market demand to succeed, a better steer is necessary. Public investments must have the strong support of businesses across the border and elsewhere. Better integration and cooperation with the Pearl River Delta region and other global markets would go a long way towards achieving a mutually beneficial partnership in completing the value creation-innovation-technology nexus. It would unlock the flow of ideas, people, things and funds to create a virtuous circle where barriers and borders fade away.
A good example is Route 128. After World War II the economy in Boston was stagnating. In 1946, Ralph Flanders and a few of his moneyed friends formed a venture capital company and make $4 million available to small Boston enterprises. The corporation was set up along Route 128 close to Harvard, M.I.T., and Tufts. The Flanders group had no preconceived ideas of what they were doing. They were quite surprised when the first applicants for capital were three young scientists who sought to start a high technology enterprise by taking advantage of the cheap rental space on offer. Route 128 became a huge success because the choice of which projects to fund were made by businessmen, who had a better sense of what “ideas” could be turned into “things”.
The government has identified 10 industries as “pillars” worthy of public promotion and support. They are: financial services, trade and logistics, tourism, professional services and other producer services, testing and certification, medical services, innovation and technology, cultural and creative industries, environmental industry, and educational services. Public investment to support the supply-side of the value creation-innovation-technology nexus has to be pro-actively linked to the prospective demand in these pillar industries. Bridging the supply and demand ends of the nexus has to be the central task of any innovation and technology policy, so that Hong Kong has the institutions necessary to link up “ideas” and “things”.
Amar Bhide, The Venturesome Economy: How Innovations Sustain Prosperity in a More Connected World, Princeton University Press, 2008