The Zig Zag

Why Subsidize Innovators?

A recent paper by William Nordhaus “Schumpeterian Profits in the American Economy: Theory and Measurement” looks at innovations and its returns to consumers and producers. Café Hayek notes that:-

“In it he estimates that innovators capture a mere 2.2% of the total “surplus” from innovation. (The total surplus of innovation is, roughly speaking, the total value to society of innovation above the cost of producing innovations.) Nordhaus's data are from the post-WWII period.

The smallness of this figure is astounding. If it is anywhere close to being an accurate estimate, the implication is that “society” pays a paltry $2.20 for every $100 worth of welfare it enjoys from innovating activities.

Why do innovators work so cheaply? One possible reason is alluded to by Nordhaus himself: excess optimism.”

But that is the problem with the article. Norhaus claims that:-

“In this study, we take a slightly restrictive definition of Schumpeterian profits. These comprise only the profits that exceed the risk-adjusted return to innovative investments.”

In fact, if, as seems likely, innovators are risk loving with respect to the returns to their innovations, this measure is going to over estimate not under estimate the super normal returns to innovation.

But the real problem with this article is the reaction it typically provokes. Tyler Cowens gut response is

“To some extent I advocate favorable tax and legal treatment for innovation.”

But this confuses fairness with efficiency. Innovators don’t capture all of the returns to their inventions – that is “unfair”. Innovators are over optimistic and so tend to “over invest in innovation” – that is economically inefficient. So perhaps we ought to be thinking about taxing rather than subsidizing innovation? More feasibly, it makes sense to think about restricting intellectual property rights in order to curb the excessive over optimism of innovators. After all most innovation registered at the patent office is an absurd waste of both the innovators and patent attorneys time

For another view see “The Case against Intellectual Property”

Posted by wardx107 at October 5, 2004 10:46 AM