Innovation Economics and Trade Policy

Adherents of the four economic doctrines (see Part I) have dramatically different approaches to trade and fundamentally different beliefs about its efficacy.

Supply-siders and liberal neoclassicalists — with their overriding focus on promoting allocative efficiency and consumer welfare — strongly favor free trade. They oppose tariffs or other restrictions in large part because they see them as reducing allocative efficiency.

Neoclassicalists believe that, if each country specializes in what it supposedly is good at (meaning, those areas in which it has a competitive advantage), efficiency is increased (just as it would be if prices were not distorted at home).

And they believe that what countries are good at is largely fixed, determined by factors outside of government control. They tar with one broad brush any efforts by nations to change what they are good at.

They do so regardless of whether these efforts are appropriate and fair (such as targeting certain industries for help) — or inappropriate and unfair (such as manipulating standards to benefit domestic firms).

In either case, the effort is branded as misguided industrial policy that only hurts the country practicing it.

Moreover, neoclassicalists largely focus on the benefits to consumers from low-wage production overseas — and ascribe the costs to workers as just the natural results of market forces that are only resisted at the cost of economic peril.

The only real difference between the two neoclassical camps is their difference in what to do about workers who are hurt by trade.

Supply-siders generally argue that there are significant risks from more generous policies to help those who are hurt by trade, including increasing government spending and blunting incentives for workers to work and take risks.

In contrast, liberal neoclassicalists argue for helping workers who are hurt by trade, in part because they believe that by doing so they can limit political opposition to trade.

Because neo-Keynesians are concerned first and foremost with workers’ welfare, they are more skeptical of trade, seeing that it leads to some workers losing their jobs. They also focus not on the benefits to consumers from low-wage production overseas, but on the costs to workers.

Neo-Keynesians believe that many U.S. workers see their wage increases restricted because of pressures on production wages from low-wage workers in developing nations.

For that reason, most neo-Keynesians favor limiting new market-opening steps, particularly with countries with lower wages and weaker labor and environmental standards — and neo-Keynesians sometimes even favor reversing past market-opening steps.

Because they want to blunt low-wage competition, neo-Keynesians’ preferred solution to globalization is to push for stronger labor and environment standards — assuming that if corporate costs go up in other nations, U.S. workers will benefit.

The same motivation underlies neo-Keynesians’ support for steps to have nations like China increase their currency values vis-à-vis the U.S. dollar.

Adherents of innovation economics are generally supportive of globalization and unimpeded international trade, but their support for trade is not based on increasing allocative efficiency, as is the case with neoclassicalists.

Instead, they support global trade for three main reasons. First, the increases in competition can spur companies to be more innovative and productive.

Second, the natural evolution to a global trading system should naturally benefit high-wage countries by creating a new global division of labor where the industrial base of these economies evolves toward more high-value-added and innovation-based goods and services.

Third, they see globalization as increasing innovation in the sense that it spurs greater learning and collaboration across borders.

Yet adherents of innovation economics temper their support for global trade with the concern that manipulation of the trading system by countries embracing mercantilist policies favoring exports (such as tariffs, unfair taxes, currency manipulation, discriminatory standards) — coupled with disregard of intellectual property standards — can hurt richer nations’ productivity and innovation.

Potentially, they can also lead to lower levels of global growth as companies make investments in places and in types of production that they would not make absent these mercantilist policies.

New domestic policies

In this way, they don’t believe that efforts to put in place robust innovation policies is “industrial policy” or any effort to fight unfair trade practices is protectionism.

This is why people who subscribe to innovation economics advocate international efforts to move the global trading system away from national economic policies that promote exports in a beggar-thy-neighbor fashion (as is currently the case today in most nations) and toward policies that support domestic innovation and productivity.

Like neo-Keynesians and liberal neoclassicalists, innovation economists do favor policies to help workers and communities adjust to trade-related dislocations. However, they would generally oppose policies to protect domestic companies from legitimate impacts from trade (as opposed to protecting them from the impacts of foreign mercantilist policies).

Finally, innovation economists argue that for trade to be effective, it must be complemented with domestic innovation policies to help the economy move up the value chain and take advantage of global economic opportunities and respond to global challenges.

For unlike neoclassical economists who believe that trade simply allows nations’ competitive advantage to be “revealed,” innovation economists believe that competitive advantage has to be created and continually sustained.

In the 21st century global economy, innovation and knowledge are the most important factors driving economic growth.

The U.S. government — indeed any government of an industrialized country — can no longer view its role in the economy as driving capital accumulation and ensuring the more efficient allocation of scarce economic resources (as conservative and liberal neoclassical economists advocate) or simply redistributing resources to the needy (or even the middle class), as neo-Keynesians advocate.

To effectively foster an innovation economics agenda, Washington policymakers must understand the limitations of today’s prevailing economic doctrines and appreciate the opportunities of the emerging doctrine of innovation economics.

In addition, Washington policymakers must embrace an innovation economics agenda that puts spurring organizational innovation and productivity at the center of U.S. economic policy.

For unless the current playbook of economic doctrines changes, the plays available to U.S. policymakers will remain the same. Given the new challenges facing the U.S. economy, we need both new plays and a new playbook.

Editor’s Note: Read Part I here.