Federal Innovation Policy Can Help-And Hurt-Economy, Economists Say. (Perspectives: News and Views of the Current Research * Technology Management Scene)

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Inconsistent actions by the U.S. government to promote competition and economic growth can actually hinder innovation and economic prosperity, according to five economists who offered examples and some remedies at the third annual "Innovation Policy and the Economy" conference in Washington, D.C. The April 16 meeting was sponsored by the National Bureau of Economic Research (www.nber.org).

Joshua Lerner, Harvard University, has studied impacts on innovation from boom and bust in the venture capital industry. Although investment activity has been cut in half in the past few quarters with no revival in sight, Lerner finds the situation not so grim. On average, venture capital has a powerful impact on innovation, with one venture capital dollar as effective as three industrial R&D dollars. However, the impact is not uniform. During booms, over-funding of favorite sectors leads to a sharp decline in effectiveness. During the 1998-2000 boom for example, 39 percent of funding was concentrated in Internet investments. Considerable sums supported similar firms such as the nine competing Internet pet food suppliers. Meanwhile, promising areas in advanced materials, energy technologies, and micromanufacturing languished unfunded. Even so, while potentially good investments go unfunded in prolonged downturns, many dire predictions seem overstated, Lerner said.

Lerner further argued that while the rise of venture capital has been an important contributor to technological innovation and economic prosperity, an effective policy agenda should not simply seek to spur venture financing. This just adds to the problem. Instead, Federal and state policies should encourage private investment, address funding gaps by supporting out-of-favor industrial segments, and focus on demand rather than supply--creating investment opportunities.

Examples would include facilitating commercialization of early-stage technology, such as the Bayh-Dole Act of 1980 and the Federal Technology Transfer Act of 1986, both of which eased entrepreneurs' ability to access early-stage research. Similarly, efforts to make entrepreneurship more attractive through tax policy (capital gains rates) may have a substantial impact on the amount of venture capital provided and the returns that these investments may yield.

IP vs. Antitrust

Intellectual property policy conveys market power to innovators while antitrust policy constrains it. This creates a fundamental conflict for R&D-intensive industries. Dennis Carlton, University of Chicago, studied this clash, assessing whether and how antitrust policy should promote competition in situations where market power depends on success from intensive R&D. The U.S. Department of Justice has blocked at least one merger on the basis of an anticipated reduction in innovation in a market where competitive position is primarily determined in the R&D lab. Given the fallacy of using potential restraint of R&D for such antitrust actions, this approach should not be used again, he maintained.

In another argument, Carlton pointed out how competitive advantage can be maintained by marketing closed rather than open systems. A closed system has components (such as a home entertainment system with DVD/CD player, speakers, TV, remote controller, and FM radio; or a suite of computer programs for word processing, e-mail, presentations, and web access) that are compatible with one another; no component can be replaced by a similar component from another manufacturer. An open system would be one where the consumer could mix and match components from many manufacturers.

In some situations, possibly unfair market power may have been obtained by the development of the closed system and there would be greater benefits for the consumer from a similar open system. But rather than trying to use the antitrust laws to attack the maintenance of such closed systems, Carlton carefully argued that intellectual property laws and regulations can indeed promote open systems and the standards-setting organizations they require. …