Innovation is the process of creating new technologies and using them in the economy. Economists usually use a very broad definition of technology, so when we’re talking about innovation, we’re not just thinking about new machines or inventions, but any new way of doing things.
Innovation is quite the buzzword these days. Businesses and governments talk about the power of innovation, universities present themselves as engines of innovation, and cities jockey to create innovation hotspots like Silicon Valley in San Francisco. The rhetoric about innovation can be a bit over the top at times, but the process of developing and implementing new technologies really is quite important for economies. Technology is a big factor for explaining why some countries are richer than others, and for determining how fast the economy grows, or if it grows at all.
Innovations don’t just fall out of the sky or hit mad geniuses in the middle of the night. Countries make large investments into researching new ideas and developing those ideas into economically useful things. Some countries, like Israel and South Korea, devote over 4 percent of their national income to research and development.¹
Investment in research and development was usually either done by the government or by private companies. But now, it’s fairly common for governments to invest directly in companies doing exciting research. For example, since 2008, the US has invested heavily in companies developing clean energy technologies—including the Tesla Motor company.²³ Economists have long fought about how much the government needs to do to promote innovation—a lot of them think it should only fund basic research which no company would have an incentive to do on its own; others think it should play a much more active role.
But increasingly, economists find it more helpful to look at the big picture of how the research at universities and government labs connects with companies in the private sector. They call this the ‘systems of innovation’ approach, as it sees new technologies as coming not from a single company or inventor, but from the interactions between countless organizations and individuals. The iPhone is a great example of how a system of innovation works; while Steve Jobs and Apple rightly get credit for designing the innovative phone, much of the technology that makes the phone possible—including the internet, GPS, touchscreens and voice recognition technology—was developed with government money.³