Economic Report of the President—2005

Following on the heels of my criticism of the President's budget for basic research on February 18th, 2005 we come across more ripe material in the Economic Report of the President for 2005. Chapter 6 discusses “Innovation and the Information Economy.” It has a nice introductory explanation:

The innovative process involves the invention, commercialization, and diffusion of new ideas. At each of these stages, people are spurred to action by the prospect of reaping rewards from their investment. In a free market, innovators vie to lower the cost of goods and services, to improve their quality and usefulness, and—most importantly—to develop new goods and services that promise benefits to customers. An innovation will succeed if it passes the market test by profitably delivering greater value to customers. Successful innovations blossom, attracting capital and diffusing rapidly through the market, while unsuccessful innovations can wither just as quickly. In this way, markets allow capital to flow to its highest-valued uses.

My argument in my previous discussion of research funding pointed out that basic research has a hard time attracting capital. The above quote points out that successful innovations (usually products built upon a foundation of basic research) attract capital. Therefore we are pumping public capital into Defense and Homeland Security products because we don't have time to wait for commercialization of those products.

The report heads off on a cautionary note:

This engine of growth can falter, however, if government policies distort the market signals that guide innovative activity. Well-meaning policies to promote the diffusion of a service or foster entry into new markets can have unintended consequences. A policy to subsidize an existing service so that more people will consume it can deter development of innovative new services that people might otherwise prefer. In addition, pioneering investors forced to share the fruits of their investment with new entrants would find it less profitable to invest in the first place, and a new market may never be developed. When government regulation, instead of a competitive process, “picks the winners,” people tend to lose.

So I guess it's okay to pick the winners for defense and homeland security. Perhaps this is why the defense department, and NASA, have thousand dollar hammers?

This chapter of the report has four main points, which I'll quote and cover one at a time.

Information technology is a key contributor to economic growth and productivity, and its importance to the economy is growing.

Well, I'm not going to disagree that managing and communicating information is the key driver of the information age. We are living that age.

Competition drives the broad diffusion of innovative low-cost, high quality information services. This has held true in markets for mobile wireless telephones, satellite television, and dial-up and broadband Internet services.

One only has to look at the growth of the industries listed to see their importance. however, satellite is faltering and broadband is limited to high-density areas. Why do I say this? I have to use satellite broadband because I live in the boonies. It's hardly perfect.

As circumstances change and industries evolve, existing government regulations may need rethinking. In particular, economic regulations aimed at correcting an absence of competition may lose their rationale when competition from new technologies emerges.

The report goes on to indicate that cable television and phone lines are natural monopolies. This is a shock to me! They would not be monopolies at all if it wasn't for government regulation. Why do we have government monopolies on cable television and phone lines anymore? There are efficiencies to be gained by allowing competition here. They use the concept of high barriers to entry as a way to define natural monopolies. However, the key barrier to entry in this space is regulation. They argue that the massive investment in copper that was needed before is fading and therefore these industries may not be natural monopolies for much longer.

I think this is a subtle argument for deregulation.

People are motivated to invest by the prospect of earning returns on their investment. Government thus has an important role to play in defining and protecting property rights in intellectual and physical capital so that entrepreneurs will be spurred to innovate.

This one is troubling. I believe that funding basic research is a government function (and that research should be royalty-free). I also believe that people should be able to profit from their hard work and good ideas. However, I am troubled by the magnitude of abuse of patents (and software patents in particular).

The only major IP discussion is about copyright infringement. This is missing much of the boat when it comes to the issues in this area.

I haven't read the whole report, and I doubt I'll have time, but my friends in high-tech industries should at least skim through Chapter 6 to get a feel for the landscape of high-tech in the national economy.

Josh Poulson

Posted Wednesday, Mar 2 2005 10:47 PM

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