Promoting Innovation in the Twenty-First Century

In my last post, I discussed how the nature of innovation in our time raises questions for Thomas Piketty’s forecast of increasing inequality in his new book, Capital in the Twenty-First Century. In this post, I argue that his policy proposals also leave out consideration of innovation and thus risk great social harm.

Piketty does not recognize how crucial extraordinary individuals are to innovation and distribution. As Robert Solow notes in his review. Piketty seems skeptical that today’s highly paid “supermanagers” add much value for their very high salaries.  Solow endorses this skepticism, agreeing that agency costs are responsible for these high salaries. On this theory, boards of public companies are cozy with these managers who often appoint them to their positions and the result is sky high compensation. But if agency costs were the cause, we should observe closely held companies paying supermanagers less, but as Greg Mankiw points out, they do not.

A much better explanation is that innovations in the structure of corporations– faster telecommunications and the availability of data that represent the details of companies’ operations—have enabled managers at the very top to make a huge difference throughout their organization. A business today is the shadow of one or a few individuals who can take the key decisions. As a result, there is a naturally high  return to superstar executives.

The importance of the modern executive to productivity and innovation raises question about Piketty’s proposal of high wealth taxes. Assuming that today’s supermanargers are in part motivated by making a better life for their children and grandchildren—a a pretty safe assumption—high wealth taxes would deter them from the often extraordinary efforts they make. The result would be fewer innovations and perhaps more importantly less rapid distribution of innovations. If, as I have suggested, innovations in the twenty-first century, being essentially ideas about how to arrange our material universe, redound rapidly to the betterment of all, the long term result will be less equality of experience between the rich and everyone else.

My recommendations for increasing equality would be to spur innovation. Permit more immigration of engineers and scientists into the United States where they can collaborate easily with other great engineers and scientists. Reduce regulation to make it easier for new companies to challenge incumbents. As commentators to my previous post correctly observed , we need a more open access society that prevents insiders from taking advantage of government to keep outsiders out, even if outsiders have better ideas than the insiders.  Improve education through increased competition and so create more human capital for more innovation. Everyone will gain in the long run from the resulting boom in applied human ingenuity.