A recent blogpost by the economist Diane Coyle quoted JK Galbraith as saying in 1952: “The modern industry of a few large firms is an excellent instrument for inducing technical change. It is admirably equipped for financing technical development and for putting it into use. The competition of the competitive world, by contrast, almost completely precludes technical development.” Coyle describes this as “complete nonsense” –“ big firms tend to do incremental innovation, while radical innovation tends to come from small entrants.” This is certainly conventional wisdom now – but it needs to be challenged.
As a point of historical fact, what Galbraith wrote in 1952 was correct – the great, world-changing innovations of the postwar years were indeed the products, not of lone entrepreneurs, but of the giant R&D departments of big corporations. What is true is that in recent years we’ve seen radical innovations in IT which have arisen from small entrants, of which Google’s search algorithm is the best known example. But we must remember two things. Digital innovations like these don’t exist in isolation – they only have an impact because they can operate on a technological substrate which isn’t digital, but physical. The fast, small and powerful computers, the world-wide communications infrastructure that digital innovations rely on were developed, not in small start-ups, but in large, capital intensive firms. And many of the innovations we urgently need – in areas like affordable low carbon energy, grid-scale energy storage, and healthcare for ageing populations – will not be wholly digital in character. Technologies don’t all proceed at the same pace (as I discussed in an earlier post – Accelerating change or innovation stagnation). In focusing on the digital domain, in which small entrants can indeed achieve radical innovations (as well as some rather trivial ones), we’re in danger of failing to support the innovation in the material and biological domains, which needs the long-term, well-resourced development efforts that only big organisations can mobilise. The outcome will be a further slowing of economic growth in the developed world, as innovation slows down and productivity growth stalls.
So what were the innovations that the sluggish big corporations of the post-war world delivered? Jet aircraft, antibiotics, oral contraceptives, transistors, microprocessors, Unix, optical fibre communications and mobile phones are just a few examples. I don’t think it’s credible to describe these as anything other than radical in their effect on society and everyday lives. It’s true that some more recent world-changing innovations – spreadsheets and internet search engines, to name two examples – were indeed created by small entrants. But it’s wrong to generalise from the special case of innovation in the digital realm, characterised as it is by very low barriers to entry. Innovation, radical or otherwise, in the material and biological realms – for example in the hardware side of ICT, in energy, in aerospace, in pharmaceuticals – remains very difficult for small entrants, because of the large resources it needs and the long time it takes to deliver returns (see my post When technologies can’t evolve). It was through the social innovation of formal research and development that these resources were mobilised, and it was in large corporations that research and development was most effectively carried out. Bell Labs was the epitome of these corporate laboratories, exceptional perhaps in its willingness to support research that was very far from market, as its Nobel prizes suggest. But it wasn’t unique; the Xerox PARC lab was legendary for developing innovations like the computer mouse and graphical interface, even more legendary for leaving them to other companies like Apple to make money from. The IBM Almaden lab turned the scientific discovery of GMR into the portable hard drives that made laptops and iPods possible. In the UK, cellular telephony was developed by Racal (in a unit subsequently spun off to form Vodafone).
Most of these developments did take place in units that were set apart from the business units, and the social value of the innovations they created was probably far in excess of the returns that their owners managed to appropriate from them. That this situation was allowed to persist testifies to the very different business environment of the times, in which big corporations were in different ways shielded from the full blast of competition. Bell Laboratories’ parent – the Bell System – held a formal monopoly over long-distance telephony. The markets that chemical companies operated in were cartelised – formally, before the war, with the carve-up of the world by du Pont, ICI and IG Farben, and perhaps informally afterwards. Electronics companies in the USA (Fairchild Semiconductor being particularly important for its role in developing integrated circuits) and the UK (including Racal and GEC) lived off soft cost-plus government defense contracts. In the corporations that created the radical innovations that made the twentieth century, the competitive pressures that free market fundamentalists insist drive innovation were blunted, even if not completely absent. Of course, few of these units now survive, in our more short-termist environment which emphasises shareholder value, and favours returning profits to investors through share-buybacks over investing in the R&D that will create the businesses of the future.
Large scale R&D survives in some sectors; in aerospace, for example. This may be partly explained by the fact that 63% of the R&D done in the US aerospace industry (in 2010) was directly funded by the US federal government. Pharmaceuticals remain an important sector for R&D, but, as I’ve written before, the exponential rise in cost of developing successful drugs is putting the sector under huge pressure. Pharma is particularly important for the UK – it is still the biggest sector for business R&D, despite a 18% decline in the last two years. Despite widespread agreement that more research in energy is needed to find more cost-effective, low carbon energy supplies, the worldwide collapse in energy R&D continues. The closest thing to an old-fashioned big company corporate R&D lab, making risky and long-ranged R&D bets underpinned by monopoly rents, is Google, but this expenditure is coming under scrutiny too.
Supporters of the proposition that radical innovation is carried out in small start-ups will argue that venture capital has taken the place of big companies as the source of funding for innovation. In the last thirty years, venture capital has indeed brought some technically innovative companies into being – the biotechnology company Genentech, for example, or ICT companies like Google. But, while the image of venture capital is supplied by a few, predominantly digital, high-tech successes, the reality is better represented by its big investments in chains of office supply warehouses and pet supermarkets. Over the long run, average returns on technically innovative projects have been poor, and fashionable sectors such as biotech have disappointed their investors. Periods in which venture capital has both delivered substantial returns and funded significant innovation are the exceptions rather than the rule – they include the period of the initial PC boom in the early 1980’s, and the dot-com boom in the late 1990’s. This is entirely consistent with the view of venture capital pioneer Bill Janeway, who in his book “Doing capitalism in the innovation economy”, finds the source of technological innovation in a combination of massive state investment (as highlighted by Mariana Mazzucato) and over-exuberant financial bubbles. Another veteran of venture capital, Jerry Neumann, in a history of the last thirty years of venture capital in the USA, concludes that “Saying VCs used to take high technical risk and now take high market risk is both an overly optimistic view of the past–the mythical golden age of heroic VCs championing the development of new technologies–and an overly optimistic view of the present–gutsy VCs funding radical innovations that create entirely new markets. Neither of these things is true. VCs have never funded technical risk and they are not now funding market risk”.
Of course, we are still seeing technological innovation – some of it quite spectacular. But if technological progress really is going faster now than it ever has been, we’d expect to see that translated into higher rates of economic growth. The evidence, though, points the other way. The UK is currently in midst of the biggest peacetime slow-down in productivity growth since the 19th century. And while the UK’s current productivity disaster has its own dynamics, across all the developed economies, well before the 2008 financial crisis, we’ve seen slowing growth in per capita GDP since 1990. Whatever the new focus on small firms rather than big organisations as the driving force for radical technological innovation has given us, it is not sustained economic growth, and if we want to get back to the growth rates we’d come to take for granted, and solve some of our big problems, this is a piece of conventional wisdom we’re going to need to rethink.