The Lessons of America’s Innovation System

by Reihan Salam

In the new issue of National Affairs, Jim Manzi describes what he calls “the new American system,” the mix of private and public institutions that has sparked an explosion of business-model innovation in sectors like software, biotech, and energy (he also notes that information technology has been deployed to “creatively to re-engineer an ever-expanding range of activities” in the telecommunications, retail, transportation, entertainment, and energy industries, among others). Yet this new American system has yet to fully penetrate the all-important domains of education and medical care, which Arnold Kling and Nick Schulz have astutely identified as ”the new commanding heights” of modern market economies. These sectors remain notably unresponsive and inefficient, a development that can be attributed to their resistance to entrepreneurial transformation.

Though Manzi emphasizes the importance of market competition, trial-and-error learning, and the entry and exit of firms, the story he tells is not quite a vindication of laissez-faire:

The institutional arrangements that have served to enable this wave of innovation consistently exhibit a four-part structure: (1) innovative entrepreneurial companies, (2) financed by independent investment firms, (3) competing and cooperating with established industry leaders, and (4) all supported by long-term government investments in infrastructure and R&D.

Manzi maintains that the government has been most constructive in fostering innovation not when it actively intervenes in the success or failure of particular firms or business models, but rather when it builds platforms for growth and innovation. He ends his essay with a series of recommendations to policymakers, and an emphasis on transforming the new commanding heights:

We cannot just write off the 30% of the workforce that works in government services, education, and medicine from productivity gains, especially given how essential these sectors are to enabling innovation and productivity growth in other parts of the economy.

Driving productivity improvements in these areas, in theory, would simply require allowing the same IT-driven gale of disruptive innovation that has transformed other sectors. The practical reality, though, is that it is very difficult to create in these industries the sorts of incentives that have driven innovation in areas like software or energy. Resources are mostly politically controlled, and various participants use this to protect themselves from disruptive change. This is not entirely cynical. Our moral intuitions about them are very different, for one thing. It is not coincidental that, in the West, schools and medicine were provided for centuries through church-linked institutions by “professionals” — a religious term in its origin, implying that teachers, nurses, and doctors were expected to place service to others ahead of self-interest. And the provision of public services, too, is taken to be different in kind from that of other services in our economy.

But reform in these areas that recognizes these realities is both essential and possible. We should focus on a number of reforms: unbundling our various integrated welfare programs to allow more targeted piecemeal improvements in government services; permitting greater consumer choice in both education and health care; providing useful, standardized outcome measurements to enable more informed consumer decision-making in all these areas; encouraging new market entrants by loosening regulatory constraints and permitting profits; and, finally, funding demonstration projects for innovative application of technologies and methods that produce measurable gains in stated outcomes-per-unit cost. Realistically, however, the best we can hope for is to make the government, education, and health sectors more market-like. They will never be as efficient as other parts of the economy.

While many reformers advocate the consolidation of various programs, it is noteworthy that Manzi favors the unbundling of integrated welfare programs in the interests of making incremental improvements, an idea I’d love to see discussed in greater detail. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.