Tuesday, February 17, 2015

Does social democracy / a large welfare state kill innovation?

Image: At The Next Web, Brad McCarty documents the history of the smartphone, including this 2001 state-of-the-art Nokia Communicator.

[Updated--see below]

As I often do with viewpoints I don't like, I find the most reputable expression of that idea so I can't be accused of choosing a poor representative for my critique. Enter Daron Acemoglu (MIT), James A. Robinson (Harvard), Thierry Verdier (Paris School of Economics), and their 2012 non-peer-reviewed paper Can't We All Be More Like Scandinavians? People with Big Ideas about welfare states eagerly point to this paper as proof that their evidence-free Big Ideas were right all along. Let's see what this paper really says.

The thrust of the paper is this: it's a well known fact that large welfare states stifle innovation, mostly due to limiting inequality and perhaps also by limiting economic insecurity. These are the "cuddly capitalists" (their term). In the "cutthroat capitalist" (their term) countries, inequality is much greater and economic security more tenuous, and--as a direct result--innovation is greater. Since the rewards are so great for success--and the consequences for failure so severe--incentives line up perfectly to maximize innovation.

So far, this isn't anything new. But Acemoglu, Robinson & Verdier take this logic one step further. Not only is there greater innovation in the cutthroat capitalist countries, they posit, but the innovation of the cutthroat capitalists makes cuddly capitalism possible. Were it not for the greater innovation and resulting economic growth which spills over from the cutthroat to cuddly capitalist countries, the large welfare states of the cuddly capitalist countries would not be possible.

But wait! There is a slight bump in the road to solemnly dismantling the welfare state in the name of innovation. It's always taken as fact that the United States, the most cutthroat of the capitalists of the developed world, handily beats the rest of the world in innovation and technology. But where is the evidence?

Fortunately, Acemoglu, Robinson & Verdier have marshalled the strongest evidence available to demonstrate the superior capacity for innovation in the United States compared to the social democracies:
The United States is also widely viewed as a more innovative economy, providing greater incentives to its entrepreneurs  and workers alike, who tend to respond to these by working longer hours, taking more risks and playing the leading role in many of the transformative technologies of the last several decades ranging from software and hardware to pharmaceuticals and biomedical innovations. Figure 1 shows annual average hours of work in the United States, Denmark, Finland, Norway and Sweden since 1980, and shows the significant gap between the United States and the rest.
Sure enough, in a graph with a y-axis that doesn't begin at zero, Figure 1 indeed shows that people in the United States work more hours than in Scandinavia, except for the weird part in the early 80's (and earlier) where the Finns worked longer, that I guess we're just ignoring:

Some problems should be immediately obvious.

First, Acemoglu, Robinson & Verdier use the United States to represent all of the cutthroat capitalists. Might their conclusions be stronger if they considered other countries with high inequality and a fragile social safety net? This issue will be taken up below, but it shouldn't be too hard to guess why they omitted other cutthroat capitalists, like New Zealand and Ireland, from their analysis.

Second, Acemoglu, Robinson & Verdier assume that more work hours at the aggregate level results in more innovation. It doesn't. Longer aggregate work hours are simply indicative of higher poverty rates. It's well established that people work longer hours in countries with higher poverty rates. Thus, since the United States has such a high poverty rate while the Scandinavian countries have such a low poverty rate, it's no surprise that the average number of hours worked is lower in the Scandinavian countries. Clearly, average hours worked each week isn't a proxy measure of innovation, but a proxy measure for a country's poverty rate.

Third, productivity research is unequivocal that working more hours results in less innovation, not more. For a striking example, productivity experts estimate that if the early Macintosh engineers had worked 40 hours per week instead of 90, the first Macintosh computer would have been ready for release a full year earlier. In short, all available research argues that long hours lead to less innovation--meaning that Acemoglu, Robinson & Verdier could scarcely have chosen a worse proxy measure for innovation.