commentary

(Pittsburgh Post-Gazette)

September 17, 2009

Capitalism Still Works: Our Economy Will Recover Because We Are Innovators and Entrepreneurs

by Krishna B. Kumar

On the campaign trail and in the Oval Office, President Barack Obama has promised to restore America's standing in the world. The damage done by the financial crisis now seems to require not a refurbishing job but an extreme makeover.

While soul-searching and even self-loathing are inevitable during a crisis, this is no time for America to shy away from a capitalist system that has produced decades of economic growth. On the contrary, as he prepares to host the G-20 leaders in Pittsburgh next week, Mr. Obama should turn to innovation and entrepreneurship—the primary engines of growth and the traits for which the world has admired America—both to rescue its sagging image and regain its economic footing.

The global crash has been widely viewed as an American export and even as a failure of the U.S. model of capitalism. After all, the boom that preceded the crash saw economic gains mainly accruing to the top 1 percent of the U.S. population. And the U.S. meltdown followed the extraordinary growth of China and India—neither of them replicas of American capitalism.

With Brazil and Russia also booming, the U.S. and Western share of world GDP has been steadily decreasing. To the new kids on the block, it was already clear that U.S. power was fading. The crisis merely etched that epitaph on the tombstone.

Or did it? In fact, the perception of American decay has far exceeded reality. When Chinese Premier Wen Jiabao, whose country holds more than $800 billion in U.S. government notes and bonds, rapped America's knuckles about getting its financial house in order, speculation grew that this spelled the end of the dollar and that global lenders would begin shunning Uncle Sam.

As it turned out, the implied threat that China would dump U.S. bonds was never credible because doing so would have tanked the value of Beijing's own portfolio. So interest rates have not soared and recent research shows that the rest of the world likes to hold U.S. bonds because its much-maligned financial system is better developed than their own.

Yes, many aspects of the U.S. economy need mending. Strengthening enforcement of financial regulations would be a big step forward. Reining in the Ponzi schemes of the Bernard Madoffs does not require new laws. It requires better enforcement of existing regulations and smarter spotting of new trends in financial innovation.

Likewise, the United States should eliminate the perverse incentives that cause rating companies to systematically underestimate risk and prompt investment funds to compensate their managers based on short-term performance.

We need to fix what's broken. But even more, we need to stimulate what isn't broken—innovation and entrepreneurship.

By increasing productivity, innovation drives growth. Creative and flexible approaches to education, research and business are crucial for innovation—and these happen to be America's comparative advantages.

Though its expenditure of 2.7 percent of GDP on research and development is not the world's highest (Japan spends 3.4 percent), the United States has granted some 324 patents per million people, more than any other country. Japan has granted 278 and Germany 138. The United States also has published the highest number of scientific and technical journal articles per million people—692, compared with 434 by Japan and 535 by Germany.

As Jeffrey Immelt, the chairman and CEO of General Electric Co., wrote recently, "We need to dispel the myth that American consumer spending can lead our recovery. Instead we need to draw on 230 years of ingenuity to renew the country's dedication to innovation, new technologies and productivity."

Economic downturns offer great opportunities for reinvention because the opportunity cost of doing something new (what people give up when they stop doing what they were doing) is low. That's why U.S. higher education enrollment has surged since wages dropped.

The same "less to lose" principle works for companies, because in a recession the cost of diverting resources from current sales and marketing to R&D and the commercialization of ideas is low. Mr. Immelt's own GE has restructured during the downturn, increased its investment in research and development and now plans to launch more new products than at any time in its history.

The United States is the most entrepreneurial country in the world, due to ready availability of venture capital, education that is as practical as it is conceptual, ease of commercialization and openness toward immigration. According to a report published by the Global Entrepreneurship Monitor, a not-for-profit research consortium, high-growth early-stage entrepreneurial activity in the United States is more than twice that of Germany and more than three times that of Japan.

Many laid-off U.S. workers are reportedly starting their own companies. This is nothing new. According to a Kauffman Foundation study, more than half of the current Fortune 500 companies were founded during a recession or a bear market or both.

Economic recovery cannot be mandated. The government need only facilitate innovation. Government has done so in Pittsburgh, helping it emerge as a hub of green-energy technologies.

State Sen. Jim Ferlo, D-Highland Park, and U.S. Rep. Mike Doyle, D-Forest Hills, are coordinating the efforts of Pittsburgh's green "ecosystem" (entrepreneurs, labor, universities and others) under a loose coalition called Green Innovators. Some of the federal stimulus money has been set aside for renewable energy projects and Pittsburgh's entrepreneurs have been eyeing this eagerly.

It is these entrepreneurs who are responsible for the former city of soot going green, for the dizzying growth of solar-cell makers such as Solar Power Industries and for PPG Industries (formerly Pittsburgh Plate Glass) now making components for windmill blades.

American companies are innovating. An energized Securities and Exchange Commission is enforcing. Individuals eager to retool their skills are enrolling in schools in large numbers. And sidelined workers are starting businesses. From this vantage point, Mr. Obama's makeover job doesn't seem extreme after all.


Krishna Kumar is a senior economist at the RAND Corp., a nonprofit research and analysis organization based in Santa Monica, Calif., with an office in Pittsburgh (kumar@rand.org).

This commentary originally appeared in Pittsburgh Post-Gazette on September 17, 2009. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.