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Ending Innovation Mercantilism

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The following is a guest post written by Stephen Ezell, Senior Analyst, Information Technology and Innovation Foundation

As it's becoming clearer every day that innovation is the central driver of economic growth, more and more countries are trying to be innovation leaders. Unfortunately, in that quest all too many countries are choosing to go down a path of "innovation mercantilism" by implementing beggar-thy-neighbor strategies designed to gain advantage at the expense of other nations and overall global innovation progress. These nations see the royal road to prosperity as through expanded technology exports and the best way to do that they believe is through gaming the international trading system through a number of mercantilist practices, including by manipulating their currencies, distorting technology standards, providing export subsidies, forcing technology transfer as a condition of market access, pirating intellectual property, and favoring indigenous over foreign technology products and services in government procurement.

While China is perhaps the most egregious example of a country practicing innovation mercantilism, it is by no means the only one, as similar (if not as prevalent) practices can be found in Brazil, Argentina, India, Japan, Russia, Singapore, South Korea, and a host of other, even European Union, nations. As these countries bend and break the rules, play zero-sum games, and think only about short-term gains for themselves at the expense of the rest of the world, they undermine and destabilize the international economy and risk killing the innovation goose that would lay the golden egg for them and for the rest of the world.

In a just-released report, The Good, The Bad, The Ugly, and The Self-Destructive of Innovation Policy, the Information Technology and Innovation Foundation (ITIF), provides a comprehensive catalog of countries' innovation policies toward skills and immigration, trade, tax, scientific research, intellectual property, government procurement, standards, and regulations. The report assesses whether countries are implementing innovation policies in ways that are either: 1) "Good," benefiting the country and the world simultaneously; 2) "Bad," failing to benefit either the country or the world; 3) "Ugly," benefiting the country at the expense of other nations; or 4) "Self-destructive," actually hurting the country while benefiting others. It finds that, unfortunately, the Good policies tend to be outnumbered by the Bad, Ugly, and Self-destructive ones.

Many of the fastest growing innovation policies are of the Ugly variety; benefiting the country, at least in the short run, but hurting the rest of the world. Mercantilist practices can indeed be effective--there is no doubt about that. China's "Ugly" practices such as currency manipulation, pilfering intellectual property, and forcing technology transfer as a condition of market access have in fact boosted the country's exports, moved productive activity to its shores, and hurt foreign producers (and in many cases knocked them out of business entirely). From 2006 to 2010, China's share of world exports jumped from 7 to 10 percent and the country ran up a $826 billion trade surplus in the years 2007 and 2008 alone.

But many of the policies that nations think are beneficial to them are actually Bad. That is, the policies hurt not only the rest of the global economy, but also the economy of the nation implementing it. An example is mercantilist countries' practice of manipulating their currencies to artificially lower them in an attempt to help their exporters. But doing so raises the price of capital goods, especially for information and communications technology (ICT) products, inhibiting the diffusion of ICTs throughout all other sectors of their economy, making those sectors less competitive, and causing overall economic productivity to stagnate. As another example of a Bad innovation policy, for every $1 of tariffs India imposed on imported ICT products (as part of its efforts to spur an indigenous computer industry), the country suffered a net economic loss of $1.30.

Why then do so many nations pursue Ugly, Bad, or even Self-destructive innovation policies? Most of them--and the apologists who defend them--have convinced themselves that they need to do this to succeed economically. They are wrong. They believe that "exports are needed to create jobs." In fact, exports don't create jobs, at least in the moderate to long-term. These nations could achieve full employment just as readily by implementing a loose monetary policy, aggressive fiscal policy, and an effective social safety net. They don't need trade surpluses to employ all their workers.

They also claim that innovation mercantilism helps them move up the value chain and get richer. But in reality, the much surer way to get rich is through raising the productivity levels of all industries, not just export-oriented ones, particularly by applying innovation and leveraging information technology. Just look at Japan. It certainly boasts world-leading manufacturers in automobiles, consumer electronics, and ICT products, but the non-traded sectors of its economy, such as retail, have only a fraction of the productivity of Western ones, it trails badly in the usage of ICTs, and it conspicuously lacks any world-class service firms. Consequently, the overall productivity of Japan's economy is 70 percent of America's. As a recent New York Times article made clear, as Japan has reached the dead-end of a predominantly export-led growth strategy, it has fallen into economic malaise.

Finally, many of these policies impoverish, not enrich, their citizens. For example, If China didn't run its $428 billion trade surplus and instead imported real goods and services instead of Treasury bills, Chinese households would on average see a 17 percent increase in their disposable income.

While many nations have bought into the wrong economic theory, it wouldn't be as serious a problem as it is if their misguided policies didn't also hurt other nations individually and global innovation rates overall. For example, when a country steals intellectual property, instead of itself expanding R&D funding, it lowers global knowledge stocks. Likewise, when one country manipulates its currency, others feel forced to follow suit to stay competitive. Thus, the global trading system devolves into a competition where every country is incented to cheat and so the overall global economy suffers. Other countries' mercantilist policies not only move innovation-based jobs away from the United States, which is bad for us, but also undermine globalization, which is bad for all.

As such, we need a system of globalization that moves nations away from Bad, Ugly, and Self-destructive polices toward Good ones, such as improved education systems, an openness to high-skill immigration, increased R&D funding, effective science and technology policies, policies to spur widespread digital transformation of their economies, etc. Good innovation policies benefit the entire world, because innovations in one place ultimately spillover to the benefit of citizens worldwide. Think of a new pharmaceutical developed in South Korea or France that benefits all peoples, or when nations adopt new techniques in teaching and training.

To be sure, when other nations implement Good, effective innovation policies, it means the U.S. will have to compete even harder to be successful in the global race for innovation advantage. So when France trumps the United States by offering an R&D tax credit six times more generous, or Denmark creates innovation vouchers for small businesses, or the Netherlands and Switzerland offer tax exempt status for profits generated from a newly patented product, this is all tough, fair competition. Ideally, countries' constructive innovation policies spur other countries to emulate or improve on them, and all countries win.

How can we end innovation mercantilism and develop a better approach to globalization? We need to start with a recognition that the current approach to globalization is not working. The new approach should be grounded in the perspective that markets drive global trade; that countries adhere to their trade agreements; that genuine, value-added innovation across all sectors drives economic growth; and that fair competition between nations to develop the best innovation policies is good for the world.

At the coming mid-November G-20 summit, President Obama needs to insist that putting an end to countries' rampant innovation mercantilism and developing a more sustainable vision for globalization top the agenda. The G-20 should demand that the World Bank and other multinational development agencies reformulate their strategies with a focus on supporting only countries that mostly practice Good innovation policies, and withdraw support from those whose predominant strategy is based on Ugly and Bad ones. The WTO needs to finally recognize and combat that what has been transpiring in the global trading system is not occasional and random infractions of certain trade provisions by countries that should be handled on a case-by-case basis, but rather that some countries continue to systematically violate the core tenets of the WTO because their dominant logic toward trade is predicated on export-led growth through mercantilist practices.

The only way to stop countries' systematic manipulation to gain competitive advantage by beggaring their neighbors is if the nations which engage in it less than others--principally the U.S., the Commonwealth nations, and most European countries--alongside with international organizations including the World Bank, WTO, and the International Monetary Fund agree to cooperate to fight it.

The status quo is no longer sustainable. We should use the institutions and rules we have at our disposal with more gusto and nip innovation mercantilism in the bud. However, if these measures prove insufficient, it may be time to think about establishing a new trade zone, perhaps modeled on the Trans-Pacific Partnership, which would include only those nations committed to good innovation policies.

Innovation is poised to continue to bring globally shared growth and prosperity--but policymakers must understand this will only happen if all countries are compelled to play by the rules mutually established by the international community to guide the economic interactions between nations.