December 2000 Fraser Forum:
Government & Innovation
Innovation, it seems, has become the soup du jour of those seeking public office. But a brief look at government and innovation shows that we should be leery of the role of government in directly promoting innovation.
The Liberals made innovation a central part of their recent election campaign platform. They committed to doubling federal research and development (R&D) to $1 billion while retaining generous R&D tax credits. They established goals regarding venture capital and Canada’s market share of global e-commerce.
In addition, the Liberals undertook a number of budget initiatives. For instance, since 1997, $2.4 billion has been spent on the Canada Foundation for Investment (CFI). It includes grants to create centres of research excellence, $900 million to create Canada Research Chairs, $100 million for knowledge economy research, $160 million for genome research, and some $200 million for general research.
These expenditures were augmented by other spending in support of post-secondary education. In other words, the federal government has spent a whole lot of our money on its vision of innovation and how to develop it in Canada.
Let’s take a closer look at innovation. Joseph Schumpeter, one of this century’s best economists, identified one of capitalism’s greatest strengths as "creative destruction." He described how capitalism could use competition to constantly re-create itself and reallocate resources more productively.
Competition has driven innovation in western societies. Firms and entrepreneurs alike are motivated—even forced—to create new products and develop better ways of providing the products we already have so that they can survive. The result is an endless process of improvement.
Economic historian Joel Mokyr has argued that innovation explains, at least in part, how western societies have become wealthy in a relatively short historical period while many other nations have languished. The importance of innovation cannot be underestimated; it has a remarkable ability to generate economic growth and prosperity.
When it comes to direct government involvement in innovation, however, there is a problem: government is bad at it. Governments are by definition monopolies, and thus not affected by competitive pressures. If a government makes a poor investment decision, or, worse still, makes a politically-motivated investment decision where the investment has little chance of succeeding (other than in generating regional votes), it does not risk going out of business. Politicians and bureaucrats aren’t risking their own life savings. But their activities still have a big cost. Bad government investment decisions mean we all have to pay for the mishaps with higher taxes; and those higher taxes curtail investment spending by individuals and businesses.
That said, there is a role for government in innovation, but the role is not direct. Governments should foster and promote environments within which innovation can occur. The best way to do this is to leave more money in the hands of entrepreneurs and businesses so they can make investments that spur innovation. Entrepreneurs will have more money for investments if governments make tax cuts, including reducing top marginal personal income tax rates, corporate taxes, and reducing or even eliminating the capital gains tax. By recognizing its important, indirect role, government can foster innovation and e-commerce in Canada. Sometimes the indirect approach is the more effective way to help.
Jason Clemens (jasonc@fraserinstitute.ca) is the Director of Fiscal Studies at The Fraser Institute. He has a Masters Degree in Business Administration from the University of Windsor.
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