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A Bretton Woods for Innovation

From the Fall 2011 Innovation issue

By Stephen Ezell

Sixty-seven years ago, representatives from 44 nations convened in the small resort town of Bretton Woods, New Hampshire to make financial arrangements for the post-World War II economy. The meetings spawned the International Monetary Fund, the World Bank, and the General Agreement on Tariffs and Trade—the precursor to the World Trade Organization.

While these institutions worked well for half a century, now that the commodity-based manufacturing system has evolved into a knowledge and innovation economy, the strains on the Bretton Woods system have become clear.

As countries increasingly recognize that innovation drives long-run economic growth, a fierce race for an innovation advantage has emerged. During the past decade alone, over three dozen countries have created national innovation agencies and strategies. Going forward, the challenge will be to balance countries’ pursuit of the highest possible standard of living for their citizens in a way that promotes, rather than distorts, global innovation.

We need a new international framework that sets clear parameters for what constitutes fair and unfair innovation competition, creating new institutions (and updating old ones) that maximize innovation.

THE GOOD, THE BAD, THE UGLY

Countries’ focus on innovation as the route to economic growth creates both opportunities and risks. They can apply their innovation policies in ways that are:  “Good,” benefiting the country and the world simultaneously; “Ugly,” benefiting the country at the expense of other nations; “Bad,” appearing to be good for the country, but actually failing to benefit either the country or the world; or “Self-destructive,” failing to benefit the country while benefiting the rest of the world.

“Good” innovation policies include increasing investments in scientific research; offering research and development tax credits; welcoming highly skilled immigrants; providing strong science, technology, engineering, and math education; and deploying advanced information and communications technologies. Countries’ “Good” innovation policies are positive for the entire world—as discoveries, inventions, and innovations made in one nation ultimately spill over to the benefit of citizens worldwide, even as they drive economic growth in the originating nation. For example, the United States initially profited the most from creating the Internet (enormous economic growth was generated by start-up “dot-coms”), but now the Internet’s benefits flow to billions around the world.

Countries’ “Ugly” policies include intellectual property theft or forced technology transfers as a condition of market access (designed to promote innovation in one nation to the detriment of others). China’s government forces many multinational companies to share their technologies with state-owned enterprises in order to operate in the country.

To compete in China’s high-speed rail market, for example, foreign multinational locomotive manufacturers like Japan’s Kawasaki or Germany’s Siemens had to offer their latest designs and produce 70 percent of each system locally. As a result, China’s state-owned locomotive manufacturers, CSR and CNR, acquired key technologies and manufacturing know-how. Now they not only dominate China’s market but compete internationally against the same multinationals that supplied them with the knowledge and skills in the first place.

“Bad” policies are strategies like import substitution industrialization that a country believes will help it, but in fact do more harm than good to the country’s economy. For every dollar of tariffs that India imposed on imported information technology products (in its effort to spur creation of an indigenous information industry) it suffered an economic loss of $1.30 because its firms and citizens had to use inferior technologies. Back in the days of Indira Gandhi’s rule, news bureaus seeking to bring the first American PCs into New Delhi found them impounded, and their executives told they should buy an Indian product—a gargantuan contraption with vacuum tubes that took up a large room.

Finally, “Self-destructive” innovation policies, such as the United States’ unwelcoming posture toward highly skilled immigrants, hurt a country while actually benefiting competitors.

Sadly, there is disturbing evidence that the global economic system is increasingly distorted, as a growing number of countries embrace what might be called innovation mercantilism. These approaches are based on the view that achieving economic growth through technology exports is preferable to raising domestic productivity through genuine innovation. 

Such nations—and China is only the most prominent—are not so much focused on innovation as on the manipulation of currency, government procurement, technology standards, intellectual property rights, and non-tariff barriers to gain an unfair advantage favoring their own technology exports in international trade. China’s currency manipulation, Brazil’s neglect for foreign intellectual property holders’ rights, and the European Union’s tariffs and restrictions on information technology imports are all forms of innovation mercantilism.

Such practices impose large costs on the global economy, while retarding global innovation and productivity. For example, by stealing intellectual property, countries reduce revenues that could have been invested in innovation. Indeed, in 2007, intellectual property theft reduced global trade by 5 to 7 percent, according to the World Customs Organization. Likewise, the OECD says that complying with country-specific technical standards adds 10 percent to the cost of an imported product.

To be sure, there is nothing wrong with countries engaging in aggressive innovation and economic competition—so long as they are competing according to the rules established by the global community. In fact, when a country competes intensely, within the rules of the system, it benefits both itself and the rest of the world. That’s because fair competition forces countries to implement the right policies to support science and technology, the right tax credits to encourage research and development, and the right education policies to train the next generation.

So when France offers an R&D tax credit six times more generous than the United States’, or Denmark creates innovation vouchers to help small businesses, or countries increase their investments in science and technology, they make tough, fair moves that force other countries to raise their games by enacting “good” policies of their own. The problem occurs when countries start to use “ugly” policies. Such strategies create incentives to cheat, and the whole system fails as everyone fights for a slice of an ever shrinking pie.

FAILING INSTITUTIONS

Unfortunately, the international economic system is governed by institutions rooted in a past era. Regrettably, the Bretton Woods framework was not designed to maximize innovation. So far, the international order has failed to produce a sustainable globalization system largely because it’s organized to deal with finances and the flow of goods across borders, not with innovation.

Not only are the three major international economic organizations—the IMF, World Bank, and WTO—ill-equipped to take on new forms of unfair or counterproductive behavior but also, by sins of omission and commission, they perpetuate the problems. These institutions do little to promote innovation policies and even less to pressure countries to play fair. There’s no one refereeing the global innovation competition.

Established after World War II, the IMF was charged with overseeing the international monetary system—the exchange rates and payments that enable countries and their citizens to buy goods and services from one another. The new entity was designed to ensure exchange rate stability and encourage member countries to eliminate trade restrictions. Unfortunately, the IMF has proven unwilling or unable to take serious action on its most important charge—curtailing the rampant currency manipulation that continues unabated in countries such as China.

As for the World Bank, not only does it do almost nothing to pressure innovation mercantilists to shape up, it often unwittingly abets them by failing to differentiate between legitimate policies and mercantilist policies. To see why, it is important to recognize that the World Bank isn’t really the “world’s” bank. It’s a collection of country desks (for example, the China desk and the India desk). The Bank’s development professionals appear to be evaluated primarily on their response to one question—did they support projects that spurred economic growth in the countries for which they are responsible? 

If they can get China or India to export more earth movers, routers, biotech products, or airplanes to the rest of the world, they get rewarded. It doesn’t matter if the result is fewer American or European workers making earth movers, routers, biotech products, or airplanes.

Like the other two bodies, the WTO has largely abdicated its role in fighting innovation mercantilism. Instead, it adjudicates disputes and views what is systemic as merely occasional infractions of trade provisions that should be handled on a case-by-case basis.

Why do these international organizations either sit on the sidelines or actively support nations engaged in innovation mercantilism? It’s because sustainable global innovation is either not their mission or not thought to be important. For the WTO, expanded trade flow is all that matters. For the World Bank and the IMF, two priorities stand out—responding to individual national economic fiscal crises and ensuring robust international capital and trade flows. Neither asks if these are the results of deeply dysfunctional mercantilist policies.

NEW FRAMEWORKS

It’s time to create an international innovation policy framework that will spur a robust global innovation economy. First, it must recognize that the central task of global economic policy should be to encourage nations to boost innovation and domestic productivity, instead of focusing on export-led growth.

The second step is to revamp the mission of existing international bodies not only to support sustainable global innovation but also to fight against innovation mercantilism.  This means stronger enforcement by global bodies like the WTO against mercantilist strategies. Third, international development organizations need to reformulate foreign aid policies as carrot-and-stick tools to prod countries toward the right kinds of innovation policies.

Finally, we need more capable international institutions that support global science and innovation. Now more than ever, the benefits of research flow globally. Nations that invest in science and research are not just helping themselves, but the entire world.

But many countries invest too little in R&D, free-riding off investments in leading countries like the United States, Germany, and Japan. The worldwide benefits of pharmaceuticals allow governments to receive new drug developments without having to pay the associated costs of researching that drug. Britain free rides by only allowing a return on domestic capital and investment. Pharmaceutical companies cannot take into account the cost of American or other foreign R&D when determining the price to sell in the U.K.

Moreover, there is less focus on global challenges. We see this particularly in research that could produce non-carbon energy sources or address pandemic diseases. In part, this is because in hot high-tech fields like biotechnology, patent races develop with competing nations perceiving a winner-take-all situation where they believe value can be appropriated from knowledge only by those who first create it. As David Hart, professor of science and technology policy at George Mason University, and Dieter Ernst, senior fellow at the East-West Center, note, “the result is duplication of effort, imprudent crash programs, and even outright fraud.”

Leading nations should therefore establish a Global Science and Innovation Foundation. GSIF’s mission would be to fund scientific research around the globe on key challenges and in particular support internationally collaborative research. For any nation to be eligible to receive funds, it would have to commit 0.1 percent of its GDP in funding and be certified by the IMF as a nation not engaged in innovation mercantilism. Such an agency would be as committed to implementing a Bretton Woods for innovation as the IMF has been to implementing the goals of the original post-World War II fiscal conference.

 It’s time for the world to move beyond seeing the pursuit of economic growth through innovation as a zero-sum game, where one country’s loss is another’s gain. The goal, instead, should be to embrace mutual global prosperity as the ideal—indeed, a multiplier—of any investment.

A new approach is needed, one grounded in the ideas that markets drive global trade; that countries should adhere to their trade agreements; that genuine innovation drives economic growth; and that constructive competition forces countries to ratchet up their game by putting in place “good” innovation policies. 

New institutions will have to be created—and old ones updated—to realize this vision.

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Stephen Ezell is a senior analyst with the Information Technology and Innovation Foundation (ITIF). He is the co-author with Dr. Robert D. Atkinson, the foundation’s founder and president, of the forthcoming book The Global Race for Innovation Advantage, and Why the U.S. is Falling Behind (Yale, 2012).

[Photo: Marshall Hopkins]

(Downloadable PDFs of individual World Policy Journal articles can be purchased through SAGE.)

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