Science and Profits

Another major question for the economic analysis of technological change is whether innovation is mainly determined by scientific constraints and stimulated by scientific break­throughs in particular fields, or whether it is driven by profit motives.

progress of science, and how important breakthroughs—perhaps macro innovations discussed above—have taken place as scientists build on each other’s work, with little emphasis on profit opportunities. For example, in his History of Modern Computing, Ceruzzi emphasizes the importance of a number of notable scientific discoveries and the role played by certain talented individuals, such as John von Neumann, J. Presper Eckert, John Maucly, John Backus, Kenneth H. Olsen, Harlan Anderson and those taking part in the Project Whirlwind at MIT, rather than profit motives and the potential market for computers. He points out, for example, how important developments took place despite the belief of many important figures in the development of the computer, such as Howard Aiken, that there would not be more than a handful of personal computers in the United States (2000, p. 13). Many economic historians, including Rosenberg (1974) and Sherer (1984) similarly argue that a key determinant of innovation in a particular field is the largely-exogenous growth of scientific and engineering knowledge in that field.

In contrast, most economists believe that profit opportunities play a much more important role, and the demand for innovation is key to understanding the process of technological change. John Stuart Mill provides an early and clear statement of this view in his Principles of Political Economy, when he writes:

“The labor of Watt in contriving the steam-engine was as essential a part of production as that of the mechanics who build or the engineers who work the instrument; and was undergone, no less than theirs, in the prospect of a renumeration from the producers.” (1890, p.

In fact, profits were very much in the minds of James Watt and his business partner, Matthew Bolton as the previous quote illustrates. James Watt also praised the patent system for the same reasons, arguing that: “...an engineer’s life without patent was not worthwhile” (quoted in Mokyr, 1990, p. 248). The view that profit opportunities are the primary deter­minant of innovation and invention is articulated by Griliches and Schmookler (1963), and most forcefully by Schmookler’s seminal study, Invention and Economic Growth. Schmookler writes:

“...invention is largely an economic activity which, like other economic activ­ities, is pursued for gain.” (1966, p. 206)

Moreover, Schmookler argues against the importance of major breakthroughs in science on economic innovation. He concludes his analysis of innovations in petroleum refining, papermaking, railroading, and farming by stating that there is no evidence that past break­throughs have been the major factor in new innovations. In particular, he argues: “Instead, in hundreds of cases the stimulus was the recognition of a costly problem to be solved or a 450

potentially profitable opportunity to be seized...” (1966, p. 199). Other studies of innovation in particular industries also reach similar conclusions, see, for example, Myers and Marquis (1969) or Langrish et al. (1974).

If potential profits are a main driver of technological change, then the market size that will be commanded by new technologies or products will be a key determinant of innovations. A greater market size increases profits and makes innovation and invention more desirable. To emphasize this point, Schmookler called two of his chapters “The amount of invention is governed by the extent of the market.” Schmokler’s argument is most clearly illustrated by the example of the horseshoe. He documented that there was a very high rate of innova­tion throughout the late nineteenth and early twentieth centuries in the ancient technology of horseshoe making, and no tendency for inventors to run out of additional improvements.

A variety of more recent papers also reach similar conclusions. An interesting paper by Newell, Jaffee and Stavins (1999) shows that between 1960 and 1980, the typical air­conditioner sold at Sears became significantly cheaper, but not much more energy-efficient. On the other hand, between 1980 and 1990, there was little change in costs, but air­conditioners became much more energy-efficient, which, they argue, was a response to higher energy prices. This seems to be a clear example of the pace and the type of innovation responding to profit incentives. In a related study, Popp (2002) finds a strong positive cor­relation between patents for energy-saving technologies and energy prices and thus confirms the overall picture resulting from the Newell, Jaffee and Stavins study.

Evidence from the pharmaceutical industry also illustrates the importance of profit incen­tives and especially of the market size on the rate of innovation. Finkelstein (2003) exploits three different policy changes affecting the profitability of developing new vaccines against 6 infectious diseases: the 1991 Center for Disease Control recommendation that all infants be vaccinated against hepatitis B, the 1993 decision of Medicare to cover the costs of influenza vaccinations, and the 1986 introduction of funds to insure vaccine manufactures against product liability lawsuits for certain kinds of vaccines. She finds that increases in vaccine profitability resulting from these policy changes are associated with a significant increase in the number of clinical trials to develop new vaccines against the relevant diseases. Acemoglu and Linn (2004) look at demographic-driven exogenous changes in the market size for drugs

of different types and find a significant response in the rate of innovation to these changes in market sizes.

Overall, the evidence suggests that the market size is a major determinant of innovation incentives and the amount and type of technological change. This evidence motivates the types of models we will study, where technological change will be an economic activity and will respond to profit incentives rather than simply being driven by exogenous scientific processes.

12.3.