The big question for this segment is how do competitive markets encourage innovation? [MUSIC] Ever since the emergence of modern economic thinking in the late 18th century, it's been widely accepted that competitive markets are among the most powerful of all drivers of innovation. You can find the classic formulation of this idea in the work of Adam Smith. Smith traced innovation and wealth ultimately to the division of labor to what he called, and I quote, the propensity to truck, barter, and exchange one thing for another. This propensity, he argued, was unique to human beings. Different people did different jobs, each pursuing their own interest. But the result would benefit everyone as everyone found ways of doing their work with increasing skill. Smith wrote, a particular person makes bows and arrows, for example, with more readiness and dexterity than any other. He frequently exchanges them for cattle or for venison with his companions. And he finds at last that he can in this manner get more cattle and venison than if he himself went to the field to catch them. But note that this mechanism only works if there's competition. If you're the only maker of bows, your customers will have to put up with whatever you produce, and you won't have to innovate. Governments are usually monopolists. If they make and sell things, they can usually eliminate competitors. Given a chance, most merchants will also try to become monopolists, which is why modern governments have laws to prevent the formation of cartels. But where entrepreneurs compete for customers, for labor, and for resources, they have to innovate. This is why many economic historians argue that the increase in market competition in recent centuries drove accelerating innovation. Marx and Engels agreed, they admired capitalism's astonishing capacity to innovate. And in the Communist Manifesto, they argued that modern capitalist societies, that is to say, societies dominated by commerce and the so called bourgeoisie, or entrepreneurs, emerged after the unification of the world in the 16th century. Here's what they wrote, the discovery of America, the rounding of the cape opened up fresh ground for the rising bourgeoisie. The East Indian and Chinese markets, the colonization of America, trade with the colonies, the increase in the means of exchange and in commodities generally gave to commerce, to navigation, to industry, an impulse never before known. Though they might put it differently, most modern historians would agree with a lot in this passage but not all markets and businesses are the same. Some capitalist societies encourage innovation more successfully than others. And governments can play a crucial role in supporting businesses, helping them get finance, protecting their innovations by allowing them to take out patents, funding research that is too costly to be funded by individual businesses, and in many other ways. This module explores some of the different factors that can influence innovation in market societies. Curiously, much economic theory is blind to the economic impact of innovation because it focuses instead on the idea of stability, of market equilibrium. The Austrian American economist, Joseph Schumpeter, is one of the few who insisted that innovation was critical to modern societies, both as a creative and as a destructive force. Today's computer revolution offers a powerful illustration of Schumpeter's ideas, as it destroys old jobs and creates new ones. In the 19th century, both businesses and governments began to actively support innovation by establishing research laboratories. The first research labs were set up in Germany. The Menlo Park laboratory, established by Thomas Edison in New Jersey, illustrates very well how a powerful brew of ego, profit seeking, market competition, and laws that protect entrepreneurs can drive innovation. But research is expensive and that's why governments and large corporations have often played a crucial role in funding or protecting research but there are subtle nuances here. Small businesses often prove more nimble and more open to experimentation than large research institutions. And the atmosphere and management of a workplace can also have an extraordinary impact on the creativity of those working within an organization. No wonder organizations, such as Google, spend so much money on work spaces that encourage serendipitous conversations to synergize collective learning among their employees. Once innovations have appeared, how fast will they spread through exchange networks? Again, different laws and political environments can make a huge difference. Patent laws, for example, can encourage innovators but they can also stifle research by creating temporary monopolies on ideas. Monopolies of all kinds can block the diffusion of good ideas, while competitive markets can usually spread them fast. The Soviet Space Program generated very little trickle down from its complex technologies into the Soviet economy as a whole and the Soviet economy was one huge monopoly. The US Space Program pioneered or encouraged the diffusion of many technologies, including the microchip. So, while there are big forces that encourage innovation, from collective learning to government policy and market competition, there are also many subtler forces that may shape rates of innovation, depending on different legal, institutional, and economic environments. Finally, we have to ask whether some individuals are more likely to innovate than others. Does innovation ultimately come down to personality? Hm, I'm not sure. [MUSIC]
