Are we innovating outside of software and finance?

July 24, 2012

This assertion, from eccentric libertarian billionaire Peter Thiel, caught my eye (via Matt Yglesias):

I think we've basically outlawed everything having to do with the world of stuff, and the only thing you’re allowed to do is in the world of bits. And that’s why we've had a lot of progress in computers and finance.

The idea here is that government regulation has gotten so onerous that innovation outside of software (hardware, I assume, is what Thiel would classify as the "world of stuff") and finance is impossible. One way of seeing if this is true is to see if there actually has been innovation outside of finance and software over the past few decades. If there has, then Thiel is trying to explain a phenomenon that is not in fact there.

Economists generally measure technological progress using a figure called "total factor productivity" (TFP). Under the standard model economists use to study economic growth, you can look at the size of the economy as being the result of multiplying how much capital (savings, infrastructure, machines, etc.) exists by how many hours people are working, and then multiplying by a third number that represents how good our technology is at turning that labor and capital into valuable goods and services. This third number is "total factor productivity". Generally, an industry is innovating if total factor productivity is going up, since that indicates that technology in that sector is improving. The Bureau of Labor Statistics measures TFP by sector of the economy. Here's how different sectors have fared since 1987, relative to where they were in 2005:

 

 

 

 

 

 

 

 

 

"Securities" is the subsection of finance that deals with futures contracts, derivatives and other financial instruments that have seen a lot of growth in the past few decades. "Software" includes companies like Microsoft that develop and distribute software, "Internet services" includes Internet service providers, search engines and other Internet-related products, and "custom programming" covers companies that write customized software for other firms.

As you can see, there has been tremendous innovation within the securities industry over the past 25 years. Whether that innovation has been to the good is a matter of debate, of course, but the finance industry has certainly gotten better at turning its labor and capital into profits. But software and custom programming have innovated at roughly the same pace as manufacturing, trade and agriculture — the sectors Thiel alleges are banned from innovating. Information services actually wasn't innovating until about 2000, when companies began to figure out how best to profit off this crazy Internet fad. Since then, it's been innovating roughly as fast as manufacturing and other non-tech, non-finance sectors.

Agree or disagree with Thiel's politics, he's trying to explain something that isn't happening.  Now, there are some who argue that we're nearing the end of the point where we can innovate at the speed we have been. Tyler Cowen made this argument in his book "The Great Stagnation," and Thiel has made a version of it in the past. But the idea that finance and tech are somehow special just doesn't hold up. Indeed, this is an old story to economists. As Nobel prize winner Robert Solow once quipped, "You can see the computer age everywhere but in the productivity statistics."

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