Innovation is Driving Economic Growth and Sparking Productivity Gains
By Jared Franz
Capital Group Economist
There’s been a lot of discussion lately about whether innovation — an engine of economic growth for decades — is slowing. Despite the boom sweeping through Silicon Valley, there is concern that American companies in particular aren’t coming up with the kind of groundbreaking advances that they have in the past. These worries have been heightened by a pullback in global productivity, which has been a critical component in raising living standards. The debate is important because there’s little doubt that a prolonged downturn in either innovation or productivity could take a toll on the global economy.
Based on my analysis, these worries are unfounded. In fact, the conditions are in place for innovation and productivity to rise solidly in coming years, both in the U.S. and elsewhere. By some measures, inventive activity is already accelerating, while productivity appears to be nearing a trough. That doesn’t mean either one will surge immediately. These cycles are normally slow to change direction, and the shifts are sometimes only visible after they’re well under way. Still, there have been periods throughout history when each has temporarily dipped before later reaccelerating, and I expect that pattern will play out once again.
For investors, there are bound to be opportunities across many industries as companies introduce a range of products and technologies. Some of these have received a fair amount of attention, such as solar panels, robotics and stem cells. Others are in relatively embryonic form, including genomics, driverless cars and wearable technology. And a few — such as lunar mining and 3D-printed organs — almost seem like the stuff of science fiction. Of course, history is littered with eagerly anticipated inventions that never panned out, and that will undoubtedly be true for some of the current crop. Nevertheless, at a time of rapid technological disruption, businesses in most industries realize there is constant pressure to stay ahead of the development curve and continually reinvent themselves.
Heavy spending on product development is helping to pace economic growth.
Many concerns about innovation center around the idea that it’s impossible for companies to match advances such as the lightbulb and air-conditioning, which laid the foundation for scores of additional breakthroughs in the decades that followed. According to this thinking, progress will continue, but on a smaller scale and with less economic payoff. For example, selling ever-tinier smartphones frees consumers of the need to lug around bulky objects, but it doesn’t compare to the boost that corporate America got from the widespread adoption of desktop computers more than 30 years ago.
There are similar concerns about productivity, which gauges the workforce’s efficiency in producing goods and services. Productivity growth is currently below 1% a year, less than half its long-term average. There are numerous theories about what’s behind this, including lingering fallout from the 2008 financial crisis and the difficulty of measuring shifts in an increasingly services-dependent economy.
But a look at underlying trends offers cause for optimism. One factor is the amount of money that U.S. companies devote to research and development. R&D spending is expected to rise 3.4% this year to approximately $514 billion. That’s roughly 2.8% of U.S. gross domestic product, the highest on record. Though the federal government and academia spend heavily on R&D, industry is the biggest contributor, representing about 70% of the total. This dynamic is also playing out around the globe in countries such as China and Japan.
Another encouraging sign is the number of applications for patents, which now far exceed levels seen prior to the financial crisis. This indicates that innovation is becoming routine across a growing number of industries. Historically, technology and pharmaceuticals have been among the biggest spenders on R&D. But innovation is occurring across a number of sectors, including energy, financials and industrials.
The potential for driverless cars and powerful batteries could transform various industries.
In the auto industry, for example, Ford and General Motors each spent about $7 billion on R&D in 2015, with much of it going toward electric cars. The first company that can build an affordable electric vehicle capable of driving 200 miles on a single charge — a psychological milestone that could change consumer buying patterns — could see an enormous upside. Beyond cars, companies are racing to develop a new generation of smaller and longer-lasting batteries that could transform the way the world produces and consumes energy. For example, sophisticated batteries could hasten the adoption of alternative energy by making it possible to store vast amounts of wind and solar power. Meanwhile, “power packs” could provide energy to homes and businesses in remote regions, allowing them to leapfrog traditional power grids.
Such creative activity would undoubtedly boost productivity, which, in turn, would benefit investors. Driverless vehicles, for example, could allow the trucking industry, which has been beset by driver shortages and rising wages, to streamline operations. It’s true that technological advances displace workers by allowing companies to perform tasks with fewer employees. But the workforce has repeatedly adapted to such changes over the years with minimal damage to the economy, as employees switch from obsolete professions to burgeoning ones. A lot depends on how rapidly this disruption occurs. More widespread use of technology, coupled with other efforts to trim costs, could raise unemployment and suppress wages.
That brings us back to where we started. Beyond any statistic, it’s important to remember that the U.S. economy has proven its dynamism and resilience countless times over the years. That’s been underpinned by a strong entrepreneurial spirit and a higher education system that remains among the best in the world. Although impossible to predict how a specific technology or invention may fare, it has always been a mistake to underestimate the power of American ingenuity.
Jared Franz is an economist based in our Los Angeles office. He has 10 years of investment experience and has been with Capital Group since 2015.