WHY IS THE U.S. SO INNOVATIVE?: It's considered de rigeur to moan and bitch about the economy right now, but this overlooks a key point, which that even in the current slowdown, the productivity of American firms and workers remains quite high. Boosting productivity is the holy grail of economics, because when it happens, everyone wins -- the economy can grow faster and real wages can rise higher without triggering inflation.

At present, and for the last decade, U.S. productivity growth has outpaced both Europe and Japan. The proximate reason is that the United States has been better at exploiting information technologies (IT) than our allies. A recent NBER paper confirms that IT has lead to productivity surges across the board; an IMF study makes it clear that Europe has yet to experience those spillovers.

The question that remains is, why is the U.S. so good at exploiting innovation? Robert Shapiro has a Slate article explaining why. The killer line (though see below):

"It's the combination of innovation in technology and business operations that usually produces the big benefits. And that's probably why we see no productivity rise in Japan or much of Europe, where IT investment has been nearly as high as here: Labor regulations and other barriers inhibit companies' abilities to use their new IT to change the way they do business."

Will Japan or Europe alter their regulatory structures to permit innovation to flourish? As a Mancur Olson fan, I'm pessimistic.

Now, I'm sure many readers are feeling pretty smug right now, thinking that this is another example of Yankee know-how. But in the long run, this is not a good thing for the U.S. With regard to foreign relations, as Jonah Goldberg notes today, the current gap between the United States and its principal allies is military -- we spend a lot on defense and they don't. If current productivity and demographic trends continue, however, in fifty years the U.S. economy will dwarf both Japan and the combined EU, and the gap will be ever-increasing as these economies shed people. I fear that the problem of "burden-sharing" will return with a vengeance, since these countries may lack both the resources and the manpower to even defend their own countries. As for our economy, we want Japan and Europe to grow, since when they grow, demand for U.S. exports rise.

Developing.... over the next 50 years....

UPDATE: Reader Thomas H. pointed out that the Bush administration is aware of this problem. The much-discussed 2002 National Security Strategy observes:

"A return to strong economic growth in Europe and Japan is vital to U.S. national security interests. We want our allies to have strong economies for their own sake, for the sake of the global economy, and for the sake of global security. European efforts to remove structural barriers in their economies are particularly important in this regard, as are Japan’s efforts to end deflation and address the problems of non-performing loans in the Japanese banking system."

U.S. pressure on Europe and Japan to change their domestic economic institutions are unlikely to work, however, unless significant economic interests within these countries also push for change (this point courtesy of Leonard Schoppa). The problem is, these groups all have vested interests in the current institutional set-up.

ANOTHER UPDATE: If you read Shapiro's Slate article, you'll see that he tries to imply that the Bush tax cuts will actually stifle innovation by raising long-term interest rates. Shapiro is right about the relationship between the two, but he's exaggerating the magnitude of the effect. &c (or is it now etc.?) is on the case.