What economy needs to have a successful Innovation Ecosystem?

There is an important, interesting topic for entrepreneurs, policy makers, people from venture industry, and eventually, for ordinary citizens who benefit from innovations. It is:

How to create a successful innovation ecosystem and what are those enabling factors that should be implemeted within a given economy?

Recently I’ve read a couple of interesting books about innovation ecosystems (one of them I warmly suggest you to read – “The Rainforest: The Secret to Building the Next Silicon Valley“) and democratic capitalism (“How Capitalism Will Save Us: Why Free People and Free Markets Are the Best Answer in Today’s Economy”). I would like to give you short summary of these books and my opinion on the points presented there. Moreover, it’s interesting to read these books syntopically (meaning having in mind one subject or topic, and crossreading in several books and from several authors).

Steve Forbes argues that free markets is the ultimate answer for the most advanced economies that can solve existing problems. He believes free market is the best economic stimulus which is creating an environment that allows companies and people to mobilize the vast resources and lead to prosperity and wealth. Sometimes he also repeats the thoughts from the famous book “Atlas Shrugged” by Ayn Rand when he saying that any intervention of the government in the economic activities that leads to restriction of free markets ends up in a crisis or depression.

On the other hand, Victor W. Hwang and Greg Horowitt explain the nature of innovation ecosystems with a perspective from profound theoretical background. they, however, add a very important dimension – human networks, and cultural behaviour. They argue that free market thinking fails to consider the impact of human nature on the innovation process. This ambitious work challenges the basic assumptions that economists have held for over a century.

So, the question I am going to put also is what’s missing from the traditional philosophy of the free market? Especially, when we think about behavioural economics and what Mr. Hwang and Mr. Horwitt call Rainforests, including insights on sociobiology, design theory, and the latest research in neuroscience and social network.

Conditions of the health economy …

… that could have successfull innovation ecosystem. Let me provide a short list mentioned by Steve Forbes and my comments on this list. I will try to put examples that are coming from my Russian experience. This list could be used also as a checklist for analysing the current conditions of a given economy.

  • The rule of law. Economy requires that terms of commercial contracts are respected and enforced, and that everyone, including politicians and government bureaucrats, abide by them. Legal system and the rule of law should guarantee safe environement for investors, business and people. Comment: Totally agree with this statement. It is very interesting how nations and countries differ from this point of view. Those countries that have spent less time in building a society where law is considered among top priorities for country’s development could be easily recognized. Let us compare UK and Russia. The last one has problems with legal system. Mainly due to short history of legal system overall. The first one on opposite has long democratic traditions with a Parliament operating since 18th century, while as in Russia the first one appeared in the beginning of 20th century, it existed very short time period, then we came back to that system only 75 years later after the Soviet Union disappeared. Brits have been living under the law for a very long time, while Russians were lacking laws during Tsarism, then under Soviet Government. What Russians developed extensively is “living under conscience”. On the oe hand it’s good, on the other hand there is no objectiveness, or unite source of justice. This leads to bribes and corruption. I’m not going to expand this thought further. However, the main point is that the traditions of legal system and orientation of the country towards the rule of law is absolutely one of the key elements for healthy economy.
  • Respect for property rights. There should be no fear that government could suddenly seize your property or nationalize your business. Property rights are a critical part of the rule of law. Your own business, an object, a piece of land, or a house or building must be protected from any interventions, including government, lobby, other businesses. Risk taking will decline in a society which doesn’t have strong property rights. Entrepreneurs would be forced to protect their property by buying influence with the political powers that be, wasting time and resources that would otherwise be devoted to growth-producing enterprises. Property rights help create prosperity because they allow people to use what they own as collateral. Property is one of the key sources of capital. Comment: I am 100% sure that entrepreneurship is firstly about risk taking. It’s embedded in the word entrerpeneur by the way. So, any environmental change that helps entrepreneur to deal with huge amount of risks is worth to consider. Property rights comes almost first in the list. I have no doubt about importance of it. Let me give you an example of comparing Russia in the so called “wild 90’s” and Russia today. There is a huge difference. Back in 90’s situation was much worse. Father of one of my best friend was a head of production of rather big plant (will not name the firm due to privacy issues). So he was telling me that the situation every day at that point of time was like, “I didn’t know am I going to be back home any given dya or not. Will I be able to maintain my property or not? Will those gangster clans seize the production I was responsible for or not?” Nowadays, situation is much better. There are certain rules and policies. However, recent protests (see 2012) showed that still government doesn’t provide sufficient level of confidence for investors, bussinessmen and ordinary people. Again, the factor is first in the row to work on.
  • Stable money. A strong and stable currency is the bedrock of a prosperious economy. Comment: Being honest have nothing to say here. Obviously true.
  • A progrowth tax system. Low taxes on income, profits, and capital gains foster more risk taking and higher growth, bringing a richer economy with a higher standard of living – and with higher government revenues. Comment: I would add a point here. I think that it’s important to have a well balanced tax income system. Not only a progrowth tax system, but a well balanced one! This is a very interesting and may be not obvious factor. So, how come? We lower taxes and get more profits for society and government in particular, do we?! Let us consider structure of tax income in the US, UK and Russia in 2011. I bring these three countries as a nexample because the structure of their budgets is different. However, there are some common characteristics which I would like to explore.

    Budget Tax Income 2011 (US, UK, Russia)

    Budget Tax Income 2011 (US, UK, Russia)

    You will easily find out that the main sources of revenue for budget are income (from citizens (rich, middle class, and poor)) and business taxes (corporations and MNCs, VAT), also customs (coming from import goods). Interesting point that more than 70% of income tax in the US is paid by rich people (top 10% of earners). Thus, tax cuts mainly influence top 10% of US citizens. Consequently it is mainly rich people who can create incentives for individuals to work, save, and invest, which can generate more revenue. Creating opportunities for them means creating opportunities for the economy, which leads to growth and prosperity.

    US_Percentage of federal income taxes and Income earned _ 2009

    US_Percentage of federal income taxes and Income earned _ 2009

    US_Tax payers_top10-percent-income-earners

    US_Tax payers_top10-percent-income-earners

    You could find this data here.

  • Ease of starting a business. One of the key factors that World Bank examines in it’s annual survey “Doing Business” is how difficult or easy it is to launch a legal commercial enterprise. It’s ranging from how much time does it take to start and access to capital to how many permissions do you need to obtain. Comment: Not a surprise that easyness of starting a business stimulates entrepreneurship. That’s why many entrerpeneurs are seeking opportunities in the US for instance.
  • Few barriers to doing business. Government should not create protectionist tariffs, regulations or barriers for business to act. If the cost of economic activity rises, less of it will take place. Comment: Agree 100%.

To summarize, if the government is able to stimulate an economy by creating a favourable environment, protecting rule of law and property rights, institutioning low taxes, ensuring sound money, and removing obstacles to starting and building a business, it will make easier for economic activity to take place.

What’s missing from the free market?

All assumptions that were made before are true for so called free market. Let us consider those assumptions (I will list only key of them).

One of the key principles of free market – it is the best at serving the needs and wants of people. Free market is about achieving the greatest possible mutual benefit because no one is forced to enter into a free-market transaction. That’s why central planning and demand for innovations dictated only by government or corporations will not reflect real life and eventually will not meet needs of people.

My comment: The question is that the system doesn’t consider that people behave imperfectly, people’s needs are different according to different levels of society development. What we will always have is Maslow’s hierarchy of needs which tells us morality, self-confidence, friendship, respect of others will come after satisfaction of basic needs like food, roof over your head, protection. In other words, self-actualization and esteem comes after the physiological needs and safety. Thus, needs of people in different societies, countries and economies will be different according to the level of this pyramid. Therefore, the principle of free market will be trasformed into serving those needs of people that are currently prevail in society. If the nation is starving, people mostly will think about how to get food and methods could be very different. Just look back at examples of Germany in 30s, Russia in 20s, Africa in 80s and 90s, etc

Maslow's Hierarchy of Needs

Maslow’s Hierarchy of Needs

Second key principle is self-interest – not “greed” – compels people in free markets to meet the needs and wants of others. Winston Churchill said that democracy was not perfect but that it was the best political system available. Combined with capitalism we get so called democratic capitalism – the only system in the world which brings prosperity and wealth to people. And it’s true humankind on average have never lived better than it’s now in 21st century. BUT! There are dark sides of democratic capitalism such as concentration of resources in hands of top 1%, greed, unethical behaviour, lack of social responsibility, demoralisation of society where the only value is earning money. These factors will be laways embedded in the human nature.

Here comes the point made by Mr. Horwitt and Hwang. They say that an important part of any economic ecosystem is human culture and behaviour. It’s not new. A lot of studies were made since 80s in the field of organizational behaviour, behavioural finance and economics. These authors made the point about innovation ecosystems. They say that one of the important aspect that exists in Silicon Valley is trust and so called ethical code without which many deals, transactions and projects would be simply impossible. My point is that culture matters, but to build such a culture is hard. I would argue that Silicon Valley is more an exception than a common example. Coming back to economy I would say that cultural values influence the economy in many ways. Firstly, with “poor” and unethical culture it’s impossible to build a prosperious society. Secondly, even if the culture is advanced (we also need to determine what is poor and what is advanced), what are those key values that drives the nation forward? One of my friends recently said that we are in the situation of cultures battle where eventually American culture will win. And I’m asking so why it will win and what are those competitive factors that allows America to win? I have no answer right now. One of my guesses is that American culture is based on addressing very basic needs of human nature (that’s why for instance Hollywood cinema industry is the only one right now in the world. But there were famous Italian, French, Russian movie industries that are now almost dead.) That’s why it is so powerful. The question is that an advanced culture in this case? And if not what will be the globalized world leaded by American culture?

Assumption that constant growth is good for society because it brings more jobs, wealth and prosperity. The 20th century prosperity was based on the technological impovements, rise of corporations and constant assumption that we need to grow. Growth creates jobs, this leads to employment and new inventions, new inventions lead us to better processes, products and services which eventually shift the level of life, bring prosperity and wealth.

In my several few posts (Why Innovations Matter (part 1, part 2, part 3)?) I’ve already made a point that the growth is no always good. The growth could be overwhelmed by people, process and controls. Especially, when it is exponential and we have limited resources. The macroeconomic development of humankind can’t always be based on imperfections: ok in 70s and 80s we shifted our manufacturing to China and India because they had cheaper labour, now they rised (China is already the second economy in the World), we need to shift our production facilities somewhere else in order to be competitive (Africa is rising – let’s move there). The thing is that at some point of time there will be no place to move. We will eventually reach the limit after which collapse could follow. My point here is that the growth should be sustainable, it should be managed otherwise the artifical system that humankind created on Planet will fall in pieces.

Lessons learned:

  • Governments should ensure conditions (such as creating a favourable environment, protecting rule of law and property rights, institutioning low taxes, ensuring sound money, and removing obstacles to starting and building a business) in economies in order to build a foundation for successful innovation ecosystem.
  • There are key principles of free markets:
  1. Free market – it is the best at serving the needs and wants of people.
  2. Self-interest – not “greed” – compels people in free markets to meet the needs and wants of others.
  3. Constant growth is good for society because it brings more jobs, wealth and prosperity.
  • There are limitations and obstacles that will never allow us to reach free markets such as imperfect human nature, cultural values and different levels of societies development.
  • Constant growth is impossible. Exponential growth (human population, industrial output, pollution, consumption of natural resources) and limitness of the Globe are two factors that could lead us to collapse in the near future.

One thought on “What economy needs to have a successful Innovation Ecosystem?

  1. Pingback: The Rainforest gets discussed on Vasily Ryzhonkov’s blog | the innovation rainforest

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