Where New Ideas Come From: The Economics of Innovation

Why ideas are unlike ordinary goods, how that makes them the engine of long-run growth, and why markets may produce too few of them.

Most goods get used up. If you eat an apple, no one else can eat it. Ideas are different. A recipe, a mathematical formula or a design for a better battery can be used by millions of people at the same time without being worn out. Economists call this property non-rival, and it makes ideas the most powerful force behind long-run economic growth.

Why ideas drive growth

A country can grow by adding more workers or more machines, but each additional machine adds less than the one before. Ideas escape this limit. Once someone discovers a better way to make steel or a new vaccine, everyone can use it. The economist Paul Romer won the Nobel prize in 2018 for showing how the search for new ideas, driven by people responding to incentives, can generate sustained growth. His approach is often called endogenous growth theory, because it explains technological progress from within the economy rather than treating it as something that simply happens.

The problem for markets

The same feature that makes ideas powerful creates a problem. Inventing something is often expensive, but copying it can be cheap. If a company spends millions developing a new product and competitors can copy it immediately, the inventor may never recover the cost. Other people benefit from the idea without paying, a pattern economists call spillovers.

Because inventors capture only part of the value they create, markets on their own tend to produce fewer new ideas than would be best for society. That is the main economic argument for patents, copyright, research grants and tax credits for research.

A better cooking stove

Suppose an engineer designs a cooking stove that uses half as much fuel. Building the first prototype took two years and a large budget. But once the design is known, a factory can copy it for the cost of materials. If anyone can copy it for free, the engineer may never be paid back, and other engineers may decide not to try. Yet society as a whole gains enormously from the design.

Many sources of ideas

New ideas come from universities, company laboratories, government research agencies, individual tinkerers and ordinary workers who find better ways to do their jobs. Economists stress that small, practical improvements, learning by doing on the factory floor or in the office, add up to a large share of productivity growth.

Thinking innovation means only big inventions

Headlines focus on breakthroughs like the smartphone or the internet. But much of the rise in living standards comes from countless small improvements to existing products and processes. Innovation includes a supermarket finding a faster way to stock shelves as well as a laboratory inventing a new drug.

Key takeaways

Ideas are non-rival: many people can use the same idea at once.
Paul Romer's endogenous growth theory shows how the search for ideas drives long-run growth.
Because ideas are easy to copy, inventors capture only part of their value, so markets may produce too few.
Small, practical improvements add up to a large share of innovation.