So a market for knowledge with positive externalities that cannot be internalised because you can’t write a contract for the skills and human capital that are created externally when the transaction happens. Rightio 🙂 .

“there are benefits to society, like higher wages (& tax revenue & govt spending), that are not given to innovators”

BTW, these aren’t externalities in the efficiency sense. Wages are a market price for labour (so the benefits are internalised), taxes and government spending are set according to spending and redistribution targets (so these are exogenous).

http://en.wikipedia.org/wiki/Pecuniary_externality

The main issue in terms of policy is whether the direct and immediate marginal social benefit is equal to the marginal social cost of the transaction. The fact that wage rates and tax take will change is not policy relevant – we should not subsidise on the basis of them.

The point is to have the right relative price for “knowledge” in this case compared to other goods in the economy – aggregate variables like wage rates and government spending are irrelevant for defining these relative prices.

But otherwise yes, you get my point, there are benefits to society, like higher wages (& tax revenue & govt spending), that are not given to innovators, which justify targeting this type of market failure.

changes to monetary policy may assist innovators, but at the expense of the rest of the economy; and fail to address the actual cause, which is the economic spatial distance from the rest of the world.

Indeed, if there are spillovers from innovation then the social benefit exceeds the private benefit – market failure. I wouldn’t quite say it prevents the spillovers, it just leads to a suboptimal amount of innovation as marginal benefit to the innovators is lower than the marginal benefit to society.

And you are right when you say using monetary policy to clean this up is a crazy way to view it. And that is how I feel with a lot of the “problems” in the economy.

If we can just identify IF and WHAT ARE the market failures we can create policies to target them – hitting at monetary policy is both indirect and dangerous.

Ok, that is my point, but you have put it much more clearly. I would suggest there are significant transaction costs, preventing knowledge spillovers and therefore reducing innovations. given this type of market failure, what is your policy response (even beyond monetary policy)? I don’t believe the correct response is to play with monetary policy, but I can see why some would see it as a simple solution.

Innovations are endogenous in the choices of agents in the market economy right. So we either have a market failure, or we have the optimal amount of innovations for given preferences of individuals in the economy.

Eg, look at this normative statement you make:

“If the problem is that we don’t have as many innovations coming to market as we should”

How do you define should here … it has to be through a market failure.

For “innovations” to be “too low” we need to say that current level of innovations is lower than the level of innovations in a counterfactual market where the social benefit is maximised – which is where the relative prices are indicative of the full social benefit and cost of “innovation”. As a result, for our should statement to hold we need to come up with a market failure.

Now, if we can’t think of a market failure that would cause this the initial normative statement is false.

A traditional market failure is simply somewhere where some costs and benefits are not incorporated in the individuals choice to supply or demand the good/service. If we think there is a situation for innovation where this happens AND there are significant transaction costs to the creation of a market that accounts for these external effect we have a market failure.

I think you have missed the point of what I describe.

If the problem is that we don’t have as many innovations coming to market as we should (causing a lack of economic growth) then shouldn’t we consider all policy alternatives to help? including monetary policy? I agree we should address the specific causes (which in my opinion isn’t monetary policy) but as you rightly point out it is not necessarily a market failure that is the cause of low economic growth.

“I agree in the usual way we think of efficiency, but surely policies can be used for more purposes than just market failure”

Redistribution.

Market failure and redistribution is all I’ve got.

“There is clearly a policy response in these types of failure even though they are not traditional “efficiency” market failures”

But if we don’t have a “market failure” we are saying that individual actions are indicative of the full social costs and benefits of their actions. This implies that any “government intervention” to change their choices will be suboptimal.

“If this market is ineffecient, i.e. the quantity supply of ideas is less than an expected equilibruim, then technology in NZ is static, or less than it should be, and there is a reason for a policy response.”

If the market is inefficient there must be an identifiable market failure.

“personally I would suggest other policy responses but some might suggest a monetary policy response because higher interest rates (for example, or a volitile exchange rate) on businesses might prevent innovations being successful (or more successful) – Isn’t this the point of the whole monetary policy discussion? And the taskforce for that matter.”

Monetary policy currently functions to ensure that changes in the general price level in the economy are stable – so that individuals and firms can focus on responding to underlying relative price signals.

If there is an identifiable market failure for these other industries then sure, government intervention is useful. But it is neither possible for nor the purpose of monetary policy to correct other policy errors or market failures.

An issue I should undoubtedly post on in the new year.

I agree in the usual way we think of efficiency, but surely policies can be used for more purposes than just market failure. And in the case of technology, if NZ isn’t recieving the technology improvements that other countries have seen, isn’t this a failure? that our firms are too small (and don’t benefit from co-located large firms) to effectively do R&D and create innovations? that they face a market which doesn’t provide the same benefits as firms in foreign markets face? These are all failures.

If technology has static, while the rest of the world is improving, this is a failure that the government can do something about. If the population isn’t increasing (and assuming there are clear benefits to population growth, such as reducing the drain of skilled NZers to Aus and increasing skilled imigrants) this is also a failure that the government can do something about. There is clearly a policy response in these types of failure even though they are not traditional “efficiency” market failures.

If you want to stick to an efficiency argument, how about this as a sort of proxy for what i’m suggesting? Consider a market for “knowledge” or a market for “ideas”, or “innovation”. All of which I am using as a proxy for the main driver of economic growth. (one must also consider separately the labour and capital markets as the other drivers of growth). If this market is ineffecient, i.e. the quantity supply of ideas is less than an expected equilibruim, then technology in NZ is static, or less than it should be, and there is a reason for a policy response.

personally I would suggest other policy responses but some might suggest a monetary policy response because higher interest rates (for example, or a volitile exchange rate) on businesses might prevent innovations being successful (or more successful) – Isn’t this the point of the whole monetary policy discussion? And the taskforce for that matter.

Im interested in what sense its not?