Kellogg’s Papanikolaou: Breakthrough Innovations Are Alive & Well

Kellogg Professor Dimitris Papanikolaou is Poets&Quants’ professor of the week for his research on breakthrough innovation

Over the last few years, economists, investors, and policymakers have grappled with a big problem: In a world where there’s so much innovation, why has productivity growth been so slow?

Total factor productivity growth—a key measure of how rapidly output is growing relative to labor and capital—has plunged sharply since the mid-2000s, and some economists have cited slowing innovation as the culprit.

Most prominent among them: Robert Gordon of Northwestern University, who wrote in his magisterial 2016 work, The Rise and Fall of American Growth, “Economic growth since 1970 has been simultaneously dazzling and disappointing”—dazzling in areas like information technology and communications, disappointing in everything else.

Gordon claims current innovations can’t match the great breakthroughs of 1870 to 1970—the “special century”—which produced electricity, the internal combustion engine, refrigeration, gas heating and cooking, and advanced water and sewage treatment. Since then, changes have been “evolutionary and continuous,” he writes, which is why he thinks productivity and GDP growth have stagnated of late.

But one economist from Northwestern’s own Kellogg School of Management, Dimitris Papanikolaou, and three co-authors—Bryan Kelly of the Yale School of Management, Amit Seru of the Stanford University Graduate School of Business, and Matt Taddy of Amazon—respectfully disagree.

Although they cite Gordon’s epic 784-page tome (a rare economics bestseller) high in their study and share his view that productivity growth has slowed, they believe the current wave of innovation is comparable to previous booms in the late 19^th and early 20^th century.

The latest version of their working paper, “Measuring Technological Innovation over the Long Run,” appeared in March.

The paper is a significant step forward in research on the history of innovation. Previously scholars relied on the number of citations of patent applications with the U.S. Patent and Trademark Office (USPTO) to identify breakthroughs. But looking at just the sheer number of citations can miss the true significance of inventions and innovations.

So, using advanced data-analysis techniques, the researchers dug into the full text of more than nine million patents filed with the Patent Office since 1836, filtered out common words, and zeroed in on the specific technical terms that identified “significant (high quality) patents as those whose content is distinct from prior patents (is novel), but is similar to future patents (is impactful).” text-based

Papanikolaou and his co-authors then constructed a different numerical index of breakthrough innovations by counting the number of patents that fell in the top 5% in novelty and impact.

Applying their method, they identified three major technological waves—the second Industrial Revolution in the mid- to late 19^th Century, the 1920s and 1930s, and the post-1980 period. “We find that advances in electricity and transportation play a role in the 1880s; agriculture in the 1900s; chemicals and electricity in the 1920s and 1930s; and computers and communication in the post-1960s,” they write.

They also found their innovation index was “a strong predictor of aggregate total factor productivity”: A one-standard-deviation increase in their index accompanied 2.5% higher productivity over the next five years. Not surprisingly, sectors and firms that introduce breakthrough technologies also experience faster productivity growth than those that do not.

In our time, the breakthrough technologies have included the microchip, software, computer networks and, increasingly, advances in genetics. A chart towards the end of their paper shows the number of breakthrough patents around the year 2000 topping even the 1920s-early 1930s and the late 1800s. But they plunged soon after the turn of the Millennium, which is consistent with the subsequent falloff in productivity growth that has vexed economists. Still, by their calculation, innovation is as strong as ever, so future researchers may have to look elsewhere to explain the productivity slowdown.

Innovation and its intersection with financial markets is a central focus of 41-year-old Papanikolaou’s research, including some with Kellogg colleague Professor Carola Frydman. Having earned his BA at the University of Piraeus in his native Greece, he got his masters’ degree from the London School of Economics before spending a year on Wall Street as a research assistant at Citigroup’s Salomon Smith Barney unit. When he returned to academia to earn his Ph.D. in financial economics from MIT, he never looked back, joining the Kellogg faculty in 2007 and spending his whole career there. He teaches MBA classes in investments and finance.