Innovation, Technological Change and the Economy

As the economy has moved from the industrial age to the information age, the driving force of innovation has excited some and frightened others. Personal computers, fiber optics, communication satellites, the World Wide Web and a host of other fascinating ideas have changed the way we work and play. Seemingly overnight, new industries have popped up with a host of new jobs to offer, while obsolete industries and jobs have gone by the wayside. The paradox that innovation is both central to economic progress and, at the same time, the cause of many economic difficulties is called the churn. The churn can be frightening to those whose lives may change because of new technologies, but we should remember that change is necessary for progress. Our challenge is to be prepared for the opportunities it affords us.

The U.S. Economy: From Muscle Power to Brain Power

In the not-so-distant past, possessing physical strength was a sure way to get a job. Farmers trudged behind their plows, pick-and-shovel laborers clawed at the earth and loading dock workers slung cargo over their shoulders. But the economy has changed dramatically over the past 100 years.

In the early 1900s, machines began to reshape the role of workers in producing goods and services as the United States moved from the agrarian (or farming) age into the industrial age. Steam power, internal combustion engines and electric motors took the place of brute strength, and motor skills replaced muscle power as a worker's most valued resource. People learned to use tractors, backhoes, forklifts, cranes, lathes, metal stampers and other devices that saved time and energy. Soon, technology advanced even further, and machines themselves began taking over more factory chores.

Today, jobs rely even less on muscle power and motor skills. America has entered the information age, and brain power—analytical reasoning, creativity, inventiveness and even humor—has surpassed motor skill as the economy's most valuable labor resource. The emergence of computer, telecommunications and satellite technologies has dramatically changed the way Americans work. It now takes only a few employees to accomplish what once required dozens. For example, the number of secretarial jobs has been declining since the late 1980s because computers and laser printers allow supervisors to type and print their own letters and memos. Even in manufacturing plants, increasingly intelligent computers are taking on mundane tasks, such as those on an auto assembly line, that once required workers' constant attention.

There is nothing new about all of this change. Innovation and the competitive spirit of the free enterprise system have always made jobs, and even entire industries, obsolete. As competition grinds onward, as businesses open, close, expand, contract or relocate, they set in motion both layoff activity and new hiring. A shorthand term for the turbulence in the labor market that is caused by innovations or new ideas is the churn. The benefit of the churn is that innovation and technological advances free workers to perform other, more important tasks—creating new industries, new jobs and more goods and services for consumers to enjoy.

The Churn in Action

The churn operates all the time, although it can be most visible during recessions, when industries come under financial stress and lay off workers. While many people return to jobs similar to those they had before a recession, some jobs do not return because innovations have rendered them obsolete.

While losing a job can be agonizing for workers and their families, the churn's long-term effect on the economy is positive. Innovations free workers in declining industries to produce more and better goods in new industries. Thousands of new enterprises add new jobs, bit by bit.

An example of the churn at work is the transportation industry. In the early 1990s, the introduction of the automobile sparked an upheaval in jobs, creating a multitude of new occupations: car designer, mechanic, and truck, bus and taxi driver, just to name a few. The impact of the automobile spilled over into dozens of other sectors of the economy. The oil industry, for example, produced new occupations: roughneck, refinery and pipeline worker, and gas station attendant among them. Nonexistent in 1870, the automobile industry created millions of jobs in the U.S. economy. Soon after the automobile came the airplane, creating yet another reshuffling of jobs.

Despite all the jobs created by the automobile and the airplane, these great inventions were not welcomed by all sectors of society, at least not at first. They created unwelcome competition for other industries—everything from the horse and buggy to railroads and water transportation. Jobs in those industries disappeared by the millions. In 1920, for example, 2.1 million Americans earned a living by working for railroads, compared with just over 230,000 today. The country employed 109,000 carriage and harness makers in 1900 and 238,000 blacksmiths in 1910. Only a few thousand Americans make a living in these occupations today.

The experience of the transportation industry has been paralleled thousands of times with thousands of innovations. In 1900, for example, it took nearly 40 of every 100 Americans working on the farm to feed the country. With technological advances in farm machinery and processes, today it requires only three. But the decline in farm jobs has not left the country hungry. Quite the contrary, the United States has enjoyed agricultural plenty and the creation of millions of industry and service jobs.

Innovation and Competition Fuel the Churn

All of these stories highlight a common theme: innovation has always had the direct effect of creating new businesses, industries and jobs and the indirect effect of destroying jobs in existing industries. Despite a constant turnover from 1900 to today, the total number of jobs has expanded greatly. And for millions of people, the backbreaking toil of farms and sweatshops has given way to the comfort of air-conditioned offices and the advantages of shorter workweeks and higher pay.

New ideas, new products, new technologies, new forms of business organization and new markets upset the status quo, rerouting demand from existing companies and industries to new ones. On the upside, winners increase sales, and they add jobs. On the downside, losers find their customers aren't buying as much, and they lay off workers.

The process of innovation and competition that recycles labor into new jobs is—more than ever—at work today. For example, there are more than 1.2 million computer programmers employed in the United States today. Among the fastest growing U.S. occupations in the 1980s were those of software designer, fax machine repairer and cellular telephone technician, jobs that scarcely existed 15 years ago.

Since the turn of the century, technological innovations have dramatically changed the way the American economy works. But for several reasons, such changes do not happen overnight.

First, the innovators themselves may not appreciate the usefulness of what they have created. For example, the inventor of the radio did not foresee that it would be useful for communicating to mass audiences. Rather, he saw it only as an improvement in two-way communications—from ship-to-ship or ship-to-shore. The steam engine, which played a huge role in igniting the industrial revolution, originally was invented by miners to pump water out of coal mines. They saw no other use for it at the time.

Second, an innovation may actually require another, complementary innovation before its usefulness can be appreciated. The laser, for example, was of little use to telephone companies until they also understood fiber optics. The combined potential of those two technologies, however, has transformed not only the telephone industry but also many others, such as cable television.

Finally, revolutionary new technologies, such as the telephone, electricity or the computer, take a long time to be fully integrated into the economy. For example, in 1910, only one-fourth of U.S. factories used electrical power. Most of these were limited to brand-new factories, while the older ones continued to rely on steam power. Twenty years later, three-fourths of factories used electricity.

Time was needed to redesign and refit older factories for electrical power. All in all, it took about 40 years for electricity to become entrenched in American society and significantly affect U.S. productivity. This has exciting implications for the computer age, which began in 1970 with the invention of the microprocessor. Because the computer is even more complex than electricity, decades could pass before we realize the extent of the computer's potential. In other words, the greatest benefits of the computer may still lie ahead.

Adapting to Change

The transition from old industries to new ones can be bumpy and sometimes painful, especially for workers who lose their jobs. But the economy cannot progress without the revitalization that engenders job destruction. It may be tempting to save jobs because no one wants to face the struggles of unemployment. But government policies to save jobs almost always fail. They retard economic progress and ultimately destroy jobs by short-circuiting the vital process of innovation.

For instance, had our ancestors been able to implement policies to freeze jobs, the United States might be stuck in the horse-and-buggy era. The former Soviet Union guarded the jobs of its citizens. Instead of spiraling upward with innovations, the Soviet Union stagnated and finally collapsed.

The best approach a society can take is to learn to adapt to change. Change often makes people feel insecure. If people are insecure about their jobs because they do not feel their skills are up-to-date, then they will more likely fear job layoffs. Because the economy is changing so rapidly, ongoing schooling and training are becoming ever more necessary for workers. Today, a growing number of corporations realize the advantages of continuously training their workers. If ideas and brainpower are the most valuable labor resource, then training and education are crucial to a company's profitability. A well-educated, well-trained labor force more readily shifts from the jobs of declining industries to those of emerging ones. Education followed by constant reeducation and training can bridge the gap between the skills of the past and those of value in the future.

Also important is a culture that embraces those who risk failure and loss to give the community something new or better than what was there before. These are the entrepreneurs. They are the people who have the energy and determination to discover new and better products and to risk taking those innovations to the market. Many are motivated by the desire to become rich and famous. Others are motivated by the desire to make the world a better place. Regardless of the goal, consumers benefit from new products and services, and workers benefit from new and exciting careers.

The world today possesses a large inventory of inventions to help plant the seeds of tomorrow's industries. The challenges for the United States lie in training workers for the jobs that will be created as these industries grow and in encouraging entrepreneurs to take the risks and endure the hardships and challenges associated with creating new and better products for the marketplace.

For additional copies of this publication, contact: Public Affairs Department, Federal Reserve Bank of Dallas, 2200 N. Pearl St., Dallas, Texas 75201-2272, or call (214)922-5254 or (800)333-4460, ext. 5254.