The New Economics of Innovation Ecosystems

A new strain of economic thought is emerging to explain how societies can grow sustainably. It’s not just coming from the public, which has already expressed discontent with the status quo through demonstrations worldwide. And it’s not just coming from business leaders, such as Richard Branson, who co-founded a group called the B Team to reset the values of corporate management. In their own quiet way, academic researchers in the field of innovation have also engaged this issue.

Today we can see the early outlines of a new economic model. Based on our work studying the dynamics of innovative communities like Silicon Valley, we have discovered certain themes common across several disciplines. As is usually the case, many of these ideas come from non-economic fields, such as biology, psychology, sociology, design, business, and law. Their discoveries point to an emerging framework. It is one that recognizes the full range of human interaction as a tool to explain how innovation ecosystems flourish.

This topic matters a lot. Global economies are grasping for new ways to operate more inclusively, create jobs, raise productivity, and elevate standards of living. But why do certain communities like Silicon Valley generate so much wealth continually over time, while other places—even those with talented people, capital resources, valuable assets, and free markets—languish? If already a society’s laws are enforced, markets are free, roads are paved, and people are educated, then what else could these communities possibly do? What economic levers are left to pull? These are riddles that many leaders, both in America’s heartland and emerging world capitals, are struggling to answer.

We have observed an emerging model of economic thinking characterized by the following five features of human interaction. They comprise important missing elements from present-day economic doctrine.

1. Social networks. Economics has historically focused on macro inputs into a system: land, labor, capital, and (many argue) technology. However, there is a growing body of psychological evidence showing that the subtleties of human-to-human connectivity profoundly shape how people create together. Two people meeting one day might hate each other, or they might found a company together. It matters to the world that Larry Page and Sergey Brin started a company, Google, after first meeting at student orientation. Value comes not just from system inputs; it also depends on the interconnections of human beings.
2. Teams. Design researchers have strong evidence that economic value is affected by how teams form, and by their internal dynamics, diversity, and mix of personalities. Human beings are emotional creatures: Our joys, passions, fears, and insecurities affect the productivity of teams. And virtually all innovation happens in teams. At Stanford, graduate student Gregory Kress and his advisor Larry Leifer recently found that, out of several criteria, empathy was the one that most strongly correlated with positive team performance. Furthermore, researchers such as Stanford sociologist Woody Powell have observed how social structures interrelate with economic activity.  Powell asks questions such as: Does a community or corporation create the right environment for teams to spawn, grow, and recombine as needed? Or does a rigid social hierarchy prevent new teams from forming or old teams from maximizing their productivity?
3. Identity. An individual’s identity shapes his or her economic behavior. Identity is defined as one’s sense of self, which includes relationships, capabilities, and geographic affiliations. As economists George Akerlof of Berkeley and Rachel Kranton of Duke note, “Because identity is fundamental to behavior, choice of identity may be the most important ‘economic’ decision people make.” For example, identifying oneself as a geek has specific economic payoffs, such as in the startup world. Furthermore, research shows that people behave based more on a belief in their own capabilities to accomplish, rather than in their knowledge or skills. It is what Stanford psychologist Albert Bandura calls “self-efficacy.” Variations in self-efficacy can help explain why individuals with similar knowledge and skills can end up behaving very differently. By extension, variations in “group-efficacy” might explain differences in economic outcomes between comparable regions or countries.
4. Trust. Legal research from scholars such as Lisa Bernstein at the University of Chicago shows that the cultural rules of daily interaction between people—like unwritten social contracts—affect value creation. How efficiently or inefficiently do people collaborate? Is a handshake enough to build trust between strangers, or does it require hiring lawyers and signing expensive contracts? In Silicon Valley, for instance, entrepreneurs rarely sign formal nondisclosure agreements before sharing their plans with each other. In the rest of the world, they almost always have to negotiate and sign such contracts. Culture can speed things up, reducing transaction costs; but it also can slow things down and kill innovative opportunities before they are born.
5. Environmental Conditions. Biologists such as Harvard’s E.O. Wilson have argued that the physical sciences can be useful in explaining the social sciences. We are increasingly seeing this happen. Science is observing how individuals behave and how their interactions affect the creation of nascent ideas, new companies, and innovative products. Environmental conditions provoke actions, actions change identities, identities shape culture, culture fosters innovation, innovation affects productivity, and productivity reshapes environmental conditions. Every interaction matters to the system. This means that when it comes to innovation, our economies behave less like controlled systems such as farms and more like uncontrolled ecosystems such as rainforests. One cannot build a rainforest by planting more trees. Instead, nurturing the right environmental conditions causes rainforests to grow sustainably, year after year.

The implications of an ecosystem-based approach for policymakers are rather profound. Culture can be a powerful lever for economic growth. Trust, particularly between diverse strangers, can influence standards of living (as argued by Claremont’s neuroeconomist Paul Zak). Leaders cannot create sustainable economic growth by edict; they must deal with human nature and all its complexity.

Therefore, policymakers should focus less on controlling economic assets and think more about how to design systems that foster valuable interactions among its actors. How can leaders engineer serendipity? How can they nurture more connectivity and diversity? How can they foster trust across social barriers, particularly those that inhibit valuable ideas, products, and companies from emerging? In short, how can they build “rainforests” instead of “farms”?

Perhaps surprisingly, many of the same people who protest capitalism and corporations also idolize Steve Jobs and Apple. It is not business per se that protesters dislike. People tend to love businesses that value their personal needs. Perhaps a new economic framework—one that respects the role of individuals and their interactions with one another in shaping their ecosystems—can be a powerful tool for restoring confidence and sustainable well-being.

Read more stories by Victor W. Hwang & Ade Mabogunje.