Why Innovation Matters to You

I am claiming that innovation has become America’s new engine of prosperity. But what does that really mean? What exactly is an “economic engine”? It is important to clarify that an economic engine is not necessarily the largest sector of an economy. Estimates of the total number of innovation jobs differ, depending on how exactly innovation is defined, but a reasonable estimate is that about 10 percent of all jobs in the United States belong to the innovation sector. While that number is growing, the innovation sector will never constitute the majority of our employment. Put simply, the average American worker will never be employed by an Internet startup or Pixar. Even manufacturing at its peak never employed more than 30 percent of the U.S. labor force.

 The reason is simple: the vast majority of jobs in a modern society are in local services. People who work as waiters, plumbers, nurses, teachers, real estate agents, hairdressers, and personal trainers offer services that are produced and consumed locally. This sector exists only to serve the needs of a region’s residents and is largely insulated from national and international competition. Economists call this the non-traded sector. Such jobs are “non-tradable” because they cannot be exported outside the region where they are produced: you need to consume them where you produce them.2

Take yoga. Today yoga is big business, and it is growing. Jennifer Aniston recently declared to People magazine, “Yoga completely changed my life,” and she is not alone. Many stars, including Madonna and Sting, are true believers, together with an estimated 15.8 million people who practice yoga regularly, up from 4 million only ten years ago. This industry is generating yearly revenues of about $6 billion in classes, retreats, private instruction, and even yoga cruises. As the writer Mary Billard put it, “Zen is expensive.” From the point of view of yoga purists, this may sound sacrilegious. But from the point of view of job creation, it’s gold. Tens of thousands of people work in the United States as yoga teachers, making up part of the 261,000 Americans considered “fitness workers” today. This number is expected to grow rapidly in the foreseeable future as Americans make more and more use of yoga centers, health clubs, and fitness facilities.

 Yoga instructors are a small part of a vast web of non-tradable jobs. In the United States, two-thirds of all jobs are in this sector. Most of the 27 million jobs created over the past two decades have been in the non-tradable sector, with health care as the fastest-growing. Even in Silicon Valley, residents are more likely to work in a store than for a high-tech firm.

By contrast, most jobs in innovative industries belong to the traded sector, together with jobs in traditional manufacturing, some services—parts of finance, advertising, publishing—and agricultural and extractive industries such as oil, gas, and timber. These jobs, which account for about a third of all jobs, are very different, because they produce a good or service that is mostly sold outside the region and therefore needs to be competitive in the national and global marketplace. For example, Microsoft and Boeing export most of their products to customers who do not reside in Seattle. Google, too, provides a service—Web search—that is mainly used outside its headquarters in Mountain View, California.

The paradox is that while the vast majority of jobs are in the non-traded sector, this sector is not the driver of our prosperity. Instead, our prosperity mainly depends on the traded sector. There are two reasons for this. The first is that productivity growth is different in the two sectors. As I mentioned earlier, in many parts of the non-traded sector, labor productivity does not grow very much. The number of yoga instructors needed to teach a class today is the same as it was fifty years ago and will probably never change. A therapy session today takes as long as it did in the time of Freud; the amount of labor needed to paint a house, fix a leaking pipe, babysit a child, or sell real estate is more or less the same as it has always been. Although parts of the non-traded sector experience productivity increases (improvements in medical technology, for example, have made doctors and nurses more productive), the more typical case is one of limited productivity increases. By contrast, productivity in the traded sector tends to increase over time, thanks to technological progress. As we have seen, it takes 75 percent fewer worker hours today than it did in 1950 to make a car. Labor productivity in the high-tech sector grows even faster, thanks to a constant stream of innovation.

 The debate on jobs often misses this key point. This productivity difference between traded- and non-traded-sector jobs matters because, as we saw, the only way to raise workers’ standard of living is to raise their productivity. Interestingly, higher productivity of workers in the traded sector means higher salaries not just for the workers in that sector but also for workers in other sectors, especially those with similar skills. Historically, when manufacturing wages inched up, other sectors had to adjust to remain competitive. For example, builders needed to raise the wages of carpenters, roofers, and plumbers to keep them from taking a manufacturing job, even though productivity in construction was flat. So even if the manufacturing sector accounted for a minority of the workforce, for decades it was an engine strong enough to lift the salaries of many American workers, including those who worked in services. From this perspective, it becomes clear why its demise is so terrifying. And it becomes equally clear why the rise of innovation is so crucial. It is more than just the jobs in that sector that are at stake—it’s the entire economy.

There is a second, related reason that the rise of innovation matters to all of us. While the first reason reflects forces that are national in scope, this second reason reflects forces that are local but equally important. Every time a company generates jobs in the innovation sector, it also indirectly creates additional jobs in the non-traded sector in the same city. Attracting a new scientist, software engineer, or mathematician to a city increases the demand for local services. This in turn means more jobs for cabdrivers, housekeepers, carpenters, nannies, hairstylists, doctors, lawyers, dog walkers, and therapists. These local service workers cluster around high-tech workers, supporting their personal needs. In essence, from the point of view of a city, an innovation job is more than a job.

 To see how this multiplier effect works in practice, let me introduce you to a small-business owner named Tim James. James is a bookbinder in San Francisco. His clients are mostly local residents and local businesses, so he is clearly part of the non-traded sector. He employs eight workers who bind books and do custom printing. His employees are good with their hands and tend to have low levels of education. If you visit his cavernous, neon-lit shop, the first things you notice are several beautiful old-style cutting and binding machines that dominate the floor. Paper is everywhere, with some pieces stacked in neat piles on the ground, ready to be used, and others in small strips. Dust covers the machines and the floor. Bookbinding appears to be a very labor-intensive craft. The technology used in James’s shop has not changed much in the past thirty years.

Although James’s shop is definitely low-tech, the performance of his business over the years closely tracks the ups and downs of the NASDAQ, which in turn closely tracks the performance of high-tech firms in San Francisco. James’s business soared during the late 1990s, the dot-com boom years. During that period, high-tech workers flush with cash filled local restaurants and bars, built new houses, and gathered in local gyms, thus vastly increasing the incomes of local service workers, including bookbinders. To keep pace with the rising demand for his products, James hired three new employees and raised everyone’s wages. During the dot-com bust that followed, demand for James’s products—and therefore the number of his employees—dropped, only to recover more recently with the expansion of the local high-tech sector.

 James’s experience is not unique. Indeed, it perfectly exemplifies the strong link between innovation jobs and local services. With only a fraction of the jobs, the innovation sector generates a disproportionate number of additional local jobs and therefore profoundly shapes the local economy. A healthy traded sector benefits the local economy directly, as it generates well-paid jobs, and indirectly, as it creates additional jobs in the non-traded sector. What is truly remarkable is that this indirect effect on the local economy is much larger than the direct effect. My research, based on an analysis of 11 million American workers in 320 metropolitan areas, shows that for each new high-tech job in a metropolitan area, five additional local jobs are created outside of high tech in the long run.

I mentioned this earlier, but it gets even more interesting. These five jobs benefit a diverse set of workers. Two of the jobs created by the multiplier effect are professional jobs—doctors and lawyers—while the other three benefit workers in nonprofessional occupations—waiters and store clerks. Take Apple, for example. It employs 12,000 workers in Cupertino. Through the multiplier effect, however, the company generates more than 60,000 additional service jobs in the entire metropolitan area, of which 36,000 are unskilled and 24,000 are skilled. Incredibly, this means that the main effect of Apple on the region’s employment is on jobs outside of high tech. (Incidentally, Apple is among Tim James’s clients: when Steve Jobs died, James was commissioned to make the family’s condolence book.) In essence, in Silicon Valley, high-tech jobs are the cause of local prosperity, and the doctors, lawyers, roofers, and yoga teachers are the effect. It is pretty simple: at the end of the day, someone has to pay for all those yoga sessions.

 All parts of the traded sector have a multiplier effect, but innovation has the largest. My analysis indicates that attracting one job in traditional manufacturing generates 1.6 additional local service jobs—less than a third of the corresponding figure for high tech. Ron Bloom, President Obama’s former manufacturing czar, liked to say, “If you get an auto assembly plant, Walmart follows; if you get a Walmart, an auto assembly plant does not follow.” He is correct: the manufacturing sector does generate local service jobs too, and this is a major benefit for communities. But he misses the fact that if a community were to attract an Internet or a biotech company of similar size, the effect on job creation in the service sector would be even larger. Not only would it create three times as many jobs, but those would be better-paying than Walmart jobs. Take a city like Seattle. Although a manufacturing company such as Boeing has twice as many jobs in Seattle as Microsoft does, it ultimately creates fewer local jobs.

How can the high-tech multiplier effect be so much larger than that of other industries? What is so special about high tech? To begin with, high-tech workers are very well paid, with salaries and benefits typically considerably above the average. This means they consume more local services than other workers and therefore create more local jobs. With more disposable income, these employees go to restaurants, visit hairdressers, and see therapists more often. According to a company report, the annual compensation of the average employee at Microsoft is $170,000. This is an incredibly high figure, especially if you consider that it takes into account everyone in the company, including secretaries and janitors. After subtracting what an employee spends on nonlocal goods, housing, taxes, and savings, this leaves about $80,000 available to be spent on local services. This amount alone can support two local nonprofessional jobs at prevailing wages. In addition to employees’ personal consumption, high-tech companies’ operations require many local business services, and this means more graphic designers, marketers, business consultants, and security guards.

 The final reason for the large high-tech multiplier effect is that high-tech firms tend to be located near each other. Bringing one high-tech company to a city eventually results in having more high-tech companies locate there, as dense high-tech clusters make high-tech firms more innovative and more successful. This clustering effect also exists in manufacturing, but it is particularly strong in high tech, for reasons that we will discover soon. The end result is the creation of more local service jobs and an even larger multiplier effect.

Policymakers and business leaders love to praise the virtues of American small businesses, invariably pointing out that small businesses are responsible for most job creation. While this is true, the vast majority of small businesses are in retail and other non-traded services. In the end their existence is dependent on the vitality of the traded sector, where large businesses are dominant. There would not be many retail jobs in a city if not for the income generated in the traded sector.

The multiplier effect is a remarkable feature of the labor market. The current public debate about the American economy is often framed in terms of an inherent tension between the interests of one group and the interests of another: the two Americas of the rich and the poor, the haves and the have-nots. While this tension may be true in the case of fiscal policy—for example, when we are deciding on how much to tax high-income earners—in most other cases it is a false juxtaposition. As far as job creation is concerned, there is no inherent contradiction between the interests of high-income workers and those of low-income workers. Indeed, the key lesson of the multiplier effect is that the economy is a tightly interconnected system, and what is good for one group typically tends to be good for another. This is a case where the rising tide does lift all boats—at least those boats that are in the same city.