Economic welfare and the allocation of resources for invention

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Citation: Kenneth Arrow (1962) Economic welfare and the allocation of resources for invention. The Rate and Direction of Inventive Activity (RSS)



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Summary:

Arrow (1962) aims to describe the economic problems facing invention which, in his article, he defines as knowledge production more generally. He begins by stating that, "from the viewpoint of welfare economics, the determination of optimal resource allocation for invention will depend on the technological characteristics of the invention process and the nature of the market for knowledge."

Arrow explains that basic assumptions in capitalist welfare economics are that there is no uncertainty and that all commodities be traded on the market which lead to three problems in welfare economics: indivisibilities, inappropriability, and uncertainty. Arrow first summarizes the academic literature in these areas (e.g., the basic theory of insurance) as a way of framing his discussion of information production.

Arrow explains that, "information is a commodity with peculiar attributes, particularly embarrassing for the achievement of optimal allocation." He concludes that:

We expect a free enterprise to under-invest in invention and research (as compared with an ideal) because it is risky, because the product can be appropriated only to a limited extent, and because of increasing returns in use. This underinvestment will be greater for basic research."

Arrow suggests that society would under-invest in research even under ideal conditions.

At the end of his short piece, Arrow explores the effects of monopoly and competition on incentives to invest and explores a number of possibilities including more individual focused incentives (as opposed to firms) and government-based and other means.

Theoretical and practical relevance:

Arrow's article has been cited cited over 5,000 times and remains one of the most highly cited and highly central articles on innovation in general and on the economics of innovation in particular. In a related sense, it is cited widely in the literature on incentives to intellectual protection and on patents in particular.