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The Risk-Reward Nexus in the Innovation-Inequality Relationship

Lazonick, W.   Mazzucato, M

January 2012

We present a new framework, called the Risk-Reward Nexus, to study the relationship between innovation and inequality. We ask: What types of economic actors (workers, taxpayers, shareholders) make contributions of effort and money to the innovation process for the sake of future, inherently uncertain, returns? Are these the same types of economic actors who are able to appropriate returns from the innovation process if and when they appear? That is, who takes the risks and who gets the rewards? We argue that it is the collective, cumulative, and uncertain characteristics of the innovation process that make this disconnect between risks and rewards possible. When, across these different types of actors, the distribution of financial rewards from the innovation process reflects the distribution of contributions to the innovation process, innovation tends to reduce inequality. When, however, some actors are able to reap shares of financial rewards from the innovation process that are disproportionate to their contributions to the process, innovation increases inequality. The latter outcome occurs when certain actors are able to position themselves at the point where the innovative enterprise generates financial returns; that is, close to the final product market or, in some cases, close to a financial market such as the stock market. These favored actors then propound ideological arguments, typically with intellectual roots in the efficiency propositions of neoclassical economics, that justify the disproportionate shares of the gains from innovation that they have been able to appropriate. These ideological arguments invariably favor shareholder contributions to the innovation process over both worker contributions and taxpayer contributions. Ultimately, precisely because innovation is a collective and cumulative process, the imbalance in the Risk-Reward Nexus not only results in greater inequality but also undermines the innovation process itself. In this paper we 1) develop the Risk-Reward Nexus framework on the basis of a theory of innovative enterprise that focuses on the collective, cumulative, and uncertain character of the innovation process, 2) critique the leading economic ideologies that, by distorting the relation between risks and rewards, have justified growing inequality over the past three decades or so, and 3) apply the analysis to the trajectories of both innovation and inequality in the U.S. economy since the 1970s. We conclude by sketching out key policy implications of the Risk-Reward Nexus approach.