Induced innovation

Induced innovation is a macroeconomic hypothesis first proposed in 1932 by J.R. Hicks in his work The Theory of Wages. He proposed that "a change in the relative prices of the factors of production is itself a spur to invention, and to invention of a particular kind—directed to economizing the use of a factor which has become relatively expensive."

Considerable literature has been produced on this hypothesis, which is often presented in terms of the effects of wage increases as an encouragement to labor-saving innovation. The hypothesis has also been applied to viewing increases in energy costs as a motivation for a more rapid improvement in energy efficiency of goods than would normally occur.

A significant application of Hicks theory can be found in the field of climate change. The exponential population growth occurred in the last century has drastically increased pressure on natural resources. In order to have a sustainable future it’s imperative to modify global strategies on climate change and the induced innovation theory can aid to model these policies.

To calculate the human impact on the environment economists often use the I=P*A*T equation where “I”, the impact variable, (for example energy consumption) is the product of “P”, the population, “A” the affluence (often embodied by GDPper capita) and “T” the technology.

The technical coefficient represents the efficiency of the system in use for particular resource and expresses the average state of technology. The decrease of "T" would indicate a gain in efficiency however “I” could still be growing or remaining stable if the improved technology is not sufficient to compensate the effect of an increase in "P" and "A". Therefore, a reduction in “I” would always mean that pressure on resources has lightened but this might not always be the consequence of using resources more efficiently (reducing T).

A fundamental issue of climate change is the excess of greenhouse gasses in the atmosphere particularly CO2 as the result of an intensified economic activity. Global GDP and CO2 emissions were growing at a corresponding rate in the until the 1970s. It was then that oil prices have increased exponentially causing people to reduce its consumption.

According to Hicks theory a change in factor prices will stimulate development of technical innovation to reduce the use of the factor for which the price increased compared to other factors. Following the oil shock significant investments were made in alternative sources of energy, more efficient cars and heating systems to mitigate oil consumption. As a result, CO2 emissions started growing at a slower rate than GDP per capita. Although petrol prices then dropped in the 1980s, CO2 emissions have continued to grow more slowly than GDP. This is an indication of a complete structural change in technology induced by the need to innovate.

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