Innovation, the American Economy’s Most Surprising Deficit
Politics / US Politics May 29, 2011 - 03:56 AM GMTBy: Ian_Fletcher
I argued in a previous article why, despite America’s current obsession with government budget issues, the real key to bringing back our economy lies in a) fixing our trade deficit and b) restoring our capacity for innovation.
Although the former problem has now grabbed significant public attention, most Americans seem to think that our national capacity for innovation is healthy and without problems.
After all, we’re the home of Silicon Valley. So things must be going great, right?
Unfortunately, no, and for the same reason that, as I explained elsewhere, our manufacturing sector isn’t healthy. While it’s true that there’s an enormous amount of innovation (and manufacturing) going on in this country, “enormous” is not, in and of itself, an adequate quantity.
To figure out how much innovation (or manufacturing) is enough for America, the quantity must be measured against how much we need to maintain our living standard. And we are, in reality, falling short in both areas.
As long as our manufacturing output is so small that we must run a trade deficit with foreign nations in order to satisfy our consumption desires, we aren’t manufacturing enough.
As long as our innovation output is so small that American industry can’t keep pace with its foreign rivals and continues to inexorably surrender market share and technological superiority to them, we aren’t innovating enough.
Yes, it’s nice that we have iPhones and other innovative American products. But for our economy to be truly healthy, we would have to be exhibiting that level of innovation in products across the board. Our cars would have to be as innovative as our iPhones. And our consumer electronics. And all the other by-no-means-low-tech products that increasingly aren’t even made in this country.
Having a few superstar sectors in our economy simply isn’t enough to deliver the living standard that Americans want. To deliver this, we need an economy in which dozens of major metropolitan areas have the same sheen of prosperity, productivity, innovation and all-round economic sophistication that the San Francisco Bay Area has.
That’s the vision to keep in your mind. Detroit as San Francisco.
People forget how small Silicon Valley really is. According to the Labor Department, it only employs 225,000 people—in a U.S. economy with a labor force of 238 million. Unfortunately, the media in this country give so much excess attention to it—and the other fancy sectors of our economy, like Hollywood and Wall Street—that people mistakenly think it and industries like it dominate the U.S. economy.
Nice work if you can get it, but they don’t.
What would it take to restore innovation to those sectors of the American economy that are deficient in it? The best analysis of this problem I know is by Gregory Tassey, the chief economist of the National Institute of Standards and Technologies, America’s only serious civilian industrial policy agency. In his book The Technology Imperative, and also in his essay, “Rationales and Mechanisms For Revitalizing U.S. Manufacturing R&D Strategies,” he argues that the key problem for U.S. innovation is what he calls the “valley of death” between pure science and commercialization.
America remains strong (though in relative decline, compared to other nations) in pure science. We remain good at commercializing discoveries and inventions that can be sold for a profit. But we are weak at the vast area of research that falls between these two extremes.
Before a new scientific discovery can reach fruition in actual products sold to customers, it must pass through many stages of research. And, crucially, much of this research cannot itself be turned to profit.
But profiting from new discoveries is impossible unless this research is done.
Because it is unprofitable, companies won’t, as a rule, engage in enough of this intermediate research. Therefore an economy that relies wholly upon private profit to finance innovation will fall short.
This research isn’t academic science either, so don’t expect the professors to fill in.
One way to look at this research is to call it useful but unpatentable ideas. Anybody who has ever talked to creative engineers, or patent lawyers, knows that a great many important ideas cannot be patented. Some are more discoveries than inventions. Others are too generic, or too easy to copy. Others consist simply in the painful process of trying and ruling out a hundred ways to implement some new fundamental principle in order to find the one or two ways that have a future.
Other ideas are not the sort of things for which patents would be even relevant. In their case, one would ideally capture their value by means of proprietary technologies, first-mover advantage, or other commercial methods. But, for any of a dozen different reasons, one cannot. So if you do this research, somebody else can harvest the profits as easily as you can.
The problem is a kind of “tragedy of the commons” applied to ideas.
Historically, the only companies that engaged in this sort of research were very large companies with monopoly or quasi-monopoly power over their ultimate product markets: companies like the old AT&T with its Bell Labs, the old IBM with its Watson Laboratory, the old RCA with its Sarnoff Research Center, or the old Xerox with its Palo Alto Research Center. Because of their oligopolistic power, they were assured of a) capturing the value of whatever they discover, rather than having it swiped by a competitor, and b) bringing in enough money, over a long-enough time frame, to pay for expensive laboratories that may take years to produce results.
There are still a few companies like this around, but not nearly enough to bridge the valley of death to the extent we need. So government has a legitimate role.
This fact, of course, drives laissez-faire ideologues crazy. But it was recognized as far back as founding father Alexander Hamilton, whose Report on Manufactures, submitted to Congress in 1791, was partly about this very topic. (What constitutes high technology changes over time, but technological innovation has been the key to economic growth since the dawn of the industrial revolution.)
During the Cold War, hundreds of billions of dollars, from the jet plane to the Internet, went into this sort of research. But because it was justified in terms of national security, not industrial innovation per se, we never really reached a solid understanding of what we was doing. So we never properly institutionalized it as a policy with an economic purpose.
As a result, our efforts today in this area are pathetically small.
For example, the Federal government’s Manufacturing Extension Partnership maintains a network of centers in every state designed to help American manufacturers adopt innovative technologies. One evaluation found that it generated $1.3 billion a year in cost savings for manufacturers and $6.25 billion in increased or retained sales—all for an annual federal outlay of only $89 million.
A single Boeing 747 costs four times that.
Another good but underfunded program is the Technology Innovation Program. An audit by the respected National Academy of Sciences vindicated its claim to generate economic benefits far exceeding its cost. One single $5.5 million grant, for example, seeded development of the small disk drive industry, which enabled creation of the iPod, the iPhone, TiVo and the Xbox.
TIP’s 2012 projected budget? $75 million.
Our rivals are far ahead of us in this game. Germany, where factory wages are now higher, and unemployment lower, than here, spends roughly two billion dollars a year on its Fraunhofer Gesellschaft. They even have a substantial presence in this country, to harvest useful American ideas for commercialization in Germany!
To get our economy back on track, we need to stop dreaming that innovation is purely a self-financing private-sector game and start paying for the innovation we need. Either that, or we’re not going to get the economy we want.
Ian Fletcher is the author of the new book Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95) He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933. He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at ian.fletcher@usbic.net.
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