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Monday, November 03, 2008

Instead of Eating the Seed Corn...
James S. Henry and Jim Manzi

We are called the nation of inventors. And we are. We could still claim that title and wear its loftiest honors if we had stopped with the first thing we ever invented, which was human liberty."  

-- Mark Twain

(The following is a longer version of a piece that appeared this week in The Nation.)

Franklin2 In the midst of our deepening recession, the US faces Bulb11_2 another  economic crisis that is less visible and dramatic than house foreclosures, bank failures, plant closings,  or stock market avalanches, but even more important in the not-really-that-long run: systematic under-investment in technology and innovation.

Indeed, nothing less than our global economic leadership may be at stake because of this underinvestment.

On the other hand, with a little bit of funding,  foresight, and determination, we believe that it may be possible to kick-start an innovation revival.

Especially at the federal level, for a  modest investment,  there’s an opportunity to create a Edison_2 whole new generation of idea-growing, job-creating  technology hubs all across the country – perhaps even an “automotive Silicon Valley”  in otherwise moribund Detroit.

  This revival would not just be about investing more heavily in R&D. Especially in troubled times like these, we need to remind ourselves that innovation has always been a critical American tradition, a crucial part of our patrimony. It is as much a by-product of our political system and cultural norms as of our business and scientific practices.

Einsteinblackboard_3 This patrimony is now at risk, not only from our failure to invest,   but also from the failure to reward and honor scientists, technicians, engineers, and inventors above lawyers, bankers, and hedge fund managers, and to recognize the central role that real innovation of all kinds has always played in our story.


Rcm001_2 For more than two centuries America has led the world in innovation.  This has been true notNaismith_3 only in science and technology, but also in business management practices, the design of new approaches to service delivery, and, indeed,  sports,  political institutions and civil rights as well. Over the long haul, this consistent track record of ingenuity and invention, complemented by heavy investments in education and science, has contributed mightily to America’s leadership role in the world economy, to our democratic culture and the prosperity of our people.

Carver Indeed, most students of economic growth now agree that the contribution of technical innovation to US national wealth has been at least as important as that of so-called “natural” resources like abundant farm-land, labor, capital, and energy.

In the post-globalization economy, where access to such resources is being commoditized, innovation has become an even more important source of competitive advantage.  In principle, this should be good news for the US. This is not only because of its past successes, but also because innovation-based competition is  “win – win,” not “beggar thy neighbor.”  Over time, every player in the competitive game stands to benefit from  the discoveries made by others.  Hydehenrietta

Typewriter On the other hand, if the US stakes its future on resource-based competition  -- or the kind of low-innovation, “big houses/big debts/big cars” model favored by Detroit, New York, and Houston until very recently  --   the competitive game will become “win-lose.”  And long-term competitive advantage then shifts to those countries with the largest supply of cheap resources, the lowest taxes, and the cheapest, most oppressed workers -- not a favorable formula for a healthy democracy.


Unfortunately, the US’ global leadership in innovation has been placed at risk by years of Slinky failure to invest adequate resources in R&D.

Spraycan To begin with, virtually every analysis of the “social returns”  -- private profits and social benefits, including employment -- to R&D investments  finds these returns to be very high. They average at least 30- 50 percent per year or more in real terms, compared with the meager 5-7 percent returns typically generated by the US stock market – or the minus 46 percent returns earned by stocks earned in the last year.   

These high returns to R&D are explained by its peculiar nature. Once discovered, new ideas  can be used over and over at low – or even zero – marginal cost. So R&D not only boosts Tape productivity in the industries that do  research; it also yields “spillover” benefits for other industries. And it speeds up  future innovations. There is NOT a finite body of good ideas sitting out there waiting to be mined. Rather, from a knowledge standpoint,  we live in an expanding universe, where each new discovery reveals whole new territories to be explored.

First_to_fly_how_wilbur_orville_wri Consistent with this, those industries that are the most R&D intensive have also consistently achieved the highest growth rates and profitability, and have also made the largest contributions to skilled employment and high incomes. The notable exceptions -- financial services, lawyering, real estate development, accounting,  plus cartelized industries like autos, cable television, and oil and gas -- are ones where clever chicanery, market power, and anti-competitive regulations have permitted vast fortunes to be achieved without much fundamental innovation at all –- until the recent collapse.


Polaroidcamera These high rewards for investments in R&D also suggest the presence of a substantial Zipper innovation spending gap. This is the gap between the current level of R&D spending and the optimal level, from the standpoint of generating growth, employment, and the many other social benefits of new ideas. Indeed, we are so far from the competitive margin that the US might be able to profitably invest several times the current $370 billion per year that US industry and the federal government now spend on R&D without driving “social returns”  below the long-term (federal) cost of capital – just 1 percent these days after inflation.

Let’s put it this way: at these interest rates, and the high expected returns, it would cost the US Government just $400 million per year in interest to double its entire current budgRefrigeratoret for civilian R&D – which might then yield an incremental $12 billion in returns. It’s about time that we realized such high multiples for the country, and not just Wall Street executives.  


Yet the recent trend in US R&D investment has been in precisely the opposite direction.

Usrdofgdp First, while US R&D spending as a share of national income has been relatively high for decades, compared to other Western countries, since the mid-1980s it has stagnated. Indeed, it now is well below the 1960s level, when the Kennedy/ Johnson Administrations’ visionary drive to reach the moon, combined with the arms race and the rise of mainframe computing, produced a sharp boost in US R&D spending.

Federal funding is one key to this gap.  While it still accounts for about 28 percent of Safetypinanim all US R&D spending, it has recently been especially sluggish. In real terms, the federal budget for basic and applied R&D has fallen for five years in a row, and will continue to slide  next year under the budget just approved by Congress.

This recent trend is even more disturbing, once we take into account the fact that nearly 60 percent of the Federal Government’s current $100 billion of R&D funding   is devoted to military and “national security” programs at the Pentagon, DOE, and the Department of Homeland Security.

Realusrd53to09b The $42.6 billion left over for non-military research in FY 2009 has to fund everything from DOE’s basic research on alternative energy to the National Institute of Health’s vital medical research program for peer-reviewed science, to NASA’s entire space budget.  As a share of national income, non-military budget for R&D now amounts to a paltry .3 per cent – the lowest share since the early 1950s, and just half the average in the late 1970s.

The $43 billion budgeted for all federal civilian R&D pales by comparison with the $700 Civvsnatsecrd_7609e billion that the US Treasury is injecting into US banks, in return for some combination of non-voting stock, very low dividends, and toxic assets. It also pales by comparison with the $29 billion bailout of Bear Stearns, the $135 billion bailout of AIG, the $200 billion bailout of Fannie Mae and Freddie Mac,  let alone the $800 billion cost (to date) of the Iraq War.

But of course that must simply be because government R&D spending is a risky venture whose outcomes are highly uncertain! 


The other disturbing point about R&D spending is that American leadership has been slipping. Relative to other countries, the US has long devoted a relatively high share of national income to R&D investment. Even now it still accounts for a disproportionate share of all global R&D  -- at least 25 to 34 percent. 

However,  while US R&D spending has recently stagnated, many other countries, including key new competitors like China and Malaysia as well as more mature ones like Korea, Singapore, and the Nordic block, have been sharply increasing R&D spending. So the gap between these leading competitors and the US in overall R&D spending is rapidly shrinking.
Since innovation is by definition a matter of human skill and creativity, not just finance, it also matters that these new competitors have also sharply increased the share of skilled researchers and technicians in their labor forces. The US’ slippage has also been aided by the “hegemon tax” --  the fact that none of these countries spend anywhere near the 50-60 percent share of R&D that the US devotes to military R&D.

Lrg_cover Overall, many high-growth developing countries have already grasped a Comparativerdkey point about economic national security that the US is still struggling to grasp. This is the fact that, as noted above, the global competitive marathon increasingly depends on productivity, innovation, and scientific skill, not just command over natural resources or vast pools of untutored “hewers of wood and drawers of water.” 

Indeed, US companies that once moved offshore simply because of cheaper inputs, lower taxes, and weaker regulation are now finding that it pays to move their R&D centers offshore as well. This is partly because of the growing availability of engineering skills in places like India, China, and Singapore, but it is also because  of the higher barriers to immigration that foreign skilled workers have faced in the wake of 9/11. This policy may or may not have had much impact on terrorism, but by forcing these workers to remain at home, it has certainly had a negative impact on our economic security. 


These disturbing trends in federal R&D spending haFord_model_t_henryve also been reinforced by recent trends in private sector spending. As we saw earlier, private investment now accounts for more than 70 percent of all US R&D. Unfortunately, because of the current financial crisis and the emerging recession, this funding is drying up even as we speak.

This is especially true for venture capital funds that have relied heavily on so-called “limited partners” like pension funds and university endowments. Such investors often manage their portfolios with fixed allocations – reserving, say, 10 to 20 percent of investments to “alternative investments,” especially the “D” side of R&D-intensive ventures. Given the stock market’s steep decline, this approach to portfolio management and the need to rebalance asset allocations have virtually dictated a steep decline in private R&D funding.
on how deep this recession is, and how much father stock markets fall, this allocation effect  will easily trim private R&D spending by 10-20 percent or more – for a budget that is already, as we’ve seen, under-funded.

Rdbyindustryus At the same time, in uncertain times like these, many private corporations and investors become less patient. – they become much less willing to invest in the kind of  low-probability/ long-lead time projects that are the essence of basic research.  It is hard to diversify away such project risks, so private capital markets tend to demand more immediate, sure-fire payoffs just when “capitalism” is most in need of  real breakthroughs.
In the aggregate, this helps to explain why the primitive “Capitalism R 1.0”  version of a market economy -- one  that relies exclusively on private investment to fund innovation – is likely to grow much more erratically than one that allows government to play a complementary role, stabilizing support for basic research in good times and bad.

So what should we do about the innovation gap? 

¶ First of all, we need to make investing in innovation the  national priority that it deserves toInventors_2 be – because future US competitiveness depends on it. In the 21st century, as global competition increases, we cannot simply “Wal-Mart” our way to  prosperity. 

At a minimum, this implies a significant boost in the current E546449b143148fb9c82239b70476d8c_2 level of R&D funding, especially in civilian funding, and perhaps increased tax credits and other incentives as well.
Of course, such measures would require increased federal spending, precisely at a time when the federal budget is already severely strained. As we’ve seen, however, the current level of spending is so modest that the US is just “one-half bank bailout” away from the kind of increase  in R&D funding that is needed. The alternative of just continuing to stagnate should really be characterized as “eating the seed corn.”

¶ Second, like most enterprises, our country really needs a national technology strategy. 

This is not a matter of “industrial policy” or “picking winners,” much less of displacing private funding with government venture capital.

Rather, it is  matter of figuring out  creative new ways to partner with private capital – including philanthropic donors  and university endowments.  The aim is to multiply the benefits, by focusing on what the government has always done best – replenishing the “seed-corn” with fundamental longer-term research.

This requires a fresh look at the appropriate role of government in innovation. From this angle,  the recent financial crisis is not all bad.  Given the disastrous example of excessive reliance on under-regulated markets that we’ve just seen, on the one hand, and the relatively successful long-term track record of government R&D on the other, this is an historic opportunity.


¶ Third, there’s a real opportunity to learn from our own innovation history, and use the 20060604siliconvalley lessons to propagate a nation-wide series of innovation hubs.

  It is especially instructive to walk backwards from the successes realized by several US examples of public-private collaboration in “technology hubs” like Silicon Valley, Boston, and Austin Texas.
In all these cases, private venture capital and entrepreneurs  were crucial. But the fact is that federal dollars also played a pivotal role. For decades the federal government generously subsidized basic research in fields like engineering, biology, physics, chemistry, and computer science at premier universities like MIT, Harvard, Stanford, Carnegie Mellon, and the University of Texas.

For example, in the case of Stanford, one of Silicon Valley’s mainstays,  the university has received enormous federal research subsidies ever since the 1940s. Combined with the Valley’s highly-competitive venture community, this provided the foundations for a technology hub that has transformed the world, with innovations like semiconductors, computer graphics,  and wireless communications, and companies like Intel, Apple, and Google.
In the case of Boston, the National Institute of Health has recently played a key role in helping the community become a technology hub for biotech and pharma research. Boston’s new leadership in this arena is based on enormous NIH funding, channeled to peer-reviewed researchers at regional teaching hospitals. Over time, the steady provision of federal tax dollars has supplied the  grist for what has since become a self-sustaining  innovation mill. Rather than “crowd out” private funding, federal funding has actually galvanized it, providing a base load of support that allowed a strong technical community – the key to any successful hub -- to take root.

Steinmetzedison The key issue is whether we can replicate  new “Bostons” or “Silicon Valleys” in other geographies,  targeted towards priority arenas for innovation like energy, health care, the environment, education, and transportation.

Each of these arenas offers a wide range of subfields. For example, in the energy arena, there’s already path-breaking work under way on clean energy, new electric distribution systems, and new forms of automotive and non-automotive  transport. In health care, innovations that lower costs (e.g. EMRs) may be just as important as clinical innovations like new devices, treatments, and compounds.

The point is not to dictate  precisely what gets worked on, but to marshal the human resources and infrastructure needed for innovation, build the partnerships with private institutions, and insist on excellence.

In this “incubation” approach, for example, we might  ask, what conditions would be needed to yield a period of sustained innovation in the automobile sector? Why not reserve, say, just  a few percent of the $25  billion that the federal government has already committed to that sector’s “bailout” for the creation of an “automotive Silicon Valley?” In such a hub, just as in Boston and Austin,  a virtuous cycle of innovation and product development would be generated. Pockets of entrepreneurial companies would spawn each other, one after another, competing aggressively and helping to free people and capital from big, slow-moving companies. Universities, communities, and corporations would complement each other’s very different styles and skills.

¶ This renewed emphasis on innovation as a source of national competitive advantage also requires us to beef up our education system, in order to deliver tens of thousands of  skilled technicians and engineers.  As we’ve seen, there’s also a need for immigration reform that provides greater access to foreign-trained skills – an alternative to the current “scarce visa” system, which basically encourages our competitors to staff up their own technology-based industries. In this case, we’re not just eating the seed corn; we’re giving it away.

Finally, the other crucial requirement of an innovation revival is a national culture that reminds young people of their innovation heritage, and encourages them to become engineers, designers, and scientists,  rather than just lawyers, accountants, and bankers -- whose preferred form of ingenuity, in Thornstein Veblen’s words, has always been “clever chicanery, or the thwarting thereof.”  As we’ve argued, now more than ever, we need to curtail all this chicanery and return to the much better American tradition, innovation on the real side of the economy.

(c) SubmergingMarkets, 2008

Jim Manzi was Chairman of Lotus Development Corporation, and is now Chairman of Thermo Fisher Corporation, a $10 billion life sciences company based in Waltham Massachusetts. 

November 3, 2008 at 12:29 AM | Permalink


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Instead of Eating the Seed Corn...
James S. Henry and Jim Manzi