Can America Invent Its Way Back?

"Innovation economics" shows how smart ideas can turn into jobs and growthand keep the U.S. competitive

Will 2009 be the year of innovation economics?

Pessimism about America's future is growing. People worry about the long-term impact of the housing crisis, global competition, and expensive energy. And the policy solutions offered by Republicans and Democrats—mainly tax cuts and government spending programs—seem insufficient.

Yet beneath the gloom, economists and business leaders across the political spectrum are slowly coming to an agreement: Innovation is the best—and maybe the only—way the U.S. can get out of its economic hole. New products, services, and ways of doing business can create enough growth to enable Americans to prosper over the long run.

Certainly the Presidential candidates are taking the idea seriously. John McCain has proposed a $300 million prize for the person or company that creates a better battery technology to power cars. Barack Obama has called for spending $150 billion over the next 10 years on clean-energy technologies. The hoped-for outcome: more jobs, more competitive trade, less dependence on foreign oil.

But here's the conundrum: If money alone were enough to guarantee successful innovation, the U.S. would be in much better shape than it is today. Since 2000, the nation's public and private sectors have poured almost $5 trillion into research and development and higher education, the key contributors to innovation. Nevertheless, employment in most technologically advanced industries has stagnated or even fallen. The number of domestic jobs in the computer and electronics sector continues to plunge while pharmaceutical and biotech companies lay off as many workers as they hire. And even the industry category that includes Google (GOOG)—Internet publishing and Web search portals—has added only 15,000 jobs since 2003.

The new field of innovation economics addresses this gap between spending and results. Economists are increasingly studying what drives successful innovation to learn how companies can get more bang from the bucks spent on R&D and higher education. At the same time, they're collecting new data on American R&D initiatives to understand what's working in the U.S. and what's not. And most important, economists are making concrete proposals about how to turn smart ideas into jobs and growth.


This focus on innovation as a crucial way to develop a competitive edge is a big change from the past. While a handful of economists have studied technological change, the main focus of policy-minded economists has, until recently, been on traditional topics such as taxes, government spending, and trade.

Now some of the brightest minds in the field, including Daron Acemoglu of Massachusetts Institute of Technology, winner of the 2005 John Bates Clark Medal for the top economist under 40, are paying a lot more attention. His work examines how government and business decisions such as outsourcing can influence the direction of technological change.

But theorizing isn't enough without good data. That's why government statisticians such as Lynda Carlson of the National Science Foundation are trying to find new ways to quantify innovation and its impacts on business. In January the NSF will launch an annual survey of 40,000 companies asking how much they spend on R&D in the U.S. and overseas, by type of business and country. "For the first time, we'll have a clear picture of what kind of research companies are doing globally and what benefits they are getting from their spending,"

says Carlson, who is spearheading the survey.

Economists are also suggesting how to use new tools to boost innovation. They're studying when prizes for technological advances make sense. They're proposing ways state and local governments can best encourage innovation-based economic development. And they're exploring how to make optimal use of the billions of dollars' worth of research conducted in government-funded national labs.

It's possible the longstanding partisan debate over tax rates and budget deficits may soon become a sideshow. "The main purpose of economic policy should be to spur innovation and growth," argues economist Robert Atkinson, head of the Information Technology & Innovation Foundation (ITIF), a nonpartisan think tank in Washington. "This is not an issue either party owns."

Historically, technological change has been the biggest force for productivity growth in the U.S. The latest figures show that "multifactor productivity"—a category that includes technological change and other improvements in business processes—accounted for 45% of productivity gains between 1987 and 2007. "Ninety-five percent of economists agree that innovation is the most important thing for long-run growth," says Acemoglu of MIT.

What's more, the best way to keep the U.S. competitive is to bank on promising new ideas. America still is a leader in resources devoted to innovation, as measured by the share of gross domestic product spent on R&D and higher education. But it can't compete with China, India, and other developing countries on labor costs. And it's unlikely the U.S. can depend on cheap capital because it borrows so much money from overseas. Indeed, personal, corporate, and government savings combined total only 14% of GDP in the U.S., vs. an average 22% among other industrialized nations.

But innovation has fallen short of its promise in recent years. While some info tech corporations are still thriving, other sectors that were supposed to drive growth have faltered. Biotech companies have produced new drugs, but so far no real breakthroughs. And nanotechnology has been slow to generate commercial products.

Worse, the historic link between jobs and innovation seems to have vanished, at least for now. In the past, pioneering industries such as automobile manufacturing and aerospace were big job creators. Today, jobs in cutting-edge sectors are down 12% since their 2001 peak. (Those industries include computer and communications hardware, software and computer-systems design, aircraft, drugs and medical devices, telecom, and Internet outfits such as Google and Yahoo! (YHOO))

Until recently, economists had few good remedies when innovation stopped producing enough tangible benefits. Thats because technological progress—the discovery of penicillin or the invention of the laser—was viewed mainly as the product of science and serendipity, and therefore not very responsive to economic forces.

As a result, economists had only one blunt tool for stimulating innovation: larger government research grants and tax breaks for businesses. Economists for the most part treated R&D spending as an investment in a physical asset, just like an office building or truck.


But there were always some who saw beyond this narrow view. In the 1940s, Joseph Schumpeter of Harvard University coined the phrase creative destruction to describe the necessary turmoil caused by innovation. Robert Solow of MIT won a Nobel Prize for economics for his work on technological progress and growth. And Dale Jorgenson of Harvard and William Baumol of New York University have been mentioned as potential Nobel laureates for their work in areas such as technological change and entrepreneurship.

Economists began taking a broader interest in innovation during the New Economy boom of the 1990s, which was driven by breakthroughs in information technology.

At the same time, economist Paul Romer, now at Stanford University, showed how spending on innovation was different from the usual sort of capital investment because the gains from new ideas and discoveries could be shared by everyone.

Today, researchers are focusing on ways to make those undertakings more efficient. "Innovation is not just exerting effort and spending money, it's problem-solving," says Karim Lakhani, a professor at Harvard Business School. Lakhani has been studying what is called distributed innovation, in which solutions to a business or technical problem are solicited from a wide variety of people. Open-source software or companies like InnoCentive, which encourages outside researchers to work on corporate problems, are good examples. By contrast, most companies are unwilling to draw on outside expertise. "It's the broadcast of the problem that is important," argues Lakhani. "By publicizing a problem, we can get access to better ideas."

Lakhani is encouraged by the growing number of prizes for innovative products, such as the Progressive Automotive X prize ($10 million for a car that gets 100 mpg). However, offering more—and smaller—prizes would allow a wider range of people to take on a challenge, he argues. "We want diversity of eyeballs."

One way to attract broader attention to a problem is to conduct more R&D overseas. In part, that's because scientists and engineers in India, China, and Eastern Europe are cheaper than their American counterparts. In addition, global collaboration can improve results by bringing in more diverse perspectives.

But globalizing research and production can also alter the direction of technological change—with potentially negative effects on U.S. prosperity. MIT's Acemoglu, who holds dual American and Turkish citizenship, argues in his work that in the past U.S. companies directed their research to take advantage of the well-educated American workforce. Now, as more multinationals move operations overseas, they are developing technologies adapted for their less skilled foreign workforces. In other words, offshoring is affecting the direction of innovation in ways that are more favorable to countries such as China and India. In particular, says Acemoglu, "China is going to have a major effect on technology."

Measuring the impact of outsourcing and other factors on innovation will require far better statistics than are now available. That's why the NSF is pushing hard to collect greatly improved data on R&D and innovation, a tough task. Its new study aims to provide useful information for both businesses and policymakers, says Carlson, who helped create the government's statistics on energy consumption before she joined NSF in 2000. The survey will ask a wide range of questions, including whether companies are using their research to create new products or simply to improve existing ones. "The new statistics will provide benchmarks for companies," says Carlson, "and allow them to see how their R&D and innovation performance compares to the rest of their industry."

Even as better data are collected, the government is also upgrading the system of economic statistics it uses to produce GDP figures. The goal: to shed more light on innovation and other drivers of growth. Late this year, the Bureau of Economic Analysis plans to publish a "blueprint for innovation" showing how the government stats can better capture innovation-related expenses such as education and R&D, says BEA director J. Steve Landefeld.


What kinds of policies can improve the performance of U.S. innovation? Since 2000, the Bush Administration has boosted spending on nondefense R&D by roughly 40%, after adjusting for inflation. Still, more could be done. Democrat Obama wants to double federal funding for basic research, which in real terms is up just about 20% since 2000. Both the GOPs McCain and Obama want to boost support for the development of less polluting technologies.

But a big point of innovation economics is that money alone is not enough.

Atkinson, of the think tank ITIF, argues that the R&D tax credit needs to be reworked to encourage collaboration. He suggests giving companies credit on their tax returns for 40% of the money they spend on research partnerships with universities and government laboratories, not just for their increased spending, as the current law allows.

Atkinson also advocates creating a national foundation, similar to the NSF, with the mission of promoting innovation. The idea has some support: In June, Senators Hillary Clinton (D-N.Y.) and Susan Collins (R-Maine) introduced legislation to set up a National Innovation Council.

One of the hottest areas in the field is the use of government aid to cultivate "innovation clusters," or collections of local companies and academic institutions working together to create new products and processes. Ideally, those alliances would build on existing expertise in a region.

Last November, for example, Maine voters passed a $50 million bond issue to help finance groundbreaking local business initiatives. In early August, grants totalling $29 million were announced, including funds to renovate a commercial pulp mill by adding a pilot plant to produce ethanol—without reducing the mill's usual output.

Will innovation economics keep America growing? Proponents are upbeat about the long-term technological possibilities, despite the current pullback. "Like the 1970s, people are going to assume that a short-term slowdown means the trend is slower as well," says Stanford's Romer. "But the arguments for long-run optimism are as strong as they have ever been."

Business Exchange related topics:US EconomyBusiness InnovationInnovation Economics

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