Limit Federal Grants to Domestic Startups

In the lab at Kitech, Korea Institute of Industrial Technology, Ansan, South Korea. Photograph by Ana Nance/Redux

Last December, President Obama signed into law the 2012 Defense Authorization Act, which included reauthorization of the Small Business Innovation Research funding program. The 30-year-old program had become a political football despite being an effective tool for overcoming the failure of the private sector to adequately fund early-stage technology commercialization.

The law directed the Small Business Administration to set eligibility requirements for SBIR grant recipients. Rather than limiting eligibility to majority American-owned small businesses as it had done in the past, the SBA in its proposed rules expanded eligibility to include “domestic business concerns,” which it defines as businesses that make a “significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor.” Unlike the SBA’s earlier definition, “domestic business concerns” could include majority foreign-owned concerns that operate primarily in the U.S.

The National Small Business Association and its technology affiliate, the Small Business Technology Council have objected to the change, arguing that the new definition would “push American small business out of the SBIR program in favor of foreign-owned businesses and consortiums.” In the act reauthorizing the SBIR program, Congress indicated to the SBA that it wanted to “preserve and maintain the integrity of the SBIR program as a program for small business concerns in the United States by prohibiting large businesses or large entities or foreign-owned businesses or foreign-owned entities from participation in the program.” While I don’t agree with the advocacy groups’ economic reasons (I explain why below), I do agree the SBA should follow Congress’s intention and limit eligibility to majority American-owned small businesses.

Who is eligible for SBIR grants is an important issue for entrepreneurs in the U.S. developing sophisticated technology, such as medical devices, geothermal heat pumps, and wireless battery chargers. The SBIR program provides in excess of $2 billion annually for technology development by requiring federal government agencies to set aside 2.5 percent of their budgets (the amount will increase to 3.2 percent under the reauthorization) for small business technology commercialization efforts. SBIR grants are very beneficial to entrepreneurs because, unlike equity financing, they are non-dilutive, and, unlike debt financing, they don’t have to be paid back.

Most economists support the SBIR program because government funding overcomes the private sector’s unwillingness to finance the commercialization of many kinds of early-stage technologies. By overcoming a market failure, the government program allows all of us to benefit from health-care breakthroughs, novel materials, and so on.

But the NSBA and the SBTC aren’t making good economic arguments when they say that SBIR grants should be limited to majority American-owned companies. Focusing grant funds on domestically owned recipients doesn’t overcome the market failure better than if foreign-owned companies are included. If the private sector fails to fund technology commercialization, then the best way to overcome that problem is to give SBIR grants to the small businesses that are developing the technologies with the greatest commercial potential. If foreign-owned businesses located in the U.S. have better technologies than American-owned businesses, then the foreign-owned ones should receive the SBIR grants.

And the advocacy groups’ argument that the SBA should focus eligibility on where the owners are domiciled rather than where the businesses operate is economically suspect. When it comes to generating economic impact and creating domestic jobs, what matters is where companies are located, not who owns them. After all, a BMW plant in Alabama creates just as many jobs as a Ford plant there; and a BMW plant in Alabama is more valuable to U.S. employment and GDP growth than a Ford plant in Germany.

Despite the weak economic arguments put forward for limiting eligibility to majority U.S.-owned firms, the SBA should do just that because it’s what Congress wants. Even if Congress reauthorized the SBIR program to help small American high-tech businesses for purely political reasons, and economic theory suggests a better approach, the SBA needs to do what Congress intended. The SBA needs to rewrite the eligibility rules (again) before they go into effect.

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