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Invest in Innovation | The Nation

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Invest in Innovation

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In the midst of our deepening recession, the United States faces another economic crisis that is less visible but may be more important than house foreclosures, bank failures, plant closings or stock market avalanches: the systematic under-investment in technology and innovation. Our global economic leadership may be at stake because of it.

About the Author

Jim Manzi
Jim Manzi, the former chairman and CEO of Lotus Development, is chairman of Thermo Fisher, a $10 billion life sciences...
James S. Henry
James S. Henry is an economist, lawyer and investigative journalist, and former chief economist at McKinsey & Co....

Also by the Author

If it really is time for accountability, we should start by holding banks and financial institutions responsible for their actions and not allow them to rob us again with TARP II.

There is much less to Obama's stimulus plan than meets the eye. What's he going to do about it?

But with only a little bit of extra funding, foresight and determination, it may be possible to kick-start an innovation revival. Especially at the federal level, we see an opportunity for a modest investment to create a 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 research and development. In troubled times like these, we need to remind ourselves that innovation has always been a crucial part of the American patrimony. It is as much a byproduct of our political system and cultural norms as of our business and scientific practices.

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

Leadership

For more than a century America has led the world in innovation. This has been true not only in science and technology but also in business management practices, the design of new approaches to service delivery, political institutions and civil rights. A 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.

Most students of economic growth now agree that technical innovation's contribution to US national wealth has been at least as important as that of so-called "natural" resources like abundant farmland, 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 United States. Innovation-based competition is a "win-win" scenario: over time, every player in the competitive game stands to benefit from the discoveries made by others.

But if the United Stakes stakes its future on resource-based competition--the kind of low-innovation, "big houses/big debts/big cars" model favored by automakers, Wall Street and the oil industry--the competitive game becomes "win-lose." Long-term competitive advantage shifts to countries with the largest supply of cheap resources, the lowest taxes and the cheapest, most oppressed workers--not a formula for vibrant democracies either at home or abroad.

High Returns

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

Virtually every analysis of the "social returns" of R&D investments--private profits and social benefits, like job creation--finds these returns to be from 30 percent to 50 percent per year or more in real terms. This compares with the meager 5 percent to 7 percent returns typically generated by the US stock market, and the minus-46 percent returns earned by a US stock portfolio over 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 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.

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, high incomes and trade. The notable exceptions--financial services, lawyering, real estate development, accounting, as well as cartelized industries like autos, cable television, and oil and gas--are ones in which clever chicanery, market power and anti-competitive regulations have contrived to create vast fortunes without much fundamental innovation at all--until the recent collapse.

The Innovation Gap

GDP Graph

These high rewards for investments in R&D also suggest the presence of a substantial 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 and employment, and the many other social benefits of new ideas. We appear to be so far from the competitive margin that the United States might be able to profitably invest several times the current $370 billion per year that industry and the federal government now spend on R&D without driving "social returns" below the federal government's long-term cost of capital--just 1 percent these days, after inflation.

With such low real interest rates, and such high expected returns, it would cost the US government only about $400 million per year in interest to double its entire current budget for civilian R&D--which, in turn, might yield an incremental $12 billion in profits and other social benefits. It's about time that we realized such high multiples for the country, not just Wall Street executives.

Yet the recent trend in US R&D investment has been in precisely the opposite direction. Historically, our R&D spending as a share of national income has been relatively high for decades, compared to other Western countries', but since the mid-1980s it has stagnated. 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.

Federal funding is one key to closing this gap. While it still accounts for about 28 percent of all US R&D spending, it has been especially sluggish in recent years. 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 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, the Department of Energy and the Department of Homeland Security.

The modest $42.6 billion left over for all federal 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 for civilian R&D pales in comparison to the $700 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.

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