Out of the Crisis Through Innovation

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By Paolo von Schirach

November 13, 2009

WASHINGTON – Recently I watched on TV an interesting and intelligent exchange between two luminaries on what the future will bring to the economic fortunes of the US. Still, and quite surprisingly to me, in all the detailed, erudite back and forth, laced with projections, variables, the role of China, what will the matter be with Europe, Japan and so forth, one key word —innovation— was never uttered let alone discussed by the two.

No America without innovation

The idea that one can talk at great length about the fiscal and economic future of the now short of breath, battered US economy without any reference whatsoever to innovation –the key historic strength of the American economy– is truly baffling. While the current gigantic mess was caused by finance going crazy, the issue is not just about restoring the banking system. Looking into the future, even assuming a healthy, properly regulated financial system, the strength of America, its real strategic assetrests in being number one in many if not most leading technologies.

America’s primacy rests on enterprise

The US did not become the biggest, the most powerful, the most resilient and most flexible economy in the world by accident. While economic performance is due to a variety of factors that combine and mesh in often peculiar and unpredictable ways, clearly the US, in large measure, owes its primacy to its decisive lead in technological innovation and its related ability and talent to rapidly transform innovation into viable and commercially rewarding products.

Innovation is the foundation of economic might

An interesting The Wall Street Journal article on the rebirth of tinkering in several engineering schools in the US, (Tinkering Makes Comeback Amid Crisis, November 12, 2009), clarifies this key point. Indeed, after the 1950s, with the seminal work of MIT Nobel Prize winner, Robert Solow, it became apparent to mainstream economists that, while labor and capital accounted for about half of economic growth, the other half was due to innovation.

Indeed.

This being the case, it may be possible to infer that US economic dominance was due in large part to huge investments in successful innovation, while its more feeble performance –if we take into account trends that developed well before the financial crisis– may be attributed to diminishing efforts in this key, strategic area.

The financial sector created this mess, fast innovation will help us out of it

It is quite obvious that the current recession, the epic mortgage industry excesses, the overleveraging of banks, the collapse of Lehman Brothers and the crippling of AIG are not tied to the rate of technological innovation. This is true. But, being in the mess that we are now, after having nurtured a consumption focused economy that was supposed to be financed by ever increasing real state valuations, how fast we get out of this mess will be determined in large measure by the rate and quality of innovation that the US economy will be able to produce and bring to fruition through successful commercialization. 

Create opportunities

Put it differently, we have now a deep recession whose length will depend in large part by the ability or inability to recycle elsewhere millions of people who used to be employed in tertiary sectors that were sustained only by excessively inflated consumer spending. But which other sectors can offer new opportunities, even assuming (and this is a huge assumption) appropriate skills and training for the people idled by the collpase of consumer spending? 

Well, many argue that there are huge opportunities to launch new, large scale and profitable enterprises that will deliver “green technologies”. This may be quite unrealistic, at least in terms of the scale of these new enterprise and hence their ability to absorb millions of unemployed Americans. Still, even if we accept the most optimistic scenario, the “green technologies”, existing or experimental, are and will be the result of a large scale process centered on innovation and all that goes with it: the schools that teach, the students who learn and then become entrepreneurs, the business environment that is receptive to new ideas, the venture capitalists willing to bet on the success of humble start-ups, led by unknown would-be entrepreneurs.

Enter “Tinkering”

The story described in the above referenced The Wall Street Journal article, notes that there is a new fervor within American engineering schools. Many student want to “tinker”. They want to “do stuff”; “make new things”. There is a proliferation of outfits that essentially provide facilities with state of the art equipment that is made available to the aspiring inventors. Among such facilities: TechShop in Menlo Park, California, and NYC Resistor in Brooklyn.

It is affordable

One of the key factors that allowed the proliferation of these laboratories that offer facilities for a fee is that a great deal of the basic high tech equipment that is necessary nowadays to design and make state of the art products has become much cheaper and thus affordable. We may not go back to the heroic times of men of genius who came up with new stuff at home, using very simple equipment. Still, we are also going away from the assumption that quality innovation requires huge and expensive facilities that only the major multinationals and/or National Laboratories (such as those run by the US Department of Energy) can fund and afford; thus restricting R&D to a very specific environment, automatically shutting off the many, otherwise creative, individuals who do not have access. And this is a good thing. So, we are “democratizing” access to the tools of the trade.

Traditional R&D: Going Down!

And, it would seem, not a minute too early, for the trends in “established”, mainstream R&D are not looking good. While indeed in the 1980s and 1990s the temples of innovation cranked the good stuff out, unfortunately, these privileged locales for sophisticated R&D apparently lost quite a bit of steam since then. As mentioned in the above referenced article, US R&D spending grew by an average of 6% in the 1980s and 1990s; while it came down to only 2.6% annual growth between 2000 and 2007. Recent projections point to further shrinking in the years ahead. Barely a trickle of growth going forward. And this cannot be good.

Low R&D, bad news for the economy

Now, if these trends amounting to severe cuts in spending for innovation are not transitory, long term this would spell disaster for the US economy. As a developed, high cost country, the US cannot compete with Asian manufacturers on cost. The China story is well known and it does not need to be rehashed here. So, the only way in which we can compete again, especially as we try and devise strategies that will get us not only out of this nasty recession but that will place us again on a path marked by robust, sustainable growth, is by promoting and commercializing innovation.

But this implies being first in many areas, or becoming the best among many competitors. Indeed, if we can be market leaders in clean energy technologies, then we may have the chance of having customers not just here at home but in the whole world, as all nations are trying to find strategies that will diminish the use, impact and cost of carbon based fuels.

America needs to invest in innovation now

But the whole idea of a sustainable, green economy is based on the assumption that we already have an ongoing, large scale effort to get to those technologies. Whereas, if indeed the rate of investment in R&D has collapsed, as the data would indicate, long term we do not have a very good chance.

Now, this phenomenon of tinkering described in The Wall Street Journal story would appear to be a welcome “counter trend”, a development pointing in the right direction. We have people, smart students, who have an appetite for innovation and who are using facilities that a decade ago could not provide the same quality and level of resources. And this is good –and it should be encouraged. Still, this interesting and increasingly popular trend cannot conceivably be enough to fill the investment gap created by the collapse of R&D run by the major corporations.

In the end, it is true that our current economic troubles have been created by speculation, overleveraging and spectacular increases in the level of private debt. And it is true that the US, as a nation, has to be on a steady diet of lower consumption and increased savings, in order to improve the individual as well as the national balance sheets.

Fine.

America’s advantage needs nurturing

But, when the worst part of the crisis will be over, what will be the strategic drivers that will create “made in the USA” added value in this global economy? Obviously nobody knows for sure. But we can rest assured that without a robust level of investment in innovative, high value, new technologies we cannot regain much lost ground, let alone acquire new leadership positions. For the moment, with debt and all, we remain the largest world economy. But only for the moment.

If others invest and we do not, eventually they’ll take the lead. The phenomenon of these “high tech workshops” that attract large numbers of new users is really promising. But this young talent and America as a whole need far bigger investments if we do not want to join the ranks of those who used to be great.

The Obama administration has established health care reform as its top priority for 2009. As we go into the new year, it may be good to consider that, while health is fundamental, you can be both healthy and comparitevely poorer. It is certainly not beyond the reach of American ingenuity to deliver better health care to all citizens, while at the same time revamping the foundations of our distinctive wealth generating apparatus. Or is it?

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