The Sputnik Fallacies
The need for innovation has never been greater, as the first section of the book explained. In addition, the very ways in which innovation happens—meta-innovation—are changing fast, as the second section of the book argued. That points to a pressing question: what to do about it? This final section of the book delves into the question of what governments, companies, and individuals can do to win in the age of disruptive innovation.
This chapter turns a critical eye to the arguments put forward by proponents of industrial policy. It is fashionable today to argue that the rise of China represents an existential economic threat to the West, one that can only be countered by a dramatic government effort akin to the Apollo moon shot.
It is right to say that developed countries need to fix various aspects of their innovation ecosystems. The United States, for example, must address flaws in its policies on immigration, education, and basic infrastructure. However, calls for an aggressive return to industrial policies of the sort seen in the 1970s and 1980s are wrongheaded and dangerous. Especially given the dramatic changes in how innovation is happening from the bottom up and the inside out, a return to the failed centralized approaches of the past would be folly.
Will China eclipse the United States as the world’s innovation powerhouse? At the end of the Second World War, American spending on research and development made up half the world’s total; today, it has dropped to one-third. South Korea, China, and India are pouring tens of billions of dollars into scientific fields that range from genomics to nanotechnology. They are producing staggering numbers of engineers and scientists, who in turn are publishing lots of papers and acquiring ever more patents.
The notion that Asian innovation is surpassing that of the West has led to much public anguish in the United States. In 2009, the Aspen Institute put on a major conference in Washington on the topic of the U.S. innovation crisis that attracted many chief executives, cabinet officials, congressional leaders, and experts on various aspects of the topic. To set the stage, the organizers revealed the results of a big poll sponsored by Intel that showed that Americans were tremendously insecure about their country’s economic leadership: roughly the same numbers believed that the United States would remain in the global innovation lead as felt that China would pass the United States. Newsweek ran an article about all this at the time titled, “Is America Losing Its Mojo?”
The pessimistic drumbeat only grew louder in coming months. A commission of twenty eminent people organized by the National Academy of Sciences and the National Academy of Engineering, which included Nobel laureates and heads of leading companies, had produced an influential report back in 2007, called Rising Above the Gathering Storm, on the threat to America’s leadership in the global economy. In 2010, at congressional urging, the commission released an update on that warning. Far from improving, declared the panel of grandees, the storm is now “rapidly approaching Category 5.” The group demanded immediate government action.
This call to arms is echoed by many who see China’s rise as a threat akin to the Soviet Union’s Sputnik program, which sent the first manmade object into orbit back in 1957. That daring feat so shocked the United States that it led to a dramatic expansion of efforts in science, engineering, and space—a government-funded boom that kicked into high gear with John F. Kennedy’s call in 1961 for the country to put a man on the moon by the end of that decade. Michael Mandelbaum, a foreign policy expert at Johns Hopkins University, has claimed that “our response to Sputnik made us better educated, more productive, more technologically advanced, and more ingenious.”
On this view, the United States should seize on the new Red Menace to launch another bold, government-led “moon shot” that would boost innovation and put the country back on top. A growing chorus of business leaders, academic experts, and labor bosses is calling for a dramatic change in government policy to salvage the broken U.S. innovation system. Thomas Friedman has devoted various of his New York Times columns to this topic, one of his favorite themes, and they have served as rallying cries for the “new Sputnik” movement.
The Sun Also Sets
Hang on a minute, though. Look closely at the claims made by the chorus of doom, and it turns out there are three dangerous fallacies embedded in the Sputnik analogy. First, this approach assumes that the rise of the rest must come at the expense of the West. The second mistake is the assumption that China’s innovation capacity is already on par with that of the United States. Finally, and perhaps most important, the moon shot mentality leads too easily to a top-down, government-dominated approach to innovation that is out of synch with the global trend toward the bottom-up, open innovation approaches that are essential to tackling the world’s most difficult problems.
Consider the flaws in turn. For one thing, the Sputnik mind-set approach assumes that innovation is a zero-sum game. If China is up, then the United States must be down. But that is not necessarily true: history shows that one company or country can benefit from the development and marketing of a clever invention, while the robust diffusion and adoption of such inventions can also benefit many others. This is a lesson that should have been made clear by the wave of hysteria in the West over Japan’s rise in the 1980s. Back then, it was popular to decry the unstoppable rise of that Asian power as an economic force that would suck away American jobs and lead inexorably to the decline of the United States. Yale University’s Paul Kennedy asked in his 1987 book The Rise and Fall of Great Powers (which posited that Japan would surpass the United States just as surely as the Yanks surpassed the Brits) just how powerful, economically, Japan would be in the early twenty-first century. His answer: “much more powerful.” Lester Thurow, dean of MIT’s Sloan School of Management during that period of American malaise, argued that “Japan would have to be considered the betting favorite to win the economic honors of owning the twenty-first century.” Both experts fueled the insecurity of the day that America’s market-oriented economy would decline as Japan’s government-directed miracle economy soared.
In fact, Japan’s peaceful rise did not come at the expense of the United States, and China’s advance today does not have to come at the West’s expense either. Just as a rising tide lifts all boats, the economic dynamism of the emerging giants today can open vast new markets and expand global trade, increase opportunities for specialization, enrich lives everywhere, and increase opportunities for competitive American firms. But the tide will not raise boats that have holes in them, which is to say it is still worthwhile for firms to remain fit and for governments to ensure that the preconditions for successful innovation are in place—including keeping out of the way when old industries and uncompetitive firms have to die to make way for vibrant new players.
To see why, consider what actually happened to Japan after those predictions made in the 1980s. After reaching the number two spot in the global economy, the country plunged into a lost decade of economic stagnation, consumer atrophy, and deep national anxiety. In fact, on some measures China has passed it to become the world’s second-biggest economy. Part of the explanation for what went wrong lies on the demand side of the ledger. After Japan’s real estate and stock market bubbles burst, the country was overburdened with bad debt. Rather than deal with the problem swiftly, as the United States did during its savings-and-loan crisis, Japanese policy makers chose the less controversial path of flooding the market with government love and money. It did not work. Consumers were unpersuaded of the country’s prospects, and demand remained anemic.
The less understood part of the Japan story has to do with supply, however. The country’s demography did not help, as it is one of the most rapidly aging societies and one with very low rates of fertility. It is also one of the developed world’s most insular and anti-immigrant nations. That double bind means the supply of available workers is declining and the theoretical growth potential for the economy is taking a hit. Still, observes Harvard’s Clay Christensen, Japan remains a wealthy, educated, and technologically sophisticated economy, so it should have been able to rebound by now if the government had gotten out of the way of the proper functioning of capital and labor markets.
Precisely because its firms had been so successful at disruptive innovation, Japan’s once-ridiculed companies (it seems unimaginable now, but Hondas were once known for unreliability, not quality) had come to dominate global markets in cars, shipbuilding, steel, and semiconductors. They surpassed their American rivals— who had been complacently basking in the profits to be found at the technology frontier—to become top of the heap. Ah, but that rise to the technology frontier is what made those Japanese upstarts vulnerable to disruption from the next wave of disruptive innovation, argues Christensen. Japan could have gotten its economy out of the cellar if its business and political leaders had encouraged the redeployment of capital and labor from stagnant, overcapitalized industries of the past to new, emerging technologies and enterprises. Instead, they defended unviable jobs and bloated companies they considered national champions, and erected trade and other barriers to protect them. That allowed the robust and more open economies of Silicon Valley and Bangalore to grab the lead in software services, Internet technologies, and other related industries of the future. Thanks in large part to those misguided industrial policies on the supply side of the ledger, Japan’s economy continues to stagnate—and its technology firms remain laggards in the Internet revolution.
The Red Menace, Reconsidered
Another fallacy embedded in the Sputnik conceit is that China has already matched America’s innovation prowess and is set to surpass it. In fact, even conceding all the gains made by emerging markets around the world, the United States remains the heavyweight champion of innovation. Whether it is by traditional measures, such as spending on research and the number of patents registered, or less tangible but more important ones, such as the number of entrepreneurial start-ups, levels of venture capital funding, or the payback from new inventions, the United States is invariably near or at the very top of all relevant global rankings.
There is more competition at the top of those rankings these days, but there are many reasons to think that the U.S. economy will remain on top for quite some time yet. While it is true that Asia will probably surpass the United States in absolute research spending and sheer numbers of technical graduates, there are reasons to be skeptical about some of the foundations of Asian innovation. In Advantage, a well-researched book released in 2011, Adam Segal of the Council on Foreign Relations argues that America’s “unipolar moment” in the global economy may be over, but that Asia’s rise does not necessarily foreshadow the decline of the United States. He points to evidence that challenges the quality of the many patents, papers, and engineering degrees seen in India and China.
Research done by Vivek Wadhwa, an entrepreneur turned academic, has debunked various myths built up around Asian engineering prowess. In work done with colleagues at Duke University a few years ago, he showed the claims that China and India were graduating far more engineers than the United States were wildly overstated. More important, while some schools, such as the Indian Institutes of Technology, produce world-class graduates, his research suggests that a number of the degrees issued from other Indian engineering schools are of poor quality. Proof of that comes from the unwillingness of multinationals and high-end local employers to accept graduates with those degrees. Also, many firms, such as the Indian software giant Infosys, are forced to spend fortunes retraining their incoming employees with local engineering degrees. When one considers the quality of engineering talent, argues Wadhwa, the United States remains on top.
Much has also been made out of China’s dramatic rise in the league table of intellectual property rights. Not so long ago, the country was known more for counterfeit drugs, pirated CDs, and patent cheats than for original innovation. Yet consider this headline from a Thomson Reuters bulletin in late 2010: “China Poised to Become Global Innovation Leader.” The publishing firm’s researchers surveyed the patenting activity of a number of countries, from the developed world’s giants to China and Korea, and concluded that the total volume of first-patent filings in China shot up at an annual growth rate of 26 percent from 2003 to 2009; the patenting rate of its nearest rival, the United States, grew at only 5.5 percent during that period. The outfit predicted that China will overtake Japan and the United States to be the global patenting leader soon. Sounds impressive, until one asks about the quality of those patents. Look closely and it turns out that about half of the patents filed by Chinese firms in 2009 were so-called utility model patents, which Thomson Reuters itself describes as “less-rigorous, more affordable forms of patents” that provide ten years of protection versus twenty years for invention patents. Again, that suggests that claims of America’s imminent demise in this area are to be taken with a grain of salt.
That is not to say that China lacks ambition, resources, or seriousness in its quest to become an innovation powerhouse. Quite the contrary, in fact. The latest five-year plan from Beijing’s technocracy puts “indigenous innovation,” by which it means creating value through homegrown invention rather than merely copying or stealing, at the top of the country’s economic priorities. This is a huge problem, and one that worries many foreign technology companies. Some are so keen to get access to the Chinese market that they agree, under intense pressure, to share their precious intellectual property with local partners. Many in the aerospace industry say GE caved in this way with a controversial avionics deal it struck with Chinese partners recently, but Jeff Immelt is adamant that such is not the case; in his view, the deal was worthwhile because it secures his firm a powerful position in the country’s booming aviation industry. Intel does both manufacturing and research in China, but Justin Rattner, its chief technology officer, confirms that his firm forbids cutting-edge technology (“our crown jewels,” he calls them) from entering that country.
The Chinese leadership is putting the squeeze on foreign technology firms precisely because it understands how far behind the West its technology firms are. That is not to dismiss the amazing contributions being made by its frugal innovators, of course, but by definition the frugalistas described earlier in this book start at the bottom of the value chain before working their way up to such elaborate technologies as the latest jet engines. That is why the Beijing government’s goals include a desire to improve the economy’s competitiveness by directing it toward technology ownership and upgrading the structure of exports from low-cost manufacturing goods to higher-value-added products and services. By building up the innovative capacity of local firms, the government hopes to reduce the dominant share of high-tech exports commanded by foreign-owned firms in favor of local ones.
All that is necessary because locals know that China still has a long way to go to match the innovation ecosystem of the United States. In fact, the same Intel poll that showed Americans to be so anxious about a rising China revealed that more than 80 percent of Chinese reached by pollsters believe that the United States is firmly in the global lead.
The OECD recently examined China’s innovation policies and potential in great detail and concluded that while the country is already a major player in science and technology, its output still falls short of the levels in OECD countries with similar levels of R&D expenditure. This inefficiency, argue the agency’s experts, points to broader deficiencies in the policies and governance system used to promote innovation as the country moves from a planned economy to something resembling a market-based one. While acknowledging the country’s dramatic increases in research spending and levels of patenting, the experts observe that these have “yet to translate into a proportionate increase in innovation performance.” That is in part because the ability of the business sector to make productive use of all that investment in R&D is constrained by lack of proper infrastructure, talent, and culture. That is in sharp contrast with the United States, which does much better in speeding inventions out of academic and government laboratories into the marketplace (though, it must be noted, it could do still better).
China’s ambition of becoming the world’s innovation superpower faces other obstacles too. R&D money is only one part of what it takes to kick-start a modern innovation economy. The country’s norms on corporate governance, enforcement of intellectual property rights and antitrust laws, and financing of R&D are all not up to international standards yet. With small exceptions such as the nanotechnology sector, the country’s basic research efforts are not yet well connected with its technology development juggernaut. The OECD also found that the country’s industrial policies have created disconnected islands of innovation in various regions or subsectors, but too few interconnections between the various bits of this archipelago. That limits the spillovers beyond the borders of those islands and creates too great a physical separation between knowledge producers and potential users.
The upshot is that while China is clearly an ambitious rising power, there is little basis to think that it has even come close to surpassing America’s innovation prowess. The OECD’s most sensitive recommendation for China helps explain why. Though acknowledging that the country’s government does need to play a role in improving such things as corporate governance, regional disparities, and environmental protection, which the markets will not tackle on their own, the experts insist that all-knowing central planners should actually do much less in many areas. China must adjust the role of the government, insists the agency, by “overcoming the legacy of the planned economy by encouraging changes in the attitudes and methods of work of government officials so as to allow market forces, competition, and the private sector to have a greater role.”
That insight points to the third problem with the Sputnik analogy: it puts policy makers on the slippery slope to the failed interventionist approaches of the past, like the heavy-handed industrial policies adopted by many countries back in the 1970s. Keen to get America’s innovation mojo back, Barack Obama used his State of the Union speech in 2011 to declare this a new Sputnik moment. But China’s rise is that of a gradual and mutually beneficial tide, not a single aggressive act or specific blow to the United States. What’s more, the moon shots were a costly and centralized technology push (the Apollo effort cost some $150 billion in today’s money, on some estimates) that is entirely unsuited to twenty-first-century models of innovation. Robert Solow, the Nobel Prize–winning economist, acknowledges that the United States must improve the productivity of its economy. The way to do this best, he explains, is to “encourage innovation in sectors with large and growing markets, such as energy.” The centralized Apollo approach worked for getting a man on the moon and back safely, costs be damned, but it is entirely inappropriate for the clean energy challenge. Ensuring that seven billion people across the globe get access to safe, clean, affordable, and convenient energy services requires the nimble interplay of policy, markets, technology, and consumers.
Yet most of the Asian countries hoping to challenge the innovation supremacy of the United States have strong, government-led innovation policies in place. As in the case of Singapore and Korea, these are often technocratically brilliant. However, innovation is not in its essence a top-down process, and so this will not be enough for sustained success. Many of these countries lack America’s resilient, open, and risk-taking culture. China would do well to learn from the experience of state planners in Europe who also have tried to engineer innovation policies to compete with the United States. They have discovered that the American approach, for all its inadequacies, fares better than the brittle, centralized innovation policies that have largely failed across the Atlantic.
The Dangers of Dirigisme
The recent scene in Salzburg was one that Joseph Schumpeter and Peter Drucker surely would have approved of. Several dozen leading government officials and academics from around the world gathered at Schloss Leopoldskron, a spectacular rococo palace located on the shores of an idyllic lake. They came not for the fresh Alpine air, the hearty Austrian fare, or even the hills alive with the sound of music. It was for a conference organized by the Salzburg Global Seminar, a European think tank, to discuss what they could do to turn their economies into innovation powerhouses.
Holding such a meeting in the heart of Europe seemed only fitting—and not just because Schumpeter and Drucker, the two great theorists of innovation, both hailed from the region. After all, it was also a European, France’s Georges Doriot, who invented venture capital during his time teaching at Harvard. And it was another Frenchman, Jean-Baptiste Say, who coined the word entrepreneur two centuries ago to describe the plucky upstart who “shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.”
Yet the star of the show was the United States. Everyone wanted to learn how Silicon Valley was created and how it has managed to keep its edge despite various booms and busts. Asia also made its mark, with innovation gurus from places such as Singapore bragging about how many billions of dollars they are spending on technology parks, tax breaks on foreign investment, and scholarships for their bright young things to go to MIT and Stanford.
So what about Europe? The blunt answer is that the old continent is something of an also-ran when it comes to innovation. That does not mean the region has no innovative companies—it certainly has a few in some areas, especially retail and financial services, with firms such as Zara, a Spanish fast-fashion chain, and Direct Line, a British online insurer. But these tend to be exceptions. It is not much of an exaggeration to say that, aside from mobile telephony, Europe has not come up with a globally disruptive innovation in decades—although Skype, an Internet telephony firm that is now part of Microsoft, once looked like it might qualify.
Europe’s innovation malaise is the result of a complex mix of factors. Some places, such as Ireland, Finland, and parts of Scandinavia, are doing better than others (or at least, in Ireland’s case, did so before the recent financial crash). And Cambridge, England, can reasonably claim to have created Europe’s best innovation cluster, albeit one that falls far short of Silicon Valley. The main thing holding back continental Europe is that it is a lousy place to start a new company. It can cost a lot of money and it takes too long to set up a business. According to the World Bank’s influential annual “Doing Business” report, government red tape means it takes nineteen days to open a business in Germany. That is certainly better than the twenty-three days it takes in Japan, but it is much more cumbersome than the six days it takes in the United States or the mere three it takes in Singapore.
In 2006, venture capitalists invested only about $9 billion in the European Union, while their American counterparts splashed out some $45 billion on new ventures. The link between venture capital and innovation is a strong one. Samuel Kortum and Josh Lerner, two American academics, have shown that “a dollar of venture capital could be up to ten times more effective in stimulating patenting than a dollar of traditional corporate R&D.” They scrutinized twenty manufacturing industries between 1965 and 1992 and found that the amount of venture capital money in a sector dramatically increased according to the rate at which businesses in that sector took out patents. From 1982 to 1992, they calculated that venture capital funds amounted to just 3 percent of corporate R&D but 15 percent of all industrial innovations.
It is true that patents have become less important in many industries and so they are an imperfect proxy for all innovation. And in some cases venture capital funds will follow rather than create innovation. Nevertheless, patents are still widely used, and Kortum and Lerner successfully validated their results with other measurements too.
But surely innovation and entrepreneurship are not the same thing? Following the most useful definition—that innovation brings to the marketplace fresh thinking that creates value for a company, for its customers, and for society at large—someone who opens yet another corner café may be a successful entrepreneur but not much of an innovator. The ones worth paying attention to are a special type of innovative entrepreneur who embraces new ideas and has the ambition to scale them quickly. These are the people who are able to carry out the creative destruction that Schumpeter marveled at. In Europe they are still too thin on the ground: too many Europeans opt for comfortable jobs working for Siemens or Electricité de France rather than the risk and bother of starting speculative new companies.
This is worrying for Europe. National champions and incumbents are not disruptive innovators. Upstarts are. From 1980 to 2001, all of the net growth in American employment came from firms younger than five years old. Established firms lost many jobs over that period and dozens fell off the Fortune 500 list. In fact, big corporations have been dying off and disappearing from stock market indices. Most of the dynamism of the world economy comes from innovative entrepreneurs and a handful of multinationals (including GE, IBM, and P&G, all of whom have stayed on the Fortune 500 list for many decades) that constantly reinvent themselves.
Carl Schramm, president of the Kauffman Foundation, which studies entrepreneurship and innovation, says that “for the United States to survive and continue its economic and political leadership in the world, we must see entrepreneurship as our central comparative advantage. Nothing else can give us the necessary leverage to remain an economic superpower.” A recent study funded by his think tank reviewed jobs data from the U.S. Census Bureau from 1977 to 2005 and found that during this period existing firms were net job destroyers, losing one million jobs net combined per year. In contrast, in their first year, new firms added an average of three million jobs. Because start-ups that get going without government help are almost the only real source of job growth in the United States, the foundation concludes that government industrial policies aimed at preserving jobs at big companies or luring larger, established firms into a particular region will inevitably fail. Such policies are “doomed not only because they are zero-sum, but because they are based in unrealistic employment growth models.”
The U.S. economy is not a free market paragon, to be sure. The Internet and related industries have all benefited from the spillover effects from government funding of universities and from military spending. However, it is wrong to think those factors alone explain American dynamism. The Soviet Union spent lavishly on its military and space programs during the Cold War, but because its economic system was ossified, there were few spillover effects.
What is more, Europe itself spends a lot of money on higher education and has a number of top universities with leading academics and researchers who produce excellent papers and win Nobel Prizes. The problem is that their ideas tend to stay in their ivory towers. Part of the explanation is that innovation is still seen as being driven by government spending on R&D, when in fact most innovation now happens in services and business models. Studies have shown that companies that outperform their peers put a much bigger emphasis on business model innovation. Indeed, that is a mistake that even the great Clay Christensen originally made. When he first developed his groundbreaking theories on disruptive innovation, he focused on the specific technologies in question—such as inexpensive computer disk drives, for example, that ultimately drove out the expensive incumbent storage technology—that he believed to be key. But as he researched the topic further, he realized that it was not the gadget or gizmo but the combination of new technologies with radically different business models that added up to disruptive innovation.
That is a lesson that many officials in Europe have not fully absorbed. The European Union has an official target to raise government R&D spending, and there is much angst over patents—an obsession that Japanese planners share. A recent edition of Science, Technology and Innovation in Europe, an annual report by the statistical arm of the European Commission, reveals exactly what is wrong. It is chock full of figures, broken down by region and industry, of research spending, patents filed, scientists employed, and other important-sounding variables. The problem is that these are all inputs into the innovation process, not outputs. There is only a cursory discussion of venture capital and no attention paid at all to entrepreneurship—the most powerful way to turn ideas into valuable products and services.
The World Is Spiky
Another problem is that European officials, like government bureaucrats everywhere, are obsessed with creating geographic clusters like Silicon Valley. The French have poured billions into pôles de compétitivité, and many others are doing much the same. There are dozens of aspiring clusters worldwide, nicknamed Silicon Fen, Silicon Fjord, Silicon Alley, and Silicon Bog. Typically governments pick a politically influential part of their country, ideally one that has a big university nearby, and provide a pot of money that is meant to kick-start entrepreneurship under the guiding hand of benevolent bureaucrats.
It has been an abysmal failure. The high-tech cluster in and around Cambridge, England, is the most often-cited counterexample. Hermann Hauser of Amadeus Capital, a leading British venture capitalist (who, curiously, also hails from Austria), is an optimist: “Silicon Valley is still the lead cow, but Cambridge is the best in Europe.” Perhaps, but that is faint praise. The main problem, argues Georges Haour of IMD, a Swiss business school, is that Cambridge suffers from the Peter Pan complex: “Inventors never want to grow up, they are happy with modest success.” One veteran of the city’s start-up scene even argues that its success came “in spite of, not because of,” government and university support.
Experts at INSEAD looked at efforts by the German government to create biotechnology clusters on a par with those found in California and concluded that “Germany has essentially wasted $20 billion—and now Singapore is well on its way to doing the same.” A World Bank assessment of Singapore’s multibillion-dollar efforts to create a “biopolis” reckoned that it had only a fifty-fifty chance of success.
The real problem holding back innovation in many countries is too much government in the form of red tape and market barriers. Planning restrictions have prevented the expansion of Ahold and other highly efficient retailers in France. Closing hours in several EU countries also act as an inhibitor. Studies of Japan and South Korea suggest the heavy hand of government is even more stifling in those countries: outside a small, highly competitive group of export industries (cars, electronic goods, and steel), inefficient, coddled domestic sectors are slow to adopt new technologies or business practices.
In the end it is companies, not regions, that are competitive. So the question for government is how to attract many competitive firms. That should throw cold water on cluster-mad politicians. It also points to sensible prescriptions to promote innovation.
First of all, stop spreading money around in politicized fashion trying to clone lots of Silicon Valleys. Steven Koonin, an official in the U.S. Department of Energy who served previously as chief scientist at BP and as the provost of the California Institute of Technology, has said that European countries spread research funds too thinly anyway. Often this leads to money being divided up on a political basis, with funds going to institutions based on influence in Brussels and European capitals rather than on the promise and merit of a particular research effort. The United States has no problem with big awards, so innovators can achieve scale. That is precisely what BP has done, setting up a $500 million research alliance run by the University of California at Berkeley to look into advanced biofuels.
However, there is an even more important factor than money: culture. Nokia’s success was not the result of farsighted planning or subsidy by the government of Finland. One Nokia executive confides: “The biggest boost to our firm was the deregulation that followed the second world war and the government’s avoidance of protectionism.” One of the most innovative things Nokia did was to spot that the handset could also be a fashion accessory. And coming from such a small and open market, it was forced to think globally.
Second, governments keen to promote innovation need to look out for market distortions and overregulation that can be stripped away. This is not to argue for no regulation: as the latter part of this chapter argues, there is actually a pressing need for a more muscular, but carefully circumscribed, role for government. The problem is that entrepreneurs can face an uphill battle legally, not just culturally, in many countries. The bankruptcy code in many places is excessively burdensome, even banning some failed entrepreneurs from running a company for years. Contrast that with America’s Chapter 11 bankruptcy proceedings, which quickly redeploy both the bankrupt firm’s physical assets and the creative energies of its leaders.
In India an overbearing system known as the Licence Raj choked the creativity out of most sectors of the economy for decades, through a mix of overregulation, petty corruption, and centralized planning. But the bureaucrats in Delhi did not understand computer software well enough to regulate it. And by the time they caught on, innovators in Bangalore and other corners of India had created a world-class industry. A similar story may be unfolding quietly in parts of China. Adam Segal has studied high-technology firms in Beijing, Shanghai, Guangzhou, and Xian. His research shows that smaller entrepreneurs in the private sector—sometimes called bamboo capitalists—are likely to be more innovative than bigger ones reliant on government largesse.
All across the developing world, where chaotic and corrupt rule can impede growth in myriad ways, extraordinary innovators are starting to flourish wherever they are not choked off by bureaucrats or fat cats. Freedom from “legacy,” in the shape of stranded assets such as fixed-line telephony or centralized power grids, has liberated African entrepreneurs and allowed them to leapfrog with technology—from having no electricity to using solar cells, for instance. So where does that leave the present Goliath of innovation, the United States?
Patching the Holes in the American Vessel
John Kao is concerned about the United States losing its global lead and becoming “the fat, complacent Detroit of nations.” In his book Innovation Nation, he points to warning signs, such as the United States’ underinvestment in physical infrastructure, its slow start on broadband, its pitiful public schools, and its frostiness toward immigrants since September 11, 2001—even though immigrants have provided much of America’s creativity. He even stoutly defends his description of the rise of Asia’s innovators as a silent Sputnik. What the United States needs, he reckons, is a big push by federal government to promote innovation, akin to the Apollo space project that answered Kennedy’s call and put a man on the moon.
Curt Carlson puts it in starker terms: “India and China are a tsunami about to overwhelm us.” As head of California’s Stanford Research Institute, which was founded in 1946 by the university to foster innovation and economic development in the region, Carlson knows the strengths of Silicon Valley from firsthand experience. Yet here he is insisting that American information technology, services, and medical devices industries are about to be lost. “I predict that millions of jobs will be destroyed in our country, like in the 1980s when American firms refused to adopt total quality management techniques while the Japanese surged ahead.” The only way out, he insists, is “to learn the tools of innovation” and forge entirely new, knowledge-based industries in energy technology, biotechnology, and other science-based sectors.
These thoughtful gurus are right to sound the alarm bells, as there are signs that the United States’ innovation ecosystem needs attention in areas such as education and basic infrastructure. However, given the dismal failure of industrial policies in the past, one should still remain skeptical of any calls for aggressive government intervention across the board. The Council on Competitiveness, an influential coalition of leading business interests, recently concluded in a report that, by and large, the outlook is bright for the United States. Yet the same council’s innovation task force also gave warning that other countries are making heavy investments that threaten to erode the U.S. position. It called for a big push in four areas: improving science, engineering, and math education; welcoming skilled immigrants; beefing up government spending on basic research; and offering tax incentives to spur U.S.-based innovation.
These are mostly sensible recommendations because they focus on those framework conditions and bits of infrastructure that the market would not provide on its own. Still, governments should tread carefully even in these areas. Consider the call to beef up American technical education. This is sensible, but some go too far in dismissing the value of arts, design, and other creative parts of the curriculum. Bill Gates is firmly in the technologists’ camp, exclaiming, “If we lose engineering, I don’t know what’s left!” Steve Jobs, in contrast, argued that the United States is flourishing because firms such as his, unlike Asian rivals, have the creativity and flair to integrate low-value components manufactured cheaply elsewhere into gorgeous and lucrative devices such as the iPad. The United States clearly needs to improve its education system, but the right way forward would provide holistic training that balances stronger technical and vocational education with more creative fields that encourage critical and integrative thinking.
Just as with education reform, the case for immigration reform is overwhelmingly strong in the United States. Many studies have shown that immigrants have played a central role in the country’s economic vitality—especially well-educated engineers from India and China. Vivek Wadhwa estimates that from 1995 to 2005, 52 percent of Silicon Valley’s technology and engineering companies were founded by immigrants. Most came to the United States to study and stayed on to work. That group also filed a quarter of the country’s global patents.
The problem is that after 9/11, Americans turned frosty toward such folk, making it harder for them to stay on after studies to work. Gates points out the absurdity of subsidizing the computer science degrees granted to foreign graduate students at top state schools such as the University of California at Berkeley only to chuck those brilliant immigrants out of the country when they ask to work and pay taxes in the United States after graduation. This chill came just as the economies back home skyrocketed, making it much easier for the new generation of hungry young world-beaters from those emerging markets to skip America and seek their fortunes back home instead. Nativists and xenophobes may cheer, thinking this means more jobs for red-blooded Americans, but that is wrong. Wadhwa points out that this simply means “there will be fewer start-ups, that entrepreneurship will boom instead in countries like India and China, and that Silicon Valley will face unprecedented competition from American-educated and -trained talent” that is forced to go home. In other words, unless the United States reforms its immigration laws quickly, it is about to lose the extraordinarily valuable gift of the world’s most talented and enterprising minds that its economy has benefited from these past decades.
The recommendation from the Council on Competitiveness that the United States should boost its investment in research and development is also sound, but again the devil is in the details. If such investment is structured as technology-neutral policies that do not favor one particular firm or technology over another—for example, via stable, long-term tax policies that encourage corporate spending on research—then they are a good idea. So too are reforms of the way new inventions, often funded with government money, make their way from academic laboratories to the market. At the moment, the law gives the technology-licensing offices at universities too much power over what ideas make it out of the lab and into the office (though a Supreme Court case in mid-2011 suggested big changes may be on the way that favor innovators over administrators). Giving faculty and employees of government laboratories greater discretion over commercialization would transform a sclerotic, centralized process into a vibrant marketplace where scientists will have every incentive to turn obscure inventions into world-changing innovations.
That points to a related area where government action could help shore up one of America’s traditional strengths: encouraging innovative entrepreneurship. Robert Litan, a scholar affiliated with the Kauffman Foundation and the Brookings Institution, coauthored an influential book some years ago called Good Capitalism, Bad Capitalism that argued that the most innovative economies have a mix of nimble start-ups (which come up with breakthrough innovations) and dynamic big firms (which do incremental improvements and scale up those breakthroughs). In contrast, the least innovative economies tend to have few start-ups and lots of state interference in markets. But he believes that the advantages held by big firms are eroding fast just as globalization, Web-enabled services, crowdsourced capital, and other powerful changes in the global economy are tilting the playing field in favor of entrepreneurs. While in the past most start-ups targeted local markets, Daniel Isenberg of Babson College argues persuasively that today’s start-ups can become “micromultinationals” from day one thanks to the Internet and global supply chain management tools.
In his new book, Better Capitalism, Litan argues that the most dynamic and high-growth economies of the future will be those that encourage high-growth entrepreneurship. How, exactly? “I’m not a fan of clusters; state guidance usually gets new technologies wrong . . . governments should get the basic infrastructure right and let capitalism work,” he says. Still, he believes America needs to stoke the start-up bonfires by opening up immigration, investing in science and technology education, liberating intellectual property from academia, and fixing the country’s fiscal mess through a value-added tax on consumption that would ease the burden of taxes in other areas like capital gains.
That is a sensible set of recommendations. And the industry lobbies are also right to say that there are important things the U.S. government must do to improve the country’s innovation framework and stay ahead of the global competition. Where the prescriptions from such groups tend to go awry is when they argue for specific subsidies or tax breaks for favored industries (such as supporting only U.S.-based innovation in today’s world of global creative networks). After all, the forces of creative destruction must be allowed to work their magic.
The Secret of Silicon Valley
Resilience in the face of disruptive forces gave Silicon Valley the edge over its nearest high-tech rival, Boston’s Route 128 technology corridor. Both clusters were riding high until the personal computer and distributed computing changed the market. Firms went through wrenching change, but those in northern California, such as Hewlett-Packard and Xerox, emerged stronger than those near Boston, such as Digital Equipment and Wang—which no longer exist. As AnnaLee Saxenian of the University of California at Berkeley has shown, Silicon Valley’s champions were nimble and networked, but those on Route 128 were brittle, top-down bureaucracies.
Sergey Brin insists that “Silicon Valley doesn’t have better ideas and isn’t smarter than the rest of the world” but thinks it has the edge in filtering ideas and executing them. That magic still happens and attracts people from around the world who are “bold, ambitious, determined to scale up, and able to raise money here actually to do it.” Brin points to Elon Musk, founder of Tesla and SpaceX, as an example.
Musk moved from South Africa and eventually settled in California to make his fortune. Musk says his equation for success is drive times opportunity times talent. Unlike many countries, he insists, America is never satisfied with the status quo. “There is a culture here that celebrates the achievements of individuals—and it is too often forgotten in history that it is individuals, not governments or economic systems, that are responsible for extraordinary breakthroughs,” he says.
That explains why innovation policies should carefully circumscribe the role of government. Liberty is a powerful force. In the past, Brin notes, innovation was dominated by elites—the “wealthy gentlemen tinkerers” of Victorian England, for example—who had privileged access to information, money, and markets. But America was different. Harold Evans, the author of They Made America, observes that the essential enabler of U.S. innovation prowess was “political innovation . . . a free society.” Britain actually invented many marvels of the modern age—radar, penicillin, and the jet engine, among many—but it was America that commercialized these inventions at scale and turned them into genuinely valuable innovations. Evans thinks a key factor was the United States’ system of universal education, which developed a broad scientific and technological workforce. Britain, in contrast, had an elitist and limited educational system. And these days, of course, much innovation happens from the bottom up and the inside out. That suggests an important but radically different role for government going forward.
A Policy Manifesto for the Age of Democratic Innovation
It is clear that the need for innovation has never been greater. As the world economy struggles to recover from the global financial crisis, governments are casting about for strategies to revive growth. They are also struggling to come up with solutions to difficult global challenges ranging from climate change and the threat of pandemics to the demographic and health burdens (think costly chronic diseases such as diabetes and heart disease) imposed by older, fatter, and sicker populations.
Accelerating the pace of innovation would certainly help countries deal with both problems. Because most of the output of rich countries now comes from nonmanufacturing sectors, where brain trumps brawn, boosting innovation offers a promising way to increase productivity and spur future growth. And even in traditional asset- and legacy-heavy industries such as manufacturing, the next chapter shows, investing in the knowledge component of those businesses can lead to a renaissance. Breakthrough technologies and disruptive business models, such as the spread in Africa of banking and medicine via mobile telephony, can make it much easier to tackle those thorny challenges.
Governments everywhere are now coming up with innovation policies they claim will boost national competitiveness and tackle environmental and other social goals. The U.S. government has bailed out GM and Chrysler, for example, and is throwing money at batteries, electric vehicles, and other energy technologies. Various European governments are following the example of their French counterpart, which is now subsidizing such “strategic” industries as toy making. Yes, really.
As that example suggests, a lot of things done in the name of innovation are simply a sham. Many of the national innovation strategies implemented in the wake of the financial crisis merely subsidize favored technologies or prop up uncompetitive national champions. In the worst cases, they are thinly disguised attempts at protectionism. Though dressed up in pro-market language, they are mostly a throwback to the failed industrial policies of the 1970s and 1980s.
These policies are far likelier to retard innovation than to spur it. That is because innovation is at heart a bottom-up process—a Schumpeterian dance of risk, failure, resilience, and reward that is foreign to all-knowing bureaucrats but second nature to entrepreneurs. Greed not only is good but also can do great good—if, that is, there are clear incentives to tackle the wicked problems of society.
But first governments must step back a little. History shows that official attempts to pick technology winners, no matter how initially promising, usually end in tears. Three decades ago, the French government developed Minitel, a national communications network that allowed users to send messages, book train reservations, and so on. This was a popular invention, and for its time a clever one. The snag was that bureaucrats insisted on keeping this a closed system, even after it became clear to everyone else that the future belonged to open networks such as the Internet. Minitel inevitably proved a dead end, and France lost out in the global Internet race.
The United States has its embarrassments too. In the wake of the 1970s oil shocks, the Department of Energy decided to invest heavily in producing synthetic petroleum, to end the country’s addiction to foreign oil. Predictably, the project proved a costly flight of fancy: billions of dollars and many years were spent on this technology dead end, but not a single barrel of “syn-crude” ever reached the market. The current version of that boondoggle is the enormously damaging subsidy given to corn ethanol. This pleases the politically powerful farm lobby, but this perverse policy has diverted corn from food markets (fueling food price hikes that have hurt the very poorest) while also harming the environment (since corn ethanol, unlike the virtuous Brazilian sugarcane variety, is not green).
These policies have failed because, despite the best intentions of central planners, top-down innovation does not work as well as the bottom-up variety. This is especially true in energy, according to a comprehensive review of energy innovation coauthored by Richard Newell, currently head of the U.S. Energy Information Administration. He points to the current boom in the shale gas industry, which is the most extraordinary development in American energy in decades, and notes that it was not predicted by government planners. Newell’s study shows that energy innovation is driven not by short-term bursts of government support but chiefly by bottom-up efforts and market forces. Indeed, the key to the shale breakthrough was not government subsidies for new technology but the clever and diligent application by market actors of existing technologies to new situations.
The top-down approach was always misguided, but it is absurdly out of place given the speed at which innovation happens today. Thanks to globalization and the rise of the information economy, new ideas move to market faster than ever before. This is in large part due to the shift from top-down innovation (of the sort made famous by AT&T’s Bell Laboratories and other secretive corporate silos) toward more open, networked, and user-driven models of innovation. Think, for example, of the iPod: the research behind it was done by firms the world over, but Apple has reaped huge rewards from its skills in design, marketing, and systems integration.
Innovation is truly a global enterprise today. Much of the value created by firms is in the form of intangibles such as knowledge networks and open business models. Yet most governments cling stubbornly to national industrial policies that offer perverse incentives for local firms to squander resources on parochial technologies and outmoded business models. That suggests that innovation works best when government does least.
However, that is not to say that governments should do nothing at all. On the contrary, there is an essential, but carefully circumscribed, role for the state in fostering innovation. Despite the recent downturn, governments must continue to invest in the handful of areas that fortify an economy’s capacity to innovate—and therefore, to grow more robustly—in the future.
For a start, only governments can ensure that the framework for innovation is sound. America’s success at maintaining the rule of law, encouraging risk capital, and applying pragmatic bankruptcy codes all played a role in the spectacular rise of Silicon Valley, for example. Governments should also encourage investment in what the OECD calls “knowledge-supporting infrastructure,” which ranges from smart electricity grids and broadband Internet networks to basic research and university education. That principle argues against massive cuts in education and infrastructure, for example. It would be far better for cash-strapped governments to cut spending on entitlement programs than to slash vital investment in the enablers of long-term economic growth.
But investing in the innovation framework must not mean picking technology winners. A better approach is the use of externalities pricing for such problems as carbon pollution, as it sets a societal goal but allows market forces—and, yes, greed—to find the most efficient way to solve the problem. Another promising advance is the official use of incentive prizes. Aneesh Chopra, the White House’s chief technology officer, argues that new technologies and a new mind-set are enabling innovation in government itself. One example involves initiatives to put much previously inaccessible public information up on the Internet, which is democratizing government data. Another way government can help, he argues, is by pushing for common standards and transparency in such areas as electronic health records. He also argues that government must act as a catalyst for greater research collaboration among academic and private sector actors at the precompetitive level.
These efforts get an endorsement from an unexpected quarter: Craig Newmark, one of the true pioneers of the Web. He founded Craigslist.org, which is the online bulletin board used by countless millions to exchange goods and services. The upstart used to throwing rocks at the establishment has, it turns out, been advising members of Congress and the Obama administration on openness, networking, and what bureaucrats like to call Government 2.0. Newmark believes Gov 2.0 can become a big deal: “By exposing data, by fixing a lot of business processes, by using the technologies of the private sector, a lot of things are being made to work in Washington, and no one is talking about it.” He is convinced that the tools of social media can be applied to civics, to rebuild what he calls “the immune system of democracy.” He believes these remarkably disruptive tools may even transform government and its relationship with civil society.
These efforts at openness are to be applauded. But, sad to say, most of what governments around the world do in the name of innovation does not resemble such efforts in the least. That is why the biggest boost governments can give to national competitiveness is to stop doing some things. The first thing is to end perverse policies that discourage collaboration outside one’s own firm or country. The tax credit offered by the U.S. government for corporate research is appropriately generous for work done inside a firm’s labs (and Congress should make this stop-and-go policy permanent) but stingy if that same work is done with, say, university researchers. In contrast, Canada’s tax law does not punish collaboration in this way.
The second thing is to stop creeping protectionism. International coordination of technical protocols can be a good thing: Europe’s embrace of the GSM standard helped its firms grab an early lead in mobile telephony, for example. However, there are worrying signs that some proposals for technology standards (for example, rules on smart grid protocols or electronic health records) are really covert attempts to produce rules favoring local technology firms. History shows that such efforts can lock local firms into dead-end technologies and leave them unable to compete globally.
The most important thing that countries must stop doing is closing their doors to immigration. Flexible labor markets are essential for a vibrant economy. Given the democratization and globalization of innovation seen in recent years, companies must be allowed to tap freely into the brainpower of billions of innovators-in-waiting worldwide if they are to remain competitive. Just as important, bright sparks from around the world must have the freedom to pursue their studies and professional ambitions, wherever in the world that may take them. Studies of innovation clusters in Israel, Taiwan, and South India have shown that the catalyst sparking the rise of those aspiring Silicon Valleys was the constant flow of talented researchers, entrepreneurs, and venture capitalists to and from the actual Silicon Valley (which owes its own success in part to immigration). Think brain circulation, not brain drain.
In sum, there are some useful things that government can do to boost innovation. Most center around the framework conditions that allow market forces to function properly so that the seeds sown by innovative entrepreneurs fall on fertile soil. The next chapter explores whether big companies can realign incentives so that they too can tap into such innovation within their own ranks. Given the dismal failure of past efforts at top-down innovation, though, governments should approach even these policies with humility. In the end, the best industrial policy is probably no industrial policy.