III
AN ENVIRONMENT FOR INNOVATION



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Government-Industry Partnerships for the Development of New Technologies III AN ENVIRONMENT FOR INNOVATION

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Government-Industry Partnerships for the Development of New Technologies This page in the original is blank.

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Government-Industry Partnerships for the Development of New Technologies An Environment for Innovation THE POLICY CONTEXT OF GROWTH The U.S. system of government and the policies developed at federal, state, and local levels collectively shape the environment in which innovation takes place. For example, federal policies affecting capital formation and corporate governance play important roles in competitive performance.1 The range and diversity of these policies are substantial. They include government policies related to taxation, especially capital gains, fiscal and monetary matters, education and training, trade promotion and expansion, regulatory policies (e.g., for antitrust and the environment), intellectual property protection, government procurement, and export control.2 These policies can all directly affect the process of innovation, sometimes decisively.3 1   See National Research Council, U.S. Industry in 2000: Studies in Competitive Performance, op.cit, p. 5. 2   See, for example, the observations of Ed Zchau, a member of Congress in the 1980s from Silicon Valley, in his article, “Government Policies for Innovation and Growth” in National Research Council, The Positive Sum Strategy, Harnessing Technology for Economic Growth, op.cit., pp. 535-539. 3   For example, intellectual property protection plays a key role in the continued development of the biotechnology industry. See Wesley M. Cohen and John Walsh, “Public Research, Patents and Implications for Industrial R&D in the Drug, Biotechnology, Semiconductor and Computer Industries” in National Research Council, Capitalizing on New Needs and New Opportunities: Government-Industry Partnerships in Biotechnology and Information Technologies, op. cit. Trade policy also has a major, if often unrecognized, impact on innovation. Restrictive trade policy can slow innovation (e.g., by restricting the acquisition of low-cost information technology systems and components) as in Brazil in the 1990s. See National Research Council, U.S. Industry in 2000, Studies in Competitive Performance, op. cit., pp. 4-5. It can also encourage the growth of national industries. The resurgence

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Government-Industry Partnerships for the Development of New Technologies The pace of technology development also depends on a variety of interrelated factors, beginning with the performance of educational organizations and the quality of scientific and engineering research carried out by public and private institutions. The strength and depth of U.S. capital markets also play a major role in availability and cost of capital.4 Public policies designed to develop, commercialize, and absorb new technologies further strengthen prospects for improved welfare and rapid economic growth.5 The core mission of the Committee on Government-Industry Partnerships is examining how public policy can stimulate the wide range of benefits technological advance can provide—from more robust economic growth to better health, from more environmentally benign energy use to more effective and lower-cost national defense. The committee’s focus on the policies that support and facilitate the development and exchange of knowledge—as within and among private firms, universities, and national laboratories—is therefore both practical and necessary. This is especially true given the increasing emphasis on the link between science and economic growth. Box A. New Growth Theory and the Knowledge-Based Economy Neoclassical theories of growth long emphasized the role of labor and capital as inputs.6 Here, technology was exogenous—assumed to be determined by forces external to the economic system. More recent growth theories, by comparison, emphasize the role of technology and assume that technology is endogenous—that is, it is actually integral to the performance of the economic system. Contributions to this academic literature come from industrial organization as well as evolutionary and     of the U.S. semiconductor industry, now taken for granted, was not assured in the mid-1980s. The industry’s resurgence arose partly through the contribution of measures to open Japanese markets and reduce dumping in the United States and third countries partly through the contributions of SEMATECH and, most importantly, the ability of U.S. firms to develop new product lines and to continue to attract capital contributed to the recovery and prosperity of the U.S. semiconductor indus-try. No one factor fully accounts for this recovery. 4   See Ralph Landau, “The Dynamics of Long-Term Growth: Gaining and Losing Advantage in the Chemical Industry” in National Research Council, U.S. Industry in 2000, op. cit., p. 20. 5   See Ralph Landau, op. cit., pp. 17-74. 6   See Robert S. Solow, “Technical Change and the Aggregate Production Function,” Review of Economics and Statistics 39, 1957, pp. 312–320 for a classic expression of the “old” growth theory.

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Government-Industry Partnerships for the Development of New Technologies institutional economics.7 Prominent among these endogenous explanations is the New Growth Theory, which has integrated and formalized many of these insights and observations into a coherent economic theory.8 Growth theory advocates underscore the importance of investing in new knowledge creation to sustain growth. It requires in turn that policy makers pay careful attention to the multiple factors that contribute to knowledge creation, including research and development, the education system, entrepreneurship, and an openness to trade and investment. Geography of economic development The new economic growth theory emphasizes the role of technology creation, believed to be characterized by significant growth externalities.9 A consequence of the renewed appreciation of growth externalities is the growing focus on the economic geography of economic development. With growth externalities coming about in part from the exchanges of knowledge among innovators, certain regions become centers for particular types of high-growth activities. Innovators are able to take advantage of the tacit knowledge available in such centers or clusters of activity to acquire relevant technological innovation and to address other business development issues rapidly.10 7   The broader literature includes Alfred Marshall, Industry and Trade, 3rd edition, Macmillan, London, 1920. Nathan Rosenberg, Inside the Black Box: Technology and Economics, New York: Cambridge University Press, 1982; Douglass C. North, Institutions, Institutional Change, and Economic Performance, Cambridge, MA: Cambridge University Press, 1990; Richard R. Nelson, The Sources of Economic Growth, Cambridge, MA: Harvard University Press, 2000; and F.M. Scherer, New Perspectives on Economic Growth and Technological Innovation, Washington, D.C.: The Brookings Institution, 1999. 8   For additional perspective on New Growth Theory, see Richard N. Langlois, “Knowledge, consumption, and endogenous growth,” Journal of Evolutionary Economics 11:77-93, 2001. 9   Paul Romer, “Endogenous technological change,” Journal of Political Economy, vol. 98, 1990, p. 71-102. See also Gene Grossman and Elhanan Helpman, Innovation and Growth in the Global Economy, Cambridge, MA: MIT Press, 1993. 10   See Michael Porter, “Clusters and the New Economics of Competition,” Harvard Business Review, November – December 1998. Also, Paul Krugman, Geography and Trade, Cambridge, MA: MIT Press, 1991, p. 23, who points out Alfred Marshall’s observation in his classic Principles of Economics that geographic clusters of specific economic activities arise from the exchange of “tacit” knowledge among business people. AnnaLee Saxenian’s review of the growth of Silicon Valley provides one view of the cluster phenomenon. AnnaLee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, Cambridge, MA: Harvard University Press, 1994. For a perspective on the federal role in Silicon Valley, see Timothy Sturgeon, “How Silicon Valley Came to Be,” in Martin Kenney, ed., Understanding Silicon Valley, The Anatomy of an Entrepreneurial Region, Stanford: Stanford University Press, 2000.

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Government-Industry Partnerships for the Development of New Technologies Locational competition and trade policy The growing understanding of the importance of knowledge and the clusters that generate and retain it has led policy makers outside the United States to adopt trade, investment, and competition policies that while appearing to derive from U.S. precepts, are in fact much more focused on positive outcomes of the national economy, rather than on rules and processes. Even in the United States improved understanding of the institutional context of economic growth has led some economists to suggest limitations to traditional trade theory, particularly with respect to the reality of imperfect international competition.11 Further, economic analysis suggests that high technology is often characterized by increasing rather than decreasing returns, justifying to some the proposition that governments can capture permanent advantage in key industries by providing relatively small but potentially decisive support to assist national industries up the learning curve and down the cost curve. In part, this is why the economic literature now recognizes the relationship between technology policy and trade policy.12 Recognition of these linkages and the corresponding ability of governments to shift comparative advantage in favor of the national economy provide the intellectual underpinning for government support for high-technology industry.13 Spillovers Another widely recognized rationale for government support of high technology exists when technology generates benefits beyond those that can be captured by innovating firms, often referred to as spillovers.14 As a related and important example, consider the case in which the cost of a given technology may be prohibitive for individual companies even though expected benefits to society are substantial and widespread.15 11   See Paul Krugman, Rethinking International Trade, Cambridge, MA: MIT Press, 1990. 12   See J.A. Brander and B.J. Spencer, “International R&D Rivalry and Industrial Strategy,” Review of Economic Studies, vol. 50, 1983, pp. 707-722, and “Export Subsidies and International Market Share Rivalry, “ Journal of International Economics, vol. 16, 1985, pp. 83-100. 13   For a discussion of governments’ efforts to capture new technologies and the industries they spawn for their national economies, see National Research Council, Conflict and Cooperation in National Competition for High Technology Industry, op.cit., pp. 28-40. For a critique of these efforts, see P. Krugman, Peddling Prosperity: Economic Sense and Nonsense in an Age of Diminished Expectations. New York: W.W. Norton Press, 1994. 14   See, for example, Martin N. Baily and A. Chakrabati, Innovation and the Productivity Crisis. Washington, D.C.: Brookings, 1998, and Zvi Griliches, The Search for R&D Spillovers, Cambridge, MA: Harvard University Press, 1990. 15   See Ishaq Nadiri, Innovations and Technological Spillovers, NBER Working Paper No. 4423, 1993, and Edwin Mansfield, “Academic Research and Industrial Innovation,” Research Policy, February, 1991. See also Council of Economic Advisers, Supporting Research and Development to Promote Economic Growth: The Federal Government’s Role. Washington, D.C., 1995. This is one of the rationales for the awards of the Advanced Technology Program. For an assessment of this program, see National Research Council, The Advanced Technology Program: Assessing Outcomes, op.cit.

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Government-Industry Partnerships for the Development of New Technologies The increasing recognition of the dynamic element of technological innovation, in particular its cumulative nature, has provided the intellectual underpinning as well as the incentive to spur local, state, and national efforts to create competitive advantage for a region, country, or industry.16 Knowledge-based economics To a considerable extent, knowledge-based economies are distinguished by the changing way that firms do business and how governments respond in terms of policy.17 Key features of a knowledge-based economy include: A capacity to successfully create and exploit scientific knowledge and technology based on a world-class science infrastructure and an entrepreneurial and innovative culture. A diffusion and building up of knowledge through effective (though often informal) information networks. These networks, facilitated by modern telecommunication technologies and frequently based on public-private partnerships, are designed to encourage cooperation among firms, universities, and government research centers. A skilled workforce based on an effective and differentiated educational system and effective job training programs. High rates of technological innovation often associated with high-technology industries, underscoring the “virtuous cycle” that these policies can engender. THE PACE OF TECHNOLOGY DEVELOPMENT AND GROWTH U.S. policy makers at the state and federal levels have focused their attention increasingly on high-technology industry and the new technologies and entrepreneurial activities that support them.18 Their concern is supported by a growing 16   The dynamic nature of international competition in high-technology industries is discussed in National Research Council, Conflict and Cooperation in National Competition for High-Technology Industry, 1996, op. cit., pp. 28-40. 17   “Just as the private sector develops innovative institutional arrangements to support and advance research, so should federal policy. In particular, one of the defining features of the knowledge economy is the increased importance of learning and innovation. Partnerships and alliances, among the private sector, universities, and government laboratories, play a key role in facilitating innovation. As a result, federal support for research in the knowledge economy needs to explicitly encourage research collaboration between industry, government labs and universities.” Kenan Patrick Jarboe and Robert D. Atkinson, “The Case for Technology in the Knowledge Economy; R&D, Economic Growth and the Role of Government,” Washington, D.C.: Progressive Policy Institute, June 1, 1998, at <http://www.ppionline.org/documents/CaseforTech.pdf>. 18   See for example, previous and current reports of the Council of Economic Advisors, Economic Report of the President, Washington, D.C.: USGPO, January 1995, 2001, and 2002.

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Government-Industry Partnerships for the Development of New Technologies body of economic thought, noted above in Box A, that the composition of the economy matters and that high technology industries in particular bring special benefits to national economies.19 This political interest, particularly at the state level in the United States, reflects the intense interest of national and regional leaders elsewhere in the world in the composition and growth of their economies. As previous National Research Council studies have described, high-technology firms are associated with rapid rates of innovation. Such firms in turn tend to gain market share, create new product markets, and use resources more productively than traditional industries do.20 High-technology firms perform more R&D than traditional firms do and generate more high-wage employment. In fact, these firms are distinguished by the high percentage of revenue devoted to research: 10 percent of revenues on R&D, in contrast to 3 percent of revenues on R&D for more traditional industries.21 Reflecting this investment, high-technology firms also create positive spillover effects, which are often locally concentrated. Spillovers benefit other commercial sectors by generating new products and processes that can lead to productivity gains. A substantial literature in economics underscores the potential for high returns from technological innovation, with private innovators obtaining rates of return in the 20-30 percent range and spillover (or social return) averaging about 50 percent.22 High-technology products are a major source of growth in the major industrialized countries. Such sectors as aerospace, biotechnology, and information systems contribute to the growing global market for high-technology manufactured goods. High-technology firms are also associated with high value-added manufacturing and with the creation of high-wage employment.23 Together these contributions provide the productivity gains that underpin recent economic performance. (See Box B for detail.) They also enhance the government’s capacity to 19   See for example, Stephen Oliner and Daniel Sichel, “The Resurgence of Growth in the late 1990’s: Is Information Technology the Story?” Journal of Economic Perspectives 14(4) Fall 2000. Oliner and Sichel estimate that improvements in the computer industry’s own productive processes account for about a quarter of the overall productivity increase. They also note that the use of information technology by all sorts of companies accounts for nearly half the rise in productivity. See also Laura Tyson, Who’s Bashing Whom? Trade Conflict in High Tech Industries, Washington, D.C.: Institute for International Economics, 1992. Tyson notes that substantial advantages in trade accrue to nations that directly support strategic industries. 20   For an analysis of the role of new information technologies in the recent trends in high productivity growth, often described as the New Economy, see the Council of Economic Advisors, Economic Report of the President, H. Doc. 107-2, Washington, D.C.: USGPO, January 2001. 21   See National Research Council, Conflict and Cooperation, 1996, op. cit. Box A, pp. 33-35, lists additional reasons why countries are concerned about their high-technology industries. 22   For example, see Ishaq Nadiri, op. cit. See also, Council of Economic Advisors, Supporting Research and Development to Promote Economic Growth, op. cit. 23   Laura Tyson, Who’s Bashing Whom? Trade Conflict in High Technology Industries, op. cit.

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Government-Industry Partnerships for the Development of New Technologies carry out core missions, including national defense, environmental protection, and development of new technologies for the production, management, and use of energy.24 The advantages of high technology industry are not without a downside. As is evident in the current economic climate, the high technology sector tends also to be characterized by considerable cyclicality. Pronounced swings in industry products and profits can precipitate layoffs and rapid depreciation in the value of stock, thus affecting the lives of ordinary citizens in very direct ways. At the same time, the industry’s long-term growth trend has been exceptionally positive, contributing significantly to employment and value creation. Government support for new technologies contributes to continual national growth and industrial leadership. Policies encouraging partnerships and other cooperative arrangements among universities, industry, and the government have proven in some cases to be effective measures for fostering the development of new productivity-enhancing technologies.25 Often such policies are related to specific government missions and procurement in sectors such as health, transport, and defense.26 In other cases, limited support to promising technologies with widespread applications may be the most appropriate approach.27 Indeed, as we see next, there is a long tradition of federal support to industry, dating from the founding of the republic. Box B. The New Economy The term “New Economy” has been used extensively in recent years to describe the economic performance of the latter part of the 1990s. The term focuses on the dynamic of the U.S. economy as it capitalizes on new technologies, new opportunities, and in particular on national investments in computing, information, and communication technologies—or collectively, information technology. As we note below, use of the term New Economy also reflects the growing conviction that sub 24   For environmental gains achieved through reduced energy demand resulting from improved energy efficiency, see, the presentation of Charles Becker in National Research Council, Partnerships for Solid-State Lighting, C. Wessner, ed., Washington, D.C.: National Academy Press, 2002. 25   See Kenneth Flamm, Creating the Computer, Government, Industry and High Technology, Washington, D.C.: Brookings, 1988. 26   See National Research Council, The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative. C. Wessner, ed., Washington, D.C.: National Academy Press, 2000. 27   This is the approach taken by the ATP at the National Institute of Standards and Technology. For an overview of government-industry collaboration and the controversies that surround it, see the introduction to the recent report on the ATP, National Research Council, The Advanced Technology Program: Assessing Outcomes, op. cit.

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Government-Industry Partnerships for the Development of New Technologies stantial change has occurred in the structure of the U.S. economy and that this change may be permanent.28 This change, it is thought, hinges on dynamic increases in productivity and the correlating impact of investments in the information technology sector.29 These structural changes indicate that the New Economy is not a fad, but a long-term productivity shift of major significance. The introduction of advanced productivity-enhancing technologies obviously does not eliminate the business cycle. Instead, the term, “New Economy” refers to particular technological and structural changes that are having a positive impact on long-term productivity and growth.30 The decade of the 1990s witnessed rapid technological change in communications, computing, and information management. This phenomenon coincided with the sustained expansion of the U.S. economy through much of the 1990s.31 Along with other structural and policy explanations, this technological change is a key element in the strong growth in labor productivity, especially after 1995.32 The term New Economy captures the role that these new technologies are thought to play in contributing to the non-inflationary growth and high employment that characterized this period. Although the New Economy is itself a macro phenomenon, its underlying dynamics appear to combine elements of technological innovation, structural change, and public policy. Technological innovation—more accurately, the rapid rate of technological innovation in information technology (including computers, software, and telecommunications) and the rapid growth of the Internet— 28   Organisation for Economic Cooperation and Development, Is There a New Economy? A First Report on the OECD Growth Project. Paris: Organisation for Economic Cooperation and Development, June 2000, p. 17. See also, M.N. Baily and R.Z. Lawrence. “Do We Have an E-Conomy?” NBER Working Paper 8243, April 23, 2001, at <http://www.nber.org/papers/w8243>. 29   This is especially so for the computer hardware sector and perhaps for the Internet as well, although there is insufficient empirical evidence on the degree to which the Internet may be responsible. For a discussion of the impact of the Internet on economic growth see, “A Thinker’s Guide,” The Economist, March 30, 2000. For a broad study of investment in technology capital and its use in various sectors, see McKinsey Global Institute, U.S. Productivity Growth 1995-2000, Understanding the Contribution of Information Technology Relative to Other Factors. Washington, D.C.: McKinsey & Co., October 2001. 30   See Council of Economic Advisors, The Annual Report of the Council of Economic Advisors, Washington, D.C.: U.S. Government Printing Office, 2000, p. 33. 31   See Dale Jorgenson and Kevin Stiroh, “Raising the Speed Limit: U.S. Economic Growth in the Information Age,” Brookings Papers-on-Economic-Activity; 0(1), 2000, pp. 125-211. 32   Ibid.

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Government-Industry Partnerships for the Development of New Technologies are seen by some as underpinning the productivity gains that characterize the New Economy. These productivity gains derive from greater efficiencies in the production of computers and from expanded use of information technologies.33 Structural changes arise from a reconfiguration of knowledge networks and business patterns made possible by innovations in information technology. Such phenomena as business-to-business e-commerce and Internet retailing are altering how firms and individuals interact, enabling greater efficiency in purchases, production processes, and inventory management.34 These structural changes are still emerging as the use and applications of the Internet continue to evolve.35 Public policy plays a major role at several levels. This includes the government’s role in fostering rules of interaction within the Internet and its discretion in setting and enforcing the rules by which technology firms and others compete.36 More familiarly, public policy concerns particular fiscal and regulatory choices that can affect the rate and focus of investments in sectors such as telecommunications. The government also plays a critical role in the innovation system.37 It provides national research capacities, incentives to promote education and training in critical disciplines, and funds most of the nation’s basic research.38 The government also plays a major role in stimulating innovation, most broadly through the patent system. Through its policies on taxation, bankruptcy, and capital market regulation, the government has encouraged entrepreneurs who, as agents of change, 33   See Stephen Oliner and Daniel Sichel, “The Resurgence of Growth in the late 1990’s: Is Information Technology the Story?” op. cit. See also Alan Greenspan’s remarks before the White House Conference on the New Economy, Washington, D.C., April 5, 2000. <www.federalreserve.gov/BOARDDOCS/SPEECHES/2000/20000405.HTM>. 34   See, for example, Brookes Martin and Zaki Wahhaj, “The Shocking Economic Impact of B2B” Global Economic Paper, 37, Goldman Sachs, February 3, 2000. 35   For a discussion of the opportunities and challenges facing the New Economy, see National Research Council, Measuring and Sustaining the New Economy. D. Jorgenson and C. Wessner, eds., Washington, D.C.: National Academy Press, 2002. In particular, see comments by Dr. Vint Cerf, who notes that the ability of individuals to interact in potentially useful ways within the infrastructure of the still expanding Internet rests on its basic rule architecture: “The reason it can function is that all the networks use the same set of protocols. An important point is these networks are run by different administrations, which must collaborate both technically and economically on a global scale.” 36   The relevance of competition policy to the New Economy is manifested by the intensity of interest in the antitrust case, United States versus Microsoft, and associated policy issues. 37   See Richard Nelson, ed., National Innovation Systems, New York: Oxford University Press, 1993. 38   See National Research Council, Trends in Federal Support of Research in Graduate Education, Washington, D.C.: National Academy Press, 2001.

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Government-Industry Partnerships for the Development of New Technologies bring new ideas and new technologies to the marketplace.39 Government procurement and awards are especially powerful in the development of new technologies to fulfill national missions in defense, health, and the environment.40 Collectively, these public policies have played and continue to play a central role in the development of the modern economy. The collective contributions of these technologies, especially information technology, are contributing to structural change in the U.S. economy. Adapted from National Research Council, Measuring and Sustaining the New Economy, D. Jorgenson and C. Wessner, eds., Washington, D.C.: National Academy Press, 2002. 39   In addition to government-funded research, intellectual property protection plays an essential role in the continued development of the biotechnology industry. See Wesley M. Cohen and John Walsh, “Public Research, Patents and Implications for Industrial R&D in the Drug, Biotechnology, Semiconductor and Computer Industries” in National Research Council, Capitalizing on New Needs and New Opportunities: Government-Industry Partnerships in Biotechnology and Information Technologies, op. cit. 40   For example, government support played a critical role in the early development of computers. See Kenneth Flamm, Creating the Computer, Washington, D.C.: Brookings, 1988. The Committee’s study of public-private partnerships has not systematically explored the important role of government procurement.