4.0
The Ingredients of Innovation

INNOVATION

Given the factors previously discussed that militate against creating (or preserving) jobs in the United States, how then is America to maintain, or preferably enhance, the future standard of living of its citizenry? The answer (and seemingly the only answer) is through innovation. “Innovation” commonly consists of being first to acquire new knowledge through leading-edge research; being first to apply that knowledge to create sought-after products and services, often through world-class engineering; and being first to introduce those products and services into the marketplace through extraordinary entrepreneurship.


Writing in Foreign Affairs, Yale President Richard Levin notes:

“To oversimplify, consider the following puzzle: Japan grew much more rapidly than the U.S. from 1950 to 1990, as its surplus labor was absorbed into industry, and much more slowly than the United States thereafter. Now consider if Japan would have grown so slowly if Microsoft, Netscape, Apple and Google had been Japanese companies. Probably not. It was innovation based on science that propelled the United States past Japan during the two decades prior to the crash of 2008. It was Japan’s failure to innovate that caused it to lag behind.”1

In the words of Wharton Professor Jeremy Siegel, “Economic growth is based on advances in productivity, and productivity is based on discovery and innovation.”2

1

R. Levin, Top of the Class, Foreign Affairs, May/June 2010.

2

The Shape of Things to Come, Newsweek, April 8, 2010. Available at: http://www.newsweek. com/2010/04/08/the-shape-of-things-to-come.html.



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4.0 The Ingredients of Innovation INNOvATION Given the factors previously discussed that militate against creating (or preserving) jobs in the United States, how then is America to maintain, or preferably enhance, the future stan- dard of living of its citizenry? The answer (and seemingly the only answer) is through inno- vation. “Innovation” commonly consists of being first to acquire new knowledge through leading-edge research; being first to apply that knowledge to create sought-after products and services, often through world-class engineering; and being first to introduce those products and services into the marketplace through extraordinary entrepreneurship. Writing in Foreign Affairs, Yale President Richard Levin notes: “To oversimplify, consider the following puzzle: Japan grew much more rapidly than the U.S. from 1950 to 1990, as its surplus labor was absorbed into industry, and much more slowly than the United States thereafter. Now consider if Japan would have grown so slowly if Microsoft, Netscape, Apple and Google had been Japanese companies. Probably not. It was innovation based on science that propelled the United States past Japan during the two decades prior to the crash of 2008. It was Japan’s failure to innovate that caused it to lag behind.”1 In the words of Wharton Professor Jeremy Siegel, “Economic growth is based on advances in productivity, and productivity is based on discovery and innovation.”2 1 R. Levin, Top of the Class, Foreign Affairs, May/June 2010. 2 The Shape of Things to Come, Newsweek, April 8, 2010. Available at: http://www.newsweek. com/200/04/08/the-shape-of-things-to-come.html. 

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rISING aBOVe THe GaTHerING STOrM, reVISITeD Speed is of the essence in introducing innovation in a competitive economy. Craig Barrett, the retired chairman and CEO of Intel Corporation, states that 90 percent of the revenues that firm derives on the last day of the year are attributable to products that did not even exist on the first day of that same year.3 Fortunately, Americans, especially immi- grant Americans, have been demonstrated to be very accomplished innovators. They are commonly risk-takers. The primary ingredients of successful innovation can thus be categorized as (1) new knowledge; (2) capable people, and (3) an environment that promotes innovation and entrepreneurship. Each of these factors is discussed, and the United States position assessed, in the succeeding sub-sections under the respective headings, “Knowledge Capital,” “Human Capital,” and the “Environment.” .1 KNOWLEDgE CAPITAL The most fundamental building block of innovation is newly acquired knowledge, often in the form of scientific or technological advancements. Margaret Thatcher observed that, . . . although basic science can have colossal economic rewards, they are totally unpre- dictable. And therefore the rewards cannot be judged by immediate results. Nevertheless, the value of Faraday’s work today must be higher than the capitalization of all shares on the stock exchange. . . . The greatest economic benefits of scientific research have always resulted from advances in fundamental knowledge rather than the search for specific appli- cations . . . transistors were not discovered by the entertainment industry . . . but by people working on wave mechanics and solid state physics. [Nuclear energy] was not discovered by oil companies with large budgets seeking alternative forms of energy, but by scientists like Einstein and Rutherford. . . .4 Unfortunately, the very real pressures of today’s financial markets make it difficult for corporations to invest in fundamental research, which by its very nature is risky, long-term, of uncertain applicability, and increasingly expensive—the latter particularly in the United States. In one survey, 80 percent of chief financial officers of United States firms respond- 3 N.R. Augustine, Is America Falling Off the Flat Earth? Washington, DC, National Academies Press, 2007. 4 M. Thatcher, Speech to the Royal Society, September 27, 1988. Available at: http://www.margaretthatcher. org/speeches/displaydocument.asp?docid=07346; M. Kenward, Let’s Get Back to Basics, Says Thatcher, New Scientist, December 16, 1989. Available at: http://www.newscientist.com/article/mg246950.900-lets-get- back-to-basics-says-thatcher.html. 

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THe INGreDIeNTS Of INNOVaTION ing indicated they would cut R&D to meet their firm’s next-quarter’s profit projections.5 Pharmaceutical companies report that only one of every ten thousand chemicals they investigate as potential new medicines is ultimately approved for patient use. According to one estimate, it costs on average $802 million, an amount that continues to increase and takes an average of 12 years, to transition one new chemical from the exploratory phase to use by United States patients.6 Such considerations represent a great barrier to investors, both large and small. In this environment the great United States corporate research laboratories of the past are increasingly becoming a thing of the past. The canonical case is Bell Laboratories, home of the transistor, the laser and numerous Nobel Laureates—which was gradually downsized until the remainder was sold to a French firm. As other nations have increased their investments in research, discoveries can be expected to shift abroad as well. For example, the development of new research tools is an important by-product of the research process. Successful innovation requires the invention of new tools that allow for more precise measurements, the production of purer or better materials, and more effec- tive manipulation of data. A case in point is the field of particle physics which employs high energy accelerators as a principal discovery tool. Since their invention, the most capable of these machines has always been located in the United States—until recently when, for the first time, the most capable machine is located abroad, in Switzerland and France. Given the trend of industry to invest less in fundamental research, focusing on more predictable development projects, it is increasingly left to government to fund the for- mer type of activity. This is consistent with the notion that governments should assume responsibility for supporting activities that produce benefits to society as a whole but not necessarily commensurately to the individual performer or underwriter. In such a scenario the nation’s research universities will have to assume even greater responsibility for performing much of the nation’s research—with that research largely being funded by the federal government. In 2008, about 43 percent of the $68 billion worth of research (basic and applied) supported by various federal agencies was performed at universities.7 It is noteworthy that such activity is rapidly becoming globalized, with the percentage of 5 J. Graham, C. Harvey, and S. Rajgopal, The Economic Implications of Corporate Financial Reporting, September 13, 2004. Available at: http://faculty.fuqua.duke.edu/~charvey/Teaching/BA456_2006/The_ economic_implications.pdf. 6 Tufts Center for the Study of Drug Development, How New Drugs Move through the Development and Approval Process, November 2001. 7 National Science Board (NSB), Science and Engineering Indicators 200. Arlington, VA: National Science Foundation (NSB 10-01), Appendix Tables 4-8 and 4-9. 5

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rISING aBOVe THe GaTHerING STOrM, reVISITeD internationally co-authored research articles almost tripling between 1998 and 2008.8 A concern going forward is the current increasing investment by the National Institutes of Health in translational (or applied) research focusing more on drug discovery as opposed to the generation of new, fundamental knowledge which is the limiting factor in true innovation. One common measure of scientific input is the fraction of a nation’s GDP that is devoted to scientific research . . . on the principle that the size of the economy to be maintained affects the size of the effort needed for its maintenance. Given similar research efficiencies among nations, which of course may or may not be the case, this factor should correlate directly (not necessarily linearly) with research output. By this measure, basic research as a fraction of GDP, the United States most recently ranked fifth among all nations.9 Turning to research and development—where the United States ranks eighth among nations on a per-GDP basis—government investment has declined from two-thirds of the nation’s total expenditure to less than one-third.10 Over half of United States federal R&D spending is defense-related. China has a relatively low R&D to GDP ratio—but has more than doubled the figure over the past decade, even while growing its GDP substantially. Viewing such trends United States research universities are increasingly creating ties to what they view as the more highly regarded overseas universities. For example, the president of Yale University has cited the benefits being realized from a partnership in the biosciences with a Chinese university. In that case, a competitive edge was derived by sending researchers to China rather than having them come to the United States because of the lower costs, excellent facilities and abundance of talented graduate students in China. United States industrial firms are increasingly adopting much the same strategy, build- ing new research facilities outside the country. Although this was initially driven by the lower cost of operations abroad, it now is often motivated by the relative availability of talent. The National Science Foundation reports that U.S.-based companies now have 23 percent of their R&D employment located abroad.11 8 NSB, 2010. 9 NSB, 2010, Table 4-12. 10 NSB, 2010, Table 4-11. 11 F. Moris and N. Kannankutty, New Employment Statistics from the 2008 Business R&D and Innovation Survey, National Science Foundation, July 2010. Available at: http://www.nsf.gov/statistics/infbrief/nsf0326/ nsf0326.pdf. 

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THe INGreDIeNTS Of INNOVaTION .2 HUMAN CAPITAL Workforce Education The chairman of the Department of Commerce’s National Advisory Committee on Measuring Innovation, Carl Schramm, notes that “Nobel Laureate Gary Becker developed a theory that empirically established that people were more important to an economy than physical capital. Becker’s now obvious observation is central to conscious attempts to induce more innovation. In his book The Vital Few, economist theorist Jonathan Hughes points out that the welfare of society, connected as it is to innovation and entrepreneur- ship, hangs on a very small number of our fellow citizens.”12 Dean Yash Gupta of the Johns Hopkins Carey Business School further notes that “. . . 30 years ago the United States had 30 percent of the world’s college students. Today we are at 14 percent and falling. Twenty years ago the U.S. was first among industrialized nations in share of population with a high school diploma and first with a college degree. Today, we are ninth in high school diplomas (and) seventh in college degrees worldwide. We are 18th out of 24 in high school graduation (rate) among industrialized nations . . . and falling.”13 At the same time, employers indicate that knowledge demands on all employees are higher than ever. A recent case reported in The New York Times stated that a firm seeking to hire employees was able to find only 47 who were qualified out of an applicant pool of 3,600.14 Science, Engineering and Mathematics It has increasingly become recognized that to be competitive in the global technol- ogy-dominated marketplace requires a highly qualified workforce. This in turn demands that virtually all job-seekers be at least “proficient” in mathematics and general science and that the nation have a cadre of highly creative individuals who possess an extraordi- nary capacity for mathematics, science and engineering. It is not necessary—or even possible—to seek to match nations such as China and 12 Carl Schramm, Made in America, The National Interest, April 2010. Available at: http://www.usinnovation. org/files/SchrammMadeinAmerica.pdf. 13 Y. Gupta, Innovation: Can a Nation Have a Second Act? Speech to the Baltimore Rotary, June 8, 2010. Figures in this quote may differ from similar indicators cited in other parts of this report due to different sources or coverage in terms of dates, degrees (four-year vs. combined two- and four-year) or countries. 14 M. Rich, Factory Jobs Return, but Employers Find Skills Shortage, The New York Times, July 1, 2010. 

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rISING aBOVe THe GaTHerING STOrM, reVISITeD India, each with approximately four times the population of the United States, in over- all quantities of scientists and engineers. Further, the race for quantity has already been rather decisively lost. Jobs performing relatively routine functions of science and engineer- ing have been lost to nations with lower cost structures and a well educated citizenry. What must be preserved in the United States, if the nation is to compete, is an adequate supply of scientists and engineers who can perform creative, imaginative, leading-edge work—that is, who can innovate. Albert Einstein wrote, “Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world.”15 The principal focus of the Gathering Storm review was on mathematics, science and engineering, not simply because of their critical importance in creating jobs but also because these are the disciplines in which American education is failing most convinc- ingly. This is not to diminish the importance of many other fields—particularly reading at the elementary school level and the liberal arts in all grades. Nor does it overlook the fact that there is indeed a limited number of truly extraordinary public schools in America. It merely recognizes that it is difficult to dismiss evidence such as the survey that found that almost 30 percent of American adults do not know the earth revolves around the sun; 16 percent do not know that the center of the earth is very hot; almost half do not know that electrons are smaller than atoms; and only about half the population is aware that dinosaurs and humans never coexisted.16 Production of Scientists and Engineers In spite of the nation’s growing population and the explosion of knowledge in sci- ence and technology and its impact during the past decade, the number of recipients of bachelor’s degrees in mathematics, engineering and the physical sciences from United States universities has remained virtually unchanged.17 The numbers of doctorate degrees awarded by United States universities in mathemat- ics and the physical sciences have likewise remained basically unchanged in the past decade.18 In contrast, the number of engineers receiving doctorates has evidenced signifi- cant growth (from about 6,000 to about 8,000 graduates per year) in the last five years for which data are available. The increase is, however, largely attributable to the growth of 15 K. Taylor, Is Imagination More Important Than Knowledge? Times Higher Education, October 2, 2002. 16 NSB, 2010, Appendix Table 7-10; National Science Board (NSB), Science and Engineering Indicators 2002, Arlington, VA: National Science Foundation, Chapter 7. 17 NSB, 2010, Figure 2-5. 18 NSB, 2010, Figure 2-14. 

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THe INGreDIeNTS Of INNOVaTION foreign student enrollment.19 As a basis of comparison, United States universities award about 150,000 MBA’s, 44,000 law degrees, 68,000 engineering (undergraduate) degrees and 8,000 engineering PhD’s each year.20 While the representation of women among those receiving bachelor’s degrees in all fields from United States universities exceeds 57 percent, less than 20 percent of the degrees in engineering are awarded to women—with the most recent trend slightly worsening.21 Among sixth graders who received scores above 700 on the mathematics Scholastic Aptitude Test thirty years ago boys outnumbered girls by 13:1. In the more recent tests, the ratio is 4:1—suggesting once again that societal rather than biological issues are at work here.22 Similarly, black and Hispanic representation among those receiving bachelor’s degrees in engineering is less than one-half their proportionate share of the overall population. The situation in the physical sciences is somewhat more bal- anced than in engineering, but still unbalanced. The comparative underrepresentation of United States citizens studying the natural sciences and engineering, particularly at the doctoral level, is of particular concern. Students receiving their undergraduate degrees in the natural sciences or engineering from United States undergraduate institutions represent 16 percent of total enrollment of those institutions. This contrasts with 47 percent in China, 38 percent in South Korea, and 27 percent in France.23 Overall, 47 percent of U.S. four-year college students fail to graduate within six years.24 Over the last decade or so the United States has fallen from first to 16th in tertiary graduation rate.25 A paradox exists in the debate over whether there is a shortage of scientists and 19 NSB, 2010, Appendix Table 2-28. 20 NSB, 2010, Appendix Tables 2-12 and 2-28; American Bar Association. See: http://www.abanet.org/ legaled/statistics/charts/stats%20-%20.pdf; and Association to Advance Collegiate Schools of Business, Business School Data Trends and 2010/List of Accredited Schools. Available at: http://www.aacsb.edu/ publications/businesseducation/200-Data-Trends.pdf 21 NSB, 2010, Appendix Table 2-12. 22 K.L. Bates, Gender Gap in Math Scores Persists, Duke University News Office, July 2, 2010. Available at: http://news.duke.edu/200/07/TIPability.html. 23 NSB, 2010, Appendix Table 2-35. 24 M.B. Marklein, 4-year colleges graduate 53% of students in 6 years, USA Today, June 3, 2009. Available at: http://www.usatoday.com/news/education/2009-06-03-diploma-graduation-rate_N.htm. 25 Organization for Economic Cooperation and Development, Education at a Glance 2009: OECD Indica- tors, Paris, 2009. Rankings include OECD members and partners, and college graduation ranking is based on Tertiary-A institutions. See: Chart A3.2 in http://www.oecd.org/document/24/0,3343,en_2649_39263238_ 43586328____,00.html. 

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rISING aBOVe THe GaTHerING STOrM, reVISITeD engineers or whether there are too many scientists and engineers for the jobs that are available. Most business leaders maintain the former; however, with regard to the more “conventional” functions of these fields it may well be that de facto there can no longer be domestic shortages of scientists and engineers. Firms facing this proposition are simply moving work elsewhere. Similarly, the observation that many scientists and engineers elect to pursue careers in other fields is in many instances simply reflective of the value placed on education in these disciplines by business, law, and medical schools and related employers and should not necessarily be decried. However, if the sole purpose of a PhD in science is considered to be to prepare future educators in science, then a surplus of sci- entists (often evidenced as a surplus of Post-Doctorate researchers) seems inevitable. The Gathering Storm recommendations are based upon the premise that federal investment in research must be doubled (the report’s second highest priority recommendation)—in which case there will be commensurate increases in demand for researchers . . . and not solely for the purpose of providing educators. Further, since only about four percent of the U.S. workforce is engaged in science and engineering, even rather large increases in employment in these disciplines will have only a modest direct impact on overall employ- ment. It is the leverage in jobs that these individuals create for others to which their value is attributable. K-12 Education About thirty percent of United States youths fail to receive a high school diploma on time.26 The United States is now 20th in high school graduation rate among industrialized nations.27 One consequence is that, according to a recent report, 75 percent of United States youth are ineligible for service in the nation’s military due to academic, physical or moral shortcomings.28 In July 2010, the unemployment rate among those of all ages who did not complete high school was 13.8 percent, whereas it was 10.1 percent among high school graduates, 8.3 percent among those with some college, and 4.5 percent among those with at least a bachelor’s degree.29 Significantly, only one in 17 children from fami- 26 U.S. Department of Education, National Center for Education Statistics, High School Dropout and Comple- tion Rates in the United States: 2007, September, 2009. Available at: http://nces.ed.gov/pubs2009/2009064. pdf; see also White House Press Release, President Obama Announces Steps to Reduce Dropout Rate and Prepare Students for College and Careers, March 1, 2010. Available at: http://www.whitehouse. gov/the-press-office/president-obama-announces-steps-reduce-dropout-rate-and-prepare-students-college-an. 27 OECD, 2009. Rankings include OECD members and partners. See: Chart A2.1 in http://www.oecd.org/ document/24/0,3343,en_2649_39263238_43586328____,00.html. 28 C. Davenport and E. Brown, Girding for an Uphill Battle for Recruits, Washington Post, November 5, 2009. 29 Bureau of Labor Statistics data available at: http://www.bls.gov/news.release/empsit.t04.htm. 50

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THe INGreDIeNTS Of INNOVaTION lies with less than $35,000 annual income obtain a bachelor’s degree by age 24.30 It is these children from low-income homes that are most under-served by the nation’s public school system. Even those students who do graduate from high school often find a chasm between the requirements for a high school diploma and what is needed to succeed in college— one result of which is that 77 percent of college freshman are unable to pass a college preparatory examination in at least one of three core subjects, and about one third have to take remedial work in college.31 Students requiring remediation graduate from college at a much lower rate compared with those who do not—a very costly attempt at a solution to the nation’s K-12 shortcomings—although it should be noted that some of this disparity is undoubtedly due to financial considerations.32 In international standardized tests involving students from 30 nations, United States fourteen-year-olds rank 25th in mathematics and 21st in science.33 In tests within the United States, little improvement has been observed over the past 40 years. This is in spite of a sevenfold increase in inflation-adjusted spending per student since World War II.34 More recently, in 1971 per-student K-12 spending was $4,489; in 2007 the cor- responding figure, adjusted for inflation, was $10,041.35 In 1973 the average score on one standardized test (the National Assessment of Education Progress) in mathematics among 17-year-olds was 304 out of 500. A third of a century later it was 306.36 In read- ing, the corresponding gain in the scores was from 285 to 286.37 In the most recent test, three jurisdictions out of 51 (50 states plus the District of Columbia) showed significant improvement in fourth grade reading, while 44 showed essentially no gain and four showed marked declines.38 Among high school seniors average scores in the National 30 R.D. Kahlenberg, Cost Remains a Key Obstacle to College Access, Chronicle of Higher Education, March 10, 2006. 31 ACT Policy Report, Courses Count: Preparing Students for Postsecondary Success, Available at: http://www. act.org/research/policymakers/pdf/CoursesCount.pdf. 32 National Center for Education Statistics, Remediation and Degree Completion, 2004. Available at: http:// nces.ed.gov/programs/coe/2004/section3/indicator8.asp. 33 NSB, 2010, Appendix Table 1-11. 34 A. Peng and J. Guthrie, The Phony Funding Crisis, Education Next, Winter 2010. Available at: http:// educationnext.org/the-phony-funding-crisis/. 35 National Center for Education Statistics, Digest of Education Statistics, 2009 (NCES 2010-013). Available at: http://nces.ed.gov/fastfacts/display.asp?id=66. 36 The Nation’s Report Card, Trend in NAEP mathematics average scores for 17-year-old students. Available at: http://nationsreportcard.gov/ltt_2008/ltt0002.asp?subtab_id=Tab_3&tab_id=tab#chart. 37 Trend in NAEP reading average scores for 17-year-old students. Available at: http://nationsreportcard. gov/ltt_2008/ltt0003.asp?subtab_id=Tab_3&tab_id=tab#chart. 38 National Center for Education Statistics, Reading 2009: National Assessment of Educational Progress at Grades 4 and 8, March 2010. Available at: http://nces.ed.gov/nationsreportcard/pdf/main2009/200458.pdf. 51

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rISING aBOVe THe GaTHerING STOrM, reVISITeD Assessment of Educational Progress have actually declined during the most recent decade for which data are available in science.39 Indications of very recent improvements in some isolated cases are now being questioned as an artifact of changing examination rigor. As but one example, in New York State eighth graders reaching the “proficiency” standard increased from 59 to 80 percent between 2007 and 2009, while the same group’s scores on the national math test remained virtually unchanged.40 This is a phenomenon which is by no means unique to New York State. McKinsey & Company, the management consultant, concluded in a recent study that disparities in U.S. K-12 education compared to those of many other nations “impose the economic equivalent of a permanent national recession—one substantially larger than the deep recession the country is currently experiencing.”41 The average student intending to major in education in United States universities ranks in the 42nd percentile of all students taking the college boards in Critical Reading, in the 41st in mathematics and in the 46th in writing.42 An international test in mathemat- ics content knowledge at the lower secondary level, involving teachers nearing the end of their college education, ranked United States future teachers in seventh place among the 15 nations that participated.43 Forty-six percent of teachers abandon their profession within five years of first enter- ing the classroom.44 Yet, according to The New York Times, when the city of New York invested $2 million in additional lawyers to assist in discharging teachers considered to 39 National Center for Education Statistics, Science 2005: National Assessment of Educational Progress at Grades 4, 8 and 2, May 2006. Available at: http://nces.ed.gov/nationsreportcard/pdf/main2005/2006466. pdf. 40 New York State Department of Education, A New Standard for Proficiency: College Readiness (Slide Presentation), July 28, 2010. Available at: http://www.oms.nysed.gov/press/PressConferencePresentation UPDATEDAM07_28.pdf. Note that for 2010 the score needed to achieve Level 3 proficiency in math was raised for eighth graders, so while the results were flat, the proportion achieving proficiency declined to 55 percent. 41 M. Hirsh, We’re No. 11! America May Be Declining, But Don’t Despair, Newsweek, August 23/30, 2010. 42 The College Board, 2008 College-Bound Seniors: Total Group Profile Report. Available at: http:// professionals.collegeboard.com/profdownload/Total_Group_Report.pdf; The College Board, SAT Percentile Ranks, 2009 College-Bound Seniors. Available at: http://professionals.collegeboard.com/profdownload/SAT- Percentile-Ranks-2009.pdf. 43 The Center for Research in Math and Science Education, Michigan State University, Breaking the Cycle: An International Comparison of U.S. Mathematics Teacher Preparation, Initial Findings from the Teacher Education and Development Study in Mathematics, 2010. Available at: http://www.educ.msu.edu/content/sites/usteds/ documents/Breaking-the-Cycle.pdf. 44 G. Saitz, Growing Great Teachers, National Education Association website. Available at: http://www.nea. org/home/3700.htm. 52

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THe INGreDIeNTS Of INNOVaTION be incompetent, the effort removed three teachers (out of a total of 55,000) over the past two years.45 McKinsey & Company concludes that if United States youth could match the perfor- mance of students in Finland, America’s economy would be between nine and sixteen percent larger.46 That equates to between 1.3 and 2.3 trillion dollars each year. It should be reiterated that the need to strengthen science and math education in the nation’s public schools is not simply to produce more graduates possessing the qualifica- tions needed to pursue degrees and careers in science and engineering. The spectrum of jobs that is available to high school as well as college graduates is increasingly demanding at least rudimentary skills in these fields. Importing Talent A logical question is how United States science and engineering has managed to prosper with such a tenuous underpinning. A substantial part of the answer is that the United States has benefited immensely from, and is highly dependent upon, foreign-born individuals talented in science and engineering who elect to study in the United States and decide to remain here after completing their education. It probably would not be an overstatement to assert that America’s science and engineering enterprise would barely function without these talented contributors. Of the PhDs in the United States science and engineering workforce under the age of 45—considered to be the most productive years in science—35 percent are foreign- born.47 Thirty-five percent of United States engineering faculty is foreign-born and 57 percent of “post-docs” in this country are temporary residents.48 Forty-six percent of the members of the United States physics team and 65 percent of the top United States scorers in the Mathematics Olympiad are the children of immigrants.49 45 J. Medina, Progress Slow in City Goal to Fire Bad Teachers, The New York Times, February 23, 2010. 46 McKinsey & Company. The Economic Impact of the Achievement Gap in America’s Schools. April 2009. Available at: http://www.mckinsey.com/App_Media/Images/Page_Images/Offices/SocialSector/PDF/ achievement_gap_report.pdf. 47 National Science Foundation, Characteristics of Doctoral Scientists and Engineers in the United States: 2006, September 2009. Available at: http://www.nsf.gov/statistics/nsf0937/pdf/nsf0937.pdf. 48 National Science Foundation, Graduate Students and Postdoctorates in Science and Engineering: Fall 2007, June 2010. Available at: http://www.nsf.gov/statistics/nsf0307/pdf/nsf0307.pdf. 49 S. Anderson, The Multiplier Effect, International Education, Summer 2004. Available at: http://www.nfap. net/researchactivities/studies/TheMultiplierEffectNFAP.pdf. 5

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rISING aBOVe THe GaTHerING STOrM, reVISITeD The contribution of foreign-born individuals is not limited to basic research: Yahoo, Sun Microsystems, eBay, Intel and Google were all founded or co-founded by immigrants from Taiwan, Germany, India, France, Hungary, or Russia. During the 10 years follow- ing 1995, 52 percent of Silicon Valley start-ups—now employing many thousands of people—were founded by immigrants.50 According to a Duke University study, foreign- born entrepreneurs during the period from 1995 to 2005 founded, or were partners in founding, one-fourth of the new engineering and technology companies in the United States, employing 450,000 workers in 2005. A strong multiplier effect exists when creative scientists and engineers are provided an innovation-friendly environment. Yet, United States immigration policy in many cases discourages qualified individuals from studying in the United States or remaining here after graduation. As the rest of the world enjoys increasing prosperity and greater freedom some foreign-born graduates of United States universities are being attracted to return home. Although this trend is not massive at this point, there are numerous specific examples relating to some of America’s more renowned researchers. A recent change of attitudes is indicated in a Kauffman Foundation survey that found a majority of Indian and Chinese students indicating they would like to remain in the United States a “few” years after graduation, but only six and ten percent, respectively, said they would like to remain permanently.51 Once a tipping point has been reached in a nation’s ability to innovate, the decline becomes self-reinforcing as students no longer seek to attend that nation’s universities and graduates seek work in more promising venues. . ENvIRONMENT The Innovation Ecosystem Once new research discoveries have been converted into products and services through the application of advanced engineering practices it becomes the role of entrepre- neurs to assure that those products and services are first to market. Even weeks can matter in the race to be first; hence, the job-creating value of research is highly perishable. It took 50 V. Wadhwa, Foreign-Born Entrepreneurs: An Underestimated American Resource, Kauffman Thought- book 2009, The Kauffman Foundation. Available at: http://www.kauffman.org/entrepreneurship/foreign-born- entrepreneurs.aspx. 51 V. Wadhwa, A. Saxenian, R. Freeman, and A. Salkever, Losing the World’s Best and Brightest: America’s New Immigrant Entrepreneurs, Part V, March 2009. Available at: http://www.kauffman.org/uploadedFiles/ ResearchAndPolicy/Losing_the_World’s_Best_and_Brightest.pdf. 5

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THe INGreDIeNTS Of INNOVaTION almost two years for one million iPods to be sold; 74 days for one million iPhones; and 28 days for one million iPads.52 Any ecosystem that delays, or worse yet, halts, the passage of ideas into products and then into markets can undermine the entire innovation process. One impediment to being first to market is often referred to as “the Valley of Death”— actually not one but several valleys. Prominent among these is the situation where a prod- uct, not yet free of significant risk but offering considerable promise, demands substantial additional investment to take the next (costly) step towards the marketplace. The operative question is what might be a source of funds under such a circumstance and in today’s economic environment risk-capital is very difficult to obtain. Collaboration across sectors is absolutely critical to sustain innovation in some indus- tries. For example, one study found that 31 percent of new products and 11 percent of new processes in biomedical fields could not have been developed or would have been significantly delayed without contributions from academic research.53 The “innovation ecosystem” thus refers to that set of circumstances which assist—or inhibit—the innovation process. Some of the more critical elements of this ecosystem include: Cost of Labor As noted previously, labor costs continue to be considerably higher in the United States than in the less developed parts of the world. For example, nearly twenty assembly workers can be employed in Vietnam for the cost of one in the United States. As other nations prosper these differences will presumably diminish; however, it can be expected to take considerable time before anything approaching parity is reached. In the case of China, the trend towards greater wealth in the cities and in certain suburbs is having an equalizing impact and some economists predict China’s advantage in the cost of manu- facturing labor will have considerably diminished within two decades. Nonetheless, the United States is likely to endure a not insignificant overall labor cost disadvantage for many years. 52 Apple Sells One Millionth iPhone, Press Release, September 10, 2007; Apple Sells One Million iPads, Press Release, May 3, 2010. 53 E. Mansfield, Academic Research and Industrial Innovation, Research Policy 20 (1991): 1-12. 55

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rISING aBOVe THe GaTHerING STOrM, reVISITeD Tort Policy As previously noted, United States firms spend over twice as much on litigation as on research—a realm unapproached anywhere else in the world.54 This tends to discourage even prudent risk-taking and consumes resources and vast amounts of time and imposes a severe opportunity-cost. Similarly, the judicial process for resolving disputes tends to be cumbersome and time consuming, such that firms often have no choice but to settle even frivolous cases if they are to avoid still further damage. This legal process often consumes years or even decades to arrive at a resolution to a dispute, yet many businesses are born, prosper and sometimes fail in five years or less. Tax Policy The United States has the second highest corporate tax rate among industrialized nations, exceeded only by Japan, backed by 17,000 pages of regulations and interpreta- tions.55 Although the United States once offered the most generous R&D tax credit in the world, it now ranks 17th of 30 OECD countries.56 It is not uncommon for United States firms to be attracted abroad by highly preferential tax rates that are offered to relocating firms. Given the growing national debt being assumed by the United States, tax rates can be expected to become an increasingly significant factor in considering where to start or expand a business. Regulatory barriers Well-intentioned regulations can and often do have important unintended conse- quences. One growing trend among start-ups is to initiate business in Canada because of the greater ease of founding, licensing, operating and selling a firm.57 In the case of 54 NSB, 2010, Appendix Tables 4-8 and 4-9; Towers Perrin, 2009 Update on U.S. Tort Cost Trends, Appen- dixes 1-5. 55 S. Hodge, U.S. States Lead the World in High Corporate Taxes, Tax Foundation Fiscal Fact 119, March 18, 2008. Available at: http://www.taxfoundation.org/publications/show/2297.html; I. Greenwald, High Corporate Tax Rate Is Misleading, Smart Money, January 25, 2008. Available at: http://www.smart money.com/investing/economy/high-corporate-tax-rate-is-misleading-22463 /; Editorial: Staggering Facts About Our Tax Code, The Lima News, April 15, 2009. Available at: http://www.www.istockanalyst. com/article/viewiStockNews/articleid/394996. 56 R. Atkinson and S. Andes, U.S. Continues to Tread Water in Global R&D Tax Incentives, Information Tech- nology and Innovation Foundation, August 13, 2009. 57 The World Bank Group ranks Canada as the second best country in the world to start a business, after New Zealand. Rankings available at: http://www.doingbusiness.org/economyrankings/. 5

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THe INGreDIeNTS Of INNOVaTION the Food and Drug Administration, which regulates 25 cents of every dollar spent by the average American, or over a $1 trillion in products ranging from cosmetics to pet foods to medical products, resources have not kept pace with responsibilities.58 The lack of certainty and predictability in the review and approval process heightens risks of failure, raises the costs of development, and makes the struggle for capital still more difficult. Cost/Availability of Capital The United States has long enjoyed a major advantage in terms of the availability of venture capital: California has had more venture capital available than any of the world’s nations (excluding, of course, the United States, making up about half of the United States total).59 Today, investors, including an increasing number abroad, are placing less and less emphasis on geopolitical borders as they search for the opportunity for financial gain. As a result, the “source of capital” advantage enjoyed by the United States in the past has been diminishing. The nation’s unique advantage is being eroded by the rise of venture financing elsewhere.60 This problem has been particularly acute for smaller firms where the availability of risk capital has greatly contracted. Protection of Intellectual Capital Much of the world’s business depends upon the United States patent system for the protection of intellectual property. Nonetheless, that system is ponderous and glacial, in part due to a shortage of an adequate number of qualified personnel and the system’s heavy dependence upon litigation. Only 26 percent of the patent examiners reviewing “business methods” patents have any industry experience.61 Less than half the judges in the “specialized” patent court have technical backgrounds. 58 See Subcommittee on Science and Technology, FDA Science and Mission At Risk, November 2007. Avail- able at: http://www.fda.gov/ohrms/dockets/ac/07/briefing/2007-4329b_02_00_index.html. 59 National Venture Capital Association data available at: http://www.nvca.org/index.php?option= com_content&view=article&id=78&Itemid=02. 60 The United States still accounts for about two-thirds of global venture investments, but venture investing in China, India, and elsewhere in Asia is growing rapidly. See Dow Jones Venture Source, Global Venture Invest- ment Rises 13% in First Quarter of 2010-Press Release, April 29, 2010. 61 K. Teska, Who Makes the Patent Calls? Mechanical Engineering, April 2010. Available at: http://memagazine. asme.org/Articles/200/April/Makes_Patent_Calls.cfm. 5

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rISING aBOVe THe GaTHerING STOrM, reVISITeD Freedom from Corruption One of the more powerful factors in deterring responsible firms from building plants, creating jobs and conducting business in any nation is the prevalence of corruption. Russia is often cited as an example of such a nation and its economy has suffered accordingly. It is noteworthy that in 2009 the United States ranked 19th in the world on Transparency International’s Corruption Perception Index, where the higher the rank the less corruption is perceived.62 The index includes such practices as bribery, price-fixing, employee theft, and misrepresentation of financial condition. Sanctity of Law In general the United States system for enforcing contracts, resolving disputes, assur- ing human safety, protecting property, caring for the environment and dealing with related issues is widely considered to be superior to that of many nations, particularly developing nations. However, as previously noted it is a costly and deliberate system to the point of incompatibility with today’s fast-moving global commerce. Cost of benefits United States standards for the provision of benefits to employees by corporations (pensions, healthcare, savings accounts, vacations, holidays, etc.) are substantially more generous—i.e., more costly—than is the case in the less-developed nations (but sig- nificantly less than in Europe). Such benefits, often costing employers one-third of wages or more, perform an important societal function; nonetheless, their existence must be reflected in the price of a firm’s products. This, in turn, impacts competitiveness. In the United States, General Motors spends more on healthcare than on steel; Starbucks more on healthcare than on coffee.63 62 Transparency International, Corruptions Perception Index 2009. Available at: http://www.transparency. org/policy_research/surveys_indices/cpi/2009/cpi_2009_table. 63 J. Appleby and S. Carty, Ailing GM looks to scale back generous health benefits, USA Today, June 24, 2005. Available at: http://www.usatoday.com/money/autos/2005-06-22-gm-healthcare-usat_x.htm; Health care takes its toll on Starbucks, Associated Press, September 14, 2005. Available at: http://www.msnbc.msn. com/id/9344634/. 5

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THe INGreDIeNTS Of INNOVaTION Export Control Laws The ability to move products and knowledge into and out of the United States is controlled by the ITAR (International Traffic in Arms Regulation), Export Controls, and Deemed Export Controls. Most of these laws and regulations were promulgated at a time when the United States held a dominant position in technology and when transferring militarily-significant knowledge out of the country was extremely difficult—neither of which pertains today. Global firms now frequently have research laboratories located in several countries working on a common project. If regulatory regimes make it exces- sively difficult to move ideas, equipment, products and people in and out of a United States research facility, the facility can simply be “quarantined” and the work performed abroad. In such cases, prototype shops often follow the research effort . . . and then fac- tories—along with the jobs they all provide. A similar circumstance exists when seeking to sell products outside the United States that have been jointly developed/produced by a United States and foreign firm. “Deemed exports” can, for example, require a professor at a United States university, if there is a foreign-national student in the class, to obtain an export license before dis- cussing material that is not even classified. The penalties for failure to comply with these relatively arcane laws can be severe. Several independent reviews have suggested that the export laws be rewritten and focused upon that smaller set of potentially highly sensitive issues (such as nuclear weap- on technology, toxins, and the like) rather than seek to apply constraints to items that can be commonly and openly purchased elsewhere in the world or are of lesser consequence (e.g., handcuffs, shotguns, and the like). The 2009 National Research Council report, Beyond Fortress America recommends a restructuring of United States export controls to better balance U.S. and national security interests by establishing a one-year sunset provi- sion, subject to renewal, on the listing of protected items. 64 visa Policy Although substantially streamlined since the tightening that immediately followed the events of 9/11, the number of individuals with needed skills who can be admitted to the 64 National Research Council, Beyond ‘Fortress America’: National Security Controls on Science and Tech- nology in a Globalized World, National Academies Press, 2009. Available at: http://www.nap.edu/catalog. php?record_id=2567. 5

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rISING aBOVe THe GaTHerING STOrM, reVISITeD United States under the legal quota has been markedly reduced in more recent years. For example, the limit on the number of H-1B visas granted annually was reduced by two- thirds to 65,000 (0.02 percent of the United States population) in 2003 after temporary increases expired.65 Even in the economic downturn of 2010, H-1B visa quotas were reached months before the end of the application period.66 These limitations on much- needed talent are in spite of an estimated twelve million illegal immigrants currently residing within the nation’s borders.67 The barriers that scientists and engineers holding temporary visas face in obtaining green cards further affects America’s ability to attract and retain a share of the world’s “best and brightest” from abroad. Availability of Markets In many industries, companies have traditionally tended to locate prototype shops and at least some serial production near R&D facilities. Likely increases in the cost of transportation due to energy price increases—attributable to market conditions, carbon taxes or recovery costs—may motivate firms to conduct manufacturing activities closer to their customer base. China is projected by some to become the largest consumer market in the world in the next decade.68 By 2025 India’s middle class is expected to grow from today’s 50 million citizens to just under 600 million.69 Employment Policy The United States has more intrusive employment policies pertaining to such mat- ters as termination rights, minimum wages, unionization, etc., than most developing nations, but considerably less demanding than those of Europe. Many of these policies perform important functions, such as protecting worker health and safety; others, particu- larly those entailing massive reporting activities, can be counterproductive to a nation’s competitiveness. 65 “H-1B visas” are non-immigrant visas that allow U.S. firms to temporarily employ foreign workers possess- ing special skills. 66 U.S. Citizenship and Immigration Services, USCIS Reaches FY 2010 H-1B Visa Cap, December 22, 2009. 67 J.S. Passel and D. Cohn, A Portrait of Unauthorized Immigrants in the United States, Pew Hispanic Center, April 14, 2009. 68 Q. Xiao, China May Be Biggest Consumer Market by 2015, China Daily, February 25, 2010. Available at: http://www.chinadaily.com.cn/china/200-02/25/content_9504280.htm. 69 D. Farrell and E. Beinhocker, Next Big Spenders: India’s Middle Class, BusinessWeek, May 28, 2007. 0

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THe INGreDIeNTS Of INNOVaTION Stability and Predictability of government, Markets, etc. The United States enjoys a distinct advantage over most developing nations with respect to government stability and predictability and is at least on a par with most devel- oped nations in this regard. Some recent events notwithstanding, consumer and financial markets, at least when compared with those of some other nations, are remarkably reli- able and transparent. In terms of “Overall Risk of Doing Business,” the United States has the 13th most favorable rating of 186 nations according to Euromoney.70 Availability of Transportation and Telecommunications In most forms of transportation the United States is well served (e.g., 4.0 million miles of roads vs. 2.2 million in China; 15,095 airports vs. 482 in China, 349 in India and 1,216 in Russia).71 However, as previously noted, this is not the case in broadband telecommunications where, in terms of density, the United States ranks 22th among the world’s nations.72 Market growth Potential As discussed elsewhere, there can be important business advantages—although decreasing as global mobility increases—to be derived from locating factories near poten- tial customers; engineering facilities near factories; and research laboratories near engi- neering facilities. Given the huge United States consumer market throughout most of the twentieth century, this has been a fundamental competitiveness discriminator possessed by United States firms. However, the United States is now a relatively mature market, the size advantage of which is being eroded or even eclipsed as a large middle-class evolves in developing nations. Speaking of Wal-Mart’s shifting focus toward nations other than the United States, Dean Junkans, chief investment officer for PNC Wealth Management, noted that, “The U.S. consumer is tired” . . . not to mention outnumbered.73 It is estimated that within a decade 80 percent of the world’s middle-class will reside in what are now 70 Country Risk 2010: A Fragile Sense of Stability, Euromoney, March 2010. 71 See CIA World Factbook, available at: https://www.cia.gov/library/publications/the-world-factbook/index. html. 72 S. Dutta and I. Mia, Global Information Technology Report 2009–200: ICT for Sustainability, World Eco- nomic Forum, 2010. 73 Y.Q. Mui, As growth in the U.S. slows, Wal-Mart puts more emphasis on foreign stores, The Washington Post, June 8, 2010. 1

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rISING aBOVe THe GaTHerING STOrM, reVISITeD categorized as developing nations. There are already 80 million people in China who can reasonably be characterized as middle-class.74 Globally, it is estimated that by the mid-2020’s, there will be two billion such consumers—with the number in China exceed- ing the total population of the United States at that time by a factor of two.75 It has been estimated that by 2030, two billion people will join the world’s middle class, with most of the addition coming from what are now considered developing countries.76 By 2020, 70 percent of China’s population is expected to have reached middle class status. Summary A large number of factors, mostly controlled by government, can strongly impact a nation’s ability to create jobs for its citizens in a competitive marketplace. While pos- sessing many inherent advantages because of its democracy and free enterprise system, America also has noteworthy disadvantages—many of which are self-imposed. 74 A. Hodgson, China’s middle class reaches 80 million, Euromonitor, July 25, 2007. 75 China’s middle class population could total 700 million by 2020, People’s Daily, July 20, 2010. 76 D. Wilson and R. Dragusanu, The Expanding Middle: The Exploding World Middle Class and Falling Global Inequality, Goldman Sachs Global Economics Paper No. 170, July 7, 2008. Note that for Wilson and Dragusanu, those with per capita incomes in the $6,000 to $30,000 range (adjusted for purchasing power) are considered middle class. 2