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EXECUTIVE SUMMARY Through the 1980s a series of studies portrayed the technological leadership and international competitiveness of U.S. manufacturing industries as imperiled and probably on the decline. Only a decade later, trends seem to have been reversed and the prospects for continued strong U.S. economic performance appear bright. Were American industries and firms really doing that poorly and foreign competitors that well a decade ago? Is the apparent reversal an accurate picture and will U.S. technological leadership and competitive strength across a broad range of industries be sustained? To help answer these questions, the National Research Council's Science, Technology, and Economic Policy (STEP) Board commissioned studies of eleven industries, including so-called ''service'' industries that were overlooked in the competitiveness debate because manufacturing was considered to be the backbone of the economy and more vulnerable. Today, services generate three-quarters of the gross domestic product, employ eighty percent or more of the workforce, and consume much of manufacturing output (e.g., commercial aircraft, medical products, and computers). The industries that the Board examined are steel, chemicals, pharmaceuticals and biotechnology, banking, trucking, food retailing, power metallurgy parts, apparel, computing, semiconductors, and computer disk drives. These studies appear in a companion STEP Board volume, U.S. Industry in 2000: Studies in Competitive Performance , with an introduction by David Mowery, University of California Haas School of Business. Pessimistic analysts in the 1980s almost certainly mistook adverse macro-
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economic trends—in particular, the high valuation of the dollar—for much more fundamental signs of structural deterioration. Nevertheless, the general picture is one of stronger performance in the 1990s on a variety of dimensions, among them investment, export market share, R&D spending, and profitability. Although not universal and not without dislocations to particular firms, groups of workers, and regions, this improvement is true of much of the service sector as well as manufacturing. Foreign competition has been a driver of change in some cases but not in all. Domestic competition, often from new entrants, has played an important role. In trucking, banking, food retailing, and most manufacturing industries, applications of information technology have enabled the introduction of new products and services and recasting of logistics and other processes to be more efficient. Although precise causal relationships and rankings cannot be determined, in the 1990s the U.S. government followed a supportive mix of macroeconomic and microeconomic policies—deficit reduction, conservative monetary policy, scaling back of economic regulation of transportation, finance, and communications, trade liberalization, relatively permissive antitrust enforcement, and strengthening of intellectual property rights. As it had in previous decades, the federal government continued to support research across a broad range of scientific and engineering fields, although the 1990s saw the beginning of a change in the research portfolio that may not bode well for the future—in particular, a decline in support of several physical science and engineering fields. Improved U.S. industrial performance also reflects a variety of private sector strategies—repositioning, product specialization, firm consolidation, internationalization of operations, manufacturing process improvement, and cost reduction—that were market driven, not guided by public policies. These benefited some established firms at the expense of others and in many industries opened opportunities for new entrants. As a result, on the eve of 2000 the structure of most industries looks very different than it did even 15 years ago. Several enduring characteristics of the American political system and economy bode well for the future—the sheer size of the domestic market, encouragement of experimentation, and relatively little protection accorded enterprises resistant to change. Indeed, contrary to recent conventional wisdom about investors' myopia, U.S. capital markets over time do a reasonably good job of favoring firms with high growth prospects. Nevertheless, in the long run international shifts in comparative advantage are inevitable, as a result of changes in national political, legal, educational, and capital market institutions, wars and other destabilizing events. Today, Americans should be wary of assuming that the 1990s marked an enduring turnaround in U.S. industry performance. Despite its general satisfaction with the progress of the last decade and guarded optimism about the future, the STEP Board concludes from its investigations that there are four policy concerns that need to be addressed:
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Carefully selected indicators and data collected nationally on a recurring basis are needed to help discern and track changes in industry structure and innovation processes and to help design and evaluate public policies affecting innovation. Current science and technology indicators and data fall woefully short of illuminating changes that are known or believed to have occurred in the 1980s and 1990s. Although questions of feasibility, reporting burden, and cost need to be examined, the STEP Board believes that, in principle, a number of steps should be taken to improve the information base for microeconomic policy design and evaluation. These include collecting data at the business-unit level of the firm, conducting innovation and technology adoption surveys, linking datasets to one another, exploiting data on the training, career paths, and work of technically trained people, and exploring public-private partnerships to produce information useful to both corporate managers and public policymakers. Lack of an adequate, well-trained workforce—particularly those skilled in creating, developing, and deploying information technologies—may inhibit the capacity of the United States to remain prosperous and a locus of innovation. Immigration quotas have been raised, some states, educational institutions, and firms are expanding degree and training programs, and companies are paying higher premiums for skilled labor or seeking it abroad. What is not clear is whether, despite these measures, there will remain a growth-limiting shortfall between supply and demand and what additional steps, if any, should be taken to alleviate it. Strengthening and extending intellectual property rights (IPRs)—conferred by patents, copyrights, and penalties for misappropriating trade secrets—are appropriate policies for advanced industrial economies where intellectual assets are the principal source of growth. It may be that in some respects these processes should be taken further than the many steps accomplished in the past 25 years. On the other hand, there is growing friction over the assertion and exercise of IPRs and claims that in some circumstances they may be discouraging research, its communication, and use. The question arises whether in some respects IPR strengthening and extension have proceeded too far. The Board's case studies and limited national data suggest that the improved competitive performance of at least some of the industries reliant on the physical and information sciences, engineering, and mathematics—electronics, software, networking, and materials processing—has come about in the face of reductions in industry-funded longer-range research. Since 1992, public investment in research in several of these fields has also declined as a result of budget reduction pressures and changing
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federal agency missions. These trends are of sufficient concern to merit a careful assessment of their long-term implications and what steps, if any, should be taken to change them. FROM "PERVASIVE DECLINE" IN THE 1980s TO "RESURGENCE" IN THE 1990s In the 1980s a series of studies portrayed the technological leadership and international competitiveness of U.S. manufacturing industries as imperiled and probably on the decline. While acknowledging U.S. strengths in academic research, the education of scientists and engineers, technological development, and venture capital financing of technology-based start-up firms, the studies observed serious weaknesses in the capacity of American corporations, compared with their Japanese competitors, to turn these first-class assets into advanced processes and commercially successful products. One study went so far as to characterize the decline of U.S. manufacturing as "systematic and pervasive" (Dertouzos et al., 1989), another as "a major historical development for this country" (Eckstein et al., 1984). The studies made several diagnoses, not mutually exclusive. It was widely believed that, despite exceptional cases such as biotechnology, U.S. firms were underinvesting in general and, in particular, shying away from new ventures with longer time horizons but the promise of eventual competitive advantage, market share gains, higher returns, and even the creation of new industries. Different analysts emphasized different sources of this risk-averse behavior—among them, low national saving rates and a higher cost of capital or required return on investments ("hurdle rates") than faced by competitors in other countries. Others decried Wall Street's dictate that corporate managers show quarterly growth in profits to maintain stock prices, a lack of "patient" capital available to Japanese or German competitors through the substantial bank holdings in industrial corporations, and the inability of managers in some U.S. industries such as semiconductors to spread the risk of new technology development across the range of businesses allied in the typical Japanese keiretsu or Korean chaebol. There was a great deal of concern that barriers to foreign market access and investment, dumping of products in third markets, public subsidies to firms and consortia engaged in technology development, and protection of mature industries from competition put U.S. companies at a serious competitive disadvantage. A perceived neglect of process research and development (R&D) and product quality by U.S. firms was attributed to poor management education and technical training as well as to investment disincentives. As a result, many observers claimed, quality across a range of products from automobiles to semiconductors was suffering and customers were turning to more reliable non-U.S. sources. Inferior precollege public education, preparation of school-leavers for work,
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and career-long training and simply the lack of culturally ingrained habits of cooperation were cited as long-term U.S. disadvantages. Only a decade after the last of these reports, the public mood and tone of academic analysis of the American economy are generally upbeat, buoyed by seven years of uninterrupted growth, low inflation, record job creation, low unemployment, and the first federal budget surplus in more than 30 years. Concerns about the competitiveness of American industries have receded even further as a result of the prolonged stagnation of the Japanese economy and the ensuing crisis slowing the economies of Korea, Singapore, Taiwan, and other Asian countries. In the rush to find fault with the Asian countries' economic and political systems, their remarkable growth performance over a generation is subordinated to their current economic problems. Striking examples of this reversal in thinking since the late 1980s are the industry-by-industry assessments of the Massachusetts Institute of Technology's (MIT) Commission on Industrial Productivity, Data Resources, Inc. (DRI), and the National Academy of Engineering (NAE) contrasted with contemporary studies of the same industries under the auspices of the STEP Board: Pharmaceuticals. . . The. . . industry has maintained an image of immunity from the deterioration of competitive advantage besetting many sectors of the American economy, such as automobiles, steel, textiles and consumer electronics. Unfortunately, this image is apparently exaggerated and probably false. Data compiled by this study indicate a clear relative deterioration in the foundation of pharmaceutical competitive positions—the research efforts necessary for discovery and introduction of new patented drugs. . . .A declining U.S. share of a growing industry is as much a concern for U.S. industrial policy as a declining share of an industry undergoing retrenchment. (NAE, 1983) . . .The industry has been by almost any measure outstandingly successful. . .one of the few industries that American firms have dominated almost since its inception, and one in which American firms continue to have an indisputable lead. During the 1980s and 1990s double digit rates of growth in earnings and return on equity were the norm for most pharmaceutical companies. . .(Cockburn et al., 1999) Semiconductors. . . The traditional structure and institutions of the U.S. industry appear to be inappropriate for meeting the challenge of the much stronger and better organized Japanese competition. . . . The technological edge that once enabled innovative American companies to excel despite their lack of financial and market clout has disappeared, and the Japanese have gained the lead (Dertouzos et al., 1989).
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Since 1989 the market position and profitability of U.S. firms have improved, especially relative to those of Japanese firms. Stronger U.S. performance is revealed in gains in global market share that rest in part on improvements in product quality and manufacturing process yields. Improved performance also reflects the withdrawal of most U.S. firms from the fiercely competitive DRAM segment and shift to logic and micromponent products where they could pursue new product opportunities. . . . The so-called "fabless" semiconductor firms have entered the industry successfully as specialists in innovative device designs (Macher et al., 1999). Chemicals. . . The international trade position of the chemical industry is eroding due to several factors. U.S. raw materials prices are rising to reach parity with the rest of the world. . . .With the decontrol of oil and rising prices of natural gas, the cost advantage of U.S. petrochemical producers has gradually disappeared. Further, the chemical industry is losing markets because of the rising volume of imports of finished goods that are major chemical markets (automobiles, consumer electronics, and apparel). Finally, the decision of several OPEC countries. . . to develop basic petrochemical capacity will make a glut of capacity for some chemical commodities, such as methanol, ammonia, and ethylene, a very likely prospect (Eckstein et al., 1984). In the 1980s, a far-reaching restructuring in the industry, consisting of divestitures and actions to focus firms on a narrower line of products and processes, contributed to improved results in many U.S. chemical firms. This restructuring process began earlier and has proceeded further in the U.S. chemical industry than in those of continental Europe and Japan (Arora et al., 1999). Computers. . . Although the U.S. computer industry remains strong, the outlook will not continue to be bright without strong initiatives. Computer builders in Japan, South Korea, and Taiwan are gaining the research and development, market research services, and technical skills they need to be strong international competitors. To ensure that the U.S. industry remains competitive as the challengers gain strength, production facilities need to be retained and upgraded. . . .U. S. computer makers must also work cooperatively with domestic chip suppliers to ensure access to the latest microcircuit technologies. . . .Software leadership is another important requirement, especially as Japan develops "software factories" and improves the programming tools that can make software development faster and more efficient (Dertouzos et al., 1989).
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Despite all the change, one element of continuity is remarkable. Despite the decline of once-dominant IBM, U.S. firms continue to dominate the rent-generating portions of the industry, such as packaged software, microprocessors, and networking. Although the U.S. share of overall industry revenue is slowly falling, rents are staying put. Consider Microsoft, Intel, and Cisco, a troika that is small in revenue but very large in rents and influence (Bresnahan, 1999). Were U.S. industries and firms really doing that badly and foreign competitors performing that well a decade ago? Is the apparent reversal today an accurate picture? Although related, distinguishing macroeconomic fluctuations and generally slower moving microeconomic or structural changes is a difficult but necessary task. The tendency is to read the cyclical set of signals for the structural trends, especially when the macroeconomic environment is especially negative, as it was in the early 1980s, or positive, as in the late 1990s. As for the future, will American industrial resurgence be sustained? Does the recent performance of a number of industries signify that they have permanently improved their comparative advantage and long-term growth prospects? Almost certainly the answer is that growth will not continue indefinitely in its current configuration or at its current rate. But even if we knew how to sustain resurgence and avoid recession, should we be satisfied with the status quo or should we aspire to a higher growth trajectory? What public policies and private-sector strategies would help achieve it? What current microeconomic trends may undermine it? What areas of ignorance need to be addressed? THE STEP BOARD'S ANALYSIS To help answer these questions, the National Research Council's Board on Science, Technology, and Economic Policy (STEP) undertook an analysis in 1997 that had an ambitious objective and involved several components. The goal was to understand the role of technological and nontechnological factors in the generally improved performance and competitive status of American industries and the public policies contributing to that improvement on the assumption that such understanding could both help sustain growth and anticipate any extensive deterioration in performance. The "technological versus nontechnological" distinction is a crude but useful way to underscore that technology and innovation, broadly conceived to include translation of prototypes into manufactured products and services, adoption of technologies from sources external to a firm, diffusion of incremental improvements in products and services, and investment in science and engineering talent and technical skills, as well as R&D, are responsible for perhaps one-quarter of economic growth in the postwar period. At the same time there are many other influences on economic performance—macroeconomic conditions; tax, regula-
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tory, and other policies that affect industry sectors differently; education; legal institutions; corporate governance; and industryand firm-level strategies. In the long run, these factors condition one another. With respect to technological factors, of particular interest is the relationship of apparent changes in public and private investment to current and future economic performance. Among the changes frequently cited are the following: There has been a marked change in the public and private shares of research expenditures, from parity in 1980 to a ratio of more than twice as much industry as federal government investment today. Largely as a byproduct of the end of the cold war there has been a change in the defense and nondefense shares of the federal government's R&D portfolio, resulting in less support for most fields of the physical sciences and engineering absolutely and relative to the biological and medical sciences. At the same time changes in the composition and orientation of private-sector research and innovation are believed to include an apparent shortening of the time horizon of corporate planning, focus on incremental improvements in technology, greater corporate reliance on external sources of technology and collaborative arrangements with public and private institutions, domestic and foreign, and movement of R&D activity off-shore or into regional concentrations of technology-intensive enterprises. In some sectors, goods production and service delivery have grown more dependent on technology and highly skilled labor but without an increase in formal R&D investment or much R&D activity at all. Nontechnological influences on performance, too, have changed in greater or lesser degree in the past decade. Firms engaged primarily in the delivery of goods and services have come to dominate the economy, accounting for approximately three-quarters of the GDP and employment. Trade has become an integral part of the U.S. economy; exports and imports have increased from approximately 14 percent of GDP in 1980 to 25 percent in 1997. The occupational structure of the economy has changed with growth at both ends of the scale—managerial and professional jobs on the one hand and low-wage, low-skilled jobs on the other hand—while the share of mid-level skilled and paid jobs has declined. The STEP Board has approached the tall order of sorting out these influences and effects from several different angles, including industry-level analysis, an examination of policy influences on corporate behavior, a review of trends in new
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venture financing, and an assessment of the adequacy of aggregate data, especially that relating to industrial innovation. Industry Studies Like the authors of the 1980s studies mentioned earlier, the Board concluded that God as well as the devil is in the details of changes at the industry and, necessarily, firm levels. Under the leadership of STEP member Ralph Landau, the Board identified a number of centers of sectoral expertise that included studies of industry performance and innovation as a principal element. For the most part these are multidisciplinary research projects sponsored by the Alfred P. Sloan Foundation at various universities. To try to standardize these case studies, the Board asked David Mowery of the Haas School of Business faculty at the University of California at Berkeley to develop a general framework to analyze the determinants of performance over the past 15 to 20 years. An exception was a study of the chemical industry, over 150 years and four countries, by Landau and Ashish Arora.1 The shorter time period was chosen to frame the change in performance and also for reasons of economy, although we acknowledge, as the chemical industry study illustrates, that the analysis would benefit from a longer horizon. The Board then convened two workshops that included the investigators selected along with industry analysts from the U.S. Departments of Commerce and Energy, the U.S. International Trade Commission, trade associations, and other organizations. The resulting commissioned papers were presented at a conference in December 1997 at the National Academy of Sciences, where they were discussed with representatives of the subject industries, interested government officials, and other scholars. Revised versions of these papers appear in a companion volume to this report, U.S. Industry in 2000: Studies in Competitive Performance. The group of industries examined (see Table 1) does not represent a sample carefully chosen to be representative of all major sectors of the economy. We were unable to recruit participants with the appropriate range of expertise to assess changes in the resource extraction industries—petroleum and mining—agriculture and forestry, and automobiles, the source of much of the initial concern about declining U.S. competitiveness in the 1970s. Individually and collectively, however, the industries are good candidates for studying transitions in performance among American firms over the past 20 years. Furthermore, they enabled us to capitalize on the cumulative work of analysts informed by close relations with firms in their subject industries and, in some cases, access to proprietary data. 1 R. Landau and A. Arora, "The Dynamics of Long-Term Growth: Gaining and Losing Advantage in the Chemical Industry," in D. Mowery, ed., 1999. The authors adapted this chapter from their book-length study, Chemical and Long-Term Economic Growth, edited with Nathan Rosenberg (1998).
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TABLE 1 Industry Studies Segments Materials processing Chemicals Commodity Specialty Steel Integrated Nonintegrated (minimills) Powder metallurgy parts Services Trucking Truckload (TL) Less than truckload (LTL) Package express Food retailing Retail banking Fabrication and Assembly Computing Mainframes Minicomputers Microcomputers (PCs) Software Networking Hard disk drives Semiconductors "Fabless" design Memory devices Microprocessors and customized devices Apparel Men's Women's Pharmaceuticals
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In contrast to the MIT, DRI, and NAE studies, our selection includes three ''service'' industries—banking, trucking, and food retailing. Although the 1990s proved unfounded the fear that U.S. manufacturing as a whole is endangered and in need of rescue, it no longer makes sense to focus exclusively on manufacturing industries, ignoring by far the largest, increasingly international, and knowledge-intensive sector of the economy. Not only are services the dominant sector of the U.S. economy, generating three-quarters of the gross domestic product (GDP) and employing 80 percent of the work force—90 percent if service functions in the manufacturing sector are included (Survey of Current Business, 1998; U.S. Department of Labor, 1998), they are a major customer for manufacturers in general and the sole customers of products such as aircraft, pharmaceuticals, and medical equipment. Conversely, information technology as well as traditional services represent a critical part of the foundation for production of high-value-added manufactured goods. In any case, it is increasingly difficult to classify as manufacturing or services a significant range of economic activities, as many companies perform functions and pursue markets in both sectors. For example, contrast the MIT commission's characterization of the computer industry of the 1980s as composed of "makers" of mainframe computers, minicomputers, and microcomputers (with software as an afterthought) with the contemporary description by Timothy Bresnahan, author of the STEP Board's computing industry case study: A few pioneering firms once supplied computers; now there are hundreds of successful suppliers of components, software, systems, services, and networks. Performance increases and price decreases, dramatic improvements in all different complementary technologies, and considerable innovation and learning-by-using by customers, all woven together by firm, market, and other institutions for coordination, have built a multi-billion dollar worldwide industry (Bresnahan, 1999). Industry analysts were asked, among other tasks, to identify and discuss the public policies that over the past two decades most strongly affected the structural evolution, technological development, and performance of the industry sectors they studied. Some of their findings are presented below. Other Study Elements Other principal elements of the project included policy analysis, review of the financing of new firms, and evaluation of research and innovation indicators. The STEP Board decided to extend some of its earliest work on tax policy and corporate investment (National Research Council, 1994) to consider how incentives for R&D and U.S. tax rules governing international activities affect the investment behavior of technology-based multinational companies. Former STEP
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CONCERNS FOR THE FUTURE The STEP Board believes that the goal of public policy should be (1) to sustain a high rate of growth of the economy over the long-term by removing sources of inefficiency and (2) to achieve a wider distribution of its benefits. The corporate strategies and apparently supportive public policies of the 1990s, although successful, almost certainly will need to be changed in the future to fit different circumstances. This race has no single clock and no finish line. Moreover, several developments have undermined the stability associated with a world of vertically integrated firms with in-house R&D and proprietary technology. One is the emergence of specialized providers of R&D and technical services purveying expertise to all comers throughout the world and moving industrially relevant technologies more rapidly across national boundaries. Several enduring characteristics of the American polity and economy probably bode well for the future. One is the sheer size of the domestic American market and the scale of its resources. A second is the remarkable flexibility of the political and economic systems, encouraging experimentation in the development and commercialization of new technology and providing relatively little protection for enterprises committed to established ways of doing business. A related factor is the culture's tolerance for failure. Finally, contrary to recent conventional wisdom about managers' and investors' myopia, markets over time, although they fluctuate, do a reasonably good job of favoring firms with high growth prospects.8 Despite the Board's general satisfaction with the progress of the past decade (and, taking a longer perspective, the postwar period) and our guarded optimism about America's economic future, the position of American industries in world markets requires further study and continual monitoring. In the meantime, our collective investigations raise four policy concerns that should be addressed: (1) the adequacy of measures and statistical data on research and innovation broadly defined; (2) the employment, income, and labor market effects of industrial resurgence and the adequacy of human capital to sustain it; (3) the implications for research, innovation, and technology diffusion of some aspects of the 8 In their chapter, Landau and Arora (1999) present recent stock market data for a number of the leading companies and industry averages for most of the industries examined in the STEP project. Their comparison strongly suggests that investors perceive which companies are well managed and have reasonable prospects for growth. Two extreme examples are the extraordinarily high valuation of Microsoft, which has few tangible assets, and the low valuation of USX, a major steel producer with large physical assets, which is not seen as having a brilliant future or impressive technological capability. Companies in technologically progressive industries like computers, software, and pharmaceuticals are deemed to have better growth prospects than firms in industries that are not. That does not mean these underinvested industries are not important to the economy, but their failure to attract capital demonstrates their modest future prospects as global financial markets become more and more integrated. As the Euro becomes a strong rival to the dollar, more sound comparison of corporate growth potential can be made on an international basis.
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continued extension of intellectual property rights protection; and (4) divergent trends in public and private investment in R&D infrastructure. Industrial Research and Innovation Data Revealing as the Board believes the industry case studies are, the findings are anecdotal. Carefully selected statistical data, collected nationally on a recurring but not necessarily very frequent basis, also are needed to help discern and track changes in innovation processes as well as to help design and evaluate public policy measures affecting innovation. Unfortunately, the data gathered by the federal government and some private investigators shed little light on the structural changes in innovation processes described above. For example, industrial R&D spending data collected at the enterprise level rather than the business-unit level cannot be linked to particular products and services or locations and reflect shifts in competition, orientation, and organization only on the basis of broad industry categories of dubious value. Current science and technology indicators and data fall woefully short of illuminating a major part of the story of American industry in the 1990s—the origins of a variety of information technology products and services and their implementation in a cross-section of industries. This is because data on innovation-related activities and investments other than formal R&D and patenting are extremely limited. In particular, technology adoption is captured only in occasional surveys and only in the manufacturing sector; specialized technology providers (consulting, engineering, and systems firms, etc.) are not surveyed regularly; intersectoral flows of information are captured poorly, in part because data on the mobility and activities of technically trained people, the principal agents of technology transfer, are not adequately developed or exploited; and measures of the value of intellectual capital and innovation are lacking. The STEP Board believes that in principle the following steps would greatly improve the information base for microeconomic policy design and evaluation, although questions of feasibility, burden and compliance, administration, and cost need to be examined:9 R&D spending data should be collected at the business-unit level. 9 The following were among the principal suggestions of scholars, analysts, industrialists, and policymakers participating in the STEP Board's February 1997 workshop on industrial research and innovation indicators for public policy (Cooper and Merrill, 1997).
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The government should conduct periodic innovation and technology adoption surveys in service as well as manufacturing industries. Emerging industries and intermediary organizations that play a key role in technology transfer and implementation should be included in appropriate surveys. Statistical agencies, scholars, universities, and professional associations should consider how human resources data (on training, career paths, and work patterns of technically trained people) can be improved and used to assess knowledge flows and innovation trends. Where possible, relevant currently collected datasets (e.g., R&D, patents, publications, employment) should be linked to each other and to geographic location by identifying information. Federal statistical agencies should explore whether public-private partnerships could produce information useful to both corporate managers and public policymakers at less cost and effort and with less burden on respondents. Labor Implications The employment and income implications of technological and industrial change have been among the most contentious economic issues in the 1990s. One debate involves the extent of job displacement by downsizing, movement of operations offshore, or other factors and the effectiveness of public policies to assist workers' adjustment and retraining. A related issue is the apparent increase in wage differences between workers at the bottom and those at the top of the income distribution. This phenomenon is probably due in part to the fact that technological changes place a premium on skilled workers and put workers with minimal basic skills at further disadvantage. This income dispersion is moderated when other measures of welfare—total compensation and household consumption—are substituted for individual wages. A third concern is that lack of an adequate, well-trained workforce may inhibit the capacity of the United States to remain prosperous and a locus of innovation. There is no doubt, in particular, about the great demand across most sectors of the U.S. economy and elsewhere for workers skilled in creating and developing information technologies. Innovation in and deployment of information technologies are straining the capacity of educational institutions and training programs to produce people with the necessary knowledge and skills to sustain this momentum. Immigration quotas have been raised, states and some firms have hastily expanded degree and training programs, and companies are paying higher premiums or accessing foreign skilled labor through foreign direct investment or telecommunications. What is not clear is whether, despite these measures, there will remain a critical shortfall between supply and demand and what if any steps should be taken to alleviate it.
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Intellectual Property Rights In advanced industrial economies where, increasingly, intellectual assets are the principal source of value, productivity, and growth, strong intellectual property rights—conferred by patents, copyrights, and penalties for misappropriation of trade secrets—are an important inducement to invention and investment. For this reason, the extension and strengthening of IPRs in the United States and elsewhere in the past 25 years were appropriate and probably necessary. It may be that in some respects those processes should proceed further. On the other hand, there is growing friction over the assertion and exercise of some IPRs and claims that in some circumstances they may be discouraging research, its communication, and use. The question arises whether in some respects IPR strengthening and extension have proceeded too far. Many enhancements of underlying IPR regimes reflect a greater professed appreciation of the incentive effects of protection on investment in R&D and use of intellectual property and appear to have had tangible results in a number of sectors, such as biotechnology and software. In recent years there has been an unprecedented surge in the overall number of U.S. patents applied for and granted to U.S. firms each year; and several major corporations, such as IBM, have made a great effort to exploit intellectual property through licensing. But these trends contrast with survey evidence suggesting that U.S. manufacturing firms in industries other than pharmaceuticals and chemicals rely more heavily on trade secrecy and lead time to recoup their R&D investments than they do on legal mechanisms such as patents and that, if anything, the effectiveness of patents as a means of appropriating R&D returns has declined since the early 1980s (Cohen et al., 1998). In short, apart from pharmaceuticals and biotechnology, the effects of IPR changes on innovation and technical advance are highly uncertain—with respect to either the incentive provided to the innovator to capture the benefits of his invention, investment, and effort and therefore invest more resources and effort in innovation or the encouragement to the inventor to provide the information to others who might improve upon it. At the same time there are concerns about the manner in which IPRs are being asserted and exercised in some circumstances. These concerns can be categorized by their potential effects: on the performance and communication of academic research concern that an international agreement favored by the European Union and the U.S. Patent and Trademark Office to extend copyrights to scientific databases will inhibit research; concern that expressed gene sequence and other biological material patents will make it prohibitively complicated and expensive to conduct research using these tools or, alternatively, expose research investigators to infringement suits; concern that allowing federal grantees to obtain patents has altered their incentives to conduct basic versus applied research;
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concern that universities', researchers', and sponsoring companies' financial interests in exploiting academic results (by IPRs and otherwise) are inhibiting open, timely scientific communication; and concern that universities' and potential industry research sponsors' inability to resolve differences over IPRs will discourage corporate support of academic research. on personnel mobility and informal technical communication between rival companies concern that enforcement of new federal trade secrecy laws, providing civil and criminal penalties for misappropriation, will have a chilling effect on mobility and informal know-how trading among firms (von Hippel, 1987). on industry investment in R&D and innovation, both radical and incremental, initial and subsequent innovation concern about the uncertainty of the scope of IPRs; concern that slow and secret patent administration processes reduce R&D incentives; concern about high litigation uncertainties and costs, both financially and in terms of the time of scientists, engineers, and managers; and concern about licensing terms barring probing the intellectual content of software or genomic material and making modifications and improvements (so-called ''decompilation'') on industry competition and structure concern about the use of patent portfolios to block competitors' entry or discourage related research; and concern about the penalties for initial innovators (e.g., business software developers) when IPR protection shifts from trade secrecy to patents. The STEP Board believes that broad reassessment of IPR policies is therefore timely. What have been the costs and benefits of the actions taken in the last several years? The unintended as well as intended consequences? What should be the direction of IPR policies in the next decade or two decades? Should there be different approaches to intellectual property protection depending on the subject matter? Long-Range Research The improved competitive performance of many of the industries examined by the STEP Board has come about in the face of reductions in industry-funded longer-range research in some sectors. The industry case studies and limited
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national data suggest that this frequent observation applies to at least some of the industries reliant on the physical and information sciences, engineering, and mathematics—electronics, software, networking, and materials processing (steel, chemicals, and metal parts). Leading corporate performers of industrial research in the 1970s—AT&T, IBM, Kodak, DuPont, and Xerox—had by the mid-1990s all downsized, redirected, and restructured their activities, particularly those concentrated in central research facilities, out of economic necessity and, in all likelihood, with near-term benefits for corporate balance sheets. The fastest-growing firms in information technology—Intel, Sun Microsystems, and Microsoft—for the most part eschewed traditional large-scale research organizations. But this pattern has not extended to pharmaceutical companies, the new biotechnology enterprises that have become profitable, or the chemical firms that have shifted emphasis to life science products. Since 1992, public investment in research as well as development has declined as a result of budget reduction pressures, but also unevenly. As a function of their dependence on agencies with changing missions and declining budgets overall—the Department of Defense (DOD), National Aeronautics and Space Administration (NASA), and the Department of Energy (DOE)—certain fields of research have borne the brunt. They include most engineering and physical science fields, especially electrical and mechanical engineering, physics, and chemistry, although apparently not computer science and materials engineering. Together, the federal government's electrical engineering research support for all performers declined 36 percent between 1993 and 1997; university research support dropped 32 percent. There is little evidence that agencies' research portfolios (e.g. the National Science Foundation's) have been adjusted to compensate for the reductions in mission agencies' spending in these fields. At the same time, research in the biological and especially the medical sciences has benefited from steady growth in the budget of the National Institutes of Health, their principal source of support. Budget projections by agency through the year 2003 show a continuation of the same trends.10 NSF data on federal spending by field of research are available only through fiscal year 1997. In most cases, the reductions began to occur in fiscal year 1993. Five years is simply too short a period to be sure that these are long-term trends. Furthermore, agency research portfolios even in the same field differ markedly in character, so that a small reduction in one agency's budget might have a qualitatively more important impact on research in the field than a larger reduction in some other agency's spending. Determining how changes in spending by an 10 See Appendix A for a detailed analysis of the impact of federal budget changes through fiscal year 1997 on major research fields related to industrial activity. These data are presented in some detail here because, surprisingly, they have not been published elsewhere although the general trends have been observed by others including the Committee on Science, Engineering, and Public Policy (1998, 1999).
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industry relate to changes in federal support of fields contributing to innovations in the industry would require a careful and detailed assessment. Despite these caveats, the downward trend in public and private investment in certain fields of research is of concern because with a lag time, overall private R&D spending tends to follow the pattern of public spending, suggesting that a downward trend is difficult to reverse; the majority of federal investment in most research fields is, appropriately, a function of particular government missions and their political support; but the productivity of a field and its long-range prospects for contributing to successful applications may be neglected in the process of allocating resources to different programs; and although there is no reason that currently constituted research fields should continue to be supported at the same or increasing levels, there is apparently no mechanism for assessing support of fields of research related to industrial activity across agencies and for making adjustments in one agency's budget to compensate for another agency's spending reductions dictated by changes in the latter's mission. The trends in several engineering and physical science disciplines are of sufficient concern to justify a selective effort to assess whether they are adverse and, if so, what steps should be taken to change them. Among the questions that need to be addressed in each assessment are the following: What kinds of research in what subfields are being negatively affected? Are investigators able to shift research sponsorship from federal agencies with declining budgets to agencies with increasing budgets? Is industry or another nonfederal source compensating for the decrease in public spending?11 To what extent do changes in support levels reflect changes in research and technological opportunities? What are the sources of support for graduate education in the field and is there a direct relationship between research funds and graduate training support? 11 For example, the nonprofit Microelectronics Advanced Research Corporation, a subsidiary of the industry-funded Semiconductor Research Corporation, is an industry-sponsored fund ($20 million in 1998) supporting long-range research at universities in technologies relevant to the semiconductor industry's technology roadmap. Its creation was motivated in part by concern about federal spending trends.
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If there is judged to be a deficiency in investment, what is the solution? The obvious answer—increased spending, greater efficiency—beg the question "how?", especially when it may not be feasible or appropriate to increase a mission agency's budget to support a particular research field. Other approaches are: Encourage inter-agency coordination. Among other forms this might take, agencies could arrange to share research facilities, avoiding duplication of infrastructure spending and maximizing limited programmatic funds. Encourage government-industry coordination. The semiconductor industry's MARCO program is an example of a private sector effort to compensate for government retrenchment. Institute a balance wheel. This might entail identifying an agency as a focal point for monitoring one or more major fields of research, assessing the need to pick up slack resulting from other agencies' mission-driven decisions, and adjust its own research portfolio accordingly. 12 Undertake high-level priority setting. OMB and the Office of Science, Technology and Economic Policy might more directly take the health of key research fields into account in issuing budget preparation instructions, conducting budget cross-cut analyses, and negotiating agencies' budget requests. CONCLUSION The STEP Board's inquiry about U.S. industrial performance was prompted by the contrast between the diagnosis in the 1980s of secular economic decline and permanent loss of competitiveness and the experience in the late 1990s of growth, profitability, and stock market acceleration. In part the earlier pessimism was a function of the narrow focus on manufacturing industries and overestimation of their foreign competition. But it is also true that underlying U.S. strengths in innovation were masked by adverse macroeconomic conditions, especially high interest rates and the high valuation of the dollar. The resurgence is therefore partly macroeconomic—the combination of steady conservative fiscal policy producing low domestic inflation, interest, and exchange rates—and partly microeconomic—the combination of diverse regulatory, trade, and research policies and the responses of U.S. firms to domestic and foreign competition, new market opportunities, and technological change. Hindsight yields cautionary lessons, however. Satisfaction with the resurgence and confidence in its sustainability run the risks of discounting the vulnerability of the macroeconomic environment and ignoring microeconomic trends 12 This is a recommendation of the Committee on Science, Engineering, and Public Policy in its recent report, Evaluating Federal Research Programs (1999).
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that may seriously undermine performance in the future. In the Board's judgment, four issues that merit attention are 1) the adequacy of measures and statistical data on research and innovation broadly defined; 2) the adequacy of human capital to sustain the resurgence; 3) the implications for research, innovation, and technology diffusion of the continued expansion of intellectual property rights protection; and 4) divergent trends in public and private investment in R&D and infrastructure. Short-term strong performance does not necessarily signify a long-term trend unless supporting institutions and policies are both strengthened and adapted. REFERENCES Arora, A., R. Landau, and N. Rosenberg, eds. (1998). Chemicals and Long-Term Growth: Insights from the Chemical Industry. New York: John Wiley & Sons. Bernard, A., and J. Jensen. (1998). Understanding the U.S. Export Boom. Working paper number 6438, (March). Cambridge, MA: National Bureau of Economic Research. Board on Science, Technology, and Economic Policy. (1994). Investing for Productivity and Prosperity. Washington, D.C.: National Academy Press. Board on Science, Technology, and Economic Policy. (1997). Borderline Case: International Tax Policy, Corporate Research and Development, and Investment. Washington, D.C.: National Academy Press. Board on Science, Technology, and Economic Policy. (1999). U.S. Industry in 2000: Studies in Competitive Performance. Washington, D.C.: National Academy Press. Bos, T. (1998). U.S. Index of Leading Indicators; Monthly SA, 1987=100. http://bos.business.uab.edu/charts/cgi-bin/charter.exe/CGI?feddal. Bresnahan, T. (1998). Computing. In U.S. Industry in 2000: Studies in Competitive Performance, D. Mowery, ed. Washington, D.C.: National Academy Press. Cohen, W., A. Gao, A. Nagata, R. Nelson, and J. Walsh. (1998). R&D spillovers: Patents and incentives to innovate in Japan and the United States. Unpublished manuscript. Committee on Science, Engineering, and Public Policy. (1999). Evaluating Federal Research Programs: Research and the Government Performance Act. Washington, D.C.: National Academy Press. Committee on Science, Engineering, and Public Policy. (1999). Observations on the President's Fiscal year 2000 Federal Science and Technology Budget. Washington, D.C.: National Academy Press. Committee on Science, Engineering, and Public Policy. (1998). Observations on the President's Fiscal year 1999 Federal Science and Technology Budget. Washington, D.C.: National Academy Press. Cooper, R., and S. Merrill, eds. (1997). Industrial Research and Innovation Indicators. Washington, D.C.: National Academy Press. Diamond v. Chakrabarty, 447 U.S. 303, 206 U.S.P.Q. 193 (1980). Dertouzos, M.L., R. Lester, and R. Solow. (1989). Made in America: The MIT Commission on Industry Productivity. Cambridge, MA: MIT Press. Eckstein, O., C. Caton, R. Brinner, and P. Duprey. (1984). DRI Report on U.S. Manufacturing Industries. New York: McGraw-Hill. Federal Reserve Bank of St. Louis. (1998). National Economic Trends. Available at http://www.stls.frb.org/publications/net. Headley, W. (1998). The Stanford Workshop on Intellectual Property and Industry-Competitive Standards: Rapporteur's report. Unpublished manuscript.
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