Investing on the Frontier: How the U.S. Can Recliam High-Tech Leadership

From
the end of World War II to the late 1970s, the United States
dominated new
technology development through massive defense spending and the
commanding lead
it accumulated during the Cold War. Now the lead is gone, the
defense dollars are
going, and, increasingly, commercial competitors define the
"state of the art."
The economic benefits that accompanied technological
hegemony-good jobs, wealth,
national well being-will be much harder to come by.

The United States can still pioneer technological development at
home and exploit
innovations that arise abroad-but only if we are willing to make
the investments
necessary to remain a leading player in global technology. In the
past, the
private sector has not accomplished that on its own, and it is
even less likely
to in an age of footloose multinational corporations.

Since World War II and even before the civilian U.S. economy has
indirectly
benefited from substantial federal funding of science and
technology, largely for
defense purposes. The record suggests that, except for a handful
of highly
visible failures where the government tried to overspecify
commercial solutions
(like the fast-breeder nuclear reactor), publicly supported
industries have paid
off handsomely in economic growth, jobs, and national prosperity.
Some of the
"winners" include the nation's leading industries in world
markets, like
electronics and aerospace. Indeed, according to a 1988 Department
of Commerce
study, five of the top six fastest growing U.S. industries from
1972 to 1988 were
sponsored or sustained, directly or indirectly, by federal
investment: computing
equipment, semiconductors, optics, imaging technologies, and
biological products.
(The only exception was lithographic services.)

Yet despite the obvious success of such investment, the debate on
public support
remains stuck on the same old question: whether the government
should be in the
game of picking winners and losers. We stand to miss a historic
opportunity
afforded by the end of the Cold War if we continue debating what
is not only
necessary but unavoidable. Rather, we should focus on how to
reallocate the
dollars that become available as defense spending winds down. The
goal should be
to invest in ways that simultaneously address pressing national
problems and
foster the commercial technological capabilities that will
sustain the American
economy into the next century.



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WHY HIGH TECHNOLOGY MATTERS

America's technological leadership has dwindled precipitously
over twelve long
years of ideological opposition to its public support. Studies
from sources as
diverse as Japan's Ministry of International Trade and Industry,
the National
Research Council, defense and nondefense agencies of the U.S.
government, the
European Community, and private-sector business groups reach the
same general
conclusions: The number of commercial technologies in which the
United States has
a clear lead over Asia and Europe has dropped sharply during the
last decade, a
clear reflection of the fact that, as a percentage of gross
national product, the
U.S. now spends about half as much developing commercial
technology as Japan and
Germany do.

Even in the aircraft industry, a major stronghold of U.S.
high-tech competence,
Europe has reached technological parity, and significant advanced
production
activities are migrating from the U.S. to Asia. This loss of
technological
position and the post-Cold War cut in public funding have
significant
implications for the long-run performance of the American
economy. Even
economists skeptical about public support to commercial
technology development
admit that technological progress fuels economic growth and that
research and
development (R&D) fuels technological progress. In fact, at least
one-quarter and
perhaps as much as one-half of the total growth rate is
attributed to advances
in technical know-how.

To paraphrase Richard Darman's smirking dismissal of high
technology, a dollar's
worth of potato chips may indeed be the equivalent of a dollar's
worth of silicon
chips for the nation's trade balance. But the two are not
equivalent for many
other determinants of economic well-being such as employment,
wages, skill
formation, productivity, investment, and research. Indeed,
ideological apologists
aside, there is emerging a bipartisan consensus that industries
can be strategic
to economic welfare in one of two ways: by providing a higher
return than the
same labor, capital, and other inputs could earn elsewhere or by
providing
spillover benefits for the rest of the economy.1

High-technology industries are strategic in both ways. They fund
a
disproportionately large amount of industrial R&D nearly 60
percent offering
innovations and skills that spill over to the economy as a whole.
These
spillovers, acknowledged by most economists to provide broad
social benefits, are
embodied in, for example, basic scientific breakthroughs with
myriad applications
as well as trained people capable of starting new enterprises.
Studies show that
as a result of spillovers of all kinds, the social returns to R&D
spending far
exceed the private returns perhaps by as much as 50 percent to
100 percent above
the return to ordinary capital.

High-tech industries also make disproportionate contributions to
the nation's
creation of high-skill, high-wage employment opportunities.
High-tech industries
account for only 18 percent of total manufacturing employment but
at least
one-third of the employment of scientists and engineers.
High-tech industries are
also high-productivity industries that pay higher compensation
than other
manufacturing industries. In 1989, the average value added per
worker in all
high-technology industries was one-third higher than the average
for all
manufacturing and two-thirds higher if only production workers
are included.


THE TECHNOLOGY STAKES

What do computers, supersonic transport, biotechnology, synfuel
plants, jet
engines and airframes, and the fast-breeder nuclear reactor have
in common? All
have received, directly or indirectly, intensive public
investment and other
kinds of public support. With the clarity of hindsight, we can
also name the
commercial winners and losers.

The winners computers, biotechnology, jet engines, and airframes
were each the
by-product of public spending for national defense and public
health, under that
old-fashioned (pre-Reagan) image of government serving the common
good. These
industries are today leading high-tech sectors of the economy and
strong sources
of comparative advantage for the nation. More often than not, the
public
contribution to their success has been discounted, forgotten, or
ignored as
politically and ideologically inconvenient to the exercise of
private power.

The losers supersonic transport, synfuels, and the fast-breeder
reactor were each
an attempt to fund directly commercial development of a specific
product with
public money. They were bigtime losers, and the public support
that nurtured them
is usually very well remembered by opponents of government
technology policy. Unlike private investors who focus on the winners, the political
debate on
government investment obsesses over the losers.

Federal support to new technology crystallized after World War II
around national
defense, nuclear energy, and, later, space exploration. The
spending model was
premised on belief that pouring the investments into science at
the front end of
the development pipelines would produce technology out the other
end. Initial
applications were developed for the military; later they would
spin off into
commercial use. In this way, U.S. defense spending promoted the
rapid development
of a host of military technologies that eventually found
widespread success in
commercial markets, including jet aircraft and engines, silicon
chips, computers
and operating systems, complex machine tools, data networks, data
compression,
optoelectronics, and advanced ceramic and composite materials.

In these cases, government underwrote the relevant basic science
research at
universities and labs, direct R&D contracts accelerated the
development of the
technology, and defense procurement at premium prices created a
strong initial
launch market. A variety of mechanisms, ranging from patent
pooling and hardware
leasing (machine-tool pools, for example) to loan guarantees for
building
production facilities, helped to lower market entry costs, to
diffuse technology
among competitors, and to set the stage for commercial market
penetration.

The government provided full-blown support in other sectors,
notably for public
health (and broadly for science research via the National Science
Foundation).
Massive government funding for biomedical research and training
research
scientists followed World War II successes in developing
penicillin and other
pharmaceuticals. Commercial winners have ranged from treatment
regimes, drugs,
and medical equipment to biotechnology.

The key to the successful cases seems to have been a development
process that met
the requirements of the commercial marketplace. Thus when the
military pushed
silicon-chip design and manufacture toward high reliability,
miniaturization,
high performance, and low costs, it was creating a trajectory
that the commercial
computer industry could ride. Similarly, when the Defense
Department turned to
the scientific community to help define the characteristics for
ARPANet, its
internal electronics communications system, it was launching a
data-networking
trajectory that would also meet that community's commercial
needs.

In that sense, the U.S. government's direct R&D sponsorship has
probably been
less important for commercial success than its procurement and
indirect support,
since the latter policies acted to diffuse the fledgling
technologies into
widespread use. It is important to note that this strategy of
public support was
not a simple stepchild of the technological successes of World
War II. For
example, government support to aeronautics predates the war,
beginning in earnest
with the creation of NASA's precursor, the National Advisory
Commission on Aeronautics, which was a vital source of the R&D
and testing during
the 1920s and
1930s that led to the modern passenger airliner. Of course, that
was in the days
when we were still willing to be public risk-takers, before the
ideological
purity set in when government acted rather than believed it
shouldn't.

In fact, some of the grandest and most successful experiments in
public support
to commercial technology occurred back then. RCA, a consortium
among the Navy and
several corporations, including General Electric and United
Fruit, grew out of
Woodrow Wilson's concern about Britain's dominance of radio
technology. But
arguably the most successful program of public support to
commercial innovation
is the Agriculture Research and Extension System. Dating from the
Morrill Act in
1862, the still-evolving system comprised of land-grant colleges,
state
experimental stations, and other federal and local instistutions
has provided
education and training, long-term R&D, and new technologies to
America's farms.
Although not without controversy (its neglect of organic farming
methods, for
example), it is still widely credited with a major role in making
American
agriculture the world's most productive.

While
such successes are suggestive, there is as much to learn from
the failures.
The defense-energy-space nexus provides robust examples that
range from outright
flops like the supersonic transport (SST), synfuel plants, and
the fast-breeder
reactor, to more complex and ambiguous cases like the development
of numerical
control for machine tools, the Space Shuttle, or photovoltaics.
The Air Force,
for example, sponsored the development of numerical control
technology for
machine tools to build advanced aircraft. But the programming
language proved too
complex for general commercial use; diffusion was slow and
civilian application
costly. The resulting development path produced a commercially
vulnerable U.S.
industry that was squeezed by Japanese competitors from the
cheaper end of the
market and German firms from the more expensive end.

Similarly, the more visible failures moved down technology
trajectories that were
commercially unacceptable for a variety of reasons. The
commercial airliner
market was aiming at short-haul and wide-body planes rather than
supersonic
speeds. The fast-breeder nuclear reactor and synfuel programs
were much more
expensive than commercial alternatives, particularly after the
oil shocks abated.
In each case, developers construed performance objectives too
narrowly and failed
to explore alternative technological paths. Demonstrations and
pilots proceeded
despite experimental evidence of failure. In other cases, like
photovoltaics,
political considerations killed development prematurely.

In short, public support for technology runs into trouble when it
proceeds down
development paths that diverge from commercial market
requirements, particularly
when it overspecifies an exotic technical solution in the form of
a particular
product. (Even in those cases, however, there are likely to be
important
technical spillovers, especially when the program funds generic
research.) Those
requirements including manufacturability and customer-defined
cost and
performance standards should not be hard to build into future
programs,
particularly if a peer-review model is adapted to include
potential commercial
producers and users.


MARKET IMPERFECTIONS

Though history shows that public investment in commericial
technology can pay
off, the question remains: Why can't the private market provide
the necessary
support? There are two kinds of answers.

First, several so-called imperfections underlie the market's
failure to invest
adequately. Innovators cannot appropriate all of the returns on
their investment.
Often, they cannot foresee sufficient returns to justify proposed
R&D.
Conversely, because of strong intellectual property protection,
firms often
engage in redundant R&D. The combined effect on the system as a
whole is
overinvestment in some technologies and underinvestment in
others.

Second, innovation is contingent on the decisions and actions of
many
groups developers, producers, and users and thus unpredictable.
Different firms
evaluate risks differently, apply different capabilities to their
technological
effort, receive different signals from their customers, and go
down different
development paths. That is how Sony and JVC/Philips developed two
quite distinct
formats, Betamax and VHS, for the VCR, and why there are at least
thirty
industrial approaches to making flat, high-resolution computer
displays.

In essence, technology development is a "path-dependent" process:
where you end
up depends on where you start and want to go. Technical progress
involves
insights that materialize only through experience in development,
production, and
use. Rather than being preordained by scientific logic, then,
technology
development is contingent.

Contingency means that some firms will go down the wrong path,
betting on, for
example, dedicated word processors rather than personal
computers. Others will
start down the right path, misevaluate the potential, and abandon
the effort.
Consider Xerox's famous Palo Alto Research Center, which
pioneered many
innovations in desktop computing, including workstations, icons
for user
interface, and the ubiquitous "mouse" pointing device. Yet other
companies, not
Xerox, successfully exploited these innovations, just as Japanese
firms
successfully commercialized the U.S.-developed technologies
underlying VCRs,
camcorders, and miniature flat displays.

Contingency also means that neither innovators nor the private
capital markets
that fund them are fully capable of evaluating the risks
involved. Some bets will
pay off big; some not at all. There will always and must always
be winners and
losers, but they can only be identified in retrospect.

This is as true for private as well as public investment. For
every Macintosh,
there are several Lisa's (an early flop from Apple). For every
IBM, there are
several GE's and Westinghouses whose technological bets on
mainframe computers
failed to pay off. For every Intel, there are assorted,
now-defunct Molectros and
Qualidynes. For every winner in a venture portfolio, there are
untold losers that
get nowhere near the publicity.

There is absolutely no evidence beyond the economist's leap of
faith that private
investment is any more capable than public investment of
separating the winners
from the losers before the fact. (The major difference, of
course, is that
private losers exit the market, while publicly backed losers are
held to the
higher standard of wasting taxpayers' money.) And as Princeton
economist Gene
Grossman argues, the magnitude of the potential social gains from
public spending
are sufficiently large to provide a comfortable margin for error
in choosing
among technologies to back. Thus picking winners and losers is
the wrong metaphor
to characterize the socially useful and necessary activity of
government in
supporting that process. Innovation is a gamble. But through
public spending,
government is actually placing bets to ensure there will be at
least some winners
for our collective future.


THE INEVITABILITY OF PUBLIC SUPPORT

There are a range of social needs from national defense to
infrastructure provi

sion that private investors simply will not effectively support
because the risk
is too high, the payoff too small, or the market too unsuitable.
As it goes about
providing for these common needs, the government becomes a
significant consumer
of technology in its own right. Like any other large customer and
lead user, the
government must pay to get the technology it needs. Very often
that means
sponsoring research and procurement that launch new industrial
capabilities. As
we have seen, such sponsorship and procurement often pay off
indirectly in the
development of commercially successful technology.

New technologies and industries tend to develop in a particular
location Silicon
Valley, for example. Such regional patterns are evidence of what
economists call
"local externalities." These externalities can take several
forms, including the
availability of a specialized pool of labor, specialized supplier
networks, and
a common knowledge pool through which firms can learn from each
other. Local
externalities tend to have a self-reinforcing effect regions or
nations that have
a strong presence in a particular industry tend to generate the
specialized
inputs and informational networks that in turn make the industry
even more
competitive over time.

Although local externalities are not unique to high-technology
industries, they
have special relevance for them. Recall that technology
development paths are
strongly characterized by learning. Some such knowledge is
footloose, that is,
embodied in products, blueprints, or open technical forums like
published
journals. Other knowledge is, however, developed only in
conjunction with
development and production. That kind of knowledge accumulates in
the specialized
local assets like labor pools and supplier networks. It is
embodied in them and
does not diffuse easily.

When Apple goes to Sony to develop the portable Mac Powerbook,
when Compaq goes
to Citizen for the LTE notebook, when IBM moves microsystem
development out of
the U.S. to Japan, these American companies are seeking access to
precisely such
specialized local Japanese assets in this case, embodying
know-how in components
and microsystems design and integration. Such local capabilities
are the probable
basis for product differentiation and new technology generation.
They help to
attract footloose technological know-how from overseas and to
exploit it
domestically. In other words, technological progress is
intimately bound with
local capabilities. Unless these capabilities exist, an economy
has no enduring
potential for operating at the technological frontier, with all
that implies for
maintaining national well-being.

Not
surprisingly, other industrial nations have recognized this
aspect of
technological advance. They know that if they organize their
economic systems
appropriately and underpin them with an aggressive mix of trade
and industrial
policies, they stand a fair chance of having the economic
benefits of high
technology accrue locally rather than abroad. This was the case
with Japan's
coordinated effort to dominate microelectronics and with Europe's
Airbus
consortium. Taiwan's proposed stake in McDonnell Douglas in
return for
transferring 60 percent of subcontracted production activities to
Taiwan is only
the most visible example of this common practice abroad.

Whether through intention or effect, the local and national
concentration of
technological benefits means that high-tech competition can take
on an inherently
beggar-thy-neighbor cast. A bigger national share of global
high-tech output can
mean a bigger national share of good jobs and greater economic
prosperity. That
is why technology-intensive industries are the source of growing
trade friction
between the U.S. and its competitors. As high-tech industries
have become
steadily more important to the economic performance of the
developed countries,
those countries commit to maintaining a local high-technology
production base by
leveraging both policies and structural differences in national
economies (for
example, the difficulty of Japanese market access).

Absent U.S. government support to domestic technology, national
economic systems
will interact in ways that tend to redistribute advanced
technological activities
and their benefits from the U.S. to other countries. We will pay
a huge price
(measured in loss of high-paying jobs, a contracting tax base,
declining local
communities, and slower economic growth). We will end up poorer.
And it matters
not at all whether this outcome is intended or simply the effect
of competition
between differently organized political economies.

The adjustment problems that follow for the U.S. make government
support to
commercial technology inevitable. Such support can be reactive
later at great
cost. Or it can be proactive now, aiming to nurture what we know
and extend it
in ways that address collective needs. If the government must
act, how should it
act to maximize the likelihood of a positive payback?


THE PAYOFF

A decade ago, in their book Government and Technological
Progress
, the
economist Richard Nelson and his colleagues provided three
recommendations for
public support to innovation that still hold.

One is to associate government R&D support with procurement or
other well-defined
public objectives. A second is to define and fund arenas of
nonproprietary
research and allow the appropriate scientific community to guide
R&D allocation.
The third is to develop mechanisms whereby potential users guide
the allocation
of applied research and development funds.

Just three additional points need to be added to those simple
guidelines.

First, any "well-defined public objective" ought to have two
characteristics. It
should be an area of clear common need for national well-being,
and where
possible, addressing that need should remove an obvious
constraint on future
prospects for long-term economic growth.

Second, when funding moves from generic, nonproprietary R&D
toward applications,
four conditions should prevail: research should pursue
alternative technological
approaches until the best development path is demonstrated;
wherever possible,
development must incorporate commercial criteria, such as cost,
performance, and
manufacturability; within those constraints, leading-edge
innovation should take
precedence over low-tech solutions to promote high-tech
capabilities, which pay
higher wages; any resulting technology should first be
commercially exploited in
the U.S. to ensure that the competencies and production
activities accrue
locally. (After all, if the government is paying the bill, it is
entitled to
domestic production, even in an age of multinationals.)

Third, and perhaps most important, public support should actively
pursue
diffusion of new technologies into widespread commercial use
within the domestic
economy. Aside from the emphasis on commercial market criteria
during application
development, there are four ways to accomplish this. One is
through incentives
like investment tax credits or leasing arrangements tailored to
encourage early
adopters. A second is through education and training. Many of the
industries
successfully launched through public sponsorship drew from a
labor pool trained
in the new technologies through federal support. In effect, a
supply of new
skills shaped demand to fit its characteristics, rather than the
reverse.

A third way to accomplish diffusion is by embedding new
technologies in public
infrastructure wherever possible, thereby making their benefits
universally
accessible. A fourth way is to adapt the agriculture extension
model to industry.
The aim would be to assist the small and medium-sized businesses
that underpin
local and regional economies in effectively adopting new
technologies and methods
of production. There is already an elaborate network of state
agencies that play
this kind of role, often in conjunction with local educational
institutions
attuned to the needs of local business. Minimal federal funding
could help build
this network into an effective national industrial extension
service and link it
to publicly sponsored innovation.

With only marginal effort, these guidelines could be applied to
existing federal
support of science and technology. But we can go further. Let's
imagine redirecting several billion dollars from defense
to new commercial
technology
development. Using existing work on critical technologies as a
point of
departure, the Office of Science and Technology Policy (or
perhaps the National
Security Council) would invest one-third of the total on
nonproprietary research
in the sciences underlying the critical technologies, subject to
review by the
NSF or the National Academies.

Another one-third would be directed to diffusion, via incentives,
training,
infrastructure, and extension. This spending would focus on
existing technologies
like those for flexible manufacturing. This funding could also
help move critical
technologies out of the lab and into manufacture. For example,
demonstration
products might be funded or loan guarantees provided for building
volume
production facilities where private capital markets were known to
balk.

The last third would go toward specific nondefense public
objectives, where
investment is likely to remove constraints on future economic
performance. Guided
by both technological and commercial market considerations, the
resulting
technologies should be capable of broad and rapid diffusion into
the economy. As
serious candidates, consider the following:

The Environment. No matter how much they are opposed by
industry, global
requirements for ever more stringent environmental cleanliness
will not be
moderated. But neither are consumers likely to adjust their
demand for jobs and
goods according to what is environmentally sustainable with
today's technologies.
These environmental and economic needs can be treated as
antithetical, the
position President Bush advanced at the Rio Summit in July.
Perhaps ultimately
they are. But it is surely an appropriate public responsibility
to explore
whether they can be reconciled.

There are several opportunities that go beyond conventional
programs in waste
reduction, cleanup, and recycling. The effort should be directed
to replacing
existing industrial production with technologies that generate no
waste or
pollution in the first place. If American's manufacturing stock
can be rebuilt
around clean production technologies, the economic possibilities
for the next
century are wide open. New U.S. industries to supply the
technologies would
develop, while established industries that adopted the
technologies would have
a strong new source of competitive advantage in environmentally
sensitive world
markets.

Energy and Natural Resources. Almost across the board,
American industries
are among the least energy- and resource-efficient producers in
the industrial
world. If there is motivation to develop the appropriate
technologies, dramatic
resource efficiencies are possible, as Silicon Valley firms
discovered when they
reduced their water usage during the last six years of drought.

A good beginning would be to study the energy and resource use of
major
industries like electronics and to evaluate resource-efficient
technologies
already used abroad. Both tasks are ideally suited to the
national laboratories.
Once opportunities for improvement are identified, competitive
contracts could
be offered to develop the necessary technologies, and investment
incentives could

promote rapid adoption. Again, new technologies to help sustain
resources and
enable efficient use would spin off entirely new industries while
boosting the
competitive position of existing ones.

Infrastructure. There is widespread agreement that much of
the nation's
networks for transportation, power, sewage, water, and
communications are eroding
and need to be rebuilt. Anyone who has operated a business where
the
infrastructure is lousy say, the phone networks in Eastern Europe
knows the
damage it wreaks on efficiency. Providing modern infrastructure
would stimulate
not only productivity but also innovations, from low-maintenance
structural
concretes to optical networks, to take advantage of the new
infrastructure.

The additional opportunity here would be to fashion new
infrastructure that uses
emerging critical technologies of the next century new materials,
visual systems
with flat-panel displays, real-time electronic controls and then
to support the
development of commercial, domestic capabilities in them through
nationwide
procurement.

With military spending and the resulting technological and
economic benefits it
generates declining, these long-term needs are likely to provide
the next
frontiers of American technological innovation. More than
technological
preeminence is at stake. Historically high growth rates,
competitive wages, and
a growing standard of living all depend on regaining leadership
in commercial
technological innovation. For twelve debilitating years, the
government has
refused to invest in America's commercial technology position.
It's high time to
revive public support and set it to the task.



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