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Journal of Applied Research in Economic Development
Published by: The Council for Community and Economic Research Feb. 2011 Volume 8, Issue 2
The Federal Role in Encouraging
Innovation: The "I's" Have It
By: Andrew Reamer
Previously published at:
http://www.innovationpolicy.org/the-federal-role-in-encouraging-innovation-th
on the Innovation Policy Blog (http://www.innovationpolicy.org/), December 17, 2010.
--------------------------------------------------Last week, in a well-reported address, New York Mayor Michael
Bloomberg made an impassioned argument that stimulating innovation is an
essential federal economic role around which Democrats and Republicans
can and should find common ground. Bloomberg called innovation
“capitalism’s most powerful force” and said “Unless we innovate, we cannot
hope to succeed. And if we do innovate, there is no way we can fail.”
The mayor then laid out six steps towards creating an innovation-based
economy: instill confidence, promote trade, reform regulations, cut business
taxes, invest in job training, and fix immigration.
I’m one with the mayor regarding the importance of innovation and the
need and opportunity for bipartisan fashioning of a federal role to encourage
it. While I agree in general with his six bullet points, I think the “how” of a
federal effort requires several more elements. Moreover, it’s important to
understand how the various elements connect with one another.
Riffing off of the key term “innovation,” each of the elements begins
with the letter “I,” so I’ll call the framework the “I formation.” Here’s the
framework, the explanation follows.
Innovation
Institutions Individuals
Investment
Information
Incentives
International Markets Immigration
Intelligent Government
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Let’s take them row by row. Innovation is the end—this being the ITIF
weblog, we’ll take its value as understood.
Economically beneficial innovations—product and process, technical and
organizational—are developed by our society’s institutions—such as large
firms, startups, colleges, local governments—through the work of
individuals, both inside these institutions and the self-employed.
What factors enhance the capacity of institutions and individuals to
innovate? I suggest that they are investment, information, and incentives.
Adequate investment in developing individuals’ skills, abilities, and
knowledge is critical. So is sufficient investment in the wide array of efforts
that support or enable innovation, such as new business development, R&D
programs, product commercialization, machinery and equipment, and
transportation infrastructure.
The many millions of individuals and institutions in the U.S. need access
to current, accurate information to make good decisions about, for example,
what careers to enter, if you are an individual; what degree programs to offer,
if you are a community college; and where to locate operations, if you are a
company.
Individuals and institutions also need the proper incentives to be
innovative, incentives provided by the marketplace (e.g., to make profits), by
the organizations in which individuals work (e.g., to get a promotion and
recognition), and by the government regulations and tax structure (e.g., to
invest in R&D).
In the last 30 years, the boundaries of the U.S. economy have become
quite porous in terms of the movement of goods, services, and people. As
one result, the health of the U.S. economy is very much a function of its
competitiveness in international markets and that in turn depends on its
ability to innovate. Moreover, U.S. innovation increasingly relies on our
capacity to build on the inventions and inputs available beyond our shores.
The nation’s remarkable attraction to immigrants presents its own
opportunities and challenges. The opportunities lie in bringing technically
talented individuals to our universities and firms and keeping them here. The
challenges are in building the knowledge, skills, and abilities of millions of
poorly educated immigrants so that the capacities of the nation’s human
capital base to create and compete do not erode.
Markets are a remarkable human innovation, a powerful means for
determining investments, information, and incentives in an international
context. However, markets have failures—tears, holes, and bloats that
misallocate resources to society’s detriment. A key federal government role is
to address these failures so that markets can work better. To bring Mayor
Bloomberg back to the conversation: “Government is not an innocent
The Federal Role in Encouraging Innovation: The "I's" Have It
Journal of Applied Research in Economic Development,
February
2011 Volume
8, Issue
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in Economic
Development,
2011 Vol. 8, No. 1
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bystander in the marketplace, and it should not pretend to be. In the face of
the current economic weakness, government must act: decisively, responsibly
and immediately.” To which I’ll add another adverb: intelligently.
Economic theory says there are four kinds of market failures for the
government to address—inadequate information (buyers and sellers need full
information to make good decisions), externalities (when the full costs or
benefits in production or consumption of a product or service aren’t
reflected in pricing, e.g., the societal benefits of innovation), public goods
(e.g., information is underproduced because it stays whole after being
consumed and is readily available to anyone, so it’s hard to make a profit),
and monopolies (which misallocate consumer resources by setting high
prices).
The federal government has five types of tools at its disposal to address
market failures—money (e.g., tax rates and credits, grants), regulations (e.g.,
patent laws), information (e.g., data on industry, occupation, and educational
attainment by county), facilitation (catalyzing relationships among potential
collaborators), and procurement (stimulating market demand for socially
valuable goods by taking advantage of economies of scale to reduce costs per
unit).
Which leads back to the “I formation”—the government has an essential
role in seeing that institutions and individuals have the investment,
information, and incentives they need to be innovative in an international
economy. And the government needs to be smart about how it carries out
that role.
The first step in being smart is to explicitly acknowledge that significant
innovation-inhibiting market failures exist. The second step is to identify the
nature of these market failures and the appropriate array of policy tools to
address them. For many reasons, including the current budget and deficit
environment, money and regulation should be instruments of last, not first,
resort—money because by definition it is expensive and regulations because
they are difficult to get right and susceptible to unintended consequences.
Information and facilitation, on the other hand, are incredibly cheap and
offer almost infinite return on taxpayer investment. (Think for instance,
about the utility of the Gross Domestic Product measure in guiding the
operation of our $14 trillion economy and the consequences if that measure
didn’t exist. The program that produces GDP cost $33 million in 2010, less
than two years of salary that the Philadelphia Phillies just announced it will
give to pitcher Cliff Lee.)
The third step is organizing federal policy tools into a thoughtful
innovation-based competitiveness strategy that sets goals and determines
how to apply a particular set of tools to achieve them.
That’s what an intelligent government would do. Sadly, over the past 30
years, ours hasn’t been that intelligent. Two impediments make that difficult.
The Federal Role in Encouraging Innovation: The "I's" Have It
Journal of Applied Research in Economic Development,
February
2011 Volume
8, Issue
2
Journal of Applied
Research
in Economic
Development,
2011 Vol. 8, No. 1
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The first is that we don’t have a federal structure for creating and
implementing a sound competitiveness strategy. Our primary economic
policy institutions—the Federal Reserve, the Treasury Department, the
Council of Economic Advisers, OMB—focus on using fiscal and monetary
policy to manage the business cycle. The current policy arrangement came
into being with the Employment Act of 1946, which sought to ensure that
the nation would not experience another Great Depression. In the
hegemonic, oligopolistic, relatively isolated economy of the time, the
competitive and innovative capabilities of U.S. firms were not a concern.
Efforts to support innovation took place outside of economic policy, e.g.,
creating the National Science Foundation
While current policy structure was an appropriate, innovative approach
to mid-20th century conditions, times have changed, dramatically. Since the
1970s, our economy has experienced increasing structural vulnerabilities
which have led to loss of economic competitiveness and economic
dislocations. However, a policy-making structure to coherently address the
new realities of global competition hasn’t followed.
Rather, the government has either ignored problems—assuming no
market failures and American exceptionalism—or created an idiosyncratic, ad
hoc, mish mash of grant programs and regulatory efforts—in education,
workforce development, technology development, economic development,
and financial markets, for example—of varying effectiveness and minimal
synergies. In contrast, many foreign nations and U.S. states and regions have
sought to create a set of inter-related policies within a coherent strategy. But
it is difficult for state and regional competitiveness strategies to be fully
effective in the absence of a federal one.
The second impediment to intelligent government is an outdated view of
how the world works. Federal economic policy is based on the Keynesian
notion that the economy is like a machine that can be operated through the
adroit use of the levers of fiscal and monetary policy and appropriate
regulations. Our economic policy agencies grew up in a world that saw the
value of size and scale and believed in the possibility of central control of
enormous resources to address major challenges. Macroeconomic policy
emerged as a form of “social engineering” consistent with the physical
engineering and industrial models that made America an economic giant—
think the Hoover Dam and Ford Motor Company—in the first half of the
20th century.
Once America became wealthy and stable enough in the 1960s to
concern itself with economic equity, the government again used the “top
down” engineering approach to design Great Society grant programs and
many such programs since. For instance, the Economic Development
Administration’s Public Works Program was built on a mechanical, formulaic
model—using precise criteria and equations to allocate funds to distressed
The Federal Role in Encouraging Innovation: The "I's" Have It
Journal of Applied Research in Economic Development,
February
2011 Volume
8, Issue
2
Journal of Applied
Research
in Economic
Development,
2011 Vol. 8, No. 1
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regions for missing physical inputs, typically roads and industrial parks, which
were expected to enable economic prosperity.
The 21st century economic world, however, cannot be managed like a
machine—it is full of complexity, uncertainty, and the unseen forces behind
the daily decisions of hundreds of millions of U.S. market actors in the
context of billions around the globe. Innovation is a very serendipitous
process; insights emerge from determination, relationships, and chance.
Moreover, technological innovations now allow institutions and individuals
to grow, change, move, and morph in ways never before possible. If the mid20th century economy seemed to operate on the principles of machine-like
Newtonian physics, the 21st century one looks like it runs on the principles
of quantum physics.
So while the “top down” approach to macroeconomic policy is
appropriate, it is inadequate for innovation-stimulating efforts—there is no
machine or formula for generating creativity. Rather, to a large extent, the
government’s effort needs to be “bottom up,” increasing the probabilities
that successful innovations emerge by providing investments, information,
and incentives that can nudge the behavior of millions of market actors in
productive directions.
There are many examples of such “bottom up” policies—small grants to
catalyze regional innovation cluster initiatives; capital gap-filling investments
and appropriate regulations that encourage private sector financing of
emerging companies; R&D tax credits; and data on occupational demand to
allow informed career decisions.
An intelligent government that can design and operate such programs as
part of an overall competitiveness strategy requires a capacities different than
those often found in government, capacities consistent with the type of
innovative firms the nation needs (as Great Society program management
skills mirrored the “command and control” skills found in bureaucratic
corporations). These capacities include creativity, risk-taking, patience,
relationship-building, and technical assistance.
Ultimately, in an unrelentingly competitive world, an innovative U.S.
economy requires intelligent government that drives the connections among
the “I’s” and leads the nation to economic strength.
Mayor Bloomberg framed his speech around the idea that a thoughtful
package of federal policies to stimulate innovation “can be embraced by
those across the political spectrum.” The notion of a government role to
improve the ability of markets to generate innovation draws on key tenets of
the Republican and Democratic parties. Politically, the opportunity exists for
bipartisan recognition that the “I’s” hold the answer to the nation’s
economic future. The need is for cooperative action to translate recognition
into meaningful policy.
The Federal Role in Encouraging Innovation: The "I's" Have It
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February
2011 Volume
8, Issue
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in Economic
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2011 Vol. 8, No. 1
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[In an exquisite bit of timing, the Senate today unanimously approved an
amended version of the House-passed reauthorization of the America
COMPETES Act, focusing "on three primary areas of importance to
improving American innovation and competitiveness: (1) increase science
and research investments, (2) strengthen STEM education, and (3) develop
research infrastructure."
Consistent with a key point of the blog, the Senate bill adds language
directing the Secretary of Commerce to complete "a comprehensive study of
the economic competitiveness and innovative capacity of the United States"
within a year of the bill's passage and, within a year after the study, "develop,
based on the study . . . , a national 10-year strategy to strengthen the
innovative and competitive capacity of the Federal Government, State and
local governments, United States institutions of higher education, and the
private sector of the United States." The requirements of the study and
strategy are detailed in seven pages of text. The text calling for a study and
strategy came fully from a bill proposed by Senator Warner this summer.
The bill authorizes several "bottom up," relationship-building programs,
including Regional Innovation and Partnerships for Innovation.
The bill also creates a number of new organizational entities, including,
within the Commerce Department, a new Under Secretary for Standards and
Technology and a new Office of Innovation and Entrepreneurship; within
NSF, a new Center for Science and Engineering Statistics; and within the
National Science and Technology Council, subgroups to coordinate STEM
education efforts, advanced manufacturing research, and policies on the
dissemination and stewardship of federally-funded science research.
So here we have bipartisan approval of a restructuring and rationalization
of federal innovation efforts and the creation of a competitiveness strategy.
While I'll reserve judgement on the Senate's specifics until I look at them
more closely (the bill is less ambitious than the House version), it's an
interesting experience to propose a major policy recommendation and read
that a form of it was agreed on a moment later. Here is hoping the House
can take up and approve the bill before adjournment. Note: House approval
in in May was not nearly as bipartisan as in the Senate--all Democrats but
only 17 Republicans voted in favor.]
The Federal Role in Encouraging Innovation: The "I's" Have It
Journal of Applied Research in Economic Development,
February
2011 Volume
8, Issue
2
Journal of Applied
Research
in Economic
Development,
2011 Vol. 8, No. 1
6