Strategy for American Innovation: Introduction
“For in a global economy, the key to our prosperity will never be to compete by paying our workers less or building cheaper, lower-quality products. That's not our advantage. The key to our success – as it has always been – will be to compete by developing new products, by generating new industries, by maintaining our role as the world’s engine of scientific discovery and technological innovation. It’s absolutely essential to our future.”
- President Barack Obama, November 17, 2010
Innovation is essential to winning the future through long-term growth and competitiveness
The history of the American economy is one of enormous progress associated with remarkable innovation. Two hundred years ago, real income per person in America averaged four percent of what it is today, the average American lived for forty years, and thirty percent of children did not survive until their fifth birthday.  Electric power, automobiles, and telephones were hardly imagined, let alone computers and air travel. There were no antibiotics or vaccines – and no understanding that germs cause disease. The word “scientist” had not yet been coined. But researchers like Isaac Newton had begun uncovering fundamental scientific foundations that would underpin two centuries of practical inventions. The U.S. Constitution empowered Congress to create effective intellectual property rights – helping add “the fuel of interest to the fire of genius,” in President Lincoln’s words. Americans later seized on the Industrial Revolution – an explosion of innovation – propelling a young country with democratic ideals to unprecedented economic heights and providing a powerful example for other nations to follow. In short, innovation is ultimately tied to America’s well-being and to our conception of the essential “American character.”
Innovation – the process by which individuals and organizations generate new ideas and put them into practice – is the foundation of American economic growth and national competitiveness. Economic growth in advanced economies like the United States is driven by the creation of new and better ways of producing goods and services, a process that triggers new and productive investments. That innovation is the cornerstone of economic growth can be seen in the advance of our national industries. Entire industries were made possible only by developing and commercializing new ideas, from the 19th century advances in railways and steam power, to the later revolution of electrification and the associated development of light bulbs, radios, televisions, electric refrigeration, and air conditioners, to the modern semiconductor, computer, and biotechnology industries. These innovative sectors have consistently raised the output of our workforce, creating better-paying jobs, raising our national standard of living, and enhancing our economic strength vis-à-vis other nations. Innovation can take many forms: a new machine that improves quality and production time in factories; a new consumer electronic device or Internet-enabled application that keeps us connected with coworkers and family; a new way of organizing the workplace that increases our productivity; or a new vaccine that protects our citizens from disease.
Since the 1940s, the United States has led the world in creating new industries and ways of doing business, establishing itself as the global innovation leader. But America cannot rest on its laurels. Unfortunately, there are disturbing signs that America’s innovative performance slipped substantially during the past decade. Across a range of innovation metrics – including growth in corporate and government R&D, the number of scientific and technical degrees and workers, access to venture capital, and the creation of new firms – our nation has fallen in global innovation-ranked competitiveness. Other nations recognize that innovation is the key to long-term economic growth and are making pro-innovation investments and adopting pro-innovation policies. Without thoughtful, decisive, and targeted actions, we cannot expect that the industries of the future will emerge and prosper in the United States.
Recognizing the central role of innovation in economic growth, the Administration’s Innovation Strategy announced in 2009 emphasized several of these disturbing trends and called for renewed and enhanced investment in innovation. These efforts were substantially supported by historic investments in the Recovery Act and included large expansions in fundamental research through agencies such as the National Science Foundation, the Department of Energy’s Office of Science, and the National Institutes of Health, accelerating fundamental breakthroughs at the beginning of the innovation pipeline. Now we must build on these efforts and ensure that the private sector can be as innovative as possible so that American workers and businesses will continue to lead the world economy in the decades ahead. New initiatives will free up wireless spectrum that will facilitate private sector investment and innovation, improve the patent system, train workers for quality jobs, catalyze the private sector to meet national priorities like clean energy, and foster the entrepreneurial spirit that has always driven this country to greater heights. This Strategy for American Innovation discusses these new points of emphasis and places them within the broader framework of the Administration’s innovation policy.
Americans have always seen themselves as experimenters and risk-takers. Now we must – at every level of society – encourage this pioneering spirit. In the 1800s, when farmers and blacksmiths took hammers to plows and harnesses, America was described as a “nation of tinkerers.” In the 21st Century, continued economic growth depends on us being a “nation of innovators” – a nation that generates the best and brightest ideas and sees that these ideas spread through our workforce. The American people will do best when their inventive, entrepreneurial spirit is unleashed. Government policy must nurture that spirit and ensure it is not deterred.
The private sector is America’s innovation engine
America’s entrepreneurs and industrial research laboratories have long produced a cascade of important innovations, from agricultural technologies to Edison’s light bulb to Bell Labs’ transistor, from General Electric’s jet engines to Google’s Internet tools. Innovation is not limited to new products but extends to new organizational models. Henry Ford’s assembly line brought affordable automobiles to Americans while bringing higher employment and wages to the car industry. Dell Computer and Amazon.com similarly developed new sales models, harnessing the Internet to bring new, competitively-priced choices to a wider array of consumers.
America’s businesses, with close knowledge and acute awareness of the costs and opportunities across our market system, are well positioned to tap the ingenuity of our workforce to solve specific challenges and cultivate new ideas in the crucible of competition. In so doing, they can perceive and generate commercially valuable ideas. And a new idea is just the starting point, because our market system, through its competitive pressures, also works to test these ideas and spread the best ones. Innovation is the entire process through which an invention is successfully put into practice and widely diffused, generating increased labor productivity for workers, profits for suppliers, and benefits to adopters and consumers.
By demonstrating how ideas can be commercialized, businesses also drive other firms to innovate, allowing organizations with different technical capacities and market insights to take the next steps. In fact, most innovation does not stand alone but complements other innovations. For example, while Apple Computer founders Steve Jobs and Steve Wozniak envisioned a mass market for a more user-friendly personal computer, it took many years and many other contributions – including improvements in software, microprocessors, monitors, memory chips, batteries, and communications technology – before the personal computer industry reached critical mass. And these complementary technologies were themselves innovations, collectively providing jobs in engineering, manufacturing, distribution, and sales, while delivering significant consumer benefits.
The American economy is built on an enduring capacity for idea creation and diffusion. Competitive markets provide strong incentives for private businesses to improve their products and operations and for capital and labor resources to be reinvested in our best ideas. The inherent uncertainty of innovation means that important breakthroughs may come from many quarters – often unexpectedly – and our decentralized markets facilitate the generation of these new possibilities. By continually reinventing itself, the private sector is the engine of innovation that brings greater prosperity to Americans.
Box 1: Social Gains from Innovation
The social gains from innovations typically greatly exceed the private return. For example, the inventions of the telephone, transistor, light bulb, dishwasher, laser, CT scan, web browser, and antibiotics have all had enormous, broad, and ongoing social benefits far in excess of any commercial profits enjoyed by the original creators. General estimates suggest that the private profits from an innovation typically account for a tiny fraction – a few percent – of the social value.
Private firms do not capture the full gains of their innovations for three essential reasons. First, users will only pay for the innovation if its benefits exceed its price. These consumer benefits – the “consumer surplus” – mean that much of the innovation’s value will immediately accrue to users. Second, the innovative business will face pressures to lower prices as other businesses imitate and improve upon the successful innovation, which shortens the profit stream of the original product; indeed, the firm that initially introduces a new innovation may not even be the one that succeeds in the marketplace. Moreover, once any intellectual property rights (the patent or copyright) expire, competitive pressures will further drive down prices and limit private profits, transferring the innovation’s value even more fully to the consumer. Finally, a successful innovation often launches hosts of additional innovations by other firms, the benefits of which are not captured by the original innovator.
With the limited scope for sustained profits in the private sector, the benefits of innovation accrue widely. Ultimately, innovation benefits society at large in the form of rising standards of living. Real incomes rise, with Americans producing more output per hour and earning more income per hour, allowing us to consume new and improved products and live longer lives.
Government as innovation facilitator
Given the central importance of innovative activity to our economic growth, the public interest in sustaining innovation is clear. The key follow-on question is whether markets alone can provide sufficient incentives for such investments. The standard lesson from economics, and history, is that an innovation-friendly environment requires public support on specific dimensions. The appropriate role for government can be understood by clarifying the precise circumstances where markets, despite their many strengths, will not produce a sufficient stream of innovations on their own. Thus, the true choice in innovation policy is not starkly between government management and no government involvement, but rather choosing the right role for government in supporting private sector innovation.
One central “market failure” is in the field of basic scientific research. Basic research typically does not have direct commercial payoffs. Yet breakthroughs in basic research underpin downstream, commercial ideas, which can bring enormous economic benefits. For example, engineering builds on Newton’s laws of motion, the biotechnology industry builds on Watson and Crick’s discovery of the structure of DNA, and the dot.com industry builds on government and university development of the Internet. Because basic science has little if any immediate commercial return, its costs are typically not easily undertaken by private investors, thus leaving government funding as a critical source of support.
Other “market failures” surround commercial invention, where markets may still fail to provide adequate incentives. As discussed in Box 1, businesses typically capture only a small portion of the benefits of their innovations, partly because consumers enjoy a substantial share of the social gain and partly because follow-on innovations may be captured by other firms.  This general issue calls for policies that enhance private sector innovation incentives. These policies can act to lower commercial research costs through mechanisms such as the Research & Experimentation Tax Credit. Other mechanisms enhance the demand for innovations. For example, demonstration funding and government procurement can encourage the creation and deployment of next generation technologies, bringing private innovation incentives closer to the social interest. Government procurement was used, for example, by the Defense Department to promote the development of the Internet. Prize competitions (see Box 2) can be especially useful in driving innovation for specific needs. Collectively, these demand mechanisms can be targeted at well-defined national priority areas, such as clean energy, and can be especially useful in contexts where markets under-price an activity’s costs, such as our national dependence on fossil fuel consumption.
Government also plays an essential role in setting and enforcing appropriate rules. Foremost in the innovation context is a well-functioning property rights system. Absent effective legal protections for innovators, other businesses can immediately exploit an innovator’s idea, undermining the incentive to invent in the first place. Public policy solves this problem through intellectual property rights – allowing limited, short-run grants of exclusive rights to catalyze inventive activity. Recognizing the importance of intellectual property rights, we must commit to their effective enforcement, as the Obama Administration has done in appointing the first Intellectual Property Enforcement Coordinator and redoubling our efforts in this area. Critically, we must also commit to making the necessary public investments to support high-quality patent examination, lower legal uncertainty, and clear persistent patent application backlogs so that innovative businesses and entrepreneurs are not faced with unnecessary risk or left waiting for years before a patent decision is made.
Box 2: Spurring Innovation through Prizes and Challenges
In his September 2009 Strategy for Innovation, President Obama called on all agencies to increase their use of prizes and challenges to mobilize America’s ingenuity to solve some of our nation’s most pressing challenges.
From the 1714 Longitude Prize that stimulated the development of the world’s first practical method to measure a ship’s longitude to the Orteig Prize that inspired Charles Lindbergh to fly nonstop from New York to Paris to the X Prize given to the inventor who creates a car that can deliver over 100 miles per gallon, prizes have a long record of spurring innovation. In the 21st century, unprecedented levels of connectivity have given rise to a renaissance for prize competitions. A recent McKinsey report found that private sector investment in prizes has increased significantly in recent years, including $250 million in new prize money between 2000 and 2007.
As the Wall Street Journal recently concluded, “These prizes have proliferated because they actually work.” Under the right circumstances, prizes have a number of advantages over traditional grants and contracts. Prizes allow the sponsor to set an ambitious goal without selecting the team or approach that is most likely to succeed, to increase the number and diversity of minds tackling tough problems, to pay only for results, and to stimulate private-sector investment that is many times greater than the cash value of the prize (Orteig competitors collectively spent $400,000 to win the $25,000 purse).
Since September 2009, the Obama Administration has taken important steps to accelerate public-sector adoption of these innovative tools. In March 2010, the Office of Management and Budget issued a formal policy framework to guide agency leadership in using prizes to advance their core mission. In September 2010, the Administration launched Challenge.gov, a one-stop shop where entrepreneurs and citizen solvers can find public-sector prizes. Throughout, the Administration built a community of practice for agencies to share best practices and lessons learned. As a result, in its first 4 months alone, Challenge.gov has featured nearly 60 challenges from more than 25 agencies across the Executive Branch, generating novel solutions for childhood obesity, advanced vehicle technologies, financing for small businesses, Type 1 Diabetes, and many other national priorities.
Another example is a challenge launched on the NASA Innovation Pavilion for a forecasting algorithm to protect America’s astronauts from radiation exposure in space. Over 500 problem solvers from 53 countries answered NASA’s call. Expecting no solutions for this long intractable problem, NASA received a solution that exceeded their requirements from a retired radio-frequency engineer in rural New Hampshire. The winner had never before responded to a government request for proposals, let alone worked with NASA. Yet, his winning approach forecast solar proton events with 85% accuracy, a result NASA dubbed “outstanding.”
Prize competitions like these mark a dramatic departure from business as usual and – thanks to newly-enacted legislation – will soon become a standard tool in every federal agency’s toolbox. On December 21st, Congress passed the America COMPETES Reauthorization Act of 2010, providing broad prize authority to all federal agencies. By giving agencies a simple and clear legal path, the America COMPETES Reauthorization Act will make it dramatically easier for agencies to use prizes and challenges. In the months to come, the Obama Administration will work closely with key agencies to leverage the new authority for ambitious prizes in areas of national priority.
Government can also accelerate innovation by setting rules in specific sectors, notably by updating or eliminating outdated regulations. To that end, President Obama signed an Executive Order in January 2011 calling for a government-wide review of regulations to update or revise them to, among other purposes, ensure that they facilitate—rather than impede—competition and innovation in addressing valid public policy goals. Effective management of public resources, such as the electromagnetic spectrum, unleashes innovation by opening markets and reducing uncertainty over usage rights and engineering design. In appropriate contexts, public leadership can help set standards for technology platforms, such as emerging smart grid or health IT technologies, providing confidence to the marketplace to develop and adopt new generations of products. Standard setting, which the government can enable through its role as convener and support through research and development, often involves facilitating coordination within the private sector to create a larger market, thus enhancing the demand for innovative products. Export initiatives further increase the market scale for U.S. businesses. Increased scale is an attraction to business innovation, while tiny, balkanized markets are not.
Finally, the government plays essential roles through public investments that businesses rely on but do not themselves create. Educational investments and workforce training provide the essential building block – a capable workforce – from which new ideas come and through which good ideas spread. Infrastructure investments, including physical and information infrastructure, connect our markets, creating attractive scale for innovation and allowing best practices to diffuse.
By championing policies that facilitate marketplace innovation, the federal government will continue to be an essential partner in the U.S. national innovation system. To that end, the Obama Administration will take appropriate public action by supporting an environment in which innovation is rewarded and best practices are diffused, investing in a technically capable workforce, supporting basic scientific discoveries, and promoting the development of the technology platforms from which future innovations will spring. Government direction can never be a substitute for the free market conditions that propel American innovation. But government must act to support those conditions and ensure that innovation, the engine of our prosperity, drives America further and faster towards higher quality jobs, healthier and longer lives, new opportunities and new industries, and the ever-expanding technological frontier.
See Angus Maddison, The World Economy: Historical Statistics, OECD Publishing, (2006).
See Robert W. Fogel, “Nutrition and the Decline in Mortality since 1700: Some Preliminary Findings” in Long-term Factors in American Economic Growth, Engerman and Gallman eds. (1986), and the review by Michael Haines, “The Urban Mortality Transition in the United States, 1800-1940”, National Bureau of Economic Research Historical Working Paper No. 134 (2001).
Robert D. Atkinson & Scott M. Andes, The Atlantic Century: Benchmarking EU and U.S. Innovation and Competitiveness, The Information Technology & Innovation Foundation (2009), available at http://www.itif.org/publications/atlantic-century-benchmarking-eu-and-us-innovation-and-competitiveness.
See, e.g., Douglas North and Robert Thomas, The Rise of the Western World: An Economic History, Cambridge: Cambridge University Press (1973); and Charles Jones, Was an Industrial Revolution Inevitable? Economic Growth over the Very Long Run, 2(1) Advances in Macroeconomics (2001).
See also William D. Nordhaus, “Schumpeterian Profits in the American Economy: Theory and Measurement”, Yale University , 2004.