The Comeback Read online

  In other words, what Abramovitz’s models couldn’t account for was the increase in output given the same number of inputs. Ignorance of the importance of innovation was also partly due to the generally inadequate data economists had to work with prior to the modern age. But Abramovitz’s “residual” had intrigued other economists.

  In 1957, American economist Robert Solow defined a breakthrough analytical model of the U.S. economy that attributed over 80 percent of the growth in economic output per worker to “technical progress.” Nevertheless, it took thirty more years before Solow was awarded the Nobel Prize in economics for his work.

  Writes Rosenburg: “It was precisely the size of this residual that persuaded most economists that technological innovation must have been a major force in the growth of output in highly industrialised economies.”

  This is the primary reason why the U.S. must remain the most innovative nation on earth: because innovation is the fuel that powers economic growth. Most important, only innovation produces the type of growth that increases our national standard of living, officially known as growth in real gross domestic product (GDP) per capita. Unfortunately, this fundamental economic truth is not well understood by many of our citizens, including our politicians.

  In large part, this is due to widespread ignorance of basic economics that has persisted since our nation’s founding in 1776. Indeed, in that year, Adam Smith noted that “many improvements [in nations’ wealth] have been made by the ingenuity of the makers of machines.” Smith made this observation in his pioneering 1776 treatise known familiarly by its short title, The Wealth of Nations, one of the foundation texts of modern economics and well known to many of our founding fathers.

  However, even though economic thinkers had no clear concept of innovation until recently, fortunately our innovators didn’t notice. Eli Whitney’s invention of the cotton gin in Georgia in 1793 fueled early creation of a massive national cotton and apparel industry. The building of a transcontinental railroad, completed in 1869, connected our vast continent and fostered growth in commerce among the states. Thomas Edison’s invention of the incandescent light bulb and his efforts to build the electrical industry created the essential electric platform for industry development to the present day. The introduction of television in the early 1950s revolutionized entertainment, family life, and cultural habits, first here and then in most of the civilized world. In 1959, the first integrated circuit patents were filed in the United States, setting off a technology explosion that continues to this day.

  So Americans were innovating from the very earliest days of our republic. But before examining the reasons the U.S. populace has been so creative, we should better understand what “innovation” actually means, in a strict economic sense (as opposed to the more general definition I used in the previous chapter).

  WHAT IS INNOVATION?

  One business dictionary defines it as the “process by which an idea or invention is translated into a good or service for which people will pay. To be called an innovation, an idea must be replicable at an economic cost and must satisfy a specific need.” Thus, essential to the concept of innovation is that it must create incremental economic value. As the joke goes, a so-called innovation that does not create incremental value is generally called a failure.

  The popular understanding of innovation focuses on new technologies such as those offered by major corporations like Intel, Microsoft, Apple, and Google, but innovation is much, much broader than that. Consider for example such relatively new firms as Starbucks, eBay, Staples, and PetSmart. In each case, the innovation was in the company business model and in how the company operated to create and serve its customers.

  One useful way to think about the broad range of possible innovations is in terms of what is called the business value chain, the sequence of activities that a firm undertakes to create and serve customers. In this construct, innovation is possible in the entire range of business functions, including research, design, engineering, sourcing, production, distribution, marketing, sales, service, and so forth.

  Yet despite this vast potential breeding ground for innovation, innovation remains relatively rare, especially those disruptive innovations that create new companies and even entire new industries. Innovation is particularly difficult for large companies and well-established companies, in part because they pay so much attention to defending what they have already achieved. Their innovation challenges have birthed a fairly large population of consultants, authors, and researchers eager to help these firms break out of their encrusted business habits. (Those consulting firms, in turn, each have their own well-established ways of doing things, but they need to be constantly innovating their practices as well.) Despite the difficulties of innovating, the U.S. has long led the world in innovation. For example, in technology hardware, we have Apple, Cisco, Dell, Intel, HP, Motorola, National Semiconductor, Nvidia, Qualcomm, and Texas Instruments. In software and services we have Accenture, IBM, Microsoft, and Oracle. Not only was the Internet invented here, but we also have the world’s leading Internet-based companies, such as Amazon, Craigslist, Google, eBay, eTrade, Facebook, Flicker, Pandora, Twitter, and Yahoo.

  We are also strong innovators in health care and related sciences. Our pharmaceutical, biotechnology, nanotechnology, aerospace, and chemical industries lead the world. Although we can complain about the costs, the fact is that the wealthiest people in the world journey to the United States to receive the best and most advanced medical treatments possible.

  Moreover, the impressive U.S. innovation track record in industrial technology also extends to the creative arts. Hollywood dominates the world’s big and small screens. Our independent studios make movies and TV programs. Our music industry and book and magazine writers and publishers are among the best and most prolific in the world.

  Why does the U.S. lead the world in innovation, especially by such a wide margin? This issue has been much studied and debated, and I am persuaded that the answer lies in what has been called American exceptionalism. In my opinion, it is the fortunate result of our nation’s rich and unique stew of individual liberty, constitutional democracy, limited government, free enterprise, social mobility, ethnic diversity, immigrant assimilation, intellectual freedom, property rights, and the rule of law. I can’t deconstruct how each factor makes its individual contribution, but I believe each is vitally important.

  I should also add that, in comparison to most of the industrialized world, Americans work harder. Despite the image of the pampered or spoiled American, the fact is that Americans on average work 1,776 hours per year. This is 467 more hours a year than Germany, 307 more hours than France, and 43 more hours than Japan. As Edison once said, success is 10 percent inspiration and 90 percent perspiration. We may also work smarter and be relatively more creative, but I don’t know for certain.

  Years ago, the Cato Institute examined certain specific factors that foster innovation. Researchers Thomas Jorde and David Teece wrote this:

  Although the evidence is sketchy, factors that are important include: the availability of a labor force with the requisite technical skills; economic structures that permit considerable autonomy and entrepreneurship; economic systems that permit and encourage a variety of approaches to technological and market opportunities; access to “venture” capital, either from a firm’s existing cash flow or from an external venture capital community; good connections between the scientific community, especially the universities, and the technological community, and between users and developers of technology; strong protection of intellectual property; the availability of strategies and structures to enable innovating firms to capture a return from their investment; and, in fragmented industries, the ability to quickly build or access cospecialized assets inside or outside the industry.14

  Now that’s a list, and I have no quarrel with most of it. But it seems to consist of factors that are and have been prevalent in other industrialized countries, so it doesn’t necessarily exp
lain the supremacy of American innovation. I think my list better accounts for America’s innovation exceptionalism.

  No other country has reached the U.S. level of creativity and innovation, and one result is that U.S. culture, language, and, to some extent, values have infiltrated other nations, multiplying the impact of our innovations themselves. This gives us global influence disproportionate to the size of our population and our economy, amplifying my concerns that innovation is too important to continue being less than an urgent national policy priority.

  Thanks to many very smart people, we have a better, but not complete, understanding of how to foster innovation. But we also have a better understanding of how fragile our innovation leadership can be. And we see increasing threats to this leadership, and so to our economic health as well.

  In February 2010, China announced it had issued a record number of patents in 2009: more than 580,000, a 41 percent increase from a year earlier.15 Meanwhile, a September 2010 report from the United Nations’ World Intellectual Property Organization announced that patent filing in the U.S. fell by 11.7 percent between 2008 and 2009.16 Indeed, the drop in the United States—as in most developed nations—can be attributed to the global economic downturn, and will likely rise when the economy recovers.

  But that’s what makes China’s growth so much more maddening.

  To sustain and even enhance U.S. innovation, there are several essential and fundamental actions that I believe need to be taken, and these are addressed in the following chapters. These actions involve every important institution in our country, including education; federal, state and local legislators, and governments; industries large, small, and not yet created; law and the courts; labor; cultural centers; banks and private equity firms; and so on. Spurring action will require that each institution recognize the challenges, establish remedial goals, and fashion appropriate strategies. Qualified and energetic leadership is needed from the United States president on down.

  We currently face a severe economic crisis, but like the Chinese, I believe every crisis contains the seeds of future success. “Innovate or die” was the concept I counseled companies about in the recent Great Recession. Some died, but many more innovated. A market cycle is tough, but it does weed out the weaker competitors and can certainly foster innovation.

  The time for action is long past due.

  4

  Entrepreneurial Innovation: The Jobs Engine

  “This summer, the America Recovery and Reinvestment Act (the ‘Recovery Act’) will shift its emphasis from short-term rescue efforts to long-term recovery and reinvestment projects. These projects will rebuild the infrastructure of today and break ground on the infrastructure of tomorrow, driving sustainable job creation, economic growth, innovation, and global competiveness.”17

  —SUMMER OF RECOVERY: Project Activity Increases in Summer 2010, Office of the Vice President, June 17, 2010

  JOB CREATION

  From the Department of Labor, the Bureau of Labor Statistics reported that the unemployment rate in the “Summer of Recovery” was:

  June: 9.5 percent

  July: 9.5 percent

  August: 9.6 percent18

  In September 2010, most Americans knew that the Obama Administration’s “stimulus package” of nearly $1 trillion had failed in its principle task of restoring real economic growth and returning Americans to work. The administration’s “Summer of Recovery” had become a “Summer of Embarrassment.”

  By the end of the summer, more and more stories like this one from the Los Angeles Times began cropping up:

  Two L.A. agencies get $111 million in stimulus funds but have created only 55 jobs

  September 17, 2010

  Two Los Angeles departments have received $111 million in federal stimulus funds yet have created only 55 jobs so far, according to a pair of reports issued Thursday by City Controller Wendy Greuel. The reports conclude that the agencies, Public Works and Transportation, moved too slowly in spending the federal money, in part because of the time it takes to secure approval of government contracts. The two agencies plan to create or retain a combined 264 jobs once all the money is spent, according to the reports.

  With unemployment above 12%, city officials should move more urgently to cut red tape and spend the money, Greuel said. “The process needs to be changed to make sure we get these projects out as quickly as possible,” she said . . .

  So far, the public works agency has shielded 37 public employee jobs from elimination as a result of the city’s ongoing budget crisis and created eight public or private jobs, the report said. Part of the problem, Greuel found, was that it took eight months to put together certain bid packages, review the bids and award the contracts. The second report looked at the Department of Transportation, which received seven grants worth nearly $41 million to purchase buses, install traffic signals and upgrade railroad crossings. Although those projects were designed to support 26 jobs, nine have been created or retained so far, Greuel’s report said.19

  Now imagine what a young start-up with a fresh new idea could have done with $111 million. I’m not advocating handouts to startups, but I am pointing out the absurdity behind the belief that government can spend its way to real job creation. The Office of the Vice President’s report might have had the best of intentions, but those intentions always—always—run into the local Public Works and Transportation Offices, which haven’t the foggiest idea how to create a job. That’s why it spent over $2 million for each job it “created.”

  The U.S. economy is in crisis, with official “unemployment” stuck near 10 percent, and actual under-employment well into double digits, and both measures are dismally much higher for youths and minorities. Much of the public is frustrated that the federal government seems unable to stimulate real growth in our economy and jobs. Yet this presumes a fallacy—that it is the government’s job to create jobs. Recently, the federal government’s massive and quick action has caused so much business uncertainty and debt, it has actually reduced jobs.

  To create the conditions for private entities to create jobs, the federal government should first do no harm. More, it can stimulate jobs by focusing on which environment is ready for innovation. The evidence of the unique economic power of innovation has been accumulating for most of our history and has become irrefutable as the high-technology revolution gained traction over the past several decades.

  The news these days is filled with stories about how small business (defined by the federal government as firms having fewer than five hundred employees) is more responsible for driving job creation compared to larger businesses, and this is indisputably true. According to the U.S. Small Business Administration (SBA), small businesses account for a full 50 percent of total U.S. employment. Moreover, small businesses account for more than two-thirds of net new job creation.

  I know firsthand the importance of small business in employment and job creation: 80 percent of the members of the Consumer Electronics Association are small businesses, and the International CES is similarly dominated by small businesses. But yet, company size is not the full story of job creation.

  A 2010 study by the prestigious National Bureau of Economic Research concluded that only certain types of small business are the primary job creators:

  There’s been a long, sometimes heated, debate on the role of firm size in employment growth . . . The widespread and repeated claim . . . is that most new jobs are created by small businesses . . . However, our main finding is that once we control for firm age there is no systematic relationship between firm size and growth. Our findings highlight the important role of business startups and young businesses in U.S. job creation. Business startups contribute substantially to both gross and net job creation.20

  Similarly, another 2010 study from the Kauffman Foundation “shows that without startups, there would be no net job growth in the U.S. economy. This fact is true on average, but also is true for all but seven years for which the United States has data,
going back to 1977.” The report concludes:

  All other ages of firms, including companies in their first full years of existence up to firms established two centuries ago, are net job destroyers . . . in terms of the life cycle of job growth, policymakers should appreciate the astoundingly large effect of job creation in the first year of a firm’s life.21

  The evidence of the job creation power of start-ups is right in front of our eyes and those of our policy makers. The implication is that government should be doing all it can to incentivize start-ups, as opposed to spending billions on subsidies and bailouts for existing large firms that, in the end, will not lead to one net American job. As summarized recently by Harvard Business School Professor Bill George:

  Many of the great job creators of the past 25 years are companies that were barely visible in 1980 or even nonexistent: Target, Home Depot, Starbucks and Amazon in the retail field; Apple, Intel, Microsoft, Dell, Google, Oracle and Cisco Systems in information technology; and Genentech, Amgen, Stryker and Medtronic in medical technology. All of them were founded by entrepreneurs and are run by innovative leaders. Their ingenuity created the jobs boom in those years and enabled them to dominate global markets for their products.22

  Moreover, the direct employment generated by companies like this doesn’t measure their full impact. For example, Apple directly employs thousands of Americans. In addition, it indirectly creates job opportunities for many more, with hundreds of thousands of unique iPhone, iPod, and iPad, applications created outside Apple. More, large U.S. companies spend an average of $3 billion on services from small companies, according to a 2010 study by the Business Roundtable.