Innovation Economics

Innovation Economics

by Robert D. Atkinson, Stephen J. Ezell

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ISBN-13: 9780300189117
Publisher: Yale University Press
Publication date: 09/04/2012
Sold by: Barnes & Noble
Format: NOOK Book
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Innovation Economics

The Race for Global Advantage
By Robert D. Atkinson Stephen J. Ezell


Copyright © 2012 Robert D. Atkinson and Stephen J. Ezell
All right reserved.

ISBN: 978-0-300-18911-7

Chapter One

The Race for Global Innovation Advantage

The so-called Great Recession that convulsed the U.S. economy from the end of 2007 to the middle of 2009 has been officially over for several years, but for most Americans it certainly doesn't feel that way. The official unemployment rate still hovers around 8.5 percent, and if the part-time workers who would rather be working full-time were included, the rate would be almost double. In fact, the Congressional Budget Office reported in February 2012 that after three years with unemployment topping 8 percent, the United States has seen the longest period of high unemployment since the Great Depression, yet it still expects that unemployment will remain above 8 percent through 2014. Less than two-thirds of adults are in the labor force, a twenty-five-year low. Worse, from 2000 to 2010, the United States did not add a single net new job. Both the federal budget and trade deficits remain unsustainably high. U.S. companies are sitting on, rather than investing, close to $2 trillion in cash reserves. And some regions remain mired in recession, with many cities, towns, and even states on the brink of bankruptcy.

By most accounts, this is all the result of an uncommonly severe but ultimately survivable financial crisis, akin to the destruction wrought by a category 5 hurricane—immense, more or less random, but with rebuilding and recovery largely assured. Economic pundits tell us that we can expect things to get back to "normal," eventually. Housing prices will go back up, unemployment will go down, and economic confidence will return, if slowly.

But neither the recession nor the slow recovery can be attributed simply to a random financial crisis caused by the burst housing bubble. Rather, we argue that a major contributing factor has been the United States falling behind in the race for global innovation advantage. Indeed, since the late 1990s especially, the United States has been losing out to other nations with respect to competitiveness and innovation, the result of too few resources going to wealth-creating investments like research and factories and too many resources going to a housing-market Ponzi scheme. America lost almost one-third of its manufacturing jobs from 2000 to 2011, while it ranked forty-third out of forty-four nations in the rate of progress in innovation-based competitiveness. Until U.S. policymakers grasp and act on this fundamental reality, we can expect recovery to be anemic and the United States to continue to lose ground relative to most other nations. Recovery will depend on two mutually reinforcing factors: a faith that America will once again lead in the global innovation economy and sufficient private and public investments in research, plant and equipment, skills, and infrastructure to realize that vision.

It's not that America hasn't faced competition before. It has. But this time it's different. Since the mid-1990s, nations around the world have accelerated their efforts to lead in innovation-based economic development (e.g., by gaining jobs in key sectors like computers and software, aviation, pharmaceuticals and biotechnology, machine tools, medical devices, instruments, and clean energy). Ever since World War II (WWII), when America's arsenal of democracy helped defeat the Axis powers, high-tech sectors had been America's sweet spot. While America might lose textile jobs or call centers, it was still the dominant technology leader. Indeed, as late as the 1960s, U.S. government funding of research and development (R&D) exceeded that of all other nations' R&D funding—business and government—combined.

But starting in the 1980s and accelerating rapidly in the new century, that all began to change. While other nations were now setting their sights on winning the race for global innovation advantage, America was asleep, convinced of its own innate economic superiority and preoccupied by the challenge of the "War on Terror" and conflicts between "Red" and "Blue" states over a range of hot-button social issues. Losing this race will have profound implications for the future of the American economy and society. This book examines how America is losing the race for global innovation advantage and what it needs to do to come from behind and lead once again.

From Rust Belt to Rust Nation

To understand what's happened to the American economy, we need to look back forty years to the early 1970s. People were driving Gran Torinos, listening to eight-track tapes, and wearing long sideburns. But the United States was enjoying the fruits of a twenty-five-year postwar economic boom during which real per capita gross domestic product (GDP) exploded, jobs were plentiful, and tens of millions of American households were vaulted into the middle class. But starting with the recession of 1969 (the longest since 1949) and then the much longer and deeper recession of 1974 (the longest since the Great Depression), that robust economic performance began to falter, leading many to question if the good times were over.

For America as a whole, the answer was an emphatic no. Things did keep getting better. Indeed, growth even accelerated from 1975 to 1985. But underneath this apparently healthy national growth was a troubling phenomenon—the emergence of two quite different economies: a slower-growing industrial Midwest and Northeast and a faster-growing South and West. After WWII and until the end of the 1960s, these regions grew at about the same rate. But starting in the 1970s and through the mid-1980s, the former areas downshifted into slow growth, with a struggling industrial belt from western Massachusetts to northern Wisconsin and down to St. Louis. Portrayed in rock ballads like Billy Joel's "Allentown" or Bruce Springsteen's "My Hometown," places that had grown in the twentieth century to become industrial powerhouses, providing a path to the American Dream for millions of workers, now faced shuttered factories, boarded-up homes, and shattered lives. But while these areas struggled, regions like the Rocky Mountains and the West boomed, growing 37 percent and 27 percent faster than the nation, respectively.

Cities that had once powered America's Industrial Revolution were now struggling for their economic lives. Take Buffalo, New York, for example. Buffeted by factories moving to the South and West, Buffalo's total income grew at less than half the rate of Brownsville, Texas, from 1969 to 1986. While Brownsville saw its jobs grow by 75 percent, Buffalo saw its jobs decline by 1 percent. Likewise, Syracuse, New York, home in the early twentieth century to companies that manufactured more diverse products than New York City, saw its income grow just 53 percent as fast as that of Santa Fe, New Mexico, with jobs growing just 28 percent compared to Santa Fe's 124 percent.

In short, entire regions never again experienced the robust growth rates they enjoyed in the century following the Civil War; they suffered deindustrialization, job loss, and fiscal crises. So if you were in Buffalo, Syracuse, or similar places, things probably weren't so good. But if you were in Brownsville, Santa Fe, or other growing places, things were likely good and getting better. Indeed, if the South had won the Civil War, economic historians might be writing about the economic decline of the United States after the 1960s and the boom of the Confederate States of America. Instead, they talk about overall modest U.S. growth.

There was a variety of reasons for the emergence of these two American economies, but a key one was that it could happen. With the completion of the Interstate Highway System in the 1970s, the emergence of jet travel, and nationwide electrification and telephone access, companies in traded sectors now had the freedom to locate almost anywhere in the United States. And they did so, with factories migrating away from the Northeast and Midwest to the South and the West. Combined with this was the emergence of new high-growth industries (e.g., electronics, aviation, and instruments) that didn't need to be located at the ports or rail spurs in the Midwest and East. Couple this with the high costs and lack of competitiveness of the "rust belt" region, and the implications were clear.

This process has played out once again in the 2000s, but on the global level. This time, it's the United States that has become the Great Lakes from a geoeconomic perspective. "Rust belt" is now "rust nation." Santa Fe has become the Syracuse of its day, with Shanghai the Santa Fe. Brownsville has become the Buffalo of its day and Bangalore, India, the Brownsville. Places like North Carolina and Georgia, which benefited from the shift of manufacturing from the North from the 1940s to the 1970s, have seen their own textile, furniture, and other traditional factories move to lower-wage nations. Today, container ships, air freight, the development of the Internet, and undersea fiber-optic cables have linked together not just state economies but also national ones. In essence, what was once a set of separate national economies in the 1970s has evolved into a single integrated global economy in the twenty-first century. And other parts of the world are now the economic engines, growing much faster than the United States (or Europe or Japan).

When Northeast and Midwest states realized their factories could relocate anywhere in the country, they began to compete fiercely with each other to attract those "smokestacks." Emblematic of efforts of the day, a 1954 issue of Fortune magazine included a full-page ad from the state of Indiana that touted its benefits as a location of corporate investment, including attractors such as "no government debt," a labor force that was "97 percent native" (with the implication that native-born workers were less likely to strike than immigrants), low taxes, and ample supplies of raw materials, calling itself "the clay capital of the world." By the 1970s, virtually every state had established an economic development agency whose mission was to go out and compete with an arsenal of tools ranging from tax breaks, to free land, to workforce training programs.

In today's global economy, nations must compete fiercely to retain and attract mobile investment. But in contrast to states competing by "smokestack chasing" forty years ago, most nations now compete by "innovation chasing," trying to grow and attract the highest-value-added economic activity they can: the high-wage, knowledge-intensive manufacturing, research, software, information technology (IT), and services jobs that power today's global, innovation-based economy. Indiana is a case in point. It no longer touts its abundant clay, but now markets itself as a place "where innovation, discovery, and success are nurtured," and "that provides a pipeline of bright minds and new thinking."

It is this intense race for global innovation advantage that most clearly distinguishes today's global economy from the collection of regional and national economies that competed to attract "smokestacks" a generation ago. As a February 2012 Washington Post article noted, "Europe, as well as Asia and Latin America, is offering ever stronger competition to the United States, even in its strongest sectors, such as Internet technology, aerospace, and pharmaceuticals." And it's not a competition for the faint of heart. In fact, it makes the World Cup look like a kids' playground game, for the struggle for innovation advantage is being fought with all the tools at a nation's disposal. Nations around the world are establishing national innovation strategies, restructuring their tax and regulatory systems to become more competitive, expanding support for science and technology, improving their education systems, spurring investments in broadband and other IT areas, and taking a myriad of other pro-innovation steps. But unlike the old competition between the U.S. states, where they generally played by national rules established in the Constitution, a new approach, "innovation mercantilism"—which can entail stealing intellectual property (IP), discriminating against foreign technology firms, requiring foreign firms to transfer technology for market access, or manipulating currency—has become a mainstay of many nations' game plans in the new global competition.

Yet, notwithstanding the intensity of this new competition, as recently as fifteen years ago, many nations did not even think they were competing. And if they did acknowledge a contest, they thought they were in last century's quest for smokestack industries like steel mills, shipbuilding, textiles, and other labor- and/or capital-intensive industries. Today, however, most nations recognize that they have to be intense competitors if they are to be successful, as more and more firms can now produce goods and services virtually anywhere on the globe. And most nations also realize that high-wage innovation- and knowledge-based industries play a key role in driving prosperity. There are now only a few nations still blind to these new realities, and unfortunately the United States is one. A bit like the old car rental commercial from the 1970s, the United States still thinks of itself as Hertz ("We're number one"), while most other nations think they are Avis, and as number two, they must try harder.

So where does this leave the United States and, for that matter, older industrial regions like Europe and Japan? Looking back to the United States of the mid-1970s, it's important to note that not all Northeast-Midwest regions were fated to relative decline. Some, in fact, transformed themselves and thrived. A case in point is Boston, which like Buffalo lost much of its industry to the South, especially textile and shoe firms in search of cheap labor. Boston looked like it was on the same path to decline as Buffalo. But unlike Buffalo, Boston reinvented itself. With the growth of the cold war and defense spending, Boston's early success in electronics (much of it a spin-off from the Massachusetts Institute of Technology) enabled a thriving tech industry. Its long-standing strength in financial services provided a base for expansion. But by the mid-1980s, Boston's future again looked troubled. Much of the region's computer industry had placed its bets on the minicomputer, and firms like Data General, Digital Equipment Corporation (DEC), and Wang all went into bankruptcy with the emergence of the California-based personal computer (PC) industry, centered in the more dynamic Silicon Valley. But Boston would rebound again around its three longstanding pillars: leading-edge research universities, a large number of talented and well-educated residents, and a venture capital industry willing to invest in the future. By the 2000s, the region's IT industry had reinvented itself. Boston also became one of the world's leading hubs of biotechnology. And it retained a strong financial services sector. Indeed, if Massachusetts were a nation, it would be the most innovative nation on earth, according to the Information Technology and Innovation Foundation's (ITIF's) Atlantic Century II report.

So if Boston could rebound to win the race, can the United States? Indeed, perhaps the single most important question confronting the United States (as well as Europe and Japan) is whether over the course of the next quarter century it will become Boston and rise from its decline through innovation and economic transformation, or Buffalo and sink further into relative economic decline.

"Becoming Boston" means moving aggressively into next-generation industries, including advanced IT, biotechnology, nanotechnology, robotics, and high-level business services, while at the same time maintaining a share of highly efficient and competitive traditional industries (such as autos, machine tools, chemicals, and so forth), and continually raising productivity in "nontraded" sectors such as retail and health care. "Becoming Buffalo" implies losing out in the competition for new, globally traded industries, continuing to lose shares in existing manufacturing industries, and experiencing slow productivity growth in nontraded sectors. Becoming Boston means putting in place an aggressive national innovation-based economic strategy, which includes both increased government investment in innovation and lower taxes on corporate investment in innovation. Becoming Buffalo implies doing what we've been doing: cutting government investment in innovation while seeing our overall corporate tax system become less competitive compared to other nations as each year goes by. Becoming Boston means waking up to the crisis, becoming full-throated advocates—indeed, zealots—for innovation, and embracing a new kind of economics ("innovation economics"), which puts advancing innovation and competitiveness at the forefront of economic policy. Becoming Buffalo means continuing in our somnolence about the nature of the global race for innovation, erecting barriers to innovation, and placing our faith in a neoclassical economics dogma that holds that countries don't compete, that innovation is "manna from heaven," and that government action to spur innovation only makes things worse. To be sure, Boston's academic infrastructure made the region ripe for innovation, but the fact remains that Boston and Buffalo took very different approaches and this has made all the difference. And the United States can do the same; or not.


Excerpted from Innovation Economics by Robert D. Atkinson Stephen J. Ezell Copyright © 2012 by Robert D. Atkinson and Stephen J. Ezell. Excerpted by permission of Yale UNIVERSITY PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents


1 The Race for Global Innovation Advantage....................1
2 Explaining U.S. Economic Decline....................17
3 Learning from the Wrong Master: Lessons from U.K. Industrial Decline....................57
4 Why Do So Many Refuse to See U.S. Structural Economic Decline?....................85
5 What Are Innovation and Innovation Policy and Why Are They Important?....................128
6 Crafting Innovation Policy to Win the Race....................162
7 Cheating as a Way to Win the Race: Innovation Mercantilism as the Strategy of Choice....................190
8 Winning the Race for Innovation Advantage with the Eight "I's" of Innovation Policy....................226
9 Why Don't We Have More Innovation and Innovation Policy?....................264
10 Can Nations Overcome the Barriers to Innovation?....................301
11 Creating a Robust Global Innovation System....................338

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