Strategy: A National Innovation Foundation

To President Barack Obama’s auto industry task force, as well as to most commentators on the industry, the main problems that General Motors and Chrysler faced this year were problems of cost. If the companies could shed mountains of debt, lower their labor and retirement costs, and cut dealers and brands, the standard story went, then they could once again become competitive. Summarizing his conditions for assisting GM and Chrysler, Obama said, “Now, what we’re asking for is difficult. It will require hard choices by companies. It will require unions and workers who have already made extraordinarily painful concessions to do more. It’ll require creditors to recognize that they can’t hold out for the prospect of endless government bailouts…it will require efforts from a whole host of other stakeholders, including dealers and suppliers.”

But the biggest obstacle to the prosperity of the Detroit-based automakers is not high costs but insufficient innovation. For too long, U.S. automakers failed to adopt world-class production methods that would bring quality up to the standards of their best foreign competitors. They introduced hybrids and other alternative-powered cars too late. And they did not cultivate the innovative capacities of their suppliers that make most of the components of their cars. The results have devastated not only the American auto industry, but also the Great Lakes regions that depend on it.

Federal policymakers’ failure to see the domestic automakers’ innovation problem cannot be blamed on the shortsightedness of individuals, nor was it unique to the auto industry. Instead, the problem was structural: Almost uniquely among economically advanced nations, the United States has no government agency or program responsible for innovation as a whole, either for a particular industry or for the entire U.S. economy. Innovation is the key to economic growth and rising standards of living. Yet there is perhaps no other issue of comparable national importance on which federal policy is so lacking. It is high time for the United States to establish a National Innovation Foundation—new, nimble, lean, and collaborative agency devoted entirely to helping businesses innovate.

For about four decades after World War II, there was no need for the federal government to worry about how innovation occurred. The U.S. economy was so dominant that there was little external, competitive pressure to cut costs—and thus R&D spending—and little chance of major innovation occurring outside the United States. Innovation was industry-driven, with leading manufacturing firms, such as the Detroit Three automakers, doing most of the work. For the most part, they required only limited and indirect government support to make their innovation systems work. These firms would do much of their research in-house and use it to develop new products. With the United States the clear leader in technology-based industries, there was no question that both the R&D for and the manufacturing of these products would happen domestically. Leading firms would make most of the components for their own products and, when using (mostly domestic) suppliers, would design the components they wanted suppliers to make. With a product mix that changed only slowly (in part because of the market power of leading firms), managers and engineers would make marginal improvements to production processes and production workers would implement them, leading to steady growth in productivity and living standards.

The federal role in innovation at that time was limited to funding basic research, subsidizing the education of scientists and engineers (key inputs into the innovation process), and maintaining a system of intellectual property law (defining property rights so as to promote innovation). To be sure, commercial innovations have resulted from federal efforts (with the Internet, originally an outgrowth of a Defense Department program, as the leading recent example). But when innovation results from these efforts, it is usually their by-product rather than their purpose.

In the last three decades, however, the U.S. innovation system has changed radically. Leading firms now face more product market competition from abroad and more frequent changes in consumer demand at home; consequently, they are less willing to make long-term, risky investments in basic and applied research. With many countries now offering competitive conditions for production and increasingly for R&D, innovation by leading U.S. firms often means that production and R&D occur abroad. Meanwhile, large manufacturers, including automakers, now rely heavily on smaller suppliers to design and produce much of what goes into their products—in cars, that means everything from radios to seats. It is now more important for smaller firms to innovate; yet many are not well equipped to do so. As a result of all these changes, firms are left with fewer incentives to innovate and little external support to help them do so.

The federal role, however, is largely what it was in the old system: funding inputs to and defining property rights for innovation. Although a handful of federal programs work directly with businesses to promote innovation, they are small and, despite welcome budget increases in the Obama Administration’s first year, they remain underfunded. To be sure, virtually all state governments and many local governments have established technology-based economic development programs to promote innovation. But states and localities do too little (because the benefits of innovation don’t stop at state lines) and often focus on the same high tech industries (such as information technology and biotechnology), regardless of whether their regional economies are well suited to those industries.

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