The Future of Innovation: Can America Keep Pace?

"The first step to winning the future is encouraging American innovation." That was Barack Obama in his State of the Union address last January, when he hit the theme repeatedly, using the word innovation or innovate 11 times. And on this issue, at least, Republicans seem in sync with Obama. Listen to Mitt Romney or Newt Gingrich or Mitch Daniels and the word innovation pops up again and again. Everyone wants innovation and agrees that it is the key to America's future.

Innovation is as American as apple pie. It seems to accord with so many elements of our national character — ingenuity, freedom, flexibility, the willingness to question conventional wisdom and defy authority. But politicians are pinning their hopes on innovation for more urgent reasons. America's future growth will have to come from new industries that create new products and processes. Older industries are under tremendous pressure. Technological change is making factories and offices far more efficient. The rise of low-wage manufacturing in China and low-wage services in India is moving jobs overseas. The only durable strength we have — the only one that can withstand these gale winds — is innovation.

Even more troubling, there are growing signs that the U.S. no longer has the commanding lead it once did in this area. Two reports from the Boston Consulting Group and the Information Technology & Innovation Foundation (ITIF) that use hard measures such as spending on research, patents and venture funding as opposed to surveys find that the U.S. ranks not No. 1 but No. 8 and No. 6, respectively. In fact, the ITIF rankings have a category that measures how much a country has improved its innovation capacity from 1999 to 2009, factoring in measures like government funding for basic research, education and corporate-tax policies. Of the 40 countries analyzed, the U.S. came in dead last.

What is innovation? We don't really have a good fix on the concept. We know it when we see it. But this much is clear: it encompasses more than just scientific or technological breakthroughs, as becomes apparent when you look at which companies are considered the most innovative. In the world of business rankings, it is very rare for a company to rank first in every survey, since the criteria often vary greatly. Yet when tackling innovation, one company, Apple, utterly dominates the lists, whoever puts them together.

So how would one define Apple's innovations? It is not a company that focuses on pathbreaking science and spews out new inventions and patents. The 2010 Booz & Co. ranking of companies by their expenditures on research and development places Apple 81st. As a percentage of its revenue, the company spends less than half of what the typical computer and electronics company does and a fifth of what Microsoft spends. Apple's innovations are powerful and profound, but they are often in the realms of design, consumer use and marketing. This is hardly unusual. In fact, the application of technology in service of a consumer need or business objective is what true innovation always has been.

Viewed from a historical perspective, that combination at the heart of successful innovation becomes clear. Len Baker, one of the founding fathers of the Silicon Valley venture-capital industry, says, "My favorite example is Isaac Merritt Singer, who invented the first commercially successful sewing machine. The real benefit to society was that he was the first person to sell to women, because prior to this it was assumed that women couldn't operate machinery. His company invented the installment plan and the trade-in. That's innovation. Think of eBay: eBay didn't create new technology. It used technology and revolutionized the way people do things." This idea of innovation as a new business process is of course older than modern capitalism itself. The system of accounting called double-entry bookkeeping, invented in Renaissance Italy, was powerfully connected to the development of trade and commerce. New ideas in all kinds of fields can fuel economic growth.

But while novel business ideas are crucial to innovation, so too is new technology. Eric Schmidt, the executive chairman of Google, argues that "you need both." In Google's case, he explains that the technological breakthrough of a new and better search program came first; only later were ideas about how to make money out of it developed by building a new model for advertising sales.

The ecosystem that encourages technological breakthroughs and their application does not develop in a vacuum. It requires great universities, vibrant companies that devote time and energy to research and — yes — large amounts of government funding. The latter may be a controversial topic in theory, but in practice, the rise of technology was clearly fueled by government. A multitude of technological innovations have been associated with the government, often with the military. Forget the steam engine (developed using cannon designs and technology) and take something as modern as the microchip. After it was invented in 1958 by Texas Instruments, the federal government bought virtually every microchip that firms could produce. The Breakthrough Institute reports in a paper that "NASA bought so many microchips that manufacturers were able to achieve huge improvements in the production process — so much so, in fact, that the price of the Apollo microchip fell from $1,000 per unit to between $20 and $30 per unit in the span of a couple years." And then there is DARPA, the Defense Department's venture-capital arm, which has had an astonishing string of successes, helping fund stealth technology, the beginnings of the global-positioning system and, most famously, the Internet.

In the rest of the world, the role of the state is not controversial. While Americans continue to debate whether government should have any role in fostering innovation, the fastest-growing economies are all busy using government policy to establish commanding leads in one industry after another. Google's Schmidt points out that "the fact of the matter is, other countries are putting a lot more money into nurturing new industries than we are, and we are not going to win unless we do something like what they're doing. South Korea is a classic example. Who would have thought that South Korea could become a major iron and steel and shipbuilding country in the world? But some 40 years ago, in their organized way, they decided those are the industries they were going to go after. And there is now increasing evidence that Chinese companies are beginning to do things that are innovative — often with government assistance." There are many who believe that China's government-led innovation won't work, but at least for now, in industries like solar panels, wind turbines and high-speed rail, China is establishing a commanding lead.

Even those who look skeptically on direct support of specific technologies agree that basic research requires government funding. Ultimately, innovation cannot work without both significant government support and a vibrant and dynamic private sector that allows people to experiment, fail and try again. The U.S. remains the best place in the world to do just that, and despite our ideological bias, the U.S. government has actually spent hundreds of billions of dollars funding science, technology and even specific industries. The problem may be less the theory than the practice. Whereas once we funded the development of the computer chip, now we dole out money to agribusiness. Like so much else in Washington, funding for innovation has become less merit-based and more politicized.

Yet even if the U.S. can put together the combination of government policy and private initiative that lets innovation bloom, it won't solve all our current problems. The U.S. is climbing out of a recession in which corporate America is doing well but unemployment remains sky-high. Those with capital are prospering, but the average worker faces powerful challenges.

Will innovation solve this problem? That's not an easy question to answer. Consider Apple, now the second most valuable company in the world by market capitalization, just after ExxonMobil. Its innovative skills have led to rich rewards for its stockholders and managers, but if you compare it with the Taiwan-based firm Foxconn, which actually makes many of Apple's products, a crucial difference emerges. The companies have comparable revenues, but Apple employs about 50,000 people; Foxconn, 1,000,000. And there lies the key lesson. We need innovation urgently. But if we are to get the U.S. back to work, we need perhaps even more urgently to rebuild American education, reform our training system, revive high-end manufacturing, focus on new growth industries and rebuild our infrastructure. In fact, finding new ways to do these old tasks might be the greatest and most important innovation of all.