© Charles W. Wessner, PhD1 Innovation, Security & Growth Perspectives from the U.S. Innovation...

© Charles W. Wessner, PhD1

Innovation, Security & Growth

Perspectives from the U.S. Innovation SystemMyths, Realities & Opportunities

Six Countries Programme Workshop Defense & Security R&D

Brussels, BelgiumNovember 19, 2004

Charles W. Wessner, Ph.D.Director, Technology and Innovation

National Research Council


The Role of the National Research Council

• The NRC Mission is the Advise the Government on Science, Engineering, and Medicine– Studies for federal agencies, Congress, and

some self-initiated; 270 Reports Issued Each Year

– Nearly 1,300 staff and 10,000 volunteers annually involved in NRC/IOM studies

– Budget of some $160 million: 85% from government agencies and 15% private

• Great Prestige. High Quality Analysis with Direct Impact on U.S. Policymaking


Presentation• Question: Is military R&D a source of

Commercial Advantage in the U.S. Innovation System?

• Myths and Realities about the U.S. Innovation System

• The Limits of Spinoff

• The Need for a Broader Technology and Security Policy

• A Better Model: The Potential for Innovation Awards in Europe


Related Questions for Today(From our Swedish Friends)

• How can public investments in security research generate maximum impact on innovation and growth?

• How to find forms (or mechanisms) to strengthen the innovation systems?

• How to increase the efficiency in public and private procurement of military products?

• How to increase innovation by encouraging the participation of small companies?

An Overview of the US R&D Portfolio

Dramatic Increases in the US Budget for Defense & Homeland Security R&D


R&D in FY 2005 Budget• Federal R&D expected to rise to $132 billion in

FY’05, up from $126 in FY’04

• Most funding increases over past few years have gone to Defense Weapons development and Homeland Security R&D (including bio-defense)

• FY’05 R&D budget continues this trend

• All other R&D agencies have seen flat or declining R&D budgets (with modest increases in some programs offset by cuts in others)


U.S. Defense R&D is High


…But Focus is on Development

Is U.S. R&D Leadership Therefore a Myth?The focus on weapons development and testing overstates the R&D element of the budget.

It is often not basic or even applied research but rather testing and certification.


Security Related R&D in Other Agencies• NIH (NIAID) is the lead agency for Bio-

Defense– Bio-defense research at NIH to be

$1.8Billion in FY2005– Most of money to go for NIH Research

Grants• NSF to fund basic research in areas related

to Homeland Security• USDA involved in food security & animal

health• Each Agency wants its Share of “Security”Source: AAAS, 2004


Post 9-11 Increase in Bio-defense R&D

NIH is the Lead Agency in Bio-defense ResearchDHS Portfolio Heavily Development and Labs Oriented

Opportunities for Security Cooperation with Europe

NIH Budget is $1.8 Billion


Current Trends are Troubling:

President’s Proposed Cuts in the R&D Budget for FY2005

• $660M cut from Basic and Applied Research at DoD

• $68M cut from DoE Office of Science• $63M cut from Energy Conservation R&D at

DoE• $183M cut from Agriculture Research• $24M cut from Transportation Research• Advanced Technology Program to be Ended• Manufacturing Extension Program: Proposed

budget down 63% from 2003 level


What are the Implications for Europe?

• Concern in Europe on impact of increased US Defense and Security R&D budgets on– European Defense and Commercial Industries– European Science Base in Trans-Atlantic

Cooperation & Competition– European Policy Aspirations

• To help address these concerns, EURAB commissioned PREST to undertake an analysis of the impacts of US Defense R&D spending– Andrew D. James, US Defence R&D Spending:

An Analysis of the Impacts, January 2004


PREST Report Findings• Defense & Homeland Security missions are driving

increases in US Defense R&D budgets• Impact of New Expenditures:

– Spin-off products & technologies from Defense R&D is a Reality

– Defense R&D Spending Impacts University Science Base and Training of Graduate Scientists & Engineers

– Defense R&D Spending Creates New Markets and is a Source of Early-Stage Seed Funding

– Leveraging Civilian Technologies (like IT) for Defense & Security Missions Improves International Competitiveness of US Firms

• Begins & Ends with the Claim that “synergies between defence and civil research are far ahead of the situation in Europe.”

Is Military R&D a Source of Commercial Advantage in

the U.S. Innovation System?

Myths about theU.S. Innovation System


Central Myth about the U.S. Innovation System

• It is a Well-oiled, Centrally Controlled, Innovation Machine

• There is a Broad Consensus on How the System Works and what Opportunities and Problems need to be Addressed

• “Military R&D is the U.S. Secret Weapon in Competitiveness Wars”


The Myth of the Rational Policy Framework

• Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation Agenda

• Reality: There is no U.S. Ministry of Science Multiple sources of policy making

• Congressional Committees, • Federal Agencies—NSF, NIH, others• State Governments

+ Positive: Multiple sources of experimentation means that the system can be more adaptive; responsive to new challenges

– Negative: Lack of coherence can lead to de facto outcomes that can hurt innovation

• Example: Post Cold War Falloff in U.S. investments in Science & Engineering Education was not a product of rational U.S. policymaking.


The Myth of the Rational Policy Framework

Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation AgendaReality: Architect of U.S. Innovation Policy


The Myth of Perfect Markets

• Strong U.S. Myth: “If it is a good idea, the market will fund it.”

• Reality: Potential Investors have less than perfect knowledge, especially about innovative new ideas– “Asymmetric Information” leads to

suboptimal investments– This means that it is hard for small firms

to obtain funding for new ideas


Federally Funded

Research Creates

New Ideas

Product Development

&

Innovation

Capital to Develop Ideas to Innovation

No Capital

The Reality: The Valley of Death Early-Stage Funding Gap


The Cash Flow Valley of Death

Technology Creation

Technology Development

Early Commercialization

Cash Flow

Federal Agencies, Universities, States,

Companies

Entrepreneur & Seed/Angel Investors

IPO

Time

Cash Flow Valley of

Death

Successful

Moderately Successful

Unsuccessful

Unsuccessful

Typical Primary Investors

Venture Capitalists

SBIR & ATP

Adapted from: L.M. Murphy & P. L. Edwards, Bridging the Valley of Death—Transitioning from Public to Private Sector Financing, Golden CO: National Renewable Energy Laboratory, May 2003


The Myth of U.S.Venture Capital Markets

• Myth: “U.S. VC Markets are broad & deep, thus there is no role for government awards”

• Reality: Venture Capitalists have– Limited information on new firms– Prone to herding tendencies– Focus on later stages of technology

development– Most VC investors seek early exit

• Large U.S. Venture Capital Market is Not Focused on Early-Stage Firms

The Military R&D Myth


The Myth of Military Spin-Offs• Euro Myth: “U.S. Defense

Research/Procurement Directly Funds Civilian Technologies”

• Reality: “Very few technologies proceeded effortlessly from defense conception to commercial application.” – Secrecy, military specs, and long lead times slow

diffusion of new defense technologies– Even efforts to use low-cost civilian technologies

for defense use, i.e., “spin-ins,” are often blocked by complicated military procurement system

Beyond Spin-off, John Alic, Lewis Branscomb, et al.


Main Role for Military R&D is Defense

• U.S. Military Expenditures from 1947 to the end of the Cold War were designed to protect the U.S., its NATO allies, and other countries around the world from Soviet Expansion

• Vast sums were deployed to this end– Hot wars were fought in Korea, Vietnam– Proxy wars in Greece, Afghanistan, many

parts of Africa– Later interventions in Bosnia, Kosovo,

Kuwait were undertaken to secure human rights and international stability


Purpose of U.S. Military Expenditure

• U.S. Military Expenditures were first and foremost designed to provide the equipment, maintenance and training to provide credible capacity to deliver armed support to U.S. allies

• Additional vast sums were (and are) spent on the U.S. nuclear deterrent

• The Goal of U.S. military expenditure is Security for the U.S. and its allies and the ability to influence events– U.S. Power Projection is Unique (though constrained)


Difference in Scale of Military Expenditure

• The United States, for better or for worse, expends over $400B per year (2004) on the military

• The UK is next at $40B followed by France at $30B and Germany at $25B (approximate figures)

• R&D represents a small portion of these amounts – usually 3% in the U.S.

• Commercial benefits are small, given the level of expenditure


Difference in Scale of Military R&D

• Within NATO, only the Defense budgets of the UK, France, Germany, and Italy exceed the R&D budgets of the U.S. military– All other NATO nations combined invest some

$3B in research and technology investment

• Why? France, Germany, Italy, Greece, Poland, and Spain spend 60% or more of Defense Budgets on Personnel

• U.S. Defense Budget Expenditures: – 35% on Personnel– 30% on Equipment (including R&D)


Positive Impacts of Military Expenditure

• Air power: The U.S. has the only significant capabilities in– Strategic Transport– Refueling– Theatre Surveillance, and – Precision Bomber capabilities among NATO nations

• Navy Carrier Groups and Submarine Fleets• These capabilities are needed to meet out of area

commitments– Advanced attack aircraft on the way: F/A 22, as are

advanced unmanned vehicles• But these New dedicated weapons systems have

limited foreseeable spin-offs


Positive Impacts of Defense Expenditures

on Civilian Economy• U.S. military expenditures did result in

substantial growth in important sectors of the U.S. economy – World War II saw the growth of the U.S.

automotive, shipping, aircraft, electronics, aluminum and steel industries

– Cold War expenditures provided support for computers, semiconductors, jet engines, and rockets

• Famous case of Boeing 707 derived from bids on Air Force Tanker contracts


But these Broader Impacts are Limited

• Few Spin-offs: Military R&D often has no civilian application and is inefficient in terms of the economy as a whole– Cases do exist, e.g., cost plus contracts for

semiconductors, but the 1950-60s model no longer applies

– Major Spin-offs, e.g., the Internet and GPS have occurred, but they are widely diffused

• GPS was for missile targeting (not for tracking kids)

– U.S. Expenditures, e.g., Stealth technologies, are often high cost efforts with no foreseeable civilian spin-off


The Demise of the Defense-Based R&D Model

• The role of the military shifted in the 1970’s and ’80s as a proportion of civilian high-tech markets– Private market for semiconductors grew rapidly,

dwarfing U.S. military needs• DoD specifications, secrecy, & long

procurement cycles vitiated potential to fund cutting-edge commercial technologies– Commercial IT far outstrips Military Development

• Some ground-breaking innovation continues to occur (e.g., the Internet) but applications are pervasive and highly beneficial for new entrants, e.g., Taiwan, India


The Productive role of U.S. Military R&D Expenditure is

Overstated• Scale: The military sector is now much smaller than

during the Cold War and has fewer linkages to the economy – Top 4 Defense firms (Boeing, Lockheed, Northrop,

& General Dynamics) have a combined market cap of $102 billion

– Intel alone has a market cap of $140 billion• Caveat: Defense sector is Employment Intensive

– Defense firms: 477,200 employees – Intel: 80,500 employees

(All data as of 11 August 04)


Military R&D Allocations Sap Funds from more

Productive Uses• Are increases in US Defense R&D spending the

most efficient approach to stimulating commercial activity?

• Is the US investing in the right kinds of R&D to enhance economic competitiveness?

• Concentration of R&D Funds on Small numbers of Engineers Working on Military applications is Inefficient

• Reduces R&D Funding for Other Sectors of the Economy


Belief in Military Based R&D Model Undercut by

Practice• Much discussion of the Military R&D

Model in the 1980s & Resulting U.S. Commercial Advantage

• The fact that there was virtually no increase in Defense Expenditures among NATO allies Undercuts the Conviction of the Argument– The ’80s did see an increase in targeted

commercial technologies


U.S. Military R&D: An Appropriate Model?

• U.S. Military R&D is– Inefficient– Overcommitted– Later-Stage

• Development Focus on Testing & Certification

– Occasionally has Major Impact• GPS• Internet

– Often Widely Shared with Others


Myths and Limitations of Spin-off


Spin-Off as a Non-Targeted Economic Benefit

• Why do U.S. policymakers like spin-off as a concept?– Because spin-off appears to cost nothing

(assuming the defense expenditure is useful)– Spin-offs help justify high defense expenditures– Spin-off appears to need no government

management or targeting, thus eliminating any interference in the marketplace

– Is this true in practice?


The Limits of Spin-Off

• The substantial separation of the defense and commercial sectors of U.S. industry limits opportunities and raises costs

• Adaptation of defense innovation to commercial use is not cost free

• Focus on defense means technologies with high commercial potential are ignored– DARPA focus in on Long-term and Military

Applications, not Civilian Uses


The Limits of Spin-Off• Compared to what?• The efficiency of investments resulting

in spin-offs to meet commercial technology needs must be compared to alternatives– Comparable private sector R&D vs..

government defense R&D? – No research at all – yes, spin-off compares

favorably to not doing R&D at all


The Limits of Spin-Off• Compared to alternative institutions

– R&D at other federal agencies• Federally-funded civilian technology initiatives,

e.g. , the ATP at NIST

– Basic Research Support at NSF or NIH• These comparisons are hard to make and

therefore rarely made• Claims for spin-off benefits tend to be

comparison free – policies focused on military R&D should be grounded in the present, not just focused on isolated success cases from 40 or 50 years ago


Spin-Off: A Success Story• Direct product conversion of a product

developed at government expense is rare but does occur

• A good case is Raytheon’s microwave oven – a classic sequential spin-off within a single firm

• The conditions for success included:– A complete redesign of the magnetron microwave

power source for ease of manufacture– A five-fold reduction in magnetron cost through

learning and scale– Development of a patented safety seal to prevent

the escape of microwave radiation– Corporate acquisition of the distribution channel


Spin-Off: 2 Failures & 1 Success

• C-5 Military Transport Aircraft Competition led to Lockheed’s victory with:– Contracts for the C-5 military transport– Concurrent development of the L-1011

commercial transport• Lockheed never made a profit on the L-1011

& later withdrew from commercial air transport

• Boeing lost the competition for the C-5 with the federal support that entailed


Spin-Off: 2 Failures & 1 Success• Having lost the C-5 competition, Boeing

then “bet the company” on the 747 – C-5 design work aided development of the 747– Timing helped: The OPEC embargo ran up

aviation fuel prices, thereby helping the more fuel efficient 747 gain market share

– The focus on the commercial market helped Boeing

• Lockheed and McDonnell-Douglas had major military business – both failed in civilian aircraft production

• Conclusion: Military support works???


Some Civil-Military Cooperation Leads to Positive

“Spin-offs”• Concurrent Development of Civil & Military Applications of a Common Technology– Nuclear reactors for submarine propulsion and then

electric power production set dominant points of the technology in the United States

– GE and Pratt/Whitney design and build jet engines for related families of civilian and military aircraft

– KC135 Stratotanker & Boeing 707 had a common origin but very different design features (375 flight hours per year vs. 3000 for the 707

• Development of Engineering Techniques & Tools to Meet Government Needs– E.g., Software for computer based design and analysis

from NASA sponsored research


Various Forms of Civil-Military

Cooperation leading to “Spin-offs”

• Dual-Use Technology Developed from Defense Agency Research Support– Defense support for University research

(e.g., Artificial Intelligence) that may be valuable to civilian industry

• Reverse Spin-off or ‘Spin-on’ to Military is increasingly common– E.g., CMOS semiconductor chip technology

was perfected in Japan for use in electronic wristwatches


What Could More European Military R&D Accomplish?

• More European Military R&D Could– Enhance some European Military

Capabilities• From a few large firms?

– Encourage Rationalization• Is this good for all countries, e.g., Sweden

and France?

– Stimulate Dual-Use, High Technology• But is this likely?


Policy Issue: Allowable vs.. Effective

• Is the push for European Defense R&D like the Push for R&D Tax Credits?– Tax Credits are Expensive and Blunt, but

they are Allowed by State Aid Rules, so…– Military R&D may be Ineffective for New

Technology, but it is Exempt from State Aid Rules, so…

• Is it a case of Efficiency vs.. the Rules – Would it be better to change the Rules?


The U.S. Critique: “Spinoff cannot serve as a realistic basis

for technology policy”--Alic, Branscomb, et al (1992)

• Defense R&D does not cover gaps in nation’s technology policies– Defense contributions are growing smaller &

more specialized– Many industries benefit little from Defense

R&D• Spin-offs offer only indirect, inadvertent

contributions– Focus on spin-offs denies more direct role for

government in technology policy


Is a French-style Model Right for Europe?

• Large State selected & supported projects, insulated from rapidly changing market forces by National Procurement -- National Champion Based– Nuclear Energy– Aerospace

• Airbus, Ariane and ESA Program– Large Scale Transportation--TGV Trains – Water and Electricity Champions

• A Strategy Not well suited for rapidly changing technologies and markets, e.g., semiconductors & computers

• Is Spinoff Really the Current U.S. Model? – Is it Effective? Compared to What?

A Better Model:

Public Private Partnerships offer more Potential for Innovation in

Europe


Important to Consider Alternatives to Military R&D: Public-Private Partnerships

• Need to focus on other policies that could more effectively support nation’s Commercial Sector, such as Public-Private Partnerships– Public-Private Partnerships focus on the

hurdles between basic research & product development

– Need to adopt policies to bridge traditional government roles and traditional private sector roles


A Program “Like an SBIR” May Offer Europe Higher Returns

than “More R&D”• No New Funds Required for SBIR

– Capitalizes on Existing R&D Investments and Procurement Funds

• Focus on Valley of Death—Key Point of Vulnerability for Firms and Products

• National Program to Meet National Needs with National Firms

• Bottom-up Approach to Security– Contributes to Innovative Solutions as well

as Growth and Job Creation


The Small Business Innovation Research (SBIR)

Program• Created in 1982, Renewed in 1992 & 2001• Participation by all federal agencies with an

annual extramural R&D budget of greater than $100 million is mandatory– Agencies must set aside 2.5% of their

R&D budgets for small business awards• To be a $2 billion per year program in 2004

– Largest U.S. Partnership Program


The SBIR Model

PHASE IFeasibilityResearch

PHASE IIIProduct

Developmentfor Gov’t orCommercial

Market

Private Sector Investment

Tax Revenue

Federal Investment

PHASE IIResearchtowards

Prototype

Socialand

Government Needs

$750K$100K

R&

D

Investm

en

t


SBIR is a Bridge in the Innovation System

• Provides a Bridge between Small Companies and the Agencies, especially for Procurement

• Provides a Bridge between Universities and the Marketplace

• Encourages Local and Regional Growth, increasingly through the University connection

• Creates jobs and justifies R&D investments to the general public


The Key Question: Would SBIR Work in

Europe?• Some Believe it Would:

– “SBIR is one of the few American Technology Programmes that can be

‘Cut and Pasted’ into European Innovation Systems”• Participant at Commission Workshop,

Brussels, June 2004

– EURAB has Recommended an “SBIR type” Program


Competitive Awards to Support SME Innovation are

Needed• SBIR is a Powerful Model– U.S. National Academy of Sciences research

shows model is flexible and effective• Recent National Initiatives & Proposal by the

Commission to Permit SBIR-Type Proposals– Investing in research: an action plan for Europe,

[COM(2003) 226 final/2 – See Section 5.3, p. 19]

– TEKES has adopted a Phase I approach– VINNOVA is initiating an SBIR Program– France is exploring an SBIR-type program


An Innovation Systems Perspective on Security

• National Security is founded on a Robust Innovation System– Need to Address Linkages among many

Facets of the Innovation System• Universities, Businesses, Government

– A Robust Innovation System will help make the Nation Militarily and Economically Secure

– Robust Defense Spending alone will not make the Nation more Innovative, thus, ultimately Less Secure

• Lesson of the Cold War


The Transatlantic Cooperation Option

• The U.S. is devoting Substantial Funds to New Technologies to Meet the Terrorist Security Threat– U.S. Capacity constraints are real– Research cooperation is historically

broad and rich– Procurement is increasingly open, and

the U.S. market is large


Conclusion


Spinoff is a Popular Concept but an Inefficient Policy at

Best• Spinoff has never been a

consistently effective approach to enriching commercial technology

• At best it is a weak and expensive substitute for more direct support of the commercial technology base– Alic, Branscomb, et al.


Benefits of the SBIR & ATP Model for Defense and

Security• Small Business can bring New Ideas and New Products to address Security Needs

• SBIR provides a Proven Pathway for Small Businesses to Help the Government Meet Defense and Security Needs

• SBIR represents a Low-Cost, High-Leverage Opportunity for National Policymakers to Meet Multiple Goals at Constant Cost—No New Funds

• SBIR & ATP address the key Issues of Firm Formation, Entrepreneurship, Employment, and Growth and is therefore of Central Policy Interest


Designing More Realistic Policies for European

Innovation

• To Lead in the Knowledge Economy– Understand innovation ecosystem

•How can innovation in commercial and defense sectors draw on & support each other?

– Provide Incentives rather than Targets selected by Consensus


A Modified European Innovation Strategy

• Create New Public Private Partnerships– Involve Large & Small Firms– Encourage National Experimentation– Involve Universities in Innovation

• Focus on 3 Interrelated Elements:– Platform Technologies:

•Respect Political Commitment– Competitive Awards to Large & Small Firm

Joint Ventures [The Advanced Technology Program (or ATP) Model]

– Competitive Awards to SMEs & Start-ups (SBIR Type Program)


Keeping Europe Secure• Keeping Europe Secure requires,

– Economic growth to safeguard the Social Compact

– New Technologies to provide Cheaper and Better Social Services, Health Care, Environmental Protection, and National Defense

• Partnerships are one way to do this

• SBIR Breaks Through the Oligopoly Supply Base for government agencies– Provides new technologies and new solutions


Common Challenges• Learning from Each Other is a Key

to Better Innovation Policy– Learning from failures (and

distortions) can be as valuable as learning best practice

• Sorting Myths from Reality is a First Step Towards More Growth and More Security


Thank You

Charles W. Wessner, Ph.D.Director, Technology and Innovation

The National Academies500 Fifth Street NW

Washington, D.C. [email protected]: 202 334 3801

http://www.nationalacademies.org/step

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