President Obama’s State of the Union address last night demonstrated the importance of U.S. science and economic competitiveness to a prosperous and growing middle class. His focus on “keeping the American Dream alive,” invoking core American values of “fair play,” and “shared responsibility,” were inexorably linked to his administration’s past innovation policy actions and proposals for 2012.

This reflects the Obama administration’s clear understanding that innovation is an intrinsic aspect of the American identity, and an indispensable tool to ensuring the future success of our economy and middle class. Indeed, as the president said last night, “innovation is what America has always been about.”

Certainly, technology can be a double-edged sword. It creates, as the president said, “new American jobs, and new American industries,” but “technology… also [makes] some jobs obsolete.” The only way to compete for the new jobs, new businesses, and new industries that technology brings is to keep our economy on the cutting edge by investing in the building blocks of innovation—the assets our businesses, workers, and industries need to stay best in class. The blueprint the president unveiled last night outlined a robust vision to invest in those building blocks, which include:

• Innovative manufacturing
• A work force with technical skills
• Thriving small and startup businesses
• Modern infrastructure
• Access to international markets
• Robust public research and development

These innovation building blocks mirror closely the broad policy areas we identified and developed in our recent package of five policy reports on U.S. science, innovation and economic competitiveness.

The president in his speech gave key examples of these innovation factors now at work in our economy. First, he alluded to the importance of innovation in manufacturing when he touted his policies that helped Detroit retool and restructure to adapt to changing market conditions. Proposing that high-tech manufacturers who innovate here at home rather than outsourcing their facilities get a tax deduction, Obama suggested “what’s happening in Detroit can happen in other industries. It can happen in Cleveland and Pittsburgh and Raleigh.” Our work on innovation clusters has long argued the same thing, and a forthcoming paper on manufacturing innovation looks into this in more detail.

The next part of the president’s blueprint for an innovative economy is technical skills for the workforce. “Higher education,” said the president, “is an economic imperative,” and outlined the problems our innovation-intensive industries face today:

“I hear from many business leaders who want to hire in the United States but can’t find workers with the right skills. Growing industries in science and technology have twice as many openings as we have workers who can do the job. Think about that: openings at a time when millions of Americans are looking for work. It’s inexcusable. And we know how to fix it.”

To address the problem, the president invoked the story of Jackie Bray, who benefited from a regional partnership between a Siemens gas turbine factory and a local community college that helped her get the skills she needed to help fill one of these technology job shortages.

In order to better equip our students with the skills they need to stay competitive in the 21st century global innovation economy, he outlined proposals to expand access to higher education, transform community colleges into community career centers, and streamline access to scattered federal workforce training assistance programs through a single program. Our papers “Building a Technically Skilled Workforce” and “Rewiring the Federal Government for Competitiveness” contain detailed versions of these proposals.

The president also noted that another piece of the puzzle to building the workforce we need is to “stop expelling responsible young people who want to staff our labs or start new businesses.” Our paper “Immigration for Innovation” addresses this need to reform our high-skill immigration system to ensure the United States remains the land of opportunity for all.

The president also spoke forcefully about the importance of inventive entrepreneurs to our economy and of the returns on public investment in research and innovation. Noting “most new jobs are created in startups and small businesses,” President Obama called for policies to help them succeed.

“Thousands of Americans have jobs,” he said, thanks to our public investments in clean technology innovation. He also pointed out that “the payoffs on these public investments don’t always come right away. Some technologies don’t pan out; some companies fail.” The fourth paper in our series on science and competitiveness, “Universities In Innovation Networks” contains five broad pieces of policy that would help accelerate the motion of basic research to market through the commercialization of university research.

President Obama also reiterated his proposal to consolidate trade and commerce agencies to make the federal government work better in ensuring businesses large and small have access to international markets for their products and technologies. Our paper “Rewiring the Federal Government for Competitiveness,” takes this proposal and goes into deeper detail about how consolidation of federal trade, technology, workforce training, and economic development programs and agencies can help promote more strategic coordination of these activities and promote innovation and competitiveness of U.S. businesses and regional economies.

The president’s State of the Union address demonstrates the importance that science and innovation policy play in his larger efforts to rebuild our middle class and return to our core American values. Innovation policy is a key piece of the toolset the Obama administration will use to develop an economy build to last and keep alive the American dream for the middle class.

Ed Paisley and Sean Pool are the coordinating editors of the series on U.S. science and economic competitiveness by the Center for American Progress. Ed Paisley is Vice President for Editorial at the Center. Sean Pool is assistant editor in charge of the Center’s Science Progress project.

Universities are not only on the front lines of scientific and technological discovery but also at times hotbeds of entrepreneurship. In 2010 alone 651 new startup companies formed around the commercialization of university-licensed technology, and more than 3,600 such small businesses founded in previous years continue to operate.

But many promising patents remain stuck in university labs, inaccessible to the market. The result: Despite the roughly $50 billion of federal dollars spent annually on university research, too few new technologies make it through the pipeline from paper, to patent, to product.

There are many structural and cultural reasons why many universities do not maximize the potential of their small-business technology spinoffs. A key one is that the federal funding on which much university research depends does not encourage universities to prioritize the commercialization of the resulting technology. As a result, universities and the researchers they employ too often do not have strong incentives to take time away from research—and applying to basic research grants—to acquire and maintain the physical, human, and financial capital required to develop technological discoveries into new and useful products.

To be sure, programs such as federal Small Business Investment Research and Small Business Technology Research grants, which we discussed last month in this series, do exist to help small businesses conduct advanced technology research and development. But these programs are geared toward entrepreneurs who already have a business plan. They do little for the thousands of potentially useful patents, those with the potential to spawn new businesses and jobs quickly, that sit idle in university labs or technology transfer offices.

The solution: Help universities develop robust innovation programs where small technology spinoff companies can flourish

The government should ensure that federal research money also supports university-led initiatives to develop innovation and entrepreneurship ecosystems that nurture tech spinoff companies. In a forthcoming paper from the Center for American Progress’s “Doing What Works” and Science Progress projects, Krisztina “Z” Holly, vice provost for innovation at the University of California, outlines a multipoint policy package to achieve this goal. Here we focus on a few of the most important components as they relate to small business success.

Next steps: Authorize changes to existing research funding

In the forthcoming paper, “Universities and Innovation Networks,” Holly proposes changing all federal research grants to ensure they cover the costs of patenting and licensing of the most promising technologies. Today many federal research grants don’t actually cover the diverse costs of extracting the economic value of funded research through commercialization.

In 2010 universities spent $323 million on legal fees associated with technology licensing alone. Certainly not all research leads to a patentable product, nor should it. But setting aside even 1 or 2 percent of existing research funding to cover not just research, but also the first steps toward commercialization, where appropriate, would make a big impact.

Next, the government should create an automatic glide path for technologies from paper, to patent, to product. Bringing university research and small-business grant makers together under a federal common application assistance program, like the one we suggested earlier in this series, would allow application procedures to be coordinated to help university researchers connect with the business expertise needed to develop patents into marketable products.

Finally, we should set aside some federal funding to incentivize universities to acquire and maintain the human, physical, and financial capital needed to support a culture of entrepreneurship. As we alluded to in a previous article in this series, setting aside even a few million dollars for technology commercialization proof-of-concept centers could go a long way. These funds would not be used to invest in specific research projects themselves, but rather to encourage universities to invest in the infrastructure of technology commercialization, such as technology transfer offices, entrepreneur-in-residence programs, and business incubators.

Evidence shows that supporting technology spinoff companies yields a great return on investment. As Holly pointed out in a 2010 Science Progress paper, a $10 million grant spread between the University of San Diego and the Massachusetts Institute of Technology for proof-of-concept centers leveraged $160 million in outside investments. At the University of Southern California a $22 million gift from a private donor for similar activities has leveraged $148 million in private capital and supports 500 jobs.

And it’s not just big name academic institutions or top-50 schools located in populous states that are creating good business opportunities with their technology. The University of Utah in the past six years has spun out 125 companies, an average of one new small business for every $12 million in federal research funding, compared to the national average of one company per $100 million. All in all, small business spawned from research at the University of Utah accounts for more than 15,000 jobs, $755 million in annual personal income, and $76 million in annual tax revenue.

Smart federal investments can help many other research universities identify and capitalize on their competitive strengths. That also helps the small businesses these campuses spin out, as well as the surrounding communities that benefit from new job creation and economic activity.

Ed Paisley is Vice President for Editorial at the Center for American Progress. Sean Pool is Assistant Editor in charge of the Center’s Science Progress online magazine. Paisley and Pool are the project coordinators and lead editors for the forthcoming series of papers on U.S. science and economic competitiveness.

The problem: Federal government assistance for innovative startup companies too often misses the mark

High-growth startup companies are one of the most important drivers of job creation in the economy today. They are also vital to tackling some of our most pressing long-term societal challenges such as improving our health care, education, and energy systems. It’s clearly in our national and economic interest to help entrepreneurs and innovators succeed.

Unfortunately, many existing small-business loan and assistance programs are not optimized to help the innovative startup firms reach their job-creation potential. The reason: Fledgling startup companies—those with great a idea but without a clear path from proof-of-concept to commercialization—face unique financing challenges that the federal government’s small-business policies are not tailored to solve.

Fully unlocking the power of America’s innovators to create jobs will require Congress to act to support high-potential startup companies at their earliest stages of growth.

The solution: Revamp small-business financing programs to get companies with high growth potential through the crucial proof-of-concept phase

Here’s a solution: Revamp small-business financial assistance programs to better serve the needs of innovative, high-growth potential startup firms.

The Obama administration has already taken some encouraging steps toward this end. In October 2011, the president issued a presidential memorandum asking agency heads and federal lab directors to review current technology transfer priorities and develop plans for improvement. And the just last week the administration announced the creation of a $1 billion Early Stage Innovation Fund. This fund will provide matching capital to private loans already made through the existing Small Business Investment Company program. To help with this, the Startup America Partnership, a public-private partnership between the White House and more than 50 corporate partners, pledged an additional $1 billion in donated services geared toward helping 100,000 entrepreneurs and innovators get businesses off the ground over the next three years.

The 50 companies involved will provide free software, consulting, and legal services to the innovative startups with the most job-creating potential. And not a dime of this $1 billion commitment comes from taxpayers.

But the federal government can do more to help bridge the gap between early-stage research and the marketplace. It needs policies and programs that:

• Increase mutually beneficial flows of knowledge and intellectual property between academia and industry
• Support university technology-based spinoff companies
• Encourage public-private partnerships that support translational research and proof-of-concept projects that demonstrate to private investors the viability of new ideas in the marketplace

Here are the avenues to achieve these ends: The Small Business Innovation Research, or SBIR, and Small Business Technology Transfer, or STTR, programs administered by the U.S. Small Business Administration allocate 2.5 percent of federal agency grants for small businesses. That’s a key resource for some small companies seeking to bring early-stage innovations to market. Yet many university innovations are created too early to spin out into a company, so this program does not fully address the need for earlier-stage proof-of-concept funding.

Although some universities have managed to secure donor and private-sector funding to cover some of the costs of proof-of-concept programs, even the most successful programs struggle to become sustainable on these sources alone. That’s why the federal government should encourage other funding sources such as industry and donor support to extend the impact of the federal funding. Given the importance of transitioning between early-stage research and spinout startup companies, funding proof-of-concept projects is an appropriate role for the federal government to play.

Next steps: Reauthorize SBIR and STTR programs and set aside money to fund proof-of-concept centers

The chairs of the Republican-controlled House Small Business Committee and House Science, Space, and Technology Committee announced on Monday they had reached a deal with congressional democrats to reauthorize the SBIR and STTR programs through 2017. While the deal contains progress on many important fronts—including increasing program funding levels and maximum award amounts, increasing eligibility for companies with more diverse investment profiles, and setting new standards and oversight—it could go further to support the journey of innovative technologies from lab bench to assembly line.

One important way to do this would be to enhance the program by setting aside a portion of funding for proof-of-concept centers. Krisztina “Z” Holly, the vice provost for innovation at the University of Southern California and executive director for the USC Stevens Institute for Innovation, first proposed this idea in a 2009 policy paper called “Innovation Model Program for Accelerating the Commercialization of Technology.”

In a forthcoming paper by Holly from the Center’s Doing What Works project and online magazine Science Progress, she elaborates on this idea, noting that “the need is now acute. If past experience can be a guide, even a modest investment of $80 million could potentially stimulate $1 billion in private-sector investment in ideas that would otherwise be too early and risky for investors to currently bet on.”

That’s an effective, efficient way to bring federal money to bear in helping the private sector create more innovative small businesses that contribute so much to job creation in our country.

Ed Paisley is Vice President for Editorial at the Center for American Progress. Sean Pool is Assistant Editor in charge of the Center’s Science Progress online magazine. Paisley and Pool are the project coordinators and lead editors for the forthcoming series of papers on U.S. science and economic competitiveness.

But what is the correspondingly simple mantra for the progressive economic philosophy? That is a harder question to answer, even for progressives. But after last night’s address we now have a strong candidate: innovation and competitiveness.

The president mentioned innovation and competitiveness numerous times throughout his address Tuesday, and outlined with surprising clarity a strategy to invest in all of its building blocks: science, education, workforce training, infrastructure, manufacturing, small businesses, access to domestic and export markets, and incentives to spur private capital investment.

This is encouraging news for us at Science Progress, since we have been working to advance the notion of the innovation-driven economy for years. Our unpublished prospectus—the document that, like a constitution, launched our little program—begins with the statement, “An appreciation for the importance of innovation must be central to any progressive philosophy.” Our mission statement from 2007 talks about the important role that science (and by extension, innovation) has on driving economic growth [emphasis added]:

“Science Progress proceeds from the propositions that scientific inquiry is among the finest expressions of human excellence, that it is a crucial source of human flourishing, a critical engine of economic growth, and must be dedicated to the common good.”

In a more recent article, we pointed out the long-simmering but still rarely discussed consensus that innovation is what drives modern economic growth, and how the United States is falling behind in educating our students with the skills to succeed in the 21st century innovation economy. Obama echoed these words when he said,

“Maintaining our leadership in research and technology is crucial to America’s success. But if we want to win the future—if we want innovation to produce jobs in America and not overseas—then we also have to win the race to educate our kids.”

In another article, we talked about how innovation and competitiveness are inseparable. An economy that does not innovate cannot compete in the long run. We pointed out how technological innovation, broadly speaking, had been responsible for between half and three-quarters of all economic growth over the 20th century. To this, the president pointed out that,

“In America, innovation doesn’t just change our lives. It is how we make our living.”

In that article we also observed how the private sector alone tends to under-invest in innovation because of the positive externalities of knowledge spillover. Much of the benefit of innovation is invisible to the market because of the unexpected ways the inventions of today influence the development of the technologies of tomorrow. This necessitates the intervention of public policy.

Today, as in the past, public policy has a strong role to play in setting the course for innovation-driven economic growth, job creation, and competitiveness. The federal government must set goals that signal to investors that there are lucrative opportunities awaiting those who invent and commercialize technologies that help solve social, medical, and environmental problems. But at the same time, we should not pick winners, but must instead let businesses in the private sector compete to commercialize only the best and most cost-effective new technologies and production methods. Again, the president echoed these sentiments in his State of the Union speech:

“The first step in winning the future is encouraging American innovation. None of us can predict with certainty what the next big industry will be or where the new jobs will come from. Thirty years ago, we couldn’t know that something called the Internet would lead to an economic revolution. What we can do—what America does better than anyone else—is spark the creativity and imagination of our people. We’re the nation that put cars in driveways and computers in offices; the nation of Edison and the Wright brothers; of Google and Facebook…

Our free enterprise system is what drives innovation. But because it’s not always profitable for companies to invest in basic research, throughout our history, our government has provided cutting-edge scientists and inventors with the support that they need. That’s what planted the seeds for the Internet. That’s what helped make possible things like computer chips and GPS. Just think of all the good jobs—from manufacturing to retail—that have come from these breakthroughs.”

In our most recent report, “Rising to the Challenge: A Progressive U.S. Approach to China’s Innovation and Competitiveness Policies,” we noted how China’s growing prowess in science, education, research, information technology, and infrastructure are all contributing to the emergence of a Chinese innovation economy. “China,” the president said on Tuesday, is

“educating their children earlier and longer, with greater emphasis on math and science. They’re investing in research and new technologies. Just recently, China became the home to the world’s largest private solar research facility, and the world’s fastest computer…[they are] building faster trains and newer airports.”

Indeed, China is also home to the world’s largest hydroelectric dam, and the world’s fastest bullet train. The number of published scientific articles in China recently surpassed that of Germany and Japan to take the number two spot behind the United States, and is on course to surpass even that within the decade.

“This is our generation’s Sputnik moment,” the president said, implicitly comparing our lack of investment in a space program, research, and education in an era of Soviet competition then to our lack of an innovation-driven competitiveness strategy in an era of global competition now.

On the whole, the president’s words on Tuesday very clearly pointed to one realization: we live in an innovation-driven global economy. The sooner our government becomes savvy to this reality, the sooner we can start to systemically accelerate our progress toward fulfilling our national priorities. Our nation needs a cross-cutting and comprehensive innovation agenda to shape federal policies toward maximizing the potential for innovation in all sectors.

And yes, the president pointed out in his address, a key part of achieving our goals will require us to rein in our deficits. But, as the president put it on Tuesday,

“Gutting the deficit by gutting our investments in innovation and education is like lightening an overloaded airplane by removing its engine. It may make you feel like you’re flying high at first, but it won’t take long before you feel the impact.”

The president has talked about Innovation before, noting that ”innovation is in our DNA.” But during Tuesday’s speech we glimpsed how innovation has the potential to become a new intellectual architecture underpinning progressive thought. Obama’s speech on Tuesday elevated innovation from just a nice sounding word that corporate CEO’s sometimes throw around, to a core element of the progressive strategy for winning the future.

Such a strategy rests on the idea that every dollar that improves a child’s abilities in math; or helps a worker obtain new skills in technology, science, engineering or business; or helps a small business find the capital to invest in new manufacturing equipment to make its product cheaper, faster, or more reliably; or connects a brilliant university researcher to an investor willing to support commercialization or his potential breakthrough; or helps a technology company market a new clean energy product overseas will pay us back down the road in innovation, job creation, tax revenue, and competitive economic growth.

“We know what it takes to compete for the jobs and industries of our time,” the president said. “We need to out-innovate, out-educate, and out-build the rest of the world.”

His words suggest that “innovation,” in its broad sense, has the potential to be as synonymous with progressivism as “tax cuts, less government” are with conservatism. After 30 years witnessing the shortcomings of trickle-down economics, it’s about time we shed those old ideas. After all, as the president said in his concluding remarks, “that’s what Americans have done for over 200 years: reinvented ourselves.”

Ed Paisley is the Vice President of Editorial at the Center for American Progress and Editorial Director for Science Progress, Sean Pool is the Assistant Editor for Science Progress.

Download the executive summary (pdf)

When Chinese president Hu Jintao alights in Washington, D.C. next week for a summit meeting with President Obama, he will learn firsthand that China is fast becoming the touchstone against which everything wrong with the U.S. economy is measured. In the run up to last year’s midterm congressional elections, candidates across the country accused one another of “sending jobs to China” instead of creating jobs at home. Members of Congress on both sides of the aisle regularly promise to seek trade sanctions against China for undervaluing its currency. The United States recently accepted a United Steelworkers petition accusing China of unfairly subsidizing its exports and hoarding raw materials essential for clean energy technology development. And U.S. companies across a range of industries are increasingly voicing their complaints about China’s theft of their intellectual property and the country’s forced transfer of cutting-edge U.S. technology in exchange for access to the nation’s vast and fast-growing domestic market.

The overarching message coming from the United States is this: If China would just stop cheating, the U.S. economy would rebound, helping both nations and the rest of the world recover more sustainably from the Great Recession and sparking broad-based economic growth on both sides of the Pacific. Equally forcibly (though in more diplomatic language), President Barack Obama is expected to deliver that same message.

What this view assumes is that if only China would stop cheating, the U.S. economy would do what it has done best for the last hundred years or so—lead the world based on our prowess at science, technology, and innovation. After all, our universities are the best in the world, or entrepreneurialism is world-renowned, and our ability to turn new ideas into new job-creating products and services is unsurpassed. But this interpretation is not entirely accurate.

China is now investing in many of the building blocks of innovation-driven economic growth that the United States has all but abandoned over the past several decades. Pick your sector and you’ll find China spends more on a per capita basis, and sometimes in total amounts, on public investments in basic science and education, research and development, or R&D, infrastructure development, and workforce training. What’s more, China’s leaders have crafted coherent policies and programs in support of domestic manufacturing and services for export abroad and to ensure Chinese companies have the prime positions in China’s rapidly growing domestic economy.

China, in short, is actively and methodically building up the basic foundations for future economic growth while also ensuring a market for its current and future products and services at home and abroad. The country’s leaders understand completely the message driven home by The World Economic Forum, in its monumental Global Competitiveness Report 2010-2011, which underscores the importance of innovation as the basis for long-term economic growth:

Although substantial gains can be obtained by improving institutions, building infrastructure, reducing macroeconomic instability, or improving human capital, all these factors eventually seem to run into diminishing returns. The same is true for the efficiency of the labor, financial, and goods markets. In the long run, standards of living can be enhanced only by technological innovation. Innovation is particularly important for economies as they approach the frontiers of knowledge and the possibility of integrating and adapting exogenous, [or imported,] technologies tends to disappear.

China and the United States have very different legal, political, and economic systems, but both are bound by the same reality that to be competitive in the 21st century global economy, they have to innovate. But unlike most political leaders in the United States, China’s leaders recognize that innovation is not created in a vacuum. Across the globe, developed and developing countries are realizing what economists have known for years—that technological innovation, more than any other factor, fuels long-term economic competitiveness and growth, and that innovation in turn requires a robust and well-integrated foundation of education, research, and infrastructure.

The widespread recognition of these principles has sparked a global race to the top in innovation, science, and technology policy. But judging from the state of our innovation policy, the United States seems to have missed the memo. Other nations see innovation and competitiveness as two sides of the same economic coin. And not surprisingly, as John Podesta, Sarah Wartell, and Jitinder Kohli point out in CAP’s recent report, “A Focus on Competitiveness,” “…other countries organize their economic policy apparatus more explicitly around the question of how to effectively compete.”

China in particular does this very well. In this paper, we examine the challenges posed to current and future innovation-led economic growth in the United States by China’s drive to boost innovation at home by any means available. As we will demonstrate, some of these challenges cut to the core of our nation’s own global economic and scientific strengths—even though some of China’s innovation policies and programs are plagued by inherent liabilities that are built into the country’s approach to innovation.

Some Chinese R&D spending, for example, ends up fueling academic fraud, a huge problem in China, where local scientists often try to lay claim to new discoveries that are bogus. But the spending levels are still impressive, as is the fact that China has taken pains to invest across the entire innovation chain from basic science, to R&D, to market creation for new technologies, to production and deployment of these technologies. This is paying innovation dividends in hybrid electric vehicles, advanced batteries, high-speed rail, and solar power systems, to name a few.

Indeed, one of China’s other innovation “assets” is its growing direct investment in basic research and development. In 2008, China’s gross national expenditure on research and development stood at roughly $66 billion, or about 1.5 percent of China’s gross domestic product. This is the highest investment level among developing economies as a percent of their domestic economy and ranks China fourth in the world in overall R&D spending behind the United States, Japan, and Germany.

Similarly, China’s massive domestic investments in global market-scale industries such as clean technology products, transportation, mobile telecommunications and aerospace are now enabling Chinese companies in these sectors to compete for business abroad and dominate their home market. Again, there are liabilities built into this strategy: Economists can point to costly misplaced investments in some of the infrastructure needed to get these industries off the ground—misinvestments that saddle the Chinese state-owned banking system with an entire new raft of non- performing loans and resulting in way too many empty science parks and regional industrial zones that are no more than property speculation gone awry.

This same strategy—key directed investments in science and innovation to spur rapid economic growth no matter the cost—is even evident in the Chinese government’s planning processes. China’s famous communist-era “five-year plans,” which often bore little relation to reality, are now precise blueprints for strategic market-oriented, innovation-led economic growth to spur job creation at home and exports abroad. Then as now, however, local political and business leaders in China’s provinces and cities, counties and townships continually go their own way in interpreting these plans and then spending the cash, often resulting in misleading statistical data flowing back to Beijing “proving” the metrics of the blueprint are being met while in fact the funds are being spent on a variety of other activities, including local property development and speculation.8

But these liabilities do not mean that U.S. policymakers can afford to be complacent. China’s so called “import/assimilate/re-innovate” model of technology development, for example, actively drives foreign companies to share their technologies with Chinese joint venture partners in exchange for access to the cheap Chinese workforce and burgeoning domestic marketplace. This strategy poses a direct challenge to U.S. competitiveness because it enables Chinese (often state-owned) companies to gain access to cutting-edge technologies but also build upon them incrementally to create a Chinese innovation ecosystem. Never mind that economists recognize that the downside to this model of economic development is that it delivers diminishing returns without genuine domestic innovation delivering world-class breakthroughs.

In the pages that follow we will examine China’s innovation assets and liabilities as the country races to build a globally competitive innovation-led economy, and then consider how the United States should react to these challenges. We then offer our recommendations to U.S. policymakers on steps our own government can take to ensure our nation rises to meet the challenges posed by China. Briefly, though, we will argue that the U.S. government needs to give our nation’s innovation engine a tuneup by:

• Modernizing our basic infrastructure to allow businesses to more effectively collaborate and compete in domestic and international markets
• Investing more in science and math education and workforce development to ensure we have workers able to participate in the technology-driven economy of the present and future
• Crafting finance policies to make more public and private capital available to innovators and bolster our culture of entrepreneurship by rewarding risk-taking and competitiveness
• Promoting international trade policies that ensure access to foreign markets, and the free flow of goods, services, knowledge, and capital across borders
• Honing our research and development policies so that we invest not just in basic research but also the full innovation lifecycle from invention, to development, to production and commercialization

These are progressive proposals that would boost our national competitiveness and jobs growth in the short run and ensure our once-dominant position in science and technology, innovation and entrepreneurship, and job creation is not eclipsed by China in the 21st century. On the eve of Chinese president Hu Jintao’s visit to Washington, these are progressive proposals that Congress and the Obama administration dearly need to take to heart.

Kate Gordon is the Vice President for Energy Policy, Susan Lyon is a Special Assistant for Energy Policy, Vice President for Editorial, and Sean Pool is the Assistant Editor for Science Progress.

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Download the executive summary (pdf)

View this post at the Center for American Progress Website.

The key feature of the proposal unveiled today is that these seven federal agencies will seek bids from regional economies around the country, requiring a “bottom up” self-organizing effort by states and localities, universities and federal research labs, workforce development agencies and the private sector. This was one of the key recommendations in our paper, “The Geography of Innovation,” and is widely regarded among economic development experts and innovation gurus as the best way to build regional innovation clusters in the United States. Capitalizing on our country’s unique regional science and technology strengths, entrepreneurial flair and strong work ethic, targeted federal funds will help these regional clusters self organize and compete on a global scale.

The Center for American Progress is at the forefront of the push to create more energy-efficient buildings and the new green jobs to do the retrofitting and weatherization work, presenting a variety of policy initiatives to the administration and Congress. These efforts, in tandem with a soon-to-be-recognized-and-funded regional innovation cluster dedicated to the same technologies and workforce development objectives, are an important way for the U.S. economy to grow and thrive on the back of 21^st century innovation technologies.

Angel investors aren’t in this game to earn their wings, of course. Wealth is the goal, but so too is job creation for these mostly local serial entrepreneurs who thrive on the thrill of building companies that help their communities grow and prosper. Problem is, these and other very early-stage investors in innovation companies—including the inventors and founders of these new companies and their friends and family who put up their first rounds of cash—often don’t reap the rewards of their early risk taking. The reason: Once a young company reaches a certain point of success it usually stumbles as it tries to bring its new product or service to market—at the very time it needs lots more money to grow.

Enter the professional venture capitalists, who demand a big majority stake in the young company in exchange for the new cash, and then do the same again when the company needs a second and third round of venture capital. In fact, venture capitalists these days are by and large not doing what they once did for the U.S. economy—backing early stage innovation to create the Googles and Genentechs they once did. This job is falling more and more to angel investors.

According to the National Association of Seed and Venture Funds, “venture capital plays almost no role in funding basic innovation, and a relatively small role in funding true startups, with only about 3 percent of the $21 billion VCs invested in 2005 going to such firms.”[1] Long-time venture capital lawyer Joseph Bartlett, who also runs the website VCExperts.com, gives a great example of this problem in action in a forthcoming report:[2]

To illustrate, let me repeat an anecdote which I share with my classes at law and business schools, to wit: In real estate the three rules of successful investing are “location, location, location.” The gag is that they are all the same rule. Transposing that wisecrack to venture capital, I preach that the three rules are: “dilution, dilution, dilution.”[3] I draw an inverted bell shaped curve on the blackboard and show how the early capital, which is the highest risk and therefore should be entitled to the highest reward, can so often be burnt out or crammed down by subsequent rounds of financing, including (as the curve slopes downward to its nadir) the “down rounds” which dilute the founder and the angels to trivial interests in the company. Then, when the company, as companies often do, recovers and is sold or goes public, the result is all too familiar: The VCs who invested in the later rounds, having crammed down their fellow investors, wind up making out like bandits, but the earliest money is left bleeding on the shore.

Angel investors know this, as do the entrepreneurs they finance, and they all take their chances anyway. Such risk-taking is the lifeblood of U.S. economic competitiveness. But increasingly these angels are not stepping up, depriving the U.S. economy of the most critical stage of risk capital formation for the creation of globally competitive new companies and good paying new jobs for their employees. “The economic impact of the seed money gap is staggering,” says Bartlett:

At a conservative minimum, at least $4 billion is lost to the U.S. economy each year. More realistically, the economy losses closer to $100 billion per year because of the funding gap. Socially, the losses are just as great. Products and services that would improve the lives of our country’s people are either never developed, or significantly delayed.[4]

Here’s one way that Congress and the Obama administration could fix the problem, according to Bartlett in his forthcoming report. The United States, he says, needs a tax efficient structure by which angels and founders and other very early stage investors in young companies can mitigate the impact of dilution brought on by subsequent venture capital financings. His vehicle for doing this are what he calls “up-the-ladder” warrants,[5] which would enable early investors in young companies to participate fully when the company eventually goes public or is sold—because of the warrants that will make up for the dilution the angels and entrepreneurs encounter because of follow-on rounds of venture financing. Warrants are financial instruments that allow holders to purchase stock in a company when the shares reach a pre-determined price—stock that can then be sold or held onto for capital gains and wealth accumulation.

The exercise price—the price at which the holder of the warrant can purchase stock—would need to be set at a number that is well “out of the money,” says Bartlett, which in financial parlance means well above the current share price, hence the name “up the ladder.” This would keep the VCs content to leave the warrants in place when they invest. Assuming all goes well with the sale or public offering of a startup financed by angels and VCs, everyone can profit. Here’s how Bartlett thinks the structure would work:[6]

• Angels invest $1,000,000 for 100,000 common shares ($10 per share) at a pre-money valuation of $3 million, resulting in a post-money valuation of $4 million ($1 million going into the new company in the form of additional stock); the founder and key employees own 300,000 common shares.
• The package includes 100 percent warrant coverage, meaning there is also a “call” on the company to issue another 100,000 shares of the company’s stock at a pre-determined exercise price.
• This exercise price must be based on pre-money valuations that are relatively win-win for subsequent venture capital investors so that these later investors do not require the warrants be eliminated as a price for future investments. So, in our example here, the warrants will be based on pre-money valuations which are in fact win/win, say at $30, $40, and $50 a share (33,333 shares in each case).
• Since the angels have invested $1 million at a post-money valuation of $4 million, they therefore own 25 percent of the company—100,000 shares out of a total of 400,000 outstanding. The three warrants, as stated, are each a call on 33,333 shares.
• Subsequent “down rounds” of VC investment—a down round means an investment at a share price lower than prior to the investment—later raise $2 million and dilute the angels’ share of the company’s equity from 25 percent to 5 percent—their 100,000 shares now represent 5 percent of 2,000,000 shares (at a cost basis of $10 per share).
• The founder and key employees own 300,000 shares, or 15 percent and the VCs own the rest (1,600,000 shares at a cost basis of 80 cents a share due the down rounds).The company then climbs out of the cellar and a trade sale is scheduled for $100 million in cash, or $50 per outstanding share.

Absent “up-the-ladder” warrants, the proceeds to the angels would be $5 million. This is not a bad return (5 times their original investment) but nonetheless inconsistent with the fact that the angels provided the initial cash capital (the founder and employee contribution is largely sweat equity). The “up-the-ladder” warrants would add to the angels’ ultimate outcome as follows: 33,333 warrants at $30 per share are in the money by $666,660 and 33,333 warrants at $40 a share are in the money by $333,330. So the angels net an additional $999,999—call it $1 million—out of the purchase price.

The angels’ total gross returns have increased to 6 times their original investment while the returns to the VCs and the founder/employees have slid to $94 million. Even if the $1 million going to the angels comes entirely out of the VC’s share, that’s a relatively trivial result—a gross payback of 39.5 times their investment versus 40 times. If the company sells for just $30 a share, the angels get nothing because the exercise price is not above the actual share price, and the VCs still make out.

Now there needs to be a reason for venture capitalists to offer these warrants not just to angel investors but also to the founders, friends, and family invested in these new and innovative companies, and perhaps also to the employees in the company who are working so hard to make it a success. Bartlett argues that capital gains on the warrants should be treated as taxable under Internal Revenue Code Section 1202, which reduces by half the tax on the gain from the sale of securities issued by so called Qualified Small Businesses, assuming that the investment has been held for five years. And the capital gains would not to be subject to Alternate Maximum Tax.

For this to work, though, there need to be carrots and sticks to persuade venture capitalists to offer and then honor these warrants all the way to a profitable “exit.” One way would be to provide the same capital gains treatment to venture capital investors under IRS Code Section 1202—provided the venture investors offer these “up-the-ladder” warrants to the founders, the angels, and other early -stage investors in the company, and perhaps the company’s employees, too.

Remember, taxpayers will not be out any money if the company is not financially successful, as this tax break only applies after successful investing. And the tax break for venture capital investors would not apply unless they offered these up-the-ladder warrants to all early-stage investors in the company between the original rounds of investments and the final valuation of the stocks upon the sale of the company.

Broad-based wealth creation in the service of stronger job creation to boost U.S. economic competitiveness. Surely that’s a win-win-win.

Ed Paisley is the Editorial Director for Science Progress and the Vice President, Editorial at the Center for American Progress.

Endnotes

[1] NASF, “Fostering Innovation Capital,” Seed and Venture Capital State Experiences and Options, May 2006, p. 4.

[2] “The Great Debate: Half Full vs. Half Empty,” a forthcoming paper by Joseph Bartlett, to be published in early 2010, which will dissent from the idea there is too much investment in venture capital in today’s environment in the United States.

[3] See www.vcexperts.com, Buzz Archive: http://vcexperts.com/vce/news/buzz/archive_view.asp?print=true&id=78.

[4] Bartlett, Keller, Materfis, “An Initial Measurement of the Impact of the Seed Money Gap in the U.S. Economy,” Section 13.1.3, www.vcexperts.com.

[5] http://vcexperts.com/vce/news/buzz/archive_view.asp?print=true&id=109

[6] Summarized from the forthcoming paper, “The Great Debate: Half Full vs. Half Empty.”

Innovation is the critical component of long-term economic prosperity, driving productivity growth and (if spread across key sectors of the economy) ensuring broad-based economic growth. Sparking innovation, however, requires capital (which is threatened by the current economic downturn), skilled-labor, scientific and technological advances, and creative collaboration between government and the private sector. Innovation cannot be dictated, but it can be cultivated.

In this paper, we focus on the importance of President Barack Obama’s call for a new federal effort to support regional innovation clusters. We know now—from a solid record of state and local achievements and academic research—that regional innovation clusters are a critical component of national competitiveness. Geographic regions that are bound together by a network of shared advantages create virtuous cycles of innovation that succeed by emphasizing the key strengths of the local businesses, universities and other research and development institutions, and non-profit organizations. Think information technology in Silicon Valley, music in Nashville, manufacturing in the Pacific Northwest, or life sciences in Massachusetts.

The United States, we argue in this paper, requires innovation policies for which responsibility is shared between regional leaders and the federal government. Leadership must begin in the clusters themselves—with local understanding of competitive strengths and strategies to increase the shared advantages that economists recognize as “positive externalities.” The federal government, however, can and should assume a vital role in which it frames critical national challenges, facilitates the flow of information and expertise to and between regions, and helps finance, in a competitive and leveraged fashion, valuable activities that clusters would otherwise be unable to undertake.

To that end, President Obama has requested that $100 million be appropriated in fiscal year 2010 for the Economic Development Administration of the Department of Commerce to support regional innovation clusters and associated business incubators.[1] That request is, by itself, a very small portion of the federal innovation budget. The U.S. government each year spends about $150 billion on basic scientific research and development. The EDA funding would help scientific breakthroughs resulting from this research find their way into new products and services that, in turn, could help foster broad-based economic growth.

We believe it is vitally important for Congress to appropriate this $100 million. After all, we devote less than 1 percent of our nation’s basic R&D budget to programs that support regional clusters, unlike our most aggressive international competitors (see box on page 2). As this paper will demonstrate, a relatively small federal initiative can be managed so that it yields significant economic advantages.

Such support could help create the next powerhouse information technology company like Google or the next pioneering biotechnology company like Genentech—and these are only two of the thousands of new companies, large and small, that spawned their groundbreaking technologies on university campuses in Silicon Valley before becoming Fortune 500 companies. New businesses, in turn, create new jobs, bolstering the overall economic well-being of the nation.

This $100 million would be money well spent. The reason: Never before has the U.S. government devoted a single penny to a comprehensive national program specifically dedicated to supporting regional innovation clusters and business incubators that fuse the geographically shared resources of universities and other research organizations, companies, research centers, governments, and workers.

Federal involvement is needed. Although the United States boasts a series of successful clusters, their true potential has not been fully realized. Cluster initiatives, according to a recent Brookings Institution report, are “too few” and they are “thin and uneven in levels of geographic and industry coverage, level and consistency of effort, and organizational capacity.”[6] Moreover, traditional clusters are under terrible stress. The automobile cluster in the Midwest is suffering not just from the perspective of the automobile manufacturers and their direct workers, but also with regard to the impact on the supply-chain, including specialized suppliers and local communities. Automobile parts manufacturers told the Treasury Department earlier this year that 130,000 jobs had been lost in eighteen months.[7]

Federal support to help innovation clusters improve their competitive strengths makes good economic sense. Begin by considering what regional economic clusters are and how they work. A simple, working definition is this: Clusters are geographic concentrations of companies, suppliers, support services, financiers, specialized infrastructure, producers of related products, and specialized institutions (such as training programs) whose competitive strengths are improved through the existence of shared advantages. So, for example, a successful cluster connects companies with academic institutions, research labs, and other nonprofit organizations in order to create the kind of virtuous cycle of competitiveness that creates jobs, stimulates business formation, and improves productivity.

What are the kinds of advantages shared by the participants in clusters? They could be a set of workers who boast particular skills, such as building boats in Maine. Or community colleges that offer training to manufacturing workers in places where advanced manufacturers are located. Or companies that decide to locate somewhere because of the presence of well-trained employees. Or research centers that conduct basic research into biotechnology close to start-up biotechnology companies. Anything, really, that creates what an economist would call a “positive externality,” a benefit that is captured not just by a single company, but by entire communities.

Positive externalities are nothing new. Nor are high-tech innovation clusters. Some, like Silicon Valley or the Route 128 corridor outside Boston, boast world-class universities and research institutions anchoring fervent communities of networked high-tech information technology and biotechnology companies served by a critical mass of commercial, legal, and financial talent. And some, like Akron, Ohio, have leveraged historical expertise; Akron’s rubber industry has spawned an innovation cluster anchored by companies committed to polymer science and advanced manufacturing innovation.

Here is what is new: The notion that regions can work closely with the federal government to consciously focus on the creation of shared advantages within clusters to create jobs, create businesses and, of course, stimulate long-term economic growth.

Job creation and business creation, the main economic benefits coming from innovative clusters, mostly spring from so called “high impact” companies (high-tech startups and established companies alike) that sell goods and services outside their clusters to both national and international markets, drawing revenue back into the cluster.[8] These “traded” services boost regional economic growth and national economic competitiveness. As measured by patent rates, productivity rates, and other innovation metrics, an innovation cluster creates new companies and new jobs in a helter-skelter but overall positive direction.

The federal government, of course, does spend money on a variety of innovation programs designed to help communities across our country create some of the ingredients necessary to replicate the success of thriving high-tech innovation clusters, such as the San Diego biotech cluster, the medical devices cluster around Minneapolis, and Research Triangle Park in North Carolina. These programs help fund the early commercialization of innovative products and services as well as regional workforce development and economic development efforts to provide the infrastructure necessary for innovative companies to flourish.

But these programs fall short of their true potential precisely because they are not organized in a systematic fashion to reap the advantages of an innovation cluster. The programs often fail to coordinate their work and leverage their unique strengths toward innovation cluster development as their central mission. That’s why a modest federal investment in a national cluster development program would multiply the benefits of our existing federal innovation programs, coordinate these efforts, and match federal expertise to the weaknesses and needs of regional clusters.

Policymakers must absolutely ensure they maintain the serendipity, competition, and ad hoc collaboration that have characterized successful clusters in the United States. The importance of regional clusters to competitiveness, however, raises three interrelated policy questions:

• Do federal programs that fail to focus on all of the ingredients needed to create a successful innovation cluster lack the direction and heft to make a difference?
• Can a government program dedicated specifically to the creation of new innovation clusters make a difference?
• And are there other factors that account for the unique innovative qualities that make Silicon Valley and Route 128 a success yet doom efforts in other regions of the country to failure?

The answer is “yes” on all three counts, which presents policymakers with a troubling dilemma: how best to invest limited federal resources?

This paper offers policymakers a guide through this dilemma. In the first part of the paper, we will explore briefly the lessons learned by those who have both led and researched innovation clusters over the past several decades. We will reconfirm the observation that, first and foremost, “place matters.”[9] Successful regional innovation clusters are not fungible—success rests upon differentiated competitive advantages that exist for different reasons in different parts of the country.

We will then demonstrate that access to finance matters, too. The greatest challenge that clusters need to bridge is the so-called “valley of death” financing gap that leaves young innovative companies with good ideas unable to fund the commercialization of those ideas due to the lack of seed-stage and early-stage financing. The current financial crisis has widened this valley, not just for young companies, but also for established companies that once could turn to more liquid debt and equity markets or to local or regional lenders and investors to fund their new ideas. Strategies to attract new private capital to regional innovation clusters are critically important.

There’s also a similar dearth of human capital—both managerial and workforce—in many regions of the country that wish to create or expand vibrant innovation clusters. American workers are very productive and much of our nation’s manufacturing sector could operate profitably in the United States if we took advantage of our global leadership in research and development, innovation, and process technologies to forge more competitive regional economies. The problem is we don’t do that today in any nationally systematic way involving clusters. The result is a growing structural unemployment problem with seemingly few solutions to match our productive workforce to the needs of innovative regional businesses.

Overcoming all of these connected hurdles requires us to rethink how we go about supporting clusters. So, also in the first part of this paper, we will examine how forward-thinking state and metropolitan governments have adopted practices that foster strong clusters, creating jobs, helping established companies grow and, of course, providing opportunities for new businesses. The key lesson for regional governments: Patience and leadership are necessary in the creation of all clusters.

Cases in point: North Carolina’s Research Triangle Park and San Diego’s CONNECT cluster—two regions that focused on all the ingredients needed for success, including federal funding—took several decades to reach their current prominence among U.S. clusters and were piloted there by a coterie of forward-thinking government, university, and business leaders. Newer clusters that recognize the importance of patience, such as those budding around the Arizona State University in Tempe, the Washington, D.C. metropolitan region’s many universities, and in rust belt cities in the Midwest such as Pittsburgh, are making headway.[10]

In the second part of the paper, we will discuss the reasons why Congress should support, and how the Obama administration should effectively implement, the president’s proposal that the Economic Development Administration be appropriated $100 million to support regional innovation clusters and associated business incubators. We will demonstrate that the Obama proposal is the answer to the failures of federal support identified in our earlier discussion of federal efforts. And we will show how this new effort—alongside dedicated White House leadership—can simultaneously increase the effectiveness of other federal programs, such as Small Business Innovation Research and Small Business Technology Transfer programs, which are administered by a variety of government agencies in coordination with the Small Business Administration, and the efforts of other Commerce programs, including those housed at the National Institute of Standards and Technology and the National Science Foundation. (See Appendix for a summary of the main federal programs that could measurably increase the impact of a clusters approach).

Support for clusters through the Department of Commerce’s EDA must be targeted at what matters most to innovation: The shared advantages that accrue to businesses, workers, and communities alike when the success of a cluster spawns a virtuous cycle of economic growth. Operating at the micro-economic level, the EDA must show a keen understanding of the ecosystem of innovation to ensure that its targeted innovation investments go where they can make a difference building cluster infrastructure and thereby do the most good for the longest time.

Specifically, we will explain how the Obama proposal provides the missing elements that are needed to support state and regional leadership. The federal government should leave leadership to the regional community, which knows best its own competitive advantages. But a bottom-up approach can reach the top level of government, with EDA supplying necessary funds to allow clusters to create shared resources, and with universities, community colleges, and research centers supplying a national framework against which the importance and success of clusters can be measured. Funding should be tightly connected to effective information exchanges, which will strengthen the ability of clusters to plot their own competitive strategy, and aligned with other federal programs through, for example, so-called “one-stop shops.”

We conclude this paper by sketching out the critical program-design elements that should be endorsed in the appropriations process for the proposed $100 million for EDA to implement a federal clusters strategy. Specifically, in this paper we propose that EDA should:

• Administer a competitive matching-grants program, with established criteria used to ensure the greatest impact of federal funding, among them an emphasis on local leadership from the private and public sectors, including universities and other research institutions.
• Align the cluster selection process with national priorities such as energy-efficiency, advanced manufacturing, and new technologies when administering this matching grants program.
• Assist economically distressed areas of the country by pooling regional resources from within and outside of distressed areas in order to bring together a critical mass of university savvy, business acumen, and productive workers.

No single grant application should have to meet all these criteria, but having these three principal guidelines in place will help ensure transparency and effectiveness. Funding should be focused on building the common infrastructure of innovation in a region, which effectively lowers the cost of business growth and creation. Examples include program development plans for business incubators and research centers, worker-training programs, and technology-transfer efforts focused on small- and medium-sized companies. Where regions have no effective clusters, smaller planning grants should also be available for the creation of strategies based on comparative advantages.

Time to act

Support for regional innovation clusters and business incubators is good public policy—and good political leadership. Successful cluster policies have been implemented at the regional level by both Republican and Democratic officials alike because clusters represent a pragmatic approach that requires collaboration with the business community and that, when successfully implemented, benefits communities as a whole.

Similarly, pioneering research into the role of clusters by policy advisors to both Democrats and Republicans has created a bipartisan foundation that increases the chances that, once initiated, federal cluster efforts will be supported for a long time by members of both parties. This is important because, as we have noted before, patience matters and, therefore, federal clusters efforts must be able to garner long-term political support.

Moreover, in a coming time of budget austerity, the regional cluster initiative does not require large sums of funding. That’s because federal support will be leveraged, providing resources that are not otherwise available but always contingent on regional governmental and private resources to amplify the impact of federal dollars. In fact, federal support in fiscal year 2010 budgets would come at an important time for state governments, which are under tremendous fiscal pressures. States including Ohio, Kansas, Connecticut, and Pennsylvania have either reduced economic development spending or encouraged large reorganizations of programs to control it.

Over time, the implementation of regional cluster strategies can increase the effectiveness of other federal spending. Just within the Department of Commerce itself, for example, export promotion and technology outreach programs at the International Trade Administration and NIST, respectively, would be strengthened by their links to effective cluster strategies, which in turn could supply valuable expertise to increase EDA’s own effectiveness. Even more importantly, federal support for regional innovation clusters presents an important opportunity for EDA to forge a close partnership with the Small Business Administration, whose own programs reach deep into local communities.

In the pages that follow we will present our analysis, conclusions, and recommendations in greater detail. In the end, we hope the case is made that Congress needs to appropriate that first $100 million toward a national program for regional innovation clusters. We are confident this step will help ensure that the $150 billion taxpayers invest annually in basic scientific research and development can better deliver on the promise of more and better jobs, new businesses, and transformative technologies across our nation.

Download this report (pdf)

Jonathan Sallet is a managing director of The Glover Park Group and a former director of the Department of Commerce’s Office of Policy and Strategic Planning under Secretary Ron Brown. (The views expressed herein represent only his views, and not those of his firm or any client thereof.)

Ed Paisley is Vice President for Editorial at the Center for American Progress and Editorial Director of Science Progress, A CAP project. He is a 20-year veteran of business and finance journalism who was previously responsible for award-winning coverage of technology finance and international finance at The Deal, a specialist Wall Street publication, and at Institutional Investor magazine.

Justin Masterman worked first as an Intern and then as a Special Assistant for Science Progress at the Center for American Progress. A recent graduate of the University of Pennsylvania, where he was a University Scholar, Justin wrote about innovation policy and economic development for Science Progress.

Notes

[1] Although the $50 million allocated for business incubators is not money explicitly dedicated to regional innovation clusters, business incubators perform a very important support function in innovation clusters. The business incubator programs accelerate the creation and development of successful businesses, an essential component of innovation clusters.

[2] Steven Ezell, “Benchmarking Foreign Innovation: The United States Needs to Learn from Other Industrialized Democracies” (Science Progress: January 12, 2009).

[3] Information gathered from program website available at http://www.competitivite.gouv.fr/index.php?&lang=en

[4] Karen G. Mills and others, “Clusters and Competitiveness: A New Federal Role for Stimulating Regional Economies.” (Washington: Brookings Institution) available at http://www.brookings.edu/reports/2008/04_competitiveness_mills.aspx.

[5] Michael E. Porter, “Why America Needs an Economic Strategy,” BusinessWeek , available at http://www.businessweek.com/magazine/content/08_45/b4107038217112_page_4.htm.

[6] Karen Mills, Elisabeth Reynolds, Andrew Reamer, and others, “Clusters and Competitiveness: A new federal role for stimulating regional economies.”,” (Washington: Brookings Institution, April 2008). Pgp. 6.

[7] The Economist, “The American Car Industry,” The Economist, February 19th, 2009, available at http://www.economist.com/business/displaystory.cfm?story_id=13145718.

[8] Zoltan J. Acs and others, “High-Impact Firms: Gazelles Revisited,” Small Business Administration, available at http://www.sba.gov/advo/research/rs328tot.pdf.

[9] Maryann Feldman, “Place Matters: Innovation Springs from Many Seeds, But Soil Is Equally Important.” (Washington: Science Progress, Center for American Progress, January 2009).

[10] http://www.scienceprogress.org/innovation-clusters/ provides some specific
regional examples.

That’s why Science Progress and our parent organization, the Center for American Progress, in early 2008 began preparing to convene two roundtable task forces, bringing together experts from both sides of the political aisle and from an array of different private- and public-sector perspectives, to discuss parent reform and innovation. One taskforce set out to identify the ingredients needed to incubate regional centers of innovation so that university-based scientific research can result in broad-based economic prosperity. The second sought to delineate the parameters of the possible in patent reform—one of the key issues the incoming Obama administration and the 111th Congress will have to tackle this year after the effort fell short in 2008.

Both issues cut to the core of U.S. science and technology policymaking that will be so critical to carrying our deeply troubled economy back to the forefront of global innovation in the 21st century. We believe this is why we attracted the caliber of participants in both roundtables, including two former U.S. commissioners of patents and trademarks, Gerald Mossinghoff and Bruce Lehman, to our patent roundtable, and the former chief counsel to the House Science Committee, Jim Turner, and (before her appointment by President-elect Barack Obama to head of the Small Business Administration) venture capitalist Karen Mills, to our regional innovation taskforce.

Our task force on regional centers of innovation included venture capitalists and corporate technology officers, university technology licensing directors and workforce development experts, and some of the nation’s leading scholars on innovation clustering and commercialization. (To see the complete list of taskforce members and advisory board members, please go to our website). The five essays beginning on page 7 (and the companion essays on our website) attempt to tease out examples of how policymakers in statehouses and different federal agencies can work together with universities to replicate the success of Silicon Valley and the Route 128 Corridor in Massachusetts in other university cities and towns—in the process detailing how place and history set the stage for specific innovations that policymakers can help commercialize.

The policy recommendations reflect that mosaic of geography and specialization. But they also include 21st-century information technology and financial tools to speed development, and include ways to benchmark success—precisely because these are untried policy initiatives that will require prudent monitoring.

Our patent reform roundtable was specifically designed to gather in one room all the different participants in the 2008 debate in order to find common ground to move legislation forward this year. And to a great degree we believe we succeeded. Our four essays beginning on page 59 detail our recommendations for improving the effectiveness of the U.S. Patent and Trademark Office, coping with abusive “patent trolls,” and weaving U.S. and international patent law and enforcement together for more effective and efficient global innovation. “The time is ripe for positive change in the U.S. patent system,” says Science Progress and CAP Senior Fellow Rick Weiss in the opening essay—a conclusion we will work hard to see to fruition in 2009.

A historical debate of a different tenor is the subject of our cover story, “Science’s Troubled Legacy: Government Contracting Run Amok.” The author, Johns Hopkins University professor Daniel Guttman, a fellow of the National Academy of Public Administration, charts the rise of the private sector “contracting estate,” which was born to harness scientific inquiry in the interests of national security in the mid-20th century. Guttman explains how our nation moved from the success of the Manhattan Project to Blackwater’s armed security units on the streets of Baghdad before presenting a set of principles that re-envision 20th-century government contract reforms for the realities of 21st-century governing.

Guttman’s bottom line: “If contractors are to continue to do basic government work then not only must laws and reality be reconciled but also the public service ethic must be extended to encompass the entire taxpayer-funded workforce, and not just the civil service.” In his essay beginning on page 47, readers will find recommendations of exactly how to enact these critical reforms—ones that the incoming Obama administration could employ to reverse the dangerous and irresponsible outsourcing of so many different government functions under the Bush administration.

There are, of course, many other science and technology policy arenas in which the Obama administration will set new policy priorities—from stem cells to climate change to space exploration—many of which we examine every day on our website, and many in which we also offer detailed policy recommendations. Inside this journal, however, we have packed lengthy analysis of three complex issues of sweeping economic and historic significance. We believe our recommendations are only the beginning of the progress our nation is about to embark upon. We hope you agree.

Ed Paisley is Vice President for Editorial at the Center for American Progress and Editorial Director of Science Progress.

Running this gauntlet of financing is not easy for life sciences companies.

But that’s only the beginning. Young life sciences startups then need to access additional capital and early business know how from economic development agencies and additional donations from federal research grants just to stay alive. They then need to attract angel investors, venture capitalists, and corporate strategic partners to build their businesses, and then if all goes well by this point—no mean feat as the science the company is commercializing has to prove not just safe and efficacious but also marketable—perhaps they can make an initial public offering on a stock exchange, becoming a public company.

Each of these factors are critical not just to commercializing new biotechnology innovations but also to creating new communities of regional innovation where startup companies succeed in traversing this difficult financing path. Many research papers on high-tech clusters have explored the need for a critical mass of life sciences expertise, business acumen, and financing muscle for not one but many startups to thrive. Each step is crucial for each individual company, though as you’ll see, there are several ways to take a product from the lab to the marketplace. So let’s consider each step in turn.

The Climate at Universities

There is a great deal of variability among academic institutions about technology transfer. Some universities have people that are full of ideas and are eager to commercialize them. Others have people that have some ideas but no interest in commercialization. This strongly influences the overall technology climate at that university.

Next, one must consider the university’s technology management office. Sometimes the influence of a technology management program will encourage innovation, and sometimes it will hinder it. Sometimes, even, there’s no technology management program at all. Finally, we must consider the endowment status from the university’s standpoint. If a university is working on building an endowment and they’re doing well, why put it at risk by seeking to commercialize novel bioscience?

All of this contributes to the fact that, from the standpoint of many academic institutions, technology licensing arrangements are often preferable to company formation in a bid to commercialize directly any intellectual property. If someone has an idea, then they can license it, and there’s no risk. The worst risk is that they will not get the money. But if that person forms a life sciences company, then that’s very risky financially. With a license arrangement, somebody gives them the money, and that’s that. It does not matter to whom they license to the IP.

The person or company seeking the license probably will not be someone in the same geographic area, and therefore won’t build any local business at all. The individual or university simply receives money, which does not stimulate the local economy.

Some universities, however, take advantage of the so called “grateful donor syndrome.” These universities understand the long-range return that they can get from a group of grateful inventors who develop a company and then have a success. Often these inventors will give large donations to their alma mater, and the cycle continues as the university attracts more and more brilliant students.

Direct revenue for the university, in the form of fees and royalties, is very positive from straight tech transfer licensing deals. Yet universities would benefit more if their graduates founded a company nearby that goes on to become a major company, or gets sold to a bigger company for a huge sum of money, or goes public on a major stock market through an initial public offering.

Economic Development Agencies

The next major factor affecting life sciences technology transfer is the role of economic development agencies, or EDAs. Firstly, they have limited fiscal resources. Secondly, there are always are more companies that need money and management expertise than the economic development people can provide for. Thirdly, these agencies are rarely focused on life sciences.

Early stage life sciences companies, or those new companies that boast little more than intellectual property and some laboratories to test their ideas, need more money and advice than EDAs can provide. The value of EDA advice is difficult to gauge, but how much money is it going to take for a new company to get to the point where getting venture capital would be cost effective? A new company needs around $1 million to $2 million dollars of economic development money to get to the stage where it has a fighting chance of attracting venture capitalists who want to see even an early stage company poised to commercialize their science.

This $1 million to $2 million dollars must come from the combination of EDAs and perhaps small business innovation research, or SBIR funding, which flows from the federal government. However, because this donated money comes at the very beginning of a long commercialization process, the return on the donation takes too long to be politically useful for EDAs.

Consider this scenario: If a politician decides to fund the construction of a building, in two years the building is complete and the politician can put his or her name on it. But if that politician decides to fund a startup company, then they’re probably going to be out of office well before that company goes public or gets sold—the point at which a politician can take credit for the initial decision to provide funding to the company. That politician’s successor’s successor might be able take credit for it. Therefore funding small businesses that will take years to make significant profits is not going to help the EDAs appear to be effective—and thus continue to win funding for themselves from taxpayers.

This funding gap is perhaps the greatest hurdle for young life sciences companies. Some states’ EDAs recognize the problem but are either limited in what they can do or are only now beginning to experiment with so-called gap funds. Other states are turning to the state pension funds, directing them to invest a small portion of their total money under management in promising local startups. And some forward-looking universities provide more than seed money to help their young companies get to the next stage.

This kind of financial assistance helps a young company so that it can present a credible story to a venture capital firm looking to invest in early-stage life sciences startups, or perhaps an “angel” investor—a wealthy individual looking to make a high risk, high reward private investment. Both venture capitalists and angel investors behave similarly. They do not want to invest unless they are relatively sure of success. This leads to the next major factor in this process: venture capital.

Venture Capital

Venture capital investors are picky investors, and they are finicky according to the demands of the marketplace. Today, the big pharmaceutical companies are not buying as many young companies for their applied science and intellectual property as they once were. The major focus at the present time is on Phase II or Phase III pharmaceutical products, or those drugs very close to possible commercialization, as well in basic medical devices. Companies with these life sciences products have a clear “exit strategy,” or way for venture capitalists to make money on their investments.

For example, if a startup biotechnology company is making something that venture capitalists are pretty sure that, say, Johnson & Johnson is going to want to add to its product line, then the startup will get money from VCs. Problem is, some life sciences venture capital firms want “an arm and leg” from smaller companies. Perhaps they’ll invest $500,000 for a 50 percent stake in the smaller company. This may not even be enough to match the money that the company has already spent. Then, when other venture capital firms invest in the company as it (hopefully) proves the effectiveness of the science its developing, the original inventor sees more and more of his or her stake in the company diluted.

Therefore, these early stage companies have to get their next rolling start in some other way. This leads directly into the next contributing factor in the life of a life sciences company: corporate strategic partners.

Strategic Partners

Strategic partners, or bigger companies on the prowl for commercializable science, have very focused interests and very specific targets that can sometimes match up with young life sciences companies. It is difficult for an early stage startup company to find a good “exit,” or sale to a bigger company, because a little company with very little money is not going to be able to knock on enough doors of big companies to find out who would want to buy them. But fortunately, many big pharmaceutical companies tend to outsource various procedures, such as toxicity tests, to smaller companies. These large, public companies do not want to deal with these tasks, so they allow smaller companies to do them for them.

This helps the smaller company grow as it now has a source of recurring income with which to continue to work on its own proprietary R&D. Sometimes these strategic partnerships result in the startups being purchased by the bigger companies—an exit that will encourage nearby universities to consider tech transfer to other young university-backed startups. This begins a sort of virtuous cycle. As the company exits and makes money, and then the university makes money, even the skeptical universities will be encouraged to fund companies rather than license their discoveries.

Initial Public Offerings

The final factor in life sciences commercialization is an initial public offering on a major or smaller stock exchange. The IPO, or the listing of a company’s shares for sale on a stock market, is an essential engine for corporate formation. Unfortunately they’re very limited now because startup life sciences companies require a very long period of time and a large level of funding before reaching the point where public investors would be interesting in buying its shares. Sometimes it takes more than 15 years.

Profitability is often required as a basis for the IPO, which hurts the chances of many private life sciences companies, most of which want to go public to raise a final pool of money to bring their new product to the marketplace. That means investment banks that bring the company to market are reluctant to underwrite their new shares. There is definitely a need for more speculative markets that could handle IPOs for companies that do not yet produce much in the way of profits.

Conclusion

Running this gauntlet of financing is not easy for life sciences companies. But it would be infinitely easier if universities embraced the idea of commercialization to build a community of innovation around their campuses, if economic development agencies were better-funded and more willing to look at long-term community development, and if venture capitalists, corporate strategic partners and investment banks were eager to invest in young life sciences companies operated in these same communities. Creating this critical mass for life sciences startups in places other than around Boston and Silicon Valley, New York and New Jersey, San Diego and Research Park Triangle, should be a key policy objective of the federal and state governments, alongside universities and the communities in which they reside.

Ed Paisley is the Editorial Director for Science Progress and the VP for Editorial at the Center for American Progress. Jennifer Nelson is a undergraduate at MIT and an intern for Science Progress.

Above all, we have come together at Science Progress in search of new ideas and new policies that ensure scientific innovation offers all Americans the opportunity to contribute to the common good.

The pages of Science Progress now in your hands brim with confidence (we’re progressives, after all) in our country’s future—optimism that is matched by clear-eyed analysis and complementary policy proposals to meet the many interlocking challenges of the 21st century. Our staff , our advisory board members, and our array of policy experts have embraced Science Progress as a unique platform to guide U.S. science, technology, and innovation policymaking in age of overlapping scientific disciplines and almost overwhelming interconnectedness. Above all, though, we have all come together in search of new ideas and new policies that ensure scientific innovation offers all Americans the opportunity to contribute to the national and global common good.

That’s why the inaugural edition of this journal begins with the section Innovation and Economic Opportunity. We open with an essay on the seemingly arcane but crucially important question of public policy quality management, followed by a telling examination of the efficacy of diversity in our quest for more innovation and higher productivity. The purpose of these two essays—and the ones that follow in this section on competitive grants, venture capital, and computer gaming—highlight the importance of encouraging out-of-the-box thinking to boost economic prosperity for all Americans. Money, though, is equally crucial, thus our case for a national innovation agenda, which rounds out the journal’s first 20 pages.

Sometimes science best presents itself in classic form—through direct dialogue, or questions and answers to elicit the voice as well as the knowledge of the research at hand. We open our Energy and the Environment section and close our Life Sciences and Public Health section with Q&As to explore directly the latest advances in biofuels and genetics. These discussions also explore new policy proposals germane to progressive ideals of clean and equitable economic and social growth. The Q&As bookend two sections replete with forward-looking analysis of other key science and technology issues, among them water management, green technologies, drug development, contraceptives, and electronic medical records.

In the middle pages of this, our first print edition— visit our online magazine at www.scienceprogress.org—reside our most comprehensive pieces of science and technology policy work, focused on national security. But like the rest of the articles in this journal, these more lengthy reports look beyond the traditional borders of national security to embrace more encompassing definitions of the term befitting the new threats faced by our nation.

This edition’s signature policy proposal—“Ubiquity Requires Redundancy: The Case for Federal Investment in Broadband”—calls for multiple broadband connections stretching across the length and breadth of our nation to cope with national security threats posed by radical terrorists, pandemics, and the consequences of more devastating natural disasters spawned by climate change. This detailed focus on telecommunications policymaking to match 21st-century threats is followed by a smaller report on the dual use dangers of biotechnology in military and commercial technologies today at home and abroad, complete with practical policy proposals to bring about global enforcement of realistic oversight mechanisms of the science that will likely dominate the 21st century. We close out the national security section with a report on a 21st-century technology—new high-tech sensors—which could secure the safety of our crumbling 20th century national infrastructure.

We end this issue of Science Progress with perhaps the least discussed but most crucial long-term aspect of science and technology policymaking—how to educate the American people about the importance and relevance of science. Communicating science today is vastly more complicated than it was at any time in the past century, when the certainty of scientific facts and those who discovered them came to reign supreme. Alas, most scientists today still communicate their facts and conclusions from on high to the American people, who increasingly find these arguments understandably unpersuasive due to the cacophony of often contradictory scientific studies.

The series of essays in the Science Communication and Education section challenge scientists and policymakers to do better—to actually engage with the American people in a dialogue when the public expresses concerns about new technologies such as synthetic biology and nanotechnology, and to explain why dueling theories about, say, the possible causes of a particular cancer are as important to understand as the possible cures to which the theories may point. In this way, manufactured controversies about the efficacy of the scientific method by anti-science proponents of, say “intelligent design” over the theory of evolution, can be effectively dismissed by a more scientifically engaged American public.

Communicating the importance of science and technology to the American people helps ensure the innovation policy proposals so key to our country’s future prosperity find a willing audience on Capitol Hill and in statehouses around the country. Science Progress is designed to tackle both tasks, so take a glance at our Table of Contents, dip into those issues that first catch your eye, but don’t limit yourself to what you know and understand. Our purpose here is to shake up U.S. science policy by offering new ideas to new challenges, drawing strength from a diversity of opinions across a range of disciplines. Th is approach is inherently progressive. It is science progress at its best.

Ed Paisley is Editorial Director of Science Progress, and Vice President, Editorial, at the Center for American Progress.

This week’s issue of the National Dialogue on Entrepreneurship includes a brief summation of Prime Minister Brown’s plan—which is contained in his proposed budget for the nation—as well as links to a new report from the UK’s National Endowment for Science, Technology, and the Arts that “reviews the latest thinking on the linkages between creative industries and the broader innovation economy.”

The newsletter, published by The Public Forum Institute’s NDE program, based in Washington, D.C., points to the “twenty-six different commitments where various British government agencies and other partners will act to support creative sectors.” The newsletter also points to Britain’s Department of Innovation, Universities and Skills “Innovation Nation” paper (recently highlighted here on Science Progress). The Department is tag-teaming with Brown’s new budget plans by requiring other UK government agencies to develop an “innovation procurement plan” to support innovation, “innovation vouchers” to help start-up companies tap universities for ideas to commercialize, and a new Public Services Innovation Laboratory.

Science Progress contributor James Turner has highlighted the need for a similar public sector emphasis on innovation in his column, “21^st Century Government: The Next Big Thing,” and in a longer paper titled The Next Innovation Revolution: Laying the Groundwork for the United States.” Britain’s innovation program may be well worth examining, too.

If the president follows through on this request when he presents his Fiscal Year 2009 budget to Congress next week, then perhaps the president and Congress together can ensure that these appropriations actually happen. That’s a big if, as one of the Advisory Board members of Science Progress, Economic Policy Institute Research and Policy Director John Irons, noted in his recent column Science and the 2009 Budget.

Bush last night chose instead to blame Congress for past failures to fund basic science research adequately. “Last year, the Congress passed legislation supporting the American Competitiveness Initiative, but never followed through with the funding,” he said. “This funding is essential to keeping our scientific edge.”

He knows, of course, that budget battles between the White House and Congress often culminate with the least visible and more long-term funding proposals losing out to the more headline-grabbing, more immediate funding needs of the nation during the final push to passage. In the coming budget debates, both Congress and the president need to keep in mind that scientific inquiry is indeed an immediate need to keep our nation economically competitive and our society healthy, diverse, and dynamic.

The Center for American Progress last November published an in-depth report that, among other things, detailed the kind of federal funding of scientific research necessary to help our nation remain at the cutting edge of science and technology innovation. In the report, A National Innovation Agenda: Progressive Policies for Economic Growth and Opportunity through Science and Technology, Irons and co-author Tom Kalil examined the specific levels of funding necessary—levels that match what president Bush called for last night. Indeed, our report and specific data from the American Association for the Advancement of Science illustrate the level of funding necessary to remain competitive. Specifically:

The National Science Foundation

The final appropriation for NSF was $6 billion, “well short of earlier House, Senate, and requested appropriations for a 2 percent” increase, according to the AAAS. The budget for NSF should be increased by 10 percent per year for the next 10 years. This would also enable an expansion of NSF’s key educational programs, such as fellowships, graduate student training grants, and programs to improve K-12 math and science education.

National Institutes of Health

The NIH budget should be doubled over the next 10 years, providing for modest real growth above the rate of biomedical research inflation. Increased NIH funding would also allow us to take advantage of recent advances in areas such as genomics (the study of entire genetic sequences of an organism and the function of genes), nanotechnology, personalized medicine, and early detection of “biomarkers” that can predict the onset of cancer and other diseases. This year’s increase was a mere 0.9 percent.

The Department of Defense

To strengthen America’s technological edge, Congress and the Defense Department should reallocate the agency’s funding so as to increase support for basic and applied research by 10 percent per year over the next 10 years. In FY2008, the Congress is likely to provide roughly $6.6 billion for DOD’s support for basic and applied research.

The Department of Energy

The Department of Energy’s Office of Science budget should be doubled over the next 10 years. According to AAAS, the DOE Science budget for FY2008 is “$4.0 billion, a 4.6 percent increase, a loss of nearly half a billion from earlier congressional appropriations.” The DOE plays a critical role in supporting unique national user facilities such as Lawrence Berkeley National Lab’s Advanced Light Source, which produces x-rays that are 1 billion times brighter than the sun.

The National Institute of Standards and Technology

NIST’s internal budget should be doubled over the next 10 years, and AAAS reported gains of “4.7 percent to $514 million.” This will help NIST keep pace with our economy’s needs for increasingly sophisticated measurement technology. NIST also has a program called the Technology Investment Program (formerly known as the Advanced Technology Program), which provides cost-shared funding to industry for the development of high-risk technologies. Numerous evaluations have demonstrated the effectiveness.

Integrated Education Research Traineeships

Science Progress advisory board member Scott Page of the University of Michigan says that the National Science Foundation’s IGERT initiative, which funds Ph.D. students in novel, interdisciplinary programs, breaks through the current incentive structures of the modern academy, which reward progress within disciplines. Doubling the IGERT carrots can provide incentives for scholars to step out of the comfort of their home departments to work with interdisciplinary teams on critical basic research so key to our national economic competitiveness.

The president’s request to double federal funding for basic scientific research was perhaps necessarily short on details. Science Progress and the Center for American Progress have those details. Now it’s time for the president and Congress to act.

That’s obviously not good for tech entrepreneurs looking for seed stage financing, or universities seeking to commercialize potentially marketable science. So what’s the good news? Well, The Seed Stage tells us about the latest report on angel investors, who financed eight percent more seed- and early-stage venture financing deals in the first half of 2007. 140,000 angel investors accounted for this investment flow, according to the report by the Center for Venture Research at the University of New Hampshire, with the money flowing to a fairly well diversified selection of information technology, biotechnology and medical devices startups.

Angel investors accounted for 42 percent of the all the money flowing to these early-stage tech companies, with traditional venture capital firms accounting for the remainder. The total amount of money invested by angel investors was down 6 percent, to $11.9 billion, from the first half of 2006, yet the size and diversity of the angel community and their tech investment targets is probably more important as more venture firms move toward late-stage venture financing.

For our purposes at Science Progress, the study highlights many of the ways in which different schools of economic thought have sought to persuade academics—and particularly those within science and technology departments—to become more directly engaged in moving knowledge from labs and classrooms into local economies. One key section on Cognitive Capitalism (it’s on page 38) is particularly informative.

Yet the OECD study fails to examine one key connection between all four of these university roles and any regional economic development plan—entrepreneurial money in the form of angel investor capital and venture capital. The relative absence of private capital in this review of the economic literature is most evident in the almost complete lack of focus on Silicon Valley and the Route 128 corridor in Boston.

There are, of course, venture capitalists, angel investors and so called repeat entrepreneurs—most of them straight out of academia—who provide the financial firepower for applied innovation in both of those high-tech centers. This deep base of risk capital is the envy of other regional centers of learning, many of which are trying to replicate the Silicon Valley experience but with decidedly mixed results.

Many finance-related web sites and scholarly journals publish plenty of information on regional development, universities and venture capital. Here is one example (subscription required) that examines the travails of wannabe Silicon Valleys around the United States, and here is another example of a solid high tech start up that had the misfortune to be based in Cincinnati. The reasons for these failures and many others should be part and parcel of any economic review of university-led innovation and regional development.

One of the goals of Science Progress is to bridge this academic divide between those who think about innovation and economic development and those who practice early-stage venture and angel financing of high tech startups. Once that happens, both groups can get together to think about government policies that might help finance innovative regional economic development.