The Innovation Gap

By Michael Collins, President, MPC ManagementAmerica isn’t doing enough in R&D to compete with foreign manufacturers. We must do more to boost innovation, productivity and incomes.

American Manufacturers are realizing that we cannot compete with foreign manufacturers on price and cost reduction. We are going to have to compete using innovation, and research and development. But many experts warn that America is not doing enough in R&D to compete with the rest of the world.

The following forecast on American R&D is from the Battelle Institute and R&D Magazine for 2009:

  • Total spending on U.S. R&D for 2009 is $383.5 billion -- a 1.75 percent increase over 2008
  • Total Government spending is $99 Billion -- a 0.34 percent increase.
  • Industry expenditures of R&D are expected to reach $258 billion -- a 2 percent increase over 2008
  • Academia and non-profits make up the remaining expenditures of $31.5 billion

Now $383.5 billion seems like a lot of money, but 1.75 percent growth is less then the rate of inflation, so the budget is not growing. In fact, in constant dollars, the total R&D budget has not grown much in the last 10 years. Many experts feel that the U.S. is simply not doing enough in R&D and we are falling into an “innovation gap.”

Two think tanks, The Information Technology and Innovation Foundation and the Metropolitan Policy Program at the Brookings Institution are calling on the Federal government to take bold measures to turn around what they call America’s declining innovation leadership and thus raise productivity and U.S. incomes. To understand why so many people are concerned, you have to examine the biggest chunks of the spending individually.

First, the federal government’s contribution is $99 billion, or 25 percent of the total R&D forecast. Government spending has been stagnant since 2000, and there are signs from the new administration that the R&D budget might have to be reduced because of the banking and other financial problems. Before 1980, the federal government supplied the largest share of R&D funds. Now industry R&D is almost three times the funding of the federal government.

In the last eight years, the federal government has shifted basic research dollars from the physical sciences to the life sciences. This is great for the biotechnology industries and health sciences (including pharmaceuticals), but it has short sheeted the other basic manufacturing industries like autos, machinery, and automation.

The private industry share of the R&D forecast is $258 billion, or 67 percent of the total. The Manufacturers Alliance public policy group in Washington, D.C. says, “The percentage of R&D investment in manufacturing has slowly but steadily declined since the late 1980s, even as the total R&D Investment has grown. The drop in funding comes at a time when other countries are sustaining and growing R&D investment.” Moreover, private industry R&D is increasingly devoted to product development and less on basic research that is needed for future innovation.

Another issue that is not discussed very often is that when manufacturing is outsourced to a foreign country, the R&D often goes with it. In our pursuit of lower costs, American manufacturers are giving our technologies and our R&D to the subcontractors. One would think that after having done this with Japan and the subsequent invasion of Japanese products into our markets in the 1980s that we would be more cautious.

Finally, American innovation is affected by the skills gap. We do not have a program underway to fill the current (much less the future needs) of manufacturers for skilled workers. At the same time, since the mid 1980s, there has been a serious drop in the number of U.S. graduates in physical sciences, engineering, and mathematics. However, the proportion of foreign students coming to our schools to graduate in these disciplines is growing, and they go back to work in their countries and often end up working for our competitors.

All of this begs the question, how do small and midsize manufacturers (SMMs) fit into this R&D picture?  SMMs are important because they are 98 percent of the U.S. manufacturers and are 60 percent of manufacturing output. They cannot afford (with a few exceptions) to do basic research, but they contribute through “spillovers.” After a technology has been developed, such as new composite materials or the new nano technologies, SMMs can use these new technologies to develop their own new products and services. This is important, but the spillover process depends a great deal on basic research -- both from the government and the large corporations. But the trends in basic research are not looking good.

What Can We Do?

If innovation (particularly R&D) is going to be the strategy that allows American manufacturers to compete against low-cost foreign manufacturers, then we need to make headway in 7 areas:

1. Manufacturing base -- R&D expenditures are proportional to the manufacturing base defined as a percentage of GDP. In his report “Securing America’s Future: The Case for a Strong Manufacturing Base,” Joel Popkin predicted that, “If the U.S. manufacturing base shrinks too much, it promotes a shift in R&D and investment to other global centers where the critical mass necessary to conduct it exists and is growing. If this happens, a decline in the U.S. long term growth rate is all but assured.”

The manufacturing base as a percentage of GDP was 22 percent in 1996. In 2005, it had dropped to 12 percent, and in 2008, manufacturing’s share of GDP was 11 percent. Obviously, the answer is to not accept the decline of our manufacturing base and to make every effort to grow manufacturing. The initial commitment to grow American manufacturing must come from the new administration. They must be convinced and convince others that manufacturing is our most important industry and the idea of transitioning to a “post industrial” service economy without a strong manufacturing base will most assuredly lead to the decline of living standards. 

2. Manufacturing R&D -- Manufacturers need to devote more money to basic research rather then development. This notion is perhaps abhorrent to our current financial “quick returns” thinking, but it is the future. The new government should do more to force China to level the playing field and to quit manipulating their currencies and protecting specific industries. This would change many manufacturers thinking about outsourcing, perhaps bringing some products and R&D back to the U.S.

3. Spillovers -- Spillovers are controlled by basic research and new technologies that are created by both government and larger manufacturers. Small and midsize manufacturers are a clever group, but they are dependent on basic research and new technologies to offer the new products and services that will allow them to compete. However, SMMS need to work on decreasing their failure rate of new product introduction by doing a better job of determining the market demand.

4. Government Spending -- It is too early to tell whether the new administration is going to be more sympathetic to U.S. manufacturers than the last administration. Once they get past the current financial crisis, they need to dramatically increase their part of the total R&D budget and invest as much in physical sciences as they do in bio research.

5. Education -- The  problem of getting more young people interested in engineering, science, and math is not going to change unless we can improve manufacturing’s image. The key to this is for the Fortune 500 manufacturers to reduce outsourcing and show more interest in keeping jobs in America. Many of our brightest students feel that a career in manufacturing is a bad investment.

6. Training -- There are some good training programs already in place that can provide journeymen and highly skilled workers. The government can help by funding and expanding the advanced manufacturing training programs by a factor of 10.

7. Tax credits -- We need to increase the tax credits on all R&D, particularly on basic research. However, the tax credit should be limited to companies that do their research and manufacture their products in the United States.

American manufacturers are not going to compete with foreign manufacturers (much less grow the manufacturing base) by implementing cost reduction and operational efficiency programs. It is going to take a real focus on innovation which includes new products, new services, new organizations, and an increased investment in R&D at all levels. The nation is at a crossroads -- We are either going to commit to growing our manufacturing base and increasing our investment in R&D, or watch GDP growth diminish.

Michael P. Collins is president of MPC Management, a manufacturing consulting company, and the author of the book, “Saving American Manufacturing."