Innovation, Security & Growth Perspectives from the U.S. Innovation System Myths, Realities & Opportunities Six Countries Programme Workshop Defense & Security R&D Brussels, Belgium November 19, 2004 Charles W. Wessner, Ph.D. Director, Technology and Innovation National Research Council 1 © Charles W. Wessner, PhD The Role of the National Research Council • The NRC Mission is the Advise the Government on Science, Engineering, and Medicine – Studies for federal agencies, Congress, and some self-initiated; 270 Reports Issued Each Year – Nearly 1,300 staff and 10,000 volunteers annually involved in NRC/IOM studies – Budget of some $160 million: 85% from government agencies and 15% private • Great Prestige. High Quality Analysis with Direct Impact on U.S. Policymaking 2 © Charles W. Wessner, PhD Presentation • Question: Is military R&D a source of Commercial Advantage in the U.S. Innovation System? • Myths and Realities about the U.S. Innovation System • The Limits of Spinoff • The Need for a Broader Technology and Security Policy • A Better Model: The Potential for Innovation Awards in Europe 3 © Charles W. Wessner, PhD Related Questions for Today (From our Swedish Friends) • How can public investments in security research generate maximum impact on innovation and growth? • How to find forms (or mechanisms) to strengthen the innovation systems? • How to increase the efficiency in public and private procurement of military products? • How to increase innovation by encouraging the participation of small companies? 4 © Charles W. Wessner, PhD An Overview of the US R&D Portfolio Dramatic Increases in the US Budget for Defense & Homeland Security R&D R&D in FY 2005 Budget • Federal R&D expected to rise to $132 billion in FY’05, up from $126 in FY’04 • Most funding increases over past few years have gone to Defense Weapons development and Homeland Security R&D (including biodefense) • FY’05 R&D budget continues this trend • All other R&D agencies have seen flat or declining R&D budgets (with modest increases in some programs offset by cuts in others) 6 © Charles W. Wessner, PhD U.S. Defense R&D is High 7 © Charles W. Wessner, PhD …But Focus is on Development Is U.S. R&D Leadership Therefore a Myth? The focus on weapons development and testing overstates the R&D element of the budget. It is often not basic or even applied research but rather testing and certification. 8 © Charles W. Wessner, PhD Security Related R&D in Other Agencies • NIH (NIAID) is the lead agency for BioDefense – Bio-defense research at NIH to be $1.8Billion in FY2005 – Most of money to go for NIH Research Grants • NSF to fund basic research in areas related to Homeland Security • USDA involved in food security & animal health • Each Agency wants its Share of “Security” Source: AAAS, 2004 9 © Charles W. Wessner, PhD Post 9-11 Increase in Bio-defense R&D NIH is the Lead Agency in Bio-defense Research DHS Portfolio Heavily Development and Labs Oriented Opportunities for Security Cooperation with Europe NIH Budget is $1.8 Billion 10 © Charles W. Wessner, PhD Current Trends are Troubling: President’s Proposed Cuts in the R&D Budget for FY2005 • $660M cut from Basic and Applied Research at DoD • $68M cut from DoE Office of Science • $63M cut from Energy Conservation R&D at DoE • $183M cut from Agriculture Research • $24M cut from Transportation Research • Advanced Technology Program to be Ended • Manufacturing Extension Program: Proposed budget down 63% from 2003 level 11 © Charles W. Wessner, PhD What are the Implications for Europe? • Concern in Europe on impact of increased US Defense and Security R&D budgets on – European Defense and Commercial Industries – European Science Base in Trans-Atlantic Cooperation & Competition – European Policy Aspirations • To help address these concerns, EURAB commissioned PREST to undertake an analysis of the impacts of US Defense R&D spending – Andrew D. James, US Defence R&D Spending: An Analysis of the Impacts, January 2004 12 © Charles W. Wessner, PhD PREST Report Findings • Defense & Homeland Security missions are driving increases in US Defense R&D budgets • Impact of New Expenditures: – Spin-off products & technologies from Defense R&D is a Reality – Defense R&D Spending Impacts University Science Base and Training of Graduate Scientists & Engineers – Defense R&D Spending Creates New Markets and is a Source of Early-Stage Seed Funding – Leveraging Civilian Technologies (like IT) for Defense & Security Missions Improves International Competitiveness of US Firms • Begins & Ends with the Claim that “synergies between defence and civil research are far ahead of the situation in Europe.” 13 © Charles W. Wessner, PhD Is Military R&D a Source of Commercial Advantage in the U.S. Innovation System? Myths about the U.S. Innovation System Central Myth about the U.S. Innovation System • It is a Well-oiled, Centrally Controlled, Innovation Machine • There is a Broad Consensus on How the System Works and what Opportunities and Problems need to be Addressed • “Military R&D is the U.S. Secret Weapon in Competitiveness Wars” 15 © Charles W. Wessner, PhD The Myth of the Rational Policy Framework • Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation Agenda • Reality: There is no U.S. Ministry of Science Multiple sources of policy making • Congressional Committees, • Federal Agencies—NSF, NIH, others • State Governments + Positive: Multiple sources of experimentation means that the system can be more adaptive; responsive to new challenges – Negative: Lack of coherence can lead to de facto outcomes that can hurt innovation • Example: Post Cold War Falloff in U.S. investments in Science & Engineering Education was not a product of rational U.S. policymaking. 16 © Charles W. Wessner, PhD The Myth of the Rational Policy Framework Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation Agenda Reality: Architect of U.S. Innovation Policy 17 © Charles W. Wessner, PhD The Myth of Perfect Markets • Strong U.S. Myth: “If it is a good idea, the market will fund it.” • Reality: Potential Investors have less than perfect knowledge, especially about innovative new ideas – “Asymmetric Information” leads to suboptimal investments – This means that it is hard for small firms to obtain funding for new ideas 18 © Charles W. Wessner, PhD The Reality: The Valley of Death Early-Stage Funding Gap Federally Funded Research Creates New Ideas Capital to Develop Ideas to Innovation Product Development & No Capital 19 Innovation © Charles W. Wessner, PhD The Cash Flow Valley of Death Adapted from: L.M. Murphy & P. L. Edwards, Bridging the Valley of Death—Transitioning from Public to Private Sector Financing, Golden CO: National Renewable Energy Laboratory, May 2003 Technology Creation Technology Development Early Commercialization Successful Cash Flow Cash Flow Valley of Death Moderately Successful Time Unsuccessful SBIR & ATP Unsuccessful Typical Primary Investors Federal Agencies, Universities, States, Companies Entrepreneur & Seed/Angel Investors 20 Venture Capitalists IPO © Charles W. Wessner, PhD The Myth of U.S.Venture Capital Markets • Myth: “U.S. VC Markets are broad & deep, thus there is no role for government awards” • Reality: Venture Capitalists have – Limited information on new firms – Prone to herding tendencies – Focus on later stages of technology development – Most VC investors seek early exit • Large U.S. Venture Capital Market is Not Focused on Early-Stage Firms 21 © Charles W. Wessner, PhD The Military R&D Myth The Myth of Military Spin-Offs • Euro Myth: “U.S. Defense Research/Procurement Directly Funds Civilian Technologies” • Reality: “Very few technologies proceeded effortlessly from defense conception to commercial application.” – Secrecy, military specs, and long lead times slow diffusion of new defense technologies – Even efforts to use low-cost civilian technologies for defense use, i.e., “spin-ins,” are often blocked by complicated military procurement system Beyond Spin-off, John Alic, Lewis Branscomb, et al. 23 © Charles W. Wessner, PhD Main Role for Military R&D is Defense • U.S. Military Expenditures from 1947 to the end of the Cold War were designed to protect the U.S., its NATO allies, and other countries around the world from Soviet Expansion • Vast sums were deployed to this end – Hot wars were fought in Korea, Vietnam – Proxy wars in Greece, Afghanistan, many parts of Africa – Later interventions in Bosnia, Kosovo, Kuwait were undertaken to secure human rights and international stability 24 © Charles W. Wessner, PhD Purpose of U.S. Military Expenditure • U.S. Military Expenditures were first and foremost designed to provide the equipment, maintenance and training to provide credible capacity to deliver armed support to U.S. allies • Additional vast sums were (and are) spent on the U.S. nuclear deterrent • The Goal of U.S. military expenditure is Security for the U.S. and its allies and the ability to influence events – U.S. Power Projection is Unique (though constrained) 25 © Charles W. Wessner, PhD Difference in Scale of Military Expenditure • The United States, for better or for worse, expends over $400B per year (2004) on the military • The UK is next at $40B followed by France at $30B and Germany at $25B (approximate figures) • R&D represents a small portion of these amounts – usually 3% in the U.S. • Commercial benefits are small, given the level of expenditure 26 © Charles W. Wessner, PhD Difference in Scale of Military R&D • Within NATO, only the Defense budgets of the UK, France, Germany, and Italy exceed the R&D budgets of the U.S. military – All other NATO nations combined invest some $3B in research and technology investment • Why? France, Germany, Italy, Greece, Poland, and Spain spend 60% or more of Defense Budgets on Personnel • U.S. Defense Budget Expenditures: – 35% on Personnel – 30% on Equipment (including R&D) 27 © Charles W. Wessner, PhD Positive Impacts of Military Expenditure • Air power: The U.S. has the only significant capabilities in – – – – Strategic Transport Refueling Theatre Surveillance, and Precision Bomber capabilities among NATO nations • Navy Carrier Groups and Submarine Fleets • These capabilities are needed to meet out of area commitments – Advanced attack aircraft on the way: F/A 22, as are advanced unmanned vehicles • But these New dedicated weapons systems have limited foreseeable spin-offs 28 © Charles W. Wessner, PhD Positive Impacts of Defense Expenditures on Civilian Economy • U.S. military expenditures did result in substantial growth in important sectors of the U.S. economy – World War II saw the growth of the U.S. automotive, shipping, aircraft, electronics, aluminum and steel industries – Cold War expenditures provided support for computers, semiconductors, jet engines, and rockets • Famous case of Boeing 707 derived from bids on Air Force Tanker contracts 29 © Charles W. Wessner, PhD But these Broader Impacts are Limited • Few Spin-offs: Military R&D often has no civilian application and is inefficient in terms of the economy as a whole – Cases do exist, e.g., cost plus contracts for semiconductors, but the 1950-60s model no longer applies – Major Spin-offs, e.g., the Internet and GPS have occurred, but they are widely diffused • GPS was for missile targeting (not for tracking kids) – U.S. Expenditures, e.g., Stealth technologies, are often high cost efforts with no foreseeable civilian spin-off 30 © Charles W. Wessner, PhD The Demise of the Defense-Based R&D Model • The role of the military shifted in the 1970’s and ’80s as a proportion of civilian high-tech markets – Private market for semiconductors grew rapidly, dwarfing U.S. military needs • DoD specifications, secrecy, & long procurement cycles vitiated potential to fund cutting-edge commercial technologies – Commercial IT far outstrips Military Development • Some ground-breaking innovation continues to occur (e.g., the Internet) but applications are pervasive and highly beneficial for new entrants, e.g., Taiwan, India 31 © Charles W. Wessner, PhD The Productive role of U.S. Military R&D Expenditure is Overstated • Scale: The military sector is now much smaller than during the Cold War and has fewer linkages to the economy – Top 4 Defense firms (Boeing, Lockheed, Northrop, & General Dynamics) have a combined market cap of $102 billion – Intel alone has a market cap of $140 billion • Caveat: Defense sector is Employment Intensive – Defense firms: 477,200 employees – Intel: 80,500 employees (All data as of 11 August 04) 32 © Charles W. Wessner, PhD Military R&D Allocations Sap Funds from more Productive Uses • Are increases in US Defense R&D spending the most efficient approach to stimulating commercial activity? • Is the US investing in the right kinds of R&D to enhance economic competitiveness? • Concentration of R&D Funds on Small numbers of Engineers Working on Military applications is Inefficient • Reduces R&D Funding for Other Sectors of the Economy 33 © Charles W. Wessner, PhD Belief in Military Based R&D Model Undercut by Practice • Much discussion of the Military R&D Model in the 1980s & Resulting U.S. Commercial Advantage • The fact that there was virtually no increase in Defense Expenditures among NATO allies Undercuts the Conviction of the Argument – The ’80s did see an increase in targeted commercial technologies 34 © Charles W. Wessner, PhD U.S. Military R&D: An Appropriate Model? • U.S. Military R&D is – Inefficient – Overcommitted – Later-Stage • Development Focus on Testing & Certification – Occasionally has Major Impact • GPS • Internet – Often Widely Shared with Others 35 © Charles W. Wessner, PhD Myths and Limitations of Spin-off 36 © Charles W. Wessner, PhD Spin-Off as a Non-Targeted Economic Benefit • Why do U.S. policymakers like spinoff as a concept? – Because spin-off appears to cost nothing (assuming the defense expenditure is useful) – Spin-offs help justify high defense expenditures – Spin-off appears to need no government management or targeting, thus eliminating any interference in the marketplace – Is this true in practice? 37 © Charles W. Wessner, PhD The Limits of Spin-Off • The substantial separation of the defense and commercial sectors of U.S. industry limits opportunities and raises costs • Adaptation of defense innovation to commercial use is not cost free • Focus on defense means technologies with high commercial potential are ignored – DARPA focus in on Long-term and Military Applications, not Civilian Uses 38 © Charles W. Wessner, PhD The Limits of Spin-Off • Compared to what? • The efficiency of investments resulting in spin-offs to meet commercial technology needs must be compared to alternatives – Comparable private sector R&D vs.. government defense R&D? – No research at all – yes, spin-off compares favorably to not doing R&D at all 39 © Charles W. Wessner, PhD The Limits of Spin-Off • Compared to alternative institutions – R&D at other federal agencies • Federally-funded civilian technology initiatives, e.g. , the ATP at NIST – Basic Research Support at NSF or NIH • These comparisons are hard to make and therefore rarely made • Claims for spin-off benefits tend to be comparison free – policies focused on military R&D should be grounded in the present, not just focused on isolated success cases from 40 or 50 years ago 40 © Charles W. Wessner, PhD Spin-Off: A Success Story • Direct product conversion of a product developed at government expense is rare but does occur • A good case is Raytheon’s microwave oven – a classic sequential spin-off within a single firm • The conditions for success included: – A complete redesign of the magnetron microwave power source for ease of manufacture – A five-fold reduction in magnetron cost through learning and scale – Development of a patented safety seal to prevent the escape of microwave radiation – Corporate acquisition of the distribution channel 41 © Charles W. Wessner, PhD Spin-Off: 2 Failures & 1 Success • C-5 Military Transport Aircraft Competition led to Lockheed’s victory with: – Contracts for the C-5 military transport – Concurrent development of the L-1011 commercial transport • Lockheed never made a profit on the L-1011 & later withdrew from commercial air transport • Boeing lost the competition for the C-5 with the federal support that entailed 42 © Charles W. Wessner, PhD Spin-Off: 2 Failures & 1 Success • Having lost the C-5 competition, Boeing then “bet the company” on the 747 – C-5 design work aided development of the 747 – Timing helped: The OPEC embargo ran up aviation fuel prices, thereby helping the more fuel efficient 747 gain market share – The focus on the commercial market helped Boeing • Lockheed and McDonnell-Douglas had major military business – both failed in civilian aircraft production • Conclusion: Military support works??? 43 © Charles W. Wessner, PhD Some Civil-Military Cooperation Leads to Positive “Spin-offs” • Concurrent Development of Civil & Military Applications of a Common Technology – Nuclear reactors for submarine propulsion and then electric power production set dominant points of the technology in the United States – GE and Pratt/Whitney design and build jet engines for related families of civilian and military aircraft – KC135 Stratotanker & Boeing 707 had a common origin but very different design features (375 flight hours per year vs. 3000 for the 707 • Development of Engineering Techniques & Tools to Meet Government Needs – E.g., Software for computer based design and analysis from NASA sponsored research 44 © Charles W. Wessner, PhD Various Forms of Civil-Military Cooperation leading to “Spin-offs” • Dual-Use Technology Developed from Defense Agency Research Support – Defense support for University research (e.g., Artificial Intelligence) that may be valuable to civilian industry • Reverse Spin-off or ‘Spin-on’ to Military is increasingly common – E.g., CMOS semiconductor chip technology was perfected in Japan for use in electronic wristwatches 45 © Charles W. Wessner, PhD What Could More European Military R&D Accomplish? • More European Military R&D Could – Enhance some European Military Capabilities • From a few large firms? – Encourage Rationalization • Is this good for all countries, e.g., Sweden and France? – Stimulate Dual-Use, High Technology • But is this likely? 46 © Charles W. Wessner, PhD Policy Issue: Allowable vs.. Effective • Is the push for European Defense R&D like the Push for R&D Tax Credits? – Tax Credits are Expensive and Blunt, but they are Allowed by State Aid Rules, so… – Military R&D may be Ineffective for New Technology, but it is Exempt from State Aid Rules, so… • Is it a case of Efficiency vs.. the Rules – Would it be better to change the Rules? 47 © Charles W. Wessner, PhD The U.S. Critique: “Spinoff cannot serve as a realistic basis for technology policy” --Alic, Branscomb, et al (1992) • Defense R&D does not cover gaps in nation’s technology policies – Defense contributions are growing smaller & more specialized – Many industries benefit little from Defense R&D • Spin-offs offer only indirect, inadvertent contributions – Focus on spin-offs denies more direct role for government in technology policy 48 © Charles W. Wessner, PhD Is a French-style Model Right for Europe? • Large State selected & supported projects, insulated from rapidly changing market forces by National Procurement -- National Champion Based – Nuclear Energy – Aerospace • Airbus, Ariane and ESA Program – Large Scale Transportation--TGV Trains – Water and Electricity Champions • A Strategy Not well suited for rapidly changing technologies and markets, e.g., semiconductors & computers • Is Spinoff Really the Current U.S. Model? – Is it Effective? Compared to What? 49 © Charles W. Wessner, PhD A Better Model: Public Private Partnerships offer more Potential for Innovation in Europe Important to Consider Alternatives to Military R&D: Public-Private Partnerships • Need to focus on other policies that could more effectively support nation’s Commercial Sector, such as PublicPrivate Partnerships – Public-Private Partnerships focus on the hurdles between basic research & product development – Need to adopt policies to bridge traditional government roles and traditional private sector roles 51 © Charles W. Wessner, PhD A Program “Like an SBIR” May Offer Europe Higher Returns than “More R&D” • No New Funds Required for SBIR – Capitalizes on Existing R&D Investments and Procurement Funds • Focus on Valley of Death—Key Point of Vulnerability for Firms and Products • National Program to Meet National Needs with National Firms • Bottom-up Approach to Security – Contributes to Innovative Solutions as well as Growth and Job Creation 52 © Charles W. Wessner, PhD The Small Business Innovation Research (SBIR) Program • Created in 1982, Renewed in 1992 & 2001 • Participation by all federal agencies with an annual extramural R&D budget of greater than $100 million is mandatory – Agencies must set aside 2.5% of their R&D budgets for small business awards • To be a $2 billion per year program in 2004 – Largest U.S. Partnership Program 53 © Charles W. Wessner, PhD The SBIR Model R&D Investment Social and Government Needs Private Sector Investment PHASE II Research towards Prototype PHASE I Feasibility Research $100K PHASE III Product Development for Gov’t or Commercial Market $750K Tax Revenue Federal Investment 54 © Charles W. Wessner, PhD SBIR is a Bridge in the Innovation System • Provides a Bridge between Small Companies and the Agencies, especially for Procurement • Provides a Bridge between Universities and the Marketplace • Encourages Local and Regional Growth, increasingly through the University connection • Creates jobs and justifies R&D investments to the general public 55 © Charles W. Wessner, PhD The Key Question: Would SBIR Work in Europe? • Some Believe it Would: – “SBIR is one of the few American Technology Programmes that can be ‘Cut and Pasted’ into European Innovation Systems” • Participant at Commission Workshop, Brussels, June 2004 – EURAB has Recommended an “SBIR type” Program 56 © Charles W. Wessner, PhD Competitive Awards to Support SME Innovation are Needed • SBIR is a Powerful Model – U.S. National Academy of Sciences research shows model is flexible and effective • Recent National Initiatives & Proposal by the Commission to Permit SBIR-Type Proposals – Investing in research: an action plan for Europe, [COM(2003) 226 final/2 – See Section 5.3, p. 19] – TEKES has adopted a Phase I approach – VINNOVA is initiating an SBIR Program – France is exploring an SBIR-type program 57 © Charles W. Wessner, PhD An Innovation Systems Perspective on Security • National Security is founded on a Robust Innovation System – Need to Address Linkages among many Facets of the Innovation System • Universities, Businesses, Government – A Robust Innovation System will help make the Nation Militarily and Economically Secure – Robust Defense Spending alone will not make the Nation more Innovative, thus, ultimately Less Secure • Lesson of the Cold War 58 © Charles W. Wessner, PhD The Transatlantic Cooperation Option • The U.S. is devoting Substantial Funds to New Technologies to Meet the Terrorist Security Threat – U.S. Capacity constraints are real – Research cooperation is historically broad and rich – Procurement is increasingly open, and the U.S. market is large 59 © Charles W. Wessner, PhD Conclusion 60 © Charles W. Wessner, PhD Spinoff is a Popular Concept but an Inefficient Policy at Best • Spinoff has never been a consistently effective approach to enriching commercial technology • At best it is a weak and expensive substitute for more direct support of the commercial technology base – Alic, Branscomb, et al. 61 © Charles W. Wessner, PhD Benefits of the SBIR & ATP Model for Defense and Security • Small Business can bring New Ideas and New Products to address Security Needs • SBIR provides a Proven Pathway for Small Businesses to Help the Government Meet Defense and Security Needs • SBIR represents a Low-Cost, High-Leverage Opportunity for National Policymakers to Meet Multiple Goals at Constant Cost—No New Funds • SBIR & ATP address the key Issues of Firm Formation, Entrepreneurship, Employment, and Growth and is therefore of Central Policy Interest 62 © Charles W. Wessner, PhD Designing More Realistic Policies for European Innovation • To Lead in the Knowledge Economy – Understand innovation ecosystem • How can innovation in commercial and defense sectors draw on & support each other? – Provide Incentives rather than Targets selected by Consensus 63 © Charles W. Wessner, PhD A Modified European Innovation Strategy • Create New Public Private Partnerships – Involve Large & Small Firms – Encourage National Experimentation – Involve Universities in Innovation • Focus on 3 Interrelated Elements: – Platform Technologies: • Respect Political Commitment – Competitive Awards to Large & Small Firm Joint Ventures [The Advanced Technology Program (or ATP) Model] – Competitive Awards to SMEs & Start-ups (SBIR Type Program) 64 © Charles W. Wessner, PhD Keeping Europe Secure • Keeping Europe Secure requires, – Economic growth to safeguard the Social Compact – New Technologies to provide Cheaper and Better Social Services, Health Care, Environmental Protection, and National Defense • Partnerships are one way to do this • SBIR Breaks Through the Oligopoly Supply Base for government agencies – Provides new technologies and new solutions 65 © Charles W. Wessner, PhD Common Challenges • Learning from Each Other is a Key to Better Innovation Policy – Learning from failures (and distortions) can be as valuable as learning best practice • Sorting Myths from Reality is a First Step Towards More Growth and More Security 66 © Charles W. Wessner, PhD Thank You Charles W. Wessner, Ph.D. Director, Technology and Innovation The National Academies 500 Fifth Street NW Washington, D.C. 20001 cwessner@nas.edu Tel: 202 334 3801 http://www.nationalacademies.org/step 67 © Charles W. Wessner, PhD