!"#$#B U S I N E S S H O R I Z O N S Q U A R T E R LY // F A L L 2 0 1 2

FOR THE NEXT THIRTY YEARS

! " # $ % & ' # ( & ) * + ,

When editors of Life magazine ranked !omas Edison "rst on the list of “the most important people of the last 1000 years,” they were recognizing the importance of innovation to improving the material condition of mankind.

Make no mistake, innovation is what drives productivity. It is what makes us wealthier and healthier (if not wiser). It is impossible to conceive of modern America today without appreciating the waves of innovation that made the United States the most powerful and dynamic large nation in history.

Innovation matters so much it’s worth pausing to ask how we get it and to wonder how we might get more of it. In this essay, I’ll propose a strategy to ensure robust American innovation over the next thirty years.

mEMOS TO THE FUTURE BUsiness Horizon Quarterly

// S T R A T E G Y F O R I N N O VAT I O N !"!#$

1) Getting Our Priorities Right

!ere are many reasons the nation must confront its large and accumulating debt. Yet, one reason that doesn’t get enough attention is that it’s harmful to American innovation. Here’s why:

Innovation is powered by many factors, one of which is the total stock of knowledge in society. !e federal government helps build the stock of knowledge through its support of basic research and development.

!e problem today—and for the last several years—is much federal research and development comes out of the government’s discretionary spending. !e growth in entitlement spending is crowding out its discretionary spending, meaning there’s less room for investments in research and development (R&D).

Some of the areas ripe for additional R&D spending that would boost innovation down the road include the National Institutes of Health, the National Science Foundation, NASA, and the National Institute of Standards and Technology.

As a report from the research group !ird Way notes, “as the cost of entitlement programs like Medicare and Social Security has skyrocketed, we’ve spent less and less of our budget educating kids, building roads, and curing disease.”

As a nation we have prioritized entitlement spending over spending on research and development. No one is arguing that the nation shouldn’t have an adequate safety net. But if it comes at the expense of productivity enhancing innovation, then everyone is made worse o". Entitlement reform will be good for its own sake; but it will also mean the nation can spend adequately on improving the nation’s knowledge base, thus bolstering innovation.

2) Tackling the Abundance of Regulation

While no one denies that an economy as advanced and complicated as America’s will need some regulation, the question is, what is the proper scope and reasonable cost of regulation? On this score, there’s bipartisan agreement that America’s current system of regulation is a mess and ripe for an overhaul.

Serious regulatory reform will be a boon for innovation. After all, regulation is designed to homogenize activities, among #rms and individuals. It’s designed to get businesses or individuals acting in precisely the same manner to achieve a desired outcome.

Yet think about the essential character of innovation for a moment. Innovation, by its very nature is heterogenous. It means doing something di"erent than before; something di"erent than from how everyone else does something. It is designed to break with the past, to disrupt established patterns of production and activity.

In that way, faulty regulation can be an innovation killer by leaving too little room for new ways of doing business, for new business models to emerge, for new techniques to take root in the marketplace.

Good regulation protects consumers, workers, and the environment while still making it possible for companies and consumers to experiment, to engage in trial and error, and to pursue new enterprises and initiatives.

3) Fix Immigration

In some ways, innovation is simply an odds game. Good innovations arise when ideas are combined with human e"ort in ways that satisfy the needs of companies and customers.

!""#$%&!#"

!"#$#B U S I N E S S H O R I Z O N Q U A R T E R LY // F A L L 2 0 1 2

To get more innovation then, it helps to have more brains and more diverse perspectives focusing on an economy’s problems and opportunities.

Of course, we have a lot of that already in the United States. But we can always use more. As Dr. Linus Pauling said, “!e best way to have a good idea is to have a lot of ideas.”

!is is one reason we need to "x America’s approach to immigration. Right now the United States brings to its shores some of the most talented and enterprising people from across the globe. Many of them come to study in our top-#ight research colleges and universities.

At the same time, we make it more di$cult than we should for those people to remain in the United States, to start companies, to get married, and to feel as if America is their home. As a result, many of them are returning to their native countries in pursuit of new opportunities, or simply to avoid putting up with visa and other hassles.

!e loss of these people—of all that human capital—means a loss of potential new innovation. !at’s why it will help to reform our nation’s immigration laws to make it easier for skilled immigrants to come to America and build meaningful, satisfying lives here.

Former Microsoft technologist Nathan Mhyrvold has said “We live in a society where technology is a very important force in business in our daily lives. And all technology starts as a spark in someone’s brain. [emphasis added] An idea of something that didn’t exist before, that once they have invented it—brought it into existence— could change everything.” !at’s why we need to bring— and keep—more brains here in the United States.

4) Get Incentives Right

!e writer Edward Conard has noted that “people create innovation by "nding ways to make improvements and by implementing those improvements—both incremental improvements and major changes.” It’s important that entrepreneurs have the access to capital they need to experiment and grow, and that the broader ecosystem of investment and risk-taking is one that is conducive to capital formation.

Implementation of innovation is one area where incentives come in to play, particularly with respect to tax policy. As it stands now, the United States has the highest corporate tax rate in the developed world. Other developed nations have, over the last "fteen years, been lowering their corporate tax rates. !ey understand that, at the margin, a high corporate tax rate is a disincentive to capital formation and to resultant innovation and productivity enhancements.

!e United States has also experienced an alarming decline in initial public o%ering in recent years. !ere are many reasons for this, but one of them is surely the disincentives to launching an initial public o%ering (IPO) created by laws such as Sarbanes-Oxley.

!e decline in IPO activity gives those of us concerned with innovation great pause. Many innovations are pushed into the commercial marketplace by new "rms that were created precisely to drive disruptive innovation.

“Innovation is the specific instrument of entrepreneurship. The act that endows resources with a new capacity to create wealth.”

- Peter Drucker

mEMOS TO THE FUTURE BUsiness Horizon Quarterly

// S T R A T E G Y F O R I N N O VAT I O N !"!#$

Companies like Google and MasterCard are some of the innovative companies to have tapped public equity markets over the last decade. No one should be satis!ed with an anemic environment for IPOs. Getting the incentive mix right—to remove barriers that discourage growing !rms from making a public debut—must be part of any comprehensive innovation strategy. 5) Adequately Fund the Patent Office

"e U.S. Constitution tells us that patents are designed “to promote the progress of science and useful arts.” In other words, they are designed to help drive innovation.

Unfortunately, such promotion is badly slowed if the o#ce designed to process applications, in our case the U.S. Patent and Trademark O#ce (US PTO), is insu#ciently equipped and sta$ed to do the job.

For too long Congress has treated the funds dedicated to the US PTO as a political football. It should instead see those funds as indispensible feedcorn to help bolster U.S. innovation.

A pro-innovation Congress will ensure that the PTO can adequately compensate its examiners, hire enough of them, and encourage capable individuals to work at the patent o#ce. Otherwise, an innovation bottleneck is created, where productive ideas in biotech, life sciences, materials science, mechanical engineering, and more are held in limbo and unable to get !nancing.

It’s worth noting that there’s a robust discussion taking place about the proper scope of patent protection. Patents that are overly broad, for example, can become a hindrance to innovation. So, one reason to make sure the patent o#ce has the resources it needs is to ensure that only patents of high quality receive protection.

AN INNOVATIVE FUTURE

"e great student of industrial capitalism Peter Drucker once noted that “Innovation is the speci!c instrument of entrepreneurship. "e act that endows resources with a new capacity to create wealth.” "is is why innovation is so important to the United States. As the wealthiest and most advanced of all the industrial democracies, the United States cannot create new wealth by copying the habits and practices of other nations. It must drive new innovation if it is to create new wealth.

"is is why the climate for innovation matters so much in the United States. Any person in the policy community would be prudent to view his or her proposals through a lens that asks, “will this advance or retard the innovative capacity of the United States?”

Too often the temptation is to forget about the e$ect or new laws on innovation and to only see the short-term bene!t of a new law or a change in rules and regulations. To ensure a brighter future at home—and for the rest of the world that depends on the success and vitality of the United States—innovation and new enterprise must be at the center of all that we do.

Nick Schulz is a National Chamber Foundation

Scholar and a frequent contributor to the

Business Horizon Quarterly. He is the coauthor

of From Poverty to Prosperity and serves as

the DeWitt Wallace Fellow at the American

Enterprise Institute. Read his full biography on

page 64.

!""#$%&!#"