America’s Two Systems of Innovation: Innovation for Production in Fostering U.S. Growth

There is strong bipartisan consensus in Washington about the urgent need to promote “innovation” to keep the U.S. economy prosperous. However, high levels of U.S. unemployment raise unsettling questions about whether our innovation system is still primed to create and maintain new jobs for Americans. In our view, innovation is indeed the key to sustaining America’s competitiveness, but the understanding of innovation has to be broadened.

Most discussions concerning innovation focus on novel breakthrough developments that give rise to game-changing American technology, thereby generating enormous wealth and value for the nation. Think of this as “novel-product” innovation, where the firm or lab producing it comes up with an entirely new technology or product. However, novel-product innovation is only half the story. Taking a novel idea or invention from concept to market requires an array of incremental product innovations, such as continual improvements in automobile transmissions, together with innovations in production processes. This concept is known as incremental and process innovation, or I&P for short. The globalization of design, production, sophisticated manufacturing, and distribution requires a new approach to this second, often forgotten form of innovation in order to avoid the risk of losing the jobs and production capabilities essential to American competitiveness.

The United States still holds a commanding advantage in novel-product innovation. It has successfully structured an innovation ecosystem to support this familiar type of innovation, and the success of leading American firms such as Apple, Google, Pfizer, and Qualcomm shows that our capabilities remain strong in this area. However, the intense emphasis on this single form of innovation has two fundamental problems. First, novel-product innovation by itself does not generate many jobs because the developmental work and production are increasingly off-shored from the beginning. As Nate Rosenberg has shown, incremental and process innovations are the true unsung heroes of economic growth.¹ Second, the complete divorce of high-end novel-product innovation from incremental product improvement and production process innovation decreases the rate and quantity of novel-product innovation and erodes overall innovative capacity. As we consider policies and business procedures for reinvigorating growth, the United States must address both challenges. We should be greatly concerned that

• • High-value-added innovations are no longer yielding the development, production, and job growth for America that we have assumed naturally follow novel innovation

• • The supply base of small and midsize firms for middle-value-added products that could benefit from supply-chain factors is both dwindling and not truly innovative

• • The changing mix of skills necessary for I&P innovation in the small and midsize enterprise (SME) supplier base falls outside the range of core skills in traditional American production shops

• • Our system of financing innovation has become increasingly narrow, focusing on specific financial vehicles, which in turn specialize primarily in novel-product innovation and require high-yield financial exits within a relatively short timeframe

These flaws have contributed to the accelerated decline in the overall share of production in the U.S. economy and to a decline in the broad-based economic benefits from America’s novel-product innovations, putting the country’s long-term advantage in novel-product innovation in jeopardy.

We argue that a strategy bolstering I&P innovation in the United States must recognize the growing interdependence of services and manufacturing in the new global landscape, because sophisticated services and goods are being integrated into many markets. An I&P strategy should focus on the same four building blocks that have worked so well for novel-product innovation:

• • Shared production assets: Firms need to fund and use assets held in common by a variety of contractual and institutional mechanisms.

• • Effective innovation network structures: Markets, contracts, and firms no longer provide adequate “glue” to effectively link pools of innovators.

• • Flexible business models: Restructuring the traditional definitions of supply and demand functions in markets is often as important as an innovative product.

• • Specialized financial institutions: Risk assessment capacity and lending/investment models appropriate to different types of innovation are necessary.

These...