Stanford University

Saving the US Economy – Effective Involvement of Government, Academia, and Business

The rapid development of the Asian economies provides numerous examples of methods to develop job growth, incubate new technologies and new products, scale-up to production and manufacture of the new product, and develop a strong economy. In a study of the industrial development of East Asia, Robert Wade in his book Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization found that Asian economies performed at record numbers over the 1970s and 1980s in large part because of the effective involvement of the government in targeting the growth of manufacturing industries. As Tom Blair, in his book Poorer Richard’s America: What Would Ben Franklin Say?, “the government of China spends their money to build industry and sell products, and the USA spends money to make the world safe.” If the USA wants to continue to be the world’s superpower and leader for peace, and indeed we should, for think about the world rife with tyrannical governments and militaristic groups causing anarchy, killing, raping, and torturing if we are not there to lead, then we must regain our economic might in order to support our world leadership role.

Consider the USA where recently the mantra has been “free market” and the US government viewed as “the problem.” Not long ago in California, and in particular the Silicon Valley, the most dynamic economy on the planet was in place, thanks, partly, to local, state, and federal government, where a tremendous incubation of new companies and new technologies was occurring. Those companies went on to produce their products in California, realizing great job growth and bolstering the economy. The birthplace of semiconductors and biotechnology, this area has thrived with the incubation and then the scale-up to production and manufacturing of new technologies. Seated next to one of the world’s wealthiest communities with much disposable income, packed with venture capitalist, ringed by three of the great universities on the planet (UC Berkeley, Stanford, and UCSF), and many other institutes providing a vast quantity of intellectual assets and intellectual property, loaded with entrepreneurs, supported by federal dollars, and even supported by state initiatives such as the 1980s California Commission on Industrial Innovation instituted by then Governor Jerry Brown ( a noted fiscal conservative, but proponent of high-tech industry and education), the Silicon Valley has long been the champion of the world economy.

However, something is changing and the change is not good. Iconic to this change, witness where the birth of the world’s first silicon chip happened in Mountain View, CA, where now that seminal site of the chip industry is a nice place to pick up some fresh produce. This produce stand once was the world’s first semiconductor lab, established by the American physicist William Shockley and where the founders of Fairchild and Intel first worked. However, nowadays just a couple of marks on the sidewalk indicate a glorious past of America’s chip making industry, among all the fruits and veggies.

Unemployment in the Bay Area is about 10%, which is higher than the national average. Clearly, the great Silicon Valley innovation machine hasn’t been creating many jobs lately in the USA. Instead, those jobs are headed to Asia.

The underlying problem isn’t simply lower costs in Asia. Rather we face a number of problems that are self-inflicted.  To paraphrase Tom Blair, American companies eat their young, often for a few years of heightened profits, then they disclose and transfer their expertise and technologies to China. Another words, we give away our know-how and hence the long-term survivability of our US companies for the sake of several years increased income for the short term gain of entry into the Chinese market. Further, we have our own misguided belief in the power of startups alone to create new technologies and U.S. jobs. Americans love the idea of the guys in the garage inventing something that changes the world. We all think of the Apple Computer start-up in a garage somewhere in Northern California back in the 70s or the more recent version of Google with a beautiful campus where innovation runs rampant. Often I hear businessmen espouse the view that we are living in a country where we create ideas but not products, and this is exactly what the US should be doing. Recently New York Times columnist Thomas L. Friedman in an opinion piece called “Start-Ups, Not Bailouts,” pointed to our significant economic problems in the USA resulting from a combination of problems, including a deteriorating educational system, lack of a healthy political and governmental atmosphere, and immigration policies that turn away “high-IQ risk takers,” leading to a diminution of entrepreneurial activities and thus the creation of new businesses and new technologies.

Startups are important for our economy, but also, as Dr. Andy Grove of Intel will argue, start-up activity alone, where products are conceived but without the subsequent scale-up to production, will lead to a less than robust economy and erode job growth, and eventually diminish further innovative start-up activity. Yes, I have argued in front of congress to back start-ups with loan and SBIR programs, and support of our great research universities, but start-ups alone without scale-up to production and development of the technology and products here in the USA cannot by themselves increase tech employment and sustain an innovation-based economy. Equally important is what comes after that moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies “scale- up,” a process whereby the employees work out design details, figure out how to build their products affordably, build factories and infrastructure, develop business partnerships often with other local businesses, and where management hires people by the thousands. Scaling is hard work and, in the eyes of Americans, maybe not as glamorous as the innovation process, but is necessary for innovation to be realized in a commercial product, and equally important, is necessary for further innovation.

The scaling-up process and manufacturing is now rarely occurring in the U.S, and as we fail to do our own manufacturing, plowing capital into young companies that build their factories elsewhere will continue to yield a poor return in creating jobs in American, decrease economic gains in the USA, lead to the eventual deterioration of innovation, and fail to build a healthy economy with a robust middle-class.

In years past, scaling-up to production and manufacture worked well in the Silicon Valley. Entrepreneurs invented something new and useful. Investors provided money to build the new business. If the founders and their investors developed good technology and business ideas, worked hard, and were lucky, the company grew and had an initial public offering (IPO) that brought additional money to finance further growth. Examples in the Valley are Intel, then Tandem Computers Inc. went through a similar process (was purchased by Compaq in 1997), then Sun Microsystems Inc. (incubated at Stanford University), Apple, Cisco Systems Inc., Netscape Communications Corp. (now a part of AOL), and recently Google, Facebook, Twitter, and many others.

As time passed, wages and health-care costs rose in the U.S., and the Chinese government devised a system to compete. American companies discovered they could have their manufacturing and even their engineering done cheaper overseas. Doing so improved the company’s margins. Management and stockholders were happy. Growth continued, and so did profitably. But the long term results of such overseas outsourcing began to show and the job machine in the great Silicon Valley began to falter.

Unfortunately, today, manufacturing employment in the U.S. computer industry is about 166,000, which is lower than it was before the first personal computer, the MITS Altair 2800, was assembled in 1975. Meanwhile, a very effective computer-manufacturing industry has emerged in Asia, employing about 1.5 million workers, including factory employees, engineers, and managers. Hon Hai Precision Industry Co. of Taiwan is the largest of these Asian companies with revenue last year of $62 billion, larger than Apple Inc., Microsoft Corp., Dell Inc. or Intel. Hon Hai Precision employs more than 800,000 people, more than the combined worldwide head count of Apple, Dell, Microsoft, Hewlett-Packard Co., Intel and Sony Corp. Indeed this is company making you I-Pod and your I-Pad.

The deterioration of US job creation is endemic to much of US industry, not just in our computer industry. Alternative energy is another example, where an emerging industry is replete with much innovation. Photovoltaics are a U.S. invention. Use of photovoltaics in home-energy applications was also pioneered by the U.S. Unfortunately, most of the photovoltaic panels are now manufactured in China. Although a Silicon Valley technology company sells equipment that is used to manufacture photo-active films, the company ships close to 10 times more machines to China than to manufacturers in the U.S., and this gap is growing. Not surprisingly, U.S. employment in the making of photovoltaic films and panels is perhaps 10,000 — just a few percent of estimated worldwide employment. New concentrating photovoltaic (CPV) systems were recently invented in California, and hopefully this new technology will continue to develop in the USA with companies such as SolFocus of Mountain View, California.

And job creation is just a part of the problem. With some technologies originally developed in the USA, such as advanced batteries, both scaling-up to production and innovation are occurring overseas. Although years in the making, mass-produced electric cars and trucks are finally on the market. New companies are emerging in the USA, including Tesla in Northern California and Fisker in Southern California. These cars rely on lithium-ion batteries. Unlike microprocessors, where many are produced in the Silicon Valley, Texas, and the East Coast by Intel, AMD, and others, the U.S. share of lithium-ion battery production is small.

The small presence of the USA in the production of high-tech batteries presents a problem for growing this, and related industry in the USA. A new industry needs an effective infrastructure in which technology knowhow accumulates, knowhow and innovation builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer-electronics devices. Those companies producing batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and following that, for the even more demanding automobile market. U.S. companies didn’t participate in the first phase of production and consequently weren’t competitive for all that followed. Any attempts by US companies now to gain entry to that market will prove very challenging. To the Obama administration’s credit, stimulus funds have been provided to support high-tech battery production.

Adversion to risk may be another problem companies face. Foreign governments often mitigate the risk of companies through government funding. The scaling and manufacturing process is very costly and can be very risky. The investments required are much higher than in the invention phase. And funds need to be committed early, when not much is known about the potential market. As Dr. Grove from Intel points out: The investment to build a silicon manufacturing plant in the 1970s was a few million dollars. By the early 1990s, the cost had risen to several billion dollars. The decision in the 1990s to build the plants for the Pentium chips needed to be made years before Intel knew whether the Pentium chip would work or whether the market would be interested in it. Because of good technology and good business decisions, along with acceptance of the associated risks, the Pentium was a huge success.

However, in previous years, when Intel’s business focused on making memory chips, Intel hesitated to add manufacturing capacity, not being sure about the market demand in years to come. Japanese competitors didn’t hesitate and invested in the plants. When the demand for memory chips rose exponentially, the Japanese roared into the U.S. market and Intel began its descent as a memory-chip supplier.

Now in even in our biotech and pharmaceutical business we see some of the same trends emerging. The biotech revolution began in the Silicon Valley area, South San Francisco to be precise, at Genentech.  The biotech industry flourished in the Bay Area and along the California Coast especially north of Los Angeles where Amgen became the world’s largest biotech company, and also in San Diego where over 500 biotech companies now exist, including such promising new start-ups as Craig Venter’s Synthetic Genomics that has partnered with Exxon-Mobil to produce algal biofuels. However, many of the active ingredients or raw materials for biotech and pharmaceutical products are being outsourced to companies in India and China, sometimes with disastrous consequences beyond the economic implications. Witness the deaths of 81 people from the drug heparin produced in China. Investigations found a contaminant, over-sulfated chondroitin sulfate, tainting raw heparin coming from China that was linked to the deaths. Along with India, China supplies more than 40 percent of the active pharmaceutical ingredients (API) used to make U.S. pharmaceuticals. And Pfizer and Johnson & Johnson have announced plans to set-up research and development facilities in China. Again, technical knowhow and innovation are being exported overseas, with long-term economic consequences, as well as the killing and sickening of people because of poor quality control overseas.

Why is the US no longer interested in scaling up to production? Perhaps the answer has to do with a general undervaluing of manufacturing, and the idea that as long as innovation process stays in the U.S., all will be well with our economy. This way of thinking seems wide spread.

Princeton University economist Alan S. Blinder in Offshoring of American Jobs by Bhagwati and Blinder have written: “The TV manufacturing industry really started here, and at one point employed many workers. But as TV sets became ‘just a commodity,’ their production moved offshore to locations with much lower wages. And nowadays the number of television sets manufactured in the U.S. is zero. A failure? No, a success.”

The overseas production of TVs not only caused a loss of jobs, but also broke the chain of experience that is so important in technological evolution. Just as happened when the US abandoned the production of batteries, abandoning today’s “commodity” manufacturing may very well lock the US out of tomorrow’s emerging industries.

Again, the economic mantra of today seems to be “free market is best, and government is the problem.” Such fundamental beliefs that have been elevated from a conviction based on observation and reasoning to an unquestioned truism are leading us down an uncompetitive path. In the past we have seen the decisive victory of free-market principles over planned economies. We now ignore the role of government in what in reality was controlled capitalism, largely oblivious to emerging evidence that while free markets beat planned economies, totally free markets have never worked well and we must consider modified capitalism as a system that works even better than free markets.

Evidence of government working through a controlled free market to develop economies and advance innovation, jobs, and a strong industry presence is observed in several Asian countries during the past few decades. These countries seem to understand that job creation and building industry must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal.

One example is the “Golden Projects,” a series of seven digital initiatives devised and managed by the Chinese government in the late 1980s and 1990s. Beijing was convinced of the importance of electronic networks that are used for transactions, communications and coordination in enabling job creation and economic growth, particularly in the less developed parts of the country. Over time, the Golden Projects contributed to the rapid development of China’s information infrastructure, job creation, and the country’s economic growth.

What do we learn from the Asian experience? First, let’s remember that government has had much to do with our success as a nation and our continued success will depend on a strong government that attracts the best minds. As an example in the great success of California, the US government helped establish important institutions for research and teaching including the University of California through the university land grant system in the 1880s,and established the Livermore National Labs with the University of California in 1952. According to the Semiconductor Industry Association(SIA), “Reversing the Decline in Federal Funding, In the 1990s, federal funding declined precipitously in the areas most critical to our industry’s continued success: the physical sciences, mathematics, and engineering. This has seriously reduced the number of faculty and students in these disciplines, slowing the pace of university research and creating a shortage of skilled workers for our companies. In the past year, SIA has energetically addressed this problem.” Furthermore, in Business and Economic History (1995), Daniel Holbrook writes that the US government did much to develop the semiconductor industry in a number of ways, including its procurement policies and an ability to lead the dissemination of important technological developments to the industry. Further, the birth of the biotech industry in California was largely a result from work at a number of great research universities, supported by government, including the University of California.

Viewing the Silicon Valley and the rest of the California tech industry, a community with a strong tradition of science and engineering exists, this community is eager to solve whatever problems they encounter. If profit margins are the problem, the scientists and engineers work on margins. Each company, independent and individualistic, does its best to expand efficiently and improve its own profitability. However, in pursuit of our individual businesses and a short term view to the yearly financial accounting goals, which often involves transferring manufacturing and a great deal of engineering out of the country, has hindered our ability to bring innovations and manufacturing at home, and has imperiled our economy. Without scaling to production and support of our educational and research institutions, we don’t just lose jobs, but we lose our hold on new technologies and eventually erode our economy.

Our current state of economic ills is partially due to our short term goals to increase the bottom line of the financials and as a consequence of many of us taking actions focused on our own companies’ next milestones. In the biotech industry this is reflected by many companies developing an “Indian” or “China” strategy to move production or studies overseas because their competitors are doing so already. And as the companies moved production or research overseas, they often found that the lower costs overseas were really not so low when studies were not performed correctly and products were delivered late and/or were of inferior quality.  As Dr. Andy Grove has suggested, companies and VCs should have a partner in charge of every company’s “U.S. strategy.”

To better compete in the world economy, the US will need to view business in the long term as well as the short term. Outsourcing overseas and giving away our scale to production for short term profits needs a disincentive, thus rebuilding our industrial base. Government needs to support our great research institutions, provide liquidity in the financial markets for all businesses, including start-ups and small businesses, and should develop a system of financial incentives, such as to levy a tax on products produced offshore. Then use the dollars from this tax to provide liquid capital to those companies creating innovative products in the USA and/or scaling their production within our borders. A government supported system such as this would provide an incentive, and a reminder, that all of us in business have a responsibility to maintain the industrial base on which this country has prospered and on which we depend for our long-term viability. Further, during our current economic crisis, allowing our great academic research institutions to fall from their current lead in science and engineering will lead to the eventual decline of our great ability to innovate and incubate new technologies and new companies. To accomplish this revitalization of our business, government will need to become less acerbic. Instead of politics being played like American football, where there are two competitors and people choose one side or the other and defend their side irrationally, politics need to be played rationally. Our current state of demagoguery between Republicans and Democrats is leading to our economic decline. We no longer have rational debate; rather we have two demagogic monologues with no positive interaction leading to inaction. As Martin Luther King III has said, “We need to learn how to disagree without being disagreeable.” Perhaps with a civil political discourse as in past times in the US, a strong US government once again enabling and working closely with business, and with business viewing the long term consequences of their actions, we can begin to realize a political and business view to the future that will rebuild our once great US economy.

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