Introduction

The Innovation Success Triangle

Major Development Stages of the U.S. NIS

Elements of the U.S. NIS

Future Evolution of the U.S. Innovation System

Endnotes

Introduction

Indeed, as Christopher Freeman defined it, a national innovation system is “the network of institutions in the public and private sectors whose activities and interactions initiate, import, modify and diffuse new technologies.”[1] Innovation systems matter because a nation’s innovation success depends on its national innovation system working effectively and synergistically.

Better understanding of the origins, development, and operation of a nation’s innovation system can help policymakers identify key strengths and weaknesses, and policy changes, needed to enhance a nation’s innovation performance. Because of a variety of factors, no nation’s innovation system is exactly the same as others. Each system is unique and needs to be understood in this context.

The U.S. national innovation system today is in crisis, and in need of thorough rejuvenation, especially through significant increases in federal government funding.

In the post-war period, the United States developed the world’s most effective national innovation system. It was not called that—indeed it is referred to as the “hidden developmental state”—but through a set of policies, and most importantly, vast government investment in R&D, most of it focused on maintaining a technological and military advantage over the Soviet Union, the United States became the clear leader in technology. But the fall of the Soviet Union meant that policymakers no longer felt an urgency and presided over the gradual and inexorable shrinking of this once preeminent system. The rise of the ideology of market fundamentalism—which still dominates Washington economic thinking—saw this shift not as a problem but a solution, as markets—not government—should be privileged. As such, the U.S. national innovation system today is in crisis, and in need of thorough rejuvenation, especially through significant increases in federal government funding. Fortunately, as reflected by the growing realization of the China technology challenge and the resultant recent bipartisan congressional advanced technology legislation, there is a growing awareness of this need.

This report first briefly describes the historical evolution of the U.S. national innovation system. It then describes the broad elements of the national innovation system organized around what is termed the “innovation success triangle”: the Business environment, regulatory environment, and innovation environment. In addition, for each element, it provides a subjective and informal ranking of the U.S. strengths relative to other nations.

The Innovation Success Triangle

One way to conceptually organize all the factors determining innovation in a nation is to think of an innovation success triangle, with business environment factors along one side of the triangle; the trade, tax, and regulatory environment along another; and the innovation policy environment along the third. Success requires correctly structuring all three sides of the innovation triangle.

An effective business environment includes the institutions, activities, and capabilities of a nation’s business community, as well as the broader societal attitudes and practices that enable innovation. Factors specific to business include high-quality executive management skills; strong IT (or as many other nations refer to it, ICT—information and communications technology) adoption; robust levels of entrepreneurship; vibrant capital markets that support risk taking and enable capital to flow to innovative and productive investments easily and efficiently; and a business investment environment that strikes the right balance between short- and long-term goals. Broader factors include a public acceptance and embrace of innovation, even if it is disruptive; a culture in which interorganizational cooperation and collaboration is embraced; and a tolerance of failure when attempting to start new businesses.

An effective trade, tax, and regulatory environment features a competitive and open trade regime, including serious efforts by government to protect its businesses against foreign mercantilist practices; support for competitive markets such that new entrants, including those introducing new business models, can flourish; processes by which it’s easy to launch new businesses and bring innovations to market; transparency and the rule of law; a reasonable business tax burden, especially on innovation-based and globally traded firms; a strong and well-functioning patent system and protection of intellectual property (IP); regulatory requirements on businesses that are, to the extent possible, based on consistent, transparent, and performance-based standards; limited regulations on the digital economy, especially toward data privacy and emerging technologies such as facial recognition and artificial intelligence; limited regulations on labor markets and firm closures and downsizing; a balanced approach to antitrust policy that recognizes the benefits of both scale and competition; and government procurement based on performance standards as well as open and fair competition. To be sure, a good regulatory climate does not mean simply the absence of regulations. As we saw with the 2008 financial crisis, the right kinds of regulations are critical to ensuring markets work and innovation flourishes. But nations need a regulatory climate that supports rather than blocks innovators, and creates the conditions to spur ever more innovation and market entry, while at the same time providing more regulatory flexibility and efficiency for industries in traded sectors.

The final leg of the innovation triangle is a sophisticated and strong innovation policy system. While markets and businesses are key to innovation, without effective innovation policy, markets will underperform.^[2] An innovation policy system includes generous support for public investments in innovation infrastructure (including science, technology, and technology transfer systems) and ideally targeting to specific technology or industry research areas; funding sector-based industry-university-government research partnerships; reshaping the corporate tax code to spur innovation and IT investment, including R&D and capital equipment and software incentives; a skills strategy, including high-skill immigration and support for science, technology, engineering, and math (STEM) education; encouraging private-sector technology adoption, including by small and mid-sized manufacturers; supporting regional industry technology clusters and regional technology-based economic development efforts; active policies to spur digital transformation in the private and nonprofit sectors, including in digital technology infrastructures (such as smart grids, broadband, health IT, intelligent transportation systems, e-government, etc.); and championing innovation in the public sector.

Major Development Stages of the U.S. NIS

In order to better understand the U.S. innovation system, it’s worth examining the history of the United States in terms of innovation and innovation policy. Clearly this brief overview cannot do justice to this enormously complex topic, but it can provide a basic outline.^[3]

For the nation’s first half century, there was a long policy conflict between Jeffersonians who advocated for a minimal role for the federal government and idealized a rural and small craftsperson economy, and Hamiltonians who advocated for a stronger role for the government in order to industrialize. The tension was never resolved, but the Hamiltonians did make progress, including funding internal improvements (canals and roadways) and supporting industrialization through tariffs and government expenditures for weapons development, such as the formation of the Springfield Armory in 1777. And since the founding of the Republic, the federal government had a robust patent system embedded in the Constitution.

With the emergence of the steel-based industrial revolution of the late 1890s, the United States joined the ranks of the world leaders, producing a host of leading-edge innovations.

The Civil War represented the transition to a second national innovation system. With the agrarian South no longer represented in Congress, the path was paved for significant legislation to move the nation forward technologically, including the building of the intercontinental railroad, and the passage of the National Bank Act. Congress also created a system of research-based land grant colleges through the Morrill Act. Funding for agricultural research helped power agricultural productivity, which freed up tens of millions of farm workers to power America’s growing factories, and helped create larger markets for industrial producers.

Still, for the first 125 years after its founding, the United States was not at the global technology frontier—that advantage was held by select European nations, first the United Kingdom and then Germany. However, with the emergence of the steel-based industrial revolution of the late 1890s, the United States joined the ranks of the world leaders, producing a host of leading-edge innovations. As business historian Alfred Chandler showed, the large American market enabled U.S. firms to successfully enter new mass production industries, such as chemicals, steel, and meat processing, and later autos, aviation, and electronics.^[4] Because scale mattered so much to innovation and firm competitiveness, U.S. firms such as DuPont, Ford, GE, GM, Kodak, Swift, Standard Oil, and others became global leaders.

Scale helped, but the United States had other advantages. One was the “greenfield” nature of development. Unlike Europe, which had to overcome a pre-industrial craft-based system, the American economic canvass was newer, enabling new forms of industrial development to be more easily established. Another advantage was the unrelenting commercial nature of the American culture and system, where commercial success was valued above all else. As President Calvin Coolidge famously stated, “The business of America is business.”

Moreover, policy to spur competition—through the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914—was used to ensure firms had the incentive to continue to innovate. And as Charles Morris’s The Dawn of Innovation: The First American Industrial Revolution shows, wars (including the War of 1812, the Civil War, and WWI) energized government-funded technology and industrial development, including helping metal-industry innovation such as precision metal measurement and interchangeable parts. During WWI, the government played a key role in advancing aviation and also electronics, with the secretary of Navy, Franklin Roosevelt, taking the lead in the formation of the Radio Corporation of America (RCA). Notwithstanding these factors, by and large, America’s industrial innovation prior to WWII was principally powered by private inventors and firms.

This changed dramatically after WWII with the emergence of a more science-based system of innovation (inspired in part by Vannevar Bush, director of the U.S. Office of Scientific Research and Development during WWII) which would become dominated by large firms and the federal government. The establishment—initially in the Great Depression and then after the war—of large, centralized corporate R&D laboratories helped drive innovation in an array of industries, including electronics, pharmaceuticals, and aerospace. On top of this, the massive federal support for science and technology in WWII helped develop the “arsenal of democracy” the Allies used to beat back the Axis powers’ threat.

With WWII and the subsequent rise of the Soviet threat, the federal government constructed a new innovation system. The massive expenditures on weaponry and R&D in World War II positioned the United States as the global leader in a host of advanced industries, including aerospace, electronics, machine tools, and others. The response to the Soviet threat—exemplified by Sputnik—helped cement America’s technology leadership. By the early 1960s, the federal government invested more in R&D than every other foreign government and business combined.

This strong federal role continued after the war, with substantial funding of a system of national laboratories and significantly increased funding of research universities. In 1945, the Army published a policy affirming the need for civilian scientific contributions in military planning and weapons production. In 1946, Congress created the Atomic Energy Commission and a system of national laboratories. The Department of Defense (DOD) established the first FFRDC (RAND) and University Affiliated Research Centers in 1947. Congress passed the Defense Production Act of 1950 and also created the National Science Foundation (NSF). Eisenhower pressed for the passage of the Interstate Highway Act. The Defense Advanced Research Projects Agency (DARPA) and NASA were established in 1958. And it provided the critical, although usually overlooked, inputs to America’s key technology hubs, including Boston’s Route 128 and Silicon Valley. Indeed, even in the late 1980s, Silicon Valley’s Santa Clara received more DOD prime contract award dollars per capita than any other county.

Federal funding of research helped drive innovation and played a key role in enabling U.S. leadership in a host of industries, including software, hardware, aviation, and biotechnology. This funding enabled the development of a host of critical technologies we enjoy today, including jet aircraft, the Internet, GPS, LED lighting, microwaves, radar, networked computers, wireless communications, and many others.[5] For the most part, this research was funded through mission-based agencies seeking to accomplish a particular federal mission (e.g., Defense, Health, Energy) and through a system of peer-reviewed basic research funding at universities.

In fact, the explicit promotion of innovation and productivity as an economic goal was largely ignored and even rejected through most of the post-war period. To be sure, there were occasional efforts during the Kennedy, Johnson, and Nixon administrations, but these were small-scale and largely short-lived. The first major post-war federal effort to explicitly support industrial innovation was made by the Kennedy administration in 1963, with its proposal for a Civilian Industrial Technology Program (CITP). The administration proposed CITP to help balance the overriding focus of federal R&D on defense and space exploration, both of which had increased as the United States sought to counter the Soviet Union in the Cold War.^[6] CITP was to provide funding to universities to do research helping innovation in sectors thought to help society, such as coal production, housing, and textiles. But despite the administration’s efforts to launch the program, Congress did not approve it, in part because of industry opposition that feared disruptive technologies. For example, the cement industry opposed the program because it feared that innovation in housing technology might reduce the need for cement in construction.

Attempts by the federal government to explicitly support commercial innovation were at best made in fits and starts, and never really got off the ground.

Two years later, the Johnson administration was able to get a redesigned effort through Congress, but only after making a number of changes. The new program, the State Technical Services program, was to fund university-based technology extension centers in the states that would work with small and mid-sized companies to help them better utilize new technologies. But despite the program’s success, the Nixon administration eliminated it, largely on the grounds that this was an inappropriate federal intervention into the economy. However, the Nixon administration proposed its own initiative, the new Technology Opportunities Program, again to support technology in solving pressing social challenges, such as developing high-speed rail and curing certain medical diseases. But again, the program was not funded by Congress.

These attempts by the federal government to explicitly support commercial innovation were at best made in fits and starts, and never really got off the ground. Moreover, they were not guided by any overriding vision or mission, unlike the government’s efforts to develop defense and space technology, which were motivated by the need to respond to the Soviet threat. And they certainly were not linked to overall economic policy, which remained focused principally on reducing business-cycle downturns, and, depending on the political party in power, reducing poverty.

This system began to gradually change in the late 1970s with the emergence of competitiveness challenges from nations such as Japan and Germany. It was with the election of President Jimmy Carter in 1976 that the federal government began to focus in a more serious way on the promotion of technology, innovation, and competitiveness. The motivation for this was the major recession of 1974 (the worst since the Great Depression), the shift in the U.S. balance of trade from one of surplus to one of deficit, and the growing recognition that nations such as France, Germany, and Japan now posed a serious competitiveness challenge to U.S. industry.

These efforts were followed up by efforts by Congress and the Reagan and Bush I administrations. Indeed, policymakers responded with a host of policy innovations, including passage of the Stevenson-Wydler Act, the Bayh-Dole Act, the National Technology Transfer Act, and the Omnibus Trade and Competitiveness Act. They created a long list of alphabet-soup programs to boost innovation, including SBIR (Small Business Innovation Research), NTIS (National Technical Information Service—expanded), SBIC (Small Business Investment Company—reformed), MEP (Manufacturing Extension Partnership), and CRADAs (cooperative research and development agreements). They put in place the R&D tax credit and lowered capital gains and corporate tax rates. They created a host of new collaborative research ventures, including SEMATECH, NSF Science and Technology Centers and Engineering Research Centers, and the National Institute of Standards and Technology (NIST) Advanced Technology Program. And they put in place the Baldridge Quality Award and the National Technology Medal.

Moreover, it wasn’t just Washington that acted. Most of the 50 states transformed their practice of economic development to at least include the practice of technology-led economic development. Many realized that R&D and innovation were drivers of the New Economy, and state economies prosper when they maintain a healthy research base closely linked to commercialization of technology. For example, under the leadership of Governor Richard Thornburgh, Pennsylvania established the Ben Franklin Partnership Program that provides matching grants primarily to small and medium-sized firms to work collaboratively with Pennsylvania universities.

But by the time Bill Clinton was elected in 1992, America’s competitiveness challenge appeared to be receding. Japan was beginning to face its own problems, in part stemming from the popping of its property bubble and increasing value of the yen. And Europe was preoccupied with its internal market integration efforts. Moreover, with the rise of Silicon Valley as a technology powerhouse, and of the Internet revolution and companies such as Apple, Cisco, IBM, Intel, Microsoft, and Oracle, America appeared to be back on top, at least when it came to innovation. And most importantly, the collapse of the Soviet Union eliminated what had been a principle motivation for bipartisan cooperation and activity to ensure the United States was the world’s leading technology power. Once that was gone, other priorities such as balancing the budget and increasing spending on social services soon trumped national innovation. As such, federal spending on innovation policy gradually shrank year after year, to the point where today as a share of gross domestic product (GDP) it is where it was before Sputnik

On top of that, the information technology entered into a new phase, with more powerful microprocessors, the wide-scale deployment of fast broadband telecommunications networks, and the rise of Web 2.0 social network platforms. As a result, it became clear to many policymakers that IT (or ICT) was now a key driver of growth and competitiveness, and that effective economic policy now had to get IT policy right.

Toward that end, the Bush II administration and Congress undertook a number of initiatives. Building on the Clinton administration’s Internet Governance Principles, which argued that government should take a light touch toward regulating the Internet, the Bush administration took a number of steps to spur IT innovation, including deregulating broadband telecommunications (now that most American homes had access to at least two broadband “pipes”— cable and DSL), freeing up radio spectrum for wireless broadband, taking a light touch with respect to regulating online privacy, and using IT to transform government itself (e-government). The fact that the United States was the clear leader in IT, including the emerging Internet economy, led many to believe all was well.

But while much of IT was thriving, U.S. industrial competitiveness was not. The United States lost over one-third of its manufacturing jobs in the 2000s, with the majority lost due to falling international competitiveness, not superior productivity.^[7] The United States went from running a trade surplus in high-technology products in 2000 to around a $100 billion deficit a decade later. While the United States used to produce significant amounts of electronic products, including computers, much of that went to China. In fact, by 2017, the trade deficit with China in electronic products was $184 billion.^[8]

There are three elements of a national innovation system: the business environment, the regulatory environment, and the innovation policy environment.

In any case, the state of U.S. industrial innovation and competitiveness has gained renewed attention after the losses of the 2000s, the Great Recession, and the emergence of robust new technological competitors—especially China. Because of this, the Obama administration proposed a number of initiatives, including the establishment of a National Network of Manufacturing Innovation (three centers have already been announced); an expansion in the research and experimentation (R&E) tax credit; increased funding for science agencies (including NSF, NIST, and Department of Energy (DOE)); policies to expand the number of STEM graduates; patent reform; and increased efforts to limit unfair foreign “innovation mercantilist” policies, among others. Congress has also introduced a variety of similar measures.

The Trump administration brought a new approach to dealing with the China challenge, but largely eschewed any formal technology policy, actually proposing cuts in overall federal R&D.[9] More recently, bipartisan efforts in Congress have led to the introduction of a number of major technology competitiveness bills to respond to the China technology challenge.

Elements of the U.S. NIS

As previously described, there are three elements of a national innovation system: the business environment, the regulatory environment, and the innovation policy environment. This section describes each, and the U.S. performance.

Business Environment

The business environment consists of three broad factors: market and firm structure and behavior; the system for financing business; and related social and cultural factors affecting how business operates.

Market and Firm Structure and Behavior

Managerial Talent

When it comes to managerial talent, it appears the United States is the world leader, and this factor has played a role in explaining past U.S. innovation leadership. As professor John Van Reenan and colleagues have shown, “[When] it comes to overall management, American firms outperform all others.”^[10] In part, this comes from environmental factors that force better management: more competition and more flexible labor markets. But it may also come from the fact that the United States developed the discipline of management (in the 1950s) and perfected it through its extensive system of business schools at universities.

Time Horizon and Risk Appetite of Firms

Despite the high quality of many U.S. managers, they increasingly find themselves in firms buffeted by pressures for short-term performance, which in turn reduces their ability to invest for the long term. For example, in a 2004 survey of more than four hundred U.S. executives, over 80 percent indicated that they would decrease discretionary spending in areas such as R&D, advertising, maintenance, and hiring in order to meet short-term earnings targets; and more than 50 percent said they would delay new projects, even if it meant sacrifices in value creation.^[11] One recent study by the CFA Institute finds that while some progress has been made in the last 15 years, too many companies are still too short term in their orientation.[12] This focus on maximizing short-term returns means companies are effective in reducing waste and pulling the plug on poor investments. But at the same time, this pressure to achieve short-term profits all too often has meant sacrificing long-term investment, which is the majority of investment in innovation. As the Business Roundtable, the leading trade association for large American businesses, reported, “[T]he obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance.”^[13]

ICT Adoption

U.S. firms are among the world leaders in adoption of ICT (e.g., hardware and software). In 2000, U.S. firms invested more as a share of sales in capital investment in hardware, software, and telecommunications than only one other Organization for Economic Cooperation and Development (OECD) nation (Sweden).[14] But that lead has shrunk. OECD reported that in 2015, seven other nations saw more business investment in software and IT equipment as a share of GDP than the United States.

However, in some areas, U.S. performance is better.[15] The United States ranks fourth in the share of businesses using cloud computing services.[16] And Van Reenan and Bloom found that U.S. firms appear to get more benefit out of IT investment than many other countries’ firms. In part, this is because U.S. firms are more willing to use IT to fundamentally restructure production processes.^[17]

Business Financing System

Venture and Risk Capital

With the establishment of the American Research and Development Corporation in 1946, the United States pioneered the venture capital industry—and remains a leader. Hundreds of private venture capital firms across the nation analyze and fund investment opportunities. The industry does more than invest funds; it also helps with key management functions such as serving on boards and advising on business strategy.

Over the last decade or so, the amount of venture investing has grown significantly, with the value of deal investment growing 4.6 times from 2006 to 2019, and the number of deals growing 3.6 times. Moreover, angel and seed funding deals grew 11 times to 5,207.[18] However, most venture capital placements are concentrated in a few states (e.g., California and Massachusetts, and to a lesser extent Colorado and Washington). However, from 2006 to 2019, venture capital funding grew slightly slower in New England and the West Coast than in the rest of the nation. 

There is also a robust “angel capital” system in the United States made up of private individuals of high net worth who invest money in entrepreneurial, high-growth companies.^[19]

Some state governments have also established programs to help with venture funding, particularly to smaller and earlier stage start-ups. Some have also created angel capital networks to help private funders better coordinate their efforts and find deals. And the federal government, through the Small Business Administration’s Small Business Investment Company, provides capital subsidies to some private-sector venture firms, while the SBIR program provides modest research grants to small firms.[20]

Firm Finance (Debt and Equity)

Firms in the United States have access to a wide array of financing sources, the vast majority of which are provided by the private sector. While the initial public offering (IPO) market is smaller than it has been in the past, many growth-oriented innovation-based firms are able to obtain capital through IPO placements. In 2019, firms raised around $39 billion through IPOs, down from the boom years of the late 1990s, but generally greater than a decade ago.[21] Small, high-growth start-ups firms also use acquisitions by larger firms as an “exit” strategy, although some in the antimonopoly camp have recently argued that large firms should be limited in their ability to purchase start-ups

Government financing for firms is quite limited. Existing firms can raise additional money on highly traded and liquid equities markets. And corporate debt, either through bonds or loans, is widely available. At the federal level, the Small Business Administration provides some direct and indirect lending to small firms, but this is not targeted to innovation-based firms or firms in traded sectors—and in fact, the significant majority goes to local-serving industries such as dry cleaners, restaurants, and liquor stores. And many state governments provide modest financing for industrial expansion and early stage firms.

Cultural Factors

As scholars such as Francis Fukuyama, Raquel Fernandez, Lawrence Harrison, and Samuel Huntington have shown, cultural factors such as trust, group orientation, and risk taking have impacts on innovation and growth.^[22]

Nature of Customer Demand

As Michael Porter’s work on competitive advantage indicates, nations with demanding consumers are in a better position because it puts pressure on firms to innovate and be more efficient.[23] While there is little good data on this, it appears American consumers are more demanding than those in many other nations. Moreover, thanks to the Internet, and applications such as Yelp and others, most U.S. consumers have immediate access to a wealth of information about businesses. We see this in terms of comparing U.S industries to ones in Europe. For example, standard business traveler hotel quality in the United States appears to be far superior to Europe, in part because American consumers demand higher quality.[24] Columbia professor Amar Bhidé has also argued that the “venturesome consumption” nature of American consumers—that is, their eagerness to be early adopters of and experiment with new products and technologies—has played a role in supporting U.S. innovation success.[25] For example, a Microsoft survey found that 54 percent of customers in the United Kingdom, 53 percent in Japan, and 58 percent in Germany don’t think their feedback to businesses is taken seriously, while only 45 percent of Americans think that way.[26]

Risk Taking and Entrepreneurship

The United States has long been seen as having a culture of “Yankee ingenuity,” meaning a deep-seated interest in tinkering, inventing, and making things better. At the same time, in part because the United States is a nation of immigrants, who by definition took a major risk to move from their native country, the United States has a strong culture of risk-taking and entrepreneurship. Combine that with a distinct culture of individualism, and this makes it easier for people—whether they are a Steve Jobs or a worker on the shop floor—to question established ways of doing things.^[27] Moreover, unlike many other nations, failure in starting a new business does not doom a professional career. (In fact, it’s been said that some Silicon Valley venture capital firms don’t want to see entrepreneurs’ business plans until they’re on their third start-up.) And compared with most other nations, Americans are more willing to take risks in terms of financing, and see the potential benefits as higher.[28]

In part because the United States is a nation of immigrants, who by definition took a major risk to move from their native country, the country has a strong culture of risk-taking and entrepreneurship.

Attitudes Toward Science and Technology

For much of its history, American culture was characterized by a general belief in the inevitability of social and economic progress. Historian Merritt Roe Smith discussed in a sampling of books from the period of the 1860s to the early 1900s with titles such as Eighty Years of Progress, Men of Progress; Triumphs and Wonders of the 19th Century, The Progressive Ages or Triumphs of Science, The Marvels of Modern Mechanism, Our Wonderful Progress, The Wonder Book of Knowledge, and Modern Wonder Workers.[29] As economist Benjamin Anderson wrote in the 1930s, “[O]n no account must we retard or interfere with the most rapid utilization of new inventions.”[30] While America still largely tilts toward innovation, the anti-innovation forces in U.S. culture are stronger today than ever in American history. Whether it is fears of job loss from automation, privacy loss from the Internet, or environmental damage from nano-tech or biotech, anti-technology forces—in the media, “public interest” groups, and the public at large—continue to gain influence, making it harder for the U.S. economy to press ahead with innovation, and making it more likely to adopt precautionary principle-based regulations, if not outright technology bans.^[31] Case in point: When MIT’s project on the future of work calls for the federal government to “tax robots” to slow down automation, it’s clear there has been a major shift in the American political economy toward innovation.[32]

Collaborative Culture

While innovation is about competition, it’s also about “coopetition” and cooperation—in other words, groups working together to drive innovation. This has become more important to enabling innovation, especially as innovation has become more challenging, with more organizations embracing open innovation. As Fred Block found, the nature of the U.S. innovation system became more collaborative.^[33] Using a sample of innovations recognized by R&D Magazine as being among the top 100 innovations of the year from the 1970s to the 2000s, they find that while in the 1970s almost all winners came from corporations acting on their own, in the 2000s, over two-thirds of the winners came from partnerships involving business and government, including federal labs and federally funded university research. The culture of collaboration in places such as Silicon Valley and Boston’s Route 128 is one of the keys to their success. Likewise, the ability of some leading U.S. universities to work cooperatively with industry has been key to driving regional innovation hubs and clusters. These collaborative learning systems, especially in clusters, are supported in part by strong IP protections—people aren’t afraid that if they talk and share they will lose proprietary IP.

Time Horizon and Willingness to Invest in the Future

For much of American history, Americans have been willing to sacrifice current consumption for future income by supporting high levels of private and public investment. Over the last three decades, this has become more challenging, as the focus of most voters and the overall political system has shifted toward current consumption, either in the form or lower taxes or greater spending. In the 1960s, when federal support for R&D amounted to 1.75 percent of GDP, this meant Americans were willing to invest 2.8 percent of their income in government R&D.^[34] Today, with per capita incomes more than three times higher in real dollars, Americans are only willing to invest just 0.87 percent of their income in government R&D (just 17 percent of the 1960s level).

Trade, Tax, and Regulatory Environment

While the business environment plays the key role in determining innovation success, government policy plays a powerful enabling (or detracting) role, particularly through the broad areas of trade, tax, and regulatory policy that shapes the innovation environment.

Regulatory Environment

Industry Structure and the Nature of Competition

Generally, the United States has embraced an approach to competition and competition policy based on maximizing consumer welfare. In contrast to the “ordoliberal” tradition of EU antitrust policy which embraces both economic and social goals, and in particular focuses on preserving competition for its own sake, the U.S. approach until recently was oriented to maximizing consumer—as opposed to producer—welfare, and was focused on anti-competitive behavior more than on market power per se.^[35] However, in the last several years, there has been an increasing push from “neo-Brandeisians” for a wholesale shift in U.S. antitrust policy to focus more on limiting firm size, regardless of conduct, and on limiting competitive effects on other businesses, especially small business.[36] The recent majority report from the House Judiciary Committee on digital maker competition reflects this trend.[37]

While there is considerable disagreement about exactly where antitrust policy should be on the continuum of more or less competition, one can make the case, as Robert Atkinson and Michael Lind do in Big is Beautiful: Debunking the Myth of Small Business that U.S. antitrust policy has been too stringent, limiting the emergence of the kind of scale needed to win in global competition, and too focused on consumer welfare rather than overall economic welfare.[38]

Moreover, in comparison with many other nations and regions, especially Europe, the U.S. NIS erects relatively few barriers to entry for firms to break into existing markets, thus ensuring robust competition and the constant threat of “Schumpeterian” creative destruction. We have seen this in industries as diverse as financial services, energy production, and transportation. In addition, the U.S. system attempts to create a level playing field with e-commerce competitors, enabling new entrants to disrupt existing markets and business for the advantage of the consumer. However, entrenched interests in industries such as real estate, car sales, taxi services, hotels, legal services, and others continue to seek to use laws and regulations to limit competition.

Combine this change in attitude with a very large national debt, and it becomes increasingly difficult for federal elected officials to ask American voters to pay more to support expanded financial support for innovation.

Regulatory System for Entrepreneurship

Academic research shows that delays caused by entry regulations are associated with lower rates of firm entry.^[39] In 2020, the United States ranked sixth on the World Bank Index of ease of starting a business, behind nations including Denmark, Korea, New Zealand, and Singapore.[40] This is down from number 1 in 2004.[41] Moreover, it is not only relatively easy to start a new business, but it is also easy to close one or lay off workers, at least in the non-unionized, non-governmental share of the economy.^[42] The latter is important, for if entrepreneurs cannot easily close or downsize businesses, and if investors cannot obtain reasonable capital recovery rates, the incentives for entrepreneurship are reduced.^[43]

Role and Form of Regulation

The U.S. system of regulations, many of which affect innovation, begins with Congress passing legislation and sometimes requiring executive branch agencies to promulgate regulations. These agencies go through an extensive public notice and comment period in which individuals and organizations can submit written comments that the agencies are required to review. In addition, the Office of Information and Regulatory Affairs (OIRA) within the White House Office of Management and Budget also conducts cost-benefit reviews of some proposed regulations, particularly those with high expected costs. To the extent OIRA finds a “significant” federal regulation inconsistent with its cost-benefit analysis, it can return the regulation to the promulgating agency (which can then revise or withdraw it). Although OIRA’s analysis does not always trump that of the agency, it does dominate. And of course, if agencies do not change their regulatory decision, Congress can also act and change the law. And this process is generally quite transparent. For example, the Clinton administration inserted greater transparency into the OIRA review process by requiring, inter alia, public disclosure of all communications between OIRA personnel and individuals not employed by the executive branch.

While regulation is not always performance based, in the last two decades, there has been a greater awareness among regulators of the importance of focusing regulations more on what the government wants to achieve, while leaving the means by which to achieve it up to the regulated entities. There is some recognition that this form of regulation is more efficient and spurs more innovation than regulation that prescribes the means.

However, it appears that the U.S. regulatory burden on innovation, both in extent and orientation, grew in the 2000s until the election of President Trump in 2016. Trump made it a key focus to reduce regulations in a wide array of areas. However, in areas such as agricultural biotech, AI, privacy, and others, the pressures for stronger regulation continue to grow. Moreover, most regulatory agency budgets have been cut or limited, making it harder for them to both modernize technologies and processes and expand staff so that they can respond quickly to firms seeking regulatory approval.

Transparency and Rule of Law

Regulations have less of a negative effect on innovation and growth when they are transparent and backed up by the rule of law so that they are consistently applied. This has generally been a strength of the U.S. system, which enjoys a well-developed, independent judiciary and a legislative framework (e.g., the Administrative Procedures Act) that works to hold government executive agencies accountable for obtaining public input and basing rules on evidence. However, the Trump administration has at times intervened—often through the president’s “bully pulpit” of Twitter—to put pressure on companies and administration agencies to act in certain ways.

Tax, Trade, and Economic Policy

Macroeconomic Environment

Macroeconomic policies can provide an overall supportive policy for innovation. U.S. macroeconomic policy has been predicated on monetary stability, focused on limiting inflation. Some have argued that in its efforts to limit inflation the Federal Reserve Board has placed too little relative emphasis on full employment, especially since the late 1970s. At least since the 1980s, U.S. macroeconomic policy has relied principally on monetary policy, rather than fiscal policy, to adjust cyclical growth rates. But the 2008 American Recovery and Reinvestment Act and the 2020 COVID recovery packages suggest that fiscal policy tools may be relied upon more going forward, especially if Democrats gain more political power and Modern Monetary Theory gains adherents.[44] In addition, because of the overriding focus on consumer as opposed to producer welfare, as well as a belief that markets should determine prices, U.S. policy toward its currency (and that of other nations) is largely non-interventionist—and to the extent it is interventionist, it is to defend a strong dollar (which helps consumers but hurts most producers, especially in traded sectors).

Tax Policy

While the prevailing view about U.S. tax policy is that it should be neutral vis-à-vis various economic activities, the reality is that it is somewhat interventionist, sometimes for good policy reasons (e.g., R&D tax credit, accelerated depreciation, etc.), and other times because of special-interest pressures for particular tax provisions.^[45] But most policymakers strive for a tax code that does not favor particular industries over others, even if it means some traded sectors exposed to international competition pay more than some non-traded sectors, and functions such as R&D with significant positive externalities are not adequately supported through the tax code.^[46]After the tax reform act of 2018, the U.S. corporate tax rate was lowered from 35 percent to a more competitive rate of 21 percent.^[47] Moreover, companies were allowed to expense for tax purposes investments made in capital equipment. However, the R&D credit is scheduled in 2022 to be reduced in value. This is on top of the fact that tax incentives for R&D are quite minimal compared with most OECD and BRIC (Brazil, Russia, India, and China) nations.[48] And the United States is also one of the very few nations that does not use a border-adjustable value added tax (VAT). Finally, there is increasing pressure from Democrats to raise taxes on business, especially corporations.

Trade Policy

For decades, U.S. trade policy was based on the belief that nations have a comparative advantage, and that an open and market-based trading system enables nations to achieve that advantage to the benefit of their consumers. This has led the United States to focus mostly on signing new trade agreements and being somewhat blasé toward trade enforcement. The Obama administration took some steps to remedy this, establishing an Interagency Trade Enforcement Center based on the belief that the benefits from trade will be less if other nations are not playing by the rules developed by the World Trade Organization. Nevertheless, funding for trade-enforcement efforts is relatively anemic, with the Office of the United States Trade Representative (USTR), Department of Commerce’s (DOC) International Trade Administration (ITA), and State Department trade efforts significantly underfunded. The Trump administration’s approach to trade has been fundamentally different than the prior Washington consensus, focused much more on bilateral (rather than multilateral) trade deals and being willing to take much tougher actions against foreign mercantilists, especially China. At least in rhetoric, the Trump administration has embraced a “results-oriented” approach to trade, rather than the prior “rules-based” one, and has used tariffs and the threat of tariffs to try to get desired results from foreign nations, especially China.

Most policymakers strive for a tax code that does n