The New Competitive Landscape
Only a decade ago, global competition shook U.S. self-confidence to the core. U.S. industry seemingly could not match the price and quality of manufactured goods that surged into the domestic market. As foreign competitors, led by Japan, moved rapidly up the ladder from textiles and steel into autos and electronics, the U.S. trade deficit exploded. Pessimists claimed that the United States was in danger of becoming an economic satellite of Japan.
Today, the picture looks quite different. By most indicators, the United States now leads in innovation. U.S. industry has improved quality, slashed costs, and shortened product cycles. It has dominated the information revolution instead of falling behind. U.S. job creation, sustained economic growth, and deficit reduction are the envy of the world. Indeed, no serious rivals to U.S. economic preeminence can be seen on the horizon.
Ironically, the greatest danger the country faces stems from the general public’s unwarranted complacency about the future. The nation should be aware of the concerns of its business and research leaders. A recent Council on Competitiveness report, Going Global: The New Shape of American Innovation, examined global trends in key high-technology sectors: health, information technologies, advanced materials, and automobiles. In surveying more than 100 heads of R&D at companies, universities, and national laboratories, representing more than $70 billion in research investments, the council found that the prevailing sentiment is unease. Executives from every sector are concerned that the unique set of conditions that propelled the United States to a position of world leadership over the past 50 years may not be sufficient to keep us there over the next 50.
Such concerns are not misplaced. New technologies are compressing time and distance, diffusing knowledge, transforming old industries, and creating new ones at a pace that is hard to grasp. Information, capital, and know-how are flowing across borders as never before. Standard goods and services can be produced in low-wage locations around the world. Low cost and high quality are now routine market requirements. The technological capabilities of many advanced economies are steadily improving, while a new wave of emerging economies is producing fast followers in some key areas and potential leaders in a few. The reality of the global economy is that companies have many choices about where to invest, and capital, technology, and talent are available globally. A number of dramatic changes in the global economy deserve special attention.
An expanding club of innovators. Professors Michael Porter from the Harvard Business School and Scott Stern from MIT’s Sloan School document in the council’s forthcoming Innovation Index that an increasing number of countries have created innovation structures on par with that of the United States. Twenty-five years ago, the only country with a per capita level of innovation comparable to the United States was Switzerland (largely as a result of high R&D expenditures combined with a small population base). More recently, several countries, including Germany and Japan, have successfully mobilized their resources to yield national innovation systems comparable in strength to that of the United States. If current trends continue over the next 10 years, more nations will be joining the elite group of innovator countries.
A wave of new competition. A number of developing countries are making the transition from imitator to innovator. Despite recent economic turmoil, several newly industrialized countries (for example, Taiwan, Korea, Singapore, and Israel) are making substantial investments in a strong national innovation infrastructure-and with some success. From a negligible patent position in 1982, for example, Taiwan has increased its presence in information technology patents filed in the United States by over 8,000 percent, thus surpassing the United Kingdom. Increasingly, the challenge for the United States is likely to come from lower-cost innovators as well as low-cost producers.
Rapid pace of technology change. The line between global leader and also-ran has become very thin, particularly in sectors that embed information technologies. The rapid pace of technological change creates more frequent entry opportunities for competitors. As a result, countries are leapfrogging generations of technology in a matter of years. For example, 10 years ago, few Americans had ever heard of Bangalore, India, now a hotbed for software investment; and Taiwan figured as a national security concern, not a low-cost innovator. Leadership can shift within a matter of generations, and in infotech, generations are counted in months. Indeed, IBM now refers to the life of its products in “webmonths” (one webmonth equals three calendar months).
Global availability of talent. In the past, workers in the developed and developing world did not compete head to head. Today, however, workers around the world compete directly not only on cost and productivity, but on creativity and competence as well. In a knowledge-based economy, individual, corporate, and national competitiveness will require both new and more extensive skill sets than have ever been required in the past. With the ability to manufacture anywhere in the world and sell it anywhere else, companies are investing wherever they find the best and most available talent pool.
Lessening of the U.S. home market advantage. Until now, the U.S. role as the world’s market of choice for launching new products propelled investment in U.S.-based innovation. Research, design, engineering, and production teams from around the world tended to cluster in the United States as part of a first-launch strategy. But four billion consumers have come into the global marketplace since the mid-1980s, and the fastest-growing levels of demand are now overseas. This pivotal shift is creating market pull for developing and launching new products globally. Although the United States will always be an attractive market for new products, the need to position scientific and engineering talent here rather than in some other big launch market is just not so compelling.
Globalization of R&D. It is tempting to believe that the United States will remain a default location for all the best investments in frontier research and technology. It does hold an enormous stock of R&D investment by foreign as well as domestic companies that will fuel innovation for years to come. Yet a growing percentage of new R&D investment is going overseas for a variety of reasons: to follow manufacturing, to provide full-service operations to major customers, to pay the entry price for market access, to benefit from an array of incentives and tax credits, and to take advantage of niche areas of expertise and talent. No one foresees a wholesale shift of domestic research offshore, but we should expect that the movement of investment, in conjunction with local efforts, will eventually create a critical mass of dollars, experience, and expertise in a number of countries that will be competitive sites for cutting-edge research.
Taken together, these changes are shaping a new and more competitive global environment for innovation. Globalization is leveling the playing field, changing the rules of international competitiveness, and collapsing the margins of technological leadership. Many business and university executives are not convinced that the United States is preparing to compete in a world in which many more countries will acquire a capacity for innovation.
Sector snapshots
In no sector is there an imminent threat to U.S. technological leadership. But companies in every sector are repositioning themselves to face new global competition. They view the capacity for innovation as one of the keys to success. Innovation creates strategic advantages, enabling companies to grow market share by introducing new technologies and products or to increase the productivity of existing ones. Going Global examined the challenges and challengers in each sector.
Health. So commanding is the U.S. lead in the biomedical arena that the game is virtually ours to lose. Unfortunately, many executives in the pharmaceutical and biotechnology industries believe that the U.S. leadership position is based largely on past investment, and they have real concerns about the future. Because the industry is so closely tied to advances in basic science, they worry about the future of research funding not only in the life sciences but also in the physical sciences, computer sciences, and engineering that have become integral to innovation in the industry. Managed care is constricting the funding for clinical research at academic health centers, an essential part of the country’s unique health innovation ecosystem. The physical and information technology infrastructure for research is inadequate for meeting today’s, much less tomorrow’s, needs. The vicissitudes of the on-again-off-again R&D tax credit in the United States compare unfavorably with offshore incentives for investment in research.
Meanwhile, other regions of the world are not standing still. In Europe, and the United Kingdom in particular, an emerging venture capital community and biotechnology industry are beginning to leverage historic scientific and technological strengths. Germany has great potential and is creating a more innovation-friendly environment for biotechnology. Japan continues to make substantial investments in biomedical research, and China is accelerating toward competing in the global medical products market. The rapid diffusion of information and researchers in what has become a global health care innovation system guarantees that offshore competition will become more important in the future than it has been in the past.
Information technology. Although the United States remains at the top of the innovation chain in information technology (IT), its margin of leadership is shrinking. Worldwide demand for information technology is growing-from $337.4 billion in 1991 to a projected $937.1 billion by 2001-but the size of the U.S. IT trade deficit starkly highlights the fact that we do not stand apart from the competition.
The barriers to entry and growth of non-U.S. players are likely to be smaller in the future than they were in the past. Technology churn is faster, providing more frequent entry opportunities. Entry costs, particularly for software, are much lower than they were for hardware. As manufacturing moves offshore, there is a growing tendency to co-locate certain types of research with manufacturing. Moreover, R&D tax credits, incentives for investment in plant and equipment, worker training credits, and one-stop regulatory shopping make offshore investments relatively more attractive for the marginal dollar of corporate investment.
As a result, the competition in IT is getting better; in some cases, much better. The Japanese are the prime competitors in a number of IT sectors, largely because of their ability to leverage innovation to wring costs out of the manufacturing process. South Korea offers an example of the large-scale public investment that is being mounted by many up-and-coming nations, investment that continues despite an economy-wide slump. U.S. industry executives see Japan and Korea emerging strongly in IT once their economies rebound.
Locating in China is a strategic decision for many companies looking to gain a toehold in the local market. Although intellectual property concerns are retarding the growth of full-service operations, the tens of thousands of highly skilled engineering graduates in China offer an attractive labor pool that draws investment in innovative activity, particularly into the Beijing area. India is also emerging as a prime location for offshore R&D activities, fueled by an excellent technical university system and the availability of high-skilled, lower-cost software engineering talent.
Israel is attracting foreign IT investment with a highly entrepreneurial environment and a good supply of graduates from Technion University. Government incentives along with a technology transfer program between the government and the private sector are stimulating foreign investment. Ireland best exemplifies the co-location of manufacturing and R&D, having used incentives to attract IT manufacturing and now seeing R&D activities coming in as well.
Stronger competition does not diminish U.S. strengths in IT innovation: a unique venture capital system, a large and sophisticated market that values innovative products, a world-class research base, and clusters of innovative activity that are splintering off Silicon Valley (arguably the most important region for IT innovation anywhere in the world). But there is a strong sense within the industry that the U.S. lead is not unassailable. There is a need for national commitment to sustain competitiveness by integrating and capitalizing on IT innovation faster than the rest of the world and to speed up the pace and productivity of product deployment.
Advanced materials. For the next 10 years or so, the United States is expected to lead in many segments of the industry, but competition for the low-end, cash-rich segments (principally feedstock and intermediate chemicals) is intense, and profits are being squeezed. In both the United States and the European Union, firms are moving into higher-margin more specialized segments of the industry: advanced materials, agricultural technologies, biotechnologies, electronic materials, and pharmaceuticals. R&D focused on research breakthroughs rather than on incremental improvements in process will play a huge role in positioning these companies for continued global leadership.
The United States historically has enjoyed a comparative advantage in attracting investment in frontier areas because of the complexity of its research infrastructure, which overseas competitors cannot easily replicate. Although there are centers of excellence in materials science in Europe and Japan and new centers emerging in China, Israel, and Russia, no country matches the United States in the sheer depth and breadth of expertise.
There are few signs that breakthrough research in materials will be globally dispersed, by U.S. companies at any rate. Indeed, the trend at the beginning of the decade to globalize research operations was reversed by the mid-1990s. Precisely because innovation occurs at the interfaces between scientific disciplines and technology platforms, proximity matters. U.S. firms may trawl globally for new ideas and talent, but their investments remained clustered in the United States.
The problem is that the dollars available for investment in breakthrough research have been shrinking, with federal funding for chemistry and the materials sciences growing only slowly relative to other disciplines. The defense sector, historically an important source of new materials research funding, has decreased in size and contribution. There is a dearth of private venture capital for small innovative materials startups, and the uncertainties surrounding funding for the Small Business Innovative Research grants further impede the availability of capital for small businesses. The long-standing underinvestment in process technology also handicaps U.S. competitiveness, because the ability to discover new materials is no sinecure unless they can be affordably commercialized.
In the final analysis, industry executives believe that the greatest challenge confronting the industry is not the loss of market leadership due to external competition but an inability to reach its potential for innovation because of these and other shortcomings in the U.S. innovation environment.
Automotive industry. Few industries are more globalized than the auto industry. Because many nations are making serious efforts to build up domestic automotive capability far beyond estimated local demand, overcapacity is creating a high-stakes competition for market share. Globalization is forcing companies to compete locally, and often to invest locally, to win market share in each aspect of the business, regardless of the national flag of the corporation.
The United States remains the dominant location for research investment by U.S. manufacturers and suppliers, but new product and process research is a growing part of the research mix overseas. Indeed, U.S. automakers face an innovation dilemma. To capture global market share, they must innovate. But the market pull for innovation in advanced materials and new powertrain designs is coming primarily from overseas, where higher gas prices are stimulating demand for fuel efficiency.
Although the Partnership for a New Generation Vehicle, a joint government-industry effort, has spurred research in the United States, the lack of domestic consumer demand for innovation is a major barrier to industry investment. The fact that there is virtually no projected growth in the U.S. market for the first time in 100 years does little to offset the centrifugal pressures on manufacturers to shift investment globally.
A look at the standings
The capacity to innovate will play a dominant and probably decisive role in determining who prospers in the global economy-for countries as well as companies. The ability to leverage innovation is critical not only to achieving national goals (improved security, health, and environmental quality) but also to sustaining a rising standard of living for a country’s citizens.
It is ironic that at a time of enormous wealth creation in the United States, the foundations of the U.S. innovation system have been weakened, jeopardizing its long-term competitiveness. The areas of greatest concern, and relative disinvestment, are funding for research and education.
The research base. For the past 50 years, most, if not all, technological advances have been directly or indirectly linked to improvements in fundamental understanding. Investment in discovery research creates the seed corn for future innovation. Although industry funding for R&D has been on the rise, industry money offers no solution to basic research funding issues. Indeed, much of the increase in industry funding has been targeted at applied R&D.
In advanced materials, company dollars are much more clearly focused on the bottom line. Twenty years ago, the R&D departments of major chemical companies devoted a significant potion of their activities to basic or curiosity-driven research in chemistry and related fields. Today, the returns from manipulating molecules are too uncertain to support what one chief scientist describes as “innovation by wandering around.”
Even in the R&D-intensive pharmaceutical industry, companies invest heavily in applied R&D but generally do not engage in high levels of basic research producing fundamental knowledge. The biotechnology industry, which holds huge potential for revolutionary changes in health care, agriculture, and other sectors, was built on 25 years of uninterrupted, largely unfettered federal support for research in the life sciences, bioprocess engineering, and applied microbiology.
In faster-moving sectors such as IT, product development virtually overshadows investment in research. With product cycles ranging from months to a few years, it is difficult to allocate money to long-term R&D that may not fit into a product window. Very few companies are able to invest for a payoff that is 10 years down the road. This is creating serious gaps in investment in next-generation technologies, such as software productivity.
Increasingly, government at all levels is the mainstay for the nation’s investment in curiosity-driven frontier research. But the amount of federal resources committed to basic research has been declining as a percentage of gross domestic product (GDP). It remains to be seen whether the projected increases for the FY99 budget signal a turning point in this downward cycle.
A consequence of tighter research budgets is that agency-funded research at universities is getting closer to the market. This has potentially enormous repercussions for the quality of university research. Universities traditionally have been able to attract top-notch scientists willing to forgo higher salaries in industry for more intriguing research in academia. As one university president noted, the cutbacks in funding for cutting-edge research challenges make it relatively more difficult for universities to differentiate their research environment from what top scientists could find in industry.
The U.S. performance also looks lackluster when benchmarked against the rest of the world. The new innovators are focusing on R&D as a key source of economic growth. In some cases their R&D intensities (R&D as a percentage of GDP) and the growth of R&D investment over a 10-year period far outpace that of the United States.
The talent pool. Long-term competitive success requires access to the best and brightest globally. Without people to create, apply, and exploit new ideas, there is no innovation process. Innovation demands not only a trained cadre of scientists and engineers to fuel the enterprise but a literate and numerate population to run it. The caliber of the human resource base must be actively nurtured; it is one of the nation’s key assets, and in a global economy, it is relatively immobile. Capital and information and even manufacturing may move rapidly across borders, but the talent pool needed to facilitate innovation does not transfer as readily. A skilled technical workforce creates real national advantage.
In every sector, the quality of U.S. human capital is a chief concern. Increasingly, companies, particularly in IT industries, are going offshore to find skilled talent, not necessarily low-cost talent. The readiness of the majority of high school graduates either to enter the workforce or to pursue advanced education is seriously questioned. U.S. students, as a whole, do not stack up well in math and science, according to recent international studies. Fifteen years ago, the Commission on Excellence in Education suggested that, “If an unfriendly power had attempted to impose on America the mediocre educational performance that exists today, we might well have viewed it as an act of war.” Incremental improvements over the years have done little to alter that assessment, but globalization is putting the standard of living of low-skilled Americans at much greater risk.
People problems extend to universities as well. Undergraduate and graduate enrollments, particularly in the physical sciences and engineering, have been static or declining for nearly a decade even as the numbers of engineering graduates doubled in Europe and increased even faster in Asia. Foreign students now make up the majority of enrollment in many U.S. graduate programs, but increasing numbers are returning home as viable employment opportunities grow overseas.
At a time when a disproportionate share of economic growth is linked to high-technology sectors, the number of U.S. scientists and engineers has actually experienced a relative decline in the first half of the 1990s versus a decade before. In this area too, foreign competition is outpacing the U.S. performance. The U.S. labor force is less R&D-intensive (total R&D personnel per 1,000 labor personnel) than in many other countries.
The national platform for innovation. If innovation were simply a matter of inventive genius fertilized by federal funding, the challenges would be relatively straightforward. But the national capacity for innovation hinges on a much more complex interface of resource commitments, institutional interactions, national policies, and international market access. Regulatory and legal frameworks are critical elements in cost and time to market, but the impact on innovation is rarely one of the yardsticks by which new regulations are assessed. In the United States, many areas of regulation continue to be geared toward a bygone era of slow technological change and insulated domestic markets.
For industries that spend heavily on research, an R&D tax credit can make an important difference in investment. But the lack of permanence of the U.S. credit, limitations on the scope of qualified activities, and relatively lower benefits make the U.S. credit internationally uncompetitive.
Interconnectedness also provides competitive advantages in a knowledge-based economy. Faster diffusion of information through public-private partnerships and strategic alliances turbocharges the learning process, and differentiated rates of learning separate the leaders in innovation from the rest of the world. But government funding sources continue to be leery of supporting partnerships for fear of crossing a line into industrial policy. Our findings suggest that this worry is probably misplaced. The closer a technology comes to being product-ready, the more likely companies are to eschew open collaboration, bringing the research in house for development.
For innovator nations such as the United States, access to international markets and protection of intellectual property are the keys to sustained investment. Although the United States maintains a highly open market to international competition, some of the fastest-growing markets abroad are also the least accessible to U.S. companies. Without redoubled efforts by the U.S. government to secure reciprocal treatment, U.S. companies cannot reap the full benefits of their innovation strategies.
It is this interlocking national network of policies, resource commitments, and institutional interaction that underpins the national capacity for innovation and attracts innovative investment into the United States. Neither industry nor academe nor government can create or sustain a national innovation system in isolation. Each is an integral player in the national innovative process. The transformation of knowledge into products, services, markets, and jobs is primarily accomplished by industry. But industry depends on access to frontier research (much of which it does not perform or fund), the availability of a creative and competent workforce and cadre of scientists and engineers (which it does not educate), the existence of national infrastructures such as transportation, information, and energy (which enhance its productivity), tax and regulatory policies that bolster the ability to invest in innovation, and access to international markets (which it cannot ensure). Industry, government, and universities are intimately involved in partnership (whether de facto or articulated) that creates a network of opportunities-and sometimes impediments-to a robust national innovation process.
That national platform for innovation is one of the country’s most valuable and least understood national assets. It is both the main driver for and principal drag on long-term U.S. competitiveness as measured by the success of U.S. companies in the global environment and by improving standards of living for Americans.
The time to bolster the nation’s strengths and shore up its weaknesses is now, when the economy is strong and its margin of leadership is solid. The global environment that is emerging is likely to be unforgiving. Neither U.S. capability for world-class science and technology nor its ability to lead international markets is insulated from global competition. If it inadvertently allows key parts of its innovation enterprise to erode, the growing numbers of innovative competitors will not be slow to fill the breach. Once lost, leadership will not be readily or inexpensively recaptured, if it can be recaptured at all.