In Depth January 29, 2009, 5:00PM EST

Rebuilding America's Job Machine

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Do they work? Paul Kedrosky, a senior fellow at the Ewing Marion Kauffman Foundation, which focuses on entrepreneurship, notes that no truly independent studies of U.S. state venture funds have been done. Another question is whether states could generate more economic activity investing in other areas, such as education. "If you put $100 million into a bunch of businesses, you will create a bunch of jobs," says Robert E. Wiltbank, an entrepreneurship professor at Willamette University who is a partner in a VC firm. "That doesn't say you will do better than anyone else."

Defenders of the funds counter that in most states, an ecosystem for tech startups has never evolved. Two-thirds of American venture capital is invested in California, Massachusetts, Texas, and New York. That strands thousands of potential companies in other states in the so-called Valley of Death, the five or more years it takes to turn an idea in a lab into a working prototype.

Ben Franklin says the $140 million it invested from 2002 to 2006 in hundreds of companies has yielded $517 million in new state taxes and generated $8 billion in economic activity. Successes include Garland, a Freeland maker of high-end kitchen ovens, and Bethlehem's Orasure, an $83 million supplier of kits to detect HIV by testing human saliva. "It's impossible to say the state has not benefited financially and economically," says Chadwick Paul, CEO of Ben Franklin's Northeast Pennsylvania arm.

When Innovative Control Systems in Wind Gap wanted to develop new computer controls for car washes in the mid-'90s, "banks wouldn't talk to us, and VCs said we weren't sexy or large enough," says President Kevin Detrick. Ben Franklin injected $236,000. When Detrick changed strategic direction in 2004, Ben Franklin organized a "tiger session" where local businessmen punched holes in his business plan. They persuaded Detrick to focus not just on hardware but also on services to help car washes manage everything from credit-card payments to reminding customers when their cars need a lube job. In 2008, Innovative Controls says it posted sales of $16 million and served 2,000 car washes. Without Ben Franklin, "I don't think we'd be here now," Detrick says.

NEEDED: FEDERAL-STATE COOPERATION

Even if there are pockets of public-private success, are these experiments big enough to make a difference, especially in competition against China, Japan, or South Korea? Well-planned assistance from Washington could have an impact, but such coordination has been weak. "There is a lot of great experimentation in commercializing new technology at the state level," says CEO Dan Berglund of State Science & Technology Institute (SSTI) in Westerville, Ohio, a nonprofit that advises regional governments. "But at the federal level, there is little funding and no strategy." Incoming SBA head Mills led a 2008 Brookings Institution study that found that 14 U.S. agencies spend $76 billion a year on economic development. But these efforts are not "linked, leveraged, or aligned," Mills said in an interview prior to her nomination. "The federal people don't talk to the state people or to industry."

If the Obama Administration can blend the states' and Washington's efforts, states that invested early in strategic industries could be the best positioned to land federal backing. That's part of Kaloyeros' thinking—to make Albany the place where "anyone who wants to demonstrate any concept in nanotechnology will have to be." His goal, he jokes, is to expand his R&D campus so he can walk to the nearest Starbucks without going outside. That Starbucks is a mile away.

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Seeding Jobs

U.S. state governments are investing their R&D dollars strategically. California has poured $400 million into public-private partnerships in biomedicine and nanosystems, while Michigan will invest $2 billion along with industry over 10 years in areas from advanced auto manufacturing to renewable energy. More such programs are noted in Investing in Innovation, a report by the National Governors Assn. and the Pew Center on the States.

To view the report, go to http://bx.businessweek.com/innovation-economics/reference/

Engardio is an international senior writer for BusinessWeek .