The Failed Promise of Innovation in the U.S.

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If the description of the last decade as an innovation shortfall turns out to be accurate, that could make a big difference in how we think about the U.S. economy. For one thing, it helps explain why the trade deficit skyrocketed. A high-wage country such as the U.S. either has to develop innovative products and services to compete with low-cost countries such as China or accept a lower standard of living. "The competitive advantage of the U.S. economy has to be leveraging our science capacity for economic growth," says Pisano of Harvard. Fewer innovative products mean a weaker trade performance.

An innovation shortfall might also have weakened the country's underlying productivity growth, which in turn influenced real wages and the ability of consumers to spend without borrowing. Certainly economists on both the left and the right believe innovation is an essential ingredient for growth. A December 2006 paper by the Brookings Institution, co-authored by Peter R. Orszag, now head of the Office of Management & Budget, observed: "Because the U.S. is at the frontier of modern technological and scientific advances, sustaining economic growth depends substantially on our ability to advance that frontier."

The flip side: A shortfall in innovation could undercut growth and incomes, especially over a decade-long period. True, the economic statistics appear to show decent productivity growth across this stretch. But since there is compelling evidence that the figures are overstated by the credit bubble and statistical problems, we can construct a plausible narrative for the financial bust that gives a starring role to innovation—or rather, to the lack of it. It goes something like this: In the late 1990s most economists and CEOs agreed that the U.S. was embarking on a once-in-a-century innovation wave—not just in info tech but also in biotech and many other technologies. Forecasters upped their long-run growth estimates for the U.S. economy. Consumers borrowed against their home equity, assuming their future incomes would rise. And foreign investors lent America money by buying up U.S. securities, assuming the country would come up with enough new products to pay off the accumulated trade deficit.

This underlying optimism about the economy's growth potential became an enabler for Wall Street's financial shenanigans and greed. In this narrative, investors and bankers could convince themselves that rising home prices were reasonable given the bright future, which was based in part on strong innovation. In the end, the credit market collapse in September 2008 reflected a downgrading of expectations about future growth, which put trillions of dollars of debt underwater.

beyond info tech

Many economists are skeptical about placing the blame on an innovation shortfall, preferring to focus on problems on Wall Street and in Washington. "I tend to see the direct causes in our regulatory system," says Paul Romer, an economist at Stanford University's Graduate School of Business renowned for his work on innovation. "The big task is to explain why risk was so badly mispriced, particularly the risk of a collapse of the housing bubble."

Whatever the ultimate cause of the downturn, a pickup in innovation would provide a welcome economic boost. In part, that could come from information technology, where the combination of Google, social networks, wireless technology, and the beginnings of cloud computing is substantially altering the way people live their lives.

Of course, no industrial revolution in the past has been based on a single technology. A combination of radio, television, flight, antibiotics, synthetic materials, and automobiles drove the productivity surge of the early and mid-20th century. The Industrial Revolution of the second half of the 19th century combined railroads, electricity, and the telegraph and telephone.

Similarly, for sustainable economic growth, the U.S. needs breakthrough innovations outside of core IT. Some technologies weren't ready for prime time 10 years ago but have matured. MacKay of Organogenesis says that after spending years cutting costs and increasing reliability, he is ready to "reinject innovation" back into the company. He is in the process of submitting new treatments for FDA approval, including a product made from living cells that helps stimulate the growth of gum tissue. "This is the type of manufacturing that won't be lost offshore," says MacKay.

MEMS, too, is maturing. Nintendo is about to release a new add-on for the Wii controller, containing an innovative MEMS gyroscope chip that makes it easier to sense a wider range of user movements. The chip is made by InvenSense, a Sunnyvale (Calif.) startup that was able to build on 10 years of industry false starts to produce something small enough and cheap enough to go into a mass consumer product. "If I had any idea how difficult it would be, I wouldn't have started the company," says CEO Steve Nasiri. He expects a fivefold increase in revenue this year, and he sees a competitive advantage for the U.S. "In MEMS technology, the U.S. is two to three years ahead of Europe and Japan," says Nasiri.

The imponderables are biotech and alternative energy. In biotech, the clinical-test pipelines are full of breakthrough treatments, any of which could turn out to be a blockbuster. But as we've seen far too many times, a drug can be promising up to the moment it is rejected by the FDA. Similarly, the potential for innovation in alternative energy is enormous, but it's hard to know which approach will pay off.

The professor, trader, and author Nassim Nicholas Taleb calls technological breakthroughs "positive Black Swans"—unexpected events with huge positive consequences that in retrospect look inevitable. Some, such as Google, come out of nowhere to dominate within a short time. Others take years to mature and are surprising only because people forgot they were there. We've learned over the past 10 years just how unpredictable technology can be. But right about now, the U.S. could use a few positive Black Swans.

Mandel is chief economist for BusinessWeek.

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