Thursday, September 20, 2007

The Need to Innovate

Recent economic data revealed the U.S. trade deficit at nearly $711 billion, down from the $758.5 billion recorded in 2006. While these numbers indicate improvements, historic records have continued to be broken, with 2006 marking the fifth consecutive year of fresh highs. This emergent trend should be a primary concern as economic imbalances widen between the haves and the have-nots. Oil and industry rich countries such as Saudi Arabia and China, must export surpluses as their inventories expands. Inversely, oil and industry poor(er) countries such as the U.S. and Britain must import the gap between the country's supply and the needed demand. These imbalances have become increasingly skewed as domestic supplies of petroleum have peaked, simultaneously with strong internal demand. This imbalance of supply and demand is met by importing more of the commodity from Canada, Saudi Arabia and Venezuela. Complicating the situation is Asia's emergence as the iconic global manufacturer of goods. To put it in perspective, "The United States' trade deficit with China climbed last year to $233 billion, the highest ever recorded with a single country."

This problem is a global issue, however the real economic drain will be felt by the have-nots as their capital is literally siphoned into the economic pool of the the haves. Case in point, every U.S. dollar spent to import oil from Saudi Arabia is a dollar less spent generating economic growth at home. The Federal Reserve chairman, Ben Beranke suggested that the, "United States and other countries must work together to right a skewed pattern of trade and investment around the globe, a move that would help worldwide economic stability."

Realistically, this idea of global teamwork as a method of correcting trade imbalances seems borderline myopic optimism. Do we really expect China to increase its already surging domestic budget and scale back their exports as a means of decreasing their trade surplus? Perhaps, but even if this is the case, what about our end of the agreement? Is it possible for the U.S. to export more and rely less on imports? This seems highly unlikely given our emergence as a service based economy.

This seemingly natural trend towards a service based economy stems from increasing economic efficiencies of supply chains, outsourcing and e-commerce. All of these advances have enabled us to develop higher end goods and services in the U.S. while outsourcing low cost production. Problems can arise as the service economy faces increasing competition from increasingly educated global competitors. While the current military and economic clout of the U.S. is impressive, our once massive technological lead has narrowed as our competition strives for educational and economic prosperity.

Leader of the Pack

There was a time when big research hubs such as AT&T Bell Labs(T), IBM(IBM) and Xerox's Palo Alto Research Center dominated the field of discovery. These massive laboratories existed as each giant corporation controlled their respective industry. The enormous cost of running these think tanks was a small price to pay to insure industry dominance. Alcatel-Lucent once boosted a research roster of 25,000, a number which dwarfs the $115 million budget and 1,000 man roster recorded in 2003.

Part of this downsizing can be attributed to the sheer quantity of sophisticated knowledge acquired over the past 30 years. According to, a site controlled by a branch of the Department of Commerce, "It has been estimated that 90% of all scientific knowledge has been generated over the last 30 years, by about 90% of all scientists and engineers who have ever lived." While this statistic is awe inspiring, it should come as no surprise to your average consumer who has enjoyed such technological advancements as the A-trak, compact disks or Apple's(AAPL) latest spectacle, the iPhone.

Even though the giant research laboratories of the past are mostly a distant memory, American firms still command impressive R&D expenditures. According to The Economist, our domestic firms spend nearly $200 billion annually, mostly focused on computing and communications. Microsoft(MSFT), Intel(INTC) and IBM for example, recorded over $6 billion during fiscal 2006, with Hewlett-Packard(HPQ) and Cisco Systems(CSCO) racking up $4 billion. Primarily, these funds were used for making incremental improvements on existing designs in order to get new products to the market fast. This is due to increasing levels of complexity. As we advance the energy and innovation required for such undertakings increases. The Human Genome Project, arguably one of our greatest achievements, required the participation of multiple countries and nearly 10 years to complete.

Interestingly, mass adoption of new technologies seems to be increasing as well. According to, The automobile took nearly 55 years before 25% of the U.S. population owned cars. Electricity 46 years. Telephones 35 years, televisions 26 years, and computers 15. Cell phones and the Internet accelerated even faster, taking only 13 and 7 years, respectively. Together these two trends appear to indicate society's strengthening appetite for increasingly more complex technology. No wonder AAPL followers were willing to pay $699 dollars for the iPhone. The point here is technology is simultaneously becoming more valuable and complex.

The Lead That Was?

America's pre-eminence with education and technology could be waning. According to, the U.S. in the 1970s accounted for nearly 70% of total worldwide R&D, while 30 years later we only commanded 44%. This shift in power may seem benign upon first glance, but the implications are far more important. The U.S. is no longer the only player in town. Aspiring scientist and engineers(S&E) now have many more selection as to where they want to learn, live and perform research. The educational upgrades made by India and China in the 1990s are beginning to mature to full fruition. India, a country nearly devoid of exploitable resources has seen its economy grow substantially over the past 10 years. The reason? India made sound investments and was able to 'harvest' the intelligence of their citizens.

Even more startling has been the Chinese's ability to grow their S&E expertise. Traditional technology vendors are no longer simply selling products into the Chinese market, they are literally moving in. Microsoft, IBM, Siemens AG(SI) and Hewlett-Packard have all set up R&D branches in China, employing 100s of individuals working to develop next generation technologies. That being said, it should have been no surprise when the PCAST reported the U.S. graduating only 59,500 engineers compared to China's 219,600 last year. Even more disappointing was a 1999 Third International Math & Science Study, which ranked U.S. students in grades K-12 19th and 18th out of 38 nations in math and science, respectively. Without educated and excited youth, who will replace our population of aging scientist and engineers?

Why Continued Innovation Matters

The foundation for America's economic strength has always been our uncanny ability to innovation and create. These two traits coupled with a free market capital system has enable American entrepreneurs and innovators to unlock and commercialize a vast spectrum of technologies, engineering processes and advanced forms of health care. The culminated effects of these advancements has placed us on the forefront of economic fortitude, military power and global prestige.

According to the Public Policy Institute of California, during the 1990s, "Existing companies in Silicon Valley cut 121,000 jobs, while companies started after 1990 created 259,000 jobs." This example of economic expansion unequivocally correlates to U.S. institutions capitalizing on the mass acceptance of the Internet and its associated amenities. As I mentioned before, America's position in the realm of R&D is unmatched by any world power, but the disparity is narrowing. Even though the U.S. spends more than any other country on R&D investments, our growth rate has averaged nearly 1 percent per year in real terms since 2000, according to As the complexity and energy costs of future innovations increases, our ability to compete globally will not be measured by our previous achievements, but by our willingness to make the necessary investments today.

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