Chapter 5

The New Global Competitive Environment

America’s innovation system has long been the envy of the world. Now the rest of the world is racing to catch up. Virtually every important trading partner has declared innovation to be central to increasing productivity, economic growth, and living standards. They are implementing ambitious, farsighted, and well-financed strategies to achieve that end. This chapter will describe how different nations studied by the STEP Board are addressing their innovation challenge.

Indeed, just as the global movement toward free markets in the 1990s became known as the Washington Consensus, the first decade of the 21st century has seen the emergence of what could be described as the Innovation Consensus. Governments everywhere have been sharply boosting investments in research and development, pushing universities and national laboratories to commercialize technology, building incubators and prototyping facilities for start-ups, amassing early-stage investment funds, and reforming tax codes and patent laws to encourage high-tech entrepreneurialism. What’s more, these efforts are backed by intense policy focus at the highest level of governments in Asia, Europe, and Latin America.

Underlying this trend is an emerging understanding of what makes a nation globally competitive. Carl J. Dahlman of Georgetown University notes that economists traditionally have viewed competitiveness as a function of factors such as capital, the costs of labor and other inputs, and the general business climate. In a more dynamic world in which information technology and communications enable knowledge to be created and disseminated at evergreater speeds, competitiveness increasingly is based on the ability to keep pace with rapid technological and organizational advances.1

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1 See presentation by Carl J. Dahlman of Georgetown University in National Research Council, Innovation Strategies for the 21st Century: Report of a Symposium, Charles W. Wessner, editor, Washington, DC: The National Academies Press, 2007.



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Chapter 5 The New Global Competitive Environment America’s innovation system has long been the envy of the world. Now the rest of the world is racing to catch up. Virtually every important trading partner has declared innovation to be central to increasing productivity, economic growth, and living standards. They are implementing ambitious, far- sighted, and well-financed strategies to achieve that end. This chapter will describe how different nations studied by the STEP Board are addressing their innovation challenge. Indeed, just as the global movement toward free markets in the 1990s became known as the Washington Consensus, the first decade of the 21st century has seen the emergence of what could be described as the Innovation Consensus. Governments everywhere have been sharply boosting investments in research and development, pushing universities and national laboratories to commercialize technology, building incubators and prototyping facilities for start-ups, amassing early-stage investment funds, and reforming tax codes and patent laws to encourage high-tech entrepreneurialism. What’s more, these efforts are backed by intense policy focus at the highest level of governments in Asia, Europe, and Latin America. Underlying this trend is an emerging understanding of what makes a nation globally competitive. Carl J. Dahlman of Georgetown University notes that economists traditionally have viewed competitiveness as a function of factors such as capital, the costs of labor and other inputs, and the general business climate. In a more dynamic world in which information technology and communications enable knowledge to be created and disseminated at ever- greater speeds, competitiveness increasingly is based on the ability to keep pace with rapid technological and organizational advances.1 1 See presentation by Carl J. Dahlman of Georgetown University in National Research Council, Innovation Strategies for the 21st Century: Report of a Symposium, Charles W. Wessner, editor, Washington, DC: The National Academies Press, 2007. 201

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202 RISING TO THE CHALLENGE The innovation agendas and precise policies differ from country to country, based on national needs and aspirations. In some cases, governments are implementing policies modeled after those of the United States. In others, they are borrowing from successful models pioneered in Europe and East Asia that leaders regard as more attuned to the competitive realities of the 21st century global economy. In that regard, other nations’ experiences offer valuable lessons for policymakers in the U.S. federal government, regions, and states. To better understand global trends in innovation policy, the National Academies’ Board on Science, Technology, and Economic Policy (STEP) conducted an extensive dialogue over the past several years to compare and contrast policies of many nations. This section presents a number of case studies from those symposia and our research. While it is of course difficult to generalize, a number of common policy themes recurred through this extensive dialogue. They include: • The paramount importance of investment in education to provide the skills base upon which an innovation-led economy is based. • The value of increasing public and private investment in research and development, with at least 3 percent of GDP generally viewed as a desired target. • The importance of establishing a far-thinking national innovation strategy that lays out broad science and technology priorities and a policy framework that addresses the entire ecosystem, including skilled talent, commercialization of research, entrepreneurship, and access to capital. Such national strategies require attention of top political leadership, coordination of government agencies, sustained funding, and collaboration with stakeholders at the regional and local level. • An increasingly prominent role for public-private partnership in which industry, academia, and government pool resources to accelerate the translation of new technologies into the marketplace. • A recognition that while universities’ primary roles are education and research, they also can serve as powerful engines of economic growth if granted greater freedom to collaborate with industry and to commercialize inventions. • Focus on programs to encourage firms to transform basic and applied research into new products and manufacturing processes. • Greater policy emphasis on the institutional framework needed to sustain new business creation, such as intellectual property-right protection, competitive tax codes, and an efficient and transparent regulatory bureaucracy. This chapter will describe how different nations studied by the STEP Board are addressing these and other issues. The chapter describes the innovation policy approaches of nations at three tiers of development.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 203 In the first tier are the emerging economic powers. We looked at China and India in some depth. Both nations have charted ambitious innovation agendas for improving living standards and moving well beyond labor-intensive manufacturing and low-skill services to high-tech and knowledge-intensive industries. They are leveraging their large domestic markets and low-cost workforces to attract foreign investment in next-tier industries and are developing globally competitive corporations. They also are making strategic choices about technologies that address domestic needs and in which they are best positioned to compete globally in the future. In the second tier are the more mature newly industrialized economies. We focus on Singapore and Taiwan, which have extraordinarily well-educated populations and have attained world standards in industries such as high-tech electronics, biotechnology research, and chemicals. They are striving to develop innovation ecosystems that will allow them to rank among the world’s richest nations and compete head-to-head with the West and Japan in next-generation industries. The third tier represents mature industrialized nations. We devote special attention to Germany because of that nation’s ability to remain globally competitive in advanced manufacturing exports despite wages and other costs that are higher than in the United States. Our case studies also include Japan, Finland, Canada, and the Flanders region of Belgium. Each of these nations has revamped their national innovation strategies in order to increase R&D spending, collaboration between industry and academia, and new technology start-ups. In most cases, it is too early to offer a full assessment of whether the strategies and policy tools selected by other nations will achieve their stated targets. What’s more, not all of these policy options are appropriate for America. Yet they offer many valuable lessons for U.S. policymakers and present a picture of the changing global context as America prepares for 21st century competition. EMERGING POWERS China’s Rapid Rise After achieving decades of astonishing growth led by export manufacturing and heavy capital investment, China’s leadership stresses that the nation’s future as a global power rests on its ability to build an innovation-led economy.2 China has pursued that goal with substantial investment and 2 Government pronouncements on the importance of innovation began earlier. For example, then- President Jiang Zemin declared in the keynote address to the National Innovation Technology Conference on Aug. 23, 1999, that “the core of each country’s competitive strength in intellectual

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204 RISING TO THE CHALLENGE impressive focus. National spending on R&D has risen by an average of 19 percent a year since 1998,3 and in under a decade has grown from less than one percent of GDP to 1.7 percent.4 China’s share of global R&D spending soared from 6 percent in 1999 to 12 percent in 2010.5 By virtually every conventional benchmark—successful patent applications, scientific publications, post-graduate degrees awarded, and global market share in high-tech goods--China’s progress in science and technology has been solid. China has emerged as a major exporter of everything from solar cells to high-end telecommunications equipment and has accelerated the construction of high-speed trains. As R&D Magazine noted, China’s financial commitments and record of generating intellectual property is such that it no longer can be regarded as an “emerging nation” in science and technology. 6 In 2010 alone, for example, China’s international patent filings surged by 56.2 percent, to 12,337, compared to average growth worldwide of 4.8 percent.7 The most visible manifestations of China’s innovation push are its sprawling science parks. China’s 54 major research parks average 10,000 acres, compared to around 350 acres in the U.S.8 China’s achievements are a testament to the nation’s ability over the past three decades to overhaul a dilapidated science and technology establishment, maintain policy focus at all levels of government, and mobilize immense public resources to invest in higher education, infrastructure, and R&D. That commitment continues to grow. China’s long-term plans call for boosting gross R&D spending to 2.5 percent of GDP by 2020 and for science and technology to account for 60 percent of the economy.9 The government has set an ambitious target of having 2 million patents of inventions, utility models, and designs by 2015.10 innovation, technological innovation, and high-tech industrialization.” Current President Hu Jintao has stressed the importance of innovation in numerous speeches. 3 UNESCO, Institute for Statistics Database, Table 25, Gross Expenditure on Research and Development in constant dollars. Growth rate from 1998 to 2008. 4 Ministry of Science and Technology of the People’s Republic of China, China S&T Statistics Data Book 2010, Figure 1-1. 5 Battelle and R&D Magazine, 2012 Global R&D Funding Forecast, December 2011 6 Martin Grueber and Tim Studt, “Global Perspective: Emerging Nations Gain R&D Ground,” R&D Magazine, Dec. 22, 2009. 7 Xinhua News Service, “China 2010 International Patent Filings up 56.2%,” China Daily, Feb. 2, 2011. 8 Data from Research Triangle Foundation. 9 State Council of China, National Medium- and Long-Term Program for Science and Technology Development, 2006-2020 (http://webcache.googleusercontent.com/search?q=cache:y800l0iQlS8J:www.cstec.org/uploads/files /National%2520Outline%2520for%2520Medium%2520and%2520Long%2520Term%2520S%26T %2520Development.doc+china+National+Medium-+and+Long- Term+Program+for+Science+and+Technology&cd=18&hl=en&ct=clnk&gl=us&client=firefox-a). 10 State Intellectual Property Office, “National Patent Development Strategy (2011-2020),” (http://graphics8.nytimes.com/packages/pdf/business/SIPONatPatentDevStrategy.pdf).

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 205 China’s heavy focus on absorbing foreign technology, rather than inventing it, also explains its industrial rise. The U.S. devotes 17.4 percent of its R&D spending to basic research, another 22.3 percent to applied research, and 60.3 percent to R&D development.11 China invests 82.7 percent of national R&D spending to development of products and manufacturing process, while devoting just 4.7 percent to basic research and 12.6 percent to applied research.12 [See Figure 5.1] When it comes to creating truly innovative products, however, China still is regarded as an underachiever.13 One hurdle is weak R&D spending by Chinese companies, especially state-owned enterprises.14 Even though business enterprises in China accounted for 73 percent of R&D spending in 2009,15 a World Bank study of nearly 300,000 Chinese enterprises big and small found that the vast majority did not conduct continuous R&D and described Chinese industry as “manufacturing without innovation.”16 China’s weak protection of intellectual property rights is a serious restraint on innovation, preventing companies from enjoying the full profits of their inventions and making foreign investors wary of conducting sensitive R&D in China.17 Other often-cited weaknesses are shortages of the right kind of 11 National Center for Science and Engineering Statistics, National Patterns of R&D Resources: 2008 Data Update, Detailed Statistical Tables, NSF 10-314 (March 2010), Tables 1-4. 12 Ministry of Science and Technology of the People’s Republic of China, China S&T Statistics Data Book 2010 , Figure 1-3 at http://www.sts.org.cn/sjkl/kjtjdt/data2010/cstsm2010.htm. 13 As a recent National Academy report concluded “China’s S&T investment strategy is ambitious and well-financed but highly dependent on foreign inputs and investments. Many of its stated S&T and modernization goals will be unachievable without continued access to and exploitation of the global marketplace for several more decades. China plays a critical role in low- and select high-tech industry production and logistics chains, but it cannot (yet) replicate these processes domestically.” National Academy of Sciences, Natural Research Council, S&T Strategies of Six Countries: Implications for the United States, Washington, DC: The National Academies Press, 2010, p.23. 14 Gruber and Studt, ibid. 15 China S&T Statistics Data Book 2010, ibid., Figure 1-2. 16 Chunlin Zhang, Douglas Zhihua Zeng, William Peter Mako, and James Seward, Promoting Enterprise-Led Innovation in China, Washington, DC: The International Bank for Reconstruction and Development/The World Bank, 2009 (http://siteresources.worldbank.org/CHINAEXTN/Resources/318949- 1242182077395/peic_full_report.pdf). 17 For examples of U.S. industry complaints, see John Neuffer, “China: Intellectual Property Infringement, Indigenous Innovation Policies, and Frameworks for Measuring the Effects on the U.S. Economy,” written testimony to the United States International Trade Commission Investigation No. 332-514 Hearing on behalf of the Information Technology Industry Council, June 15, 2010. (http://www.itic.org/clientuploads/ITI%20Testimony%20to%20USITC%20Hearing%20on%20Chin a%20%28June%2015,%202010%29.pdf ). See also Semiconductor Industry Association, Maintaining America’s Competitive Edge: Government Policies Affecting Semiconductor Industry R&D and Manufacturing Activity, March 2009, p.31. “Most [semiconductor] companies surveyed indicated that they would not locate their most advanced and critical R&D activities in China, despite encouragement and even pressure by the government to do so, and regardless of the

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206 RISING TO THE CHALLENGE Box 5.1 Constraints on Innovation in China China’s massive investments in technological infrastructure, science education, and research programs are key elements in laying the foundation for an innovation economy. But these investments in themselves do not mean that China will become a leading innovator in the near term. As China’s Vice Minister of Science and Technology, Ma Songde commented in 2006, “most Chinese high-tech products are copies from other countries and that original inventions are rare on the mainland.”18 In this regard, a recent report by the National Academies noted that “Although the growth in S&T funding is remarkable, there are still institutional issues that must be resolved. In particular, there is a general lack of openness and transparency in funding decisions, which negatively affects the ability of China to recruit first-rate scientists. Additionally, most R&D spending is geared toward development activities, rather than basic research. As a result, the quality and quantity of cutting-edge basic research is still small compared to that of the United States.” 19 The current World Bank report on China observes that notwithstanding China’s growing supply of skills and advanced industrial base, most R&D is conducted by the government and state-owned enterprises in a manner that is divorced from the needs of the economy. China has seen a sharp increase in patents and published papers, but few have commercial relevance.20 The report indicates that “China has relatively few high-impact scientific activities in any field,” and that the “quantity [of patents] has not been matched by the quality of the patents.”21 The centerpiece of China’s innovation effort, the so-called ‘indigenous innovation” initiative, emphasizes the exertion of commercial leverage against foreign firms to induce the transfer of technology that will be “absorbed, assimilated, and re-innovated” with Chinese intellectual property—arguably not availability quality and size of incentives, due to concerns about the inadequacy of intellectual property protection in that country.” 18 Seminar remarks summarized in Open Source Center Report (July 24, 2006). 19 National Research Council, S&T Strategies of Six Countries, Implications for the United States, Washington, DC: The National Academies Press, 2010, page 30. The report further notes that “although China’s university system graduates hundreds of thousands of scientists and engineers each year, a critical shortage exists of highly qualified faculty, many of whom are attracted instead to opportunities in the private sector.” 20 World Bank, China 2030, Washington, DC: The World Bank, 2012. 21 World Bank, Supporting Report 2: China Grows Through Technological Convergence and Innovation. Washington, DC: World Bank, 2012, pages 177-178.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 207 a program focused on fostering original discoveries.22 Despite these limitations, developing major new innovations is not the only source of national strength. Programs that focus on acquiring new and established technologies can help develop the technological competitiveness of the Chinese economy and provide the opportunity for commercial success, first within China and next in export markets, thus laying the foundation for steadily higher levels of commercial application of advanced technologies. To address these challenges to its innovation system, the World Bank recommends that China concentrate on raising the technical and cognitive skills of its university graduates, building a few world-class research universities with links to industry, increasing the availability of patient risk capital for start-ups, and fostering clusters that bring together dynamic companies and universities and allow them to interact without restriction.23 human resources, weak linkages between government-funded research institutions and the private sector,24 a science and technology establishment that prizes the quantity of journal publications and patents over quality and added- value, and over-dependence on government bureaucracy in investing R&D funds. A study by the Chinese Ministry of Science and Technology and the Organization for Economic Co-Operation faulted “deficiencies in the current policy instruments and governance promoting innovation.” As a result, the study concluded, the government’s heavy investments in R&D have “yet to translate into a proportionate increase in innovation performance.”25 As Deng Wenkui, director-general of the State Council Research Office put it: “Although China is a science and technology country with great skill, it is not a powerhouse.” He added that “without reform and innovation, China cannot develop.”26 22 State Council, “Guidelines for the Medium and Long Term National Science and Technology Program (2006-2020) June 2006. 23 World Bank, China 2030, op. cit. 24 See Denis Fred Simon and Cong Cao, China’s Emerging Technological Edge: Addressing the Role of High-End Talent, Cambridge: Cambridge University Press, 2009. 25 OECD Reviews of Innovation Policy, op. cit. This lack of performance is reflected in the innovation component of the World Bank’s Knowledge Economy Index (KEI), which ranks China 63rd in the world despite its large absolute spending on R&D. The innovation component of the World Bank’s index is based on total royalty payments and receipts, patent applications granted by the U.S. PTO and scientific and technical journal articles. World Bank, Knowledge Assessment Methodology at http://go.worldbank.org/JGAO5XE940. 26 Remarks by Deng Wenkui of the State Council Research Office at the Sept. 19, 2011 National Academies symposium “U.S.-China Policy for Science, Technology, and Innovation” in Washington, DC.

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208 RISING TO THE CHALLENGE China Basic Applied Development U.S. 0 20 40 60 80 100 Percent FIGURE 5.1 China devotes less that 5 percent of total R&D spending to basic research. SOURCE: China: Ministry of Science and Technology of the People’s Republic of China, China S&T Statistics Data Book 2010, Figure 1-3; for U.S.: National Center for Science and Engineering Statistics, National Patterns of R&D Resources: 2008 Data Update, Detailed Statistical Tables, NSF 10-314 (March 2010), Tables 1-4. NOTES: China data for 2009; U.S. data for 2008. Determined to correct these shortcomings, the Chinese government over the past five years has launched an ambitious agenda to “transform China’s economic development pattern so that it is driven by innovation,” in the words of Ministry of Science and Technology official Yang Xianyu.27 President Hu Jintao has declared that innovation “is the core of our national development strategy and a crucial link in enhancing the overall national 27 From presentation by Yang Xianyu of the Ministry of Science and Technology in National Research Council, Building the 21st Century: U.S. - China Cooperation in Science, Technology, and Innovation, Charles. W. Wessner, editor, Washington, DC: The National Academies Press, 2011.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 209 strength.”28 Such pronouncements have been backed with a flurry of initiatives at the central, provincial, and local levels to upgrade the nation’s innovation ecosystem. Among other things, the government is greatly increasing spending on R&D, boosting incentives for corporate R&D, urging universities and government research institutes to form stronger links with industry, building immense science parks, investing aggressively in broadband infrastructure, and vowing to improve intellectual property-right protection. The strategy is embodied in The National Medium and Long-Term Program for Science and Technology Development, 2006-2020, a document drafted over two years and that received input from some 2,000 experts.29 The overarching goal is to make China an “overall well-off society” driven by innovation. Among the key targets for 2020 are to become one of the world’s top five generators of invention patents and published scientific papers, and to reduce China’s dependence on foreign technology to 30 percent.30 The document also lists 16 “megaprojects” that will receive heavy government financial backing. The aspect of the game plan that has generated the most attention overseas is the government’s emphasis on “indigenous innovation.” The goal is to ease China’s dependence on imported technology and to nurture companies that can compete at home and abroad with their own intellectual technology. As outlined in the 15-year science and technology plan and numerous published rules and guidelines over the past five years, the strategy includes compelling foreign companies to transfer core technology as a price for being able to sell into China’s immense domestic market.31 In addition to generating tension with trade partners, China’s innovation strategy seems fraught with internal contradictions. Although the stated goal is to achieve an innovation-driven economy led by market forces and enterprises, the technology drive is built around large state-led projects. 28 Hu Jintao report to the 17th National Congress of the Communist Party of China, Oct. 14, 2007. See Xinhua, “Innovation tops Hu Jintao’s Economic Agenda,” Oct. 15, 2007 (http://news.xinhuanet.com/english/2007-10/15/content_6883390.htm). 29 Cong Cao, Richard P. Suttmeier, and Denis Fred Simon, “China’s 15-Year Science and Technology Plan,” Physics Today, December 2006 (http://www.levininstitute.org/pdf/Physics%20Today-2006.pdf). 30 National Medium- and Long-Term Program for Science and Technology Development, op. cit. 31 For an extensive discussion of the controversies surrounding China’s indigenous innovation policies, see James McGregor, “China’s Drive for ‘Indigenous Innovation: A Web of Industrial Policies, “U.S. Chamber of Commerce, Global Intellectual Property Center, APCO Worldwide (http://www.uschamber.com/sites/default/files/reports/100728chinareport_0.pdf). Also see U.S. International Trade Commission, China: Intellectual Property Infringement, Indigenous Innovation Policies, and Frameworks for Measuring the Effects on the U.S. Economy, Investigation No. 332- 514, USITC Publication 4199 (amended), November 2010 (http://www.usitc.gov/publications/332/pub4199.pdf) and Alan Wm. Wolff, “China’s Indigenous Innovation Policy,” testimony before the U.S. China Economic and Security Review Commission, Washington, DC, May 4, 2011.

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210 RISING TO THE CHALLENGE Although the strategy acknowledges that China needs multinational investment and greater international collaboration, it is intends to extract technology from foreign companies to create domestic champions that will eventually compete directly against them. As an extensive study of China’s technology modernization drive by CENTRA Technologies concludes: “Caught between a tradition of state planning and the need for markets—and between an interest in foreign technology assimilation of the lure of domestically developed technology—China’s innovation system faces an ambiguous future.”32 Nevertheless, there is little question China has the raw potential—and certainly the determination—to emerge as a 21st century innovation power. China has passed Japan as the world’s second-largest spender on R&D.33 Tertiary enrollment in China rose from 2 percent in 1980 and 22 percent in 2007. As of 2008, China had 27 million post-secondary students, compared to 18 million in the U.S.34 Forty percent of those students are in engineering, math, and science.35 China’s research workforce that has tripled to some 1.6 million since 1997,36 and a pool of science and engineering Ph. D’s that swelled more than fourfold over that time to 20,000. China has extraordinarily high savings and investment rates of around 40 percent of GDP, double the rate of most other nations. China also has the world’s second largest manufacturing base [See Figure 5.2], a surplus labor pool of more than 150 million people, superb trade logistics, the world’s fast-growing market for advanced technology products, and the ability to absorb global knowledge through direct foreign investment and an extensive network of overseas Chinese.37 32 Micah Springut, Stephen Schlaikjer, and David Chen, “China’s Program for Science and Technology Modernization: Implications for American Competitiveness,” CENTRA Technology Inc., prepared for The U.S.-China Economic and Security Review Commission, 2011 (http://www.uscc.gov/researchpapers/2011/USCC_REPORT_China's_Program_forScience_and_Te chnology_Modernization.pdf). 33 OECD, Main Science and Technology Indicators: Volume 2011/1, 2011, p. 18. Data comparison based on current U.S. dollars. 34 UNESCO. 35 See Carl Dahlman, World Under Pressure, op. cit. 36 UNESCO Science and Technology database. 37 See presentation by Carl Dahlman of Georgetown University in National Research Council, Innovation Policies for the 21st Century, Charles W. Wessner, editor, Washington, DC: The National Academies Press. Also see Carl Dahlman, in Building the 21st Century: U.S. - China Cooperation in Science, Technology, and Innovation, op. cit.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 211 2,000 Manufacturing Value-added (Billions of Constant 2005 Dollars) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 U.S. China Japan Germany Korea India FIGURE 5.2 China is second only to the United States in manufacturing value- added. SOURCE: United Nations Statistics Division, National Accounts Main Aggregates Database at http://unstats.un.org/unsd/snaama/selbasicFast.asp. China’s Evolving Innovation System China re-entered the global economy in the late 1970s with a scientific establishment, higher education system, and industrial base that had been crippled by nearly three decades of chaotic rule under Mao Zedong. After its victory in 1949, the Communist Party implemented Soviet-style central planning. Private industrialists fled to Hong Kong and Taiwan, and state took control of the factories left behind. Millions perished in famine as the result of the Great Leap Forward, Mao’s disastrous grass-roots industrialization drive. Scientists and academics were purged in an anti- rightist campaign and again during the Cultural Revolution from 1966 to 1976, when educated Chinese were banished to manual work in the countryside and universities were shut to virtually all but workers, farmers, and soldiers. That 10-year period cost China a generation of top scientists and engineers whose absence is still felt.

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310 RISING TO THE CHALLENGE introduce new or significantly improved goods and services.468 The Science, Technology, and Innovation Council said in a 2008 report that R&D spending by Canadian firms is “falling behind our major competitors and the gap is growing.”469 Business R&D spending equaled around 1 percent of GDP in 2009, compared to a 1.6 percent average for OECD nations.470 [See Figure 5.14] Milway, executive director of the Institute for Competitiveness and Prosperity, recently remarked that this performance “is another bit of evidence that our businesses are not competing on the basis of innovation, value-added and sophistication.”471 Total R&D intensity in Canada has thus been trending downward for the past decade, to 1.81 percent of GDP in 2010. [See Figure 5.15] There also are concerns that Canada is falling short of its goal of building a sufficient base of knowledge workers. A report by the Canadian Council on Learning in August 2010 said Canada lags in early childhood education. While science, math, and reading test scores still are relatively high in secondary school, other nations are advancing faster. 472 Canada ranks 20th among OECD nations in terms of natural science and engineering degrees as share of total degrees and 17th in the number of people in science and technology occupations. Such challenges have not slowed Canada’s commitment to investing in the science and technology foundations of an innovation-led economy. It is early to pass judgment on Canada’s efforts to stimulate private investment in R&D, since many of the new programs were implemented just prior to the 2008-2009 recession, which forced companies to cut back. To address challenges in R&D investment and with the skilled workforce, the Canadian government also remains committed to expanding research collaborations with foreign companies and universities, to improving incentives to attract direct foreign investment, and to recruiting top talent. 468 Industry Canada, Foreign Affairs and International Trade Canada, and Statistics Canada, “Survey of Innovation and Business Strategy,” 2009. A summary of the survey’s findings can be found on the Industry Canada Web site at http://www.ic.gc.ca/eic/site/eas-aes.nsf/eng/h_ra02118.html. 469 Science, Technology, and Innovation Council, State of the Nation 2008 (http://www.stic- csti.ca/eic/site/stic-csti.nsf/eng/00019.html). 470 OCED, Main Science and Technology Indicators, 2010. 471 Rebecca Lindell, “Canadian R&D Spending Continues Downward Spiral: StatsCan,” Postmedia News, Dec. 8, 2010. 472 Canada Council on Learning, Taking Stock of Lifelong Learning in Canada (2005-2010): Progress or Complacency? Aug. 25, 2010.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 311 2.15 2.10 2.09 2.05 2.04 2.04 2.07 2.04 2.00 2.00 1.96 R&D/GDP (Percent) 1.95 1.92 1.90 1.90 1.85 1.80 1.81 1.75 1.70 1.65 2001 2002 2003 2004 2005 2006 2007 2008 2009p 2010p FIGURE 5.15 Canadian R&D intensity has been trending downward in the past decade. SOURCE: Statistics Canada, CANSIM, tables 358-0001 and 380-0017 and Catalogue nos. 88-001-XIE and 88F0006XIE. NOTE: Data for 2009 and 2010 are preliminary. Japan Japan has taken a number of actions since the mid-90s to improve its innovation system, many of them inspired by the United States.473 Japan has strengthened protection of intellectual property, overhauled science and technology policy institutions, enacted its own version of the Bayh-Dole Act to make it easier for universities and research laboratories to commercialize technology, and bolstered industry and academic science partnerships.474 Japan 473 A National Academy report recently concluded, however, that Japan has still not adequately addressed some longstanding weaknesses in its S&T system “which include immobility of personnel, inadequate entrepreneurialism, insufficient opportunity for younger researchers, and abiding problems with industry-university-government collaboration.” National Academy of Sciences, S&T Strategies of Six Countries, op. cit., p. 43. 474 See Sadao Nagaoka and Kenneth Flamm, “The Chrysanthemum Meets the Eagle— The Co- evolution of Innovation Policies in Japan and the United States,” in National Research Council, 21st Century Innovation Systems for Japan and the United States: Lessons from a Decade of Change,

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312 RISING TO THE CHALLENGE also undertook a number of initiatives to increase entrepreneurialism, including a small-business loan program similar to America’s Small Business Innovation Research program. To spur corporate R&D spending, Japan grants generous tax credits. Largely as a result, Japanese spending on research and development surged from 2.77 percent of GDP in 1994 to 3.8 percent in 2008 before declining slightly to 3.62 percent in 2009.475 [See Figure 5.16] Japanese companies account for three- quarters of that spending, the highest ratio among OECD nations.476 Driving this change was the realization that innovation would be central to restoring growth to the Japan’s stagnating economy in the wake of the financial crash of 1990. Even though Japanese R&D investment and output of patents remained quite strong on world standards throughout the 1990s, Japanese companies stumbled as they tried to make the transition from products derived from well-developed technologies to the creation of more fundamental breakthroughs.477 Japan’s competitiveness in industries such as semiconductors and consumer electronics waned with the rise of new rivals in South Korea and Taiwan. Japan had largely missed out on the U.S.-led booms in biotechnology and software.478 Japan’s commercial scene, dominated by large conglomerates, was not producing many dynamic start-ups. The rapid pace of change ushered in by the information technology revolution and globalization did not play to the strengths of Japan’s large industrial conglomerates. Japan’s policy shift began in earnest with passage of the Basic Law on Science and Technology in 1995.479 Under that plan, the government spent ¥17 trillion ($206 billion in current U.S. dollars) from 1996 through 2000 on science and technology programs. During the subsequent five-year basic plans, another ¥49 trillion were invested. These funding increases helped Japanese universities and national laboratories upgrade laboratories that had become outdated.480 Sadao Nagaoka, Masayuki Kondo, Kenneth Flamm, and Charles Wessner, Eds., Washington, DC: The National Academies Press, 2009. 475 Japanese Ministry of Internal Affairs and Communications, Statistics Bureau at http://www.stat.go.jp/english/data/kagaku/index.htm. Data refer to fiscal years. 476 OECD, OECD Science, Technology and Industry Scorecard 2011, Figure 2. 5.2. 477 Lee Branstetter and Yoshiaki Nakamura, “Is Japan’s Innovation Capacity in Decline?” National Bureau of Economic Research, Working Paper 9438, January 2003. 478 Some analysts attribute Japan’s decline as a leader in consumer electronics, characterized by innovative products such Sony’s Walkman audio devices, to increased importance of embedded software, an industry dominated by U.S. companies, rather than hardware design. See Ashish Arora, Lee G. Branstetter, and Matej Drev, “Going Soft: How the Rise of Software-Based Innovation Led to the Decline of Japan’s IT Industry and the Resurgence of Silicon Valley,” National Bureau of Economic Research, Working Paper 16156, July 2010. 479 For an unofficial translation of the Science and Technology Basic Law (Law No. 130 of 1995) see http://www.mext.go.jp/english/kagaku/scienc04.htm. 480 National Science Foundation, “The S&T Resources of Japan; A Comparison with the United States,” Access at http://www.nsf.gov/statistics/nsf97324/intro.htm.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 313 4 3.80 3.62 3 R&D/GDP (Percent) 2.77 2 1 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 FIGURE 5.16 Japanese R&D intensity peaked at 3.8 percent of GDP in FY2008 before declining slightly in FY2009. SOURCE: Japan Ministry of Internal Affairs and Communications, Statistics Bureau, Accessed at . NOTE: Data refer to fiscal years. Japan also strengthened national coordination of its innovation strategy. The Council for Science and Technology Policy, established in 2001, became part of the Prime Minister’s Cabinet. The council drafts comprehensive science and technology policies to respond to national and social needs, advises on how to allocate resources, and evaluates major projects. Funding focused on life sciences, nanotechnologies and new materials, information and communication, and environmental technologies.481 The government did not, however, assume greater central control over research. To the contrary, in 2004 it gave national universities and research institutes more autonomy to allocate resources, collaborate with industry, and set 481 For an extensive discussion of changes in Japanese innovation policies, see Akira Goto and Kazuyuki Motohashi, “Technology Policies in Japan: 1990 to the Present,” in 21st Century Innovation Systems for Japan and the United States.

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314 RISING TO THE CHALLENGE their own research priorities by separating them from the civil-service system. These institutions were transformed into non-profit corporations. Because they account for the bulk of scientific and technological research, the independence given universities and national labs is expected to allow resources to be used more flexibly and efficiently. In another crucial institutional reform, government agencies have begun to allocate much greater shares of R&D funds on the basis of peer-reviewed competition.482 The greater focus on innovation has led to dramatic increases in scientific research in strategic areas.483 In 1992, the government set a goal of tripling investment in life sciences over the next decade. By 2001, the number of biotech companies had risen from a few dozen to 250; the goal was to have 1,000 biotech companies by 2010. In nanotech, Japan was spending almost as much on research as the United States--$940 million—as of 2004. Fuel cells, an important technology not only for portable electronic devices but also for future electrified vehicles, also received heavy emphasis. Robotics is another top Japanese research priority. The government is especially interested in developing technologies used in core components that can be applied across the industry, such as power sources, control systems, mechanics, software, and structures. Two of Japan’s biggest investments in science were the $1 billion Spring-8, one of the world’s largest synchrotron radiation facilities, and the Earth Simulator, a $450 million scientific computer billed as the world’s fastest when it opened in 2003. Japan also has resuscitated R&D consortia, a key element of industrial policy until the 1980s. The government cut funds for consortia in areas like semiconductors following trade friction with the U.S., but began to renew such programs after Sematech started to benefit U.S. producers and Japanese chipmakers’ fortunes declined.484 Strengthening University-Industry Partnerships Japan has moved to strengthen universities’ collaboration with industry. In 1999, Japan enacted a law that gave universities and research institutes the ability to patent investments derived from publicly funded research, similar to the Bayh-Dole Act of 1980. Since then, these institutions have established technology-transfer organizations. The government also helped universities set up Collaborative Research Centers that compete for government grants for joint 482 A concise analysis of Japan’s shift in innovation policy is found in National Research Council, S&T Strategies of Six Countries: Implications for the United States, Committee on Global Science and Technology Strategies and Their Effect on U.S. National Security, Washington, DC: The National Academies Press, 2010. 483 See presentation by David K. Kahaner of the Asian Technology Information Program in Innovation Policies for the 21st Century, op. cit. 484 Nagaoka and Flamm, op. cit.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 315 university-industry research, small-business incubators, and a network of 45 Venturing Business Laboratories, which help young researchers commercialize their work. In addition, the government relaxed rules that had barred university faculty from serving on the boards of private companies. These efforts led to significant results. University-industry research collaborations surged from around 1,500 in 1995 to more than 6,000 in 2003. Companies spun out of universities increased to around 150 a year as of 2003, nearly half of them in life sciences and information and communication technologies.485 While it is too early to assess the full impact of Japan’s reforms, there have been noticeable improvements. The World Economic Forum ranks Japan 9th overall in its most recent Global Competitiveness Index and 4th in innovation.486 Patent applications by universities and technology-licensing offices increased from 641 in 2001 to 8,527 in 2005, a comparable level to the United States. University-industry joint research projects jumped from less than 1,500 annually in 1995 to more than 10,000 in 2005. Spinoffs from Japanese universities also rose sharply.487 And overall, Japanese patent applications have been increasing in recent years. [See Figure 5.17] Such data suggest that university-industry partnerships have become “important for science-based innovation in Japan,” said Masayuki Kondo of Japan’s National Institute of Science and Technology. “They narrow the gap between Japanese high science and technology potential and low industrial performance to help strengthen the innovation capability of Japanese industry.” However, Mr. Kondo said, Japanese universities bring in only a fraction of the licensing revenues of American universities. Only a handful of Japanese spinoffs so far have gone public.488 Stronger protection of intellectual property rights has improved Japan’s innovation system since the early 1990s. Initially, the Japanese government responded to pressure from the U.S. to strengthen enforcement of violations. The World Trade Organization’s Trade-Related Aspects of Intellectual Property Rights (TRIPs) agreement in 1995 also had a major impact. The government enacted a series of other reforms since then, including the Basic Law on Intellectual Property in 2003 and establishment of the Intellectual Property High Court in 2005, which is modeled after the U.S. Court of Appeals of the Federal Circuit. Criminal sanctions have been raised, and the scope of invention that is patentable has been greatly broadened.489 485 Presentation by Masayuki Kondo of Japan’s National Institute of Science and Technology Policy in 21st Century Innovation Systems for Japan and the United States. 486 World Economic Forum, The Global Competitiveness Report 2011-2012, op. cit. 487 Presentation by Masayuki Kondo, op. cit. 488 Ibid. 489 See presentation by Sadao Nagaoka of Hitotsubashi University in 21st Century Innovation Systems for Japan and the United States.

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316 RISING TO THE CHALLENGE 60,000 50,000 U.S. PCT International Applications 40,000 Japan 30,000 20,000 Germany China 10,000 Korea 0 2006 2007 2008 2009 2010e FIGURE 5.17 Japanese patent applications have been increasing in recent years. SOURCE: WIPO, "International Patent Filings Recover in 2010," February 2, 2011, PR/2011/678. NOTE: 2010 data are estimated. IPR protection in Japan is now widely recognized to be very high. According to Business Software Alliance, Japan has the third-best record of enforcement following the U.S. and New Zealand. Patent-infringement claims have increased sharply. The overall impact on Japanese innovation is more difficult to assess because there are concerns that the IPR system’s complexity and overburdened judiciary may hinder the ability of companies to commercialize technologies efficiently and raise transaction costs.490 Rediscovering Small Companies Small business played a big role during Japan’s post-war economic takeoff. But starting in the 1970s, new company formation began to fall to the point where entrepreneurship was perceived as stagnant, explained Takehiko Yasuda of Japan’s Research Institute of Economy, Trade, and Industry. One reason was that Japanese policy tended to protect small enterprises from large 490 Ibid.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 317 firms, rather than see them as sources of innovation and job creation.491 Policymakers also viewed large corporations as bigger contributors of wage and labor productivity. By the 1990s, however, the government recognized that start- ups were providing major stimulus to the economies of the U.S. and England.492 The government began introducing policies to encourage more start- ups in 1999. It enacted the Small and Medium Enterprise Basic Law to promote their growth. Two years later, the government launched the Start-up Doubling Plan, which set a goal of increasing the number of start-ups from 180,000 in 2001 to 360,000 in five years. Japan removed minimum capital requirements for new limited-liability companies, established the National Startup and Venture Forum to educate entrepreneurs, reformed the bankruptcy code, and launched a start-up loan program through the government-owned National Life Finance Corporation. The loans required no collateral, guarantors, or personal guarantees. In 2008, this unit was folded into the Japan Finance Corporation, whose small- and medium-sized business unit provided ¥20 trillion in support in 2009.493 Japan also established its own Small Business Innovation Research program, modeled after the one run by the U.S. Department of Commerce. The program aims to enhance the ability of small and midsized enterprises to develop technology and innovative products. As with the U.S. SBIR program, Japanese agencies that make research grants set aside a certain portion of their funds for small and midsized enterprises. Removing the minimum capital requirement of ¥10 million for joint- stock companies in 2004 had an immediate impact. Between Feb. 1, 2004, and Jan. 21, 2006, there were 24,639 confirmed applications with 20,211 notification completions. Based on the success of this policy, the Japanese government enacted the Corporate Law in 2005 to remove the minimum capital requirement for establishing firms in general, which is consistent with the U.S. joint-stock corporation policy. Remaining Challenges for Start-Ups One of Japan’s most pressing challenges is to create new companies. A 1997 survey by Japan’s Ministry of Public Management, Home Affairs, Post and Telecommunications found that only one in 50 employed people aspired to become entrepreneurs, a very low level on world standards, and that only half of them were actually preparing to become self-employed.494 The environment has 491 S&T Policies in Six Nations, op. cit. 492 See presentation by Takehiko Yasuda of the Research Institute of Economy, Trade, and Industry in 21st Century Innovation Systems for Japan and the United States. 493 Japan Finance Corporation Web site. 494 Employment Status Survey by the Ministry of Public Management, Home Affairs, Post and Telecommunications, 1997.

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318 RISING TO THE CHALLENGE not improved dramatically since then. Of 59 nations studied by the Global Entrepreneurship Monitor, Japan ranks second to the bottom, behind only Italy, in entrepreneurial activity.495 A lack of capital is a major reason. A survey of start-ups found that 49 percent of Japanese entrepreneurs reported that “procuring funds for entry” is a major problem, well ahead of finding customers and hiring high-quality employees.496 To remedy this problem, the National Life Finance Corporation set up a new program to lend up to ¥10 million to start-ups without requiring collateral, guarantors, or personal guarantees. Between 2002 and 2006, the number of recipients rose from 2,975 to 7,942.497 Some Early Progress Japan’s new innovation system has begun to change the dynamics of the national economy. Patenting and technology transfer from Japan’s top public research institutes have increased sharply. That system is still evolving, however, and inefficiencies remain. America’s National Institutes of Health, for example, coordinates all government-funded biomedical research. In Japan, similar activity is dispersed among many funding agencies that do not share information on researchers, according to a 2006 analysis by Yosuke Oka, Kenta Nakamura, and Akira Tohei.498 Nor are there guiding principles of peer review across agencies. “This could explain why a small number of star scientists receive a large share of research funds from multiple funding agencies,” the authors noted. Government research funding also tends to flow to a handful of top schools. The top 10 universities garner half of research grants in Japan.499 Even though patent filings increased, technology transfer from Japanese research universities was not impressive when measured licensing revenue, according to Dr. Oka, Dr. Nakamura, and Dr. Tohei. Among other things, they attributed the poor performance to rudimentary technology-transfer contract practices and overly restrictive rules on using research funds. University researchers prefer “informal collaborations” to get around red tape. What’s more, despite relaxed rules allowing academics to work in the private sector, most university researchers remain at their jobs rather than circulate 495 Donna J. Kelley, Niels Bosma, Jóse Ernesto Amorós, “Global Entrepreneurship Monitor 2010 Global Report,” Global Entrepreneurship Research Association, 2011, pg. 23. 496 Applied Research Inc., “Survey of Environment for Start-ups,” November 2006. 497 Data cited in Yasuda presentation, op. cit. For an explanation of the National Life Finance Corporation program, see Jun-ichi Abe, “Small Business Finance & Support for Startups in Japan (Case of NLFC),” National Life Finance Corporation, December 2004 (http://www.afdc.org.cn/upload/18/downloads/JUN-ICHI%20ABE.pdf). 498 Yosuke Oka, Kenta Nakamura, and Akira Tohei, “Public-Private Linkage in Biomedical Research in Japan: Lessons of the 1990s,” in 21st Century Innovation Systems for Japan and the United States. 499 Ibid.

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THE NEW GLOBAL COMPETITIVE ENVIRONMENT 319 through industry. Sadao Nagaoka and Kenneth Flamm suggest that Japan still may lack the complementary institutions needed to make U.S.-style industry- university partnerships more effective, such as infrastructure for supporting high-tech startups, availability of risk capital, and professional services.500 A number of reforms have been proposed in Japan to address many of these shortcomings. While it is too early to measure progress, the changes implemented over the past decade in Japan’s innovation ecosystem have provided a much stronger institutional framework for success in the 21st century global knowledge economy. 500 Nagaoka and Flamm, op. cit.

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