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A new mechanism to fund R&D.

For decades, the U.S. government has done an outstanding job of supporting basic scientific research. Thanks to federal funding, Americans have learned a great deal about everything from their place in the cosmos to the composition of their genes. This knowledge is of great social value.

However, if left alone, basic research is of little commercial value. Although the government has succeeded in developing technologies for our nation's defense--with some spillover into the commercial sector--it has never seen fit to help industry more fully capitalize on the fruits of the nation's investment in research and development.

Today, in a world in which a firm's ability to innovate is often the key to economic success, a consensus is emerging that the federal government must do more to promote innovative activities that go beyond basic scientific inquiry. Many economic, government, and industry experts now agree that if we are to increase productivity, spur economic growth, and create jobs, we must give industry help in transforming scientific understanding into something more usable.

Experts also agree that the focus of new investment should be on the intermediate phase of the research process called "precommercial R&D"--the conversion of basic research into generic technologies, which in turn can be used to create specific products. The classic example is the conversion of physics research into semiconductors, which are used to build computers.

The rationale for making these investments is analogous to the sound economic one traditionally used for supporting basic research. Because of the great uncertainties and risks involved in trying to turn generic technologies into products, private firms tend to invest well below what is socially optimal. As a result of this market failure, the government has a responsibility to invest in projects aimed at promoting more, and more rapid, product commercialization.

Support for precommercial R&D was boosted during the presidential campaign, when Bill Clinton called for a federally funded R&D program that would invest in civilian technology. The difficult question, however, and one that must be faced early in the Clinton administration, centers on the type of organization that is best suited to carrying out this program.

Many technology-policy specialists have argued for the creation of a new executive-branch department. But the plain truth is that the formation of any such organization will be driven by lobbyists for dying industries and congressional pork vendors and will be subject to party politics. Others have advocated the formation of more consortia modeled on Sematech, the semiconductor research group in Austin, Texas, but these, too, often owe their existence more to lobbying power than to national consensus on their importance. Though we may have obtained some marketable results from consortia, the process by which they were formed is not a model upon which future R&D decisions should be based.

What is needed is an organization that will help industry identify research that could potentially be commercialized and then provide financial support. It must be able to make decisions free from power politics and insulated from narrow self-interest--whether congressional, executive branch, or corporate. Accomplishing these goals would be best served by the creation of a unique new federally funded, quasi-public entity--the Civilian Technology Corporation.

Guidelines for success

The first step in determining how to bolster precommercial R&D is to establish the principles that will guide the policy for public investment in R&D. Strict guidelines can help protect against government manipulation of private markets. Markets free of bureaucratic micromanagement and driven by industrial efficiency are fundamental to U.S. economic strength. The market system should remain the cornerstone of our economic efficiency, even as pressure builds to shelter industries from global competition. By remaining independent, industry increases the likelihood of its success in conducting risky and technologically complex R&D projects.

There are six guidelines that, together, should keep U.S. industry free from government intervention, yet still enable federal funding of precompetitive R&D.

Cost-sharing between government and industry. Direct government subsidies or grants to private firms for R&D or technology development can redirect scarce resources, both financial and human, into unproductive channels. To ensure that precommercial R&D funded by the government is relevant, private-sector firms or institutions should share 50 percent of total program costs.

Cost sharing provides incentives necessary for the efficient allocation of federal and private resources. It ensures that projects match, as closely as possible, commercially relevant R&D because companies will not risk capital unless they believe that there is at least a reasonable chance for commercial payoff. Most of the past federal R&D programs that lacked cost sharing failed to meet R&D objectives. This was readily apparent in the Department of Energy's plans to develop alternative energy demonstration projects during the late 1970s.

Several federal R&D programs, notably the Commerce Department's Advanced Technology Program and the Small Business Innovation Research program, now include cost-sharing provisions. The extent to which these programs have been successful is due largely to the requirement that corporations share R&D costs.

A legitimate public concern is whether cost sharing merely subsidizes industry's lower-priority technology development projects. The risk can be minimized by careful review of potential projects and by choosing only those that industry is seriously committed to carrying forward. Moreover, because we are clearly underinvesting in R&D at the national level, we must assume this risk if we hope to stimulate economic growth.

Industry involvement in project initiation and design. The long-term objective of extending the government's financial commitment to precommercial R&D is to enhance U.S. productivity and raise living standards. To do this, R&D support should be closely linked to commercial markets and should be concentrated in areas with potentially wide industrial applications. Collaborative R&D ventures funded through government/industry partnerships should be proposed and structured by industry so that market signals, not federal government officials, determine R&D objectives.

Diversification of investments. A broad portfolio of investments in technical fields, including the medical sciences, biotechnology, materials science, manufacturing and process technologies, and computer and telecommunications technologies, should help ensure that a stronger government role in precommercial R&D does not become captive to the interests of a particular technology champion or a set of companies.

Projects should be open to foreign firms that make a substantial contribution to U.S. gross domestic product. Barriers to foreign participation in U.S. government-funded cooperative R&D projects are increasingly viewed as a way to protect national interests. Foreign participation is now restricted in collaborative R&D projects sponsored by Commerce's Advanced Technology Program, the National Center for Manufacturing Sciences, and Sematech, for example. In most instances, a U.S. firm is defined as one under the control of U.S. citizens or incorporated in the United States. In a few cases, such as the Advanced Technology Program, foreign firms may participate in a project if their involvement would enhance U.S. competitiveness over the long term more than if foreign firms were excluded.

In a global economy, goods and services move rapidly across national boundaries. Government should encourage the flow of the most up-to-date technologies and production capabilities so that they can benefit U.S. industrial performance. Many of the foreign-owned corporations located in this country also provide training that improves the quality of the U.S. work force, and they contribute directly to U.S. economic growth and standards of living.

Restrictions on foreign participation in government technology programs can damage U.S. economic interests. They isolate the economy from scientific and technological advances made in other industrialized nations. Drawing on progress made by Japanese firms in ceramics and semiconductor manufacturing technologies, for example, can benefit U.S. firms and the nation's technological strength.

Moreover, many competitive U.S. companies have extensive R&D and manufacturing agreements with foreign concerns. They are an important part of a company's competitive strategy. Cooperation in R&D often reduces innovation costs and time-to-market for products and allows monitoring of advances overseas.

Insulation from political concerns. The selection of a precommercial venture should be based on its technical and economic merit. Evaluations of competing R&D proposals that might be sponsored under an expanded federal program should be conducted by independent experts in the relevant scientific, technological, and economic areas. Political considerations should not influence technical output, the location of R&D facilities, or the management of research projects.

Pressure from special-interest groups results in less-than-optimal outcomes in federal R&D decisions. In The Technology Pork Barrel, Linda Cohen and Roger Noll detail the rich history of federal policy mistakes that result when federal R&D becomes captive to special interests. It is simply too easy for funding or site selection to be targeted to local political constituents, regional interests, or agency bureaucracies. Support based on political considerations leads to wasteful, open-ended subsidies of inefficient, uncompetitive firms and industries.

Political pressure has driven much of the decision-making process in the limited government-funded, precommercial programs that exist today. Though they have merit, Sematech and the National Center for Manufacturing Sciences, for example, were established as much in response to special-interest pleading by industry as they were by an objective analysis of the potential benefit to the

national welfare. An "industry-led" approach to technology policy should not include allowing an industry to control subsidies to its firms or to influence specific government decisions on R&D investments. Technology policy should not be allowed to serve as another refuge for firms and industries that seek special treatment under the cloak of work deemed "strategic" to national competitiveness.

A rigorous project-evaluation mechanism. Detailed technical and economic evaluations are essential to any technology program, especially in precommercial R&D. An independent evaluation should be undertaken by qualified experts, including those with technical, managerial, and economic expertise. Review procedures in prior government programs have been compromised because they take the form of annual reports to Congress or the executive branch, which are often conducted by mission-agency employees with a direct interest in having these projects continue. Technical evaluations of precommercial R&D work and the potential contribution it can make to national economic welfare should be conducted by nongovernmental groups with no role in program management or funding decisions.

The same approach should apply to terminating projects. Funding should be cut off when the objectives of a joint R&D venture are reached as well as when results of a project are unsatisfactory. Federal agency officials and Congress should, as a matter of policy, follow recommendations by review panels to terminate a project.

Principles into practice

With these principles as guides, the report in which we participated proposed a significantly different type of organization to fund precommercial R&D--the Civilian Technology Corporation. The CTC would be a quasi-public corporation, probably located in Washington, D.C., that would be established with a one-time congressional appropriation. A board of directors, comprised of private economists, scientists, and engineers with no ties to government, would manage the CTC. Directors would be nominated by the president and confirmed by the Senate. They would then hire a staff.

Recognizing that private citizens have political leanings, the board might consist of, say, seven people, four from one party and three from the other. The chairmanship would rotate, and when a board member left, the president would nominate a replacement from the opposite party, thereby alternating party control. This is how the International Trade Commission is set up.

It would be up to individual companies, corporate partners, or private consortia, including universities and federal labs, to propose projects to the CTC, which would not initiate any work. The board would then convene an advisory panel of private economists, scientists, and engineers to judge whether proposals are focused on precommercial R&D, whether they would help the company commercialize research, and whether they would have a significant impact on the U.S. economy and competitiveness. If the panel deemed a proposal worthy, the board would then decide on the level of funding and the percentage that the company would be required to provide. Generally, the company would have to pay for at least half the project costs. The CTC could then make a grant or provide a loan or loan guarantee for the project.

The R&D work would be conducted completely by the company or consortium. The CTC would provide no personnel, would maintain no facilities, and would not manage the project. It would, however, monitor the work. If the project led to the development of a product or service, the CTC would receive income from royalties, license fees, or from taking an equity position, most likely in the form of stock warrants. (The government profited from warrants it received in the Chrysler bailout.)

A reasonable level of funding for the CTC would be a one-time appropriation of $5 billion. This is the amount of seed money we believe necessary to make a significant impact in bolstering the U.S. economy by developing technology through precompetitive R&D. During the presidential campaign, senior advisors to Bill Clinton alluded to the same figure. The money would cover all startup costs and overhead for 10 years and would provide for project funding, aided by royalties and other income later in the CTC's lifetime. Since most companies would be required to contribute a minimum of 50 percent to projects, the CTC could bring to bear $10 billion over 10 years.

It is important that the CTC be designed to sustain itself through royalties and other income mentioned above. If the CTC were a government agency, it would be subject to annual appropriations, making it captive to the political process. This dependence contributed to the failure of the Synfuels Corporation, a quasi-public entity in energy R&D started by President Carter. Congress determined the specific types of projects Synfuels could pursue and effectively micromanaged it into impotence. The CTC would be free of this degree of political control.

However, the CTC would have to be evaluated. Its performance and operation would be reviewed by independent nongovernment panels after its fourth and tenth years of existence. Thus, though outside the government, the CTC would be subject to direct reporting requirements.

Benefits of a quasi-public approach

The advantages of a quasi-public approach to federal R&D financing become apparent when one considers how it would differ from the popular alternatives, such as a civilian counterpart to the Department of Defense's Defense Advanced Research Projects Agency. A highly skilled, motivated, and flexible staff is essential to the success of any organization. The CTC would not be subject to complex, burdensome civil-service rules and legislated postemployment restrictions. Operating as an independent corporation, it could attract a broad range of first-class scientists, engineers, business managers, and academics by offering compensation packages competitive with those in the private sector.

The CTC would also be free of cumbersome, litigation-prone government procurement regulations. It could make direct loans and grants and even take an ownership stake in cooperative ventures, which is difficult or impossible for government agencies under current federal guidelines.

Financing precommercial R&D through a CTC would also be a more focused and efficient method of stimulating investment than a tax credit or a permanent research and experimentation (R&E) credit. Although certainly beneficial, these incentives are limited in scope. They are subject to precise eligibility criteria, which often precludes the participation of small and mid-sized firms. Furthermore, tax incentives are available only to firms that perform R&D. In theory, the CTC would encourage firms with limited resources or those just beginning R&D work to accelerate their R&D efforts.

Another deficiency inherent in tax measures is that they have an extremely limited impact on technology adoption rates. A company can take a credit simply for conducting R&D. There are no incentives to see research through to product development and no federal oversight is involved in determining whether the R&D work is actually carried out. In a CTC project, the company would be required to do everything possible to commercialize its research, with the CTC providing both incentives and oversight.

Finally, neither the use of tax credits nor dependency on a government agency to promote R&D does much to leverage market pull, a crucial element in the innovation process at the precommercial stage. Research will most directly respond to market needs if proposals come from companies and the companies share the costs. The CTC offers the best chance to forge close links between the performer of R&D and potential customers in commercial markets.

Admittedly, there are drawbacks to a quasi-public approach. No matter how isolated the CTC might be at its beginning, it (or any similar new organization) would face pressure to fund projects favored by Congress, the executive branch, and special-interest lobbies. The pressure will be eased, however, if Congress and the executive branch are involved in selecting the CTC board, if there is no need for annual Congressional appropriations, and if program evaluation is performed on a regular basis by independent experts. A scientific and business peer-review system for evaluating proposals would help preserve the goal of funding projects with high rates of return and would help protect against subsidization of politically powerful industries.

Another potential disadvantage of the CTC is the uncertainty in investment decisions when there is no clear market signal that a payback on R&D is likely. The type of investments the CTC would make are, by definition, high-risk ventures. The success or failure of the CTC's portfolio would depend, to a great extent, on the wisdom and judgment of its board of directors and staff. An associated danger is that the CTC might unknowingly fund work that duplicates efforts already under way within the government. To prevent overlap, key federal agency officials could be made ex-officio members of CTC's board. The CTC would consult regularly with federal officials such as the director of the Office of Management and Budget, the secretary of commerce, and the White House science advisor.

A key issue would be how to judge success or failure of projects in CTC's investment portfolio. Lack of a large number of commercial products resulting from CTC-funded ventures would not necessarily indicate failure. CTC-funded projects might well speed the rate of technology adoption, advance the technological frontier in industry, and help private firms carry projects to the stage where venture capital is available. These are just a few of the R&D payoffs not captured in cost/benefit calculations and other assessments that recognize success only in terms of commercial payback.

Moreover, the CTC should not be required to achieve a high average rate of return on its investments. A zero or slightly positive net rate of return would decrease or even eliminate the need for more money from Congress.

Any attempt to set goals for investment returns could potentially create an atmosphere in which CTC's board and staff are encouraged to fund projects close to the commercialization stage, rather than pre-commercial R&D with broad national benefit. However, because companies will be the project initiators, we can count on them to keep projects that have clear commercial payoffs to themselves. Companies would have no incentive to take on CTC as a partner since CTC would dilute the company's profit margins on the technology. Anecdotal evidence to date on the motivations driving corporate participation in Commerce's Advanced Technology Program support this conclusion.

A rate of return on investment of 15 to 20 percent on CTC-funded projects obviously would signal that the projects should have been undertaken exclusively by the private sector. Likewise, if there are no failures in the CTC portfolio, one would conclude that the R&D ventures should have been funded entirely by industry. Oversight procedures, such as making the CTC board subject to testimony at congressional hearings or audits by the General Accounting Office would serve as additional mechanisms to ensure accountability.

Other challenges would confront the CTC. One is the need to establish strict guidelines on what technology areas actually constitute precommercial R&D for a wide range of industry applications. In theory, the CTC board might draw on the expertise of outside experts through advisory councils, either established now or created specifically for this purpose. The CTC would need to carefully consider a broad, industrywide list of precommercial technologies on which to focus its investment funds.

Strong support exists on Capitol Hill to establish a mechanism to fund technology investments. At the end of the last session, Representative George Sangmeister (D-Ill.) introduced legislation to create a version of a Civilian Technology Corporation. Senator Ernest Hollings (D-S.C.) introduced a more comprehensive bill, which would create the corporation we have proposed. He plans to reintroduce the legislation early this year. In addition, Representative George Brown (D-Calif.), chairman of the House Science, Space, and Technology Committee, plans to introduce a House bill that is similar to the Hollings legislation.

Regardless of its final configuration, a new mechanism is needed to help move the country in a direction that leverages our technological and intellectual strengths. Clearly, guidelines can be drawn that can protect against political direction of industrial activity, while at the same time serve to stimulate long-term economic growth. Most important, perhaps, there is a sound economic rationale for extending the federal role in civilian technology. We should move quickly to recognize and act on that rationale.

Recommended reading

Linda R. Cohen and Roger G. Noll, The Technology Pork Barrel. Washington, D.C.: The Brookings Institution, 1991.

Michael L. Katz and Janusz A. Ordover, "R&D Cooperation and Competition" in Brookings Papers on Economic Activity, Martin Neil Baily and Clifford Winston, eds. Washington, D.C.: The Brookings Institution, 1990.

D.C. Mowery and N. Rosenberg, Technology and the Pursuit of Economic Growth. New York: Cambridge University Press, 1989.

J.S. Wilson, The Contribution of Infrastructure, Human and Physical Capital, and R&D Investments to Productivity Growth. Paper prepared for the Science, Technology, and Economic Policy Board, National Research Council, Washington, D.C. 1991.

Harold Brown, a counselor at the Center for Strategic and International Studies in Washington, D.C., chaired the Panel on the Government Role in Civilian Technology of the Committee on Science, Engineering, and Public Policy, National Academy of Sciences, National Academy of Engineering, and Institute of Medicine. John Wilson, a senior staff officer at the National Research Council, was the panel's project director.
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Title Annotation:research and development
Author:Brown, Harold; Wilson, John
Publication:Issues in Science and Technology
Date:Dec 22, 1992
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