1. Innovation, Security & Growth Perspectives from the U. S
Innovation, Security & Growth Perspectives from the U.S. Innovation System Myths, Realities & Opportunities 
Six Countries Programme Workshop
Defense & Security R&D
Brussels, Belgium
November 19, 2004
Charles W. Wessner, Ph.D.
Director, Technology and Innovation
National Research Council
© Charles W. Wessner, PhD

2. The Role of the National Research Council
The NRC Mission is the Advise the Government on Science, Engineering, and Medicine
Studies for federal agencies, Congress, and some self-initiated; 270 Reports Issued Each Year
Nearly 1,300 staff and 10,000 volunteers annually involved in NRC/IOM studies
Budget of some $160 million: 85% from government agencies and 15% private
Great Prestige. High Quality Analysis with Direct Impact on U.S. Policymaking
© Charles W. Wessner, PhD

3. Presentation
Question: Is military R&D a source of Commercial Advantage in the U.S. Innovation System?
Myths and Realities about the U.S. Innovation System
The Limits of Spinoff
The Need for a Broader Technology and Security Policy
A Better Model: The Potential for Innovation Awards in Europe
© Charles W. Wessner, PhD

4. Related Questions for Today (From our Swedish Friends)
How can public investments in security research generate maximum impact on innovation and growth?
How to find forms (or mechanisms) to strengthen the innovation systems?
How to increase the efficiency in public and private procurement of military products?
How to increase innovation by encouraging the participation of small companies?
© Charles W. Wessner, PhD

5. An Overview of the US R&D Portfolio
Dramatic Increases in the US Budget for Defense & Homeland Security R&D

6. R&D in FY 2005 Budget
Federal R&D expected to rise to $132 billion in FY’05, up from $126 in FY’04
Most funding increases over past few years have gone to Defense Weapons development and Homeland Security R&D (including bio-defense)
FY’05 R&D budget continues this trend
All other R&D agencies have seen flat or declining R&D budgets (with modest increases in some programs offset by cuts in others)
© Charles W. Wessner, PhD

7. U.S. Defense R&D is High
© Charles W. Wessner, PhD

8. …But Focus is on Development Is U.S. R&D Leadership Therefore a Myth?
The focus on weapons development and testing overstates the R&D element of the budget.
It is often not basic or even applied research but rather testing and certification.
© Charles W. Wessner, PhD

9. Security Related R&D in Other Agencies
NIH (NIAID) is the lead agency for Bio-Defense
Bio-defense research at NIH to be $1.8Billion in FY2005
Most of money to go for NIH Research Grants
NSF to fund basic research in areas related to Homeland Security
USDA involved in food security & animal health
Each Agency wants its Share of “Security”
Source: AAAS, 2004
© Charles W. Wessner, PhD

10. Post 9-11 Increase in Bio-defense R&D NIH is the Lead Agency in Bio-defense Research DHS Portfolio Heavily Development and Labs Oriented Opportunities for Security Cooperation with Europe
NIH Budget is $1.8 Billion
© Charles W. Wessner, PhD

11. Current Trends are Troubling: President’s Proposed Cuts in the R&D Budget for FY2005
$660M cut from Basic and Applied Research at DoD
$68M cut from DoE Office of Science
$63M cut from Energy Conservation R&D at DoE
$183M cut from Agriculture Research
$24M cut from Transportation Research
Advanced Technology Program to be Ended
Manufacturing Extension Program: Proposed budget down 63% from 2003 level
© Charles W. Wessner, PhD

12. What are the Implications for Europe?
Concern in Europe on impact of increased US Defense and Security R&D budgets on
European Defense and Commercial Industries
European Science Base in Trans-Atlantic Cooperation & Competition
European Policy Aspirations
To help address these concerns, EURAB commissioned PREST to undertake an analysis of the impacts of US Defense R&D spending
Andrew D. James, US Defence R&D Spending: An Analysis of the Impacts, January 2004
© Charles W. Wessner, PhD

13. PREST Report Findings
Defense & Homeland Security missions are driving increases in US Defense R&D budgets
Impact of New Expenditures:
Spin-off products & technologies from Defense R&D is a Reality
Defense R&D Spending Impacts University Science Base and Training of Graduate Scientists & Engineers
Defense R&D Spending Creates New Markets and is a Source of Early-Stage Seed Funding
Leveraging Civilian Technologies (like IT) for Defense & Security Missions Improves International Competitiveness of US Firms
Begins & Ends with the Claim that “synergies between defence and civil research are far ahead of the situation in Europe.”
© Charles W. Wessner, PhD

14. Myths about the U.S. Innovation System
Is Military R&D a Source of Commercial Advantage in the U.S. Innovation System?
Myths about the U.S. Innovation System

15. Central Myth about the U.S. Innovation System
It is a Well-oiled, Centrally Controlled, Innovation Machine
There is a Broad Consensus on How the System Works and what Opportunities and Problems need to be Addressed
“Military R&D is the U.S. Secret Weapon in Competitiveness Wars”
© Charles W. Wessner, PhD

16. The Myth of the Rational Policy Framework
Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation Agenda
Reality: There is no U.S. Ministry of Science
Multiple sources of policy making
Congressional Committees,
Federal Agencies—NSF, NIH, others
State Governments
+ Positive: Multiple sources of experimentation means that the system can be more adaptive; responsive to new challenges
Negative: Lack of coherence can lead to de facto outcomes that can hurt innovation
Example: Post Cold War Falloff in U.S. investments in Science & Engineering Education was not a product of rational U.S. policymaking.
© Charles W. Wessner, PhD

17. The Myth of the Rational Policy Framework
Euro Myth: U.S. Innovation Policy is based on a coherent National Innovation Agenda
Reality: Architect of U.S. Innovation Policy
© Charles W. Wessner, PhD

18. The Myth of Perfect Markets
Strong U.S. Myth: “If it is a good idea, the market will fund it.”
Reality: Potential Investors have less than perfect knowledge, especially about innovative new ideas
“Asymmetric Information” leads to suboptimal investments
This means that it is hard for small firms to obtain funding for new ideas
© Charles W. Wessner, PhD

19. Federally Funded Research Creates New Ideas
The Reality: The Valley of Death
Early-Stage Funding Gap
Capital to Develop Ideas to Innovation
Federally Funded Research Creates New Ideas
Product Development
&
Innovation
No Capital
© Charles W. Wessner, PhD

20. Cash Flow Valley of Death
The Cash Flow Valley of Death
Adapted from: L.M. Murphy & P. L. Edwards, Bridging the Valley of Death—Transitioning from Public to Private Sector Financing, Golden CO: National Renewable Energy Laboratory, May 2003
Technology Creation
Technology Development
Early Commercialization
Successful
Cash Flow
Cash Flow Valley of Death
Moderately Successful
Time
SBIR & ATP
Unsuccessful
Unsuccessful
Federal Agencies, Universities, States, Companies
Typical Primary Investors
Entrepreneur & Seed/Angel Investors
Venture Capitalists
IPO
© Charles W. Wessner, PhD

21. The Myth of U.S.Venture Capital Markets
Myth: “U.S. VC Markets are broad & deep, thus there is no role for government awards”
Reality: Venture Capitalists have
Limited information on new firms
Prone to herding tendencies
Focus on later stages of technology development
Most VC investors seek early exit
Large U.S. Venture Capital Market is Not Focused on Early-Stage Firms
© Charles W. Wessner, PhD

22. The Military R&D Myth

23. The Myth of Military Spin-Offs
Euro Myth: “U.S. Defense Research/Procurement Directly Funds Civilian Technologies”
Reality: “Very few technologies proceeded effortlessly from defense conception to commercial application.”
Secrecy, military specs, and long lead times slow diffusion of new defense technologies
Even efforts to use low-cost civilian technologies for defense use, i.e., “spin-ins,” are often blocked by complicated military procurement system
Beyond Spin-off, John Alic, Lewis Branscomb, et al.
© Charles W. Wessner, PhD

24. Main Role for Military R&D is Defense
U.S. Military Expenditures from 1947 to the end of the Cold War were designed to protect the U.S., its NATO allies, and other countries around the world from Soviet Expansion
Vast sums were deployed to this end
Hot wars were fought in Korea, Vietnam
Proxy wars in Greece, Afghanistan, many parts of Africa
Later interventions in Bosnia, Kosovo, Kuwait were undertaken to secure human rights and international stability
© Charles W. Wessner, PhD

25. Purpose of U.S. Military Expenditure
U.S. Military Expenditures were first and foremost designed to provide the equipment, maintenance and training to provide credible capacity to deliver armed support to U.S. allies
Additional vast sums were (and are) spent on the U.S. nuclear deterrent
The Goal of U.S. military expenditure is Security for the U.S. and its allies and the ability to influence events
U.S. Power Projection is Unique (though constrained)
© Charles W. Wessner, PhD

26. Difference in Scale of Military Expenditure
The United States, for better or for worse, expends over $400B per year (2004) on the military
The UK is next at $40B followed by France at $30B and Germany at $25B (approximate figures)
R&D represents a small portion of these amounts – usually 3% in the U.S.
Commercial benefits are small, given the level of expenditure
© Charles W. Wessner, PhD

27. Difference in Scale of Military R&D
Within NATO, only the Defense budgets of the UK, France, Germany, and Italy exceed the R&D budgets of the U.S. military
All other NATO nations combined invest some $3B in research and technology investment
Why? France, Germany, Italy, Greece, Poland, and Spain spend 60% or more of Defense Budgets on Personnel
U.S. Defense Budget Expenditures:
35% on Personnel
30% on Equipment (including R&D)
© Charles W. Wessner, PhD

28. Positive Impacts of Military Expenditure
Air power: The U.S. has the only significant capabilities in
Strategic Transport
Refueling
Theatre Surveillance, and
Precision Bomber capabilities among NATO nations
Navy Carrier Groups and Submarine Fleets
These capabilities are needed to meet out of area commitments
Advanced attack aircraft on the way: F/A 22, as are advanced unmanned vehicles
But these New dedicated weapons systems have limited foreseeable spin-offs
© Charles W. Wessner, PhD

29. Positive Impacts of Defense Expenditures on Civilian Economy
U.S. military expenditures did result in substantial growth in important sectors of the U.S. economy
World War II saw the growth of the U.S. automotive, shipping, aircraft, electronics, aluminum and steel industries
Cold War expenditures provided support for computers, semiconductors, jet engines, and rockets
Famous case of Boeing 707 derived from bids on Air Force Tanker contracts
© Charles W. Wessner, PhD

30. But these Broader Impacts are Limited
Few Spin-offs: Military R&D often has no civilian application and is inefficient in terms of the economy as a whole
Cases do exist, e.g., cost plus contracts for semiconductors, but the s model no longer applies
Major Spin-offs, e.g., the Internet and GPS have occurred, but they are widely diffused
GPS was for missile targeting (not for tracking kids)
U.S. Expenditures, e.g., Stealth technologies, are often high cost efforts with no foreseeable civilian spin-off
© Charles W. Wessner, PhD

31. The Demise of the Defense-Based R&D Model
The role of the military shifted in the 1970’s and ’80s as a proportion of civilian high-tech markets
Private market for semiconductors grew rapidly, dwarfing U.S. military needs
DoD specifications, secrecy, & long procurement cycles vitiated potential to fund cutting-edge commercial technologies
Commercial IT far outstrips Military Development
Some ground-breaking innovation continues to occur (e.g., the Internet) but applications are pervasive and highly beneficial for new entrants, e.g., Taiwan, India
© Charles W. Wessner, PhD

32. The Productive role of U.S. Military R&D Expenditure is Overstated
Scale: The military sector is now much smaller than during the Cold War and has fewer linkages to the economy
Top 4 Defense firms (Boeing, Lockheed, Northrop, & General Dynamics) have a combined market cap of $102 billion
Intel alone has a market cap of $140 billion
Caveat: Defense sector is Employment Intensive
Defense firms: 477,200 employees
Intel: 80,500 employees
(All data as of 11 August 04)
© Charles W. Wessner, PhD

33. Military R&D Allocations Sap Funds from more Productive Uses
Are increases in US Defense R&D spending the most efficient approach to stimulating commercial activity?
Is the US investing in the right kinds of R&D to enhance economic competitiveness?
Concentration of R&D Funds on Small numbers of Engineers Working on Military applications is Inefficient
Reduces R&D Funding for Other Sectors of the Economy
© Charles W. Wessner, PhD

34. Belief in Military Based R&D Model Undercut by Practice
Much discussion of the Military R&D Model in the 1980s & Resulting U.S. Commercial Advantage
The fact that there was virtually no increase in Defense Expenditures among NATO allies Undercuts the Conviction of the Argument
The ’80s did see an increase in targeted commercial technologies
© Charles W. Wessner, PhD

35. U.S. Military R&D: An Appropriate Model?
U.S. Military R&D is
Inefficient
Overcommitted
Later-Stage
Development Focus on Testing & Certification
Occasionally has Major Impact
GPS
Internet
Often Widely Shared with Others
© Charles W. Wessner, PhD

36. Myths and Limitations of Spin-off
© Charles W. Wessner, PhD

37. Spin-Off as a Non-Targeted Economic Benefit
Why do U.S. policymakers like spin-off as a concept?
Because spin-off appears to cost nothing (assuming the defense expenditure is useful)
Spin-offs help justify high defense expenditures
Spin-off appears to need no government management or targeting, thus eliminating any interference in the marketplace
Is this true in practice?
© Charles W. Wessner, PhD

38. The Limits of Spin-Off
The substantial separation of the defense and commercial sectors of U.S. industry limits opportunities and raises costs
Adaptation of defense innovation to commercial use is not cost free
Focus on defense means technologies with high commercial potential are ignored
DARPA focus in on Long-term and Military Applications, not Civilian Uses
© Charles W. Wessner, PhD

39. The Limits of Spin-Off Compared to what?
The efficiency of investments resulting in spin-offs to meet commercial technology needs must be compared to alternatives
Comparable private sector R&D vs.. government defense R&D?
No research at all – yes, spin-off compares favorably to not doing R&D at all
© Charles W. Wessner, PhD

40. The Limits of Spin-Off Compared to alternative institutions
R&D at other federal agencies
Federally-funded civilian technology initiatives, e.g. , the ATP at NIST
Basic Research Support at NSF or NIH
These comparisons are hard to make and therefore rarely made
Claims for spin-off benefits tend to be comparison free – policies focused on military R&D should be grounded in the present, not just focused on isolated success cases from 40 or 50 years ago
© Charles W. Wessner, PhD

41. Spin-Off: A Success Story
Direct product conversion of a product developed at government expense is rare but does occur
A good case is Raytheon’s microwave oven – a classic sequential spin-off within a single firm
The conditions for success included:
A complete redesign of the magnetron microwave power source for ease of manufacture
A five-fold reduction in magnetron cost through learning and scale
Development of a patented safety seal to prevent the escape of microwave radiation
Corporate acquisition of the distribution channel
© Charles W. Wessner, PhD

42. Spin-Off: 2 Failures & 1 Success
C-5 Military Transport Aircraft Competition led to Lockheed’s victory with:
Contracts for the C-5 military transport
Concurrent development of the L-1011 commercial transport
Lockheed never made a profit on the L-1011 & later withdrew from commercial air transport
Boeing lost the competition for the C-5 with the federal support that entailed
© Charles W. Wessner, PhD

43. Spin-Off: 2 Failures & 1 Success
Having lost the C-5 competition, Boeing then “bet the company” on the 747
C-5 design work aided development of the 747
Timing helped: The OPEC embargo ran up aviation fuel prices, thereby helping the more fuel efficient 747 gain market share
The focus on the commercial market helped Boeing
Lockheed and McDonnell-Douglas had major military business – both failed in civilian aircraft production
Conclusion: Military support works???
© Charles W. Wessner, PhD

44. Some Civil-Military Cooperation Leads to Positive “Spin-offs”
Concurrent Development of Civil & Military Applications of a Common Technology
Nuclear reactors for submarine propulsion and then electric power production set dominant points of the technology in the United States
GE and Pratt/Whitney design and build jet engines for related families of civilian and military aircraft
KC135 Stratotanker & Boeing 707 had a common origin but very different design features (375 flight hours per year vs for the 707
Development of Engineering Techniques & Tools to Meet Government Needs
E.g., Software for computer based design and analysis from NASA sponsored research
© Charles W. Wessner, PhD

45. Various Forms of Civil-Military Cooperation leading to “Spin-offs”
Dual-Use Technology Developed from Defense Agency Research Support
Defense support for University research (e.g., Artificial Intelligence) that may be valuable to civilian industry
Reverse Spin-off or ‘Spin-on’ to Military is increasingly common
E.g., CMOS semiconductor chip technology was perfected in Japan for use in electronic wristwatches
© Charles W. Wessner, PhD

46. What Could More European Military R&D Accomplish?
More European Military R&D Could
Enhance some European Military Capabilities
From a few large firms?
Encourage Rationalization
Is this good for all countries, e.g., Sweden and France?
Stimulate Dual-Use, High Technology
But is this likely?
© Charles W. Wessner, PhD

47. Policy Issue: Allowable vs.. Effective
Is the push for European Defense R&D like the Push for R&D Tax Credits?
Tax Credits are Expensive and Blunt, but they are Allowed by State Aid Rules, so…
Military R&D may be Ineffective for New Technology, but it is Exempt from State Aid Rules, so…
Is it a case of Efficiency vs.. the Rules
Would it be better to change the Rules?
© Charles W. Wessner, PhD

48. The U.S. Critique: “Spinoff cannot serve as a realistic basis for technology policy” --Alic, Branscomb, et al (1992)
Defense R&D does not cover gaps in nation’s technology policies
Defense contributions are growing smaller & more specialized
Many industries benefit little from Defense R&D
Spin-offs offer only indirect, inadvertent contributions
Focus on spin-offs denies more direct role for government in technology policy
© Charles W. Wessner, PhD

49. Is a French-style Model Right for Europe?
Large State selected & supported projects, insulated from rapidly changing market forces by National Procurement -- National Champion Based
Nuclear Energy
Aerospace
Airbus, Ariane and ESA Program
Large Scale Transportation--TGV Trains
Water and Electricity Champions
A Strategy Not well suited for rapidly changing technologies and markets, e.g., semiconductors & computers
Is Spinoff Really the Current U.S. Model?
Is it Effective? Compared to What?
© Charles W. Wessner, PhD

50. A Better Model:
Public Private Partnerships offer more Potential for Innovation in Europe

51. Important to Consider Alternatives to Military R&D: Public-Private Partnerships
Need to focus on other policies that could more effectively support nation’s Commercial Sector, such as Public-Private Partnerships
Public-Private Partnerships focus on the hurdles between basic research & product development
Need to adopt policies to bridge traditional government roles and traditional private sector roles
© Charles W. Wessner, PhD

52. A Program “Like an SBIR” May Offer Europe Higher Returns than “More R&D”
No New Funds Required for SBIR
Capitalizes on Existing R&D Investments and Procurement Funds
Focus on Valley of Death—Key Point of Vulnerability for Firms and Products
National Program to Meet National Needs with National Firms
Bottom-up Approach to Security
Contributes to Innovative Solutions as well as Growth and Job Creation
© Charles W. Wessner, PhD

53. The Small Business Innovation Research (SBIR) Program
Created in 1982, Renewed in 1992 & 2001
Participation by all federal agencies with an annual extramural R&D budget of greater than $100 million is mandatory
Agencies must set aside 2.5% of their R&D budgets for small business awards
To be a $2 billion per year program in 2004
Largest U.S. Partnership Program
© Charles W. Wessner, PhD

54. The SBIR Model PHASE III Product PHASE II PHASE I Development Research
Social
and
Government Needs
Private Sector
Investment
PHASE III
Product
Development
for Gov’t or
Commercial
Market
PHASE I
Feasibility
Research
PHASE II
Research
towards
Prototype
R&D Investment
$100K
$750K
Tax Revenue
Federal Investment
© Charles W. Wessner, PhD

55. SBIR is a Bridge in the Innovation System
Provides a Bridge between Small Companies and the Agencies, especially for Procurement
Provides a Bridge between Universities and the Marketplace
Encourages Local and Regional Growth, increasingly through the University connection
Creates jobs and justifies R&D investments to the general public
© Charles W. Wessner, PhD

56. The Key Question: Would SBIR Work in Europe?
Some Believe it Would:
“SBIR is one of the few American Technology Programmes that can be
‘Cut and Pasted’ into European Innovation Systems”
Participant at Commission Workshop, Brussels, June 2004
EURAB has Recommended an “SBIR type” Program
© Charles W. Wessner, PhD

57. Competitive Awards to Support SME Innovation are Needed
SBIR is a Powerful Model
U.S. National Academy of Sciences research shows model is flexible and effective
Recent National Initiatives & Proposal by the Commission to Permit SBIR-Type Proposals
Investing in research: an action plan for Europe, [COM(2003) 226 final/2 – See Section 5.3, p. 19]
TEKES has adopted a Phase I approach
VINNOVA is initiating an SBIR Program
France is exploring an SBIR-type program
© Charles W. Wessner, PhD

58. An Innovation Systems Perspective on Security
National Security is founded on a Robust Innovation System
Need to Address Linkages among many Facets of the Innovation System
Universities, Businesses, Government
A Robust Innovation System will help make the Nation Militarily and Economically Secure
Robust Defense Spending alone will not make the Nation more Innovative, thus, ultimately Less Secure
Lesson of the Cold War
© Charles W. Wessner, PhD

59. The Transatlantic Cooperation Option
The U.S. is devoting Substantial Funds to New Technologies to Meet the Terrorist Security Threat
U.S. Capacity constraints are real
Research cooperation is historically broad and rich
Procurement is increasingly open, and the U.S. market is large
© Charles W. Wessner, PhD

60. Conclusion
© Charles W. Wessner, PhD

61. Spinoff is a Popular Concept but an Inefficient Policy at Best
Spinoff has never been a consistently effective approach to enriching commercial technology
At best it is a weak and expensive substitute for more direct support of the commercial technology base
Alic, Branscomb, et al.
© Charles W. Wessner, PhD

62. Benefits of the SBIR & ATP Model for Defense and Security
Small Business can bring New Ideas and New Products to address Security Needs
SBIR provides a Proven Pathway for Small Businesses to Help the Government Meet Defense and Security Needs
SBIR represents a Low-Cost, High-Leverage Opportunity for National Policymakers to Meet Multiple Goals at Constant Cost—No New Funds
SBIR & ATP address the key Issues of Firm Formation, Entrepreneurship, Employment, and Growth and is therefore of Central Policy Interest
© Charles W. Wessner, PhD

63. Designing More Realistic Policies for European Innovation
To Lead in the Knowledge Economy
Understand innovation ecosystem
How can innovation in commercial and defense sectors draw on & support each other?
Provide Incentives rather than Targets selected by Consensus
© Charles W. Wessner, PhD

64. A Modified European Innovation Strategy
Create New Public Private Partnerships
Involve Large & Small Firms
Encourage National Experimentation
Involve Universities in Innovation
Focus on 3 Interrelated Elements:
Platform Technologies:
Respect Political Commitment
Competitive Awards to Large & Small Firm Joint Ventures [The Advanced Technology Program (or ATP) Model]
Competitive Awards to SMEs & Start-ups (SBIR Type Program)
© Charles W. Wessner, PhD

65. Keeping Europe Secure Partnerships are one way to do this
Keeping Europe Secure requires,
Economic growth to safeguard the Social Compact
New Technologies to provide Cheaper and Better Social Services, Health Care, Environmental Protection, and National Defense
Partnerships are one way to do this
SBIR Breaks Through the Oligopoly Supply Base for government agencies
Provides new technologies and new solutions
© Charles W. Wessner, PhD

66. Common Challenges
Learning from Each Other is a Key to Better Innovation Policy
Learning from failures (and distortions) can be as valuable as learning best practice
Sorting Myths from Reality is a First Step Towards More Growth and More Security
© Charles W. Wessner, PhD

67. Thank You Charles W. Wessner, Ph.D.
Director, Technology and Innovation
The National Academies
500 Fifth Street NW
Washington, D.C
Tel:
© Charles W. Wessner, PhD