The New American System

Main St. Agenda by from National Affairs, March 24, 2014

Below is an abridged version of Jim Manzi’s piece from the Spring 2014 issue of National Affairs. For the full version click here.

Thirty years ago, during the 1984 Super Bowl, Apple presented what has become widely cited as the greatest television commercial in history. The ad was titled “1984” and began with gray imagery of crowds marching in unison to stare at a huge screen where a Big Brother figure gives a speech. A woman in bright colors runs through the crowd, chased by riot police, and smashes the screen with a huge hammer. Only then does the Apple logo appear with the announcement of the original Mac.

I was watching the Super Bowl that year on a primitive large-screen TV with dozens of other students in the dining hall of my dorm at the Massachusetts Institute of Technology. Many of us at the time saw ourselves as trying to survive in the wreckage of an American economy that seemed to have lost is ability to innovate.

There is much talk in Washington now about the need for a new era of American innovation to help us break out of an economic rut. But there is far less understanding of what might be required to revive our economic prospects.

By 1820, the United States had achieved a level of GDP per capita roughly equal to that of Western Europe. By 1900, it had achieved a decisive global advantage compared to all potential strategic rivals. And though Europeans certainly live very well in 2014, the United States remains indisputably ahead.

How has America achieved and sustained these great gains in living standards? Because there are only 24 hours in a day, there are really only two ways to increase labor productivity. The first is to increase our use of other inputs like land or equipment. The second is to invent and implement new ideas for getting more output from a given set of inputs—that is, to innovate. The root of American economic success hasn’t been luck, or land, or conquest; it has been innovation.

The nation’s approach to achieving innovation has varied with the times, but it has generally demonstrated an almost ruthless pragmatism in implementing the core principles of free markets and strong property rights, overlaid with decisive government investments in infrastructure, human capital, and new technologies.

Highly distributed trial-and-error learning motivated by enlightened self-interest has always been the key driver of innovation. The government’s role is mostly that of an armed referee rather than a participant in the economy. In this sense, America’s underlying innovation policy has been “no policy.”

But significant government overlays have always existed to reinforce our free economy. Indeed, the federal government has been active in shaping specific kinds of innovation since the first months of the republic, when Alexander Hamilton published his epochal 1791 Report on Manufactures, which proposed subsidies and protections for developing manufacturing industries. (Broadly speaking, the subsidies weren’t implemented but the tariffs were, and they increased as political constituencies grew up around them.) The West Point military academy was founded in 1802 in large part to develop a domestic engineering capability, and armory expenditures stimulated the growth of an indigenous manufacturing capability. Other significant investments in infrastructure included financing, rights of way, and other support to build first canals and then railroads. In 1843, Congress allocated the money to build a revolutionary telegraph line from Washington, D.C., to Baltimore that pioneered many of the important innovations—such as suspended wires—that would come to be used to build out the national telegraph network and later the telephone network. Henry Clay called this program of tariffs and physical infrastructure—along with national banking—“The American System.”

From roughly 1870 to 1970, the goals of conquering disease, educating the unschooled, and winning wars provided the strongest impetus for government investments in innovation. What’s more, in the Cold War era, America exhibited a faith in large institutions that was unmatched in our country before and has not been seen since. The big-institution approach was an incredibly successful program for innovation that created the conditions for the growth of the information economy, as well as much of the aerospace and biomedical industries and related fields. But it also planted the seeds of its own obsolescence (or at least a drastically reduced relevance). Innovation in the new economy looks quite different, a fact that America is still struggling to understand.

I stumbled into a career at the heart of technology innovation just as this transition was occurring, when I joined the data-networks division of AT&T’s Bell Labs in 1985. Data networks were basically combinations of devices called modems that allowed computers to send and receive data over regular phone lines. It was one little corner of the information revolution, but its transformation illustrates some very broad trends, and ultimately led me to participate in the invention of what has become known as “cloud computing.”

In 1999, two friends and I started what has now become a global software company. We began developing software and soon confronted the practical challenge of actually delivering the software to a customer for use. Installing large-scale software for a major corporation was complicated, expensive, and labor-intensive. When we delivered a software prototype to one early customer, that customer didn’t have IT people to install it, so we allowed the company temporary access to the software via the internet—that is, they could simply access it much as they would any website.

Our customer eventually floated the idea of continuing to use our software via the internet while paying us “rent” for it. We were running low on money and had few options. We theorized that eliminating the installation step could radically reduce costs, particularly if we designed our whole company around this business model rather than how traditional software companies were organized. We experimented with this approach, eventually we made it work, and committed to it. But this decision was highly contingent: It was the product of chance, necessity, and experimentation.

Indeed, the innovations that have driven the greatest economic value have not come from thinking through a chain of logic in a conference room, or simply “listening to our customers,” or taking guidance from analysts far removed from the problem. America’s most successful innovations have come almost without exception from iterative collaboration with our customers to find new solutions to difficult problems that have come up during the course of business. At the creative frontier of the economy, and at the moment of innovation, insight is inseparable from action.

More generally, innovation in our time involves producers and providers trying different approaches with relatively few limits on their freedom to experiment and consumers choosing freely among them in search of the best value. And it requires that we allow people to do things that might seem stupid to most informed observers. But we must not prop up failed experiments, nor unduly restrict huge rewards for success.

The institutional arrangements that have served to enable such innovation consistently exhibit a four-part structure: (1) innovative entrepreneurial companies, (2) financed by independent investment firms, (3) competing and cooperating with established industry leaders, and (4) all supported by long-term government investments in infrastructure and R&D.

Perhaps the most important recent example of unexpected innovation following this approach has involved the extraordinarily quick and unexpected transformation of our energy economy — a transformation that has run directly contrary to what had long been the government-led strategic approach to energy innovation.

In 2008, the International Energy Agency reflected widespread conventional wisdom when it projected that U.S. oil and natural-gas production would remain flat or decline somewhat through about 2030, therefore necessitating ever-growing imports. In the last few years, however, a technological revolution has transformed this situation with breathtaking speed. The most important technology has been hydraulic fracturing, often called “fracking,” but other important developments have included tight-oil extraction, horizontal drilling, and other new applications of information technology. The current IEA prediction is that America will be the world’s largest oil producer within five years and that, by 2030, North America will be a net oil exporter.

The benefits of this change are enormous. Geopolitically, we will no longer have to negotiate under duress with entities in the Middle East, Africa, and elsewhere. Environmentally, these new technologies have yielded a net shift from coal to gas. Economically, about half of America’s merchandise trade deficit in recent years has been in petroleum, so the energy revolution will materially reduce our chronic trade deficit.

America has led this technological revolution, and the primary driver of U.S. success has been the regulatory framework of strong property rights and free pricing. Among the world’s key petroleum-producing countries, only the United States allows private entities to control large-scale oil and gas reserves. And outside of North America, hydrocarbon pricing is typically governed by detailed regulatory frameworks. In combination, ownership of mineral rights and freer pricing allows economic rewards to flow to innovators in America. Moreover, many of the recent technological advances have been made through trial-and-error and incremental improvements, which map well to a Darwinian competition among a network of independent companies, as opposed to huge one-time projects by industry giants or quasi-governmental organizations.

Finally, government subsidies for speculative technologies and research over at least 35 years have played a role in the development of the energy boom’s key technology enablers: 3-D seismology, diamond drill bits, horizontal drilling, and others. Government-led efforts that are less obviously related—such as detailed geological surveys and the defense-related expenditures described earlier that enabled the U.S.-centered information-technology revolution, which has in turn created the capacity to more rapidly develop “smart drilling” technology—have clearly also been important.

But the new American approach to innovation has yet to reach much of America’s economy. Its potential to spur further growth and opportunity remains enormous. To make the most of this new American system in our time, policymakers should pursue four basic goals.

First, they should build infrastructure: roads, bridges, dams, and railways. According to the World Economic Forum, American infrastructure quality now ranks 23rd best in the world after having been in the top ten less than a decade ago.

Second, policymakers should invest in building visionary technologies. America’s technology strategy through most of its history was to commercialize the discoveries of European science. We began investing massively in basic research in the post-World War II era only because there was nobody else left to do it.

But the sweet spot for most government research funding will likely be visionary technology projects, rather than true basic research on one extreme, or commercialization and scale-up on the other. We have a long track record of doing this well and an existing civilian infrastructure that can be repurposed. The Department of Energy’s national laboratories, the National Institutes of Health, and NASA are each adrift and should be given bold, audacious goals. They should be focused on solving technical problems that offer enormous social benefit, but are too long-term, too speculative, or have benefits too diffuse to be funded by private companies.

We should return the DOE’s labs to a more independent contractor-led model and might set for one lab the goal of driving the true unit-cost of energy produced by a solar cell below that of coal, and a second lab the same task for nuclear power. We could combine the 27 independent institutes and centers of the NIH into a small number of major programs and task each with achieving measurable progress against a disease. We could task NASA with leading an international manned mission to Mars. Each organization should have one goal, which should be sufficiently concrete that we can all know if it has been achieved, and sufficiently impressive that people are proud to work toward it.

Third, we should build human capital. Here, we are losing our edge. Our immigration system, for instance, should be reconceived as a program of recruitment, rather than law enforcement or charity. And the essential process of improving our schools and universities will require a serious commitment to encouraging competition and innovation within education itself.

Fourth and finally, therefore, we must significantly deregulate and encourage competition in the three sectors that have been most resistant to the new American system of innovation: government services, education, and medicine.

Spending on the core welfare-state programs of health care, education, pensions, and unemployment insurance dwarfs spending on innovation programs. Even small improvements resulting from a modernized welfare system and a more competitive health-care system could free up the resources necessary to invest in our future without increasing taxes or exacerbating our budget problems. Our main limitation in pursuing an aggressive innovation program is a deficit of vision and confidence, not a lack of money.

America has again invented a new variation on our unparalleled system for expanding prosperity and opportunity. It holds the promise of again propelling enormous improvements in living standards and charting a path for unmatched success. But if the American miracle is to power our growth for another generation, we need to understand it, and unleash it.

Read the full version of this piece from National Affairs.