A Confused Oligarchy Stagnated Innovation and Starved America’s Parasite Industries, Further Weakening Detroit

A Confused Oligarchy Stagnated Innovation and Starved America’s Parasite Industries, Further Weakening Detroit….

With such a tax base as afforded by the auto industry, Detroit offered the latest amenities of cities of the era and was called the “Paris of the Midwest”. The name implies that Detroit, at one time the fourth largest city in America, had the leading livability standards of the age. We know this was not the case for many of the underserved communities within Detroit, which led to a social cancer. Yet for others in Detroit, a booming city meant rising property values, good schools plus social and cultural benefits.

In the 1970s, even though domestic competitors were not a threat, foreign competitors emerged with a better mousetrap. With OPEC’s manipulation of high fuel costs, Japanese cars found an entrance into the U.S. market. Having established a foothold, they brought in better cars that competed against the Big Three’s higher quality vehicles.

What happened to Detroit’s innovation in the face of foreign competition? It seemed that the oligarchy was dazed by the machinations of OPEC and Washington’s tepid response. Prices would rise for a bit and then fall. Successive waves of price manipulations led to multiple calls for a national energy policy that never emerged, yet signaled confusion in the American industry. All the while, America’s love of big muscle cars survived the frustrating fluctuations in fuel prices. The confusion of Washington’s signals and America’s flip flopping sentiments left Detroit faltering in strategy.

The auto market eventually shifted, but in the confusion, Detroit lost its way, waiting to respond with real innovation and instead doling out body style and grill changes as substitutes for competitive innovation. U.S. buyers now perceived that true technological shifts were coming from foreign competitors, and the big three lost market share.

Detroit saw some of this impact, and the region surrounding Detroit suffered even more. All of America was impacted as the auto industries’ parasitic industries declined with autos. Detroit’s jobs fell, resulting in declining home values as people left. Taxes then declined, followed by a cut to city services, suffering city budgets, and higher crime, all exacerbating the flight to the suburbs, as the fall of Detroit spiraled on.

Could innovation have been a key to turning Detroit around? Yes, new businesses not tied to the falling auto industry, could have replaced the void if Detroit government was not so lockstep tied to the Big Three. While cities like Pittsburgh and Akron began to find ways to reinvent themselves, Detroit clung to autos in a mutual death spiral.

Innovation is a key factor but innovation comes from people, and people want to live in a city that brings to them a vibrant place to live. Thriving cities cater to innovators by fostering livability. Detroit has recently been given the “Un” honor of being the most unlivable city, the most miserable city in America. Therefore it has a severe innovator recruitment gap.

Detroit cannot go from the bottom of the livability scale to the top without enduring years working a plan for turn around. The beginning years will entail efforts to correct the cancers that are killing Detroit. They will also include years implementing a city plan that creates a land use of a highly livable city that can be Detroit 20 years from now.

The rebuilding will begin with a concerted effort to bring the right businesses to the right locations within Detroit as outlined in the 20-year plan. The right businesses will be those that can hire the right people with the level of education that exists now, plus those that can capitalize on the assets that Detroit has now. Detroit can then grow the city piece by piece back toward a Paris of the Midwest, if that is its vision of a livable city that can be enjoyed by all its citizens.

Innovation Built Detroit

Innovation created the car. The car built Detroit. Between 1895 and 1900 when 69 auto companies were started, none were in Detroit. By 1909, 270 auto manufacturers competed in the auto industry, which is really wild. Yet, still only 41 of those were in Detroit in 1909. How then did Detroit come to dominate the auto industry?

Detroit did have some natural benefits of transportation routes and of being close to iron, fuel, wood, and other northern industrial cities. And, Ford and Olds were truly genius innovators. But as or more importantly, Detroit generated a critical mass of innovators. A total of 141 auto companies spun off from parents in Detroit when their founders thought they had better mousetraps.

By 1915, the top selling autos came from Detroit and hundreds of suppliers relocated to Detroit to meet the needs of the largest selling auto manufacturers. This close proximity of cross innovation accelerated Detroit’s growth, and isolated manufacturers could not keep up with the pace of Detroit’s collective innovation.

Eli Whitney’s two innovations changed the world. His first was the assembly line. In 1914, his assembly line became the cotton gin of the north as Ford adapted it to cars and they began flying out the factory doors, driving down costs and price.

By 1929, with over 21 million cars in America, the more continually innovative companies like Ford had absorbed most of the spin off companies, and the Big Three in the Detroit region produced 80% of the cars in America. Detroit owned the market.

With such a prolific production of cars, other industries across America grew rapidly in response. Metal industries, rubber, fuel and fueling stations, highways, the tourist industry, hotels, road construction, and even real estate and construction grew as the car led to an urbanization of America. The Auto industry transformed America.

To fund this transformation, the financial industry also had explosive growth, spiking in the 1920s. The majority of Americans could not afford cars, radios, and homes on America’s average income, so just as we saw a financing bubble in 2008, extraordinary credit was extended in the 1920s, spurring more growth and more consumer debt until it reached its breaking point.

As a result of such credit-driven spending on cars, radios and homes, millionaires were created. By 1929, the top 0.1% of America owned 42% of America’s wealth. By 1929, Ford was one of the richest men in America with an annual income of $14 million compared to his well-paid workers making $750. By 1929, America had expended its credit economy, the bubble popped and the Great Depression hit.

Car production dropped in half, and industries supporting cars fell precipitously. Reduced output brought wage cuts and layoffs in the auto industry, further exacerbating the depression. Reacting to the income disparity that occurred before the depression and sympathetic to the plight of affected workers, Social Democrats passed the Wagner Act of 1935 supporting unions. Immediately upon passage, strikes changed the face of Detroit.

Now, combining a growing, pent up demand for autos after WWII, the need for additional production capacity, the need for land in a landlocked Detroit, continuing innovation leading to new manufacturing techniques, a desire to move away from the increased risk and cost of Detroit’s unions and to create parallel operations to reduce union power, and the change from people to automation driven by excessive labor costs, the auto industry began its migration away from Detroit.

In the next decade, the Big Three built 25 plants, all of which were at least 15 miles out from the city of Detroit. In the following decade with the advent of new highways and FHA housing available mainly to whites, whites migrated out of the city and took small businesses with them. Between 1947 and 1963, 134,000 manufacturing jobs left Detroit, enough for a third of the working population.

In same time period, auto manufacturing in the state of Michigan would drop from 58% of the total to 40%. During the exodus of auto manufacturing and the beginnings of white flight, the U.S. Department of Defense piled on with the decision to diversify armament production away from Detroit.

Within this timeline of the rise and the beginning of the fall, innovation was a key factor that led to accelerated production, which paid for the 300 people per day moving to Detroit. The influx of a million and a half people, paid for by the car, brought in the taxes and built the infrastructure of Detroit that allowed Detroit to annex lands to grow from 39 square miles to 109.

What was left when the majority of companies and people left the city were citizens that stayed, a government that cared to help them, some good assets, some obsolete ones, a considerable amount of empty buildings, a lot of brownfield sites, and a need for a viable plan to use what assets and strengths that were left to turn the city around.

Do Business Schools Graduate Business Leaders Who Disregard America as A Stakeholder?

In a recent Linkedin group discussion, a business school graduate questioned whether we should be discussing the politics of business on the  site; rather should we be using the group discussion for issues only regarding business development and networking.  I responded that global issues of jobs are the pivotal issues we should be discussing.  My response is below.

In March 1989, a federal grand jury indicted one our most infamous Wharton alumni, Michael Milken, on 98 counts of racketeering and fraud.  In 1993, after being released from prison for serving time on six counts securities and tax violations and paying $1.1 billion to those he abused, Mr. Milken founded the Prostate Cancer Foundation and then Faster Cures, making a difference in medical research processes.   Fortune magazine called him “The Man Who Changed Medicine” in a 2004 cover story on his philanthropy.

Mr. Milken had a second chance to atone for classic Wall Street greed that erupted into criminal activity.  Yet, had he not spent time in prison for his misdeeds, would his unethical financial manipulations been acceptable by Wall Street standards?  Many in America judged him as the poster child for the problems with business schools; that schools like Wharton send guys like him to Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Goldman Sachs without adequately preparing them to deal with the ethics of business. 

My class certainly touched on the ethics issue, going as far as to review “Den of Thieves”, an eye opener account of how a few brilliant business school graduates harmed America.  While we all gained from courses that increased insights into ethical choices and their global effects on business, if the objective of these courses was to inspire the next generation of Wall Streeters to rise above recent activity that will be recorded by history as “Milken crack steroids”, they did not succeed.

I appreciate mutually beneficial Linkedin connections.  However, at this historic fulcrum, when our childrens’ future are being defined by  our nation’s business leaders, I have acted on a purpose beyond my personal business goals by starting a blog, www.jobvoucherplan.com  to advocate for the unemployed in America.  As I write, I sense Wharton grads’ responsibility to help set our country’s path.

Milton Friedman, avowed defender of free markets, said that “the business of business is business”.  Our grads, armed with his quotes have been enlisted by investment banks and multinational corporations to transfer capital and jobs offshore.  Brandishing his philosophy, our grads chide protectionists stating that America must out innovate others to advance our country.  They then use the shield of American property laws to transfer American innovations to offshore subsidiaries, favoring international shareholders without regard for America as a corporate stakeholder.

Michael Porter is now publicly modifying Freidman’s concept with corporate social responsibility, including countries as stakeholders.  Recognizing a stark difference in this business theory from Freidman’s, I am raising issues of corporate responsibility regarding country of origin, increased national security definitions of American innovation, reevaluation of property laws regarding intellectual capital, and defining corporations as U.S. citizens with citizen rights, but equally as important, with citizen responsibilities.

Assuming that the Wharton Alumni group is specifically for professional development, networking and career/business building, if discussing these topics helps us develop deliberated beliefs about these historic issues, does it fit the group intent?  Even if we take Milton’s distilled view of business as the basis of our overarching context for business, I would say emphatically yes.  At a minimum, dismissing these issues as politics, limits our responsibility to examine a greater context for business decisions we make.   More importantly, discussing these issues may assist Wharton business leaders to consider business alternatives that create maximum profits for global shareholders while exercising corporate citizen stewardship for America.

Free Trade Must Mitigate Effect on Losers by Multinational Corporation Policy

In a perfect world, free trade expands benefits for all who participate.  All countries trade their comparative advantages.  Whether capable of producing their own goods or reliant on export/ imports, each country grows from trade and the size of the world’s economic pie increases “fairly”.  The problem with this concept is how each country defines fair trade and how each financial class within each country defines it as well.

Many in the U.S. define free trade as that which increases our country’s well being while simultaneously increasing the wealth of our trading partners .  However, with the massive differences in per capita wealth that has persisted in this century, much of the world defines fair trade as redistributing wealth of the existing world economic pie to benefit further those countries that have thus far been left out of the equation.

This viewpoint, supported by the developing world , gave rise to entrepreneurial opportunity.  Wherever there exists economic differential, we can count on the American entrepreneur to opportunistically derive wealth from it’s existence.  America’s $800 billion annual trade deficit is a result of that drive.

Combined with the accumulated wealth of America’s wealthy, our opportunists created a job sucking pump that was primed several decades ago and the rush of exiting jobs flowing past us is a river so powerful that we as American consumers dare not wade through it.

What started as a gold rush of infrastructure projects into China (and elsewhere. China is the stand in for my post) soon became in the eighties the first significant transfer of production jobs that would begin displacing U.S products out of American stores.  As more of us bought these lower prices goods, a percentage of U.S. employees drifted away from full time employment. 

As Americans reinforced wealthy investors’ decisions about their initial Chinese ventures, increased wealth made at the expense of U.S. workers was reinvested in China to create even more volume of low cost goods to be sold back to America creating even more job losses and downward pressures on U.S. production labor wages.

Downward price pressures on labor wages soon spread to other fields as China began to supplant white collar jobs, and as lower blue collar wages began to influence the entire wage spectrum.  What had been several decades of barely increasing real purchasing power for the average American family reversed course in the nineties and Middle America found itself ever more reliant on imported low cost goods and credit to make up for lower earnings.  In response, purchases of Chinese goods and job losses accelerated.

As jobs exited and import purchases increased, the circular pump that had been primed by the difference in income levels between Middle America and the average Chinese worker was now in full force with America’s wealthy, MNCs, and China’s sovereignty each extracting a share of the pump’s profit.

We now look out at the flooded impassible streets of cheap Chinese goods flowing past our empty factories and wonder how it all happened.  What’s worse, the average American cannot attempt to shut the floodgate that has been left open by America’s trade policy.  Our understanding of “fair trade” has been circumvented.  To re-establish a sense of free trade, America needs a comprehensive MNC policy.  The pump that is slowly draining Middle America’s purchasing power and reinforcing a global shift of economic power to the East can be mitigated by comprehensive MNC reform.  For this to occur, the desire to resuscitate Middle America must take precedence in the minds of our representatives in Washington over the desires of their benefactors.  

America is not going to put low cost overseas jobs back in the genie’s bottle nor should we.  But we must create a comprehensive policy that gives American businesses the ability to innovate,  and that gives America the benefit of her citizen’s innovation by keeping that innovation in America for a time.  We must create, through policy, a way for Americans to debate the effects of trade policies and to determine potential net benefits.  We must create a way for businesses and employees displaced from policies deemed to be a net benefit to America to be assisted in transition, and for those that gain the most benefit from changing trade policies to compensate those hurt most from the shift.

Globalization is the phrase whispered above the rush of wage equalizing floods.  Comprehensive MNC Policy should be the phrase shouted in the Halls of Congress.

While The U.S. Invented the Internet; Other Countries Will Use It to Reinvent Themselves

by Al Logiodice

February 15, 2011

I’ve been working in internet-related businesses for more than a decade, and mostly in e-commerce. When we started out, people thought that ecommerce was going to put Walmart out of business. But the real transformative power of the internet isn’t going to be in commerce; it’s going to be in social interaction. To put it bluntly, the internet will be the most important tool that democracy and self-determination has ever found.

Back in the 1930s we did have some social upheaval, and the US was at some risk of becoming socialist. But the primary communication medium of that day (radio) saved democracy in the US. It was also a spoke-and-hub style of communication…one speaker, many listeners. Now the internet allows us (worldwide) the ability to have true peer-to-peer conversation; everyone can talk with anyone.

I think that peer-to-peer conversation (facebook, twitter, etc.) was the turbocharger that Egypt needed to make the changes that they made. Something similar is happening in Bahrain, and probably soon in Saudi Arabia.

In those countries people will figure out how to use the internet as the means to their self-determination. They have no roadmap, no plethora of talking heads like we do, so they can invent something that actually works as they go along. It seems that the older generation use these new media as fluidly as the youth.

And they may invent a self-determination that improves on ours, while we wallow in our old hybrid model; we’re partly stuck in our old world of talking heads telling us what to think. Imagine telling your grandfather that he should be Twittering (“I’ll slappa you face!”). We’re still stuck listening to Beck and Coulter and Maddow and others, telling us what to think, where to look, what’s important, etc., rather than listening to each other, exchanging ideas, and learning from each other. 

While the US may have invented the internet, other countries are going to use the internet to re-invent themselves. The internet is well on it’s way to revolutionizing democracy, but maybe just not ours. We’ll be stuck in our own hole for a long time, while the Egypts, Bahrains, Irans, and maybe even Chinas use the web to come up with entirely new models of governance and society.

In addition to his experience as an E-commerce manager; designing, developing, and operating B2C and B2B websites, contributing to organizational development, corporate strategy, program/project management, Mr. Logiodice is a regular contributer to the White House Group on Linkedin.

Can the Job Voucher Plan Create Renewal in America?

A sense of purpose is as important to one’s work fulfillment as the financial reward that work provides our family.  I am reminded of the story where a passerby asks a stone mason who is chipping away at a cornerstone what he is doing, and the mason replies not that I am cutting a block, but that I am creating a cathedral.  Here in Florida, I am surrounded by neighbors who have lived in their homes for 30 years only to turn them over to the bank because of hard times.  Their share of the “cathedrals” they created for our country was stored in their home. When the banks foreclosed on them, they lost the results of their life’s work. 

Losing their home is just one step down the painful road that millions of Americans are enduring during this Great Recession.  With the loss of so many millions of jobs, the difficulties of just one jobseeker can get lost in all the noise.  How do jobseekers cope when they have become part of the 99ers, those whose extended unemployment has run out?

During this Great Recession, as each month passes, the job seeker begins to realize that somehow this recession is different. In the first days after he recovers from the shock of losing his job, he determines to quickly pursue businesses which best meet his career and geography requirements. As the months go by, he realizes that opportunities are diminishing, and he must now lower expectations if he is to cover expenses and keep the kids in the same schools.  As unemployment compensation comes closer to the end, he recognizes he may have to move to open up more job possibilities. He reluctantly lists his home only to find over time that it is competing in a surplus market, and that its value is lower than the mortgage.

Yet he persists, getting up each day to comb opportunities till dusk with a hopeful heart of scheduling a job interview. His efforts pay meagerly because interviews are not plentiful in this stagnated market. Each month, more people transition to the unemployed, and they are being called in before him. He has similar qualifications, but somehow because he has been out longer, employers begin questioning why he has not been hired. Sensing their skepticism on the phone, he shows a lack of self confidence in the few interviews he gets, further lessening his chances for hire. His wife and kids quietly grow anxious with him, and he fears they are wondering what his “failure” will mean to their lives, their friendships, and their futures.

At some point, any job would be better than grieving through this spiraling loss of self worth. Then one surprisingly sunny spring 2011 morning, he turns on the TV to see President Obama, surrounded by leaders of both parties on the White House lawn, announcing the “Job Voucher Plan”. As promised, within weeks, the internet and local papers begin filling with job offers in all areas of employment. His spring is renewed with hope.

After several interviews, he begins working again, and not in some makeshift job, but one with career potential and purpose. The owner of a small business has painted a picture of an innovation in need of an American with the skills to make his dream a reality. Now purpose driven, he sets about to create real value for his employer and his community.

He knows that small business ventures are not always successful and that there are no guarantees this job will turn into something permanent. But the American people have committed for the next two years to give him 25 hours a week to help his employer and product to success.  Each morning seems brighter as he gains control through his efforts to build a career in this new small business venture. Not only is his family experiencing this change; he sees a purpose growing in the entire community. There is a belief that we are all working for something larger, for a renewal in America.

While this spot is not where he had hoped he would be in the years leading up to the Great Recession, he now has a sense that things will get better. He is being paid the same wages as before the recession but with fewer hours. He will help this company with hope and loyalty of purpose, and will have done his part to dig America out of its slump. As the economy improves and competition for employees heats up, his small business owner will compete to keep his new, valuable employee. Nonetheless, the job seeker will diligently use his 15 extra hours a week to once again pursue the American dream.

The above chart shows unemployed broken down by time of unemployment.  It does show a slowdown in newly unemployed.  However, it does not accurately depict all unemployed because many have fallen off the curve and are no longer counted.  Unfortunately, it does show that the mean time of staying unemployed is growing.

Ensuring a Sustainable World Will Create Significant Job Opportunities.

As wealth continues its transfer from industrial to emerging nations, if war does not return the world to a dark feudalism well before political, economic or physical limits are reached, at some point the entire world could reach a balanced standard of living.  What GDP would the western world would have to accept to achieve a balanced world economy?  Calculations, using today’s technology and known resources, suggest that a balanced living standard would be about one quarter the output of western nations today. For the sake of citizens of wealthy nations, who like I feel entitled or at least hopeful that we will maintain our material well being, I am rooting for innovation and exploration to vastly improve that balanced trajectory.

Futurists state that resources such as energy, water, and food may be among the factors that will limit the entire world from achieving the wealth frontier boundaries that have been set by western society. America can and should innovate to keep these barriers from limiting a higher world parity.  In creating solutions, we can build national core skills and provide jobs for Americans in the process.

While an economical solution to drawing and storing mass energy from the sun does not exist, and while the world still fears nuclear, innovation should unlock today’s yet unknown energy solutions to keep energy from being a limiting factor. Wind and solar electricity cost twice that of coal and natural gas, and electric grids are limited in areas of the United States that could produce most efficiently. However, as the oil era wanes, our future energy shortfalls are eminently more solvable than a shortage of sperm whale spermaceti seemed to America as the era of blubber energy was forever expiring.

Current technologies exist today to extend water capacity, to conserve water usage, and to create potable water for much of the world.  As an example, today’s power plants release 70 percent of consumed fuel as inefficient heat back into the environment.  Cogeneration plants can capture much of this wasted energy to convert the world’s seas into potable water. In a world filled with sun and water, the future brightness of tomorrow’s innovators should solve energy and water shortages.

 Even as America is touted as the bread basket of the world, the future will look back on our modern technologies as unsustainable just as we look back on the industrial pollution of the 1960’s as an unsustainable abuse. The world will question why we didn’t see how our food production processes were depleting soil, relying on too few strains of genetically produced seeds, and altering humans’ ability to resist disease from our livestock antibiotics.  However, globalization will create the need to transfer the best parts of America’s food production capabilities to other countries and to cause the world to restrict rich soil areas to food production, easing at least short and mid-term food pressures.

I am most concerned about the byproducts of innovation as a limiting factor. For instance, what are the effects on codependent species such as bees and birds of immersing an entire world in communication waves? What will be the effect of weakening the collective immunity of the world through pervasive use of antibiotics and antivirals? And while no-one has definitively linked the explosive acceleration of both number and scale of natural disasters to global warming, what will be the tipping point that creates an unstable environment for mankind?

These issues require a forward focus.  America can capitalize on solving tomorrows economic, environmental, and world sustenance issues before they become crises.  America can create national core skills the unite the world before our common sustenance needs divide the world into civilizations competing globally for antiquated solutions, or worse that plunge the world into a war of survival.

Will America’s Lack of a Multinational Corporation Policy Bring a Resurgence of War? (Part 1)

World history has been dominated by trade wars and military interventions to resolve trade conflicts. From the 15^th through the 19^th centuries, shipping merchants became wealthy competing for trade routes and exploiting price differences between nations’ captive markets.  Wealthier nations financed mercantilism to increase their gold coffers at the expense of other nations that lacked merchant ships and navies to protect them.

In the 19^th century, those nations of Europe and America that had accumulated wealth through mercantilism, now invested in the transformative industrial innovations of their time.  For much of the 19^th and 20^th centuries, the industrial revolution compounded the wealth of these nations, and advanced the theoretically achievable wealth of the entire world.  However, a concentration of industrial strength by relatively few countries led to export surpluses that drove countries to compete for trade routes, and that eventually caused an eruption of war. 

In the 20^th century, technology advances supported worldwide business capability, yet wars, government corruption, and misguided trade barriers dissuaded businesses from expanding to other countries. But the wars did temporarily thrust underground the notion that trade differences should be settled through bloodshed.  Nonetheless, the United States pursued military dominance.  As the 20th century ended, the U.S. emerged the sole superpower, creating a unique opportunity.  For the first time in history, the entire world could peacefully pursue economic parity.

The world responded by leveraging wage imbalances between the world’s rich and poor nations.  Entire civilizations altered age-old governance systems so their people could participate in world wealth redistribution.  China created a capitalistic engine to support its socialist goals as the center of the ASEAN economy.  India reduced the pressures of its caste system to benefit from newfound prosperity.  And we are witnessing today the Middle East standing up to dictatorships that have shielded their people from participating in the world’s economy

Europe’s and America’s businesses reacted by aggressively expanding into global markets through direct foreign investments of multinational corporations (MNCs). Their expansion resulted in the transfer of both wealth and jobs to other countries, and created a formidable force that wounded America.  As we face down this force, America should be asking the following questions 1) through our military support of world stability, did we better America’s future?, 2) can we simultaneously innovate to advance our nation’s wealth frontier while supporting the rise of the rest of the world?  And 3) have we determined an economic path forward that will protect the world from a reemergence of military struggles?  The answer to these questions will depend on the ability of United States to develop a coherent policy regarding MNCs.

Bruce Nussbaum’s Blog on HBR

 

Bruce Nussbaum recently posted this blog on Havard Business Review.  His message was spot on.  He heralded the issue with trumpets. Multinationals are not just transferring jobs overseas through direct foreign investments.  To gain access to China’s markets, they must couple DFI with technology transfer.    Here is my short editorial.  Our great American hope for competition, American innovation is being sold to the highest foreign bidder.  The way to compete with this innovation drain is to reseed innovation here in the fertile ground of small domestic American businesses.   Now Bruce’s great article:

What’s Wrong With America’s Innovation Policies

10:12 AM Wednesday January 26, 2011
by Bruce Nussbaum  

President Obama gave a stirring speech last night, saying “We need to out-innovate, out-educate, and out-build the rest of the world.” He used the word “innovate” more times in his State of the Union than any other U.S. president. To those of us who believe the future of the country depends on its innovative capabilities, this was hugely positive. But the obstacles to boosting innovation in the US are far higher than the President acknowledged. Indeed, as CEOs gather at the World Econimic Forum in Davos, they are much greater than most business leaders are willing to say.

Here are some harsh truths that President Obama did not face in his State of the Union speech: there is very little actual innovation taking place within Big Business; Washington innovation policy is placing big bets in the wrong places; China’s innovation policy is superior to America’s.

Let me explain. A devastating National Science Foundation Business R&D and Innovation Survey that generated almost no media discussion when it was released in the fall showed that only 9% of the 1.5 million for-profit public and private companies in the U.S. had any product, service or process innovation between 2006 and 2008. Of manufacturing firms, 22% innovated. In non-manufacturing, a mere 8% innovated. As economist Michael Mandel has observed, “you can’t be an innovation economy if only 9% of your companies are innovating.”

Under both Democratic and Republican administrations, for nearly 20 years, Washington has been placing the wrong bet on R&D. Hundreds of billions in government funding has gone into bio-sciences without any significant return. Genonomics was heralded as the Next Big Thing after silicon, the driver of future economic growth. It isn’t producing results in terms of new companies, jobs, or economic growth in general, yet billions more flow into NIH and universities every year.

China’s brilliant “Fast Follower” innovation policy is generating the biggest transfer of technology in history. A combination of state-driven policies is driving this policy — requiring Western companies to partner with Chinese firms to do business; demanding transfer of the latest technologies in exchange for access to markets; favoring “indigenous innovation” in government purchasing; fencing off green and other industries from foreign competition; offering low-interest state-bank loans to local champions. This industrial policy is at odds with WTO standards, but is a boon to Chinese economic growth and a long-term threat to U.S. global competitiveness.

A realistic American innovation policy will need to take these three harsh truths into account. We need a much more skilled business leadership than we have currently, capable of creating as well as managing. We need to refocus government investment into manufacturing, energy, and materials. And we need much more vigorous global economic policy that meets the challenge of China’s innovation policies.

When President Obama speaks of a “Sputnik moment,” he clearly understands the need for innovation. The next step is crafting policies that deal with the harsh truths of American innovation and move us forward.

Bruce Nussbaum is a member of the Council on Foreign Relations. A former assistant managing editor for Business Week, he is professor of Innovation and Design at Parsons The New School for Design.

A Math Example Clarifies The Debate About Free Trade

Sharpen your pencils, get a cup of coffee, and grind through this simplified math example that clarifies why jobs are being lost to places like China and India through free trade.  Hopefully the exercise will be enlightening.  It also explains mathematically why America must innovate to make up for lost jobs and to keep wages from being depressed.  If you have any questions while going through the exercise, leave it in the comment section and I will promptly answer it for you.

The Debt Ponzi Collapse Exposed the Real Crisis: A Transfer of Investment and Jobs

Notwithstanding that the current economic crisis was initiated by a debt ponzi scheme that collapsed inflated home prices, creating credit and capital illiquidity, the real crisis is what the collapse finally exposed.  Over the last 25 years, a series of bubbles and bursts have masked the underlying long term transfer of investment and jobs from America to other countries.  The following is an extremely simplified but useful example of how this occurred and why debate continues to surround free trade.

Assume:

• 2 countries X, Y
• 10 people per countries X and Y
• 1 International banker / multinational company (Banker)
• 10 products each requiring 1 person /year of work
• Products expire in 6 years requiring replacement
• Capital has infinite life, interest rate is 0%, material and transportation costs are free

 

Country X

• Banker lends to multinational who creates 10 factories
• 10 Factories each hire 1 person to create a total of 10 products per year
• Workers are paid 1 dollar for each unit of work and products are priced at 1.2 dollars
•  At the end of each year, each person borrows .2 dollars and buys 1 product
• After 6 years, all people have earned labor wages to pay back loans and own 5 products
• After 6 years, 60 units are produced and 50 are consumed
• In 6 years, Banker nets 10 units, zero dollars (60 dollars revenue less 60 dollars) labor, and creates  2.4 dollars value per factory
• With excess units, Banker seek more consumers
• Some products are already reaching obsolesence so cycle must repeat

 

Country Y

• For first 6 years country Y is agrarian but educates its people preparing for industry
• With high unemployment, workers are willing to work for .2 dollars
• Country Y government collects .2 dollars for multinational privilege to invest in country Y
• After first 6 years, Banker builds a factory to produce 1 product (a)
• Banker hires 1 person and loans person 1 dollar to buy product (a)
• During next 5 years, factory produces 5 units and 1 is consumed by country Y, 4 units of product (a) are sold to Country X
• Banker nets 3 dollars, selling 5 units for 5 dollars, labor costing 1 dollar, country Y collecting 1 dollar
• Banker benefits .6 dollars by moving factory to country Y
• As capital is returned, Banker reinvests in country Y
• Country Y invests dollars gained by multinationals in securing future benefits for its people

 

Country X responds

• Because prices are lower, workers in country X buy 4 units of product (a) from country Y
• Plant producing product (a) reduces output to 1 unit during next 5 years
• Worker from factory (a) is laid off and replaced by part time worker
• Small company with innovative idea generates product requiring loan and worker
• Banker loans small company to build factory to produce product
• Small company hires worker that was producing product (a) so that employment is maintained

 

Over Time

• Banker corporation continues to invest in country Y
• Country X must continue to innovate to create new products to replace jobs taken by country Y
• The rate at which country X cannot keep up with the transition of jobs to country Y correlates to the rate at which jobs are lost and wages are depressed in country X

 

Benefits and costs of free trade to residents of Country X

• Workers who have jobs benefit .8 dollars over 5 years from buying lower cost product
• If innovation keeps pace with the transfer of jobs overseas, creating high paying jobs within country x, residents of country x receive more goods and are wealthier
• However, if the following occur, residents of country x is poorer, and country X borrows 2.5 dollars over 5 years from banker to pay unemployment benefits to laid off worker:

o   If innovation does not keep pace

o   If investment wealth is limited and bank receives higher rate of return for funding multinational transfer of jobs than on innovation investment

o   If multinationals purchase innovation and transfer innovation to country y

o   If economic shock creates illiquidity and halts investment in innovation

 

Benefits and costs of free trade to Banker / multinational

• Under scenarios listed above, the banker / multinational continues to benefit

o   With innovation, banker has additional investment options

o   Without innovation, wealth of the working class is transferred through multinational transfer of jobs to the banker

• However, if free trade and excessive investment in country Y cause jobs to shift too quickly, then:

                o   Country X deficit increases to unsustainable level

o   High unemployment in country X causes widespread default on consumer loans

o   Banker / multinational is at risk of negative return