America Is Losing Its Edge

We have heard over and over again that America is still the world’s fountain of innovation, the home of fracking and Facebook. The two “F’s” of American innovation are about to become one: The collapse of oil prices portends a collapse of the shale boom. High-yield energy bond yields have soared from 5% to 12% in the past few months, and investors are fighting to get to the door. Most unconventional oil and gas projects are unprofitable at $60 a barrel, and that’s where oil will trade for the next year or two.

Facebook is a clever gimmick, but it doesn’t do much for productivity.

It doesn’t help to crank up the theme from Rocky and chant, “We’re Number One!” We are in trouble, with a stagnating economy and falling incomes, and we are about to be in much, much worse trouble.

What’s left of the U.S. economy net of alternative hydrocarbons doesn’t look impressive. Here are a few facts about American capital investment:

Take out the energy sector, and capital investment by S&P companies remains 8% below the 2008 peak. We never had an investment recovery.

Take out the top six companies in the S&P technology sector (IBM, Apple, Microsoft, Intel, HP, Micron), and S&P tech capital expenditures are down by a 40% since 2000 and down by 25% since 2013. The top six account for 75% of all capital expenditures among S&P tech companies (in 2000, it was less than 50%). All but the quasi-monopoly tech giants show an investment depression.

In deflated dollars, nondefense capital goods orders from American manufacturers are 20% below the 2000 peak and 5% below 2008.

It’s no surprise that productivity and wages are stagnating: investment in plant and equipment is falling. America is losing its edge. We had better fight to keep our lead before we have to play catch-up.

Meanwhile, R&D and engineering capabilities are burgeoning abroad. As a Dartmouth business school professor reports on the Harvard Business Review blog, U.S. multinationals are building R&D centers in China and India. The quality of engineering and scientific talent in the world’s two most populous countries is rising rapidly:

The remarkable reality is that many big American R&D spenders have undergone a quiet transformation of their product development capabilities during the last decade that includes embedding Asian capabilities much closer to the core of their operation. Offshore engineering centers have become central to businesses such as Microsoft, Abobe, and Synopsys.

As an investment banker active in Hong Kong, I see brilliant innovations popping up in China every day. Per capita, China may be less innovative than America, but with 1.4 billion people, a very small proportion of prospective innovators adds up to a very big number.

America still has the world’s best technology, but the gap is closing. If we don’t change course, we are going to go the way of Britain.

Reaganeconomics was founded on tax cuts and sound monetary policy, but it also included a massive high-tech R&D effort, the Strategic Defense Initiative, driven by federal R&D spending. As a young consultant for the National Security Council, I researched the issue for Norman Bailey, then special assistant to the president–and the president cited the economic benefits of SDI-related R&D in a subsequent speech.

What do we need? I offer 6 ways for America to regain its edge…

1) We need to jump from 30th place to 1st place in secondary-school math achievement. That means our kids have to stop playing video games and crack the calculus text.

2) We need to spend hundreds of billions of dollars on frontier R&D on the old DARPA model. No more trillion-dollar budgets for an F-35 that won’t fly.

3) We need to aggressively recruit talented engineers, scientists and tech entrepreneurs from overseas. We are still training a lot of the rest of the world’s best talent, and we should strive to keep them in the U.S. That’s the urgent priority of immigration reform. Latin Americans are irrelevant to the U.S. economy (net immigration basically stopped when the construction boom collapsed). We’re arguing about the wrong things.

4) We need patent reform (cutting the duration of many classes of patents to perhaps 5 years from 20), as Prof. Reuven Brenner brilliantly argued last year in the Wall Street Journal.

5) We need reductions in corporate and capital gains tax rates and a regulatory rollback.

6) We need to rebuild basic infrastructure. Some of this can be done through private initiative but not all, or most.

We need all of the above. Any five of the above will fail without the sixth ingredient in the recipe. Can we do it? Of course. Will we? It’s not even on the political agenda.