California's Innovation Economy Standing

 

Advancements in global communication and the ability of companies to outsource both goods and services have been major factors increasing a global economy. Ten years ago Thomas Friedman, in his book The World is Flat, outlined the global changes which have lead to this massive globalization. Ranking and understanding where California stands globally on the Innovation Scale is the first step in developing a comprehensive policy to spur future economic growth in this vital area of our economy.
 
Innovation State has complied research from around the world, to provide a comprehensive global innovation economic standing and outlook. Since globalization, many look to California as leader of innovation, although our government has failed to create a plan and vision. It’s time that California must not only look to benchmark itself on other states, but also other countries. With exponential advances in technology, it is the utmost importance for California’s policy leaders to be informed with the macroeconomic trends and how we can better prepare Californians for the future.

California and the World

Looking from a global perspective at California’s innovation economy, some may argue that California is leading the world with innovative products and services. However, there are several economic indicators that portray a different perspective. But before delving into the numbers and metrics, the distinction between two types of economics must be defined. The distinction of neoclassical economic thought with the innovation economic thought is how growth in the economy is sustained and the context of this growth. Neoclassical economics is focused on market price signals of tangible commodities, i.e. wheat, oil, and milk. With these commodities, the growth of the economy is based on the accumulation of factors such as capital and labor. Innovation economics is focused on the capacity of the economy to create more effective processes, products and business models. With the majority of the economic growth focused on the knowledge and technology, i.e. R&D, patents and trademarks. Along with California, the United States is known for being a very entrepreneurial and innovative country, although there are indications that the U.S. is losing its competitive edge with California at forefront of the decline in the innovation economy.    

 
Internationally, the United States is ranked 6th on the Global Innovation Index (GII), which is a comprehensive and extensive annual report about the international innovation standings with over 70 different metrics. This index takes into account innovation inputs and outputs with the inputs including, institutions, human capital and research, infrastructure, market sophistication and business sophistication. The innovation output index includes, knowledge and technology and creative outputs. Figure 1 (right, hover for details) illustrates the ranking of the U.S. which leads in 6th behind, Switzerland, United Kingdom, Sweden, Finland and Netherlands.

 
 

Figure 1 Data from Global Innovation Index


The United States does lead the world in some of the metrics calculated by GII, primarily the subindex of market sophistication due to the amount of investment compared to total value of stocks traded and venture capital deals relative to the total GDP. However, there are several indicators that reveal that the nation will have larger economic problems in the future if the United States does not change its current course. One of the more concerning indicators is the percentage of total graduate students currently enrolled in science and engineering (S&E). Currently, the United States ranks 84th in the world with only 15 percent of the total graduates in S&E programs. Thailand leads the world with over 53% of its graduates enrolled S&E.
 
Another concerning indicator that is a part of the innovation economy, is the capability of the citizens to purchase new products. The growth of the U.S. Purchasing Power Parity (PPP) to GDP growth per worker is at a stagnant 0.5 percent, placing the U.S. 77th. Technology in the long-run does become cheaper, but other costs continue to grow given inflation rates. These indicators are just the tip of the iceberg with regards to California’s innovation economy.
 
 

The innovation economy not only holds its strength on the education of its citizens but along with the ability for innovators to share and secure their innovations with patents. With patents innovators can now use their innovations as intellectual property (IP), the U.S. leads the world in the quantity of patents filed with the United States Patent & Trademark Office (USPTO) every year. In 2011, the number of foreign submitted patents surpassed 50 percent of all the filings submitted to the USPTO.
Interestingly, the Chinese have been submitting the most patents from a foreign country, with recent policy changes promoting the incentives for state-owned-enterprises to file more patents. Although not all patents are created equal, the U.S. Chamber of Commerce recently reported that nearly three quarters of the Chinese filed patents were “junk patents” referring to the “utility” and “design” patents which are not reviewed when they are submitted. These patents have proliferated the Chinese patent law because the definition of “invention” in Chinese patent law is quite relaxed, “any new technical solution relating to a product, process or improvement…” Even though this is an important metric for the country and state it does not necessarily prove that the innovation in that country is quantifiably more compared to another.


An additional important metric of the innovation economy for the U.S. to explore is the amount of research and development (R&D) spending relative to a nations GDP. R&D is the mother’s milk of invention, without companies and organization taking time to explore new options, there would be no change to products or businesses. The capability of R&D to improve business functions and services has been empirically studied throughout several decades and has proven to be a positive correlation to output. Several studies have indicated that a 10 percent increase in industry R&D will have an average of 15 percent rate of return and as high as a 30 percent return. Not only does it improve the returns for the specific organization conducting the R&D, but along with the industry of that specific R&D cluster, will also see an economic benefit. (Institute for Fiscal Studies)
 
The U.S. ranks 8th internationally with 2.8 percent of GDP spent towards R&D. Figure 3 displays the top 27 countries that have committed a significant portion of their GDP towards R&D. Israel, Finland and Sweden have the highest percentage of R&D to GDP with 3.9, 3.6 and 3.4, respectively. Figure 4 illustrates the percentage of GDP change from 2001-2011, which reveals a greater change in policies for some countries trying to capture the growth of an innovation economy.
 

Figure 3 Data from The World Bank

Figure 4 Data from The World Bank
The top three countries that allocated more funds to R&D as a percentage of GDP from 2001-2011 are Estonia, China and Slovenia with a growth of 239 percent, 93 percent and 65 percent, respectively. Not only has Estonia doubled its R&D, it has been the most proactive country in the past decade trying to revamp its economy towards a knowledge economy. Since 2001, Estonia created a six year strategic plan through their Estonian R&D Council to determine the direction of R&D and innovation in the country. In their latest strategic plan Estonia, has set out specific benchmarks that they hope to reach at the end of the six years. They include, increasing productivity per employed person to 80 percent of the EU average, raising the level of investment in R&D to 3 percent of GDP and increasing the share of Estonian exports in world trade to 0.11 percent. All of these are objectives which Estonia is striving to accomplish by 2020.

 

After two previously successful R&D strategies, Estonia has revamped their third R&D strategy to include factors that were not fully developed in the previous two. These can be categorized under several areas of improvement. First is to take more input from broad stakeholders. The Estonian government has performed well with developing the strategy within the government and certain ministries; however coordination and involvement with all stakeholders including industry and universities was not fully developed. Second, is the business involvement; there are only 400 companies in Estonia that perform R&D. Engaging with companies that are not yet performing R&D can be accomplished by strengthening the cluster organizations and developing government sponsored finance and initiative projects. Finally, creating more targeted and focused programs with key importance technologies using “smart specialization approach” promoted by the Organization for Economic Co-operation and Development (OECD).

 

The OECD has recognized that an innovation economy is a key driver for economic growth and have developed a framework for European and other member nations of the OECD, called the smart specialization approach. This detailed report, breaks down how a country can find and develop their economic strategies geared toward the future. The core of smart specialization can be divided into four major concepts.
 
The Self-discovery or entrepreneurial discovery process. This process is unlike the top down approach to economic planning but rather a bottom up approach where the private sector is discovering and producing information about new activities and the government provides the conditions for the search to happen. Acting as an ear for the private industry and to assess potential and empower those actors (i.e. entrepreneurs and companies) most capable of realizing the potentials. Creating and coordinating resources to help the environment of structural change and uncertainty, risk and information asymmetries.
  
Activities, not sectors for setting knowledge investments. While specific industry sectors still matter, the issue is how these sectors are using investments. Activities can be tied to specific technologies or technology mix, to specific capabilities, natural assets etc. In general what is discovered as future priorities are those activities where innovative projects complement existing productive assets, hence the need to differentiate the target of smart specialization according to the overall position of a given activity (e.g. modernization, transition, and diversification).
  
Smart specialization entails strategic and specialized diversification. Rather than encouraging specialization along predetermined paths, the smart specialization approach recognizes that new or unexpected discovers of activities might emerge within a given part of an innovative system leading to “specialized diversification”. That is specialization on selected activities that provide a comparative advantage based on differentiation of their operations and products in global markets.
  
Evaluation and monitoring. As other versions of new industrial policies, smart specialization emphases the need for policy makers to carry out evidence-based monitoring and evaluation and to feed back into policy design. It also requires flexibility in policy making to be able to benchmark and criteria for success and failure. Smart specialization policies need to have measurable goals, whether it involves increase in new business formation or business R&D or commercialization of products.
  
The rationale for smart specialization goes beyond traditional market failure arguments for framework conditions and highlights the role of regional governments, knowledge-based institutions and entrepreneurs, in shaping specialization and competitiveness in a holistic place-based approach. General purpose technologies play a particularly essential role in straightening existing specializations and revealing new economic opportunities in high tech sectors but also in traditional industries.
 
 

Another approach to developing an innovation economy is to take a more direct investment approach, as in Singapore’s central government focused in the early 2000’s to establish a center for biomedical research. They created Biopolis in 2003 which is a biomedical complex of seven buildings with over two million square feet of laboratories, offices, and meeting spaces. Within a decade, Biopolis had established a reputation as a world-class biomedical research hub and put Singapore on the scientific world map. The biomedical sciences industry has generated economic wealth, created jobs, improved human health and the quality of life. Since 2000, manufacturing output of biomedical sciences has increased by nearly fivefold from $6 billion in 2000 to $29.4 billion in 2012. Employment in the biomedical sciences manufacturing industry grew 2.5 times, from 6,000 to 15,700 in the same period. In 2012, the value added of the biomedical sciences industry rose to $15.3 billion, contributing 25.5 percent of total manufacturing value added (Agency for Science, Technology and Research 2013).  
 

Relative to the world, California’s economic condition is relatively stable, however with growing specialization and competitiveness around the world, California must create a plan for innovative competitiveness. It stands that although the U.S. has positioned itself as one of the leading nations in innovation, it has grown despite there being any plan involved. California mirrors this as it has grown despite there being no policies to promote innovation. Developing a strategy for California’s innovation economy should encompass the OECD’s smart specialization framework and understanding California’s diverse economic standings is key to developing a strategy.  

California and The United States

California leads the nation but for how long?

 

Leading the nation with the most populous state with over 38 million people, California’s economy is one of the most diverse and thriving economies in the country, adding $2.2 trillion to the national GDP. Although California’s economy could be improved with creating a vision and a plan to drive California’s economy to an innovation economy. Figure 5 (below) displays each states standing in the Information Technology and Innovation Foundation’s (ITIF) annual New Economy Index which details each state’s competitiveness in the innovation economy.

 

California ranks third in the 2014 report, behind Massachusetts and Delaware. From the 2012 California has increased its position by one place, primarily California thrives on innovation capacity, due to Silicon Valley and high-tech clusters in Southern California. California still dominates the venture capital industry, receiving 55 percent of U.S. venture investments, and also scores extremely well across the board on R&D, patents, entrepreneurship and skilled workforce indicators. Where California ranks the lowest in ITIF’s annual report is immigration of knowledge workers, foreign direct investment, and health information technology.
 
Figure 6 (right, hover & scroll for details) illustrates California’s total gross state product (GSP) categorized by industry. Not surprisingly, real-estate, rental and leasing, accounts for $341 billion or 16 percent of California’s GSP, followed by professional and business services and the government. Figure 7 depicts the growth or decline of industries over the pass 10 years from 2002 to 2012. The greatest top 5 sectors for growth are in natural resource extraction with oil and gas extraction leading a 500 percent increase, followed naturally by pipeline construction and chemical manufacturing, with a 290 percent and 232 percent, respectively. The sixth highest growth was computer systems design, followed by data processing and internet publishing, 136 percent and 125 percent, respectively. Beyond natural resources, the technology sector continues to be the largest sector for growth and will continue to be as we move through 2020. On another major and important front for California’s economy is the manufacturing sector, which in the past decade California has seen a major decline, illustrated in figure 8 (below). This decline in manufacturing is not limited to only California, it is a macroeconomic trend that has effected every state across the country. Manufacturing accounted for only 9 percent of California’s employment in August 2013; year over year, manufacturing employment fell slightly, whereas almost every other industry in the state grew.

 


Manufacturing has been declining for decades and will continue to be a sluggish sector in California. During the recession, the construction industry contracted most sharply. As the housing market rebounds and the existing housing stock is being absorbed by California’s growing population, construction employment is rebounding as well. Over the past year, construction employment grew about 5 percent and is projected to grow 26 percent by 2020. Service and trade industry jobs are also projected to grow quickly over the next decade (projected by the Public Policy Institute of California).
 
 

Figure 8 Data from Bureau of Economic Analysis

Figure 9 Data from Bureau of Economic Analysis

Figure 10 Data from Bureau of Economic Analysis

 
 

The overall decline in manufacturing is a broader economic change that supports the drive to move California and the nation away from the standard run-of-the-mill jobs to knowledge and innovation based jobs. Figure 9 displays the employment of manufacturing jobs from 2000 to 2011 in each state, in which California leads the country with the greatest decline in manufacturing jobs. In fact, every state across the county lost jobs in manufacturing, regardless of policy. Although certain sectors of manufacturing have rebounded and have even expanded in California. Figure 10 depicts apparel manufacturing which is the only manufacturing that is actually expanding in California. From 2000 to 2013 apparel manufacturing output has increased 58 percent where all other sectors have been declining. Although, apparel manufacturing is not specifically regarded as an innovative industry, it is an industry that is using technology to improve the quality and durability of their products.
 
 
American Apparel has been leading this apparel manufacturing boom in Southern California, by investing in a 6,000 employee factory in the heart of Los Angeles, which manufactures in a seven-story 800,000-square-foot facility where it produces more than 55,000 different products and garments. The company also owns and operates its own fabric dye house, garment dye house, and knitting facility, all based in Los Angeles. It does not outsource its labor, paying factory workers an average of over twelve dollars an hour and often more than $100 a day. Garment workers for similar American companies in China earn approximately 40 cents per hour. It claims to have the ‘highest earning apparel workers in the world.’ The factory claims to have the capacity to produce 1 million shirts per week and manufacture 275,000 pieces a day and is the largest single garment factory in the United States. They among, many others employ countless technologies to improve efficiencies within the factory to delivery to their stores.



Overall, California’s economic recovery is slowly moving forward, along with the nation. With about 1.6 million Californians that remain unemployed, nearly double the number who were unemployed before the recession. Creating jobs and increasing full-time employment in the technology sector is key to California’s recovery. A thriving California economy leads to a financially strong state to support more education and healthcare.
 
Although California has several key industry clusters, such as film, computer systems design, high-tech, apparel manufacturing and wine-making, the state’s economy is highly diversified, similar to the mix in the nation. Economic policy should reflect the breadth and movement toward the innovation economy. Similar to the OECD’s ‘specialization approach’ policy should act as a catalyst to support technology in multiple industries. Although, it’s important not to promote a niche specific industry booms such as clean tech, as they don’t normally deliver stable, steady growth. But, technological advances have been without a doubt the number one driver of growth in California’s major cities and valleys.
 
Even with promoting the innovation economy, ultimately, the number one way to promote economic opportunity is through education. It’s essential for the well-being of the state that more is done to promote more graduates in science, technology, engineering and mathematics (STEM). With an increase in graduate with these degrees the opportunities in these areas will only increase the quality of life not only for the STEM holder, but for all Californians.