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Emerging Technology Report #17: August 5, 2002

Supporting Technology Development in the U.S. and "Industrial Policy"

Louis Ross (Global Emerging Technology Institute)

Though the technology sectors continue to struggle, a tech recovery will occur within the next two or three years at the latest, spurred by an improving economy, a need for greater security after the terrorist attacks and breakthroughs expected in emerging technology areas in which federal and state research dollars are helping to fund the continuation of innovative research. A good deal of these funds will go directly to university research initiatives, including those which are also supported by industry. Though public money, university and non-profit funds comprise a relatively smaller portion of the aggregate amount of R&D spending, it is critical in helping to absorb the risk of developing unproven green-field technology development, especially in times when the capital markets suffer due to a slow economy and other sources of funds become harder to obtain.

At a time when global markets are very nervous and funding has been more difficult to raise and deploy, other sources of funding become crucial to keep the development of innovation moving in the right direction. During the past two years, venture capital funding fell to $6.2 billion in the first quarter of this year, a 23% drop from the fourth quarter of 2001, according to the most recent data from Venture Economics, the National Venture Capital Association and PricewaterhouseCoopers. Needless to say, the fact that nearly $95 billion in VC funding is not being deployed or may be given back to limited partners who invested in the funds will mean that companies must find other alternatives, especially if they are very early stage. Corporate R&D, another key supplier of funds for start-ups and creator of them, has been down. Industrial R&D is expected to increase only 3.2% in 2002, its slowest growth in nearly 10 years. On the other hand, federal R&D, with all agencies receiving increases, is expected to see its best growth in more than a decade. Some key large technology firms do plan to eventually boost their R&D budgets, and this will lead to a beneficial trickle-down effect eventually and will precede the next tech boom.

For example, Microsoft's Bill Gates recently announced that his firm would add 5,000 employees and ramp up research and development spending by 20 percent, increasing the R&D budget, especially for in-house incubation projects, to $5.2 billion in fiscal 2003, representing more than 16 percent of net revenues. IBM this week opened a sophisticated new semiconductor factory, spending more than $2.5 billion to build and equip. It was the largest single capital investment the company has ever made. I.B.M. still invests heavily in R&D related to advance the design, manufacture and materials used in semiconductor chips. It is spending more than $500 million a year on semiconductor R&D and is deeply involved in supporting research for key emerging technologies.

The most competitive firms will not take a knife to their R&D budgets too much or, if so, will not do so for too long. A key point to remember here is that increases in R&D were driven by industry investment that, in turn, was indirectly influenced by government/non-private sector actions. It is expected that the federal government will spend $75.5 billion on the conduct of R&D in 2002, an increase of 4.7% over that which had been anticipated for 2001. Approximately $15.4 billion is provided by universities and other nonprofit organizations, representing about 3% more than was committed in 2001.

Funding university start-ups has become an important objective for governments and early stage investment firms and has kept key research initiatives going and created new ones. The return time horizon is longer for such firms, but later stage investors need to keep abreast of what is going on in these highly specialized areas and can do so by observing the projects that are being supported, on a global basis, by public entities. This activity has a strong impact on the direction of large corporate R&D budgets, and that provides strong incentives for the development and founding of start-up companies. Perfect examples of the successful industrial policy in the U.S. has been the development of the internet, which was funded for at least a decade by the government before the private sector took an interest in it. Other areas include next-generation wireless technologies, the basis of which was originally a military project. The government now is strong supporting biotech related R&D, including nanotechnology. Needless to say, the next crop of successful companies will be in the areas mentioned above. These will include most certainly next-generation wireless and biotechnology both of which will be provided a great boost from enabling technologies such as MEMS and nanotechnology. Expect a lot of breakthroughs to be borne out of government-supported projects that are embraced by large technology companies and supported through their own strategic R&D efforts. Universities will also play a key role. There is increasing evidence that public-private sector cooperation in regard to the above will increase, be enhanced and made more efficient.

Support for university start-ups really began less than two decades ago and still is evolving. This is when the government made it a priority to promote commercialization efforts, which demanded greater involvement by the private sector and the investment community. The presence of experienced angel investors and early/late stage venture firm's helps to provide a continuity of funding and help to screen the best companies that come out of their early stages. For very early stage ventures, it is estimated that institutional VC money only accounts for less than a third of the available funding.

There are a number of university research initiatives that have received federal, state and large corporate funding in the U.S. These groups also provide facilities for university start-ups that include R&D facilities and permit companies to develop small-batch prototypes. Such facilities may not be available to them other wise. Also, firms obtain valuable experience and important funding from working on government research projects, greatly benefiting for industrial policy initiatives. They also create new companies by acting as technology licensing organizations, transferring rights to new venture companies. Public funding can be crucial in regard to maintaining the liquidity of a start-up before it is ready for later stage institutional funding.

If history can serve as an indicator, the economic problems of today may lead to the development of a whole new host of competitive companies. It was noted recently that such firms as Apple Computer Inc., Dell Computer Corp., Microsoft Corp., Oracle Corp., and Sun Microsystems Inc. all were launched during difficult economic times and at a time when venture capital was scarce and the infrastructure for financing start-ups was much less developed. A much more advanced public-private sector R&D apparatus coupled with a more integrated and advanced private equity industry should lead to an even larger technology boom in the future.

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