Investing In Innovation Is Key To Boosting Wisconsin's Business Prospects

Economic growth and development hinge on how firms conduct business. Companies striving to maximize profits can compete in two ways: They can minimize their operating costs or they can innovate, develop new products and increase their market share. In practice, many firms mix these options by focusing on innovation while keeping an eye on costs.

Economists generally agree that innovation is the engine of long-term sustainable economic growth and development. Innovation is key to what 20th century economist Joseph Schumpeter called "quality competition." When businesses compete based on quality, they focus on innovation to bring new ideas, products and processes to markets as well as set their product apart and gain consumers. By comparison, "ordinary competition" focuses on pricing the good or service the firm offers. These businesses seek to reduce costs, by keeping taxes, labor and capital costs low, limiting regulations, and often requiring employees to gain skills on their own rather than investing in their workforce with training and education. These firms often emphasize short-term profits over longer-term growth.

Firms engaged in quality competition will seek a business climate that differs from firms engaged in ordinary competition because their drive to innovate relies on people — labor is an asset, not a cost. Because innovation is a purposeful outcome of employees' intellectual contributions, these firms require a business climate built on access to a diverse pool of highly educated and skilled people, strong networks facilitating the flow of information, and public investment in research and development. These companies benefit by being geographically close to similar firms, forming an innovation cluster. The reward for these innovators is greater long-term profit because they internally generate an advantage over their competitors. Those firms that can obtain patents for their products may benefit from monopoly control over price and thus revenue. This is widely seen the pharmaceutical industry when a company can charge relatively high prices until the patent expires and generic alternatives enter the market.

To innovative firms, a positive business climate invests in education, has a quality workforce of innovative employees, and a culture of invention, risk-taking, adaptation and entrepreneurship. Innovative firms and the employees they hope to hire are drawn to such communities by their cultural events, entertainment and arts venues, diverse dining opportunities and public services that include libraries, schools, parks and public safety.

States with higher levels of per capita income are more likely to have higher levels of education and a greater concentration of innovative firms, as measured by investments in R&D according to a new report, Innovation and Economic Performance: R&D within Wisconsin issued by the University of Wisconsin-Extension Center for Community and Economic Development, and the UW-Madison Department of Agricultural and Applied Economics. These trends indicate that innovative firms require access to people with higher levels of education, which in turn lead to higher levels of income.

Nationally, Wisconsin ranks 20th in innovation as measured by public and private R&D spending data gathered by the National Science Foundation. An average of $708 was spent per person in Wisconsin from 2010 to 2012. New York, North Carolina, Ohio and Texas are among larger states that are also in the middle of the pack. In the Midwest, Michigan, Minnesota and Missouri spend more than Wisconsin.

Businesses are the primary source of R&D spending. In Wisconsin, they account for 88 percent; another 10 percent comes from nongovernmental agencies such as the Wisconsin Alumni Research Foundation. The federal and state governments contribute the remaining 2 percent. There is an important distinction, though, between the source of spending and the organization actually doing R&D. While a large share of spending comes from businesses, some are not actually undertaking the R&D; rather, they finance or contract with other entities, such as the University of Wisconsin, to actually conduct the R&D.

In fiscal year 2015, UW-Madison spent $1.07 billion on R&D, ranking sixth in the nation, down from fourth place, the first time in 44 years Wisconsin was not in the top five. The Medical College of Wisconsin, which expended the second largest amount of Wisconsin universities, spent $200 million. Other schools around the country are increasing their R&D spending.

One reason so many firms contract with other parties, such as the UW, to conduct R&D is that they tend to shy away from basic research, the expensive systematic study undertaken to gain knowledge without specific applications toward processes or products in mind. The potential marketability of the results from basic research is too uncertain and risky for private businesses to pursue. Innovative businesses would rather partner with those institutions that are better positioned to undertake that basic research. Firms themselves more often concentrate on applied research, which involves the systematic and practical application of science for a specific, profit-driven purpose.

The industries that spend the most on R&D nationally are underrepresented in Wisconsin. Nationally, the firms that pursue quality competition are in computers and electronics, chemicals and pharmaceuticals, information technology and transportation equipment. These innovative industries employ few Wisconsin workers. The sectors that hire the most Wisconsinites, largely manufacturing, tend not to invest in innovation as measured by total spending across the U.S. In other words, compared to the nation as a whole, Wisconsin firms tend to engage more often in ordinary competition rather than quality competition. This lack of activity in the nation's most innovative industries could limit Wisconsin's potential for sustained economic growth and development.

Wisconsin's emphasis on industry clusters as a model for economic development is a good start. As listed by the non-profit Wisconsin Economic Development Institute, these clusters include wind energy, biotechnology, food products and processing, and others, with emerging opportunities in information technology and medical devices. But for economies to thrive, more than geographical proximity is necessary.

Effective clusters include firms that value people and innovation — in addition to being connected through shared specialized suppliers and service providers. Environments that facilitate networking and learning opportunities for employees can help these firms gain technological savvy, an entrepreneurial culture and emphasis on learning, helping them adapt to changing market conditions. Effective economic clusters thrive on quality competition, not ordinary competition.

For companies, communities and states that want to attract innovative firms and reap the potential gains for employees and households, effective strategies may include developing place-making through good schools and libraries, fostering quality-competition-focused industrial clusters and cultivating a culture of invention.

In addition to investing in quality public education to train the workforce, the public sector can promote public-private partnerships to facilitate networking for business leaders and the overall workforce, notes another report, Innovation and Economic Performance: Strategy Options for Wisconsin, also issued by the UW-Extension Center for Community and Economic Development, and the UW-Madison Department of Agricultural and Applied Economics. These opportunities can be one-time workshops and seminars organized by higher education institutions, ongoing professional development courses or more social gatherings for networking. Local or regional economic development organizations can partner with business to offer continuous learning opportunities for specific industries and for the workforce.

Prior research has shown that despite Wisconsin ranking low in new firm formation, most of the state's job creation comes from start-up companies. As seen through the lens of quality competition and innovation, the low start-up rates could be considered troublesome because new firms often bring innovations to the market.

Governments can invest in innovation through tax credits for R&D by small and medium firms, low-interest loans, grants or loan guarantees to help small and medium firms adopt new technologies, grants for professional development, technical assistance and opportunities for international networking. In addition, high-quality employees attracted to such innovative firms will want to live in communities with good schools, opportunities for recreation, natural amenities and cultural events. Local communities can invest in these resources, and the state can offer incentives for them in the form of grants and loans. The greater profits to be had from quality competition, however, can take longer to realize than the short-term gains of ordinary competition, especially if a community lacks the features that attract these firms and their employees.

In reality, the most profitable firms balance ordinary and quality competition by investing in innovations while keeping an eye on costs. Policymakers in individual communities can form regional partnerships to foster long-term economic growth, a popular goal for residents who want to make their hometowns better for their children. State policymakers could support these efforts, but the political cycle often leads to policies that favor ordinary competition and its emphasis on short-term gain.

Tessa Conroy is an economic development specialist at the University of Wisconsin-Extension Center for Community and Economic Development and an assistant professor in the UW-Madison Department of Applied & Agricultural Economics. Steven Deller is a community development specialist at the Center and a professor in the UW-Madison Department of Applied & Agriculture Economics. Partial support for this work came from the U.S. Department of Commerce Economic Development Administration University Center at the University of Wisconsin-Extension.