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USJI Voice Vol.29

Role of the Government in Promoting Small, Innovative Firms

September 12,2017
Yamaguchi Eichi
Eiichi Yamaguchi
Professor, Kyoto University

1. The Loss of Innovation Model in Japan

Since the turn of the century, scientific research in Japan has stagnated. The number of published academic articles from Japan has stalled, falling far behind the publication numbers of the United States, which leads the field, and China, which is rapidly catching up. The stagnancy is noticeable even when compared to the publication numbers of Britain and Germany.

Looking at the breakdown of publication numbers in the top 100 fields, Japanese publication numbers are declining in 61 such fields, which include applied physics, materials science, solid-state physics, and molecular biology. These fields represent the areas of scientific research that are directly connected to industry. As to the reason behind this trend, one theory is that the shift of the business world away from scientific research in the late 1990s led to many young and talented scientists losing hope in their field of study and abandoning the pursuit of future research.

During the 1960s, a succession of Japanese businesses established central research institutes for engaging in basic research. These were modeled after the research organizations of U.S. firms like AT&T and IBM. At the time, 80% of Japanese research and development (R&D) funding came from private companies, with the central research institutes playing a core role.

However, the late 1990s saw high-tech companies like NTT, Hitachi, NEC, and Sony downsize their central research institutes and retreat from their basic research. With organizational frameworks remaining intact and R&D funds remaining at the same level, staff numbers were reduced and the scope of research was narrowed. Accordingly, many scientists and technicians were redeployed away from the frontline of research. Here too Japanese businesses were following the example of their U.S. counterparts in placing the priority on shareholders’ interests. AT&T, IBM, and other U.S. firms had successively withdrawn from basic research, which required a long-term perspective.

2.The Birth of a New Innovation Model: The SBIR Program

The 1990s thus saw the end of the central research institution-based innovation model in both Japan and the United States. However, while the United States created an alternative model of scientific innovation, Japanese one was lost. What happened?

This divergence is attributed to an incident in 1982, when the U.S. government enacted the Small Business Innovation Research (SBIR) program. The mission of the SBIR program is to encourage innovation by providing funding via eleven federal agencies , including the Department of Defense, the Department of Health and Human Services, and the Department of Energy, to young and as-yet-unknown scientists. To date, the program has funded over 40,000 small businesses.

The program has numerous distinctive features. First, federal agencies with extramural research funds that exceeded $100 million are legally obligated to allocate a certain portion of their extramural research funds to the SBIR program. This portion has steadily increased over the years, reaching 3.2% in 2017, a total funding of $2.5 billion.

Second, there is a robust three-phase program for supporting innovation among small businesses. Businesses selected for Phase I are eligible to receive an award of seed money for high-risk innovation, up to $150,000 in total cost for 6 months. Phase I awardees are then eligible for a Phase II award, which is up to $1,000,000 in total cost for 2 years. In Phase III, small businesses are introduced to venture capital funding from non-SBIR sources and provided management advice.

Also of note regarding Phase III is the fact that some federal agencies such as the Department of Defense may enter a production contract with an awarded small business for research products that the U.S. government wishes to procure. Since the technologies and products that created by scientists associated with these small business under this kind of system did not exist previously, there is not yet any market for them. When the government purchases these technologies and products, it is effectively creating a market for them, thus stimulating the growth of the business.

The above features of the SBIR make one thing abundantly clear: the program founded on the concept of science-driven innovation is susceptible to market failure. Commencing basic research with the hope of ultimately deriving a concrete technology or product is a highly risky proposition. Therefore, businesses and investors who rely on the players in the market economy will often fail to obtain the necessary funding. To address this problem, the government uses its tax revenue to provide financial assistance to young and as-yet-unknown scientific innovators, which helps them survive the perilous early period of entrepreneurship.

3.The Japanese SBIR Program and Its Failure

In 1999, Japan followed the United States’ example by launching its own version of the SBIR program (Chūshō kigyō gijutsu kakushin seido; “Program for Small and Medium Business Technological Innovation”). However, the Japanese SBIR program was designed to provide financial assistance to existing small/medium businesses. In this sense, it is fundamentally different from its U.S. counterpart, whose mission is to generate entirely new technologies, products, and businesses by transforming young scientists into innovators.

A comparison of the net sales for the years 2006-2011 of businesses selected for the Japanese SBIR program with those of businesses that were not selected showed that, among the selected businesses, average net sales per business declined by 200 million and among the non-selected businesses it increased by 70 million. Thus, the SBIR-selected businesses showed worse performance than those not selected. This finding clearly denotes that priority for funding was given to small/medium businesses that were performing poorly.

Lacking the mindset to transform young scientists into entrepreneurs, the Japanese program ended up becoming nothing more than a vehicle for propping up existing small/medium businesses. This fact is also attested by an academic background analysis, in which the SBIR programs of Japan and U.S. are compared in terms of the academic expertise of the representatives of the SBIR-selected organizations. Whereas only 7.7% of the representatives of organizations selected for the Japanese SBIR program have a PhD, the equivalent figure for the U.S. program is 74%.

There is also a critical difference in terms of whether the PhD is in basic science. Among the 7.7% of Japanese representatives with a PhD, most have their doctoral degrees in a non-basic science subject like engineering, agriculture, or medicine. On the other hand, of the 74% of U.S. representatives with a PhD, the majority have a doctoral degree in a pure science subject such as chemistry, physics, or biology/life science. This finding reflects the difference in mindset: the U.S. SBIR program targets young and as-yet-unknown scientists who would otherwise remain in university and incentivizes them to engage in entrepreneurship.

4. Toward a New Innovation Model

To trigger innovation, there must be an interplay between knowledge creation and value creation. In my innovation diagram, the former is the horizontal axis and the latter is the vertical axis (see Fig.1).

One starts with knowledge creation—“science”—and uses this paradigm to create new value—“technology.” Technology is what gives science its value; that is the starting point.
Usually, people try to develop existing technologies so that they impart this added value. I call this “paradigm sustaining innovation.” However, paradigm sustaining innovation will always reach an impasse.

What happens once we ended up in this impasse? One must go back to our established knowledge of science and engage the knowledge, what we might call “the soil of science” to discover a new paradigm, as shown in Fig.1. This new paradigm will then enable the creation of new value. I call this “paradigm disruptive innovation.”

What was the impact of the demise of the central research institutes of large companies during the 1990s? This demise meant that the knowledge in the soil was excised and cast out from the innovation paradigm. Consequently, emergent knowledge creation became impossible, and paradigm disruptive innovation dried up.

The key to truly effective academic–industrial cooperation is to create a field of resonance wherein the existential desires of the actors of knowledge creation resonate with those of the actors of knowledge embodiment. The U.S. SBIR program enables such a field of resonance to exist by encouraging inventors of technology or their team members to develop a business venture.

If physicists, for example, limit their attention to physics, no new innovation will emerge. For birth of new innovation, academics must traverse two or more domains; for example, there must be physicists who also engage in psychology, or physicists who also engage in philosophy. However, this does not mean engaging in econophysics and the like. The importance lies in mastering the ability to cross over into multiple domains, which I call “transilience.”

To systematize such academic transilience, I prepared a map of academic disciplines. I call this the academic landscape. Using Google search, I identified 39 disciplines that are well known to all. I then used Google Scholar to plot the distance between each of these disciplines. As shown in Fig. 2, the resulting landscape shows 10 central disciplines aligned like a constellation. These are mathematics, physics, informatics, chemistry, life science, psychology, philosophy, economics, law, and ecology.

The connections among these disciplines allow interdisciplinary teams to be formed, or individual researchers to specialize in multiple disciplines. For Japan, gripped as it is with an inward silo mentality, this is the only way forward. Physics expert does not know jargons of biological science. Those in the humanities cannot understand the language of science. Therefore, we need a field where each side resonates with the other. Breakthroughs will be achieved through the mutual understanding of each other’s existential needs. It is only by systematically practicing such knowledge transilience that Japan can close the gap and stand at the frontline once again.

 

Related USJI Research Project by the Author
United States – Japan Comparison of the Influence for SBIR Programs on Creating New Industries


The USJI Voice is a policy-related opinion paper produced by researchers at USJI-affiliated universities. The USJI Voice is written for experts in areas connected to U.S.-Japan relations. Please share with us your opinions and suggestions related to your areas of interest.

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