Executive Summary
In order to realize the world’s commitment to ensuring education for all by 2015, important innovations and reforms will be needed in the governance and financing of global education. In 2008, Presidential Candidate Barack Obama committed to making sure that every child has the chance to learn by creating a Global Fund for Education. Secretary of State Hillary Clinton has recently called for a new architecture of global cooperation that requires institutions to “combine the efficiency and capacity for action with inclusiveness.” A new Global Fund for Education should be an independent and inclusive multi-stakeholder institution that builds upon existing institutions and supports country-driven solutions. It must be capable of mobilizing the approximately $7 billion annually still needed to achieve education for all, while holding all stakeholders accountable for achieving results with these resources.

None of these objectives will be achieved without a major rethinking of the global education architecture and an evolution of current mechanisms for financing education. More than 75 million children remain out of primary school, and only 53 of the 171 countries with available data have achieved gender parity in primary and secondary education. Achieving these two Millennium Development Goals, and the broader Education for All Goals set out by 164 countries, will require more capable international institutions. A Global Fund for Education that links funding to performance, that ensures a greater share of resources reach schools and that coordinates the efforts of diverse stakeholders is essential to putting these goals within reach.

In order to realize President Obama’s vision for creating a Global Fund for Education, significant leadership by the United States on global education will be needed in the coming year. A clear commitment by the United States to leverage the contributions of other nations and work together to support country-driven strategies through a Global Fund for Education could catalyze unprecedented international energy around achieving education for all.

Policy Brief #169

Learning from Existing and Innovative Mechanisms

The Global Fund for Education should reflect an evolution of the successful elements of existing multilateral mechanisms. Seven years ago, the Fast Track Initiative (FTI) was launched as the primary financing vehicle for achieving education for all. Working with key donors and international institutions, the FTI was supposed to mobilize the resources needed to close the massive education-financing gap. Housed within the World Bank, the FTI has not yet been able to build a strong public brand, engage the support of a number of leading donors or mobilize adequate resources from major donor countries.

The FTI has not been capable of generating resources on a scale consistent with its founding vision of achieving universal education for all. Although the FTI initially focused on expanding bilateral investments in education, in 2003 it created a multilateral Catalytic Fund to mobilize additional resources with an early focus on countries without major bilateral donors. In 2006, the FTI’s multilateral Catalytic Fund represented approximately 2% of aid commitments to basic education. Although the number of countries contributing to the Catalytic Fund has increased in recent years, many of the biggest donors are still not participating, and just three countries accounted for over 70% of total pledges in 2008. As a result, the FTI faces a shortfall of $1.2 billion for the coming year, which is more than all the money it has received from donors in the last six years. Although many countries endorsed by the FTI have experienced increases in bilateral basic education funding, their share of overall assistance focused on basic education has not increased, a fact that makes it hard to rule out the possibility that overall aid trends were largely responsible for that growth.

The FTI has recently undertaken a set of internal governance reforms designed to improve its performance, but these changes alone are unlikely to overcome some of the structural challenges it still faces. Without independent capacity for action, more inclusive governance, greater attention to conflict-affected countries and stronger accountability for results the FTI will not be able to mobilize sufficient resources or deliver the results that it was set up to achieve. At the same time, the FTI’s model of requiring and supporting the development of comprehensive national education strategies and seeking to align donor funding around these strategies should be incorporated in any evolution to a Global Fund for Education. Similarly, the FTI’s ambition of aligning bilateral flows along with multilateral funding remains an important objective to ensure that all types of donor funding are being fully leveraged.

A Global Fund for Education should also draw on the successful experience of other innovative global development financing mechanisms. Among the most successful of these new institutions is the Global Fund to Fight AIDS, Tuberculosis, and Malaria (GFATM). Since its inception, the GFATM has generated commitments of over $20 billion and is now the leading source of external financing for tuberculosis and malaria. One of the keys to the GFATM’s success in resource mobilization has been the strong engagement of both civil society and developing countries as full partners with donors in its governance. Civil society representatives and developing countries have equal standing in decision-making at the global level within the GFATM. As a result, civil society stakeholders have been at the center of the largely successful drive for resource mobilization for the Fund and partner countries are more invested in its success.

Toward a Global Fund for Education

The core mission of the Global Fund for Education should be to mobilize the financing needed to achieve universal quality education. Linking successful early learning with meaningful opportunities for secondary education, the Global Fund for Education should maintain a focus on achieving universal quality basic education for all while also supporting early childhood learning and secondary schooling as part of a comprehensive approach to education. The GFE should be guided by a set of core principles, focused on key objectives, and reflect an evolution of existing mechanisms:

1. Independent Capacity for Action

Independence from any other international institution will be essential to establish the public profile necessary to succeed in this resource mobilization challenge. The independence of the Global Fund to Fight AIDS, Tuberculosis and Malaria has been a key to its success, while the lack of independence of the FTI has been a primary obstacle to its ability to mobilize sufficient resources. An independent Global Fund for Education should still leverage the expertise and commitment of other international institutions, such as UNESCO, UNICEF and the World Bank. Technical experts from these institutions can play an important role in supporting countries both in the development of national strategies and in the effective implementation of these strategies.

2. Inclusive Governance

Inclusive governance will be critical to building a multi-stakeholder constituency that is committed to mobilizing resources. Developing countries, civil society and donor countries should be equal partners in a system in which there is equal representation and the support of each constituency is necessary for major decisions. Such a requirement in the governance structure of the GFE will not only strengthen the internal decision-making process by subjecting it to the scrutiny of diverse perspectives but will also provide external legitimacy and increase the effectiveness of its implementation efforts. Without such inclusiveness, the Global Fund for Education will not be able to succeed in either mobilizing donors to make education a top priority nor in ensuring that these resources are being well-spent in partner countries.

3. Country-Driven Solutions

Developing countries should set the agenda for the best approach for themselves through the development of comprehensive national education strategies. The Global Fund for Education should build on the FTI’s ambition of aligning donor investments around comprehensive national education plans that reflect country-driven solutions. In order to ensure that strategies are truly national—not simply government plans—the Global Fund for Education should mandate that civil society and other non-governmental stakeholders are full partners in the development of these strategies at the national level. Just as inclusive participation at the global level supports effective resource mobilization, ensuring full participation at the national-level supports effective implementation by diverse stakeholders.

4. Accountability for Results

Accountability must be central to the design of the Global Fund for Education. Systems to ensure financial accountability and that money actually reaches the school level and helps students learn are essential to the effectiveness of the Fund. Performance-based disbursement, which connects continued funding with demonstrated results, is the best way to create incentives for recipient countries to deliver on promised results. In addition, key indicators including gains in enrollment, gender equity and student learning outcomes should be included among performance measures. Utilizing improved measures for assessing student learning will be critical to improving completion rates and maximizing the development gains from education. In order to ensure some reasonable predictability of financing, countries that show strong performance should be eligible for extensions of funding over significant periods.

5. Focus on Low-Income and Conflict-Affected States

Given the inevitable limits on the resources of the Global Fund for Education, it is important to establish an allocation principle for distributing funding. First, the eligibility for funding should be limited to low-income countries, or those countries that are eligible for funding under the World Bank’s IDA window. Second, there should be special attention to the challenges of states currently experiencing or emerging from conflict and mechanisms to ensure support for education in these states. Third, the GFE should prioritize those countries categorized as least-developed and that have the most limited national resources. Finally, funding should generally be linked to the level of effort by national governments in supporting education.

6. Leverage and Align Donor Resources

The Global Fund for Education holds enormous promise for mobilizing funding from a diverse array of donors. Just as the Global Fund to Fight AIDS, Tuberculosis, and Malaria has leveraged a two-to-one match of U.S. resources from the rest of the world, the Global Fund for Education could similarly leverage global resources for education. In order to ensure adequate incentives for countries to contribute their fair share, donor board seats should be allocated and adjusted with reference to donor contributions. In addition, there should be a regularized replenishment process built into the initial design that is linked to the overall resource needs for universal education and that encourages long-term commitments by donors. The GFE should also be committed to providing multiple channels for donor assistance, both bilateral and multilateral, as long as these funds are truly aligned with national strategies. While there is a clear need to expand multilateral financing for education far beyond what has been possible to date, it is also important that ongoing bilateral commitments are much better integrated with the objectives of national education strategies.

A Global Fund for Education holds the key to delivering on the world’s commitment to education for all by 2015. Evolving current mechanisms into a more independent, inclusive, and accountable institution can catalyze the resources and performance needed to achieve universal education. Since education is one of the most leveraged of all development investments, establishing a Global Fund for Education would make a major contribution to reducing global poverty, empowering women, and promoting economic growth in low-income countries around the world.

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Nearly eight years after a U.S.-led invasion toppled the Taliban regime, Afghanistan remains far from stable. As President Barack Obama considers alternatives to increasing the number of U.S. troops in Afghanistan, his administration’s new counternarcotics strategy meshes well with counterinsurgency and state-building efforts in the country. It is a welcome break from previous ineffective and counterproductive policies. The effectiveness of the policy with respect to counternarcotics, counterinsurgency and state-building, however, will depend on the operationalization of the strategy. The details are not yet clear, but the strategy potentially faces many pitfalls.

Efforts to bankrupt the Taliban through eradication are futile and counterproductive since they cement the bonds between the population and the Taliban. But interdiction is very unlikely to bankrupt the Taliban either. Security needs to come first before any counternarcotics policy has a chance of being effective. Counterinsurgent forces can prevail against the Taliban, without shutting down the Taliban drug income, by adopting an appropriate strategy that provides security and rule of law to the population and by sufficiently beefing up their own resources vis-à-vis the Taliban. Rural development is a long term and multifaceted effort. Simplistic strategies that focus simply on price ratios or try to raise risk through “seed-burn-seed” approaches are ineffective. Wheat replacement strategy as a core of the alternative livelihoods effort is singularly inappropriate for Afghanistan. Shortcuts do not lead to sustainable policies that also mitigate conflict and enhance state-building.

The Obama administration will need to reduce expectations for quick fixes and present realistic timelines to Congress, the U.S. public and the international community for how long rural development and other counternarcotics policies in Afghanistan will take to show meaningful and sustainable progress that advances human security of the Afghan people, mitigates conflict and enhance state building. Unless this is conveyed, there is a real danger that even a well-designed counternarcotics policy will be prematurely and unfortunately discarded as ineffective.

The New Strategy in Afghanistan’s Context

In summer 2009, the Obama administration unveiled the outlines of a new counternarcotics policy in Afghanistan. The new policy represents a courageous break with previous misguided efforts there and thirty years of U.S. counternarcotics policies around the world. Instead of emphasizing premature eradication of poppy crops, the new policy centers on increased interdiction and rural development. This approach strongly enhances the new counterinsurgency policy focus on providing security to the rural population, instead of being preoccupied with the numbers of incapacitated Taliban and al Qaeda.

In Afghanistan, somewhere between a third and a half of its GDP comes from poppy cultivation and processing and much of the rest from foreign aid, so the illicit poppy economy determines the economic survival of a large segment of the population. This is true not only of the farmers who cultivate opium poppy frequently in the absence of viable legal and illegal economic alternatives. But, as a result of micro- and macro-economic spillovers and the acute paucity of legal economic activity, much of the economic life in large cities is also underpinned by the poppy economy. After a quarter century of intense poppy cultivation, the opium poppy economy is deeply entrenched in the socio-economic fabric of the society. Islamic prohibitions against opiates notwithstanding, the poppy economy inevitably underlies Afghanistan’s political arrangements and power relations. Profits from taxing poppy cultivation and protecting smuggling rings bring substantial income to the Taliban. A recent CRS report (August 2009) estimates the income at $70-$100 million per year, which accounts for perhaps as much as half of Taliban income. But many other actors in Afghanistan profit from the opium poppy economy in a similar way: former warlords cum government officials; members of Afghanistan’s police; tribal chiefs; and independent traffickers.

Moreover, the Taliban and many others who protect the opium poppy economy from efforts to suppress it derive much more than financial profits. Crucially, they also obtain political capital from populations dependent on poppy cultivation. Such political capital is a critical determinant of the success and sustainability of the insurgency since public support or at least acceptance are crucial enablers of an insurgency. Indeed, as I detail in my forthcoming book, Shooting Up: Counterinsurgency and the War on Drugs, along with providing order that the Afghan government is systematically unable to provide and capitalizing on Ghilzai Pashtun sentiments of being marginalized, protection of the poppy fields is at the core of the Taliban support. By not targeting the farmers, the new counternarcotics strategy is thus synchronized with the counterinsurgency efforts because it can deprive the Taliban of a key source of support. Its overall design also promises to lay the necessary groundwork for substantial reductions in the size and impacts of the illicit economy in Afghanistan.

However, while appropriate in its overall conception, the new strategy has pitfalls. Specifically how to operationalize interdiction and rural development will to a great extent determine the effectiveness of the strategy—not only with respect to the narrow goal of narcotics suppression, but also with respect to counterinsurgency and state-building. While many of the details still remain to be developed, some of those that have trickled out give reasons for concern.

Effects of Previous Eradication-Centered Policy

During the 2008-09 growing season, the area of cultivation in Afghanistan fell by 22% to 123,000 hectares and opium production fell by 10 percent to 6,900 metric tons (mt). Much of this decline in cultivation was driven by market forces largely unrelated to policy: After several years of massive overproduction in Afghanistan that surpassed the estimated global market for opiates by almost three times, opium prices were bound to decline. Even at 6,900 mt, production still remains twice as high as world demand, leading to speculation that someone somewhere is stockpiling opiates.

More significant, the persistence of high production betrays the ineffectiveness of simplistic policies, such as premature forced eradication before alternative livelihoods are in place, which since 2004 (until the new Obama strategy) was the core of the counternarcotics policy in Afghanistan. Policies that fail to address the complex and multiple structural drivers of cultivation and ignore the security and economic needs of the populations dependent on poppy cultivation generate vastly counterproductive effects with respect to not only counternarcotics efforts, but also counterinsurgency, stabilization and state building.

The eastern Afghan province of Nangarhar provides a telling example. For decades, Nangarhar has been one of the dominant sources of opium poppy. But over the past two years, as a result of governor Gul Agha Shirzai’s suppression efforts—including bans on cultivation, forced eradication, imprisonment of violators and claims that NATO would bomb the houses of those who cultivate poppy or keep opium—cultivation declined to very low numbers. This has been hailed as a major success to be emulated throughout Afghanistan.

In fact, the economic and security consequences were highly undesirable. The ban greatly impoverished many, causing household incomes to fall 90% for many and driving many into debt. As legal economic alternatives failed to materialize, many coped by resorting to crime, such as kidnapping and robberies. Others sought employment in the poppy fields of Helmand, yet others migrated to Pakistan where they frequently ended up recruited by the Taliban. The population became deeply alienated from the government, resorting to strikes and attacks on government forces. Districts that were economically hit especially severely, such as Khogiani, Achin and Shinwar, have become no-go zones for the Afghan government and NGOs. Although those tribal areas have historically been opposed to the Taliban, the Taliban mobilization there has taken off to an unprecedented degree. The populations began allowing the Taliban to cross over from Pakistan, and U.S. military personnel operating in that region indicate that intelligence provision to Afghan forces and NATO has almost dried up. Tribal elders who supported the ban became discredited, and the collapse of their legitimacy is providing an opportunity for the Taliban to insert itself into the decision-making structures of those areas. And all such previous bans in the province, including in 2005, turned out to be unsustainable in the absence of legal economic alternatives. Thus, after the 2005 ban, for example, poppy cultivation inevitably swung back.

The Ingredients of Success

Security
The prerequisite for success with respect to narcotics is security, i.e. sustained state control of territory. Without it, Afghanistan cannot be stabilized and the state strengthened; nor can counternarcotics policies be effective. Whether one adopts iron-fisted eradication or sustainable rural development as the core of a counternarcotics policy, security is essential. Without security first, counternarcotics efforts have not yet succeeded anywhere. Suppression without alternative livelihoods in place requires firm control of the entire territory to prevent illicit crop displacement and harsh suppression of the population dependent on illicit crops. Apart from being problematic with respect to human rights, this harsh approach is also very costly politically. Rural development requires security, otherwise investment will not come in, the population will not make risky long-term investments in legal crops and structural drivers of cultivation will not be effectively addressed. Development under a hail of bullets simply does not work, and in the context of insecurity, illicit economies persist and dominate.

Nor have counternarcotics policies, such as eradication or interdiction, succeeded in bankrupting or severely weakening any belligerent groups profiting from drugs anywhere in the world. Not in China, Thailand, Burma, Peru, Lebanon or even Colombia. Instead, they cement the bonds between marginalized populations dependent on illicit crops and belligerents plus severely reduce human intelligence flows to the counterinsurgent forces.

But counterinsurgent forces can prevail against insurgents and terrorists without stopping or reducing the terrorists’ drug-based financial inflows—either by increasing their own forces and resources vis-à-vis the belligerents or by adopting a smarter strategy that is either militarily more effective or wins the hearts and minds. This was the case in China, Thailand, Burma, and Peru where counterinsurgents succeeded without eradication. Evidence that counterinsurgent forces can prevail without bankrupting the belligerents through eradication also holds in the case of Colombia where the FARC has been weakened militarily not because of the aerial spraying of coca fields, but in spite of it. Today, more coca is grown there than at the beginning of Plan Colombia; but as a result of U.S. resources and training, Colombian forces were capable of greatly weakening the FARC even though forced eradication virtually eliminated human intelligence from the population to the government.

Interdiction with the Right Focus
The broad focus of the new counternarcotics strategy on interdiction is well placed, but interdiction’s effectiveness will depend on its objectives and execution. Just like eradication, interdiction will not succeed in bankrupting the Taliban. The Taliban has many other sources of income, including donations from Pakistan and the Middle East, taxation of legal economic activity, smuggling with legal goods, wildlife and illicit logging. In fact, it rebuilt itself in Pakistan between 2002 and 2004 without access to the poppy economy. Overall, drug interdiction has a very poor record in substantially curtailing belligerents’ income, with only a few successes registered in, for example, highly localized settings in Colombia and Peru.

Instead, the objective of the policy should be to reduce the coercive and corrupting power of organized crime groups. But achieving that requires a well-designed policy and a great deal of intelligence. Previous interdiction efforts in Afghanistan have in fact had the opposite effect: they eliminated small traders and consolidated the power of big traffickers, giving rise to the vertical integration of the industry. They also strengthened the bonds between some traffickers and the Taliban (although many traffickers continue to operate independently or are linked to the government).

Large-scale interdiction that targets entire networks and seeks to eliminate local demand for opium from local traders, which some are arguing for, is extraordinarily resource-intensive given the structure of the Afghan opium industry. Prioritization will need to be given to devoting scarce resources to drug interdiction or directly to counterinsurgency. The odds of success are not high. But even if such an interdiction strategy did succeed in shutting down local demand, the policy would become counterproductive since in local settings its effects would approximate the effects of eradication, thus once again alienating the population. Such large-scale interdiction is thus not currently appropriate for Afghanistan.

But even the NATO-led selective interdiction of targeting designated Taliban-linked traffickers (the United States has identified fifty such traffickers) is not free from pitfalls. First, selective interdiction can actually provide opportunities for the Taliban to directly take over the trafficking role or strengthen the alliance between the remaining traffickers and the Taliban, thus achieving the opposite of what it aims for. In fact, interdiction measures in Peru and Colombia frequently resulted in tightening the belligerents-traffickers nexus and belligerents’ takeover of trafficking.

Second, uncalibrated interdiction can provoke intense turf wars among the remaining traffickers, thus intensifying violence in the country and muddling the battlefield picture by introducing a new form of conflict. Mexico provides a vivid example of such an undesirable outcome. In the Afghan tribal context, such turf wars can easily become tribal or ethnic warfare.

Third, such selective interdiction can also send the message that the best way to be a trafficker is to be a member of the Afghan government, thus perpetuating a sense of impunity and corruption and undermining long-term state building and legitimacy.

Finally, the effectiveness of interdiction is to a great extent dependent on the quality of rule of law in Afghanistan plus the capacity and quality of the justice and corrections systems, all of which are woefully lacking in Afghanistan and are deeply corrupt.

Comprehensive Rural Development
Rural development appropriately lies at the core of the new strategy because, despite the enormous challenges, it has the best chance to effectively and sustainably strengthen the Afghan state and reduce the narcotics economy. But for rural development to do that, it needs to be conceived as broad-based social and economic development that focuses on improvements in human capital—including health care and education—and addresses all of the structural drivers of opium poppy cultivation. In Afghanistan, these drivers include insecurity; lack of physical infrastructure (such as roads), electrification and irrigations systems; lack of microcredit; lack of processing facilities; and the absence of value-added chains and assured markets. They also include lack of land titles and, increasingly, the fact that land rent by sharecroppers has become dependent on opium poppy cultivation as land concentration has increased over the past eight years. Poppy cultivation and harvesting are also very labor-intensive, thus offering employment opportunities unparalleled in the context of Afghanistan’s economy.

The price-profitability of poppy in comparison to other crops is only one of the drivers and frequently not the most important one. Without other structural drivers being addressed, farmers will not switch to licit crops even if they fetch more money than the illicit ones. By the same token, however, farmers are frequently willing to sacrifice some profit and forgo illicit crop cultivation as long as the licit alternatives bring them sufficient income and address all of the structural drivers, including the insecurity to which farmers are exposed in illicit economies.

Unfortunately, the wheat distribution program that was the core of rural development in Afghanistan last year (and that is slated to be its key component this year) is likely to be woefully ineffective for several reasons. First, in 2008, the program was based solely on an unusually high price ratio of wheat to poppy, driven by poppy overproduction and a global shortage of wheat. However, this price ratio is unlikely to hold; Afghanistan’s wheat prices are dictated anyway by surrounding markets, such as Pakistan and Kazakhstan. Second, the program did nothing to address the structural drivers. In fact, it had counterproductive effects because the free distribution of wheat undermined local markets in seeds. Afghan farmers can obtain seeds; their challenge lies in how to obtain profit afterwards. Thus, some sold the wheat seed instead of cultivating it. Third, those who actually cultivated wheat frequently did so not for profit, but for subsistence to minimize costs of buying cereals on the market. In fact, because of land distribution issues, many Afghan farmers do not have access to enough land to cover even their subsistence needs with wheat monocropping. A key lesson from alternative development over the past thirty years is that monocropping substitution strategies are particularly ineffective. Fourth, if all of current poppy farmers switched to wheat cultivation, Afghanistan would experience a great increase in unemployment since wheat cultivation employs 88% less labor than poppy cultivation and harvesting do.

Instead of wheat, rural development in Afghanistan needs to emphasize diversified high-value, high-labor-intensive crops, such as fruits, vegetables and specialty items like saffron. Generating lasting off-farm income opportunities will also be important, but even more challenging than jump-starting legal agromarkets.

After eight years of underresourcing and neglecting agriculture development, the new counternarcotics policy’s focus on the farm is appropriate. But the new strategy needs to take care not to throw away the baby with the bath water. The effort still needs to include developing value-added chains and assured internal and external markets plus enabling sustained access to them. Once again, thirty years of history of alternative livelihoods show that without value-added chains and accessible markets even productive legal farms become unsustainable and farmers revert back to illicit crops.

Finally, rural development requires time. Perhaps in no country in the world since Mao wiped out poppy cultivation in China in the 1950s did counternarcotics efforts face such enormous challenges as they do in Afghanistan—in terms of the scale of the illicit economy, its centrality to the overall economy of the country and hence its vast marco- and micro-economic and political effects, the underdevelopment of the country and its human capital and the paucity of viable economic alternatives. Even under much more auspicious circumstances along all the above dimensions, counternarcotics rural development in Thailand took thirty years.

Conclusion

Clearly, there is a need to quickly bring some economic, social and rule of law improvements to the lives of the Afghan people. Without such quick, visible and sustainable change, it will become impossible to rebuild the confidence of the Afghan people in the future, harness their remaining aspirations and to persuade them that the central state with support of the international community is preferable to the Taliban or local warlord- or tribal-based fiefdoms. But there is an equal need to urge strategic patience in the United States—both for counterinsurgency and for counternarcotics.

Eradication can be a part of the mix of counternarcotics policies, but should only be adopted in areas that are free of violent conflict and where sufficient legal economic alternatives are available to the population. Interdiction needs to focus on reducing the coercive and corrupting power of crime groups. Before interdiction measures are undertaken, an analysis of second and third- order effects needs to be conducted. It needs to be carefully calibrated with the strength of law enforcement in Afghanistan to avoid provoking dangerous turf wars, ethnic violence and cementing the relationship between the Taliban and the traffickers. It also needs to target top traffickers linked to the Afghan government. Interdiction needs to encompass building the justice and corrections system in Afghanistan and broad rule of law efforts. Rural development needs to address all structural drivers of poppy cultivation. It needs to focus not only on the farm, but also on value-added chains and assured markets. It needs to emphasize diversified high-value, high-labor intensive crops, and not center on wheat.

Evaluations of counternarcotics policies need to back away from simplistic and inappropriate measures, such as the numbers of hectares eradicated or traffickers caught. Instead, the measures need to encompass the complexity of the issue, including, size of areas cultivated with licit as well as illicit crops, human development indexes, levels of education, the number of resource-poor farmers dependent on illicit crops for basic subsistence or vulnerable to poverty-driven participation in illicit economies, food security, availability of legal microcredit, prevalence of land titles and accessibility of land, infrastructure density and cost of infrastructure use (such as road tolls), availability of non-belligerent dispute resolution and arbitrage mechanisms, quality of property rights, prevalence of value-added chains, and accessibility of markets. The United States and its allies must reduce public expectations for quick fixes and dedicate increased resources to rural development for a long time. Although U.S. forces do not need to stay in Afghanistan for decades, economic development will take that long.

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Policy Brief #172

Why Institutions Matter

When experts and pundits are asked what the president and Congress should do to promote economic growth, they typically respond with a list of policies, often mixed with stylistic and political suggestions. Few focus on institutional change, which is too easy to conflate with yawn-inducing “governmental reorganization.”

This neglect of institutions is always a mistake, never more than in times of crisis. Throughout American history, profound challenges have summoned bursts of institutional creativity, with enduring effects. The dangerous inadequacies of the Articles of Confederation set the stage for a new Constitution. The Civil War resulted in three amendments that resolved—at least in principle—our founding ambivalence between the people and the states as the source of national authority, between the states and the nation as the locus of citizenship, and between slavery and the equality the Declaration of Independence had proclaimed and promised. Similarly, the Federal Reserve Board, Bretton Woods international economic system, Department of Defense, National Security Council, CIA, Congressional Budget Office and Department of Homeland Security all arose through changes occasioned by great challenges to the nation.

Today’s economic crisis is reflected in three distinct but linked deficits—the fiscal deficit, the savings deficit and the investment deficit. Meeting these challenges and laying the foundation for sustained economic growth will require institutional as well as policy changes. 

	RECOMMENDATIONS
	Today’s economic crisis is characterized by three distinct but linked deficits—the fiscal deficit, the savings deficit and the investment deficit. Meeting these challenges and laying the foundation for sustained economic growth will require institutional as well as policy changes. The following institution-based recommendations would help the nation meet the current economic crisis and could help prevent future crises of similar destructiveness. To promote fiscal sustainability, change longterm budget procedures and create empowered commissions—answerable to Congress but largely insulated from day-to-day politics. To boost savings, consider new mandatory individual retirement accounts as a supplement to Social Security. To improve public investment, create a National Infrastructure Bank with public seed capital—this entity would mobilize private investment and force proposed projects to pass rigorous cost-benefit analysis as well as a market test. Today’s polarized political system is an obstacle to reform in every area, including the economy. A multi-year collaboration between Brookings and the Hoover Institution produced a series of suggestions. At least two of those suggestions are worth adopting: Alter redistricting authority, so state legislatures can no longer practice gerrymandering. Experiment, in a few willing states, with compulsory voting—to move politicians away from the red-meat politics of appealing only to their bases, which now dominate elections, and toward a more moderate and consensual politics.

Institutional reform

Promoting fiscal sustainability

Setting the federal budget on a sustainable course is an enormous challenge. If we do nothing, we will add an average of nearly $1 trillion to the national debt every year between now and 2020, raising the debt/ GDP ratio to a level not seen since the early 1950s and sending the annual cost of servicing the debt sky-high. Restoring pay-as-you-go budgeting and putting some teeth in it are a start, but not nearly enough. We need radical changes in rules and procedures.

One option, recently proposed by a bipartisan group that includes three former directors of the Congressional Budget Office, would change the giant entitlement programs: Social Security, Medicare and Medicaid. The new rules would require a review every five years to determine whether projected revenues and outlays are in balance. If not, Congress would be required to restore balance through dedicated revenue increases, benefits cuts or a combination. After a financial crisis in the early 1990s, Sweden introduced a variant of this plan, which has worked reasonably well.A number of Brookings scholars—including Henry Aaron, Gary Burtless, William Gale, Alice Rivlin and Isabel Sawhill—have suggested a Value Added Tax (VAT) as part of a program of fiscal and tax reform. Burtless offers an intriguing proposal that would link a VAT to health care finance. Revenue from the VAT would be dedicated to—and would cover—the federal share of health care programs. If the federal cost rises faster than proceeds from the VAT, Congress would have to either raise the VAT rate or cut back programs to fit the flow of funds. The system would become much more transparent and accountable: because the VAT rate would appear on every purchase, citizens could see for themselves the cost of federal support for health care, and they could tell their representatives what balance they prefer between increased rates and reduced health care funding.

Another option draws on the experience of the Base Realignment and Closure Commission, which enables the military to surmount NIMBY politics and shut down unneeded bases. The basic idea is straightforward: once the independent commission settles on a list of proposed closures, Congress has the option of voting it up or down without amendment. A similar idea undergirds the president’s “fast-track” authority to negotiate proposed trade treaties, which Congress can reject but cannot modify.

Suitably adapted, this concept could help break longstanding fiscal logjams. Here is one way it might work. Independent commissions with members from both political parties could submit proposals in designated areas of fiscal policy. To increase bipartisan appeal, each proposal would require a super-majority of the commission. In the House and Senate, both the majority and the minority would have the opportunity to offer only a single amendment. This strategy of “empowered commissions” changes the incentive structure in Congress, reducing negative logrolling to undermine the prospects of proposals that would otherwise gain majority support.

Empowered commissions represent a broader strategy—using institutional design to insulate certain activities from regular and direct political pressure. For example, the Constitution mandates that federal judges, once confirmed, hold office during “good behavior” and receive salaries that Congress may not reduce during their term of service. (By contrast, many states subject judges to regular election and possible recall.) In another striking example, members of the Board of Governors of the Federal Reserve Board are appointed to 14-year non-renewable terms, limiting the ability of the executive branch to change its membership rapidly and removing governors’ incentives to trim their policy sails in hopes of reappointment. Additionally, action by neither the president nor any other entity in the executive branch is required to implement the Fed’s decisions, and Fed chairmen have been known to take steps that vex the Oval Office.

This strategy is controversial. Officials with populist leanings often argue that fundamental decisions affecting the economy should be made through transparent democratic processes. The counterargument: experience dating back to the founding of the republic suggests that when interest rates and the money supply are set at the whim of transient majorities, economic growth and stability are at risk.

Boosting savings

An adequate supply of capital is a precondition of long-term economic growth, and household saving is an important source of capital. During the 1960s, U.S. households saved 12 percent of their income; as recently as the 1980s, that figure stood at 8 percent. By 2005–2006, the savings rate dipped into negative territory, and today it stands at a meager 3 percent. In recent years, funds from abroad—principally Asia— filled the capital gap. But evidence is accumulating that foreign governments have reached the limit of their appetite (or tolerance) for U.S. debt. To avert a capital shortage and soaring interest rates, which would choke off growth, we must boost private savings as we reduce public deficits.

For a long time, tax incentives for saving have been the tool of choice. But as evidence mounts that these incentives are less effective than hoped, policy experts are turning to alternatives. One rests on a key finding of behavioral economics: default settings have a large impact on individual conduct and collective outcomes. If you require people to opt in to enter a program, such as 401(k) retirement plans, even a modest inconvenience will deter many of them from participating. But if you reverse the procedure— automatically enrolling them unless they affirmatively opt out—you can boost participation.

To achieve an adequate rate of private saving, we may need to go even further. One option is a mandatory retirement savings program to supplement Social Security. Workers would be required to set aside a fixed percentage of earnings and invest them in generic funds—equities, public debt, private debt, real estate, commodities and cash. For those who fail to designate a percentage allocation for each fund, a default program would take effect. (Participants always would have the option of regaining control.) As workers near retirement age, their holdings would be automatically rebalanced in a more conservative direction. One version of this proposal calls for “progressive matching,” in which low-earning individuals receive a subsidy equal to half their payroll contributions; those making more would get a smaller match along a sliding scale, and those at the top would receive no match at all.

This strategy requires careful institutional and programmatic design. To ensure maximum benefits to wage earners, the private sector would be allowed to offer only funds with very low costs and fees. To ensure that the program actually boosts net savings, individuals would be prohibited from withdrawing funds from their accounts prior to retirement; except in emergencies, they would not be allowed to borrow against their accounts; and they would be prohibited from using them as collateral. And a clear line would be drawn to prevent government interference in the private sector: while government-administered automatic default investments would be permitted, government officials could not direct the flow of capital to specific firms.

Improving public investment

The investment deficit has a public face as well. Since the early 19th century, government has financed and helped build major infrastructure projects—roads, bridges, ports and canals, among others, have spurred economic growth and opened new domestic and international markets. Recently, however, public infrastructure investment has fallen well short of national needs, and often has been poorly targeted. Americans travelling and working abroad are noticing that U.S. infrastructure is falling behind not only advanced countries’ but rapidly developing countries’ as well. A study by Emilia Istrate and Robert Puentes of Brookings’s Metropolitan Policy Program, presented in a December 2009 report entitled “Investing for Success,” documents three key shortcomings of federal infrastructure investment: it lacks long-term planning, fails to provide adequately for maintenance costs, and suffers from a flawed project selection process as benefits are not weighed rigorously against costs.

Istrate and Puentes explore several strategies for correcting these deficiencies. One of the most promising is a National Infrastructure Bank (NIB), to require benefit-cost analyses of proposed projects, break down financial barriers between related types of investment (facilitating inter-modal transportation, for example), and improve coordination across jurisdictional lines. The NIB could be funded through a modest initial infusion of federal capital designed to attract private capital. Projects receiving loans from the NIB would have to provide for depreciation and document the sources of funds to repay the face amount of each loan, plus interest. In short, the NIB would be more than a conduit for the flow of federal funds; it would function as a real bank, imposing market discipline on projects and making infrastructure investments attractive to private capital, partly by providing flexible subordinated debt.

Istrate and Puentes identify diverse problems that designers of an NIB would confront. Insulating the selection process from political interference would pose serious difficulties, as would providing federal seed capital without increasing the federal deficit and debt. Requiring the repayment of loans could skew project awards away from projects that cannot easily charge user fees—wastewater and environmental infrastructure projects, for example. Despite these challenges, a properly designed bank could increase the quantity of infrastructure investment while improving its effectiveness, reducing bottlenecks and promoting economic efficiency. The potential benefits for long-term growth would be considerable.

Creating the Political Conditions for Reform

The rise of political polarization in recent decades has made effective action much more difficult for the U.S. government. Polarization has impeded efforts to enact even the progrowth reforms sketched in this paper. A multiyear collaboration between the Brookings and Hoover Institutions—resulting in a two-volume report, Red and Blue Nation?, with Volume One published in 2006 and Volume Two in 2008— has mapped the scope of the phenomenon. This effort has shown that, while political elites are more sharply divided than citizens in general, citizens are more likely now to place themselves at the ends of the ideological spectrum than they were as recently as the 1980s. With a smaller political center to work with, even leaders committed to bipartisan compromise have been stymied. The fate of President Bush’s 2005 Social Security proposal illustrates the difficulty of addressing tough issues in these circumstances.

It might seem that the only cure for polarization is a shift of public sentiment back toward moderation. The Brookings-Hoover project found, however, that changes in institutional design could reduce polarization and might, over time, lower the partisan temperature. Here are two ideas, culled from a much longer list.

Congressional redistricting

While population flows account for much of the growth in safe seats dominated by strong partisans, recent studies indicate that gerrymanders account for 10 to 36 percent of the reduction in competitive congressional districts since 1982. This is not a trivial effect.

Few Western democracies draw up their parliamentary districts in so patently politicized a fashion as do U.S. state legislatures. Parliamentary electoral commissions, operating independently and charged with making reasonably objective determinations, are the preferred model abroad.

Given the Supreme Court’s reluctance to enter the thicket of redistricting controversies, any changes will be up to state governments. In recent years, voter initiatives and referenda in four states—Washington, Idaho, Alaska and Arizona—have established nonpartisan or bipartisan redistricting commissions. These commissions struggle with a complicated riddle: how to enhance competitiveness while respecting other parameters, such as geographic compactness, jurisdictional boundaries, and the desire to consolidate “communities of interest.” Iowa’s approach, where a nonpartisan legislative staff has the last word, is often cited as a model but may be hard to export to states with more demographic diversity and complex political cultures. Arizona has managed to fashion some workable, empirically based standards that are yielding more heterogeneous districts and more competitive elections.

Incentives to participate

Another depolarizing reform would promote the participation of less ideologically committed voters in the electoral process. Some observers do not view the asymmetric power of passionate partisans in U.S. elections as a cause for concern: Why shouldn’t political decisions be made by the citizens who care most about them? Aren’t those who care also better informed? And isn’t their intensive involvement an indication that the outcome of the election affects their interests more than it affects the interests of the non-voters? While this argument has surface plausibility, it is not compelling. Although passionate partisanship infuses the system with energy, it erects road-blocks to problem-solving. Many committed partisans prefer gridlock to compromise, and gridlock is no formula for effective governance.

To broaden the political participation of less partisan citizens, who tend to be more weakly connected to the political system, several major democracies have made voting mandatory. Australia, for one, has compulsory voting; it sets small fines for non-voting that escalate for recidivism, with remarkable results. The turnout rate in Australia tops 95 percent, and citizens regard voting as a civic obligation. Near-universal voting raises the possibility that a bulge of casual voters, with little understanding of the issues and candidates, can muddy the waters by voting on non-substantive criteria, such as the order in which candidates’ names appear on the ballot. The inevitable presence of some such “donkey voters,” as they are called in Australia, does not appear to have badly marred the democratic process in that country.

Indeed, the civic benefits of higher turnouts appear to outweigh the “donkey” effect. Candidates for the Australian Parliament have gained an added incentive to appeal broadly beyond their partisan bases. One wonders whether members of Congress here in the United States, if subjected to wider suffrage, might also spend less time transfixed by symbolic issues that are primarily objects of partisan fascination, and more time coming to terms with the nation’s larger needs. At least campaigns continually tossing red meat to the party faithful might become a little less pervasive.

The United States is not Australia, of course. Although both are federal systems, the U.S. Constitution confers on state governments much more extensive control over voting procedures. While it might not be flatly unconstitutional to mandate voting nationwide, it would surely chafe with American custom and provoke opposition in many states. Federalism American-style also has some unique advantages, including its tradition of using states as “laboratories of democracy” that test reform proposals before they are elevated to consideration at the national level. If a few states experiment with compulsory voting and demonstrate its democracy- enriching potential, they might, in this way, smooth the path to national consideration.  

Conclusion

In challenging times, political leaders undertake institutional reform, not because they want to, but because they must. Our own era—a period of profound economic crisis—is no exception. Even in circumstances of deep political polarization, both political parties have accepted the need to restructure our system of financial regulation.

As well, recognition is growing that we face three key challenges—a fiscal deficit, a savings deficit and an investment deficit—that have eluded control by existing institutions and, unless checked, will impede long-term economic growth. The question is whether we will be able to adopt the needed changes in an atmosphere of reflection and deliberation, or whether we will delay until a worse crisis compels us to act.

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Policy Brief #173

America needs to transform its energy system, and the Great Lakes region (including Minnesota, Wisconsin, Iowa, Missouri, Illinois, Indiana, Ohio, Michigan, Kentucky, West Virginia, western Pennsylvania and western New York) possesses many of the needed innovation assets. For that reason, the federal government should leverage this troubled region’s research and engineering strengths by launching a region-wide network of collaborative, high intensity energy research and innovation centers.

Currently, U.S. energy innovation efforts remain insufficient to ensure the development and deployment of clean energy technologies and processes. Such deployment is impeded by multiple market problems that lead private firms to under-invest and to focus on short-term, low-risk research and product development. Federal energy efforts—let alone state and local ones—remain too small and too poorly organized to deliver the needed breakthroughs. A new approach is essential.

	RECOMMENDATIONS
	The federal government should systematically accelerate national clean energy innovation by launching a series of “themed” research and commercialization centers strategically situated to draw on the Midwest’s rich complex of strong public universities, national and corporate research laboratories, and top-flight science and engineering talent. Organized around existing capacities in a hub-spoke structure that links fundamental science with innovation and commercialization, these research centers would engage universities, industries and labs to work on specific issues that would enable rapid deployment of new technologies to the marketplace. Along the way, they might well begin to transform a struggling region’s ailing economy. Roughly six compelling innovation centers could reasonably be organized in the Great Lakes states with total annual funding between $1 billion and $2 billion. To achieve this broad goal, the federal government should: Increase energy research funding overall. Adopt more comprehensive approaches to research and development (R&D) that address and link multiple aspects of a specific problem, such as transportation. Leverage existing regional research, workforce, entrepreneurial and industrial assets.

America needs to transform its energy system in order to create a more competitive “next economy” that is at once export-oriented, lower-carbon and innovation-driven. Meanwhile, the Great Lakes region possesses what may be the nation’s richest complex of innovation strengths—research universities, national and corporate research labs, and top-flight science and engineering talent. Given those realities, a partnership should be forged between the nation’s needs and a struggling region’s assets.

To that end, we propose that the federal government launch a distributed network of federally funded, commercialization-oriented, sustainable energy research and innovation centers, to be located in the Great Lakes region. These regional centers would combine aspects of the “discovery innovation institutes” proposed by the National Academy of Engineering and the Metropolitan Policy Program (as articulated in “Energy Discovery-Innovation Institutes: A Step toward America’s Energy Sustainability”); the “energy innovation hubs” created by the Department of Energy (DOE); and the agricultural experiment station/cooperative extension model of the land-grant universities.

In the spirit of the earlier land-grant paradigm, this network would involve the region’s research universities and national labs and engage strong participation by industry, entrepreneurs and investors, as well as by state and local governments. In response to local needs and capacities, each center could have a different theme, though all would conduct the kinds of focused translational research necessary to move fundamental scientific discoveries toward commercialization and deployment.

The impact could be transformational. If built out, university-industry-government partnerships would emerge at an unprecedented scale. At a minimum, populating auto country with an array of breakthrough-seeking, high-intensity research centers would stage a useful experiment in linking national leadership and local capacities to lead the region—and the nation—toward a more prosperous future.

The Great Lakes Energy System: Predicaments and Possibilities

The Great Lakes region lies at the center of the nation’s industrial and energy system trials and possibilities. No region has suffered more from the struggles of America’s manufacturing sector and faltering auto and steel industries, as indicated in a new Metropolitan Policy Program report entitled “The Next Economy: Rebuilding Auto Communities and Older Industrial Metros in the Great Lakes Region.”

The region also lies at ground zero of the nation’s need to “green” U.S. industry to boost national economic competitiveness, tackle climate change and improve energy security. Heavily invested in manufacturing metals, chemicals, glass and automobiles, as well as in petroleum refining, the Great Lakes states account for nearly one-third of all U.S. industrial carbon emissions.

And yet, the Great Lakes region possesses significant assets and capacities that hold promise for regional renewal as the “next economy” comes into view. The Midwest’s manufacturing communities retain the strong educational and medical institutions, advanced manufacturing prowess, skills base and other assets essential to helping the nation move toward and successfully compete in the 21st century’s export-oriented, lower-carbon, innovation-fueled economy.

Most notably, the region has an impressive array of innovation-related strengths in the one field essential to our nation’s future—energy. These include:

• Recognized leadership in R&D. The Great Lakes region accounts for 33 percent of all academic and 30 percent of all industry R&D performed in the United States.
• Strength and specialization in energy, science and engineering. In FY 2006, the Department of Energy sent 26 percent of its federal R&D obligations to the Great Lakes states and is the second largest federal funder of industrial R&D in the region. Also in 2006, the National Science Foundation sent 30 percent of its R&D obligations there.
• Existing clean energy research investments and assets. The University of Illinois is a key research partner in the BP-funded, $500 million Energy Biosciences Institute, which aims to prototype new plants as alternative fuel sources. Toledo already boasts a growing solar industry cluster; Dow Corning’s Michigan facilities produce leading silicon and silicone-based technology innovations; and the Solar Energy Laboratory at the University of Wisconsin-Madison, the oldest of its kind in the world, has significant proficiency in developing practical uses for solar energy. Finally, the region is home to the largest U.S. nuclear utility (Exelon), the nation’s largest concentration of nuclear plants and some of the country’s leading university programs in nuclear engineering.
• Industry potential relevant to clean energy. Given their existing technological specializations, Midwestern industries have the potential to excel in the research and manufacture of sophisticated components required for clean energy, such as those used in advanced nuclear technologies, precision wind turbines and complex photovoltaics.
• Breadth in energy innovation endeavors and resources. In addition to universities and industry, the region’s research laboratories specialize in areas of great relevance to our national energy challenges, including the work on energy storage systems and fuel and engine efficiency taking place at Argonne National Laboratory, research in high-energy physics at the Fermi National Accelerator Laboratory, and the work on bioenergy feedstocks, processing technologies and fuels occurring at the DOE-funded Great Lakes BioEnergy Research Center (GLBRC).
• Regional culture of collaboration. Finally, the universities of the Great Lakes area have a strong history of collaboration both among themselves and with industry, given their origins in the federal land-grant compact of market and social engagement. GLBRC—one of the nation’s three competitively awarded DOE Bioenergy Centers—epitomizes the region’s ability to align academia, industry and government around a single mission. Another example is the NSF-supported Blue Waters Project. This partnership between IBM and the universities and research institutions in the Great Lakes Consortium for Petascale Computation is building the world’s fastest computer for scientific work—a critical tool for advancing smart energy grids and transportation systems.

In short, the Great Lakes states and metropolitan areas—economically troubled and carbon-reliant as they are—have capabilities that could contribute to their own transformation and that of the nation, if the right policies and investments were in place.

Remaking America’s Energy System within a Federal Policy Framework

America as a whole, meanwhile, needs to overcome the massive sustainability and security challenges that plague the nation’s energy production and delivery system. Transformational innovation and commercialization will be required to address these challenges and accelerate the process of reducing the economy’s carbon intensity.

Despite the urgency of these challenges, however, a welter of market problems currently impedes decarbonization and limits innovation. First, energy prices have generally remained too low to provide incentives for companies to commit to clean and efficient energy technologies and processes over the long haul. Second, many of the benefits of longrange innovative activity accrue to parties other than those who make investments. As a result, individual firms tend to under-invest and to focus on short-term, low-risk research and product development. Third, uncertainty and lack of information about relevant market and policy conditions and the potential benefits of new energy technologies and processes may be further delaying innovation. Fourth, the innovation benefits that derive from geographically clustering related industries (which for many years worked so well for the auto industry) have yet to be fully realized for next-generation energy enterprises. Instead, these innovations often are isolated in secure laboratories. Finally, state and local governments—burdened with budgetary pressures—are not likely to fill gaps in energy innovation investment any time soon.

As a result, the research intensity—and so the innovation intensity—of the energy sector remains woefully insufficient, as pointed out in the earlier Metropolitan Policy Program paper on discovery innovation institutes. Currently, the sector devotes no more than 0.3 percent of its revenues to R&D. Such a figure lags far behind the 2.0 percent of sales committed to federal and large industrial R&D found in the health care sector, the 2.4 percent in agriculture, and the 10 percent in the information technology and pharmaceutical industries.

As to the national government’s efforts to respond to the nation’s energy research shortfalls, these remain equally inadequate. Three major problems loom:

The scale of federal energy research funding is insufficient. To begin with, the current federal appropriation of around $3 billion a year for nondefense energy-related R&D is simply too small. Such a figure remains well below the $8 billion (in real 2008 dollars) recorded in 1980, and represents less than a quarter of the 1980 level when measured as a share of GDP. If the federal government were to fund next-generation energy at the pace it supports advances in health care, national defense, or space exploration, the level of investment would be in the neighborhood of $20 billion to $30 billion a year.

Nor do the nation’s recent efforts to catalyze energy innovation appear sufficient. To be sure, the American Recovery and Reinvestment Act (ARRA) provided nearly $13 billion for DOE investments in advanced technology research and innovation. To date, Great Lakes states are slated to receive some 42 percent of all ARRA awards from the fossil energy R&D program and 39 percent from the Office of Science (a basic research agency widely regarded as critical for the nation’s energy future). However, ARRA was a one-time injection of monies that cannot sustain adequate federal energy R&D.

Relatedly, the Great Lakes region has done well in tapping two other relatively recent DOE programs: the Advanced Research Projects Agency–Energy (ARPA-E) and Energy Frontier Research Centers (EFRCs). Currently, Great Lakes states account for 44 and 50 percent of ARPA-E and EFRC funding. Yet, with ARPA-E focused solely on individual signature projects and EFRC on basic research, neither initiative has the scope to fully engage all of the region's innovation assets.

The character and format of federal energy R&D remain inadequate. Notwithstanding the question of scale, the character of U.S. energy innovation also remains inadequate. In this respect, the DOE national laboratories—which anchor the nation’s present energy research efforts—are poorly utilized resources. Many of these laboratories’ activities are fragmented and isolated from the private sector and its market, legal and social realities. This prevents them from successfully developing and deploying cost-competitive, multidisciplinary new energy technologies that can be easily adopted on a large scale.

For example, DOE activities continue to focus on discrete fuel sources (such as coal, oil, gas or nuclear), rather than on fully integrated end use approaches needed to realize affordable, reliable, sustainable energy. Siloed approaches simply do not work well when it comes to tackling the complexity of the nation’s real-world energy challenges. A perfect example of a complicated energy problem requiring an integrated end-use approach is transportation. Moving the nation’s transportation industry toward a clean energy infrastructure will require a multi-pronged, full systems approach. It will depend not only upon R&D in such technologies as alternative propulsion (biofuels, hydrogen, electrification) and vehicle design (power trains, robust materials, advanced computer controls) but also on far broader technology development, including that related to primary energy sources, electricity generation and transmission, and energy-efficient applications that ultimately will determine the economic viability of this important industry.

Federal programming fails to fully realize regional potential. Related to the structural problems of U.S. energy innovation efforts, finally, is a failure to fully tap or leverage critical preexisting assets within regions that could accelerate technology development and deployment. In the Great Lakes, for example, current federal policy does little to tie together the billions of dollars in science and engineering R&D conducted or available annually. This wealth is produced by the region’s academic institutions, all of the available private- and public-sector clean energy activities and financing, abundant natural resources in wind and biomass, and robust, pre-existing industrial platforms for research, next-generation manufacturing, and technology adoption and deployment. In this region and elsewhere, federal policy has yet to effectively connect researchers at different organizations, break down stovepipes between research and industry, bridge the commercialization “valley of death,” or establish mechanisms to bring federally-sponsored R&D to the marketplace quickly and smoothly.

A New Approach to Regional, Federally Supported Energy Research and Innovation

And so the federal government should systematically accelerate clean energy innovation by launching a series of regionally based Great Lakes research centers. Originally introduced in the Metropolitan Policy Program policy proposal for energy discovery-innovation institutes (or e-DIIs), a nationwide network of regional centers would link universities, research laboratories and industry to conduct translational R&D that at once addresses national energy sustainability priorities, while stimulating regional economies.

In the Great Lakes, specifically, a federal effort to “flood the zone” with a series of roughly six of these high-powered, market-focused energy centers would create a critical mass of innovation through their number, size, variety, linkages and orientation to pre-existing research institutions and industry clusters.

As envisioned here, the Great Lakes network of energy research centers would organize individual centers around themes largely determined by the private market. Based on local industry research priorities, university capabilities and the market and commercialization dynamics of various technologies, each Great Lakes research and innovation center would focus on a different problem, such as renewable energy technologies, biofuels, transportation energy, carbon-free electrical power generation, and distribution and energy efficiency. This network would accomplish several goals at once:

• Foster multidisciplinary and collaborative research partnerships. The regional centers or institutes would align the nonlinear flow of knowledge and activity across science and non-science disciplines and among companies, entrepreneurs, commercialization specialists and investors, as well as government agencies (federal, state and local) and research universities. For example, a southeastern Michigan collaboration involving the University of Michigan, Michigan State University, the University of Wisconsin and Ford, General Motors, and Dow Chemical could address the development of sustainable transportation technologies. A Chicago partnership involving Northwestern and Purdue Universities, the University of Chicago, the University of Illinois, Argonne National Lab, Exelon and Boeing could focus on sustainable electricity generation and distribution. A Columbus group including Ohio State University and Battelle Memorial Institute could address technologies for energy efficiency. Regional industry representatives would be involved from the earliest stages to define needed research, so that technology advances are relevant and any ensuing commercialization process is as successful as possible.
• Serve as a distributed “hub-spoke” network linking together campus-based, industry-based and federal laboratory-based scientists and engineers. The central “hubs” would interact with other R&D programs, centers and facilities (the “spokes”) through exchanges of participants, meetings and workshops, and advanced information and communications technology. The goals would be to limit unnecessary duplication of effort and cumbersome management bureaucracy and to enhance the coordinated pursuit of larger national goals.
• Develop and rapidly deploy highly innovative technologies to the market. Rather than aim for revenue maximization through technology transfer, the regional energy centers would be structured to maximize the volume, speed and positive societal impact of commercialization. As much as possible, the centers would work out in advance patenting and licensing rights and other intellectual property issues.Stimulate regional economic development. Like academic medical centers and agricultural experiment stations—both of which combine research, education and professional practice—these energy centers could facilitate cross-sector knowledge spillovers and innovation exchange and propel technology transfer to support clusters of start-up firms, private research organizations, suppliers, and other complementary groups and businesses—the true regional seedbeds of greater economic productivity, competitiveness and job creation.
• Build the knowledge base necessary to address the nation’s energy challenges. The regional centers would collaborate with K-12 schools, community colleges, regional universities, and workplace training initiatives to educate future scientists, engineers, innovators, and entrepreneurs and to motivate the region’s graduating students to contribute to the region’s emerging green economy.
• Complement efforts at universities and across the DOE innovation infrastructure, but be organizationally and managerially separate from either group. The regional energy centers would focus rather heavily on commercialization and deployment, adopting a collaborative translational research paradigm. Within DOE, the centers would occupy a special niche for bottom-up translational research in a suite of new, largely top-down innovation-oriented programs that aim to advance fundamental science (EFRCs), bring energy R&D to scale (Energy Innovation Hubs) and find ways to break the cost barriers of new technology (ARPA-E).

To establish and build out the institute network across the Great Lakes region, the new regional energy initiative would:

• Utilize a tiered organization and management structure. Each regional center would have a strong external advisory board representing the participating partners. In some cases, partners might play direct management roles with executive authority.
• Adopt a competitive award process with specific selection criteria. Centers would receive support through a competitive award process, with proposals evaluated by an interagency panel of peer reviewers.
• Receive as much federal funding as major DOE labs outside the Great Lakes region. Given the massive responsibilities of the proposed Great Lakes energy research centers, total federal funding for the whole network should be comparable to that of comprehensive DOE labs, such as Los Alamos, Oak Ridge and others, which have FY2010 budgets between $1 and $2 billion. Based on existing industry-university concentrations, one can envision as many as six compelling research centers in the Great Lakes region.

Conclusion

In sum, America’s national energy infrastructure—based primarily upon fossil fuels—must be updated and replaced with new technologies. At the same time, no region in the nation is better equipped to deliver the necessary innovations than is the Great Lakes area. And so this strong need and this existing capacity should be joined through an aggressive initiative to build a network of regional energy research and innovation centers. Through this intervention, the federal government could catalyze a dynamic new partnership of Midwestern businesses, research universities, federal laboratories, entrepreneurs and state and local governments to transform the nation’s carbon dependent economy, while renewing a flagging regional economy.

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Policy Brief #174

A nation’s education system is a pillar of its economic strength and international competitiveness. The National Bureau of Economic Research analyzed data from 146 countries, collected between 1950 and 2010, and found that each year of additional average schooling attained by a population translates into at least a two percent increase in economic output. A 2007 World Bank policy research working paper reported similar results. Based on these findings, if the United States increased the average years of schooling completed by its adult population from the current 12 years to 13 years—that is, added one year of postsecondary education—our gross domestic product would rise by more than $280 billion.

The story also can be told by focusing on the returns to education for individuals. The difference in income between Americans who complete high school and those who drop out after 10th grade exceeds 50 percent. Large income differentials extend throughout the continuum of education attainment, with a particularly huge gap occurring between an advanced degree and a four-year college degree.

Although education clearly pays, the education attainment of the nation’s youth has largely stagnated, falling substantially behind that of countries with which we compete. In 1960, the United States led the world in the number of students who graduated from high school. Today young adults in many countries, including Estonia and Korea, exceed their U.S. counterparts in education attainment.

	RECOMMENDATIONS
	America’s economic productivity and competitiveness are grounded in education. Our public schools and our higher education institutions alike are falling behind those of other nations. Four policy proposals offer substantial promise for improving American education, are achievable and have low costs: Choose K–12 curriculum based on evidence of effectiveness. Evaluate teachers in ways that meaningfully differentiate levels of performance. Accredit online education providers so they can compete with traditional schools across district and state lines. Provide the public with information that will allow comparison of the labor market outcomes and price of individual postsecondary degree and certificate programs.

The problem of low education attainment is particularly salient among students from low-income and minority backgrounds. The graduation rate for minorities has been declining for 40 years, and majority/minority graduation rate differentials have not converged. Hispanic and black students earn four-year or higher degrees at less than half the rate of white students.

The economic future of the nation and the prospects of many of our citizens depend on returning the United States to the forefront of education attainment. Simply put, many more of our students need to finish high school and graduate from college.

At the same time, graduation standards for high school and college must be raised. Forty percent of college students take at least one remedial course to make up for deficiencies in their high school preparation, and a test of adult literacy recently given to a random sample of graduating seniors from four-year U.S. institutions found less than 40 percent to be proficient on prose and quantitative tasks.

Barriers to Innovation and Reform

Our present education system is structured in a way that discourages the innovation necessary for the United States to regain education leadership. K-12 education is delivered largely through a highly regulated public monopoly. Outputs such as high school graduation rates and student performance on standardized assessments are carefully measured and publicly available, but mechanisms that would allow these outputs to drive innovation and reform are missing or blocked. For example, many large urban districts and some states are now able to measure the effectiveness of individual teachers by assessing the annual academic growth of students in their classes. Huge differences in teacher effectiveness are evident, but collective bargaining agreements or state laws prevent most school district administrators from using that information in tenure or salary decisions.

Further complicating K-12 reform is the fact that authority for education policy is broadly dispersed. Unlike countries with strong national ministries that can institute top-down reforms within the public sector, education policy and practice in the United States are set through a chaotic network of laws, relationships and funding streams connecting 16,000 independent school districts to school boards, mayors, and state and federal officials. The lack of central authority allows the worst characteristics of public monopolies to prevail—inefficiency, stasis and catering to interests of employees—without top-down systems’ offsetting advantage of being capable of quick and coordinated action.

The challenges to reforming higher education are different. The 6,000-plus U.S. postsecondary institutions have greater flexibility to innovate than do the public school districts—and a motive to do so, because many compete among themselves for students, faculty and resources. However, while output is carefully measured and publicly reported for public K-12 schools and districts, we have only the grossest measures of output for post secondary institutions.

Even for something as straightforward as graduation rates, the best data we have at the institutional level are the proportion of full-time, first-time degree-seeking students who graduate within 150 percent of the normal time to degree completion. Data on critical outputs, including labor market returns and student learning, are missing entirely. In the absence of information on issues that really matter, postsecondary institutions compete and innovate on dimensions that are peripheral to their productivity, such as the winning records of their sports teams, the attractiveness of their grounds and buildings, and their ratio of acceptances to applications. Far more information is available to consumers in the market for a used car than for a college education. This information vacuum undermines productive innovation.

Examining Two Popular Reforms

Many education reformers across the political spectrum agree on two structural and governance reforms: expanding the public charter school sector at the expense of traditional public schools and setting national standards for what students should know. Ironically, the evidence supporting each of these reforms is weak at best.

Charter schools are publicly funded schools outside the traditional public school system that operate with considerable autonomy in staffing, curriculum and practices. The Obama administration has pushed to expand charter schools by eliminating states that don’t permit charters, or capping them, from competition for $4.35 billion in Race to the Top funding. Both President Obama and Education Secretary Arne Duncan have proposed shuttering poorly performing traditional public schools and replacing them with charters.

What does research say about charter schools’ effects on academic outcomes? Large studies that control for student background generally find very small differences in student achievement between the two types of public schools.

For example, on the 2005 National Assessment of Educational Progress (the “Nation’s Report Card”), white, black and Hispanic fourth graders in charter schools performed equivalently to fourth-graders with similar racial and ethnic backgrounds in traditional public schools. Positive findings do emerge from recent studies of oversubscribed New York and Boston area charter schools, which use lotteries to determine admission. But these results are obtained from children whose parents push to get them into the most popular charter schools in two urban areas with dynamic and innovative charter entrepreneurs.

What about common standards? Based on the belief that high content standards for what students should know and be able to do are essential elements of reform and that national standards are superior to individual state standards, the Common Core State Standards Initiative has signed up 48 states and 3 territories to develop a common core of state standards in English-language arts and mathematics for grades K-12. The administration has praised this joint effort by the National Governors Association and Council of Chief State School Officers, made participation in it a prerequisite for Race to the Top funding, and set aside $350 million in American Recovery and Reinvestment Act funding to develop ways to assess schools’ performance in meeting common core standards.

Does research support this approach? The Brown Center on Education Policy at Brookings examined the relationship between student achievement outcomes in mathematics at the state level and ratings of the quality of state content standards in math. There was no association. Some states with strong standards produce high-achieving students, such as Massachusetts, while other states with strong standards languish near the bottom in terms of achievement, such as California. Some states with weak standards boast high levels of achievement, such as New Jersey, while others with weak standards experience low levels of achievement, such as Tennessee.

Four Ideas

For every complex problem there is one solution which is simple, neat, and wrong. — H. L. Mencken

I will avoid Mencken’s approbation by proposing four solutions rather than one. Although education has far too many moving parts to be dramatically reformed by any short list of simple actions, we can start with changes that are straightforward, ripe for action and most promising, based on research and past experience.

Link K-12 Curricula to Comparative Effectiveness

Little attention has been paid to choice of curriculum as a driver of student achievement. Yet the evidence for large curriculum effects is persuasive. Consider a recent study of first-grade math curricula, reported by the National Center for Education Evaluation and Regional Assistance in February 2009. The researchers randomly matched schools with one of four widely used curricula. Two curricula were clear winners, generating three months’ more learning over a nine-month school year than the other two. This is a big effect on achievement, and it is essentially free because the more effective curricula cost no more than the others.

The federal government should fund many more comparative effectiveness trials of curricula, and schools using federal funds to support the education of disadvantaged students should be required to use evidence of effectiveness in the choice of curriculum materials. The Obama administration supports comparative effectiveness research in health care. It is no less important in education.

Evaluate Teachers Meaningfully

Good education outcomes for students depend on good teachers. If we have no valid and reliable system in place to identify who is good, we cannot hope to create substantial improvements in the quality of the teacher workforce.

A substantial body of high-quality research demonstrates that teachers vary substantially in effectiveness, with dramatic consequences for student learning. To increase academic achievement overall and address racial, ethnic and socioeconomic achievement gaps, we must enhance the quality of the teacher workforce and provide children from poor and minority backgrounds with equitable access to the best teachers.

Despite strong empirical evidence for differences in teacher performance—as well as intuitive appeal, demonstrated when we remember our own best and worst teachers—the vast majority of public school teachers in America face no meaningful evaluation of on-the-job performance. A recent survey of thousands of teachers and administrators, spanning 12 districts in four states, revealed that none of the districts’ formal evaluation processes differentiated meaningfully among levels of teaching effectiveness, according to a 2009 report published by The New Teacher Project. In districts using binary ratings, more than 99 percent of teachers were rated satisfactory. In districts using a broader range of ratings, 94 percent of teachers received one of the top two ratings, and less than one percent were rated unsatisfactory. In most school districts, virtually all probationary teachers receive tenure—98 percent in Los Angeles, for example—and very small numbers of tenured teachers are ever dismissed for poor performance.

Conditions of employment should be restructured to recruit and select more promising teachers, provide opportunities for them to realize their potential, keep the very best teachers in the profession, and motivate them to serve in locations where students have the highest needs. The precondition for these changes is a valid system of evaluating teachers.

The federal government should require school districts to evaluate teachers meaningfully, as a condition of federal aid. Washington also should provide extra support to districts that pay substantially higher salaries to teachers demonstrating persistently high effectiveness and serving in high-needs schools. But, because many technical issues in the evaluation of on-the-job performance of teachers are unresolved, the federal government should refrain, at least for now, from mandating specific evaluation components or designs. The essential element is meaningful differentiation—that is, a substantial spread of performance outcomes.

Accredit Online Education Providers

Traditional forms of schooling are labor-intensive and offer few economies of scale. To the extent that financial resources are critical to education outcomes, the only way to improve the U.S. education system in its current configuration is to spend more. Yet we currently spend more per student on education than any other country in the world, and the appetite for ever-increasing levels of expenditure has been dampened by changing demographics and ballooning government deficits. The monies that can be reasonably anticipated in the next decade or two will hardly be enough to forestall erosion in the quality of the system, as currently designed. The game changer for education productivity will have to be technology, which can both cut labor costs and introduce competitive pressures.

Already, at the college level, online education (also termed “virtual education” or “distance learning”) is proving competitive with the classroom experience. Nearly 3.5 million students in 2006—about 20 percent of all students in postsecondary schools and twice the number five years previously—were taking at least one course online, according to a 2007 report published by the Sloan Consortium.

In K-12, online education is developing much more slowly. But, the case for online K–12 education is strong—and linked to cost control. A survey reported on page one of Education Week (March 18, 2009) found the average per-pupil cost of 20 virtual schools in 14 states to be about half the national average for a traditional public school.

Local and state control of access to virtual schooling impedes the growth of high-quality online education and the competitive pressure it contributes to traditional schooling. Development costs are very high for virtual courseware that takes full advantage of the newest technologies and advances in cognitive science and instruction—much higher than the costs for traditional textbooks and instructional materials. These development costs can only be rationalized if the potential market for the resulting product is large. But, states and local school districts now are able to determine whether an online program is acceptable. The bureaucracy that may be most disrupted by the introduction of virtual education acts as gatekeeper.

To overcome this challenge, K-12 virtual public education would benefit from the model of accreditation used in higher education. Colleges and universities are accredited by regional or national bodies recognized by the federal government. Such accrediting bodies as the New England Association of Schools and Colleges and the Accrediting Council for Independent Colleges and Schools are membership organizations that determine their own standards within broad federal guidelines. Once an institution is accredited, students residing anywhere can take its courses, often with the benefit of federal and state student aid.

Federal legislation to apply this accreditation model to online K-12 education could transform public education, especially if the legislation also required school districts to cover the reasonable costs of online courses for students in persistently low-performing schools. This approach would exploit—and enhance—U.S. advantages in information technology. We are unlikely to regain the international lead in education by investing more in business as usual; but we could leapfrog over other countries by building new, technology-intensive education systems.

Link Postsecondary Programs to Labor Market Outcomes

On a per-student basis, the United States spends two and one-half times the developed countries’ average on postsecondary education. Although our elite research universities remain remarkable engines of innovation and are the envy of the world, our postsecondary education system in general is faltering. The United States used to lead the world in higher education attainment, but, according to 2009 OECD data, is now ranked 12th among developed countries. We have become a high-cost provider of mediocre outcomes.

Critical to addressing this problem is better information on the performance of our postsecondary institutions. As the U.S. Secretary of Education’s Commission on the Future of Higher Education concluded in 2006:

Our complex, decentralized postsecondary education system has no comprehensive strategy, particularly for undergraduate programs, to provide either adequate internal accountability systems or effective public information. Too many decisions about higher education—from those made by policymakers to those made by students and families—rely heavily on reputation and rankings derived to a large extent from inputs such as financial resources rather than outcomes. Better data about real performance and lifelong working and learning ability is absolutely essential if we are to meet national needs and improve institutional performance.

Ideally, this information would be available in comparable forms for all institutions through a national system of data collection. However, achieving consensus on the desirability of a national database of student records has proved politically contentious. One of the issues is privacy of information. More powerful is the opposition of some postsecondary institutions that apparently seek to avoid accountability for their performance.

The way forward is for Congress to authorize, and fund at the state level, data systems that follow individual students through their postsecondary careers into the labor market. The standards for such state systems could be recommended at the federal level or by national organizations, to maximize comparability and eventual interoperability.

The public face of such a system at the state level would be a website allowing prospective students and parents to compare degree and certificate programs within and across institutions on diverse outcomes, with corresponding information on price. At a minimum, the outcomes would include graduation rates, employment rates and average annual earnings five years after graduation. Outcomes would be reported at the individual program level, such as the B.S. program in chemical engineering at the University of Houston. Price could be reported in three ways: advertised tuition,average tuition for new students for the previous two years, and average tuition for new students for the previous two years net of institutional and state grants for students eligible for federally subsidized student loans. These different forms of price information are necessary because institutions frequently discount their advertised price, particularly for low-income students. Students and families need information about discounts in order to shop on the basis of price.

Many states, such as Washington, already have data that would allow the creation of such college search sites, at least for their public institutions. The primary impediment to progress is the federal Family Educational Rights and Privacy Act (FERPA), which makes it very difficult for postsecondary institutions to share data on individual students with state agencies, such as the tax division or unemployment insurance office, in order to match students with information on post-graduation employment and wages. Congress should amend FERPA to allow such data exchanges among state agencies while maintaining restrictions on release of personally identifiable information. To address privacy concerns, Congress also should impose substantial penalties for the public release of personally identifiable information; FERPA currently is toothless.

Creating a higher education marketplace that is vibrant with transparent and valid information on performance and price would be a powerful driver of reform and innovation. Easily addressed concerns about the privacy of student records and political opposition from institutions that do not want their performance exposed to the public have stood in the way of this critical reform for too long. America’s economic future depends on returning the United States to the forefront of education attainment. Simply put, many more of our students need to finish high school and graduate from college. Investments in improved data, along with structural reforms and innovation, can help restore our leadership in educational attainment and increase economic growth.

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Policy Brief #175

As the nation strives to recover from the “Great Recession,” job creation remains one of the biggest challenges to renewed prosperity. Small businesses have been among the most powerful generators of new jobs historically, suggesting the value of a stronger focus on supporting small businesses—especially high-growth firms—and encouraging entrepreneurship. Choosing the right policies will require public and private decision-makers to establish clear goals, such as increasing employment, raising the overall return on investment, and generating innovations with broader benefits for society. Good mechanisms will also be needed for gauging their progress and ultimate success. This brief examines policy recommendations to strengthen the small business sector and provide a platform for effective programs. These recommendations draw heavily from ideas discussed at a conference held at the Brookings Institution with academic experts, successful private-sector entrepreneurs, and government policymakers, including leaders from the Small Business Administration. The gathering was intended to spur the development of creative solutions in the private and public sectors to foster lasting economic growth.

	RECOMMENDATIONS
	What incentives and assistance could be made available to “gazelles” and to small business more generally? What policies are likely to work most effectively? In the near term, government policies aimed at bolstering the recovery and further strengthening the financial system will help small businesses that have been hard hit by the economic downturn. Spurred by the interchange of ideas at a Brookings forum on small businesses, we have identified the following more targeted ideas for fostering the health and growth of small businesses (and, in many cases, larger businesses) over the longer run: Improve access to public and private capital. Reexamine corporate tax policy with an eye toward whether provisions of our tax code are discouraging small business development. Promote education to help businesses struggling with shortages of workers with particular skills, and promote research to spur innovation. Rethink immigration policy, as current policy may be contributing to shortages of key workers and deterring entrepreneurs who wish to start promising businesses in our country. Explore ways to foster “innovation-friendly” environments, such as regional cluster initiatives. Strengthen government counseling programs.

The term “small business” applies to many different types of firms. To begin, the small business community encompasses an enormous range of “Main Street” stores and services we use every day, such as restaurants, dry cleaners, card shops and lawn care providers. When such a business fails, it is often replaced by a similar firm. The small business community also includes somewhat bigger firms—in industries such as manufacturing, consulting, advertising and auto sales—that may have more staying power than Main Street businesses, but still tend to stay relatively small, with under 250 employees. While these two kinds of small businesses contribute relatively little to overall employment growth, they are a steady source of mainstream employment. If economic conditions do not support the formation of new businesses to replace the ones that fail, there would be a significant net destruction of jobs and harm to local communities.

Yet another type of small business has an explicit ambition for rapid growth. These high-growth companies are sometimes known as “gazelles.” According to the Small Business Administration, small businesses account for two-thirds of new jobs, and the gazelles account for much of this job creation. The most striking examples—such as Google and eBay—have tended to be in high-tech industries and were gazelles for a significant time before they graduated to be very large businesses. However, gazelles exist in all industry types and in all regions of the country, and the large majority are not grazing in the nation’s technology-dominated Silicon Valleys. According to one expert, the three largest industry categories for high-growth companies are restaurant chains, administrative services and health care companies. One non-high-tech example is Potbelly Sandwiches, a restaurant chain that began in Chicago. Another is the San Francisco-based Gymboree Corporation, a provider of child development programs and children’s clothing.

 

Fostering the Development of High-Growth Companies

High-growth small businesses represent only about 5 percent of total startups, making it important to determine how to spot and foster them. A key common characteristic is that growth is critically dependent on the entrepreneurs who start these companies; they are people on a mission, charismatic leaders who can inspire creativity and commitment from their staffs.

The age of these firms is highly correlated with when their growth is highest. Generally, the most dramatic growth occurs after at least four years of existence—and coincidentally lasts about four years—before it slows again to a more typical pace for small businesses. Of course, some firms such as Google defy this pattern and continue to experience high growth for many years.

Although dynamic small businesses can be found nearly everywhere and in many industries, some regions spawn more of them than others. These regions may have especially supportive features, such as a critical mass of potential workers with relevant skills, a social climate and network that encourage idea generation, locally available venture capital, or some combination of these factors.

Unfortunately, attempts to anticipate which companies or even industries are likely to produce gazelles are prone to error. Thus, excessive emphasis on national industrial policies that favor specific industries are likely misplaced. Without knowing how to target assistance precisely, broad strategies, such as assistance with funding, knowledge, contacts and other essential resources, may be the best approach to fostering high-growth businesses. Such support has the added value of also aiding Main Street businesses.

Many of the most promising policies focus on removing obstacles that hinder entrepreneurs with solid business plans from launching and expanding their businesses.

Funding

As a result of the burst of the dot.com bubble in early 2000 and the recent financial crisis, small businesses have found the availability of venture capital funds drastically diminished. The crisis has also made it more difficult to obtain funding from banks and other conventional means. These trends particularly affect the “missing middle” of small businesses—roughly, those with between 10 and 100 employees.

The venture capital market. Historically, venture capital has financed only a relatively small portion of small businesses, but those financed have tended to be the ones with the greatest growth potential. In recent years, firms that eventually grew to where they could issue initial public stock offerings generally relied more heavily on venture capital financing than the average small business.

The dollar value of venture capital deals funded today is only about one-fifth the size it reached at its peak. While the peak amount may have been too large, today’s value is probably too small. With their capital heavily invested in a small range of industries and locales, it seems likely that venture capital firms have missed a high proportion of potential investment opportunities. Further, “once burned, twice shy” funders have increasingly focused on larger, later-stage ventures. Consequently, mezzanine financing, which new companies need to survive and thrive in the critical early stages, is scarce.

The funding problems partly stem from venture capital firms today having less money to invest. Some investors who formerly contributed to such firms have become more risk-averse, and worse performance figures have discouraged new investors. Lack of venture capital affects some industries more than others, and even some green energy companies—viewed by some as one of the nation’s more promising industry sectors—have moved to China, where financial support is more readily available.

Bank lending. In contrast to large businesses, which can turn to capital markets for funding, many small businesses are dependent on banks for financing. Although the worst of the 2008–09 credit crunch is behind us, many small businesses still find it difficult to obtain bank loans. Community banks, a key source of small business financing, have been hard hit by losses in commercial real estate, which have limited their lending capacity. Further, many small business owners who historically would have used real estate assets as collateral for expansion loans can no longer do so because of declines in real estate prices. In addition, small businesses that have, in the past, used credit cards to purchase equipment and supplies have been hindered by reductions in credit limits.

Overall economic conditions

The high degree of uncertainty currently surrounding the economic and financing climate may have prompted many entrepreneurs and would-be entrepreneurs to hold off on growth plans. Despite their reputation as high-flying risk-takers, good entrepreneurs take only calculated risks, where the benefits outweigh the dangers. Uncertainties about the future trajectory of the economy merely increase risk without raising potential rewards.

Government policies

Government policies affect the climate for small businesses in many ways. For example, small businesses face substantial hurdles when entering the complicated world of federal grants and contracts. At the state level, severe budget shortfalls mean that even well-designed initiatives to boost small businesses may founder.

The Small Business Administration (SBA) assists the full continuum of small businesses through a variety of means. These include: an $80 billion loan guarantee portfolio; specialized counseling and training centers; specialized business development programs targeting the socially and economically disadvantaged; oversight to ensure that at least 23 percent of federal government contracts go to small businesses (with certain preferences for minority and women-owned businesses); and the Small Business Innovation Research and Small Business Investment Companies programs.

The Obama administration is attempting to broaden support for small businesses by bringing the SBA into multi-agency initiatives that tackle common problems. For example, the Departments of Energy, Commerce, Housing and Urban Development, Education, and Labor, along with the National Science Foundation and the SBA, are supporting a five-year, nearly $130 million Energy Regional Innovation Cluster.

Strength of “social capital”

Through the 1990s, the United States was a worldwide leader in fostering innovation and entrepreneurship and reaped the reward of employment growth. Current international comparisons suggest that we are now closer to tenth place among some 70 nations in our ability to support innovation. Much of what has kept our nation from remaining in the top spot appears to relate to insufficient cultural support for entrepreneurship.

Strong social networks in specific geographic regions appear to substantially bolster the growth of innovative businesses. These networks are built around entrepreneurial dealmakers who serve as the nodes of the network, forming connections among researchers, entrepreneurs and investors. Unfortunately, many regions and industries lack strong networks.

Access to decision-making information. Entrepreneurs need an array of information and advice about how to tackle the problems that arise at different stages in business development. The SBA reports that companies that have taken advantage of their long-term counseling programs, for example, have higher growth than companies that have not.

Opportunity for all. Social networks are self-selecting, and some people have to work extra hard to gain entry to a region’s network of entrepreneurs. While various organizations exist to help women and people of color access entrepreneurial skills and information, these efforts may not suffice. Under-representation of any group presumably would filter out a number of potential high-growth companies.

Workforce issues

A long-time strength of the American workforce, worker mobility has declined. This trend has been attributed in part to an aging population and in part to the current difficulty people have in selling their homes. Businesses report difficulty finding employees with the right training, especially at the technician level, where straightforward vocational training could help.

Global competition

Increasing global competition for good projects, entrepreneurs and capital is a positive trend from an international perspective, but runs counter to the national goal of promoting rapid growth in U.S. industry and employment. Today, many entrepreneurs can choose among starting a business here, in their home country, or even in a third, more hospitable nation. At the same time, current U.S. immigration policy hinders entrepreneurs from coming here to launch their companies. A recent report from The Brookings- Duke Immigration Policy Roundtable concluded that “educated workers with the knowledge and skills to innovate are critical” to the United States and recommended increasing the annual number of skilled visas.

 

Policy Goals for Small Business

Measuring Results

More work is needed to identify key policy goals and priorities related to small business success. Critically, what would constitute “improvement” in public policy regarding small business employment, and how would we measure it? Clearly, increasing the total number of jobs created each year (by both small and large businesses, net of job destruction) would be a positive outcome, all else being equal. Another potential goal would be improving the “quality” of the jobs created, as measured by average compensation or by job creation in new industries or geographic areas where unemployment is high. Creating “good jobs” that bring generous compensation would seem to be always desirable, but this outcome could conflict with other social goals, for example, if the jobs created required skills out of the reach of groups that are traditionally difficult to employ.

Slowing job destruction could be as important as increasing the creation of new jobs, but discouraging layoffs without increasing performance would do more harm than good. The trick is to raise the quality of marginal firms so that their improved performance allows them to retain employees they would otherwise have to let go.

A final key factor in setting policy goals that would support small businesses is measuring the cost to taxpayers of the initiatives that flow from the goals. This includes the subsidy cost contained in the federal budget, as well as costs and tradeoffs in society at large.

Changing Key Policies

Small businesses face both short-run and long-run challenges. With regard to the former, many small businesses have been hard hit by the recession and appear to be lagging behind larger businesses in their recovery. The cyclical struggles of this sector in part reflect the dependence of many small firms on the still-strained banking system for their financing; they also reflect the high toll that our extremely soft labor markets have taken on demand for Main Street goods and services. Thus, government policies aimed at broadly bolstering the recovery and further strengthening the financial system will yield important benefits to small businesses.

The government, in conjunction with the private sector, can also take steps that will foster an economic environment that is supportive of entrepreneurship and economic growth over the long run. Specific policy steps that might help small businesses (and, in many cases, large businesses) include:

Improve access to public and private capital. Implementing serious financial reform will reduce the likelihood that we will see a repeat of the recent credit cycle that has been so problematic for the small business sector. When credit market disruptions do occur, policymakers should be attentive to whether temporary expansions of the SBA loan guarantee program are needed to sustain lending to creditworthy borrowers. The SBA should also consider expanding the points of access to its loan programs through an expansion of its lending partners. Finally, the SBA (or a similar entity) might encourage venture capital funds to broaden their investments beyond familiar areas by systematically bringing these investors together with entrepreneurs from neglected geographic regions and business sectors.

Reexamine corporate tax policy. More thinking is needed about whether provisions in our tax code discourage small business development in a way that is harmful to the broader economy and that places the United States at a relative disadvantage internationally. For example, Congress might consider whether it would be beneficial, on net, to lower employment taxes as a way of spurring hiring at businesses with high-growth potential. In addition, some analysts believe there would be gains from increasing tax credits for research and development and further lowering taxes on capital equipment. A design priority in all cases should be simplicity, as complicated rules can limit take-up among smaller firms that do not have extensive accounting or legal expertise.

Promote education and research. Entrepreneurs report difficulty in finding workers with the skills they need for manufacturing, technology and other jobs that do not require four-year college degrees. Access to such educational opportunities, including tailored vocational training, should be affordable and ubiquitous.

At the university level, improvements are needed in the way academic research is brought to the commercial market. Continued public and private support for basic research might be wise, particularly if we are in a trough between waves of innovation, as some analysts believe. The large investments by the National Science Foundation, National Institutes of Health, Defense Advanced Research Projects Agency, and other ambitious public and private programs laid the groundwork for many of the high-growth businesses of today. It may be worth exploring whether support for research in “softer” areas than the sciences might do an equal or better job of inspiring innovations.

Rethink immigration policy. A reconsideration of limits on H1-B visas might help entrepreneurs struggling with shortages of workers with particular skills. In addition, current immigration policy discourages immigrants who want to establish entrepreneurial businesses in America. Any efforts to expand immigration are frequently perceived as “taking jobs away from Americans,” but studies have shown that new businesses create jobs for Americans.

Explore ways to foster “innovation-friendly” environments. Some regions of the United States clearly do a better job of encouraging innovation. Silicon Valley is the classic example, but there may be as many as 40 such clusters scattered around the country. While clusters often arise organically, typically near major universities, some states have made an explicit commitment to innovation and entrepreneurship. Examples include the Massachusetts Technology Collaborative and California’s Biological Technologies Initiative, involving community colleges statewide. Federal, state and local policymakers should keep a keen eye on ways of adapting best practices from these initiatives as information becomes available about which elements are most effective.

Strengthen government counseling programs. The SBA might do more to expand and tailor its already successful growth counseling programs to better meet the needs of both Main Street and potential high-growth businesses, as well as firms at different developmental stages. Any effort to expand small businesses’ opportunities for federal grants and contracts should be accompanied by significant streamlining of the application process.

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Policy Brief #177

Recommendations

The recent clash between a Chinese fishing vessel and the Japanese coast guard in the East China Sea demonstrates continuing potential for conflict between China and Japan over territory and maritime resources, one that could affect the United States. China’s stronger navy and air force in and over the waters east and south of the country’s coast is one dimension of that country’s growing power. But the deployment of these assets encroaches on the traditional area of operations of Japan’s navy and air force—and a clash between Chinese and Japanese ships and planes cannot be ruled out.

Unfortunately, civil-military relations in these two countries are somewhat skewed, with China’s military having too much autonomy and Japan’s having too little. And neither country is well equipped to do crisis management. Avoiding a naval conflict is in the interests of both China and Japan, and the two governments should take steps to reach agreement on the now-unregulated interaction of coast guard, naval, and air forces in the East China Sea. The two militaries should also continue and expand the exchanges and dialogues that have resumed in the last few years.

Finally, Japan and China should accelerate efforts to reach a follow-up agreement to implement the “political agreement” governing the exploitation of energy resources in the East China Sea. That will remove another potential source of tension. It is in neither country’s interest to see a deterioration of their relationship.

The Basic Problem

The clash on September 7 between a Chinese fishing vessel and ships of the Japanese coast guard exposes worrisome trends in the East Asian power balance. China’s power in Asia is growing. Its economy has just passed Japan’s as the biggest in the region. The capabilities of the People’s Liberation Army (PLA) are growing steadily while those of Japan’s Self-Defense Forces (SDF) are improving only slightly. The PLA’s budget has grown by double digits each year, while the SDF’s is essentially flat. Moreover, the focus of Chinese military modernization is power projection: the ability of its air and naval forces to stretch their reach beyond immediate coastal areas. Over the last ten years, the share of modern equipment in various platforms has increased (see table).

<not-mobile message="To see PLA Modernization Table, please visit the desktop site">
TABLE 1: Modernization of the PLA

Type	2000: percentage modern	2009: percentage modern
Surface ships	< 5%	~ 25%
Submarines	< 10%	50%
Air force	< 5%	~ 25%
Air defense	~ 5%	40 - 45 %

Source: Office of the Secretary of Defense, “Annual Report to Congress: Military and Security Developments Involving the People’s Republic of China 2010,” August 2010 p. 45.[http://www.defense.gov/pubs/pdfs/2010_CMPR_Final.pdf].

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Japan does have a significant military presence in East Asia, in collaboration with the United States, its ally. Surface and subsurface vessels of the Japan Maritime Self-Defense Force regularly patrol the East Asian littoral in order to protect vital sea lanes of communication and to assert the country’s maritime rights. Planes of the Air Self-Defense Force monitor Japan’s large air defense identification zone and scramble to challenge intrusions by foreign military aircraft. Both the maritime force and the Japan Coast Guard are responsible for protecting the Senkaku/Diaoyu Islands, located near Taiwan, which Japan regards as its sovereign territory.

China views the East China Sea differently. It claims the Diaoyu/Senkaku Islands as Chinese territory. It has undertaken oil and gas drilling in the continental shelf east of Shanghai, partly in an area that Japan claims as its exclusive economic zone (EEZ) and an appropriate site for its own drilling. China’s definition of its EEZ encompasses the entire shelf, while Japan argues that the two should split the area equitably. In 2004 and 2005, the contest for resources fostered concerns in each country about the security of its drilling platforms. There was a danger the dispute might become militarized. Tokyo and Beijing, seeking a diplomatic solution, reached a “political agreement” in June 2008, but efforts to implement it have made little progress.

More broadly, China seeks to establish a strategic buffer in the waters east and south of its coasts. So the People’s Liberation Army Navy and Air Force are expanding their area of operation eastward. China’s Marine Surveillance Force makes its own contribution to “defend the state’s sovereignty over its territorial waters, and safeguard the state’s maritime rights and interests.” By challenging Japan in the Senkaku/Diaoyu Islands, expanding naval operations, sailing through maritime straits near Japan, surveying the seabed, and so on, China creates “facts on—and under—the sea.” Expanding air force patrols can create “facts in the air.”
Lurking in the background is the Taiwan Strait dispute, and the concern that Japan, as a U.S. ally, would be drawn into any conflict between the United States and China over the island.

Reinforcing the specifics of naval and air operations is a more general anxiety that each country has about the intentions of the other. Japanese watch China’s military modernization with deep concern, and are anxious about the long-term implications for their country’s strategic lifeline: sea lanes of communication. China has worried that looser restrictions on Japan’s military and a stronger U.S.-Japan alliance are designed to contain its own revival as a great power and prevent the unification of Taiwan. In addition, vivid memories of the past—particularly China’s memories of Japanese aggression in the first half of the twentieth century—darken the shadow of the future. Strategists in both countries cite with concern the old Chinese expression, “Two tigers cannot coexist on the same mountain.”

A Senkaku Scenario

These trends plus the salience of naval and air operations suggest that a clash between Japan’s formidable forces and China’s expanding ones is not impossible. As the recent clash demonstrates, the most likely site is the Diaoyu/Senkaku Islands, which are unpopulated but which each country believes strongly to be its sovereign territory. Indeed, a group of American specialists who reviewed Japan-China security relations in 2005 and 2006 concluded that “the prospect of incidents between Chinese and Japanese commercial and military vessels in the East China Sea has risen for the first time since World War II. If an incident occurs, it could result in the use of force—with consequences that could lead to conflict.” Further, trouble over oil and gas fields in the East China Sea is not out of the question.

To be clear, civilian leaders in China and Japan do not desire a conflict or a serious deterioration in bilateral relations. Each country gains much from economic cooperation with the other. Yet even if objective interests dictate a mutual retreat from the brink, they might be unable to do so. Once a clash occurred, other factors would come into play: military rules of engagement, strategic cultures, civil-military relations, civilian crisis management mechanisms, and domestic politics. In the end, leaders may lose control and regard some outcomes, especially the appearance of capitulation, as worse than a growing conflict.

Let us explore a Senkaku scenario in detail. It would likely begin as China’s Marine Surveillance Force (MSF) challenges the perimeters that the Japan Coast Guard (JCG) maintains around the Senkaku/Diaoyu Islands. Because the JCG’s rules of engagement are ambiguous, a JCG ship then rams an MSF vessel. Surface ships of the People’s Liberation Army Navy and Japan’s Maritime Self-Defense Force hurry to the area and take up positions. Planes of Japan’s air force and China’s Air Force soon hover overhead. Submarines lurk below. Ships of the two navies maneuver for position. And although fairly tight rules of engagement regulate the units of each military, those rules might not be exactly appropriate for this situation, leaving local commanders discretion to act independently in the heat of the moment.

Chinese strategic culture, with its emphasis on preemption and preserving initiative, could come into play. Perhaps the captain of a PLAN ship sees fit to fire at an MSDF vessel. The Japanese vessel returns fire, because its commander believes that doing so is the proper response and does not wish to be overruled by cautious civilian bureaucrats in Tokyo. Planes of the two air forces get involved. The longer the encounter goes on, predicts one American naval expert, the more likely it is that Japan’s “significantly more advanced naval capabilities would, if employed, almost certainly cause the destruction of PLAN units, with significant loss of life.”

Quite quickly, commanders in the field would have to inform their headquarters in each capital about the incident. Would they convey a totally accurate picture, or would they shade reality to put themselves in the best possible light? Would they necessarily know exactly what happened? When a Chinese naval fighter jet collided with a U.S. reconnaissance aircraft off the island of Hainan in April 2001, the local command probably lied to those higher up about which side was responsible. By the time the Central Military Commission in Beijing reported to civilian leaders, the story of the encounter between the two planes was very different from the truth. Failure to tell “the whole truth,” however, is certainly not unique to the PLA.

In the Diaoyu/Senkaku scenario, the odds are that civilian and military decision-makers in Tokyo and Beijing would not receive a completely accurate picture. They would have to respond in a fog of uncertainty, giving free rein to a variety of psychological and organizational factors that would affect the handling of information.

The military services would have a monopoly on information, impeding the voicing of contrarian views. The preexisting beliefs of each side about the other would distort their views of the reports from the field. Each side also would be likely to judge its own actions in the best possible light and those of the adversary in the worst. Groupthink, the temptation to shade reports so that they are consistent with what are assumed to be the leaders’ views and a tendency to withhold contrarian views in a tense situation would be at play.

So, there is a real chance that decision-makers in each capital would receive a picture of the incident that was at variance with the “facts,” a picture that downplayed the responsibility of its units and played up that of the other side. Working with distorted information, they then would have to try to prevent the clash from escalating into a full-blown crisis without appearing to back down. At that point, crisis management institutions in each capital would come into play, and they most likely would not respond well. Policymakers in each capital might miscalculate in responding.

The first response element to consider is the interface between senior military officers and civilian officials. In China, the interface between the military, party and government hierarchies occurs at only a few points. The most significant point of contact is at the top, in the Central Military Commission, where the party general secretary and PRC president (currently Hu Jintao) is usually chairman. But that person may be the only civilian among about ten senior military officers. Moreover, the PLA guards its right to speak on matters of national security and its autonomy in conducting operations, so the institutional bias in this instance is likely to be against restraint. On the Japanese side, civilian control has been the rule, but the autonomy of the Self-Defense Forces has increased since the late 1990s; moreover, senior officers have resented their exclusion from policymaking circles. Therefore, in the event of a clash there would likely be tension and disagreement between “suits” and “uniforms” over how to respond.

Next is the issue of the structure of decision-making in Japan and China. In both, bottom-up coordination between line agencies is difficult at best, so if initiatives are to occur, they have to come from the top down. Yet in theory and often in practice, the “top” in each system is a collective: the Cabinet in Japan and the Politburo Standing Committee in China. The need for consensus on matters of war and peace is particularly acute.
 
Neither the Japanese nor the Chinese system is flawless when it comes to handling fairly even routine matters. Coordination among line agencies is often contentious, which slows down any policy response. The Chinese system is segmented between the civilian and military wings of the hierarchy. Policy coordination mechanisms exist that facilitate top-down leadership, with Chinese leaders probably more dominant than their Japanese counterparts. But tensions still exist between the priorities of the core executive and those of the bureaucracies.

In more stressful situations, it is likely that, first, leaders receive information from below that is biased and self-serving, and ineluctably view that information through a lens that distorts the images of both their own country and the other. Second, they act in the context of a security dilemma, in which military capabilities, recent experiences on specific issues, and sentiments about past history shape the perception of each of the intentions of the other. Third, each decision-making collective relies for staff support on bodies that themselves are a collection of agency representatives: in Japan the group working under the deputy chief cabinet secretary for crisis management and in China both the appropriate civilian leading group and the Central Military Commission, each of which has its own perspective. Neither system has shown itself adept at responding to situations of stress that do not rise to the level of seriousness of a military clash. Neither, therefore, is likely to do well in the conflict scenario envisioned here.

Fourth is the matter of domestic politics. Although each government would have reason to keep such a clash secret, the Japanese side would probably be unable to do so because the government is rather porous and the media would see little advantage—commercial or otherwise—in suppressing a “hot” story. A leak from the Self-Defense Forces, the Ministry of Foreign Affairs, or the Ministry of Defense is all but certain. That would energize the Japanese press, with its predilection for viewing security issues in zero-sum terms. Once the news became public in Japan, it would undoubtedly stir up the Chinese public, whose hard-edged, anti-Japanese nationalism circulates quickly on the Internet and is a vocal and influential force. It is a tide against which Chinese leaders and officials, worried about domestic stability and defensive about inevitable charges of softness, are reluctant to swim. If in this instance, large demonstrations erupted, the regime would be more inclined to a tough response. Thus, the PLA’s preference for firmness and public nationalistic outrage would combine to squeeze civilian leaders.

To make matters worse, at least some of China’s nationalistic citizens have tools with which to mount their own tough response: cyber warfare. They would mount an array of attacks on Japanese institutions, which in turn would anger the Japanese public and incline the government to take a stronger stance itself. Inexorably, the spiral would descend.

None of the steps in this scenario is certain. If a clash between China and Japan occurred, it would not necessarily mean that the two governments could not contain and prevent the incident from escalating. Yet each loop in the downward spiral would increase the probability that subsequent, reinforcing loops would occur, and their cumulative effect would be to reduce Tokyo and Beijing’s chances of succeeding in their efforts to manage the crisis.

The United States Factor

If such a clash occurred, it would pose a serious dilemma for the United States. The U.S. commitment to defend Japan, enshrined in Article 5 of the Mutual Security Treaty, applies to “territories under the administration of Japan.” The Senkaku/Diaoyu Islands are under Japan’s administrative control, even though Washington takes no position on which state (China or Japan) has sovereignty over them under international law. Successive U.S. administrations have reaffirmed that application, suggesting that the United States would be legally obligated to assist Japan if the People’s Liberation Army attacked or seized the islands. In the more ambiguous contingency of a fight over oil and gas fields in the East China Sea, Washington would not be legally obligated to render assistance to Japan, but Tokyo would likely pressure it to do so.

In any clash over the islands or some other part of the East China Sea that could not be immediately contained, Tokyo would thus look to Washington for help in standing up to China’s probable reliance on coercive diplomacy. Washington seeks good relations with both China and Japan. It does not want to get drawn into a conflict between the two, especially one that it believed was not necessary to protect the vital interests of either. A Senkaku scenario is not, from the U.S. perspective, the issue where the American commitment to Japan is put to the test. But Washington would understand that not responding would impose serious political costs on its relations with Tokyo and would raise questions about U.S. credibility more broadly among other states that depend on the United States for their security. Congressional and public opinion would probably favor Japan or, at least, oppose China.

Avoiding a Tragedy

If such an accidental clash is not in Chinese, Japanese, or American interests, what should be done to avoid it?

First, the two governments should take steps to reduce the most likely source of conflict: the unregulated interaction of coast guard, naval and air forces in the East China Sea. There are a variety of conflict-avoidance mechanisms that could be employed. The U.S.-Soviet Incidents at Sea Agreement is a useful precedent.

Second, the two militaries should continue and expand the exchanges and dialogues that have resumed in the last few years. Moreover, they should be sustained even if minor tensions arise (China has a tendency to suspend exchanges in those cases).

Third, the two governments should accelerate efforts to reach a follow-up agreement to implement the “political agreement” governing the exploitation of energy resources in the East China Sea. That will remove another potential source of tension.

Objectively, these are relatively easy steps. They have been hard to take but they should be pursued. Even more difficult are initiatives that would remove the underlying sources of conflict: resolution of the Diaoyu/Senkaku Islands dispute; reaching a broader and mutually acceptable approach to resource exploration in the East China Sea; remedying the institutional factors in each country that would turn small incidents into crises and make crisis containment difficult; creating mechanisms that would ameliorate the mutual mistrust fostered by China’s rise and any strengthening of the U.S.-Japan alliance; gearing the alliance to shape China’s rise in a positive, constructive direction; and mitigating memories of the past so they do not cloud the future.

All of these projects are very difficult. They are constrained by bureaucratic resistance and political opposition. But it is not in either country’s interest to see a deterioration of what can be a mutually beneficial and peace-promoting relationship.

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[1] In order to maintain neutrality on the territorial dispute, I use both the Japanese and Chinese names in this policy brief.
[2] “Sino-Japanese Rivalry: Implications for U.S. Policy,” INSS Special Report (Institute for National Strategic Studies, National Defense University, April 2007), p. 3 [http://libweb.uoregon.edu/ec/e-asia/read/SRapr07.pdf].
[3] As it did concerning a Taiwan fishing vessel in 2008.
[4] Bernard D. Cole, “Right-Sizing the Navy: How Much Naval Force Will Beijing Deploy,” in Right-Sizing the People’s Liberation Army: Exploring the Contours of China’s Military, Roy D. Kamphausen and Andrew Scobell, eds. (Carlisle, PA: Strategic Studies Institute, U.S. Army War College, 2007), pp. 543–44.
[5] Thus, the annual report on China of the U.S. Department of Defense warns that China’s neighbors could underestimate how much the PLA has improved; China’s leaders could overestimate the PLA’s capabilities; and both might ignore the effect of their decisions on the calculations of others. Office of the Secretary of Defense, “Military Power of the People’s Republic of China 2009,” March 2009, p. 20 [www.defense.gov/pubs/pdfs/China_Military_Power_Report_2009.pdf.

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Policy Brief #178

One of the strongest narratives in U.S. history has been the contribution made by talented, hard-working and entrepreneurial immigrants whose skills and knowledge created a prosperous new country. Yet today, the nation’s immigration priorities and outmoded visa system discourage skilled immigrants and hobble the technology-intensive employers who would hire them. These policies work against urgent national economic priorities, such as boosting economic vitality, achieving greater competitiveness in the global marketplace and renewing our innovation leadership.

In the long term, the nation needs comprehensive immigration reform. In the short term, policymakers should focus on reforms that are directly related to increasing the "brain gain" for the nation—creating new jobs and producing economic benefits—to produce tangible and achievable improvements in our immigration system.

	RECOMMENDATIONS
	Rebalance U.S. immigration policies to produce a "brain gain," with changes to visas that will allow employers to access workers with the scientific and technological skills they need to improve economic competitiveness, employment and innovation Tie immigration levels to national economic cycles to meet changing levels of need Use digital technologies to modernize the current visa system

Background

Immigrants are now one-tenth of the overall U.S. population—a situation that defies facile stereotyping. Immigrants have made significant contributions to American science and economic enterprise, most notably in the areas of high-tech and biotech.

• Immigrants’ productivity raises the U.S. Gross Domestic Product (GDP) by an estimated $37 billion per year
   
• More than a quarter of U.S. technology and engineering businesses launched between 1995 and 2005 had a foreign-born founder
   
• In Silicon Valley, more than half of new tech start-up companies were founded by foreignborn owners
   
• In 2005, companies founded by immigrants produced $52 billion in sales and employed 450,000 workers
   
• Nearly a quarter of the international patents filed from the United States in 2006 were based on the work of foreign-born individuals (more than half of whom received their highest degree from an American university)
   
• Economists calculate that, as a result of immigration, 90 percent of native-born Americans with at least a high-school diploma have seen wage gains
   
• Historically, immigrants have made outsize contributions to American science and technology, with Albert Einstein perhaps the leading example. One-third of all U.S. winners of Nobel prizes in medicine and physiology were born in other countries Far from "crowding out" native-born workers and depressing their wages, well-educated, entrepreneurial immigrants do much to create and support employment for Americans.

In order to fully reap the benefits of the worldwide talent market, U.S. immigration policy must be reoriented. Current policy is significantly—and negatively—affected by the unintended consequences of the 1965 Immigration and Nationality Act that made family unification its overarching goal. Although the law may have contributed to the high-tech boom by removing long-standing, country-specific quotas and expanding immigration from places with strong science and engineering education programs, its main effect was to enable immigrants to bring in family members, without regard for the new immigrants’ education, skill status or potential contributions to the economy.

Thus, in 2008, almost two-thirds of new legal permanent residents were family-sponsored and, over the past few years, the educational attainment of new immigrants has declined.

U.S. employers have a large, unmet demand for knowledge workers. They are eager to fill jobs with well-trained foreign workers and foreign graduates of U.S. universities—particularly those with degrees in the sciences, technology, engineering and mathematics—the "STEM" fields that continue to attract too few U.S.-born students. In 2008, the "Tapping America’s Potential" business coalition reported that the number of U.S. graduates in STEM had been stagnant for five years, and that number would have to nearly double by 2015 to meet demands.

Meanwhile, the United States is falling behind in the pace of innovation and international competitiveness. Evidence for the decline in innovation is the decreasing U.S. share of international patents. In 2009, for the first time in recent years, non-U.S. innovators earned more patents (around 96,000) than did Americans (93,000). Only a decade earlier, U.S. innovators were awarded almost 57 percent of all patents.

To date, Congress—for a variety of reasons, including partisanship—has stalled in addressing the problems of immigration and immigration policy. Unfortunately, this inaction extends to problems hampering the nation’s economy that, if remedied, could help the United States grow employment, pull out of the current recession more quickly and improve its position in the global economy.

Game-Changing Policy Reforms

Rebalance Fundamental Goals

The goals of U.S. immigration policy should be rebalanced to give priority to immigrants who have the education and talent to enhance America’s economic vitality, by stimulating innovation, job creation and global competitiveness. At the same time, it should decrease emphasis on family reunification (other than parents and children of U.S. citizens). Changing the composition of the immigration stream, even without increasing its size, would result in a "brain gain" for the United States.

Other countries, such as Canada, the United Kingdom and Australia, strategically craft immigration policy to attract skilled and unskilled workers, making the benefits easy to see and strengthening public support for immigration in the process. Canada, for example, explicitly targets foreign workers to fill positions for which there are not enough skilled Canadians. Applicants for admission to the country accumulate points based on their field of study, educational attainment and employment experience. Upon reaching the requisite number of points, the applicant is granted a visa. Some 36 percent of all Canadian immigrant visas are in the "skilled-worker" category, as opposed to only 6.5 percent in the United States.

An interesting by-product of this strategy—which is both clearly articulated and of obvious benefit to the national economy—is that Canadians see the benefits of the policy and, as a result, immigration is far less controversial than in the United States. In 2005 polling by The Gallup Organization, only 27 percent of Canadians wanted to decrease immigration, whereas 52 percent of U.S. citizens did. And, three times as many Canadians (20 percent) as Americans (seven percent) actually wanted to increase it.

An obvious place to begin the rebalancing process would be with the many foreign students who come to the United States for education in scientific and technology fields. They are familiar with our culture and speak English. Many would like to stay and build careers here. But, under current visa rules, most are sent home as soon as they graduate. A complete policy reversal is needed, with automatic green cards for foreign graduates of U.S. science and technology programs.

In fact, the United States should make it as easy as possible for these highly trained students to stay, since the expansion of job opportunities in India, China and other growth-oriented countries now offers them attractive options. Our current counterproductive policy, quite simply, puts the United States in the position of training our global competitors.

New York City mayor Michael Bloomberg, in a December 2009 Meet the Press interview, said about immigration: "We’re committing what I call national suicide. Somehow or other, after 9/11 we went from reaching out and trying to get the best and the brightest to come here, to trying to keep them out. In fact, we do the stupidest thing, we give them educations and then don’t give them green cards."

Universities collectively invest huge sums in the development of these students. In addition, research suggests that increasing the number of foreign graduate students would increase U.S. patent applications by an estimated 4.7 percent and grants of university patents by 5.3 percent.

Another strategic policy change would be for the federal government to take U.S. workforce and economic conditions into account when setting immigration levels and annual H-1B visa numbers for scientists and engineers. Such a flexible approach would reflect labor market needs, protect American workers’ jobs and wages, and dampen public concerns about employment losses during lean economic times.

Revamp the Antiquated Visa System

Increase the Number of Visas for Highly-skilled Workers

Today’s visa programs for high-skilled workers are not large enough to fill the numerical demand for such employees and are too short in duration. For example, H-1B visas for workers in "specialty occupations" are valid for a maximum of six years. Between fiscal years 2001 and 2004, the federal government increased the annual allocation of H-1B visas for scientists and engineers to 195,000. The rationale was that scientific innovators were so important for the country’s long-term economic development that the number set aside for those specialty professions needed to be high. Since 2004, that number has returned to its former level, 65,000—only a third of the peak, despite rapid technologic change in almost every field, such as information, medicine, energy and logistics.

Most of these visas are allocated within a few months of becoming available. Even in recessionplagued 2009, applications exceeded the supply of visas within three months. Almost half of the visa requests came from U.S. employers, most of them in high-tech industries. Clearly the demand for visas is greater than the supply, and a minimal step would be to raise the set-aside for high-skilled workers to the previous, 195,000 level.

Only a small percentage of aliens with student visas and aliens with H-1B visas are able to change directly to legal permanent resident status—about seven percent of each category, according to a study published in 2005—although about half of H-1B visa-holders eventually become legal permanent residents. Such an uncertain path is not conducive to career (or employment) planning in a competitive environment.

Several additional small programs support talented scientists and entrepreneurs. These, too, could be aligned with economic goals, expanded or more effectively promoted:

• The O-1 "genius" visa program allows the government to authorize visas for people with "extraordinary abilities in the arts, science, education, business, and sports." In 2008, around 45,000 genius visas were granted. The clear intent is to encourage talented people to migrate to America. However, the current program is too diffuse to have much impact on the level of scientific and technological innovation talent in the United States.
   
• The EB-5 visa program offers temporary visas to foreigners who invest at least $500,000 in the nation’s rural or "targeted employment areas" or at least $1,000,000 in other areas. If the investment creates at least ten jobs, the visa automatically becomes a permanent green card. The program is authorized by Congress to offer approximately 10,000 visas per year, but it is significantly underutilized—about 500 EB-5 visas a year were granted between 1992 and 2004. In 2009, 3,688 people did become legal permanent residents under the "employment creation (investors)" category, a number that includes spouses and children.

According to a March 2009 report from the Department of Homeland Security, the causes of the persistent underutilization of this program include "program instability, the changing economic environment, and more inviting immigrant investor programs offered by other countries." The report makes a number of recommendations designed to streamline program administration and encourages greater efforts to promote the program overseas.

Update the Visa System Infrastructure

Aside from questions about the number of visas allowed, the infrastructure for considering and granting visas needs a major upgrade. Currently, the U.S. visa process requires people seeking entry to provide paper copies of sometimes hard-to-obtain documents. Often these are lost in the system and must be submitted repeatedly. Obtaining a visa can take months and, in some cases, years. Implementation of the USA PATRIOT Act has slowed the process even further.

The visa system should adopt digital technology to reduce both errors and delays. Further, if the nation’s immigration policy moves toward a more credential-based approach, any new electronic processes should be designed to minimize the potential that false documents regarding an individual’s education and experience will be accepted.

Tie Immigration Levels to National Economic Indicators

To ease U.S.-born workers’ understandable worries about job competition from immigrants, Congress should tie overall annual levels of immigration to the unemployment rate and growth in the Gross Domestic Product. Immigration levels can be adjusted up or down depending on the level of economic conditions. These fluctuations should occur automatically, triggered by authoritative statistical reports.

Political Hurdles to Immigration Reform

U.S. news reporting on immigration focuses heavily on illegality and largely ignores the benefits of immigration. Sadly, important news organizations follow the tradition set in the 19th century, when many journalists railed against groups of newcomers, such as immigrants from Ireland and China. Immigration opponents’ unfavorable media narratives, often widely publicized, have a discernible impact on public opinion and affect policymaking. The economic, social, and cultural benefits of immigration are rarely reported.

The State of Public Opinion

Immigration does not rank high on Americans’ lists of the country’s most important problems. In 2008, only four percent of Americans (mostly people from Southwestern border states concerned about illegal entry) thought immigration was the country’s most important problem. Even during 2007’s acrimonious national debate about comprehensive reform, 60 percent of Americans believed new arrivals benefit the country. But public opinion can shift quickly, which makes politicians wary. Fifty-seven percent of voters in the November 2010 mid-term election considered immigration a "very important" issue, ranking it 7th and on a par with taxes and national security/war on terror, according to the Rasmussen report.

The Need for Reform Follow-Through

Administration and enforcement of immigration laws and visa programs are complex, in part because federal, state and local officials are involved in various aspects and are overseen by multiple federal agencies. Aligning the goals of these different entities to put an emphasis on the brain gain can help build support for policy improvements.

As the report of a 2009 Brookings Forum on Growth Through Innovation pointed out with regard to promoting innovation more broadly, "while the actions we need to take are clear and reasonably simple to outline, our political culture erects insurmountable barriers to long-term planning, funding and implementation."

Achieving an Improved Immigration Policy

It will be difficult to achieve comprehensive, coherent policy reform in the face of many competing goals and interest groups and in the current polarized political environment. The task is made more difficult by the divided authority over immigration matters within Congress, involving several committees and subcommittees with competing interests and different political dynamics. Individual members of Congress tend to focus on local concerns, forestalling consideration of broad, long-term national interests.

In the past, elected officials have overreacted to specific episodes of problems related to immigrants or anti-immigrant sentiments in developing policy, rather than taking into account long-term national economic priorities. Just as deleterious, stalemate and inaction have prevented needed reforms, despite a frustrating status quo for employers who need talented scientists and engineers, and who could hire many more Americans if they could fill key slots with skilled workers they cannot find in their local workforce.

A spectrum of experts has suggested creation of a broadly representative, independent federal immigration commission that could develop specific policies under parameters set by Congress. Proposals for such a body have the common themes of depoliticization, insulating members from parochial political pressures and relying on technical experts. Given past missteps and the current policy stalemate, it makes sense to consider such proposals seriously, in the hope that all aspects of immigration—especially those that affect U.S. economic vitality—receive the thoughtful attention they need.

Conclusion

The immigration policy reforms in this paper focus on those that would have swift and direct positive impact on the nation’s economy. Clearly, these are not the only reforms the system needs. A fairer, more comprehensive immigration policy also would:

• Develop more effective and cost-effective border control strategies
   
• Strengthen the electronic employment-eligibility ("e-verify") system and add an appeals process
   
• Improve the immigration courts system and the administration of immigration law
   
• Work harder to integrate immigrants into American life and teach them English and
   
• Create a path to citizenship for illegal immigrants with requirements that applicants learn English, pay back taxes, and pay fines.

Meanwhile, a number of the needed corrections to the system as it affects national economic goals, employment, innovation, and global competitiveness can be addressed, including:

• Tying visa and immigration levels to U.S. economic indicators, in order to assuage American workers’ concerns about threats to employment and wage levels
   
• Creation of an automatic green card for foreign graduates of U.S. science, technology, engineering, and mathematics educational programs and other steps to make staying in the United States a desirable option
   
• Expansion of visa programs (especially H-1B for highly skilled workers) and making more effective the O-1 and EB-5 visa programs and
   
• Creating a modern, electronic visa system.

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Policy Brief #180

	EXECUTIVE SUMMARY
	The year 2010 in Afghanistan had some encouraging signs but on balance it was less positive than had been hoped. In 2011, therefore, it is important to do two things: first, look for further improvements in our strategy; and second, develop a backup plan, should the current approach not yield the kind of progress that is necessary and expected. This policy brief addresses the first challenge, improving the U.S./NATO counterinsurgency campaign. The basic logic of current strategy is accepted, but several new initiatives or ideas are explored to make it more promising and more effective. Three main ideas are developed: Promoting Afghan political organizations built around ideas and platforms, not individuals and ethnicities, in a change from longstanding American policy that could improve the quality of governance in the country. Taking pressure off the bilateral U.S.-Afghan relationship on the issue of anticorruption, largely by creation of an international advisory board consisting of prominent individuals from key developing countries like Indonesia and Tanzania that have had considerable success improving their own nations' governance in recent times. Offering a civilian nuclear energy deal to Pakistan, conditional on clear action by Islamabad to shut down insurgent sanctuaries that are currently using its territory to attack the Afghan government as well as NATO forces.

The past year was not without good news in Afghanistan. It saw a successful deployment of nearly another 40,000 NATO troops to Afghanistan; twice as much growth in Afghan security forces together with a much more robust approach to their training; increases in American civilian capacity in Kabul and in the field; and highly effective targeting of Afghan (and Pakistani) insurgents within Afghanistan and just over the border with Pakistan. I would also count the September parliamentary elections as more good than bad, since it was Afghans who held other Afghans accountable for infractions, and since the Karzai government appears on balance to be tolerating an outcome that will reduce the strength of its cronies in the elected assembly (though this issue remains a work in progress). Finally, NATO's decision at the November Lisbon Summit to emphasize the year 2014 as the time when Afghanistan would assume full control of security operations-rather than President Obama's earlier preference to emphasize July 2011 as the point when the U.S. departure would begin-clarified the American and international commitments to get the job done right before going home. Among other benefits, this change should help convince more Afghan and Pakistani fence-sitters that they can count on us, rather than encouraging hedging behavior out of fear of a premature, hurried NATO exit.

However, 2010 also witnessed a roughly 50 percent increase in the overall level of violence that can only partially be explained by our increased presence and tempo of operations. That increase reflects a very resilient insurgency. Problematic relations between the Obama administration and the Karzai government have also continued, the corruption problem has remained intractable (largely fueled by the western presence with all of its trappings), and the Pakistani government still tolerates sanctuaries for the Haqqani network and the "Quetta Shura Taliban" (that is, the Afghan Taliban) on its territory.

For the most part, the strategy of the International Security Assistance Force (ISAF) under General David Petraeus, and the efforts of the international community more broadly, seem sound. The paramount goal in Afghanistan is to put the country's government in a position to control its own territory. That is the way to ensure that no large terrorist sanctuaries re-emerge there that could threaten the United States, nuclear-armed Pakistan, or other core western interests. But to achieve that goal, a comprehensive counterinsurgency approach that helps build up the Afghan state is needed, because establishing control of territory requires that the government possess a certain legitimacy among its people-which in turn requires some measure of economic and political progress. Hence, to achieve a fairly simple goal, we have properly undertaken a fairly ambitious strategy, after having tried the opposite, minimalist approach for the first half dozen years of the war only to see the Taliban make a comeback. Yet the strategy still needs improvement to address its two main vulnerabilities: the weakness and corruption of the Afghan government, and the schizophrenic approach to the war on the part the Pakistani government. This policy brief proposes ideas to address each of these problems. The proposals would also improve the prospects of any sound backup plan that might have to be considered this year, such as the concept that Brookings Senior Fellow Bruce Riedel and I have recently developed that we call a "Plan A-" for the country.

Afghan Governance and Anti-Corruption Efforts

Working with the Karzai government is an inherently complex matter. On the one hand, we have no choice but to partner with Afghanistan's elected leader, who in fact remains reasonably popular among his own people with a 62 percent favorability rating according to the latest polls. On the other hand, the government is widely seen as ineffective by many of its own citizens, helping generate motivation and recruits for the insurgency. So do we work with Karzai, or work around him? In fact, we must do both. We need a better way to help the Afghan government improve its performance without inciting periodic public spats along the way that set back our efforts to cooperate. And we also need a way to help build for Afghanistan's post-Karzai future, the sooner the better.

Improving Afghan Governance and Fighting Corruption

General Stanley McChrystal's 2009 assessment of the situation in Afghanistan famously and dramatically concluded that corruption in the Afghan government was comparable to the insurgency itself in posing a serious threat to the country. As such, General Petraeus has been right to focus intently on corruption since assuming command, including assigning the formidable Brigadier General HR McMaster to the task, and some positive things are happening as a result. More intelligence assets are being devoted to the problem. Field commanders and development specialists are more aware of the need to understand the power of money, and to be cognizant of whom they are empowering or embittering through their contracting processes and economic development efforts.

Yet problems remain. Corruption remains very serious. And disputes about corruption with President Karzai still go public too often. The United States and the international community more generally should reframe the issue of fighting corruption, as Marine Colonel Greg Douquet and I have previously argued. The challenge should be seen and described primarily as one of improving governance in Afghanistan rather than tackling a culture of criminality.

Blantant, extreme corruption must be prosecuted. But by criminalizing routine corruption, we not only encourage unrealistic expectations in the U.S. Congress and elsewhere about the progress that is achievable over the next few years, we may miss opportunities to work with Afghan "reconciliables"-individuals who may have had some corrupt tendencies yet also try to provide a certain level of effective governance. We also fail to recognize our own past role in the dynamic. Pumping billions of dollars a year into a poor economy, and inadvertently favoring certain power brokers and tribes over others in the process, feeds the very corruption that we so abhor.

Research on fighting corruption and improving governance points to a better way of thinking about this problem. One key insight from renowned development expert Paul Collier and others is that young democracies with weak checks on presidential powers and an easy source of cash tend to have major problems with corruption-so Afghanistan's challenges, rather than being viewed primarily as criminal, should be expected in some ways. Taking this tone with the Karzai government can improve atmospherics and bolster our odds of eliciting cooperative behavior from Kabul.

Another key finding from MIT's Benjamin Olken and other researchers is that trained, independent auditors deployed from the central government to various parts of the country can improve the quality of government performance. Government auditors could also counter the "inverse pyramid" patronage network that is common in the Karzai administration, a network in which corrupt officials "invest" in purchasing government positions and their "dividends" are paid to them in the form of bribes and extortion. Reforming Afghanistan's government will require reversing this trend, or at least mitigating it, through such auditors and other governmental improvements.

And perhaps most important of all, the development literature shows that a number of countries around the world have made headway in combating corruption and improving governance over the years. Brookings and World Bank scholars Daniel Kaufmann, Aart Kraay and Pablo Zoido-Lobaton document progress in places including Indonesia, Hong Kong, Georgia, Albania, Tanzania and Rwanda. We should try to involve more experts from such countries in the effort. President Karzai and others might react more positively to hearing suggestions about how to reduce bribes, check nepotism, and improve governance from Indonesians or Tanzanians rather than Americans.

With U.S. assistance, Afghanistan's government has improved. We are now seeing points of light in the anticorruption effort, such as President Karzai's new specialized anticorruption agency-the High Office of Oversight. Several key ministers in the Karzai cabinet are also exemplary on this front, including for example Minister of Interior Mohammadi. We should emphasize their sound efforts more often. But there is clearly a long way to go, and an international contact group may help.

Strengthening Afghan Political Parties and Institutions

Afghanistan's corruption problem is largely rooted in the fact that the young political system is still too driven by personalities-and to a lesser extent ethnicity-and not enough by ideas.

Part of the challenge is to make sure that Mr. Karzai relinquishes power in 2014, when he reaches the constitutional limit of two full presidential terms. Prudence requires that we assume Mr. Karzai will seek to change the constitution or otherwise manipulate the electoral and legal process to stay in office-not out of any megalomania, but as much as anything out of fear for himself and his friends and relatives given the uncertainty of who might follow him in office. As such, it is possible that Karzai could declare martial law and suspend future elections. He could seek a peace deal with insurgents that makes him the compromise candidate under a future modified constitution. He could even consider a military coup.

It is important to deflate this possibility before it gains momentum. U.S. policymakers should, for example, mention publicly that Mr. Karzai will no longer be president after 2014. This is unobjectionable as a point of legal fact-at least right now-so there is no reason to shy away from saying so. Talking about it enough will help clarify the international community's intentions and expectations. And given Afghanistan's long-term need for international security and economic assistance, Afghan leaders would have to take notice.

The second imperative is to strengthen Afghan political organizations. That means helping Afghanistan's reformers and patriots, of whom there are many, to form strong political movements. Mr. Karzai has chosen some good cabinet officials and governors, but these are just a few individuals. Afghanistan's organized political parties are very weak. There are some fledgling new movements-like the one spearheaded by former foreign minister and presidential candidate Abdullah Abdullah. But they are loosely organized and have relatively vague policy platforms.

Afghanistan needs political movements tied to ideas and governing principles rather than ethnicity or individuals. Mr. Karzai has so far discouraged their formation. He has argued that Afghans dislike political parties because of the legacy of Communist Party abuses in the late 1970s and 1980s. But the 1980s are increasingly ancient history. Those who oppose parties today seem motivated mostly by their own desire to divide and conquer a weak, inchoate opposition.

It is time for the U.S. government and the many other governmental and nongovernmental organizations present in Afghanistan to strongly support the activities of new political movements. They should encourage and fund Afghans as they hold policy conferences, create research institutes, do grass-roots political organizing, and talk policy and politics in print, on television and on the radio. This approach need not be anti-Karzai; the president himself could form a party.

Such dynamics could affect even the shorter-term calculations of Afghan politicians. If Afghan voters in 2014 and thereafter are empowered to make real policy choices, candidates will take notice and start developing ideas they can run on. That may be as good an antidote to weak governance and rampant corruption as we can find-not only for the future but for today as well.

Getting Pakistan Off the Fence

Pakistan arguably remains the most complex ally the United States has ever had in wartime. Nine years into the campaign, we still cannot clearly answer the question of whether Pakistan is with us or against us. America needs bold new policy measures to help Islamabad-in all its many dimensions and factions-make up its mind.

Despite allowing massive NATO logistics operations through its territory and helping the United States pursue al Qaeda operatives, Pakistan tolerates sanctuaries on its soil for the major insurgencies fighting in Afghanistan. These include the Afghan Taliban (known as the Quetta Shura Taliban because its principle base remains in Quetta in the Pakistani province of Baluchistan) as well as the Haqqani and Hezb-i-Islami Gulbuddin (HiG) networks. The Haqqanis straddle the border between the Afghan provinces of Khost, Paktia, and Paktika as well as North Waziristan and other tribal areas within Pakistan; HiG is further north, operating in and around the Khyber Pass connecting Kabul and Jalalabad in Afghanistan with Peshawar and points east in Pakistan. Thus, all three major Afghan insurgent groups have home bases in Pakistan, and despite the occasional drone strike are generally beyond NATO's reach as a result.

Pakistan has taken some worthy actions against extremists in its remote northern and western areas in recent years. Specifically, it has recognized the so-called Pakistani Taliban (the Tehrik-i-Taliban Pakistan, or TTP) as a mortal threat to the Pakistani state and responded accordingly in some tribal areas. Pakistanis argue, however, that limited numbers of ground troops combined with the past year's devastating floods prevent them from doing more. Quetta, North Waziristan, and other key places remain dens of iniquity, havens for extremists who continue to attack NATO and Afghan troops across the border and then return home for rest, regrouping, and fresh recruiting. Major command-and-control hubs are permanently located within Pakistan as well, and key insurgent leaders like Mullah Omar (to say nothing of Osama bin Laden) probably remain safely ensconced on Pakistani territory where U.S. forces cannot get at them. But it is perhaps not just a matter of available troops. Pakistan would rather have the Taliban and the Haqqanis back in power, especially in the country's south and east, than any group like the former Northern Alliance, which it views as too close to India. Since Islamabad cannot be sure that the current Afghan political system will survive, therefore, it keeps a backup plan based largely on the Taliban and its associates.

Under these circumstances, part of the right policy is to keep doing more of what the Obama administration has been doing with Pakistan-building trust, as with last fall's strategic dialogue in Washington; increasing aid incrementally, as with the new five-year, $2 billion aid package announced during that dialogue; encouraging Pakistan-India dialogue (which would help persuade Islamabad it could safely move more military forces from its eastern border to its western regions) and coordinating militarily across the Afghanistan-Pakistan border region. But President Barack Obama needs to think bigger. The clarification that the U.S.-led ISAF mission will continue until 2014, and indeed beyond, at the November Lisbon summit was a step in the right direction but more is needed.

Obama should offer Islamabad a much more expansive U.S.-Pakistani relationship if it helps win this war. Two major incentives would have particular appeal to Pakistan. One is a civilian nuclear energy deal like that being provided to India, with full safeguards on associated reactors. Pakistan's progress on export controls in the wake of the A.Q. Khan debacle has been good enough so far to allow a provisional approval of such a deal if other things fall into place as well, including Islamabad’s compliance with any future fissile production cutoff treaty. Second is a free trade accord. Struggling economically, Pakistan needs such a shot in the arm, and a trade deal could arguably do even more than aid at this point.

But the key point is this: Pakistan should be told that these deals will only be possible if the United States and its allies prevail in Afghanistan. Small gestures of greater helpfulness are not adequate; bottom-line results are what count and what are needed. If Afghanistan turns around in a year or two, the deals can be set in motion and implemented over a longer period that will allow the United States to continually monitor subsequent Pakistani cooperation in the war. These terms are really just common sense, and they are based on political realism about America's domestic politics as well as its strategic interests, since there is no way the Congress would support such a nuclear deal if Pakistani policy ultimately contributed to our losing the war in Afghanistan.

Conclusion

Current strategy in Afghanistan is built on reasonably sound counterinsurgency principles and is fairly promising in its prospects for the year ahead. But every such operation is different. That is a basic corollary of counterinsurgency theory, with its emphasis on local politics, conditions, and personalities-meaning that there is no reason to believe that current strategy is good enough just because its fundamentals are time-tested.

A number of other policy reforms, beyond those discussed here, may be worth considering in the coming months as well. The numerical goal for the Afghan security forces is probably still too low, and should approach 400,000 uniformed personnel rather than the current 305,000 target (this debate is well underway as of this writing). The legal system remains weak, with glaring problems such as a major dearth of judges and severely inadequate pay for prosecutors, as well as no clear strategy for linking the formal justice system to the local, traditional justice systems that remain important in Afghanistan today. Finally, in the aftermath of the September 2010 parliamentary elections, some patchwork solution to the disenfranchisement of Pashtuns in provinces like Ghazni where many of them could not vote (or had their votes thrown out) is probably needed. Perhaps some additional modest number of Pashtuns could be given non-voting adjunct status in the parliament, allowing their voices to be heard even if they were ultimately not able to win seats.

But the three changes to our current approach discussed in this policy brief are central, and have not received their due attention. On the anticorruption front, adoption of a less bilateral approach that includes a high-level international advisory body on good governance for the Karzai government could improve the tone and substance of the effort. On the Afghan politics front, the international community should be unapologetic about supporting Afghan political parties built on ideas and agendas more than personalities and ethnicities. And finally, in regard to Pakistan, an informal but public U.S. offer to pursue a bilateral civilian nuclear energy deal should Pakistan help us win the war by clamping down on insurgent sanctuaries, might motivate greater efforts by our on-again off-again allies across the border. Adoption of these recommendations would improve our prospects for at least moderate success in Afghanistan and help make 2011 the belated turnaround year that we so badly need.

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Policy Brief #181

The new normal for local, state and federal governments is fiscal austerity. Although President Obama supported education during his State of the Union address and in his budget proposal to Congress, cash-strapped localities and states—which foot most of the bill for educating America’s children—may have to balance their budgets with cuts to schools and teachers. The recession exposed a long-developing structural imbalance between public expenditure versus raising the revenue for public services. Especially on education, reality has set in, with a vengeance.

Cutting public expenditure is not necessarily a bad thing. There are, however, some activities that have become so fundamentally governmental and so critically important to the nation’s future that they require special care during a period of severe budget trimming. Education is one such example.

The Brown Center on Education Policy at Brookings has recently developed proposals to ensure that federal investments in education have impact. These proposals present the dual advantage of low costs of implementation at the federal level coupled with the promise of considerable leverage at the state and local level. Two of those proposals are presented in this brief: increasing digital and virtual education and expanding consumer information on higher education.

	RECOMMENDATIONS
	One important path to individual opportunity is higher levels of educational attainment. The U.S. economy is marked by an increasing economic divide between those who are educated and those who are not. In a time of fiscal austerity, every federal dollar invested in education must have a return. Congress should: Increase digital and virtual education. In reauthorizing the No Child Left Behind Act, provide that parents of economically disadvantaged students who are eligible for federal Title I funding should be able to direct that the funding associated with their child be spent to cover the costs of enrolling their child in virtual courses or in a virtual school.   Expand consumer information in higher education. Amend the Higher Education Act (HEA) to require that states that receive federal funds for statewide longitudinal data systems provide information on completion rates, employment levels, and annual earned income for each degree or certificate program and for each degree-granting institution that operates in the state. This information could be disseminated on the Internet.

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Editor's Note, Oct. 12, 2011: Congress has passed a trio of trade agreements negotiated during the George W. Bush administration and recently submitted by President Obama. The authors of this policy brief say the pacts with South Korea, Colombia and Panama will boost U.S. exports significantly, especially in the key automotive, agricultural and commercial services sectors.

Policy Brief #183

A trio of trade agreements now pending before Congress would benefit the United States both economically and strategically. Carefully developed accords with South Korea, Colombia and Panama will boost U.S. exports significantly, especially in the key automotive, agricultural and commercial services sectors.

Among the other benefits are:

• increased U.S. competitiveness
• enhancement of U.S. diplomatic and economic postures in East Asia and Latin America
• new investment opportunities
• better enforcement of labor regulation and
• improved transparency in these trading partners’ regulatory systems.

The pacts are known as Free Trade Agreements, or FTAs. The Korean agreement (KORUS) was negotiated in 2006-2007 and revised in 2010. The Colombian agreement (COL-US, sometimes known as COL-US FTA) was signed in 2006. The agreement with Panama (PFTA, sometimes known as the Panama Trade Promotion Agreement) was signed in 2007. All have the support of the Obama administration.

	RECOMMENDATIONS
	The three FTAs will substantially reduce these trading partners’ tariffs on U.S. goods, opening large markets for U.S. commerce and professional services. In combination, they will increase the size of the U.S. economy by about $15 billion. Furthermore, they will help reverse a slide in U.S. market influence in two important and increasingly affluent regions of the globe. Approval of all three agreements is in the national interest. To move forward, both Congress and the administration should take these appropriate steps: Congress should approve the trade agreements with Korea (KORUS), Colombia (COL-US) and Panama (PFTA) without additional delays.   To maximize the trade and investment benefits of KORUS, the administration should actively engage in the KORUS working groups, such as the Professional Services Working Group.   Similarly, the U.S. Trade Representative should participate in the Joint Committee’s scheduled annual meetings, in order to maintain a highlevel focus on U.S.-Korea trade, drive further trade liberalization and enable the committee to serve as a forum for broader discussions on trade in East Asia.   The Colombia-U.S. Joint Committee should include representatives of Colombia’s Trade and Labor Ministers with their US counterparts. The presence of the Labor minister should facilitate progress under the FTA through strengthened labor standards and timely implementation of all elements of the agreed-upon action plan. This Committee and specialized working groups could increase the pace of bilateral interaction and help officials identify important areas for discussion, negotiation and agreement.   Panama has ratified the Tax Information and Exchange Agreement which entered into force on April 2011. Panama and the US should strengthen bilateral communication so that collaboration in the battle against money laundering is pushed even further with greater cooperation.

Economic Effects of the Korea Agreement

The economic benefits to the United States from KORUS are especially significant, as the agreement will provide preferential market access to the world’s 11th largest—and a fast-growing—economy. In 2010, U.S.-Korea trade was worth $88 billion, comprising U.S. exports of $39 billion and imports of $49 billion, making Korea the United States’ seventh largest trading partner. According to the independent, quasi-judicial U.S. International Trade Commission (ITC), exports resulting from KORUS will increase the U.S. gross domestic product (GDP) by up to $12 billion. This constitutes a remarkable gain in both real and percentage terms.

To the United States, KORUS offers diverse economic advantages. Most strikingly, KORUS will open Korea’s service market to U.S. exports, allowing the United States to exploit its competitive advantages in financial services, education and information and communications technologies. The agreement also will lead to increased imports from Korea, which in turn will help the United States achieve greater economic specialization. The likely effects of more specialization—and of increased Korean investment in the United States—include greater U.S. efficiency, productivity, economic growth and job growth. Meanwhile, U.S. investors will gain new opportunities in the increasingly active Asia-Pacific region.

Lately, passage of KORUS has assumed enhanced importance with the impasse in the World Trade Organization’s Doha Round. No longer can the United States reasonably anticipate that Doha will lead to improved access to the Korean market. Moreover, an FTA between Korea and the European Union (EU) that took effect July 1st confers preferential access to European exporters, undermining the competitiveness of U.S. businesses in Korea. Even before the European FTA, the United States had been losing valuable ground in Korea. Between 2000 and 2010, the United States fell from first to third in the ranking of Korea’s trading partners (reversing positions with China), as U.S. products declined from 18 to only 9 percent of Korean imports. Failure to approve the agreement can be expected to lead to a further decline. These moves will strongly assist U.S. producers of electronic equipment, metals, agricultural products, autos and other consumer goods. For example, agricultural exports are expected to rise $1.8 billion per year.

On the services front, KORUS will increase U.S. businesses’ access to Korea’s $560 billion services market. Financial services providers, the insurance industry and transportation firms stand to benefit substantially. KORUS usefully builds on the link between investment and services by improving the ability of U.S. law firms to establish offices in Korea. In addition, the agreement establishes a Professional Services Working Group that will address the interests of U.S. providers of legal, accounting and engineering services, provided that U.S. representatives engage actively in the group. KORUS also requires that regulations affecting services be developed transparently and that the business community be informed of their development and have an opportunity to provide comments, which the Korean government must answer.

On the investment front, KORUS affords a chance to strengthen a bilateral investment relationship that probably is underdeveloped. In 2009, the U.S. foreign direct investment flow to Korea was $3.4 billion, while there was a net outflow of Korean foreign direct investment to the United States of $255 million. KORUS supports market access for U.S. investors with investment protection provisions, strong intellectual property protection, dispute settlement provisions, a requirement for transparently developed and implemented investment regulations and a similar requirement for open, fair and impartial judicial proceedings. All this should markedly improve the Korean investment climate for U.S. business. It will strengthen the rule of law, reducing uncertainty and the risk of investing in Korea.

On the governance side, KORUS establishes various committees to monitor implementation of the agreement. The most significant of these is the Joint Committee that is to meet annually at the level of the U.S. Trade Representative and Korea’s Trade Minister to discuss not only implementation but also ways to expand trade further. KORUS establishes committees to oversee the goods and financial services commitments, among others, and working groups that will seek to increase cooperation between U.S. and Korean agencies responsible for regulating the automotive sector and professional services. These committees and working groups, enriched through regular interaction between U.S. and Korean trade officials, should increase levels of trust and understanding of each county’s regulatory systems and help officials identify opportunities to deepen the bilateral economic relationship.

Strategic Effects of the Korea Agreement

Congressional passage of KORUS will send an important signal to all countries in the Asia-Pacific region that the United States intends to remain economically engaged with them, rather than retreat behind a wall of trade barriers, and is prepared to lead development of the rules and norms governing trade and investment in the region. KORUS will provide an important economic complement to the strong, historically rooted U.S. military alliance with Korea. It also will signal a renewed commitment by the United States in shaping Asia’s economic architecture.

The last decade has seen declining U.S. economic significance in Asia. Just as the United States has slipped from first to third in its ranking as a trading partner of Korea, similar drops are occurring with respect to Japan, Indonesia, Malaysia and other Asia-Pacific economic powers. In all of Northeast and Southeast Asia, the United States has only one FTA in effect, an accord with the Republic of Singapore. Passage of KORUS now would be particularly timely, both as a sign of U.S. engagement with Asia and as a mechanism for ensuring robust growth in U.S.-Asia trade and investment.

To illustrate how KORUS might affect U.S. interests throughout the region, consider regulatory transparency. The KORUS transparency requirements could serve as a model for how countries can set and implement standards. They might for example, influence the unfolding Trans-Pacific Partnership negotiations, talks that could set the stage for a broader Asia-Pacific FTA. U.S. producers, investors and providers of commercial and professional services could only benefit from a regional trend toward greater transparency and the lifting of barriers that would ensue. Other KORUS provisions favorable to the United States could function as similar benchmarks in the development of U.S. relations with Asia-Pacific nations and organizations.

Effects of the Colombia Agreement

COL-US will also strengthen relations with a key regional ally and open a foreign market to a variety of U.S. products. Bilateral trade between Colombia and the United States was worth almost $28 billion in 2010. COL-US is expected to expand U.S. GDP by approximately $2.5 billion, which includes an increase in U.S. exports of $1.1 billion and an increase of imports from Colombia of $487 million.

COL-US offers four major advantages:

• It redresses the current imbalance in tariffs. Ninety percent of goods from Colombia now enter the United States duty-free (under the Andean Trade Promotion and Drug Eradication Act). COL-US will eliminate 77 percent of Colombia’s tariffs immediately and the remainder over the following 10 years.
   
• It guarantees a more stable legal framework for doing business in Colombia. This should lead to bilateral investment growth, trade stimulation and job creation.
   
• It supports U.S. goals of helping Colombia reduce cocaine production by creating alternative economic opportunities for farmers.
   
• It addresses the loss of U.S. competitiveness in Colombia, in the wake of Colombian FTAs with Canada and the EU as well as Latin American sub-regional FTAs.

With respect to trade in goods, U.S. chemical, rubber and plastics producers will be key beneficiaries of COL-US, with an expected annual increase in exports in this combined sector of 23 percent, to $1.9 billion, relative to a 2007 baseline according to the ITC. The motor vehicles and parts sector is expected to see an increase of more than 40 percent. In the agriculture sector, rice exports are expected to increase from a 2007 baseline of $2 million to approximately $14 million (the corresponding increases would be 20 percent for cereal grains and 11 percent for wheat).

These and other gains will result from the gradual elimination of tariffs and from provisions that reduce non-tariff barriers as well. Among the latter, the most important changes would be increased transparency and efficiency in Colombia’s customs procedures and the removal of some sanitary and phytosanitary (or plant quarantine) restrictions. With respect to trade in services, Colombia has agreed to a number of so-called "WTO-plus" commitments that will expand U.S. firms’ access to Colombia’s $166 billion services market. For instance, the current requirement that U.S. firms hire Colombian nationals will be eliminated, and many restrictions on the financial sector will be removed.

On the investment front, the potential advantages to the United States also are substantial. In 2009, the U.S. flow of foreign direct investment into Colombia was $1.2 billion, which amounted to 32 percent of that nation’s total inflows. COL-US improves the investment climate in Colombia by providing investor protections, access to international arbitration and improved transparency in the country’s legislative and regulatory processes. These provisions will reduce investment risk and uncertainty.

COL-US presents significant improvements in the transparency of Colombia’s rule-making process, including opportunities for interested parties to have their views heard. COL-US also requires that Colombia’s judicial system conform with the rule of law for enforcing bilateral commitments, such as those relating to the protection of intellectual property. In addition to access to international arbitration for investors, COL-US includes dispute settlement mechanisms that the two governments can invoke to enforce each other’s commitments. Taken as a whole, these provisions offer an important benchmark for further developments in Colombia’s business environment. The transparency requirement alone could reduce corruption dramatically.

Labor rights have been a stumbling block to congressional approval of COL-US. The labor chapter of the agreement guarantees the enforcement of existing labor regulations, the protection of core internationally recognized labor rights, and clear access to labor tribunals or courts. In addition, in April 2011, Colombia agreed to an Action Plan strengthening labor rights and the protection of those who defend them. In the few months the plan has been in effect, Colombia has made important progress in implementation. It has reestablished a separate and fully equipped Labor Ministry to help protect labor rights and monitor employer-worker relations. It has enacted legislation authorizing criminal prosecutions of employers who undermine the right to organize or bargain collectively. It has partly eliminated a protection program backlog, involving risk assessments. And, it has hired more labor inspectors and judicial police investigators.

Besides economic benefits, COL-US offers sizable strategic benefits. It would fortify relations with an important ally in the region by renewing the commitment to the joint struggle against cocaine production and trade. Under the agreement, small and medium-sized enterprises in labor-intensive Colombian industries like textiles and apparel would gain permanent access to the U.S. consumer market. With considerable investments, Colombia would be able to compete with East Asia for these higher quality jobs, swaying people away from black markets and other illicit activities.

While Congress deliberates, the clock is ticking. Colombia is also looking at other countries as potential trade and investment partners in order to build its still underdeveloped infrastructure and reduce unemployment. Complementing its FTAs with Canada, the EU, and several countries in the region, Colombia has initiated formal trade negotiations with South Korea and Turkey and is moving toward negotiations with Japan. A perhaps more telling development is China’s interest in building an inter-oceanic railroad in Colombia as an alternative to the Panama Canal: on July 11th President Juan Manuel Santos signed a bilateral investment treaty with China (and the UK) and is expected to meet Chinese President Hu Jintao in the fall.

Effects of the Panama Agreement

Although Panama’s economy is far smaller than Korea’s or even Colombia’s, the PFTA will deliver important economic and strategic benefits to the United States. Considerable gains will take place in U.S. agriculture and auto manufacturing. Moreover, the PFTA will strengthen the U.S. presence in the region, allowing for the stronger promotion of democratic institutions and market-based economies.

U.S. merchandise exports to Panama topped $2.2 billion in 2009. The PFTA’s elimination of tariffs and reduction in non-tariff barriers will cause this figure to grow. For example, rice exports are expected to increase by 145 percent, pork exports by 96 percent and beef exports by 74 percent, according to the ITC. Exports of vehicles are expected to increase by 43 percent. The PFTA also guarantees access to Panama’s $21 billion services market for U.S. firms offering portfolio management, insurance, telecommunications, computer, distribution, express delivery, energy, environmental, legal and other professional services.

Panama’s trade-to-GDP ratio in 2009 was 1.39, highlighting the preponderance of trade in Panama’s economy and the international orientation of many of its sectors. Following passage of the PFTA, Panama will eliminate more than 87 percent of tariffs on U.S. exports immediately. The remaining tariffs will be removed within 10 years for U.S. manufactured goods and 15 years for agricultural and animal products.

PFTA protections to investors—similar to protections accorded under KORUS and COL-US—are especially valuable, as Panama receives substantial investments associated with sectors that will benefit from both from the expansion of the canal and from other infrastructure projects. A fair legal framework, investor protections and a dispute settlement mechanism, all features of the PFTA, are almost certain to increase U.S. investments in Panama. Panama’s Legislature also recently approved a Tax Information Exchange Agreement with the United States and amended current laws to foster tax transparency and strengthen intellectual property rights. These are crucial steps in preventing the use of Panamanian jurisdiction as a haven for money laundering activities.

Panamanian laws and regulations prohibiting strikes or collective bargaining were a concern that initially delayed implementation of the PFTA. But, these laws have been changed, with the exception of a requirement that 40 workers (not the recommended 20) are needed to form a union; the 40-worker requirement has been kept partly because labor groups in Panama support it. The PFTA’s labor chapter protects the rights and principles outlined in the International Labor Organization’s 1998 Declaration on Fundamental Principles and Rights at Work.

Besides offering economic advantages to the United States, the PFTA is a strategic agreement. Strengthening economic links with Panama should bolster the U.S. capacity to address cocaine trafficking in the region, in light of Panama’s location as Colombia’s gateway to North America. The importance of the canal, now undergoing an expansion that will double its shipping capacity, further underscores the U.S. need to strengthen bilateral relations with Panama.

The time to act is now. Like Colombia, Panama has been negotiating with economic powerhouses other than the United States. It recently signed a trade agreement with Canada and an Association Agreement with the EU. Delaying passage of the PFTA would generate a loss of market share for a variety of sectors of the U.S. economy.

Conclusion

All three FTAs encourage trade by removing tariff and non-tariff barriers. All the agreements provide access to large services markets, foster transparency and offer significant strategic advantages to the United States. Congress should approve each of them now.

The authors would like to thank Juan Pablo Candela for his assistance with this project.

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Policy Brief #184

The Leahy-Smith America Invents Act (AIA) approved in September 2011 constitutes the most significant overhaul of the American patent system in decades. This policy brief examines some key patent law changes and studies mandated by the legislation, and provides recommendations for companies on successfully navigating the new landscape. [Editor's Note: the legislation was signed into law by President Obama on September 16, 2011.]

Perhaps most notably, the new law will move the United States away from a “first to invent” system and closer to the “first to file” approach used in much of the rest of the world. Other important changes include a new proceeding in the U .S. Patent and Trademark Office (PTO) for third-party challenges to the validity of a recently issued patent, an expanded mechanism for a third party to provide information to the PTO that could be used to narrow or eliminate claims in a pending patent application being prosecuted by a commercial rival, and the introduction of a new, broadly applicable patent infringement defense based on prior commercial use.

	RECOMMENDATIONS
	Under the “first to file” provision of the AIA, companies should be more careful when producing pre-filing disclosures for venues such as conferences and trade shows, with the understanding that under the AIA those disclosures may play a much larger role than in the past with respect to patentability of the associated IP.   Under the AIA, rights to an invention prior to a filing date will depend more on the history of relevant disclosures and less on nonpublic, internal company documents such as laboratory notebooks. All companies—large and small—should consider how to modify their procedures for protecting, evaluating, and filing patents on their inventions accordingly.   The AIA provides a grace period during which inventors can disclose their invention without losing the right to patent it, but leaves uncertainty regarding the definition of “disclosure”. Companies should carefully monitor case law and PTO actions that will undoubtedly help clarify this issue in the coming years.   Companies should reevaluate the extent and manner to which they use provisional patent applications to preserve IP rights.   In light of the increased number of mechanisms available to challenge the validity of pending and issued patents, companies engaged in patent prosecution should reconsider the tradeoffs of performing their own thorough prior art searches during patent prosecution. By finding and disclosing relevant prior art to the PTO, companies may reduce the likelihood that the disclosed prior art will be used successfully against them in future validity challenges.

In addition, there are several other aspects of the AIA that do not change patent law, but may have far reaching consequences. For example, an AIA mandated study by the Government Accountability Office promises to furnish vitally important information on the economic impact of patent litigation by non-practicing entities, and will almost certainly influence future patent legislation. Under the AIA, the hurdles small businesses face in protecting their patents internationally will also receive attention through a PTO study.

It will take many years to develop a mature body of case law and legal scholarship on the full impact of the AIA. What is clear today is that it will profoundly impact the ways that patents are filed, prosecuted, and litigated in the coming years. Companies and other entities that retool their patent strategies to address these changes will be in a much stronger position to maximize the value of their intellectual property (IP) portfolios.

First Inventor to File

One of the most significant components of the AIA concerns the move from a first to invent system to a first to file system. Under this provision, which takes effect 18 months after the AIA is enacted into law, an inventor may win the race to create the invention but lose the race to file the corresponding patent application, and thus lose the right to patent the invention.

However, the AIA includes an important exception in the form of a grace period allowing an inventor or others who obtained information from the inventor to make disclosures regarding the invention in advance of filing a patent application, as long as the application is filed within one year after the first disclosure. Some form of grace period has been a feature of the U.S. patent landscape since the 19th century, and allows an inventor time to examine the commercial practicability of the invention, engage in discussions with potential partners and customers and secure the resources necessary to draft a patent application.

The inclusion of both first to file language and a grace period in the new patent law creates what could amount to a hybrid between first to invent and first to file. For example, in the case of two inventors who independently disclose the same invention immediately following its conception, both the pre-AIA “first to invent” law and the post- AIA “first to file” law can favor the earlier discloser, who is by definition the earlier inventor if the disclosure is truly immediate. However, in the absence of disclosure in advance of a patent filing, pre-AIA law favors the earlier inventor, while the AIA “first to file” provision will favor the earlier filer.

As a result, under the AIA inventors and the companies that employ them must think much more carefully about how to manage pre-filing disclosures. Put simply, silence can be costly. To the extent that a company remains quiet about an invention while contemplating whether or not to pursue patent protection, it stands exposed to the possibility of losing the right to do so if a competitor files first. A company wishing to avoid this risk faces the additional challenge that the AIA does not specifically define what constitutes “disclosure” sufficient to preserve patentability. The use of provisional patent applications, which offer advantages including a more formalized way to document the dates and content of disclosures than activities such as presentations at trade shows, should also be reevaluated in light of the AIA.

Some companies may find themselves targeted by competitors’ disclosures engineered specifically to foreclose patent opportunities. To reduce vulnerability to such attacks, companies can engage in preemptive “defensive” disclosures, but must be mindful of the impacts of these disclosures on their own patent filing deadlines.

In addition, employees engaged in intellectual property creation can be made aware that there is an increased need to pursue timely steps to secure patent protection on new inventions. Internal company systems for documenting, reporting, and rewarding innovations can be modified to better match the provisions of the AIA. Companies should also consider the budgetary impact of the AIA in terms of the amount and timing of expenditures.

It is important to recognize that the AIA leaves substantial differences between the patent laws in the United States and those in other countries. For example, unlike in the United States both pre- and post-AIA, in Europe an inventor’s own public disclosures in the year prior to a patent filing can be invalidating prior art. To the extent that for financial or other reasons a company needs to defer filing a U.S. patent application to a future date, in one sense the systems have actually moved farther apart. This is due to what amounts to a newly incentivized option to buy some measure of protection in the U.S. by disclosing in advance of a filing at the cost of losing patentability in Europe. This requires careful consideration of disclosure plans.

Best Mode and Invalidity

The AIA does not alter the requirement that a patent application must “set forth the best mode contemplated by the inventor of carrying out” the invention. However, somewhat paradoxically, for proceedings commenced on or after the date of its enactment, the AIA eliminates the alleged failure to follow this requirement as grounds for asserting invalidity.

This change has the potential to alter a fundamental compact between an inventor and the government that is at the core of the patent system, which grants a patent holder the right to exclude others from practicing an invention in exchange for disclosing the best mode contemplated by the inventor. The AIA eliminates the failure to make this disclosure as grounds for asserting invalidity. Some inventors may view this as creating an incentive to intentionally withhold information on how to best carry out an invention.

Supplemental Examination

The AIA creates a new supplemental examination procedure, effective one year after enactment, allowing a patent owner to request that the PTO perform a supplemental examination to “consider, reconsider, or correct information believed to be relevant” to a patent. Subject to certain exceptions, this process can prevent a patent from being “held unenforceable on the basis of conduct” relating to this information.

The supplemental examination provision is particularly relevant to inequitable conduct allegations that are frequently raised by defendants in patent litigation. Defendants often try to identify information relating to the prosecution of patents that have been asserted against them that, in their view, indicates inequitable conduct rendering the patents unenforceable. Supplemental examination provides a way for a patent owner to preemptively attempt to inoculate a patent against such allegations.

Pre-Issuance Submissions

Beginning one year after the AIA is enacted, third parties will have the option of providing pre-issuance submissions of prior art accompanied by “a concise description of the asserted relevance of each submitted document” to the PTO in connection with a pending application. Such submissions can be used, for example, to attempt to prevent or hinder the issuance of a patent that the submitting party views as detrimental to its interests. However, to the extent that a patent examiner finds the arguments provided through a pre-issuance submission unconvincing, the resulting patent might actually be strengthened, not weakened.

Prior Commercial Use Defense to Infringement

Since 1999, alleged infringers of business method patents have had access to a “prior use” provision that can constitute a defense against infringement, provided certain conditions are met. For patents issued on or after the date of enactment of the AIA, the prior use defense can be applied, subject to certain exceptions, to patent infringement claims covering a much broader range of subject matter “consisting of a process, or consisting of a machine, manufacture, or composition of matter used in a manufacturing or other commercial process.”

Post-Grant Review Proceedings

Post-grant review proceedings are conducted through the PTO in order to reconsider alreadyissued patents, and can lead to the confirmation, cancellation, withdrawal, or modification of patent claims. T he phrase “post-grant review” is sometimes used to broadly refer to multiple types of post-grant proceedings including the ex parte and inter partes reexaminations available under pre- AIA patent law, and sometimes to more narrowly refer to a specific new review option created by the AIA (in fact, in the AIA itself the phrase is used in both the broad and narrow meanings).

Under pre-AIA patent law, a requester wishing to initiate an ex parte or inter partes reexamination provides the PTO with one or more published prior art references and an explanation why those references, in the view of the requester, raise a “substantial new question of patentability.” The PTO can either grant or deny the request; if the request is granted, an ex parte reexamination proceeds without any further input from the requester (unless the requester is the patent owner), while in an inter partes reexamination the requester participates during the reexamination process.

Both types of reexaminations have proven to be highly effective ways for third parties to challenge the validity of issued patent claims, often in tandem with or as a lower cost alternative to challenges adjudicated through the Federal court system and the International Trade Commission. According to data released by the PTO in June 2011, 92% of the requests for ex parte reexamination filed since the proceeding was introduced in the 1980s have been granted, and fewer than one quarter of patents subject to ex parte reexamination have emerged without any claim changes or cancellations. Inter partes reexamination was introduced in 1999; since then 95% of inter partes reexamination requests have been granted, and only 13% of patents subject to inter partes reexamination have survived with all claims confirmed.

The AIA leaves ex parte reexamination in place, but a year after enactment will replace inter partes reexaminations with “inter partes review” proceedings adjudicated by a newly renamed Patent Trial and Appeal Board within the PTO. The pre-AIA threshold to grant an inter partes reexamination of a “substantial new question of patentability” will be replaced with a higher threshold requiring that the PTO find a “reasonable likelihood that the petitioner would prevail with respect to at least one of the claims challenged in the petition.” This higher standard will also be applied to inter partes reexaminations filed during the transition period immediately following enactment of the AIA and preceding the shift to inter partes review. Inter partes review requests must be filed no earlier than nine months (and in some cases longer) after the grant or reissue of the patent being challenged.

Additionally, the AIA creates a new “post-grant review” process through which a petitioner who is not the patent owner can request the cancellation as invalid of one or more claims of a patent granted or reissued within the previous nine months. The PTO can authorize a post-grant review if the information presented by the petitioner, “if not rebutted, would demonstrate that it is more likely than not that at least one of the claims challenged in the petition is unpatentable.” Under the AIA this threshold can be satisfied not only using traditional invalidity arguments based on settled law, but also by a petition that raises “a novel or unsettled legal question that is important to other patents or patent applications.” This language amounts to an invitation to address “novel or unsettled” legal questions through the PTO, raising a number of issues relating to respective roles the courts and the PTO will play in resolving them.

For companies engaged in or threatened with patent litigation or those that simply want to launch a pre-emptive strike at patents held by a competitor, post-grant review introduces a new way to challenge patents. The AIA contains estoppel and other provisions intended to prevent a requester from having two bites at the apple by challenging a claim in both a PTO post-grant (or inter partes) review and a civil action or International Trade Commission proceeding. However, in some circumstances these provisions may turn out to be largely toothless, since patent cases often involve multiple defendants who form joint defense groups and engage in coordinated attacks on patent validity. There is nothing in the AIA preventing one defendant from challenging claim validity through a post-grant or inter partes review and another from simultaneously or later asserting invalidity of the same claims in the federal court system or at the International Trade Commission.

The AIA also expressly provides that, starting one year after enactment, statements by a patent owner filed in a federal court or with the PTO regarding claim scope can be cited to the PTO for consideration in ex parte, inter partes, and post-grant review proceedings to determine claim meaning.

Other Provisions

In addition to codifying many changes to patent law, including those described above, the AIA contains other provisions that will likely have a significant impact on the operation of the PTO and on future patent legislation. Several of these provisions are discussed below.

Fee Diversion

One of the most controversial aspects of the patent reform debate has pertained to the practice of fee diversion, which arises because the PTO takes in an amount in fees that exceeds its appropriation. The Senate version (S. 23) of the AIA passed in March 2011 provided for the creation of a fund that would have allowed the PTO roll over excess funds into future fiscal years. However, in the House version (H.R. 1249) passed in June 2011 that became the template for the final legislation, this provision was removed and replaced with a newly established “Patent and Trademark Fee Reserve Fund” to be held in the treasury and into which excess fees will be deposited. This approach does not cleanly put the fee diversion issue to rest, and the details of how the reserve fund will be managed in future years remain unclear.

Studies Mandated by the AIA

The AIA mandates several studies, including one to be performed by the Government Accountability Office to examine the “consequences of litigation by non-practicing entities, or by patent assertion entities,” to gather data, among other things, on the volume of litigation, the number of cases found to be without merit, the costs to patent holders, licensees, licensors, and inventors, the economic impact of this litigation, and the “benefit to commerce, if any, supplied by non-practicing entities or patent assertion entities that prosecute such litigation.”

“Non-practicing entities” and “patent assertion entities” are terms that are sometimes used to describe companies that have little or no business other than the assertion of patents. Patent litigation involving these entities has grown significantly in recent years, in large part due to the potential for large judgments and settlements. The GAO study provides an opportunity for an unbiased examination of a significant aspect of the litigation environment, and is likely to produce information that will be valuable in drafting future patent legislation.

The AIA also mandates that the PTO perform a study on international patent protections for small businesses. T he financial burden of obtaining international patent protection is particularly heavy for small companies due to the combined costs of performing many different country-specific filings. As a result, many small companies either avoid foreign filings altogether, or perform foreign filings only for a small subset set of countries and only for the patents that they believe to be the most valuable. A goal of the AIA-mandated study is to determine whether to recommend establishing a loan or grant program to help small businesses defray the costs associated with international patent protection.

It is likely the study will conclude that such a program would be beneficial to small businesses, but it is just as likely that implementing it will prove to be extremely difficult in the current budgetary environment. However, the study may influence future patent legislation in the United States and abroad, and may be useful in multilateral discussions regarding international patent protection.

Conclusion

The AIA will reshape how United States patents are obtained, challenged, and valued in acquisition, licensing, and litigation settlement discussions. Companies that overhaul their intellectual property strategies in light of the provisions of the AIA will be in a better position to maximize the value of their patent portfolios and to strengthen their options in patent litigation matters.

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Missouri's population is spreading out, adding to the costs of providing services and infrastructure across the state, according to a new study released today by the Brookings Institution Center on Urban and Metropolitan Policy.

The 84-page study, Growth in the Heartland: Challenges and Opportunities for Missouri, reports that Missouri's population is quickly dispersing, with smaller metropolitan areas experiencing some of the state's fastest growth and residency in unincorporated areas on the rise. Though new residents and jobs fueled prosperity in the 1990s, the report finds that growth has slowed in the past year, and suggests that the state's highly decentralized development patterns could become troublesome as Missouri contends with a slowing economy and serious budget deficits.

Sponsored by the Ewing Marion Kauffman Foundation, Growth in the Heartland provides the most comprehensive and up-to-date body of research and statistics yet assembled analyzing the direction, scope, and implications of development in Missouri. In addition to assessing the consequences of those trends for the state's fiscal health, economic competitiveness, and quality of life, the report addresses the potential role of state and local policy in shaping those trends in the future. Specific findings of the report conclude that:

• Growth in the Columbia, Springfield, Joplin, and St. Joseph metropolitan areas strongly outpaced that of the Kansas City and St. Louis metropolitan areas in the 1990s. Altogether the four smaller areas captured fully one-quarter of the state's growth and doubled the growth rate of the Kansas City and St. Louis areas.
  
  
• Population and job growth also moved beyond the smaller metro areas and towns into the state's vast unincorporated areas. Overall, residency in these often-outlying areas grew by 12.3 percent in the 1990s—a rate 50 percent faster than the 8.1 percent growth of towns and cities.
  
  
• Most rural counties reversed decades of decline in the 1990s, with eight in ten rural counties experiencing population growth and nine in ten adding new jobs. By 2000, more rural citizens lived outside of cities and towns than in them, as more than 70 percent of new growth occurred in unincorporated areas.

"Missouri experienced tremendous gains during the last decade, but the decentralized nature of growth across the state poses significant fiscal challenges for the future," said Bruce Katz, vice president of Brookings and director of the policy center. "The challenge for Missouri is to give communities the tools, incentives, and opportunities to grow in more efficient and fiscally responsible ways."

The Brookings Institution Center on Urban and Metropolitan Policy is committed to shaping a new generation of policies that will help build strong neighborhoods, cities, and metropolitan regions. By informing the deliberations of state and federal policymakers with expert knowledge and practical experience, the center promotes integrated approaches and practical solutions to the challenges confronting metropolitan communities. Learn more at www.brookings.edu/urban.