MIT professor and former IMF chief economist Simon Johnson explains his plan to boost the innovation and job-creating power of the U.S.

The decades after World War II saw great innovation, the development of new business sectors, and advances in medicine and technology. That all came with big jumps in wages and productivity. But the period was followed by a decades-long slump in wages for the middle class, lower productivity growth, and growing income and wealth inequality. So is there a way to return to the days when everyone benefited more?

There is, according Simon Johnson, professor of entrepreneurship at the MIT Sloan School of Management and a former chief economist at the International Monetary Fund. He is also co-author of the new book, Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream. Johnson joined the Knowledge at Wharton radio show on SiriusXM to discuss the key points of his plan to recreate the economic juggernaut of those storied post-war years. (Listen to the podcast using the player above.)

An edited transcript of the conversation follows.

Knowledge at Wharton: Where does the idea of growth benefiting the very few come from?

Simon Johnson: We had this period in the 1940s, 1950s, definitely into the 1960s, and arguably into the 1970s where more or less everyone benefited and it was a broad middle-class development…. From the 1980s, it tips over and becomes more of an exclusive model. Median wages don’t go up very much, if at all, from the late 1980s. So it’s the last three decades really.

Knowledge at Wharton: How did the monolith of American science research and development come about by necessity during World War II, and how did that propel the economy through a couple of decades?

Johnson: It is a fascinating story that a lot of people have forgotten. At the very beginning of World War II when America was on the sidelines, there was a realization in top scientific circles, and also a bipartisan realization in Washington, that the U.S. didn’t lead the world in terms of relevant technology for fighting the war. As a result, there was a systemic and eventually large-scale push to develop technologies, including radar, that had a huge immediate impact, and of course including the development of the atomic bomb, that was transformative in many ways.

From that experience and those very intense five years and winning World War II came the rather profound thought that we could have a big systematic push led by the public sector on basic science for domestic peaceful, productivity-enhancing purposes. And that became a major emphasis and a real boost to the private sector. So it was more or less a paradigm mental shift in terms of what the government can do and how to use public resources. But it was very much tied with private sector development —  a public/private partnership which the U.S. really pioneered and was adopted by a lot of people around the world.

“We have about 280,000 jobs in and around genomics … because we put $3 billion of U.S. federal money into the human genome project.”

Knowledge at Wharton: You cite some fascinating examples in the book. For example, the transistor — the basis for semiconductors and thus computer technology — was created by Bell Labs, a private company. But it was built upon critical work done with radar during World War II. The transistor replaced the vacuum tube. And then there was some more basic research done by the government on that which helped lead to the semiconductor. So it wasn’t Silicon Valley folks in a garage creating this. The government also created the internet, GPS, and many other things, or at least funded them.

Johnson: That’s absolutely right. Although the way I would frame it is by saying it was a partnership between the public sector and the private sector. Yes, there were Silicon Valley geniuses literally in their garages and they played a role. But there was also this big public commitment to basic science, which was actually less about economic development and more about national security.

So in addition to what you just said about transistors and semiconductors, I would remind everyone that there were very few customers for transistors at the beginning, other than the U.S. military. In fact the missile men, rocket program in the early 1960s bought most of the transistors that were manufactured. Vacuum tubes didn’t work very well in rockets. Transistors solved that problem. It really became a commercial product only at the end of the 1960s, beginning of the 1970s. So the government is involved in the development of digital electronic computers all the way through until it really starts to take off in the 1970s.

Knowledge at Wharton: There’s a great quote in your book, “Almost everything about your computer today and the way you use it stems from government funding at early stages.” You also noted that 85% of U.S. electronics research in 1959 was paid by the federal government. And the Defense Department funded nearly half of all semiconductor R&D from the late 1950s until the early 1970s.

Johnson: Yes. And it was seen as an important part of national security, particularly after the Soviet Union launched the Sputnik, the first artificial man-made satellite in 1957. And so the response to that technological challenge was to invest a lot more in our own technology, train people, educate people. So the National Defense Education Act of 1958, we argue, is an absolutely essential complementary piece to the government push on R&D. You need a demand for skilled labor and a supply of skilled labor. And you need to spread the jobs and opportunities throughout the …. population. That’s what we did into the 1960s.

Knowledge at Wharton: It’s very interesting that the federal government took a lot of the big risks with the basic research, which typically is not all that profitable – at first. It’s often a long-term pay out, 15 or 20 years, something most companies are loathe to do because they’re looking for a much faster return on investment. So the government, in partnership with universities and with companies, did the basic research. They let others earn the profits. And it’s these big industries that help sustain our economy and might not have come about for years if there wasn’t this partnership. Or it might have been done by other countries, which would have taken the lead instead of us. So there are a couple of very important things for our economy in there.

Johnson: The government definitely played the role as a catalyst. Maybe it’s more than a catalyst, but definitely at least a catalyst. And in terms of international competition, you put your finger on a very important point. It is win/win when new technologies get developed somewhere else. We can adopt them and use them. But whoever first creates a technology and manages that breakthrough — human genome project would be a good point, a more recent example — whoever does that as a country and as a region and as a city tends to get a disproportionate share of the good jobs for a long period.

So we have about 280,000 jobs in and around genomics right now in the U.S. because we put $3 billion of U.S. federal money into the human genome project and mapping the human genome — $3 billion went in over 15 years. We get $6 billion a year out of that in terms of taxation. That’s an amazing rate of return. But no private company would have done it because of the spillovers and because you can’t capture these big social rates of return in a private fashion on the basic science. You can on the applied stuff, but not when you’re doing the big breakthroughs.

Knowledge at Wharton: So the federal government then cut funding for basic research quite a bit. Now the private sector picked up most of the slack as far as the dollars were concerned. So there is still a large amount of R&D obviously in the U.S. The problem is how the private sector invests in R&D is different. The government takes the long view — it’s not looking to make a profit. It develops the basic research, and companies spin off products from the government-funded basic research.

Johnson: That’s exactly right. So we like private R&D. We don’t want to be misunderstood on that. And we’d like, actually, more of it to happen. But the key point is time horizons are fundamentally different. So if you go to the stock market and say, “Hey, we’ve got a great idea that may or may not pan out and have massive social impact in 15 years” you’re not going to get that funded. People want to know what’s the return to me as an investor. And that’s how the system works. And we’re not trying to change that.

“At our peak in the mid-1960s, public research and development was about 2% of GDP. … We are now around 0.7% of GDP.”

What we’re saying is you need a government push to try and get the breakthroughs and to try and get these social spillover effects that may affect obvious companies or it may have an effect far away in a different part of the economy that you can’t anticipate. Those are all going to be benefits. But no private enterprise and no private philanthropist … has got enough resources and could fund that on the scale that the government has been able to do in the past, and still does some of it, but we’ve backed away and we should re-up in terms of that commitment.

Knowledge at Wharton: How much has the government backed away over the years?

Johnson: At our peak in the mid-1960s, public research and development was about 2% of GDP, so that’s one in $50 spent in the economy. We are now around 0.7% of GDP, and that’s the right way to think about it. Because everything grows over time, obviously. And you want to think about how much you’re investing in the basics and in the potential breakthroughs relative to the size of the economy. We’re spending less than half relative to the size of the economy. In our book, we suggest pushing back up by about 0.5% of GDP — that’s about $100 billion per year. That’s a substantial commitment that would move the needle. That would create about four million new, good jobs over time.

It would not put us back to where we were in the 1960s, but actually to where we were in the 1980s under Ronald Reagan. So this commitment to the breakthroughs has slipped gradually over the decades. We think that you can’t go back to the 1980s, but you can put more money in. You can get a better path for the future by betting more on finding these breakthroughs.

Knowledge at Wharton: Would you talk about this ‘valley of death’ concept that you have in the book?

Johnson: So in addition to the need to fund breakthroughs and to fund that acquisition and accumulation of knowledge, there is also the issue of how do you commercialize it? How do you cross over for something that’s capital intensive, for something where the returns to a particular investor and particular private company may be uncertain?

Now, obviously, within IT, when companies that we’ve seen grow, like Google and Amazon, there are purely private sector ways to do that. And we’re not trying to get in the way. But if you look at more capital-intensive technologies, for example around clean energy or more efficient energy, there have been a number of prominent cases. We talk about a prominent U.S. company that makes batteries in the book, that developed basic technology. They wanted to take it to scale, but couldn’t find the funding in private markets in the U.S. and the government wasn’t providing the support that would make a difference. So they did fund it. And they have scaled up. But they did it in China.

Some people say, well, the Chinese have got a fundamentally different economic model and that’s an issue. But I would say at its core the Chinese have actually studied American history and have thought about public/private partnerships and are finding ways for the public sector to help the private sector develop knowledge and cross the ‘valley of death’ to get to commercial scale. And that’s even more challenging than anything you may think they’re doing in terms of cheating the system.

Knowledge at Wharton: The book notes that a contingent of Chinese came over and studied our research park model, and went back and did a quite good job of duplicating it.

Johnson: The Chinese and others have paid close attention to what we’ve done in the past and have learned from our experience. They’ve looked at versions of what we did that were applied in Taiwan, in Singapore, in other parts of Asia. So there have been some refinements that have gone on. The good news is we can do better. And we have built some amazing clusters of innovation, including with public/private partnerships in and around, for example, biotech. So Cambridge and Boston, Mass., have benefited greatly from that.

The problem is, it’s a bit isolated. It’s more in life sciences than it is in other things. These geographic-leading clusters on the east coast and the west coast have become immensely crowded and very expensive as a place to do business. We haven’t yet spread enough of that opportunity into other parts of the country. We think the time is ripe to take advantage of the fact we have a lot of really good technical, managerial skilled talent across the country. That’s a big geographic advantage we have that we should be leveraging at this point.

“By reigniting and boosting this innovation machinery … and by spreading it around the country, you will get the breakthrough products and the new ideas.”

Knowledge at Wharton:  You list 102 towns that you believe are ripe to be significant technology hubs right now in the U.S.

Johnson: Many places want more good jobs and are working really hard, and there’s a lot of local energy heading in that direction. We think, once again, the federal government could play a catalytic role in those places where people want those jobs.

Knowledge at Wharton: The bottom line seems to be that this investment in R&D leads to new products, new companies, maybe new industries sometimes as we’ve seen. And also creates well-paying jobs.

Johnson: That’s the key bundle and that’s what we had in the post-war period, which is productivity grows. That’s good. That’s the base of your economic growth. That means you’ve got more stuff to go around in the economy. But as part of that productivity growth machine, you generate good jobs. Productivity growth has slowed overall since the 1970s. To the extent we have productivity growth in some parts of the economy, it is not associated with more good jobs, it’s associated actually with fewer good jobs. So certainly the middle-income, middle-skilled jobs have been squeezed out. We have a so-called polarization of the job market that’s going on and there’s a lot of evidence to support this.

We think that by reigniting and boosting this innovation machinery that we have already in the U.S. — we’ve just sort of let it fall a little bit into disrepair — and by spreading it around the country, you will get the breakthrough products and the new ideas, and that’s your productivity piece.

But you will also have a lot of people employed in building the infrastructure, supporting the scientific effort, running the labs. Some of those people have Ph.Ds, absolutely. A lot of them don’t. In the genomics industry, for example, the average wage is $70,000 per year. Those are good jobs, but those are not all Ph.D. jobs. There’s an entire complex of people working in that industry with many different education levels. Those are jobs that are not going to be outsourced any time soon to China or anywhere else.

Knowledge at Wharton: Another point that you make is that if we don’t do it someone else will.

Johnson: There are plenty of countries that led in terms of technology development during human history. We could go back to Rome. We could talk about Venice from the 1300s. We could obviously talk about the U.K. in the 19th century. The U.S. steps up in the late 19th century, becomes an innovative, engineering place. From the 1940s, it really applies science and figures out how to move the next level of science into commercial products. Nobody’s ever seen anything like that ever before in the world. And that builds the middle class like you’ve never seen before.

We lost that; we backed away from it. Others have figured this out. But it’s not a win/lose situation. It’s not that we have to beat up on some other country or take it away from some other country. On the contrary, we need to do what we’re good at, which is innovate, create jobs. That will help us. That will benefit everybody else who trades with us. We will have more of those good jobs in the U.S. states if we lead in terms of developing new technologies. That’s the key bottom line.

“We propose building and developing 20 to 30 new hubs for technology development around the country.”

Knowledge at Wharton: So there’s a sweet spot for R&D. It involves a triad of government funding for basic research such as for the NIH (National Institutes of Health) and for universities. And then industry, which does its own research, of course, would pick up the development side of the R&D more so.

Johnson: Yes, that is exactly the model with the universities playing a key role. That was what was figured out during World War II and that was the key innovation. Because universities are a little bit isolated from commercial pressures, they have a longer time horizon. The incentives are a little bit different.

But you don’t want what some people call the ‘ivory tower’ effect. You don’t want the researchers just looking at the research for its own sake. You need those private sector, private industry connections. I would suggest that MIT, historically and the modern version, is one example of how to do this. Stanford, of course, is another. Other great schools including the University of Pennsylvania have done this as well. Carnegie Mellon in Pennsylvania stands out as a place where there’s a lot of conversation and connection with the private sector, a lot of interest in developing products that could really change the world, but there’s also time and space for deeper research in the labs, and the government is funding that piece of it. So it’s that triangle, as you said.

Most other countries really struggled to build that. I’m from the U.K. and there has been progress in this direction, but it took centuries to really change how some of these big name, prestigious universities operated. The U.S. has always had, or at least since the 1940s, something of an edge this space.

Knowledge at Wharton: Could you run through how much this would cost and how it might work, and how the money might get distributed?

Johnson: We propose building and developing 20 to 30 new hubs for technology development around the country. At full scale it would cost about $100 billion a year. That would create 4 million new jobs over time. It would absolutely move the needle in terms of supporting the middle class. And we propose upside capture mechanisms so that the capital appreciation you get from the equity and the land value that rises when you do this, some of that would flow back not to new government programs, but come back to all Americans in the form of a cash dividend. Cash into everyone’s pocket as a result of this renewed public commitment to research and development.