The budget “blueprint” released on March 16 by the new Administration proposed the largest cuts in history to Federal science support. If enacted as proposed it could mark the end of the bipartisan consensus on such support that has endured since World War II. The Department of Energy would be particularly hard hit, with both basic and applied research facing some $3 billion in cuts. Singled out for elimination was the Advanced Research Projects Agency–Energy (ARPA-E), DOE’s seven-year-old, $300 million-per-year breakthrough research agency. Some are concerned about how this will impede the technological progress we need to deal with climate change, but that’s the least if it. There is a deep economic issue here, because the real importance of ARPA-E can only be fully understood in the context of the key economic role of the U.S. innovation system and upcoming advances in energy technologies.

Innovation and the Economy

Growth economists have long understood how economies expand: Technological innovation is the dominant cause. Multi-decade innovation waves—sometimes called Kondratiev waves—gradually build around core technologies, go through rapid expansion, stabilize at more moderate growth rates, and eventually reach technological maturity. The IT wave, and, in parallel, a smaller biotech wave, are the current, familiar ones. But railroads, mass production, electricity, and automobiles launched earlier innovation waves. The waves don’t disappear but rather build plateaus of growth into the economy and are succeeded by the next wave that creates a new plateau on top of the previous ones. This is how economies grow over time beyond the effects of mere demography; in other words, this is how economies not only get larger but more prosperous on a per capita basis.

In the period following World War II, the United States built an economy whose comparative advantage was its capacity for innovation. It led nearly all the innovation waves in the second half of the 20^th century: aviation, electronics, space, nuclear power, computing, and the internet. The U.S. economy missed only one wave in that period: the quality-manufacturing wave in the 1970s and 1980s. Japan created the precision technologies, processes, and business models necessary for quality production, superseding the earlier mass-production wave the U.S. economy had created in the 19^th century. It was a very different production system that took a decade for U.S. manufacturers to figure out and emulate, for which the U.S. economy paid a big price: It lost industrial leadership in the auto and consumer electronics sectors. But then Japan largely missed the IT wave that took off in the 1990s.

Energy—the Next Innovation Wave

The next wave now looks to be energy technology. In a country with growing income inequality and a lack of quality jobs, an energy innovation wave is particularly critical because it is job-creating, while the IT/software advances that U.S. policymakers and media now emphasize are trending toward “jobless innovation.” One major energy innovation has already scaled: Fracking technologies (hydraulic fracturing and 3D seismic imaging), first developed at Federal energy labs then scaled up by industry, gave the U.S. economy a dramatic first-mover advantage.¹ This development has transformed the U.S. energy supply, dramatically cut domestic energy costs, and reduced power costs for the manufacturing sector by more than 15 percent, making it significantly more globally competitive.

There are two additional major new innovative sectors now in the launch stage: wind and solar. These are now becoming trillion-dollar sectors scaling up at rates akin to Moore’s Law. Although U.S. R&D played a key role in creating these sectors, it has lost implementation leadership. Like Japan before it, China has developed an innovative production system—one that is “manufacturing-led,” characterized by innovations in simplified product design and production processes that cut costs. It has given China a unique ability to rapidly scale up the production of new goods. China also adds a sizable dose of mercantilism to its mix.

It now dominates world production of solar, boasting five of the world’s six largest solar companies, has the largest wind turbine company, and is on track to generate a quarter of its electricity from wind by 2030. China did not enter wind and solar for the environmental benefits; rather, it saw them as rapidly growing advanced-technology sectors where it could dominate and capture major world export markets. It now has. While the U.S. economy maintains the overall lead in technological advances through its still-strong research in these areas, it is in the process of ceding the financial gains of production.

The Next Challenge: Electric Vehicles and Batteries

Electric cars are the next critical battleground in the emerging energy innovation wave. Three nations are the leading contenders: China, Germany, and the United States. As Jonas Nahm of Johns Hopkins SAIS has researched, China’s ten electric car companies are increasing production using their ability to rapidly scale up at lower cost, while the country’s own rapidly growing car market acts as an anchor market. China is doing the same things it did to achieve sector dominance in solar and wind.

German car companies are politically powerful with strong union support, but they have been late to the electric table. Like many legacy sector industries in many countries, Germany’s car companies resisted disruptive innovations like electric vehicles and the corresponding shift from internal combustion engines. But seeing growing markets coming, German car companies are now moving to catch up.

The United States, after early advances, now seems to be reversing course. U.S. researchers led many of the early advances in lithium ion batteries. The Federal government played a critical supporting role in creating a major new electric car company by providing loan guarantees to Tesla during the Great Recession, enabling it to survive and expand. Tesla now has a higher market capitalization than Ford; it has been a highly profitable investment to date. But Tesla remains a relatively small car producer compared to the Big Three; electric cars will only scale up in the United States if Detroit joins in.

Alas, the new Administration, despite campaigning on promises to recapture U.S. industrial leadership, could now be in the process of ceding leadership in this potentially very large industrial sector. Although U.S. car companies have endured bankruptcy or massive losses three times in past decades because of volatile oil prices, they are finding irresistible their current short-term profits from sales of light trucks and larger vehicles powered by internal-combustion fossil-fuel engines. They are moving to shut down the fuel economy standards that would promote the use of electrics. The possibility that Detroit will once again be producing the wrong vehicles when energy prices next shift, the exact situation that slashed their world and domestic market shares twice before, appears again possible, as they sacrifice the long term for the gains of the short term.

But that’s only part of the story. Critical to the future of electric vehicles are continued battery technology advances. We must continue to drive battery weight and cost down and performance up (including for greater vehicle range) if electrics are going to be a pervasive technology. Batteries may well be the core technology for the next generation of the auto industry: The battery is the new engine. This presents a challenging technology problem: either lithium ion batteries must get significantly better or we will need a new kind of battery design. We need some breakthroughs on this front before Detroit can adapt to electrics. This is where ARPA-E comes in.

ARPA-E’s Breakthrough Role

ARPA-E was authorized in 2007 and first funded in 2009 in an attempt to replicate the famous DARPA model that has so transformed defense technologies. The idea was, if DARPA could create the internet, personal computing, stealth, precision strike, and drones in the defense sector, why not apply the same model to the toughest energy technology challenges? The ARPA-E concept had strong support from the past three very talented Energy Secretaries (Sam Bodman, Steve Chu, and Ernie Moniz), and strong bipartisan backing in Congress, including from Energy Appropriations Subcommittee Chairman Lamar Alexander (R-Tennessee) and Energy Authorization Committee Chairwoman Lisa Murkowski (R-Alaska), who supported the model from the outset.

Organizational cultures tend to get locked in early, and ARPA-E had remarkable leadership from the start. Arun Majumdar, its first director (now Precourt Professor at Stanford, where he runs the university’s energy initiative) had been a DARPA-funded researcher, so he knew the model. He put into place DARPA’s famous policies of empowering world-class project managers; instituting a flat, non-hierarchical structure; pursuing only those breakthroughs that could have revolutionary effects; employing a “technology visioning” process for technology challenges; and relying on the “hybrid” model of joining startups with university experts to merge the capabilities of both.

Then ARPA-E invented new practices. For example, its “tech-to-market” concept of putting experts on technology scale-up onto its development teams turned out to be so successful that even DARPA has copied it. There could be no greater institutional compliment: The parent has adopted the child’s new brainstorm.

As everyone in the technology world knows, ARPA-E is “hot.” ARPA-E reports that since 2009 it has provided approximately $1.3 billion through thirty focused programs and three open-funding solicitations to some 475 projects.² Of those, 206 are now “alumni” projects; the rest are ongoing. ARPA-E’s project teams cumulatively have published 1,104 peer-reviewed technical papers that have been cited 13,518 times, and have been awarded 101 patents. Many teams have successfully leveraged ARPA-E’s investment: 36 have started new companies, 60 have continued their technology development with other government support, and 45 have cumulatively raised $1.25 billion in publicly reported funding from the private sector to bring their technologies into commercial applications.

The appropriate response to an R&D agency with this track record is “wow.” Has ARPA-E transformed the energy sector yet? No: Technology implementation takes time. Remember that DARPA supported the development of the internet in 1969; it didn’t begin to scale up until the mid-1990s. It’s hardly the time to change channels on ARPA-E.

Battery advances have been one of ARPA-E’s obsessions, and it has been sponsoring a rich portfolio of potential breakthroughs. In just one example of a number of promising projects, one startup, teamed up with university researchers, wants to change the composition of batteries to include different chemicals that can provide much higher energy density (the amount of energy relative to the size of the battery).³ However, each new chemical brings new challenges to the battery design. One promising approach, which could increase the energy density of lithium ion batteries by as much as 40 percent, is to use silicon as the active material in the battery’s negative electrode (anode). This would be a game-changer. But the reaction of lithium with silicon causes severe swelling and contraction of the silicon anode material as the battery charges and discharges, which has defeated previous attempts to create a stable product. This team is aiming to control particle structures at the nanoscale through new advances in materials synthesis, creating potentially unique opportunities to address the silicon anode challenge.

ARPA-E is the breakthrough agent at DOE. DOE has a traditional basic research agency doing foundational work and applied research agencies working with industry, both of which play important roles. But the wild card is ARPA-E. It may well not capture the breakthroughs in battery technology we need—this is high-risk stuff. But this kind of advance is more likely to occur at ARPA-E than at any other agency.

What about the private sector—can’t it support this work? The short and long answer is no. This kind of research, as economists have demonstrated, is too high risk for a private firm to undertake. In economic terms, this is a classic “market failure.” Could venture capital firms support startups trying to do this? No, because after 2009 venture capital support for new energy technologies collapsed.⁴ VCs like software startups that can be stood up within five years with zero manufacturing and infrastructure costs; they have pulled out of energy technology because it takes too long and is too high risk. Over 40 percent of what they now do is software. The best bet is to let ARPA-E do it; like DARPA, this is what it was designed to do.

Will We Catch the Wave?

Of the major innovation waves of the past 75 years, the United States missed leading only one: the Japan-led quality-manufacturing boom. Missing a wave is painful for a U.S. economy that relies on innovation for growth. In the 1970s and 1980s, this led directly to the creation of the Rust Belt. It marked the beginning of the trends of increasing income inequality and the decline of the middle class that helped to propel Donald Trump into office. Will the United States now miss the next innovation wave in energy? This time it’s particularly serious: As noted, unlike software, new energy technologies stand to create many jobs, and serve as job multipliers across the economy. Missing this innovation wave will mean a major potential loss of quality employment.

The United States caught the first energy wave, fracking, and translated it into major economic gains. China now leads the implementation of the next two: solar and wind. If the next big one is electric vehicles, ARPA-E is arguably a critical breakthrough innovation institution for achieving the battery advances this requires (as well as to other energy breakthroughs). Other agencies and the private sector aren’t anywhere near as well positioned.

Clearly, some see ending ARPA-E as a way to curtail research on climate change technologies, now a partisan issue. This is foolhardy, for there are vastly greater stakes here. This may be about—and this is just one example—future leadership of the auto sector, still a massive global industry in which the U.S. position has declined. As Norm Augustine, former chairman of Lockheed Martin and a winner of the Medal of Technology, put it recently regarding energy R&D in general and ARPA-E in particular, “When you want to lighten an airplane load, you don’t start by throwing out the engines.”