Timothy T. Taylor Home Page
Journal of Economic Perspectives
Articles and Writing
Economics Textbook
Classroom Teaching
The Teaching Company
High School Pedagogy

Articles and Writing

March 26, 1989
"The Ominous Sputter of R&D"
San Jose Mercury News
By Timothy Taylor
<< Back to 1989 menu

WHEN people think of research and development, they tend to think of mega-projects. Like the Apollo program to put a man on the moon. Or the superexpensive superconducting supercollider that may soon be built in Texas. But most R&D consists of smaller projects, like an attempt to create a faster computer chip, or a new medicine, or a more accurate measuring instrument. These goals may seem less expansive, but people around Silicon Valley will tell you that R&D is the lifeblood of their companies. At Hewlett-Packard, for example, products that didn't even exist three years ago account for more than half of sales.

That's why it should be frightening for U.S. competitiveness and terrifying for high-tech industry that the growth in national R&D spending has sputtered in the past few years.
The chart below illustrates the story, using data from the National Science Foundation. From 1980-1985, national R&D funding increased about 5.7 percent faster than inflation each year. Since 1988, though, R&D spending has increased only 2.1 percent per year faster than inflation. If R&D spending had continued increasing at the faster rate, the nation would have spent $24 billion more on R&D in the last three years than it actually did.

The slowdown in industrial R&D spending is perhaps the most discouraging part of the story. Over the past few decades, industrial funding for R&D has become ever more important; in fact, it has grown from about one-third of total R&D funds in 1960 to about two-fifths of total R&D funds in 1970 to about half of all R&D funds in the 1980s.

But industry doesn't seem eager to be the R&D workhorse any longer. In the machinery industry, where computer companies fund three-quarters of the R&D, R&D spending was up 8 percent a year faster than inflation from 1980-1985, but has grown only 3 percent faster than inflation since 1985.

In the professional and scientific instruments industry, increases in real R&D spending averaged about 9 percent from 1980-1985. In the last three years, there hasn't been any increase.

The electrical equipment industry, where most of the R&D is related to telecommunications or semiconductors, corporate R&D spending increased about 9 percent faster than inflation each year from 1980-85. Since then, the annual change has been a decline of about half a percent a year.

After discussing this slowdown with a number of people, I can say with confidence that no one has a fully persuasive explanation. But here are the seven most plausible, partial explanations I've heard.

  • The percent of sales explanation. Many high-tech companies determine their R&D budget simply by taking some percentage of their sales. In 1985, the high-tech industry had one of its worst years ever for sales, which dragged down R&D budgets as well. This theory could explain why R&D grew more slowly in 1985, but it doesn't explain the relatively rapid growth of R&D during the recession in the early 1980s or why R& D growth has stayed slow since 1985.
  • The takeovers and buyouts explanation. When one company borrows a lot of money to buy another, one easy place to cut costs, so the loans can be repaid, is the R&D budget. Similarly, if a company feels threatened by a takeover, it may start to focus on keeping short-term profits and its stock price high, even if that means sacrificing the long-term by cutting back on R&D spending.

    This theory is quite popular, especially among those who dislike corporate takeovers for other reasons, but economic studies of takeovers and leveraged buyouts have mixed results. Some studies show that more R&D tends to increase the stock price of a company, and that R&D doesn't seem to be cut after most mergers or takeovers.
  • The cooperative research explanation. More and more companies are doing joint R&D. As one contributing explanation for the slowdown in R&D, Jeanne Alford of the Semiconductor Industry Association said that some companies are probably cutting back their individual research as they participate more in joint research efforts. To the extent that joint research efforts eliminate duplicated effort, it may be possible to get the same results with fewer R&D dollars.

    If true, this raises two obvious dangers. First, the point of cooperative R&D was to get more bang for the buck, not the same bang for fewer bucks. Second, it's still not clear how successful these joint R&D efforts will be. Pinning the nation's R&D hopes on an untried vehicle with lower levels of funding doesn't make much sense.
  • The budget crunch explanation. The recent slowdown in government R&D is probably due, in large part, to the need to cut budget deficits. I think this explanation is politically true and economically foolish. Cutting the deficit by cutting productive R&D investments in America's future is just as shortsighted as a company cutting its R&D because of a takeover threat.
  • The government echo explanation. Industrial R&D spending often follows the level of government funding, according to Dr. Jules Duga of Battelle Memorial Institute, which tracks these issues. For example, industrial R&D spending increased sharply in the late 1960s, at the same time that federal non-defense R&D was increasing to pay for the space program. This theory implies that increased government spending on R&D, particularly civilian R&D, would stimulate industry R& D.
  • The mature industry explanation. Jennifer Jones, vice-president at Regis McKenna Inc., hypothesized that part of the slowdown in R&D might reflect more mid-size companies in Silicon Valley. Small companies tend to plow back more of their money into R&D than do mid-size or larger corporations. By this logic, one way to get more R&D would be to create, somehow, a number of powerful new start-up companies.
  • The tougher competitive environment explanation. Competition in today's high-tech industry, from at home and abroad, is probably more sophisticated and tougher than ever before. When every expenditure has to be justified on a tight bottom line, with no room for error, the calculated gamble of R&D spending may look much less attractive.

Whenever seven plausible explanations can be produced, it probably means that the whole issue is not yet well-understood.

What is known, though, is that trend of only 2 percent real growth in R&D should continue at least through this year, according to the most recent forecast from Battelle. One week after that forecast was released, Time magazine said, "Unless the U.S. can match Japan's all-out research effort, the race to dominate 21st century technology may be over before it has begun."

If this country doesn't start putting its money in the R&D fare box, the high technology train may leave without us.

<< Back to 1989 menu