September 30, 1990
"Federal R&D Spending Encourages Private R&D Spending Directly, Since Companies Usually Chip in Part of the Costs of any Project. Tax Incentives will Help Revive Research and Development"
San Jose Mercury News
By Timothy Taylor
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TOO often, discussions of research and development projects seem to focus on an immense and particular goal. High- definition television. A cure for AIDS and cancer. Putting a man on the moon. The atomic bomb.

Such projects are obviously important, but from the viewpoint of the economy as a whole, the hundreds of thousands of small-time R&D projects are more important. It's vital for the U.S. economy to plant thousands of R&D seeds, because there's no knowing in advance which ones will be duds and which will grow into redwoods.

At first glance, the United States might seem to be keeping up fairly well in its R&D spending. The top line on the graph shows that although R&D spending (adjusted for inflation) was flat through most of the 1970s, it rose sharply in the first half of the 1980s and has continued to rise since. The United States currently spends about 2.6 percent of GNP on research and development, which would seem to compare pretty well with France (2.3 percent of GNP), West Germany (2.8 percent) and even Japan (2.9 percent).

But the composition of that R&D spending sends a less comforting message. A full third of the U.S. R&D spending goes to defense, compared with only about 5 percent for Japan and Germany. When it comes to R&D spending for the commercial civilian economy, the U.S. lags far behind. If you wonder why the new technological discoveries seem to be coming more and more from Japan and Europe, look back at the number of additional R&D seeds they planted in the last two decades.

Even more troublesome, "the emphasis in military R&D has steadily shifted toward the development of specific weapons technologies and away from research which leads to basic scientific discoveries or to efficient transfer of technology to commercially viable products," writes Kenneth Arrow, a Nobel laureate economist at Stanford University.

In the 1990 Economic Report of the President, George Bush wrote: "America's continued economic progress depends on the innovation and entrepreneurship of our people. I will therefore continue to press for a permanent research and experimentation tax credit and for increased federal support of research with widespread societal benefits that private firms would not have adequate incentives to undertake . . . "

Fine words. But as shown by the middle line on the graph at left, direct federal funding for R&D didn't rise from 1970 to 1982, then rose sharply for several years, and has since leveled off. The sharp increase in the early 1980s can be almost totally accounted for by the rise in defense-related R&D spending, as shown in the bottom line of the graph.

If high deficits preclude spending more on civilian R&D, much could be achieved by transferring some defense-related R&D funds to civilian projects. Federal R&D spending encourages private R&D spending directly, since companies usually chip in part of the costs of any project. However, this support works better for large companies than small ones. The table at bottom right shows that while federal funds commonly account for about 15 percent of R& D spending at small- and medium-sized firms, the feds are chipping in over 40 percent of the R&D spending for the largest companies.

Or to put the same point another way, 84 percent of federal R&D money that goes to corporations goes to the largest of them, even though those corporations only do 66 percent of total corporate R&D spending.

From a bureaucratic point of view, this makes complete sense. Large companies can set up large projects, fill out reams of paperwork, and develop long-term connections with government. Small companies are at a disadvantage in competing for big grants.

The way to correct this bias is not to add more bureaucracy by setting up panels to hand out R&D money to small- and medium-sized companies. Instead, it is simpler to make the tax credit for R&D permanent. In fact, the increase in private R&D spending that happened between 1981 and 1985 happened when the R&D tax credit was first enacted and given a five-year trial. Since then, the credit has expired and been re-enacted three times, and private R&D spending has slowed substantially.

A tax credit is especially suitable when it cannot be clear even to the most able administrator which R&D projects will pay off, but where it is in the interests of society as a whole to scatter a greater number of seeds.

R&D SPENDING BY FIRM SIZE

The larger the firm, the greater the percentage of R&D spending is provided by the federal government. The second column shows total R&D spending by firms; the third column shows how much of that money came from federal funds. The fourth column shows the percentage that federal funds represent of the firm's R&D spending. Figures are given in billions of dollars and represent 1988 spending.

Number of employees Total R&D spending Federal funds % fed. funds Less than 500 $7.4 $ .9 12.1% 500 to 999 $1.7 $ .1 5.9% 1,000 to 4,999 $8.4 $1.5 17.8% 5,000 to 9,999 $5.6 $1.0 17.8% 10,000 to 24,999 $11.6 $1.9 16.4% 25,000 and up $64.7 $27.6 42.7% TOTAL $99.4 $33.0   Source: National Science Foundation, Science Resources Series.

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