Growth through Research and Development

Abstract

In 2004, the public sector in the OECD countries spent approximately USD 190 billion on research and development (R&D), which corresponds to almost 30 per cent of all the R&D (USD 650 billion) conducted in these countries. If we examine who carries out R&D, we can see that the private sector accounts for 68 per cent, Government research institutes (laboratories) for 12 percent, universities for 17 per cent and other nonprofit organisations for 3 per cent. Here there are cases where the Government funds R&D in the business/industrial sector and vice versa, but in Europe the overwhelming majority of Government funding goes to Government-controlled universities and research institutes. A widelyaccepted estimated is that 25-20 per cent of publicly-funded research goes in turn to the defence industry. Here, however, there are major differences between different countries. In the USA, the percentage is 50-60 per cent and in England and France 25-30 per cent, while the figure is 10 per cent or less in most other OECD countries.

Apart from the fact that publicly-funded research is intended to satisfy public needs relating, for example, to defence and the environment, there are two main reasons that are linked to failures in the R&D market that motivate Government intervention.
• First, it has been shown that the total return on R&D investments for society as a whole (the social return) is greater than the private return (i.e. the return for the company investing in R&D). This is because the company cannot utilise all the results of its R&D and some of the new knowledge gained is transferred to other companies in the form of spillovers (see section 3).
• Secondly, R&D is associated with high risks, which creates barriers and discourages companies from conducting R&D. This applies in particular to small companies, which often have difficulties to find the funding required.

In both cases, companies on a free market will invest less in R&D than the level that is optimal for society at large (Arrow, 1962).The most logical approach for the State is to fund R&D where the difference between private and social return is considerable, i.e. where spillovers are extensive, as it is this type of R&D that would not otherwise be carried out. The research literature on publicly-funded R&D focuses a great deal on this issue of the private and social return on R&D.

The Government can perform R&D itself at its own universities or research institutes. However, the Government can also stimulate R&D that is conducted by companies, either by reducing the private cost for R&D or by increasing the return on R&D, or by helping companies to understand the opportunities offered by new technology, i.e. by reducing uncertainty. The aim of this report is to summarise what the research literature in the field of economics says about how publicly-funded R&D affects productivity and growth. Above all, however, the report addresses how government research policy and the Government-funding of R&D should be organised to be as effective as possible. This covers both publicly-funded R&D that is performed by companies and R&D at Government-controlled universities and research institutes.

The report is arranged as follows. Section 2 discusses the advantages and disadvantages of different types of public-funding of R&D. Section 3 analyses what differentiates R&D from other forms of input and why spillover effects occur. The empirical literature on the return on R&D and the relationship between R&D and growth is presented. This applies to both private R&D and public R&D. How publicly-funded R&D affects private R&D theoretically and empirically is presented in section 4. How R&D at universities can be transferred to business and industry and who should own the results of university research is discussed in section 5. Europe is compared to the USA here. Section 6 analyses the issue of how the Government should finance the universities – by means of a fixed allocation or on a project basis (competition). The consequences of funding on a competitive basis are discussed and advantages of scale in the university sphere are analysed. Section 7 summarises the conclusions.

Keywords: R&D, government financing, universities, business sector, subsidies, innovation

JEL Classification: O31, O32, O38