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The consequences of cutting corporate R&D budgets

William A. Galston

A paper published earlier this year, “Killing the Golden Goose? The Decline of Science in Corporate R & D,” documents the extent to which large corporations have reduced their investment in basic research. Between 1989 and 2007 (the peak years of their respective economic cycles), the basic research share of private R & D fell by about half. This does not mean that basic science is less important for innovation. Rather, firms have become more reliant on external sources of basic research. As authors Ashish Arora, Sharon Belenzon, and Andrea Patacconi put it, large firms appear to value the golden eggs of science but not the golden goose itself. They resort increasingly to short-term and incremental innovation, which usually does not involve large investments in science.

The authors find two principal reasons for this shift. First, increased global competition is associated with reduced investments in science as well as in physical plant. In the face of this competition, firms are shifting away from the creation of new knowledge toward the “commercial application and protection of existing knowledge.”

Second, in recent decades, firms have narrowed their scope by redeploying assets toward their higher value activities. A well-known proposition in innovation studies is that “investments in basic research are more profitable in diversified firms,” in part because a broad range of activities makes it more likely that the inherently unpredictable results of basic research will be of commercial value to the firm financing the research. Consistent with this, the authors find that the firms that have decreased their scope the most show the largest decline in in-house basic science.

These findings, the authors conclude, have important implications for public policy. Large firms rely increasingly on startups to develop new inventions. But startups rely substantially on university-based research, which is funded by public agencies such as the National Science Foundation and the National Institutes of Health. Because basic research remains essential for innovation, the pace of innovation is bound to slow if budgets tighten at the NSF and the NIH, as they have during the recent years of sequestration.

Even in these polarized times, surely the political parties at least agree that it is counterproductive to reduce the public investments that contribute to innovation, which is at the core of economic growth in a knowledge-intensive economy. Or can they?

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