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While we love to focus on the entrepreneurs and startups that bring new technologies to market, so much of the groundbreaking innovation that has driven the U.S. economy occurs well before the private sector even gets involved. I’m talking about the research and development at universities and government labs that helps push our technological frontiers ever further, paving the way for economic growth.

The National Science Foundation released a report earlier this week with a seemingly celebratory headline, announcing that R&D at U.S. universities hit an all-time high in 2011. But its explanation for the increase should worry us, given today’s unfortunate political climate. Most of the increase came from the stimulus bill, a one-time injection of funds by the federal government that buoyed university R&D by $4.2 billion in 2011.

Not only was last year’s peak temporary, but if Congress fails to reach a deal on the so-called “fiscal cliff” and instead allows the sequestration cuts to the budget to occur, federal R&D—at universities and elsewhere—could fall precipitously. The cuts could amount to nearly $30 billion in nondefense R&D over five years, according to Science Progress, a blog associated with the Center for American Progress, a liberal think tank. Much of that decrease would fall on universities, which is why many of them are scrambling to advocate against sequestration.

As the NSF report indicates, the bulk of university R&D is funded by the federal government, and there’s good economic reasoning behind that. Economists generally agree that private firms systematically underinvest in R&D, because they can’t capture all the value from that investment.

Researchers have also attempted to measure the “spillover” value of R&D and estimate the uncaptured social value of R&D to be 50 to 150% above private rates of return. Firms lack the incentive to invest in R&D up to socially optimal levels.

The type of R&D that the private sector is willing to undertake is limited, as a report from earlier this year from the National Research Council explains:

The vast majority of corporate R&D has always been focused on product and process development. This is what shareholders (or other investors) demand. It is harder for corporations to justify funding long-term, fundamental research. Economists have articulated the concept of appropriability to express the extent to which the results of an investment can be captured by the investor, as opposed to being available to all players in the market … Although individual industry players may find it hard to justify research that is weakly appropriable, it is the proper role of the federal government to support this sort of endeavor.

Moreover, as the NRC authors explain, a highly competitive market actually makes long-term research less likely to occur because of added pressure on firms’ bottom line. In other words, if your idea of the ideal marketplace involves giant monopolies, there’s less reason to favor government investment in research. If it’s centered on smaller startups and lots of competition, federal R&D is unquestionably essential.

So when I read the headline that university R&D peaked last year, I’m more worried than anything else. Economists agree that R&D is essential to economic growth, and they understand that the private sector alone isn’t up to the job. The case for subsidy is strong, and yet Washington is in a budget-cutting mood. The last thing that ought to be cut is R&D, but that kind of long-term thinking hasn’t historically been Congress’s strong suit.

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Tagged: Business, R & D

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