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The Arithmetic of R&D

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October 19, 2005

The Arithmetic of R&D

Michael Mandel

In a post entitled More Free Lunch Economics from Michael Mandel, PGL on Angry Bear writes:

An increase in government-sponsored R&D might be a very nice thing as Mandel suggests, but he seems to dodge the question as to how we pay for this extra expenditure. Do we cut some form of private or government consumption? If so, then I?? call this saving.

First, I like free lunch economics. The economic history of the past 200 years is basically one long free lunch, with productivity growth far outrunning anything which could be justified on the basis of physical capital investment alone. Since 1948 output per person has grown by 2.3% annually. Out of that, the contribution of physical capital is only 0.9% (see page 6 of this BLS release)

Second, I think PGL misunderstands the arithmetic of R&D. If R&D is an investment, then spending on R&D creates a long-lived asset with a rate of return. If that rate of return exceeds the interest rate on debt, then it is socially beneficial to borrow to fund R&D expenditures. I don't need to find other cuts to fund it.

To put it another way, suppose we were going to do the government budget the right way, and divide it into an operating budget and a capital budget. Then the right policy goal would be to hold down the deficit in the operating budget. R&D, however, would fall on the capital side of the ledger (because it's a long-lived asset) and wouldn't count against the operating budget deficit.

Unfortunately, PGL's misunderstanding is shared by many economists and politicians, which is why R&D spending is vulnerable to cuts when Congress goes looking for money to fund hurricane recovery and the Iraq war.

[Incidentally, I appreciate this debate because it's giving me a chance to get some things clear in my own mind]

04:51 PM


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So why can't a panel of intelligent economists go and educate the government about the follies of short-term, left-wing misguidedness?

Basic Research is currently only $52 billion, or 0.5% of GDP. It should be 1% of GDP, or $120 billion. This will generate trillions in new wealth in the years to come, by paying just 0.5% of GDP into this field.

And it is hardly an expenditure. It creates jobs for thousands of top PhDs, who in turn pay back a lot of income taxes already.

Posted by: Kartik at October 19, 2005 09:25 PM

Kartik: ??eft-wing misguidedness? In case you hadn’t noticed, there are a lot of right-wing deficit hawks as well. And it is the right that particularly wants to attack the spending side rather than raising taxes. When a budget-busting bipartisan spending bill comes up, the dissenters are typically conservative Republicans. True, Clinton did cut the supercollider, but Reagan made similar cut-the-muscle mistakes in his early years.

I won’t let the left off the hook, though. If we are going to reduce the deficit by cutting spending, the best way to do it is by cutting the sacred cows of the left – entitlements and other benefits. If only those damn left-wingers like George W. Bush didn’t insist on increasing Medicare benefits!

Posted by: knzn at October 20, 2005 12:38 PM

One of the advantages to outsourcing a massif tech base to foreign nations, is that they will do more of the heavy lifting in future tech R&D, Intel's investment in India will be fully supported by their education system. We gain by the reduction in the cost of products returned, and they will need to invest more in tomorrow's R&D.

The economics question is supported by R&D, effect on the reduction of product cost. The Federal Reserve sees clearly innovation increases product value, and that effect is counted against price inflation. We need to define only the proper direct for our, R&D investment.

We can not let up, on full support for R&D, in life enhancing health care in our country. More of our R&D's direction must be investing in our nations health care, and now is the right time to support this R&D investment.

Posted by: Mike Reardon at October 21, 2005 03:24 AM

We need an asian country to develop something wonderful like the Soviet Union did with Sputnik in 1957. That would kick up out of our indifference.

Posted by: Lord at October 21, 2005 02:14 PM

I did not misunderstand anything. You need to cut out your habit of misrepresenting what others have said. Beyond that - I agree with your call for having an operating budget v. a capital budget. But at the end of the day, a dollar spent by the government means taxes now or in the future. To restate the reality of budget constraints is not saying that investment in R&D is a bad thing. I never said it was. When you can recognize that we basically agree on a few things, maybe we can have a more productive dialogue.

Rant off and a recommendation. Dean Baker over at at Maxspeaks has a proposal on pharma R&D. You'll likely agree with at least part of it. Check it out and I'm hoping you provide a post on Dean's recommendation.

Posted by: pgl at October 23, 2005 07:22 PM

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