The coming R&D crash

The coming R&D crash

By Brad Plumer , Updated: February 26, 2013

One of the few things Republicans and Democrats have been able to agree on in recent years is that the government should be spending more on basic scientific research — the sort of research that, in the past, has played a role in everything from mapping the human genome to laying the groundwork for the Internet.

“Government funding for basic science has been declining for years,” Mitt Romney wrote in his 2010 book No Apology. “It needs to grow instead.” In his most recent State of the Union address, President Obama sounded a similar note: “Now is the time to reach a level of research and development not seen since the height of the space race.”

So it’s notable that the exact opposite is, in fact, about to occur. Thanks to budget pressures and the looming sequester cuts, federal R&D spending is set to stagnate in the coming decade. The National Institutes of Health’s budget is scheduled to drop 7.6 percent in the next five years. Research programs in energy, agriculture and defense will decline by similar amounts. NASA’s research budget is on pace to drop to its lowest level since 1988.

As a result, scientists and other technology analysts are warning that the United States could soon lose its edge in scientific research — and that the private sector won’t necessarily be able to pick up the slack.

“If you look at total R&D growth, including the corporate and government side, the U.S. is now at the low end,” says Rob Atkinson, president of the Information Technology and Innovation Foundation (ITIF). “We’re seeing other countries, from Germany to Korea to China, make much bigger bets. And if that persists for long enough, it’s going to have an impact.”

So how dire is the situation, really?

Let’s start with some basic charts. Over the past decade, federal spending on R&D has grown in real terms, according to the American Association for the Advancement of Science (although it’s shrinking as a percentage of GDP). That’s been driven largely by Bush-era increases in defense and life-sciences spending:

At its peak in 2009, the federal government funded some 31 percent of all R&D in the country, with private firms and universities financing the rest. The array of federal programs is staggering, from semiconductor work at the Pentagon to climate-change research at NOAA to clinical trials for cancer at the National Institutes for Health. About half of the spending here is “basic” research and half “applied” research.

Yet as a recent report from ITIF explains, this landscape is set to shift now that Congress is putting strict limits on discretionary spending. If the sequester spending cuts take effect on Mar. 1, total spending on research and development will drop to 2007 levels and grow only slowly thereafter (below, black line). Federal R&D spending will decline sharply as a share of GDP:

How worrisome is this projected stagnation in federal R&D spending? A lot depends on how valuable you think government research actually is — and on that point, the debate can get surprisingly contentious.

There’s a long, long list of world-changing innovations that can be traced back to federally funded R&D over the years. The Department of Energy’s research labs spawned digital recording technology, communications satellites, and water-purification techniques. Pentagon research laid the groundwork for the Internet and GPS. The current shale-gas fracking boom couldn’t have happened without microseismic imaging techniques that were developed at Sandia National Laboratories.

But that’s not necessarily the best way to look at things. The key question here is how much of this innovation might have happened without government involvement. And as Stanford’s Roger Noll explains in this NBER essay, economists have fairly nuanced views on this.

Many economists agree that private companies tend to under-invest in very basic scientific research, since it’s hard for one firm to reap the full benefits from those discoveries. So the federal government, which now funds 60 percent of all basic research in the United States, is likely irreplaceable here. What’s more, studies have found that many types of government R&D spur private companies to conduct their own additional research. That is, the two are complementary, not substitutes.

But the situation is murkier for other forms of public R&D. Many government programs are focused on advancing commercial technologies in specific industries — and those could well be crowding out private-sector activities. What’s more, some government R&D programs are so focused on demonstrating their usefulness to Congress that they stick with “safe” research that the private sector would have done anyway.

When the Congressional Budget Office reviewed the evidence in 2007, it concluded that government-funded basic research generated “substantially positive returns.” And it found that, on the whole, government R&D helped spur additional private-sector R&D rather than displace it. Yet the CBO also noted that some types of government programs may very well be crowding out private research. Likewise, a 2007 survey by the Bureau of Labor Statistics found that the social returns for many public R&D programs were “near zero.”

“It’s not always cut-and-dried,” says Scott Wallsten, president of the Technology Policy Institute. “In theory there are certainly things that are good for society that aren’t profitable for private companies to do. Basic research especially. But when you move out from that, it sometimes becomes more questionable.”

Indeed, this is one area that has recently divided Republicans and Democrats. During the 2012 campaign, Romney heaped praise on basic research programs like ARPA-E, which funds long-shot energy research. But he criticized Obama’s support for programs that try to commercialize new technologies — such as loan guarantees for mature solar firms.

In the near future, however, this debate is moot: When the sequester takes effect on March 1, it will affect all types of R&D, regardless of type or value. In the National Institutes of Health, because of the way grants are structured, the immediate 5.3 percent sequester cuts for 2013 will mean that little new research of any type will get funded this year, explains former NIH director Elias Zahouni.

Meanwhile, there’s the international context to consider. Atkinson points out that United States is in danger of losing its spot as the undisputed world leader on R&D — both public and private. Not only is the federal government paring back its research budget, but the corporate sector isn’t making up the gap either. “In most countries,” he says, “corporate R&D is up over the past decade. Ours didn’t, it stayed stagnant.”

The causes for America’s private-sector R&D stagnation are complex, Atkinson says, ranging from impatient investors to unfavorable tax policies. But ITIF projects that the United States will soon spend less on all types of R&D as a percentage of its economy in the coming decade than countries like Australia and South Korea (though we’ll still spend a lot more in absolute terms, since our economy’s much bigger). Even China is catching up:

There are a few ways to interpret this chart. The sanguine view is that other countries are tossing more money at scientific research that will have positive spillover benefits for the entire world — including us. If China invents a cure for cancer, we all benefit.

Others worry, however, that the U.S. economy could suffer from the fact that a greater share of research is happening elsewhere. A 2012 report by the National Science Foundation, for instance, found that U.S. firms were now shifting much of their R&D work overseas. And the United States has recently developed a trade deficit in high-technology goods, after surpluses during the 1990s.

Many lawmakers seem to take the alarmist view. President Obama in particular has insisted that the United States can’t fall behind on R&D. A sample line: “We’ve got to make sure that we’ve got the best science and research in the world.”

Finding the money to do that will be difficult in an era when Congress is insisting on tight budgets. Some policymakers have tried to put forward novel approaches to R&D — like Sen. Lisa Murkowski’s (R-Alaska) idea for an “Advanced Energy Trust Fund” that would dedicate a portion of revenues from oil and gas drilling to energy research. (Obama embraced a similar idea in his State of the Union.) Other economists have suggested that the government should lean more heavily on prizes or tax credits as a way of funding innovation.

Yet many of those ideas are fairly small-bore. Getting R&D back to where it was at the height of the space race, as Obama has suggested, will either take a hefty portion of policy creativity — or a big shift in budget politics in the years ahead.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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