Federal funding andd the level of private expenditure on basic research.

• Author: Robson, Martin T.

1. Introduction

   Economists have long been interested in questions concerning the role of government in stimulating private-sector innovation. In the late 1950s, Blank and Stigler [2] asked, in particular, whether government-funded industrial research and development (R & D) activity was likely to stimulate or substitute for private-sector expenditure on R & D. A number of studies have since addressed this issue and most conclude in favor of the existence of a positive relationship between federal R & D expenditures and the level of private R & D investment.(1) Leyden and Link [8] have provided a theoretical rationale for this observed complementarity. They suggest that federally-funded industrial R & D activity may generate knowledge spillovers and other infratechnology that may raise the productivity of inputs into private R & D.

   R & D is a heterogeneous activity, and a question which has received relatively little attention in the literature is the extent to which the apparent complementarity between federal and private industrial R & D spending holds for the different components of firms' R & D budgets. Cross-section evidence on this issue, produced by Link [13], suggests that:

   (a) expenditures on development projects are the only component of private R & D that receive a stimulus from federal R & D allocations; and

   2. that federal R & D in fact has a significantly negative effect on private expenditures on basic research.(2)

   This latter finding is of more than passing interest, as there is evidence to suggest that the returns to private investment in basic research may be significantly higher than those to other components of private R & D.(3) The effectiveness of federal R & D expenditures as a mechanism for stimulating private R & D investment would be somewhat diminished if, as is indicated, they have the effect of diverting private expenditures away from basic research towards components of R & D which have relatively low expected returns.

   The purpose of this paper is to offer a further examination of the relationship between federal R & D expenditures and private investment in basic research, from the perspective afforded by aggregate time series data. While such an approach necessarily sacrifices some of the information which may be gleaned from studies of inter-firm or inter-industry variations in research activity, it has the merit of permitting a more detailed consideration of the dynamics that may be present in the relationship between basic research and its determinants. Within this framework, we find evidence of a significantly positive relationship between federal R & D expenditure and private basic research, echoing the complementary relationship usually found in studies of total private R & D spending. The positive effect is most pronounced for federal spending on basic research, but federal expenditures on applied research and development also appear to provide a significant short-run stimulus to private basic research.

   The layout of the rest of the paper is as follows. Section H discusses the underlying analytical framework, whilst section III presents the econometric results. Section IV provides some brief concluding remarks.

2. The Analytical Framework

   Our investigation of the relationship between federal R & D expenditure and the level of private investment in basic research is couched within the following simple supply and demand framework, which describes the determination of the level of funds allocated to basic research at the individual firm level:

   (Supply) [P.sub.S] = f(PBR, SALES) f1 > 0, f2

   [Mathematical Expression Omitted]

   Equation (1) describes the determination of the "supply price" (marginal cost) of funds for private expenditure on basic research (PBR). As a claim on the firm's resources, basic research is assumed to compete with alternative uses such as capital investment, advertising, promotional activities, etc. Assuming that expenditures on all such items - including spending on basic research - are characterized by diminishing returns, it follows that as additional funds are allocated to basic research at the expense of these competing claims, the opportunity cost of investing in such research will rise. Hence the positive sign attached to the partial derivative of PBR in this equation. This effect is reinforced if, as might plausibly be the case, the risk premium attached by the firm to the marginal unit invested in basic research rises with the level of spending in this area.

   The availability of funds for private basic research is assumed to be a positive function of the firm's sales - issues of risk and moral hazard generally inhibit the ability of firms to raise external finance for R & D activity and necessitate the use of internally-generated funds. A rise in the level of SALES reduces the shadow price of funds for basic research, generating the negative sign for this variable in equation (1).

   The negative sign on the derivative of PBR in equation (2) - for the "demand price" of funds for basic research - follows from the assumption, noted above, that there are diminishing returns to funds invested in PBR. Two factors may give substance to this assumption. Let x denote the probability of making a significant discovery...