Industrial R and D: determinants and consequences.

• Author: Hall, Bronwyn H.

In modern industrial economies, technical change and innovation are considered to be a major impetus behind economic growth and improvements in the standard of living. Although many "actors" are important in creating a climate in which innovation can flourish, in a market economy it is primarily private firms that deliver the benefits of scientific research and technological innovation to consumers. For this reason, I and other economists have focused on understanding and measuring the forces that determine individual firm performance in this area, and on evaluating the effectiveness and direction of industrial research.

Economic analysis of industrial R and D has led many to question whether private firms have an incentive to undertake the amount of R and D that is optimal for society as a whole.(1) This causes us to ask by how much the private returns to R and D fall below the social returns; whether our capital market and corporate governance systems do a good job of encouraging R and D investment and innovation; how effective such government policies as the R and D tax credit are; and how our performance and policies compare to those of other large developed economies. My own recent research has examined: the consequences of U.S. capital market structure and the corporate restructuring wave of the 1980s for the performance of R and D; the effectiveness of the R and D tax credit in inducing firms to increase their R and D spending; the contribution of industrial R and D both to productivity growth and to the private returns of individual firms during the recent past; and comparisons of U.S. firm performance in this area with that of France and other countries.

The Market for Corporate Capital and Industrial R and D

During the past decade many observers viewed the wave of restructuring and downsizing in the U.S. manufacturing sector as inimical to investment in R and D in that sector. Some went so far as to argue that the market for corporate control had a serious negative impact on companies' long-term investment, which in turn contributed to the decline of the United States in global competitiveness. Beginning with a study for a 1987 NBER Conference on Corporate Takeovers, I have investigated the evidence behind this argument in a series of papers, and reached the conclusion that the picture has been greatly overdrawn. Still, there is no doubt that a variety of external forces led simultaneously to an increase in leverage and a reduction in R and D investment in certain sectors.(2)

The financial restructuring of U.S. public corporations can be divided loosely into three classes of activity: ordinary merger or acquisition activity; leveraged buyout or going private transactions; and large shifts in the balance sheet toward debt without going private. During the 1980s, the relationship among these three activities and the R and D activities of the firm varied substantially, with only the third being clearly associated with declines in R and D spending. Ordinary merger activity unaccompanied by changes in leverage seems to have gone on throughout the period without having much impact on firms' R and D policies. After a merger, the typical firm had an R and D-to-sales ratio that was equal to a size-weighted average of the intensities of the two merging firms.(3) Not only does this imply that mergers are not necessarily negative for R and D investment, but it also indicates that cost-saving on R and D was probably not the primary motive for these mergers.

Leveraged buyouts and going private transactions increased dramatically during the 1980s, but the potential impact on R and D spending was minuscule, for the simple reason that most of these took place in sectors where R and D investment historically had not been an important part of business strategy (food, textiles, auto parts, tires, fabricated metals, and miscellaneous manufacturing). In ten years, the total amount of annual R and D investment involved was less than 0.5 percent of annual industrial R and D spending during the period.

However, leveraged restructurings in which the firm was not taken private also increased during the 1980s, and these transactions often were followed by substantial declines in R and D investment throughout the period and particularly in the latter half: for example, the decline in R and D intensity for such firms was about 0.8 percent (from 3.4 to 2.6) for 1982 to 1987. The firms involved were primarily in sectors with relatively stable long-horizon technologies (petrochemical, steel, autos) that have been under pressure from...