Declining Federal Research Undercuts the US Strategy of Innovation

Just about everybody in the U.S. agrees that America must maintain its economic position and stay ahead of China and other foreign competitors, by using a strategy of innovation. Innovation is commonly defined as being first to acquire new knowledge through leading edge research: being the first to apply that knowledge to create sought after products and services; and being the first to introduce these products and services into the marketplace. If the U.S. is really committed to using innovation as it primary competitive strategy, then we must do a better job of doing the first step—leading-edge research.

There are two fundamentally different kinds of research that lead to innovation. The first is basic research, which is generally conducted by the federal government. The second is research and development—also called applied research—which is generally conducted by private firms. Basic research differs from research and development because it investigates basic science and is high-risk and seldom results in commercial products in the short-term. Private research and development, on the other hand, uses the new technological ideas discovered by basic research to develop new products and is driven by shareholder value and short-term profits.

The United States has a long history of investing in federal basic research going back to World War II, when federal research was used to develop radar, electronics, atomic power, jet fighters, and many other technologies used to win the war.

After the war, the US continued to invest in basic science research, which was used to create many of the technologies and industries we see today. Federal basic research was the initial research used in developing the Google search engine, global positioning satellites, supercomputers, artificial intelligence, speech recognition, the Internet, smart phone technologies, the shale gas revolution, seismic imaging, LED light technology, magnetic resonance imaging MRI, advanced prosthetics, and the human genome project. Many of these new technologies led to new industries spawning many new markets. An example that everybody understands is the internet developed by ARPANET (advanced research products agency) of the Defense Department.

The development of new technologies into useful products was accomplished by private companies, but all of these products came, initially, from federal basic research in many fields of science. As an example, transistors were not suddenly discovered by the electronics industry; they came from people working with wave mechanics and solid-state physics. Light-emitting diode technology began with the study of infrared emissions from gallium arsonide and other semiconductor alloys. Magnetic resonance imaging came from research into spin echoes and free induction decay.

How important Is Basic Research?

A study published in 2019 in the journal Science shows that one-third of all U.S. patents since 1970 relied on government-funded research. The study was based on an investigation of all patents issued from 1926 to 2017, and underscores the importance of funding basic federal research.

The Decline of Basic Research

According to the Information Technology and Innovation Foundation, ITIF, federal basic research has been declining for 22 out of 28 years. The following chart shows that as a percentage of GDP, federal research has fallen from a high of 2.5% in 1964 to 0.61% in 2018.

Source: Information Technology and Innovation Foundation – December 2018.

The chart also shows that business research and development as a share of GDP continues to grow. The chart begs an obvious question: Since private research and development has grown from from 0.7% in 1956 to 2.0% of GDP in 2016, isn't this adequate to support our strategy of innovation? Do we really need federal basic research? I will make the argument that the answer to both questions is no—that we need to increase the federal basic research budget.

The primary reason we can't just rely on private R&D is that 80% of the funding of business research and development is applied research that leads to products, and the other 20% is basic research. This is because basic research is very risky; long-term; has uncertain applicability; and probably won't lead to short-term profits.

One of the big problems facing corporations is the dominance of the financial sector. In an earlier article, "We Must Save America’s Manufacturing Sector,” I showed that as the manufacturing sector has declined, it has been replaced by the service sector in terms of GDP and influence. Like it or not, America's multinational corporations are pushed to achieve short-term profits and shareholder value as their number one priority.

Since the financial sector is now the dominant sector in the economy, the trend to reduce costs, including R&D budgets, is gaining traction. According to the ITIF report on the ingredients of innovation, 80% of chief financial officers in the U.S., responded that they would cut R&D to meet their firms next quarter projections. In addition, manufacturing continues to move to foreign countries, taking research and development with them. According to the same ITIF report, "U.S.-based companies now have 23% of their research and development employment located abroad.”

Many of the boards of multinational corporations are being dominated by activist board members who want to achieve short-term profits any way they can. A good example is what happened to the DuPont Company. For more than 200 years, DuPont has invented innovative products sold all over the world. Their experimental station–a research lab–invented products like Nylon, Freon, Lycra, Neoprene, and Kevlar. But in 2016, their fifth largest shareholder, Trian Fund Management, demanded the company cut $4 billion from the business and double the stock price to optimize shareholder value.

In 2016, Trian Fund Management forced a change in the company's approach to research and development. They wanted to reduce R&D costs and do a stock buyback that would lead to quicker profits. They successfully did the stock buyback and laid off 5000 people worldwide. Part of this cost reduction led to a 20% reduction the R&D budget, the layoffs of hundreds of research people, and the closure of one research lab.

A survey of the major corporations by Sullivan and Cromwell showed that in 2018, there were 260 activist campaigns going on in the U.S.. During this same year, according to a July 2019 report from J.P. Morgan, stock buybacks reached $800 billion. The point here is that the emphasis is on short-term profits, cost-cutting, and stock buybacks, which can cannibalize innovation, slow growth and harm U.S. competitiveness. In this environment, there is little chance that the investment in basic research by U.S. corporations will improve anytime soon.

Current problems

1. Foreign Competitors: The U.S. is not keeping up with foreign competitors in terms of investment in federal research. Federal research is now 0.6% of GDP and would have to be increased $100 billion just to equal 1980 levels. The article, “Dwindling Federal Support for R&D is a Recipe for Economic and Strategic Decline”, says that China's investment in government research has increased 56% since 2011 and Russia's investment increased by 13%. During the same period, the U.S. investment in basic government research fell by 12%. The articles summary states that, “this is a recipe for decline, economically and strategically.” Using the measure of basic research as a fraction of GDP, the United States was ranked fifth among all nations.

2. Federal Deficits: One of the biggest problems facing the basic research budget, or any other non-defense budget, is the federal deficit. The federal deficit has grown to more than $22 trillion and is constantly used as the excuse to cut federal non-defense budgets. A good example is the need for an infrastructure program to improve our highways, bridges, ports, sewers, water lines etc. This problem has been ignored for 30 years and would now cost $4 trillion to fix. Because of rising deficits and debt, it is not likely Congress will invest in the infrastructure or federal basic research, even though both are critical to the innovation strategy that is supposed to fuel America's competitiveness. In fact, the federal basic research budget is scheduled for a $5 billion cut in 2020.

Conclusions

The federal report “Rising Above The Gathering Storm Revisited” concluded that "the U.S. appears to be on a course that leads to declining, not growing, standard of living for our children and grandchildren.”

It is difficult to see the positive outcomes of an investment in basic research because it does not lead to visible products in the short term, and the long-term outcomes from not investing in basic research are masked by short-term economic successes in the economy. But. in the long term, disinvestment can lead to stagnant productivity, lagging competitiveness, and reduced innovation.

The problem of multi-national corporations bending to the will of the finance sector and focusing on short-term profits as their priority is beneficial to shareholders but may be devastating to the country over the long-term. Ralph Gomory, former senior vice president of science and technology at IBM, succinctly summarized our current situation. He said, "what is good for America's global corporations is no longer necessarily good for the American people."

America's stated goal is to compete in the world market by using a strategy of innovation. But if we can't invest in the basic research and science that creates the opportunities for new technologies, it is difficult to see how America is going to compete with the Asian countries or remain the number one economy in the world.

Michael Collins is the author of The Rise of Inequality and the Decline of the Middle Class.