Media Briefings

BUSINESS INVESTMENT IN R&D: More likely to be a shortfall than an excess

  • Published Date: December 2014

Business policies that encourage firms to invest more in research and development (R&D) are likely to boost growth, according to research by Vincenzo Denicoló and Piercarlo Zanchettin, published in the December 2014 issue of the Economic Journal.

Their study corrects a mistake found in some of the leading economic growth textbooks. This mistake reflects a common misunderstanding of economic effects that play a crucial role in the growth process. By clarifying those effects, the researchers shed new light on the way policy intervention may affect growth.

Economists agree that technological progress is a key engine of growth. In market economies, technological progress is largely driven by R&D investments made by private firms. A crucial issue is, therefore, whether firms have too much, too little or just the right incentive to invest in research.

Most economists (but not all) also agree that the private incentives to invest are not necessarily aligned with the social ones. In other words, they agree that in a market economy, there may be too little or too much investment in R&D.

This study does not question this consensus nor the existing views as to why there might be too little R&D. But it does contend that the reasons why there might be too much R&D have been misunderstood.

Conventional wisdom attributes the possibility of over-investment in R&D to the so-called ‘business-stealing effect’ whereby an outsider who innovates and obtains a technological leadership gains market share at the expense of the incumbents. The new study proves that this effect by itself does not cause over-investment.

As a consequence, in growth models in which only the business-stealing effect is at work, overinvestment in R&D is not possible. Ironically, after developing one such model, a leading growth textbook asks students to explain why the model can exhibit over-investment. The correct answer is that it cannot.

Over-investment in R&D is possible in more highly structured models where other effects are also at play. But even in such models, it is less likely than conventional wisdom may suggest.

The main policy implication of the new research is that policy-makers should be less concerned about the possibility that the share of GDP devoted to research may be excessive. This suggests that policies that more strongly encourage firms to invest in R&D may benefit society as a whole.

ENDS

Notes for editors: ‘What Causes Overinvestment in R&D in Endogenous Growth Model?’ by Vincenzo Denicoló and Piercarlo Zanchettin is published in the December 2014 issue of the Economic Journal.

Vincenzo Denicoló and Piercarlo Zanchettin are at the University of Leicester.

For further information: contact Vincenzo Denicoló on 0116-252-2629 (email: vd51@le.ac.uk); Piercarlo Zanchettin on 0116-252-5319 (email: pz11@le.ac.uk); or Romesh Vaitilingam on +44-7768-661095 (email: romesh@vaitilingam.com; Twitter: @econromesh).