What does market failure tell us about mission-oriented R&D?

1. What does market failure tell us about mission-oriented R&D? David C. Mowery Haas School of Business U.C. Berkeley

2. outline • The market failure rationale. • Mission R&D in OECD economies’ public R&D spending. • Characteristics of mission R&D. • A brief example: defense-related R&D. • Some implications. • Conclusion.

3. The market failure rationale • Common economic justification for public R&D investment. • Implies an allocation of R&D funding driven by magnitude of the private-social returns “wedge.” • Associated with a broader V. Bush (1945) “social contract” (Guston & Keniston, 1994): • Autonomy for scientists in setting R&D agenda: “Curiosity-driven” research. • Reliance on peer review. • But what share of public R&D investment is covered by this analytic framework?

4. Mission-oriented R&D spending within the OECD • R&D investment to support gov’t agency programs. • Frascati: R&D spending classified by “socioeconomic objective” of funding agency. • Defense, space, agriculture, health, energy, industrial technology (categories based on funding-agency missions) account for at least 50%, and in most cases, >60%, of public R&D spending in 2003-2004 for South Korea, USA, UK, France, Canada, Japan, and Germany. • Spending on “advancement of knowledge,” arguably the category most closely connected with the “market failure” rationale, accounts for 25 - 30% of public R&D budgets in these economies.

7. Characteristics of mission R&D • Mission R&D often combined with other policies (procurement) that enhance or offset the effects of funding for innovation. • In some cases (early US semiconductor IC development), procurement was more significant than R&D funding. • Complementary policy portfolio (regulation; healthcare delivery systems) varies considerably among mission agencies. • Major source of investment in R&D infrastructure (facilities, equipment, etc.) in many OECD economies (including US), and a large university-centered infrastructure in US. • WWII: UCB & Manhattan Project; MIT & the Rad Lab=> university FFRDC.. • Creation of US academic computer science research infrastructure supported by DoD investment during 1950s – 1970s. • Agency policy & personnel, rather than peer review, is central to policy and funding allocation in postwar US mission R&D programs. • Office of Naval Research; Agriculture Dept.; DARPA • Variation among mission R&D programs is nearly as great as contrast between mission and “advancement of knowledge” R&D programs. • Compare share of development, basic research in NIH, DoD, NSF R&D budgets. • Much of the direct “output” of mission R&D in fields such as defense, space, health, etc., is sold to gov’ts or in other “nonconventional” markets (healthcare: 3d-party payers). • Complicates measurement of pecuniary “spillovers” from innovation.

9. The economic consequences of US defense R&D • Little consensus on the consequences of US defense R&D spending. • Through the 1980s, defense spending was portrayed by many critics as a drag on national competitiveness. • At least some of the IT-related technological pillars of the “New Economy” of the 1990s originated in defense R&D and procurement. • Growth of “entrepreneurial” US universities aided by defense-related R&D. Less of this is apparent in Europe. • Stern et al. (2000): comparative analysis of “national innovative capacity” doesn’t show strong benefits from defense-related R&D; Guellec & v. Pottelsberghe (2001) gov’t defense-related R&D investment has negative effects on measured TFP growth within OECD. • Effects of defense-related R&D differ considerably among sectors. • Contrast outcomes in IT, machine tools, nuclear power. • Scale and structure both matter. • Relatively open R&D system, diversity in defense suppliers and procurement, pluralism in defense-related R&D funding agencies may enhance civilian benefits. • But these structural advantages may be attainable only in the context of enormous scale. • What’s the counterfactual?

11. Defense spending and IT innovation • Defense applications of IT-related industries => substantial federal involvement: • Pluralism: Support for R&D in industry, universities, gov’t labs. • Substantial procurement demand=> reduction in unit costs, penetration of new technologies into nonmilitary applications. • Federal influence on technology development was strongest in the early years of development. • Similarities between civil & defense-related demand; military procurement accounted for larger % of total demand. • Structure of defense R&D and procurement policy aided technology diffusion, entry, competition. • Procurement policy supported entry by new suppliers, especially in semiconductors. • Relatively weak IPR environment => substantial interfirm spillovers, limited market power in semiconductors, Internet through the 1980s. • Semiconductors, computer HW, SW all display declines in spillovers/spinoffs over time. • COBOL vs. ADA. • VHSIC program.

12. Post-9/11 (& Iraq) defense R&D • Increased federal share of national R&D, largely attributable to growth in defense/homeland security share of federal R&D. • White House FY 2008 budget request cuts long-term DoD R&D. • Congress has reversed previous cuts, largely through earmarks. • Procurement (especially procurement of advanced systems) also likely to decline or remain flat. • “Homeland security” R&D dominated by biomedical research (~40% of $5 billion in FY ’08 “homeland security” R&D budget request). • Share of “black” programs within DoD R&D budget (20 – 22%) has not grown since 9/11.

13. Some implications • Temptations and risks in applying “lessons” from mission R&D in one area to another: • “Evidence” of underutilization of DoD patents cited in support of Bayh-Dole Act of 1980. • Applying the “DARPA model” to US energy R&D (“ARPA – E”). • Using mission-agency R&D programs for broader objectives than those of agency mission (e.g., SBIR, Clinton Technology Reinvestment Program, DoE weapons-lab work for civilian technologies) has a mixed track record. • Emphasis in “Mode 2,” “Triple Helix” claims about “new forms of governance” seems overstated, given longstanding influence of mission agencies. • Many of the hallmarks of governance associated with the “Republic of Science,” e.g., peer review, have been less influential within mission R&D. • Inter-institutional collaboration, evaluation against objectives other than “contribution to knowledge,” have long history in mission R&D. • Ebb & flow of political popularity of different agency missions (defense, space, energy) has had major consequences for US public R&D investment portfolio. • Soaring biomedical R&D budget, flat/ declining budgets for physical sciences reflects shifting political fortunes of mission agency R&D budgets, despite importance of physical sciences in biomedical research advances. • Significant cross-national contrast in profiles of mission R&D among EU member states. • EU R&D funding accounts for ~ 5% of total member-state public R&D.

14. Conclusion: Innovation policy & mission R&D • Rather than market failure, innovation systems approach is needed: • Sectoral & national systems matter a great deal. • Focus on structure of institutions and incentives within these institutions within mission-agency fields. • Caution is needed in applying “lessons” from one field of mission R&D to others. • Need to both broaden focus (recognize array of complementary policies) and narrow focus (on the sectoral/institutional specificities) in assessing mission programs. • From a policymaker perspective, the weakness of the greater richness & complexity of an “innovation systems” perspective may be its greater richness & complexity. • Coordination across fields, mission agencies, complementary policies within a mission-agency area is essential but difficult. • “GDP share” targets for gov’t R&D spending mean little without decisions on allocation among mission R&D agencies. • Sector-specificity is difficult to insert into a speech, onto an index card, or onto a slide. • But an indispensable starting point is recognizing that the market-failure analysis applies to a limited share (often less than 50%) of most nations’ “on-budget” R&D investment portfolios.