Thursday, September 6, 2012

Corporate Investment: Research and Development

Numerous articles have castigated US corporations for being shortsighted in focusing strongly on immediate gains at the expense of long-term growth. It was pleasantly surprising to find evidence that corporations, as a whole, may have been more diligent than was believed.

An article in The Economist addresses trends in national investments in research and development (R&D). The author lists two reasons generally given for why corporations might hesitate to make the long-term—and risky—investment in R&D. The first involves pressure to deliver current profits and meet market expectations.

"....firms may face pressure from shareholders to rein in R&D budgets. Research is a current cost that delivers benefits in the distant future (although the drugs industry shows that pay-offs can disappoint). There is survey evidence that bosses choose to scrimp on R&D in order to hit earnings targets or to pay larger dividends to investors."

The second involves the temptation to limit the need for R&D investment by buying out the competition.

"Competing firms race to be the first to invent new products; one of the rationales for merging with a rival can be to dull this competition. The pharmaceuticals industry has seen massive consolidation, for example: of 42 American drugs firms that existed in 1988, only 11 remained in 2012. Case studies suggest this may reduce R&D growth rates. In the six years before their 1999 merger, Astra and Zeneca increased R&D by an average of 19% a year. In the six years after AstraZeneca’s R&D growth was just 1% a year."

This chart indicates that private industry has been doing more than its share in keeping national R&D spending at a reasonable level.

Private R&D has been growing faster than the economy as a whole and fast enough to cancel the decline in public investment. That is the good news. The bad news is that the US has long been behind Japan in R&D investment, and has recently been overtaken by an ambitious South Korea.

Here are some other interesting points from the article:

"Europe as a whole has a weak R&D-to-GDP ratio, despite German efforts. It currently stands at around 1.9%, far below a European Union target of 3%. Britain’s position is particularly poor. Unlike in America, business R&D has fallen in tandem with public spending, dropping from 1.5% of GDP in 1986 to 1.1% in 2009. Of rich countries, only Italy looks worse."

So, let us congratulate our corporations on their performance, and concentrate our efforts on regaining a higher level of public investment.

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