R&D Credits Essential for Competitiveness: New Evidence

A new SSRN paper finds that research and development (R&D) helps manufacturers keep ahead of competition from imports. U.S. manufacturing firms in industries with strong import competition from China fared better 50 percent better when they had larger stocks of capital used for R&D. While this finding is intuitive, it provides an important piece of evidence that reiterates a critical point about the U.S. economy: international competitiveness is extremely important and smart R&D policy (including tax credits) is a key method of maintaining it.

The authors Johan Hombert and Adrien Matray use granular industry-level data on imports from China and show that these imports have a significant impact on the performance of U.S. manufacturing firms. They then examine whether this impact changes depending on how much R&D capital firms have. In order to make sure the R&D capital isn’t related to other factors, they use state-level changes in R&D credit policy during the 1980s.

Their results here show that firms that had access to cheaper R&D and were thus more likely to acquire more R&D capital had an easier time “climbing the quality ladder” and staying competitive in the face of import competition.

While trade can be very beneficial to overall economies, it can also be detrimental to individual firms and even whole industries. Hombert and Matray also show that increased import penetration decreased fixed capital growth and employment growth—but only for the firms that invested less in R&D. Firms that did increase R&D spending had no effective change in their employment growth despite the import competition, and decreased their investment in fixed capital far less than other firms.

The paper thus not only provides evidence of the effectiveness of R&D, it also provides evidence of the effectiveness of the R&D tax credit: in U.S. states where the credit was enacted businesses did more R&D and thus had an easier time avoiding import competition. The R&D credit is therefore an important policy tool not only because it helps businesses invent new products and increase productivity, but because it helps businesses survive amidst cutthroat international competition.

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