Fueling Innovation: The Role of R&D in Economic Growth

Innovation drives economic growth. But what fuels innovation? At the heart of it, research and development (R&D) activities allow scientists and researchers to develop new knowledge, techniques, and technologies. As technology changes, people can produce more with either the same amount or fewer resources, thereby increasing productivity. As productivity grows, so does the economy.

A recent study by Begun Erdil Sahin adds to the already wide breadth of economic literature that affirms this notion—investing in R&D increases economic growth. From a sample of 15 Organization for Economic Cooperation and Development (OECD) countries, including the United States, she estimates that a 1 percent increase in R&D spending could grow the economy by 0.61 percent. This means that as countries invest more in R&D, their economy will grow faster.

Significant interest in understanding how innovation impacts the economy started to gather in economics during the 1980s. Prior to this, the general consensus in economics was that innovation just “happened” and improved the economy through technological change—basically, government policy had little impact on long-term economic growth.

However, some economists started to realize that innovation could be shaped by public policy and that as much as innovation was critical for economic growth, we had a hand in shaping the driver of economic growth. Part of this realization coincided with a better understanding of human capital, or in other words, that workers could be quantified by the sum of their accumulated knowledge. And such increases in knowledge meant workers could use technologies better and more efficiently, leading to higher productivity. The United States spends the most on R&D worldwide, estimated at $465 billion in 2014 (from business and government). China comes in second at $284 billion, and Japan comes in third with $165 billion.

However, putting that figure as a percentage of GDP provides a more telling picture. R&D expenditure as a percentage of GDP, also known as “R&D intensity,” gives a better gauge of the importance a country has placed on innovation and future growth. The more a country sets aside today for R&D, the greater the dividends they stand to reap in the future. In that sense, among OECD nations, Korea leads in R&D intensity at 4 percent, followed by Japan at 3.4 percent, and then the United States trailing in third at 2.8 percent. For comparison, the R&D intensity of all OECD nations averages at 2.4 percent. Countries such as Korea and China have focused on expanding heavy investment into R&D over the past decade, as demonstrated in Figure 1.

Figure 1: R&D intensity of selected countries, 2000-2013. Source: World Bank Data.

Although the United States currently outperforms many OECD nations in R&D intensity, if China’s trend of rapid research and development funding continues expanding as seen from Figure 1, it may well outpace U.S. R&D intensity within a decade. Battelle estimates that in absolute dollar figures, China will outspend the United States by the early 2020s.

Public policy has a role to play in increasing R&D investments. One policy is direct funding of scientific and engineering research. Another is through the tax code with measures like R&D tax incentives and “innovation boxes,” which allow companies to enjoy lower tax rates on profits generated through patents, research, innovation, or other creative activities.

As nations seek to drive economic growth through innovation, they should not compromise on the fuel of innovation – investment in research and development.