Sunday, December 11, 2005

The Myth of the Importance of R&D Spending for Growth

One myth that is widely accepted is the idea that spending on research and development (R&D) is more important for economic growth than other forms of investment and that R&D should thus be subsidized by the government. Thus, in the strategy plan of the European Union for making the EU the most competitive economy in the world, raising R&D spending to 3% of GDP is one of the most important parts.

Yet, what evidence exists that R&D spending will have a greater impact than other forms of investment spending. None.

A comparison of different EU countries illustrates this. The two fastest growing economies, Latvia and Estonia , have R&D spending levels far below average, as have all the other relatively rapid growing Eastern European countries. And even if you exclude the Eastern Europeans, largely the same pattern of negative correlation between growth and R&D spending exists. The four fastest growing of the old 15 member countries are Ireland, Luxembourg, Spain and Greece, all of whom have R&D spending below the European average.

This negative empirical correlation between growth and R&D spending should in my view not really be interpreted as R&D spending really having a negative impact on growth. This empirical pattern instead reflect that countries with low R&D spending by coincidence have a better policy in other areas. This is illustrated by the fact that one country with low R&D spending, Italy, have low growth as they pursue bad economic policies. Indeed, I think R&D spending is probably better for growth than pure consumption. However, as the empirical facts illustrate, there is no reason to believe that it will yield higher returns than other forms of investments, so there is certainly no reason for governments to subsidize it.


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