The Impact of Sequestration on the US Innovation Landscape

bridges vol. 35, October 2012 / Innovation Matters

By Stephen Ezell



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Stephen Ezell Unless Congress and the Obama Administration act otherwise, on January 1, 2013 budget enforcement procedures known as sequestration introduced in the 2011 Budget Control Act will require cuts in US discretionary spending in order to achieve $1.2 trillion in savings from 2013 to 2021. Sequestration will lead directly to cuts in the U.S. government's investment in research and development (R&D). Specifically, compared to constant 2011 R&D investment levels, sequestration will lead to an 8.8 percent, or $12.5 billion, cut in federal R&D expenditures in Fiscal Year (FY) 2013 and a total $95 billion reduction in federal R&D from 2013 to 2021.

Though the intent of the sequestration is to gain control over the ever-increasing federal debt (which topped $16 trillion in 2012 and which does pose a real, long-term threat to the economy), the sequestration of federally funded R&D will end up having the opposite effect. This is because the empirical evidence shows that investment in R&D generates significant productivity gains and therefore increases in GDP and real standards of living. Thus, cutting R&D expenditures will actually increase annual deficits and the total debt by comprising economic growth. In a new report, Eroding Our Foundation: Sequestration, R&D, Innovation, and U.S. Economic Growth, the Information Technology and Innovation Foundation (ITIF) analyzes the impact of the impending cuts in federal R&D investment, projecting that this decline in federal R&D will reduce GDP by at least $203 billion—and possibly as much as $860 billion—over the ensuing nine-year period.1 At $203 billion, this loss would be equivalent to eliminating all sales of new motor vehicles for a half year, two years of airline travel, or six years of attendance at all professional sporting events. Moreover, ITIF estimates that sequestration of R&D would result in the US economy having approximately 200,000 fewer jobs per year between 2013 and 2016. This would result in the US unemployment rate being 0.2 percentage points higher than it would otherwise be. In addition to the losses in productivity, GDP, and employment, ITIF further finds that R&D sequestration would reduce the United States' innovation knowledge base of publications and patents. Specifically, ITIF estimates that sequestration would result in US scientific journal publications declining almost 8 percent and patents near 3 percent over the 9-year period from 2003 to 2012.

Reductions in federal R&D investment would be particularly deleterious to the US economy because federal R&D funding plays a critical role in the US innovation ecosystem. The federal government funds 31 percent of all R&D and 60 percent of all basic R&D. (The federal government also plays a large role in the performance of R&D: between them, federal laboratories and the nation's universities perform 70 percent of all basic R&D.) Because federal funding is a key source of R&D investment, the sequester will directly cause a 3 percent drop in total US R&D in 2013. Moreover, the decrease in federal R&D investment would likely lead to a decrease in private sector R&D investment, because federal R&D and corporate R&D investments are complements. For example, Andrew Toole finds in a February 2012 Research Policy article, "The impact of public basic research on industrial innovation: Evidence from the pharmaceutical industry" that there are positive returns to public investment in the private sector and that public investment in life sciences research through the National Institutes of Health (NIH) empowers the earliest stage of pharmaceutical drug discovery.2

Sequestration comes at a particularly bad time because the United States is already falling behind peer countries in investing in research and development. Indeed, sequestration's looming reductions of federal R&D investment are merely emblematic of declining federal R&D investment as a share of GDP and stagnant levels of U.S. R&D intensity (total R&D as a share of GDP) over the past several decades. As ITIF writes in a new book, Innovation Economics: The Race for Global Advantage, federal R&D investment grew (in constant dollars) at just 0.3 percent per year from 1987 to 2008—much lower than its average annual growth rate of 4.9 percent from 1953 to 1987, and ten times lower than the rate of GDP growth over that period. In fact, to merely restore federal support for research as a share of GDP to 1987 levels, Congress would have to increase federal support for R&D by almost $110 billion—per year.


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This (pre-sequester) decline in federal R&D investment is a primary reason why the United States has slipped to ninth among Organization for Economic Cooperation and Development (OECD) nations in R&D intensity and why other nations have dramatically outstripped the United States in R&D intensity growth over the past two decades. In fact, while U.S. R&D intensity increased by a paltry 10.4 percent from 1995 to 2008, it increased by 20.5 percent in Germany, 42 percent in Korea, 65 percent in Finland, 135 percent in Singapore, and 170 percent in China.

Another concern is that an increasing share of US federal R&D goes toward defense- (or mission)-oriented R&D activities. The United States ranks a lowly 39th in non-defense government R&D expenditures as a percent of GDP, with 51.4 percent of the US federal R&D budget devoted to defense-oriented R&D, almost triple the United Kingdom's share of 18.3 percent. In contrast, non-US OECD countries, on average, allocate 96.1 of their federal R&D budgets to nondefense-oriented activities. And whereas just 5 percent of the U.S. federal R&D budget is dedicated explicitly toward economic growth, the OECD average is three times greater, and much more in countries such as Finland and Korea, which allocate 40 percent and 44 percent, respectively, of their federal R&D budgets toward broader economic growth.3

The simultaneous slowdown in growth of federal R&D investment (and its shift toward defense-oriented activities) also helps accounts for why the United States is increasingly falling behind OECD peers in university research funding, as ITIF finds in University Research Funding: The United States is Behind and Falling.4 In 2008, the United States ranked just 22nd out of 30 countries in government-funded university research and 21st in business-funded university research. Not surprisingly, the United States also lags in growing this funding. From 2000 to 2008, the United States ranked 18th in the growth of government-funded university research, with countries like China, Korea, and the United Kingdom significantly outperforming the United States. Worse still, the United States ranked 23rd in the growth of business-funded research, with it actually declining as a share of GDP. In contrast, collaboration between universities and business grew dramatically in a range of countries, including Austria, China, Israel, and Taiwan.

The coming sequestration will only exacerbate these trends and further compromise the United States' ability to innovate. As the New York Times wrote on Sunday, October 6th in The Seeds that Federal Money Can Plant, "government support plays a vital role in incubating new ideas that are harvested by the private sector, sometimes many years later, creating companies and jobs."5 For instance, the US National Research Council's report Continuing Innovation in Information Technology examined eight key computing technologies—including digital communications, databases, computer architectures, and artificial intelligence—directly tracing in each case a path from government-financed research to commercialization.6 The report calculated that the portion of revenue at 30 well-known corporations that could be traced back to the seed research backed by government agencies equaled nearly $500 billion per year. As Peter Lee, a Microsoft Research corporate vice president who spearheaded the report, noted, "If you take any major information technology company today, from Google to Intel to Qualcomm to Apple to Microsoft and beyond, you can trace the core technologies to the rich synergy between federally funded universities and industry research and development."7

Ultimately, federal investment in R&D, science, and technology represents an investment that produces a larger economy in the future—generating wealth, jobs, and tax revenues. To cut it is completely short-sighted. Unfortunately, sequestration is simply emblematic of the kind of "helter-skelter" economic policy making that has prevailed in Washington over the past several years. Just four years ago, the prevailing mantra in Washington was "stimulus" and pumping as much government investment into the economy as possible. The operational instrument of stimulus measures was the American Recovery and Reinvestment Act (ARRA), an $840 billion package that included $100 billion of innovation-oriented investment that went to infrastructure building, broadband Internet and smart grid deployment, and for increases in federal R&D funding at agencies such as the National Science Foundation, the National Institutes of Health, and the Department of Energy's Office of Science.8

This "one-time" increase in funding for these agencies represented a nice bump but wasn't tied into long-term goals at these agencies. In essence, ARRA funds resulted in giant "windfalls," where government agencies, national laboratories, and universities took the cash and began building new facilities, hiring researchers, and investing in research programs. But today, the new buildings sit vacant, research programs are being axed in midstream, and many researchers sit in limbo as sequestration has resulted in considerable uncertainty for the federal R&D enterprise. As ITIF notes in Leadership in Decline: Assessing U.S. International Competitiveness in Biomedical Research, sequestration will result in a 7.9 percent cut in 2013 NIH funding (a $2.5 billion reduction), the largest cut in the agency's history. This whipsaw-like boom and bust cycle of funding introduces tremendous uncertainty into the biomedical research enterprise, making it difficult for researchers, research institutions, and businesses to make long-term planning and investment decisions.9 In fact, the US research enterprise would operate far more optimally if we had stable, well-targeted R&D investments, as opposed to highly uncertain surges and then declines in expenditures.

In essence, the United States has moved from a strategy of indiscriminately spending money to artificially pump up the economy to indiscriminately slashing investment because now the prevailing politics suggest the rapidly rising debt is the greater threat to economic growth. But the underlying problem is that since at least 2000, the United States has made constant resort to artificial measures to pump up the economy, whether the artificially low interest rates under President George W. Bush and Federal Reserve Chairman Alan Greenspan or President Obama's stimulus package. What these represent is adrenaline shots to try to stimulate a weak heart, when what's really needed is effective policies to strengthen the heart muscle; that is, the competitiveness, innovation, and productivity capacity of the US economy. In other words, the kinds of policies that nations like Austria, Germany, and Sweden have been implementing around technology, tax, trade, and talent to ensure their economies are some of the most competitive in the world.

While deficit reduction is clearly a necessary task for the United States, growth is a key component to achieving that task and thus the reality is that cutting R&D expenditures will in fact negate efforts to reduce the deficit. In order to remain competitive in the face of global competition in innovation, the United States should rather be increasing its investment in R&D, not reducing it. If it fails to do so, the United States will continue to lose ground to those countries that already surpass it in the relative size of their R&D sectors within their economies, enabling them to make quicker gains within the global innovation landscape. And it will only further comprise the ability of its economy to support competitive and innovative companies and their ability to produce innovative products and services that drive economic growth and support increased standards of living and quality of life for citizens around the world.

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The author, Stephen Ezell, is a Senior Analyst with the Information Technology and Innovation Foundation (ITIF), with a focus on international information technology competitiveness and national innovation policies.

 

References:

1. Justin Hicks and Robert D. Atkinson, " Eroding Our Foundation: Sequestration, R&D, Innovation and U.S. Economic Growth," (Washington, DC: ITIF, September 2012), http://www2.itif.org/2012-eroding-foundation.pdf.

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2. Andrew A. Toole, "The impact of public basic research on industrial innovation: Evidence from the pharmaceutical industry", Research Policy, Volume 41, Issue 1, February 2012, Pages 1-12, ISSN 0048-7333, 10.1016/j.respol.2011.06.004, http://www.sciencedirect.com/science/article/pii/S004873331100117X.

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3. Organization for Economic Cooperation and Development (OECD), OECD Science, Technology and Industry Scoreboard 2011 (Paris: OECD, 2011), 119, http://www.oecd-ilibrary.org/science-and-technology/oecd-science-technology-and-industry-scoreboard-2011_sti_scoreboard-2011-en.

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4. Robert D. Atkinson and Luke Stewart, "University Research Funding: The United States Is Behind and Falling," (Washington, DC: ITIF, May 2011), http://www.itif.org/files/2011-university-research-funding.pdf.

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5. Steve Lohr, "The Seeds That Federal Money Can Plant," New York Times, October 6, 2012, http://www.nytimes.com/2012/10/07/technology/making-the-case-for-a-government-hand-in-research.html.

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6. National Research Council of the National Academies, "Continuing Innovation in Information Technology," 2012, https://download.nap.edu/catalog.php?record_id=13427#toc.

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7. Lohr, "The Seeds That Federal Money Can Plant."

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8. Recovery.gov, "Track the Money," http://www.recovery.gov/Transparency/fundingoverview/Pages/fundingbreakdown.aspx.

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9. Robert D. Atkinson et al., Leadership in Decline: Assessing U.S. International Competitiveness in Biomedical Research (Washington, DC: ITIF and United for Medical Research, May 2012), 2, http://www2.itif.org/2012-leadership-in-decline.pdf.

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