Empirical evidence on knowledge spillovers from R&D
The empirical evidence is quite consistent in showing that social rates of return to R&D are large, and typically significantly higher than private rates of return.
The characteristics of knowledge outlined above – non-rivalry, together with a varying degree of non-excludability and other features such as uncertainty – suggest the possibility of market failures around knowledge, including spillovers and tensions between ex ante incentives for creation and ex post incentives for diffusion. However, the extent of these market failures is an empirical question.
The most widely studied aspect of market failures around knowledge is knowledge spillovers from R&D, as measured by the social versus private returns to R&D activity. The private returns accrue to the specific firm that undertook the R&D, whereas the social returns additionally include returns to other firms throughout the economy. These studies are quite consistent in finding that:
- the private rates of return to R&D are high; and
- the social returns to R&D are higher than the private returns.
Good reviews of the empirical evidence can be found in Weiser (2005), Cameron (1998) and Grilliches (1992). Estimates of private rates of return to R&D generally fall in the 20% to 30% range. Studies of the spillover benefits from R&D on average yield estimates of spillovers that are around two times higher than private rates of return – thus giving total social rates of return (private returns plus spillovers) in the order of 90% to 100% (Weiser, 2005; Cameron, 1998; Griffith, 2000)[9].
Although the private returns to R&D appear very high, Dowrick (2003) notes that a study by Bernstein and Nadiri (1991) found that private returns to R&D of 20-30% across a number of industries were broadly similar to the private returns to investment in physical capital. This suggests that there may not be a substantial risk premium on R&D investment relative to investment in plant and equipment, and consequently that investment in R&D may be privately optimal at the firm level[10].
The important point from a policy perspective is not the size of the private or social returns in isolation, but rather the difference between them.
In any case, the most important point from a policy perspective is not the size of the private or social returns in isolation, but rather the difference between them. The source of any difference is attributable to spillovers - one of the main potential sources of market failure identified earlier. These spillovers and their large size suggest that the marginal social benefit to more R&D is higher than the marginal social cost. Indeed, Jones & Williams (1998) conclude that even in an R&D-intensive country like the USA, the socially optimal amount to invest in R&D could be two to four times the actual amount invested[11].
There are studies that have questioned the evidence of large R&D spillovers. For example, a recent paper by Diego Comin (2004) argues that econometric R&D spillover studies potentially suffer from omitted variable bias[12]; that is, there are additional explanations for spillovers that are not covered by the studies, making the effect of R&D appear stronger that it really is. Comin presents an alternative approach that suggests investment in R&D in the USA is close to the social optimum.
There are also a number of difficult measurement problems in assessing the private and social returns to R&D. These are well-summarised in Hall (1996), and include: (1) the effect of price index measurement on the measurement of productivity growth; (2) the low variability of R&D spending in individual firms and the difficulties that this creates for identifying the intertemporal aspects of knowledge production; and (3) the importance of R&D depreciation estimates for measuring rates of return.
However, despite the existence of some contradictory findings, on balance the majority of the literature points in the direction of significant spillovers from R&D. There is also no reason to think that the measurement problems associated with studying returns to R&D are necessarily any worse than for econometric studies of other topics. After surveying the measurement difficulties, Hall (1996) nonetheless states in her conclusion that there is “overwhelming evidence that some positive externalities exist for some types of R&D”. For these reasons, we think that the most parsimonious explanation for the divergence between private and social returns to R&D found in the literature is that significant spillovers are occurring – although the size of spillovers is likely to vary depending on a number of factors such as the type of R&D, the industry, the degree of excludability (eg, via intellectual property rights), and country-specific factors like size and distance from the technology frontier (country-specific factors are discussed further below).
Notes
- [9]An interesting side point is that most studies suggest that spillovers between industries are important as well as those within industries.
- [10]Some studies have found a larger gap between returns to investment in physical capital vs R&D. To the extent that such a gap exists, there are several possible explanations, including systematic risk associated with R&D and finance constraints.
- [11]This is not to say that the presence of spillovers necessarily implies government intervention is warranted, as there will be costs and benefits associated with any potential policy that need to be considered. These are discussed further in the concluding section of the paper.
- [12]A potential for omitted variable bias could occur if another activity is omitted from the study but is both causally related to productivity increases and correlated with R&D. One example could be human capital: a firm with greater capability to perform R&D is likely to actually perform more R&D. To the extent that studies attempt to control for such effects (as at least some do), the findings will be more reliable.
