Productivity boost: India's increasing R&D spending may not be enough

It is often argued that India needs to substantially increase its research and development (R&D) capabilities to improve productivity, which is essential to compete in global markets. This, it has been pointed out, will also help expand India’s industrial base and create employment. Unfortunately, India’s spending on R&D, which is about 0.7 per cent of gross domestic product (GDP), is much lower than that of its peers and is a big impediment to accelerating economic growth. According to some experts, India needs to increase R&D expenditure to about 3 per cent of GDP. Industrialist Naushad Forbes has rightly argued on these pages that large Indian companies spend very little on R&D. While there is little doubt that India must focus on R&D, simply increasing expenditure may not be enough.

In this context, economist Ufuk Akcigit of the University of Chicago has shown that an increase in R&D expenditure, particularly in the United States (US), has not led to a corresponding improvement in productivity. His findings, contained in an article in the latest issue of Finance & Development, published by the International Monetary Fund, can help policymakers avoid possible errors in other countries as well. Expenditure on  R&D by the US  in the 1980s was about 2.2 per cent of GDP, rising to 3.5 per cent in recent years.  However, average productivity growth, which was 1.3 per cent between 1960 and 1985, has declined in the subsequent decades, except for a brief increase in the 2000s. Even though the number of people working on patent production increased substantially over the decades, productivity fell.

This paradox is explained by how resources are allocated. In terms of size, research shows small firms tend to be more innovative. On the other hand, large dominant corporations tend to focus on strategic moves over innovation, which affects potential output. There is enough evidence that market concentration increased in recent decades across several economies. Evidence from Italy shows that as businesses climb up in size, they tend to hire more politicians and innovation suffers. Since large corporations prioritise protecting their strategic positions, they not only acquire potential small rivals but also hire researchers from smaller firms at a premium, even when they don’t necessarily need them. For instance, at the turn of the century, 48 per cent of inventors in the US worked for large estabilshments — companies at least 20 years old and employing over 1,000 people. By 2015, this number had increased to 58 per cent. Many researchers were often placed in roles where they could not fully utilise their skills. The learning from this is that as a result of this, R&D at macro level suffers, which has adverse implications for growth and development.

Some of these insights can be useful for developing economies like India. While it is essential to have large corporations leverage economies of scale, the government must ensure that firms do not use their dominant positions to stifle competition. To be fair, some of it will be unavoidable in the short to medium term. However, the government should not support large corporations at the expense of small and emerging businesses, which can potentially develop disruptive technologies resulting in substantial productivity gains. Fiscal support for R&D, wherever possible, should also not put smaller firms at a disadvantage. Focusing on a handful of corporations or champions may boost growth in the short run, but their dominant position can affect productivity and growth in the long run.