The paradox of innovation investment

Investment in R&D = increases in productivity? This is what you would think. However in the US there has been rising investments in R&D but not the corresponding increases in productivity growth. Although total R&D spending has grown from 2.2% of GDP in the 1980s to 3.4% in September 2024, productivity growth has actually declined.

A major factor behind this paradox is the evolving nature of innovation. Research b reveals that while the share of the population engaged in patent creation has nearly doubled over the past 20 years, productivity growth has been cut in half. Several factors may explain why higher R&D spending is failing to drive productivity gains in the US:

• Reallocation of R&D resources: A growing portion of R&D funding is being directed to large, established companies. Although these firms have substantial resources, studies indicate that inventors tend to become less innovative after transitioning from smaller startups to major corporations.

• Market dominance over innovation: As companies expand and establish themselves as industry leaders, their priorities often shift from groundbreaking innovation to maintaining their competitive position. Research has found that larger firms increasingly engage in competition-limiting activities—such as lobbying policymakers—while their patent output declines.

• Talent acquisition to suppress competition: Larger firms often recruit skilled professionals from smaller rivals but fail to fully utilise their potential, which can stifle innovation. This hiring strategy may be aimed at reducing competitive threats rather than fostering creativity.

Addressing the innovation paradox is a pressing concern for US policymakers. While investing in R&D is vital, ensuring that these investments are utilised efficiently and fostering an environment that supports innovation—particularly within startups and smaller firms—is equally important. To drive meaningful productivity growth, the US must go beyond merely increasing R&D spending and work toward cultivating a more dynamic and innovative economic landscape.

Dynamic efficiencyand R&D

Dynamic efficiency is concerned with the efficient use and allocation of resources over time. Its attainment usually entails investing a substantial quantity of the resources available, to improve the capital stock or for further research and development. The development of new products means that a different mix of goods and services may serve consumers better in the long term, improving allocative efficiency. Investment in R&D today means that production can be carried out more efficiently in the future, improving productive efficiency. For a firm, dynamic efficiency may also involve implementing better working practices and better human capital management. For example, better relationships with unions help to introduce new working practices. In 1923, Henry Ford’s car factory was one of the most efficient firms in the world. But, by today’s standards, that same car factory would be left far behind. Therefore, dynamic efficiency is concerned with the optimal rate of innovation and investment to improve production processes, which helps to reduce the long-run average cost curves.

Source: IMF F&D Productivity – September 2024

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