In July this year, US government statisticians redefined research and development (R&D) as akin to capital goods. R&D spending, they said, amounts to fixed assets, or investment; it should now count toward US gross domestic product (GDP) (1). And last week, this change showed up in the US Federal Reserve’s data on flows of finance in America, helpfully recording inflated asset values and lower debts.
This all seems innocuous enough. After all, R&D is just a down-payment on the future, so why not redefine it as a capital item rather than an expense?
But things are not that simple. R&D is essential, not just to economic growth, but also to the self-respect of society – for without scientific curiosity and technological adventure, the world would be a static, drab place. However, every successful outcome of R&D is usually accompanied by fruitless scientific enquiry, malfunctioning prototypes, and dismal market failures: take forlorn phone maker Blackberry today, or GlaxoSmithKline’s diabetes drug, Avandia, which was dropped in 2011 because it caused heart problems. In general, therefore, R&D pays back rather rarely (2).
Of course, with firms making established goods or services, the caprice of the market ensures that bankruptcy or urgent state bailouts are always possible – think British Leyland in the 1970s, or General Motors after 2008. Yet the direct, immediate production of profit tends to prevail. But with R&D, profit prospects are intrinsically low, and usually lie years away.
When it isn’t trying something entirely new, the brave innovating firm confronts other suppliers – their experience, sunk costs, distribution channels and brand reputation. Also, as Alexander Fleming’s chance discovery of penicillin famously confirms, the innovating firm often needs some real luck. Altogether, then, R&D tends only to succeed after repeated efforts. Turn a profit from making another packet of crisps? Easy enough. Convince airlines of your brand new jet’s airworthiness? As Boeing’s faulty 787 Dreamliner has shown, that’s tough.