The Economics of Innovation - ACS Publications - American Chemical

7 The Economics of Innovation

Downloaded by UNIV OF CALIFORNIA SANTA BARBARA on April 9, 2018 | https://pubs.acs.org Publication Date: August 8, 1980 | doi: 10.1021/bk-1980-0129.ch007

EDWIN MANSFIELD University of Pennsylvania, Philadelphia, PA 19104

The purpose of this paper i s to summarize very b r i e f l y some results that my students and I have obtained i n some econometric studies financed by the National Science Foundation. These studies pertain to the social rates of return from investments i n new technology. By a social rate of return, economists mean the rate of return to society as a whole. Although it has long been recognized by economists that estimates of such rates of return are of crucial importance i n formulating any rational policy toward c i v i l i a n technology, no estimates of this sort have been made for industrial innovations. To help fill this gap, we constructed a model which indicates how such estimates can be made for many, but by no meansall,innovations. This model includes the pricing behavior of the innovator, the effects of the innovation on displaced products, and the costs of uncommercialized R and D and of R and D outside the innovating organization, as well as a large number of other factors. In an econometric study described in detail in a recent book (1), we obtained very detailed data concerning 17 innovations from the producers and users of the new technologies, and applied this model to obtain an estimate of the social rate of return i n each case. Practically a l l of these innovations were of average or routine importance, not major breakthroughs. (For one thing, we wanted to avoid biasing the sample toward innovations that probably had relatively high rates of return.) Although the sample cannot be regarded as randomly chosen, there is no obvious indication that i t i s biased toward relatively profitable innovations (socially or privately) or relatively unprofitable ones. In large part, i t contains undramatic, runof-the-mill improvements in products and processes, l i k e a new type of thread or an improved machine tool. As many studies indicate (2), this i s the type of work that accounts for most industrial research and development. The findings are quite striking. The median social rate of return from these 17 innovations was about 56 percent, which indicates that the investments in these new technologies paid off 0-8412-0561-2/80/47-129-095$5.00/0 © 1980 American Chemical Society Smith and Larson; Innovation and U.S. Research ACS Symposium Series; American Chemical Society: Washington, DC, 1980.


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handsomely from society's point of view. To check this result, we used the same model to estimate, for one of the nation's largest firms, a lower bound on the social rate of return from i t s investment in new process technology in 1960-1972. This result too was about 50 percent. Of course, our sample, although large relative to what was previously available, i s too small to support definitive conclusions, but the results certainly suggest that, even taking into account the riskiness of innovative a c t i v i ty, the rate of return from investments in new technology has tended to be high. To extend this sample and to replicate our analysis, the National Science Foundation commissioned two follow-on studies, one by Robert R. Nathan Associates and one by Foster Associates. Nathan, based on i t s sample of 20 innovations, found the median social rate of return to be 70 percent and the median private rate of return to be 36 percent. Foster, based on i t s sample of 20 innovations, found the median social rate of return to be 99 percent and the private rate of return to be 24 percent. Thus, their results, like ours, indicate that the median social rate of return tends to be very high, and much higher than the private rate of return. (The private rate of return i s , of course, the rate of return to the firm that introduced the innovation.) One reason why economists are interested in estimates of this sort i s that they provide clues as to whether we as a nation are under-investing or over-investing in c i v i l i a n technology. If the marginal social rate of return from investments in c i v i l i a n technology i s greater than the marginal social rate of return from other uses of the relevant resources, this i s evidence of an under-investment in c i v i l i a n technology. Unfortunately, our results pertain to the average, not the marginal social rate of return from investments in c i v i l i a n technology. William Fellner and Zvi Griliches have argued that i t i s legitimate—or at least not too r a s h — t o make the jump from average to marginal rates of return. Indeed, in Griliches's view, there i s no reason to believe that the marginal rate of return differs much from the average rate of return. If this i s the case, our results certainly suggest that there may be an under-investment in c i v i l i a n technology in the United States, since the average rate of return seems very high. Our findings concerning rates of return are quite consistent with other econometric studies that have relied on more indirect methods and have used more highly aggregated data. In a previous study based on s t a t i s t i c a l production functions (3), I found that the marginal rate of return from R and D in the chemical and petroleum industries was 30-40 percent. Minasian obtained similar results. In a more recent study, Terleckyj has estimated about a 30 percent rate of return from an industry's R and D (in manufacturing), based only on the effects of an industry's R and D on i t s own productivity. In addition, his findings suggest a very substantial effect of an industry's R and D on productivity

Smith and Larson; Innovation and U.S. Research ACS Symposium Series; American Chemical Society: Washington, DC, 1980.


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growth i n other industries, resulting in a social rate of return greatly exceeding the 30 percent figure. Without exception, econometric studies based on production functions point in the same direction as our studies described above. Although these and other investigations (including our own) have noteworthy limitations, i t i s remarkable that the results, which rely on quite different methods and data, are so similar (4). To see why there may be some under-investment in c i v i l i a n technology, one must recognize that private rates of return may not equal social rates of return. As i s evident from our 17 case studies, as well as the detailed investigation of the R and D a c t i v i t i e s of the major firm during 1960-1972, firms often cannot appropriate a l l of the social benefits from an innovation. A good example i s a new type of thread that we studied. Although the social rate of return was over 300 percent, the private rate of return was only 27 percent, partly because other firms began imitating the new thread within six months after the innovator introduced i t . Our findings provide the f i r s t glimpse of the differences between private and social rates of return from investments i n new technology. In general, social rates of return seem to exceed private rates of return, although this i s not always the case. Specifically, the median social rate of return i s about double the median private rate of return in our sample, and the social rate of return from the major firm's investment in new process technology in 1960-1972 seemed to be at least double the private rate of return. When we look at specific innovations, the difference between the social and private rate of return seems to be related to the economic importance of the innovation (measured by absolute annual benefits) and to the costs of imitating the innovation. These results are quite consistent with hypotheses put forth by economic theorists (jL). Socially worthwhile innovations—that i s , projects where the social rate of return i s high enough to warrant going ahead with the p r o j e c t — w i l l not be carried out i f the perceived private rate of return i s so low that the potential innovator rejects the project (5). An important question facing policy makers i s - how frequently does this situation arise, and in what areas i s i t most prevalent? If this situation i s common, i t suggests the desirability of direct or indirect government support for such projects. If i t i s much more common in some types of industries and for some types of innovations than for others, then this support should be focused on such industries and such types of innovations. Economists have long recognized that this question l i e s at the heart of any discussion of public policy toward c i v i l i a n technology, but u n t i l now there has been no direct evidence concerning i t . Our results cannot indicate a great deal about the frequency with which such situations arise, because our data pertain to innovations that were carried out. (The d i f f i c u l t y , i f net



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impossibility, of obtaining such data for innovations that were not carried out should be obvious.) But a limited amount of evidence can perhaps be derived on this score from the data concerning the 17 innovations. For 9 of these innovations, we could obtain data concerning the approximate private rate of return expected from the innovation by the innovator when i t began the project. In 5 of the 9 cases, this expected private rate of return was less than 15 percent (before taxes), which indicates that these 5 projects were quite marginal from the point of view of the firm. (Indeed, the executives of the firms confirmed that they were marginal.) Yet the average social rate of return of these 5 innovations was over 100 percent. Unless the social rate of return drops precipitously when the expected private rate of return f a l l s from 10 or 12 percent to (say) 5 or 6 percent, this result seems to indicate that there may be many projects where the expected rate of return was a b i t lower than for these 5 projects (with the result that they were not carried out), but where the social rate of return would have been quite high. Among the innovations for which we have data, there i s no significant correlation between an innovation's expected private rate of return and i t s social rate of return. Thus, unless there i s a sharp discontinuity i n the slope of whatever relationship exists between the expected private rate of return and the social rate of return, no evidence exists to suggest a precipitous drop i n the social rate of return when the expected private rate of return f a l l s from 10 to 12 percent to 5 or 6 percent. These results, like those discussed above, may point toward some under-investment in c i v i l i a n technology. What sorts of public policy mechanisms might be adopted to help deal with whatever under-investment may exist in c i v i l i a n technology? At least three kinds of mechanisms are suggested frequently—government grants and contracts to industry and universities for more such work, increased use of government laboratories for such purposes, and tax credits for private industry. Our results indicate some of the problems in each of these mechanisms, with regard to grants and contracts, as with any selective mechanism, one runs into the problem that benefits and costs of various kinds of R and D are very hard to forecast. Even major corporations have d i f f i c u l t i e s using various forms of cost-benefit analysis for R and D project selection, although they have a benefit concept that i s much easier to estimate than most government agencies do. To i l l u s t r a t e how far off benefit estimates are, the chances were about 50-50 that a new product's (or new process's) estimated discounted profits would be more than double, or less than one-half, the actual discounted profits in one major firm we studied (6). Also, such estimates may be biased for parochial, s e l f i s h , or p o l i t i c a l reasons, the result being a distortion of social p r i o r i t i e s , i f the estimates are taken seriously. Turning to the increased use of government laboratories to



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promote c i v i l i a n technology, our results suggest the problems i n having R and D conducted by organizations that are not i n close touch with the marketing and production of the product. I t i s very important that there be unimpeded flows of information and good coordination of R and D, on the one hand, and marketing and production, on the other. Otherwise, the R and D i s likely to be misdirected, or even i f i t i s not, i t may be neglected or resisted by potential users. This i s a d i f f i c u l t problem for various divisions of a firm, and i t would seem to be made worse i f the R and D i s done in government laboratories. In the last decade, many governments have tended to convert government laboratories and to increase the amount of government-financed R and D done i n industrial firms i n order to bring R and D into closer contact with application and commercialization. Turning to tax credits, i t i s evident that they would reward firms for doing R and D that they would have done anyway, that they would not help firms with no profits, and that they would encourage firms to define R and D as widely as possible. Some of these problems might be solved by a tax credit for increases i n R and D, but many problems remain. For example, firms would s t i l l have an incentive to redefine R and D, and for firms that can appropriate l i t t l e of the social returns from new technologies, R and D would s t i l l be unprofitable even i f the tax credit existed. At present, i t i s d i f f i c u l t , i f not impossible, to specify what combination of these (and other) mechanisms would be most effective i n compensating for whatever under-investment there i s in c i v i l i a n technology. But i t seems l i k e l y that any such c i v i l i a n technology program should be neither large-scale nor organized on a crash basis, that i t should not focus on helping sick industries (merely because they are sick), that i t should not get the government involved i n the latter stages of development work, that a proper coupling should be maintained between technology and the market, and that the advantages of pluralism and decentralized decision making should be recognized. Given the current uncertainties (which, as we have repeatedly stressed, are great), i t would seem wise to proceed with considerable caution, and to build into any program the capacity and necessity to resolve many of the key uncertainties before too big a commitment i s made. F i n a l l y , i t i s important to recognize that our nation's technology policies cannot be separated from i t s economic p o l i cies. Measures which encourage economic growth, saving and investment, and price s t a b i l i t y are l i k e l y to enhance our technological position. And measures which reduce unwarranted regulatory burdens are l i k e l y to do the same. Just as many of our current technological problems can be traced to sources outside science and engineering, so these problems may be resolved i n considerable part by improvements in the general economic climate i n the United States. Indeed, improvements i n


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o u r g e n e r a l e c o n o m i c c l i m a t e may h a v e more i m p a c t o n t h e s t a t e o f U . S . t e c h n o l o g y t h a n many o f t h e s p e c i f i c m e a s u r e s t h a t h a v e b e e n proposed t o s t i m u l a t e t e c h n o l o g i c a l change.


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Acknowledgements The s t u d i e s c i t e d i n t h i s paper were supported by a grant from the N a t i o n a l Science Foundation. Of course, the Foundation i s n o t r e s p o n s i b l e f o r the o p i n i o n s expressed here. T h i s paper i s based l a r g e l y on m a t e r i a l taken from r e f e r e n c e 1.


Literature Cited 1. Mansfield, E . ; Rapoport, J.; Romeo, A.; Villani, E . ; Wagner, S.; Husic, F. "The Production and Application of New Industrial Technology"; W.W. Norton: New York, 1977. 2. Mansfield, E . ; Rapoport, J.; Schnee, J.; Wagner, S.; Hamburger, M. "Research and Innovation in the Modern Corporation"; W.W. Norton: New York, 1971. 3. Mansfield, E. "Industrial Research and Technological Innovation"; W.W. Norton for the Cowles Foundation for Research in Economics at Yale University: New York, 1968. 4. Mansfield, E. Federal Support of R and D Activities in the Private Sector, in "Priorities and Efficiency in Federal Research and Development"; Joint Economic Committee of Congress: Washington, D.C., October 29, 1976. 5. Mansfield, E. "The Economics of Technological Change"; W.W. Norton: New York, 1968. 6. Beardsley, G; Mansfield, E. A Note on the Accuracy of Industrial Forecasts of the Profitability of New Products and Processes; Journal of Business, January 1978. RECEIVED

November

13,

1979.


The Economics of Innovation - ACS Publications - American Chemical

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