Cost of Ideas Rising, Slowing Productivity Gains

Paid post by Continuum Economics

Cost of Ideas Rising, Slowing Productivity Gains

By Kevin Harris


  • Weak productivity growth in recent years is a major concern for human welfare and for government budgets. One important issue in assessing the outlook for productivity is the contribution that comes from research. Recent evidence shows what human intuition suggests—that there are diminishing returns to research. Many growth models, however, assume constant returns to research, which could result in misleadingly high productivity and growth estimates.
  • Bottom line: Research may suffer from diminishing returns. A new study suggests research spending needs to double every thirteen years in order to maintain steady growth in the contribution of innovation to U.S. productivity. If this new finding is correct—and if other drivers of productivity do not take up the slack—prospects for gains in productivity and output growth are weaker than assumed in most longer-term economic forecasts.
  • Market implications: Interest rates and productivity growth rates are directly correlated—that is to say, weaker-than-expected productivity growth leads to lower-than-expected real interest rates, all else equal. Slower productivity growth also means lower returns on investment in productive capital and lower real wages.

Figure 1: Productivity Growth on a Troubling Path (y/y, % change)


When productivity is rising rapidly, human welfare rises, debt becomes more manageable, and aging demographics become less worrying. Therefore, the slowing of productivity growth across most developed economies is a major concern. In particular, a recent NBER working paper (1) on the productivity of research raises the troubling prospects that productivity growth may have a natural slowing tendency. The paper shows that gains from innovation are becoming steadily more expensive over time. In other words, research suffers from diminishing returns.

The authors of the study looked at the number of research hours needed to keep the reduction in cancer deaths falling, crop yields rising and the number of transistors in a microchip doubling at the pace seen in recent decades. They also looked at firm-level data on research and development spending and innovation. In general, across these various approaches, the authors find that the hours of research needed to roughly double every thirteen years in order to maintain steady growth in U.S. national income through innovation (Figure 2).

Figure 2: U.S. R&D Spending—Actual and Spending Needed to Maintain Steady Productivity Gains ($, millions)


We will not delve further into the details of the study here. Readers interested in the research can follow the link in the footnote below. Rather, we want to look at some implications of diminishing returns to research.

Bad, But Not Terrible, for the Rest of Us

When thinking about issues as complex as productivity, it is helpful to have an intellectual framework. The UK Office for National Statistics (ONS) has kindly provided such a framework, which identifies innovation as one of five main drivers of productivity growth. The complete list of drivers includes:

•  Investment in physical capital

•  Innovation

•  Skills

•  Enterprise

•  Competition

This five-point list offers reason for hope. There are sources of productivity gain other than innovation, so diminishing returns to research do not foreclose the possibility of rapid productivity gains.

Figure 3 helps illustrate the point that there are slowing trends in the growth of research and development spending and of productivity, but they are hardly in lockstep. Factors other than research and development spending account for a good part of the gain in productivity over time.

Figure 3: U.S. R&D Spending and Productivity (q4/q4 % change, R&D spending deflated by final goods PPI)


Sadly, as we have noted elsewhere, some of the other drivers of productivity gains are not particularly healthy, either. Investment as a share of output has been falling over time, and there is evidence that competition and enterprise are both less than dynamic these days. There is need for improvement across the entire productivity framework.

An additional concern, newly arisen, is that the relative tax subsidy for research spending has been reduced under the newly passed tax bill. Preferential tax treatment for R&D was preserved in the bill, but a lower overall corporate tax rate reduces the tax that is avoided under the R&D tax credit. At the same time, the Trump administration’s budget proposal sharply reduces federal spending on research through the National Institute of Health and the National Science Foundation. It remains to be seen whether Congress will go along with these suggested cuts.

Embarrassing for Growth Economists—Time to Rethink Long-Run Forecasts

One troubling issue for the economics profession is that our standard growth models generally assume constant returns to research. If diminishing returns are the actual case, then model-based long-run growth estimates are probably too high. If that is the case, then the outlook for inflation and interest rates may need to be reconsidered, too.

Are We Just Measuring Wrong?

As with any new piece of research, the NBER paper has to stand the test of professional scrutiny, and scrutiny takes time. As we noted in one of our current research Themes, there is a possibility that productivity is being mis-measured. Growth may be stronger, and inflation weaker, than official data reflect, simply because the economy is changing too fast for GDP accounting practices to keep up. That same measurement problem may explain the decline in research productivity found in the NBER paper, because that paper relies partly on standard GDP accounting.

We do not think that can be the full explanation, though. The NBER authors brought several data sets and research approaches to their work, some of which do not seem vulnerable to GDP accounting problems. In addition, there is research as far back as 1994 showing a decline in patents filed per research dollar spent. That research helps to confirm the results of the recent NBER paper, and is not vulnerable to the problem of GDP mis-measurement.


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(1) Nicholas Bloom, Charles I. Jones, John Van Reenen, Michael Webb, Are Ideas Getting Harder to Find?, NBER Working Paper No. 23782, September 2017

Analyst Certification: I, Kevin Harris, certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of RGE nor has any inducement been received in relation to those views.I further certify that in the preparation and publication of this report I have at all times followed all relevant RGE compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.
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