Fuqua Professor: The United States Government Must Spur Private Sector Innovation

Sharon Belenzon believes the U.S. should foster corporate research to stay economically competitive

April 26, 2023
Animated GIF of Sputnik

Professor Sharon Belenzon of Duke University’s Fuqua School of Business says the partnership between big corporations and government entities has historically driven innovation in the United States. However, Belenzon says the U.S. government has an opportunity to further unlock corporate innovation as geopolitical tensions rise. 

Belenzon cites the Soviet Union’s launch of the Sputnik satellite in 1957 as an example of a historical event that spurred the U.S. to invest in private-sector research and development (R&D) projects. In a policy brief, Belenzon and his co-author Larisa C. Cioaca, a Fuqua Ph.D. candidate, argue that the reward mechanism was guaranteed demand: firms that demonstrated superior technological capabilities in R&D races received lucrative noncompetitive contracts from the government for the resulting products. In this respect, the government effectively de-risked corporate scientific research. Belenzon says once the Cold War ended, the U.S. became less aggressive in supporting corporate innovation in that way, focusing more on supply-side policies (lowering the cost of R&D), rather than increasing the private value of scientific research through public demand mechanisms.

In related work, Belenzon and Professor Ashish Arora write in a piece for the National Bureau of Economic Research that in the last 30 years, U.S. labor productivity grew at a pace slower than any time after 1870. The authors attribute the decline to the demise of corporate research labs and the transfer of R&D to universities and small startups, which sometimes lack the ability to scale findings.

Belenzon believes that geopolitical tensions between U.S. and China might create a new “Sputnik moment” for governments to invest in corporate research.

Belenzon shares his ideas in this Q&A.

Q: How can governments spur innovation in private companies?

A: Government support for innovation can be categorized into two main components: the supply side, which focuses on the production of scientific knowledge and the creation of new Ph.D. programs typically through universities; and the demand side, which seeks to encourage private investment in research by increasing demand for new goods and services that embody new scientific knowledge. In some cases, these policies are used together, with downstream purchases promised for successful R&D projects.

Supply-side policies aim to lower the costs of research and development (R&D) by providing grants and subsidies. In 2021, the federal government provided $179.5 billion in R&D funding, including $64.2 billion in R&D from the National Institutes of Health and national labs, $13.6 billion in R&D performed in federally funded research and development centers, $52 billion in R&D performed by industry, $37.7 billion in R&D performed in universities, and $11.9 billion in R&D performed by nonprofits, state government facilities, and others.

Moreover, the government incentivizes businesses to participate in R&D through procurement—buying technology-intensive products —which is a demand-side policy. To offset the implementation costs of R&D in production (unlike a research grant, procurement law requires that knowledge produced under a research contract must be implemented in a downstream product or service), the government rewards firms with superior technological capabilities by guaranteeing demand for the resulting products. Procurement is a large and growing component of U.S. government support for innovation, while funding for R&D to businesses has been shrinking. In 2019, the federal government awarded businesses $6.4 billion in grants (a 7% decrease from a decade earlier), $47.8 billion in contracts for R&D services (a 20% decrease), compared with $309.1 billion in contracts for other services (a 17% increase), and $233.2 billion in contracts for products (an 8% increase).

Q: How effective is the current U.S. government strategy to encourage corporate R&D?

A: The U.S. government is implementing an “all of the above” strategy to encourage corporate R&D, with varying degrees of effectiveness. For instance, the federal government has altered public procurement in recent decades in ways that have weakened the incentives for private companies to invest in innovation.

On the procurement side, after the collapse of the Soviet Union, technological superiority became less important to public procurement compared with projects that emphasized social and economic development. Procurement contracts increasingly prioritized dual-use technologies (those with both military and civilian applications) and commercial-off-the-shelf (COTS) products and services. These changes redirected corporate R&D toward problems that already had existing private-market applications. Naturally, those problems did not require the same new scientific sophistication that characterized the pursuit of America’s technological superiority. The unintended consequence was a potential decline in corporate scientific research.

Q: What do you see as the ideal way for the U.S. government to partner with corporations around R&D?

A: Collaboration between the U.S. government and corporations is essential for cutting-edge innovation. The private sector's massive investment resources are necessary to tackle the technological challenges our society faces. Public demand can also encourage corporations to invest in risky scientific research, especially in a technology's early years, when private demand may be insufficient. Therefore, the U.S. government should consider amending its procurement policy to incentivize innovative corporations to solve "extreme quality" problems (at the expense of efficiency, cost-cutting, and even competition). It should also examine the potential impact of antitrust policies aimed at limiting firm scale and scope on corporate participation in scientific research, especially given the natural relationship between big size and incentives to invest in general-purpose-technologies (more on this in the last question below).

The mix of demand and supply-side innovation policies are required for the overall health of the American innovation ecosystem and the rate and direction of innovative activity. While demand-side policies such as the COVID-19 vaccine procurement programs can deliver useful goods and services to the government, their role in encouraging private investment in R&D, particularly upstream research, is not well understood compared with the extensive academic literature on government-supported R&D policies. While government funding for public science produced in universities may be beneficial for producing trained scientists and science, translating university science into market innovations is challenging. Startups and university spinoffs may be effective in some cases, but in other cases, significant frictions may arise in the technology market. Government procurement policies that favor firms with commercial and manufacturing assets may affect established companies and startups differently.

Q: Can you give us some industry examples of how this might work?

A: Let me start with an example from the 20th century, the invention of the laser. In the 1950s, the Department of Defense (DOD) funded competing teams in the R&D race to build the first laser. Military contractor Hughes Research Laboratories demonstrated the ruby laser on May 16, 1960, followed by demonstrations at TRG and Bell Labs shortly thereafter. It took many years for private laser markets to develop. Throughout the 1960s, the government acted as the “buyer of first resort.” Procurement contracts for measurement and optical communication lasers enabled corporate research laboratories to scale and improve the technology. By 1969, the DOD’s share of the laser market was 63.4%. In the early 1970s, growth in military laser procurement slowed, universities curtailed their laser purchases, and companies redirected their R&D toward commercial applications that held promise for short-term returns on investment. Applications in communications, measurement, cutting, and welding emerged. In the 1980s, lasers became prominent in the consumer economy as supermarket scanners, printers, and optical discs. The important point is that government demand drove firm engagement in upstream R&D when private market demand for the technology was insufficient. In the 21st century, the government could play a similar enabling role in clean energy or autonomous vehicles, to name just two examples.

The COVID-19 mRNA vaccine development serves as a prominent recent example of the power of a specialized innovation ecosystem, whereby the four sectors of the innovation ecosystem play their respective roles (small firms, big firms, universities and the government). The foundational research was conducted by university researchers with government funding (a supply-side policy), while startups like BioNTech, Moderna, and Arbutus contributed to developing the technology required for safe vaccine delivery. Established pharmaceutical firms such as Pfizer were responsible for testing, production, and distribution. The division of labor among multiple firms was a significant advantage, and government procurement played a crucial role as well. Importantly, unlike the typical role assigned to the government in the American innovation system of funding upstream research in universities and leaving commercial applications to firms, the government's advance market commitments (a demand-side procurement instrument) to purchase the vaccine were critical.

Q: Why do you think we are in a unique moment for the government to unlock innovation in corporate research and development?

A: The United States is losing ground in innovation as other countries, most notably China, are stepping up their investments in science and technology. For example, China almost quadrupled its R&D intensity from 0.57% in 1995 to 2.2% in 2019. The United States experienced a modest increase over the same period, from 2.4% in 1995 to 3.1% in 2019. In terms of human capital, China doubled its investment in higher education between 2012 and 2021. By 2025, the country is projected to produce nearly double the number of annual STEM Ph.D. graduates compared with the United States. If we don’t take steps now, American leadership will be a thing of the past.

However, it is important to recognize that the erosion in American leadership is not uniform. America is still strong in industry segments where U.S. companies invest heavily in leading-edge scientific research (e.g., in quantum computing and artificial intelligence). However, as fields mature these advantages shrink and foreign firms take the lead (e.g., in 5G telecommunications and semiconductors). Sustained public and private investments in leading-edge scientific research are essential for stemming the tide of foreign competition.

Q: What advice would you give to U.S. lawmakers as the first step in moving forward on these ideas?

A: The economic prosperity and national security of America are, to a considerable extent, dependent on the nation's ability to lead in innovation, particularly in science-based innovation. Over the last thirty years, there has been an increasing specialization between universities that prioritize scientific research and large corporations that prioritize technology development. Despite this, the knowledge generated by universities is often not easily applicable to the creation of new products and services. Although small firms and university technology transfer offices have attempted to compensate for the lack of corporate research, they are not capable of replicating the interdisciplinary and large-scale approach required to tackle major technical challenges. Consequently, there has been a deceleration in the translation of scientific discoveries into innovative technologies that fuel economic growth and employment.

The backbone of the American innovation ecosystem is primarily provided by major corporations. Corporate laboratories play an integral role in the development of science-based technologies. Corporate researchers generate vital research that serves as the foundation for general-purpose technologies, often in conjunction with university researchers and startups. Additionally, these corporations that emphasize research and development are essential for scaling up and commercializing various applications of general-purpose technologies, making them even more valuable.

General-purpose technologies, by design, are adaptable to a broad range of products and processes. Consequently, firms that develop such technologies are incentivized to operate in various markets to realize financial returns. In the absence of such returns, companies lack the motivation to invest in the development of these technologies and the underlying scientific research.

Corporate research in the U.S. is becoming increasingly concentrated in a select few industrial sectors (such as information and communication technologies and pharmaceuticals) and backed by only a handful of large firms that possess the necessary scale and scope to make sizeable and risky investments in scientific research.

It is imperative for policymakers to acknowledge that limiting big firms from innovating new products or venturing into new markets would result in decreased investments in research, leading to further deterioration of American leadership. Essentially, the size of these companies is correlated with their investment in fundamental research and development, which encompasses general-purpose technologies. Policymakers must recognize that not all large corporations are the same - those that engage in scientific research are vital to our future as they fund and produce research that no other sector in the economy can. Therefore, it is crucial to safeguard such firms from misguided antitrust measures that could jeopardize their capacity to utilize their size to benefit society through investing in scientific research.

On the demand side, policymakers should also consider reinstating the practice of rewarding firms that demonstrate technological superiority but lack the incentives to invest in risky upstream R&D due to missing or insufficient private market demand, with guaranteed public demand through non-competitive procurement contracts for the resulting products.



This story may not be republished without permission from Duke University's Fuqua School of Business. Please contact media-relations@fuqua.duke.edu for additional information.

Contact Info

For more information contact our media relations team at media-relations@fuqua.duke.edu.