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CHAPTER 2 THE ROLE OF R&D AND THE CHANGING R&D PARADIGM ...technical progress is by far the most important source of economic growth of the Michael Boskin and Lawrence Lau, Technology and the To assess the likely adequacy of Federal energy-R&D programs in meeting the nation's long-term energy needs, it is necessary to understand both the nature of the research activities that promote the public good and the present status of the national energy R&D enterprise. This chapter is divided into three major sections. The first section outlines the rationales for Federal involvement in energy R&D. The second section presents a picture of government and industrial support of energy R&D, beginning with a discussion of the trends in overall government and industrial expenditures for R&D and the allocation of the government R&D budgets among various categories. Following an overview of the budgets of the Department of Energy (DOE), its energy-technology R&D programs are described, along with a brief history of their evolution. The current state of, and the trends in, various private-sector energy R&D efforts are then outlined. The third section discusses the various forces and factors mainly responsible for the recent trends observed in public and private sector funding of energy R&D. The chapter concludes by highlighting the possible consequences of these observations on the rationales for government involvement in promoting the development of energy technologies suitable for meeting potential challenges to the national energy system. RATIONALES FOR R&D ACTIVITIES Technological progress plays a central role in the modern economy: It is an important contributor to economic growth and a crucial factor in determining the competitiveness of firms in the marketplace, nationally and internationally. R&D is widely recognized to be the linchpin of technological advance, and levels and rates of growth of R&D expenditures are viewed as reliable indicators of innovative capacity. Organization for Economic Cooperation and Development 'Cited in SEAB (1995). Michael Boskin was Chairman of the Council of Economic Advisors under President Bush. (OECD) countries spend significant amounts on R&D activities. Annual public and private R&D investments within the OECD have, on an average, exceeded 2 percent of GDP during the last two decades. These activities are funded and performed by many organizations, including firms, universities, and government laboratories. Although the roles of various institutions involved in the national R&D enterprise vary from country to country, the main funder and performer of R&D in industrial economies is generally the private sector. More than one-half of all OECD R&D expenditure is financed by companies, and they perform two-thirds of all R&D activities.' Traditionally, firms have supported R&D because the technical advances made possible by innovation allow them to improve productivity, succeed in competitive markets, and meet environmental and regulatory requirements. R&D has also contributed to the development of new products and, in many cases, the creation of new markets. Although businesses have traditionally developed research capabilities in house, they have also established collaborative links with other organizations, such as universities, and acquired the results of innovation from other enterprises through licensing or takeovers. Within firms, decisions about the magnitude and nature of R&D performance are mainly guided by consideration of economic returns (though other returns such as the public relations benefits of high-profile research breakthroughs are also deemed important). As noted in Chapter 1, a number of economic studies have shown that rates of return of R&D to firms, although difficult to measure precisely, are high and that returns to society, from lower cost, improved, or new products and services, are even higher. Of course, firms will usually engage in R&D only when the results are appropriable and offer rates of return exceeding those of other available investment options (such as acquisition of new machinery, advertising, or speculative asset purchases). There are, however, many R&D activities that do not offer enough of an incentive for the private sector, but whose results can yield significant benefit to the nation as a whole. In these cases, there are often good reasons for government to step in and support R&D efforts. Rationales for government participation in R&D in general—and in energy R&D in particular-include the following: Some kinds of innovations that would lower costs for all consumers, and hence are in society's interest, are not pursued by individual firms because the resulting gains are judged unlikely to be appropriable. Therefore, the firm that does the R&D may obtain little advantage over competitors who can utilize the results nearly as fast as the first firm, but without paying for them. This "free rider" problem can be, and is, overcome to some extent by creating research consortia, such as the Gas Research Institute (GRI) and the Electric Power Research Institute (EPRI), which are discussed below. But, even in consortia, industry tends to eschew basic research, and even much applied research, in favor of shorter term product development. Some kinds of innovations are not pursued by the private sector because they relate to production or preservation of public goods-national security, for example-that are not reflected in the profit-and-loss statements of firms. Still other kinds of innovations are not pursued by companies because they relate to reduction of environmental and other externalities. There is little incentive for firms to invest in such innovations unless regulations, emission charges, or other policy instruments internalize these externalities into the private sector's economic calculus. • Research that is costly and has a high chance of failure may exceed the risk threshold of the private sector, even though, from a societal point of view, having a certain number of such projects in the national R&D portfolio is worthwhile because occasional successes can bring very high gains. Further, research that will take a long time to complete is likely to fall short of the private sector's requirement for a rate of return attractive to investors, even if confidence of success is high. Fusion energy R&D provides an example where the chance of failure is substantial and the time scale would probably be too long for the private sector even if success were assured, but where the potential benefits of the technology are so large and the prospects of other very long-term energy options are so uncertain that government investment is clearly in society's interest. In view of the complementary nature of the rationales for R&D investments in the public and the private sectors, an understanding of activities in both of these sectors is needed to assess the appropriateness and effectiveness of the government's energy R&D portfolio. A PICTURE OF ENERGY R&D This section presents a picture of the energy R&D activities currently funded by DOE, other Federal agencies, state governments, industry, and other countries. It shows a general decline in both public and private support for energy R&D, which, although explainable and perhaps in some respects reasonable, highlights the possibility that some important opportunities relating to the energy challenges ahead are not being addressed. The R&D Context In 1995 (the latest year for which accurate data are available), total U.S. investment in R&D was $171 billion, equivalent to 2.4 percent of that year's GDP; 1995 is the third successive year in which both industrial and Federal research funding declined in real terms. Figure 2.1: Total U.S. R&D expenditure by source of funds, 1970 to 1995. *NSB (1996). |