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. 2 OECD (1997). 3 OECD (1997). 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. 4 Figure 2.1: Total U.S. R&D expenditure by source of funds, 1970 to 1995. NSB (1996). As Figure 2.1 shows, the proportion of total R&D funded by industry has grown steadily over the last three decades: In 1970, the government supplied 57 percent of all dollars spent on R&D in the United States; in 1980, industry spent more than Federal agencies for the first time; and by 1995, the private sector supplied more than $3 of every $5 spent on R&D. Yet, even though it accounts for a greater proportion of the total, industrial R&D has recently been both scaled back and restructured with a view to providing short-term benefits. (This "changing paradigm" of private sector R&D is discussed at length below.) At the same time, with shifting attitudes toward the role of government in society and increased demands on discretionary spending, Federal support for R&D has come under pressure, decreasing at an average constant-dollar rate of more than 2.6 percent every year since 1987. Furthermore, as shown in Figure 2.2, the Federal government's funding priorities for civilian R&D have changed over time: During the last 15 years, expenditures on health and space programs have shown generally steady gains, even as energy-related funding has declined. Federal Energy R&D Figure 2.2 illustrates that energy-related research has been a significant component of Federal nondefense R&D expenditures during the last four decades. Before the first energy crisis (1974), most of the government's energy R&D expenditures supported the development of nuclear energy; the Department of the Interior (DOI) also funded some research on fossil fuels-as production largely occurred on Federal lands-but there were no formal programs in energy efficiency or renewables (see Figure 2.7). Figure 2.2: Trends in Federalnondefense R&D by budget function, 1960 to 1997. DOE was formed in 1977 in response to the perceived need to diversify energy-supply sources in the wake of the oil-price shocks of the 1970s. Although it became the leading agency responsible for Federal energy R&D, other agencies have also made, and continue to make, significant scientific and technical contributions in this area. Indeed, the importance of energy to national security, economic well-being, and environmental sustainability makes the Environmental Protection Agency (EPA), National Aeronautics and Space Administration (NASA), National Science Foundation (NSF), Department of Defense (DOD), Department of Transportation (DOT), Department of Commerce (DOC), and DOI all logical partners of DOE in sustaining U.S. leadership in energy sciences, services, and technologies. Agencies often work together on energy-related issues, a prominent example being the U.S. Global Change Research Program, the government's response to the problem of climate change, which is described in Box 2.1. Other examples include the joint efforts of DOD and NASA, which have been instrumental in the development of fuel cells; DOD's research into turbines, which has contributed a great deal to the substantial rise in the efficiencies of gas turbine and combined-cycle power plants over the last decade; and the work of several agencies, which made possible the three-dimensional seismic and directional drilling advances that have revolutionized oil exploration and production. Additionally, the indirect actions of many Federal agencies contribute significantly to improving energy efficiency throughout U.S. homes, industry, and transportation systems, as well as to the development of intellectual and innovation resources. The Role of DOE Considered by agency, DOE is the fourth largest performer of Federal R&D (after DOD, the Department of Health and Human Services, and NASA). Yet, as described below, only a small share of the DOE's budget actually relates to energy R&D, and an even smaller share to energy-technology R&D, defined here as R&D focused on specific technologies for exploiting fossil fuels, nuclear fission, nuclear fusion, renewable energy, and improvements in energy end-use efficiency (conservation). Budget Overview DOE's FY 1997 total appropriation of $16.2 billion is shown, broken down by business line, in Figure 2.3. Most of the appropriation is spent on activities relating to the U.S. nuclear weapons complex: "National Security" comprises maintenance and security of the weapons stockpile, efforts to prevent nuclear proliferation, and R&D supporting the U.S. Navy's nuclear propulsion plants; and "Environmental Quality" supports the cleanup of former nuclear-weapons production sites and the disposal of civilian and military spent fuel and high-level nuclear waste. Figure 2.3: DOE FY 1997 appropriation by business line. Total appropriation is $16.2 billion. Source: DOE (1997a). 'This definition excludes the research supported through programs such as Basic Energy Sciences and Environmental and Biological Research, which are discussed separately. |