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The Consequences of Austerity for Future Global Innovation

Jamus Lim's picture

While the world remains largely fixated on the series of unfortunate events playing out in Europe, it may be worthwhile stepping back a little from the immediate crises and thinking about the longer-term consequences of austerity plans in the developed world for the world economy. In particular, thinking about medium- and longer-run budget cutbacks in the developed world---something that even the strongest proponents of short-term Keynesian stimulus recognize---in the context of innovation (and by implication, long-run economic growth) may offer some insight on an unfolding global picture.

The first thing to establish in looking at the phenomenon is the extent to which future fiscal positions are likely to contract. In this regard, the data suggest that the impact of fiscal contraction on developed country discretionary public expenditures (which are directed to, among other things, public funding for research) will be nontrivial. Relative to average expenditures in 2003--08, outlays in the United States can be expected to go down by about 2 percent of GDP by the 2030s (see figure below, top panel), and likewise many European economies, if they hope to attain fiscal sustability, will need to shrink their budgets by about a half percentage point of GDP annually over the next ten years (see figure below, bottom panel). So the first point to take away is that austerity in the developed world is a significant possibility in the medium to long run.

Sources: World Bank staff calculations, using CBO Long-Term Budget Outlook (XLS) and EC Public Finances in EMU (PDF).
Notes: Expenditures for the United States measured as projected noninterest outlays in the extended baseline scenario. Expenditures for the European Union are measured as the projected cumulative budget cuts till 2020 for each respective economy required to attain a 60 percent debt/GDP ratio by 2030. Data for Portugal were not available for the baseline, and consequently the COM forecast was used.

Now, this would not matter as much for global innovation if the developing world (most of which is not expected to experience sharp fiscal contractions in the longer run) makes up for this decline in research output from the developed world by sharply increasing their research output, either through higher productivity or, by dint of their larger populations, a larger absolute number of innovations.

Unfortunately, insofar as research quantity is concerned, the developing world is unlikely to pick up the slack. The number of researchers and technicians involved in research and development activities in high income countries is more than two times that in developing countries (3.6 to 1.7 million, respectively). As for productivity, after adjusting for variable research productivity, the picture is even worse: considering just the Euro-Periphery economies, the United Kingdom, and the United States, versus the emerging BRIICK (Brazil, Russia, India, Indonesia, China, and South Korea) economies, productivity-adjusted research output in the latter group is about a a third that of the former (see figure below, upper panel). And this picture is unlikely to change anytime soon: R&D expenditures, while rapidly rising in the developing world, remain a small fraction of GDP (and smaller GDPs, for that matter) (see figure below, lower panel). So the second point to take away is that it is unlikely that developing countries will be scaling up their innovations to an extent that successfully offsets the anticipated reduction in developed-world research activity.

Source: World Bank staff calculations, using World Development Indicators.
Notes: Productivity-adjusted research output calculated as total number of scientific and technical journal articles as a share of total number of researchers and technicians in R&D. The Euro-Periphery economies are Portugal, Ireland, Italy, Greece, and Spain, and BRIICK economies are Brazil, Russia, India, Indonesia, China, and South Korea.

Taken together, the bottom line is that that world is likely to be worse off, innovation-wise, in the years ahead. To the extent that innovation is the ultimate engine for economic growth, then, we might expect to see modestly slower global growth---led by relative slowdowns in the developed countries---unfold over the next 10 or 15 years.

Some caveats: Even though the focus here is on public sector expenditure on research, this is not to suggest that the public sector is responsible for most, or even much, of the innovation we observe today. Yet the public sector did play/are playing a collaborative, as well as catalytic, role in the creation of, among other things, nuclear energy, the sequencing of the human genome, the early Internet (Al Gore notwithstanding), and, of course, space technology. And even without a direct innovative function, government funding is often central for many private sector research endeavors. Indeed, an entire literature has emerged that explores the case for (or against) public subsidies, insofar as it may help overcome the free rider problem and stimulate research activity (or crowd out private R&D).

Furthermore, the data that we show are available forecasts for public expenditures, rather than expenditures specifically earmarked for funding research. Nevertheless, to the extent that any declines in public sector expenditures will proportionately reduce research funding,[*] then the main message would continue to carry through.

Note as well that the research productivity adjustment only corrects for quantity differences between economies, not quality differences; so the interpretation of the productivity-adjusted research output chart should keep this source of potential bias in mind. However, correcting for quality will likely lower the research output of developing countries even further; after all, the majority of top universities and researchers reside in the high-income countries.

Finally, this is premised on the assumption that the decline in fiscal expenditures in the developed world is pretty much baked into the cake (at least within the time horizon considered). It may yet be the case that the developed world more than overcomes the economic malaise that it currently finds itself in, and rapidly returns to trend rates of growth. This could help resolve (in a positive fashion) the discouraging fiscal outcomes described here. While there may be convincing reasons why this would not be the case, one should not dismiss the optimistic outcome wholesale.

*. The likelihood of which is reasonably high; if anything, politicians may regard cuts in research funding to be relatively easier than cuts to well-established social welfare programs, which tend to have more politically-mobilized (and energized) beneficiaries.

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