R&D in Knowledge-Intensive Economies

Knowledge-intensive economies draw on a broad range of knowledge, goods, skills, and activities, including the funding and performance of R&D. The level of R&D relative to other expenditures provides an indication of the priority given to advancing S&T relative to other public and private goals.

A growing emphasis on R&D is a measure of the development of a knowledge-intensive economy. In government accounts, R&D must compete for funding with other programs supported by discretionary spending, from education to national defense. The budget share devoted to R&D thus indicates governmental and societal investment in R&D relative to other activities. Similarly, the amount for-profit companies spend on R&D relative to other investments indicates how important they consider technological improvements to be as a basis for developing markets and exploiting demand for better processes, goods, and services.

R&D enables but does not guarantee invention, and invention does not automatically lead to innovation, the introduction of new goods, services, or business processes in the marketplace. Differences in national systems of innovation may make one country more effective than another in translating R&D investments into economic growth or other social benefits. In the end, it is the results of R&D expenditures that matter, not their amount.

Internationally, R&D is concentrated but becoming less so.

Over the past two decades, R&D has principally been performed and funded in North America, Europe, and Asia by the 30 developed member nations of the Organisation for Economic Co-operation and Development (OECD) (figure O-19figure.).[5] The United States and Japan provided close to 60% of the estimated $772 billion OECD total in 2005, little changed from 61% of the $480 billion OECD total in 1995.

But this picture is changing (table O-2 table.). For nearly a decade, R&D expenditures are estimated to have risen rapidly in selected Asian and Latin American economies and elsewhere. The average annual R&D growth rate of nine non-OECD economies (Argentina, China, Israel, Romania, Russian Federation, Singapore, Slovenia, South Africa, and Taiwan; there are no data for India) tracked by the OECD was about 15.5% from 1995 to 2005, compared with an OECD average of 5.8%. Over the decade, the OECD share of the combined total dropped from an estimated 92% to 82%. Likewise, the combined share of the United States and Japan, the two largest R&D-performing countries, declined from 56% of the total in 1995 to 48% in 2005.

China's expansion of R&D was by far the most rapid and sustained of all (figure O-20figure.). According to OECD figures, it had the fourth largest expenditures on R&D in 2000 ($45 billion), which increased in 2005 to an estimated $115 billion, further moving it up in rank. Given the lack of R&D-specific exchange rates, it is difficult to draw conclusions about China's absolute R&D volume, but its nearly decade-long, steep ramp-up of R&D expenditures and R&D intensity is unprecedented in the recent past. Other less-developed countries that appear set to become sizable R&D performers include Brazil ($14 billion in 2004) and India ($21 billion in 2000).

Industry R&D in manufacturing and services is expanding and increasingly crossing borders.

In most OECD countries, the manufacturing and services sectors account for more than 60% of total R&D funding and performance. However, sector concentration and sources of funding vary substantially among these countries.

Industrial R&D in the United States is highly diversified. No single U.S. industry accounted for more than 16% of total business R&D (table O-3 table. and figure O-21figure.). The diversity of R&D investment by industry in the United States is also an indicator of how the nation's accumulated stock of knowledge and well-developed S&T infrastructure have made it a popular location for R&D performance in a broad range of industries.

Most other countries display higher sector concentrations than the United States. In countries with less business R&D, high sector concentrations can result from the activities of one or two large companies. This pattern is notable in Finland, where the radio, television, and communications equipment industry accounted for almost half of business R&D in 2004. Other industries also exhibit relatively high concentrations of R&D by country. Automotive manufacturers rank among the largest R&D-performing companies in the world. Because of this, the countries that are home to the world's major automakers also boast the highest concentration of R&D in the motor vehicles industry. This industry accounts for 32% of Germany's business R&D, 26% of the Czech Republic's, and 19% of Sweden's

The pharmaceuticals industry accounts for 20% or more of business R&D in Denmark, the United Kingdom, Belgium, and Sweden. Among OECD countries, only the Netherlands and Japan report double-digit concentration of business R&D in the office, accounting, and computing machine industry.

One of the more significant trends in both U.S. and international industrial R&D activity has been the growth of R&D in the service sector. ICT services account for a substantial share of the service R&D totals.

In most OECD countries, government financing accounted for a small and declining share of total industrial R&D performance during the 1980s and 1990s (figure O-22figure.). In 1981, government provided 21% of the funds used by industry in conducting R&D within OECD countries. By 2001, government's funding share of industrial R&D had fallen below 7% and continued to fluctuate between 6.8% and 7% through 2005. Among major industrial countries, government financing of industrial R&D performance shares ranged from as little as 1.2% in Japan to 54% in Russia in 2005. In the United States in 2006, the federal government provided about 9% of the R&D funds used by industry, and the majority of that funding came from Department of Defense contracts.

An indicator of the globalization of industrial R&D, the relative prominence of foreign sources of funding for business R&D, increased in many countries in the 1990s (figure O-23figure.). The role of foreign funding varies by country, accounting for less than 1% of industrial R&D in Japan to as much as 23% in the United Kingdom in 2004. Directly comparable data on foreign funding sources of U.S. R&D performance are unavailable, but data on U.S. investments by foreign multinational corporations (MNCs) suggest this is rising as well. (See section on multinationals' R&D conducted abroad later in this overview.) This funding predominantly comes from foreign corporations; however, some of it also comes from foreign governments and other foreign organizations. For European countries, growth in foreign sources of industry R&D funds may reflect the expansion of coordinated EU efforts to foster cooperative shared-cost research through its European Framework Programmes for Research and Technological Development.

R&D/GDP ratio is an elusive policy goal but a useful indicator of R&D intensity.

A country's ratio of R&D to GDP depends on many things, among them the extent and structure of industrialization, orientation toward R&D in various sectors of the economy, availability of trained personnel, the nature of R&D infrastructure, and government policy. This makes meeting any specific R&D/GDP ratio an elusive policy goal. However, R&D/GDP ratios do provide a quick view of the R&D intensity of an economy relative to support of other public and private goals. Thus, emphasis on R&D can be seen as a measure of a knowledge-intensive economy.

Existing wealth generally bestows an advantage in moving toward a knowledge-intensive economy. R&D intensity indicators, such as R&D/GDP ratios, show that the developed, wealthy economies are well ahead of lesser developed economies. In many cases, this ratio heavily reflects the level of industry-funded R&D. Although industrial R&D does not generally respond directly to government policies, it thrives where favorable framework conditions exist, and these are subject to government influence.

Overall, the United States ranked seventh among OECD countries in terms of reported R&D/GDP ratios (2.6% in 2005). Israel (not an OECD country), devoting 4.7% of its GDP to R&D, led all countries, followed by Sweden (3.9%), Finland (3.5%), and Japan (3.2%) (table O-4 table.).

Most non-European, non-OECD, or developing countries invest a smaller share of their economic output in R&D than do OECD members. Despite its rapidly rising investment in R&D, China reported an R&D/GDP ratio of just 1.3% for 2005—but relative to a GDP marked by sustained, record growth. All Latin American countries for which such data exist have R&D/GDP ratios at or below 1%. The pattern of this indicator broadly reflects the wealth and level of economic development of these countries.

High-income countries that emphasize the production of high-technology goods and services (i.e., have or are moving toward knowledge-intensive economies) are also those that tend to invest heavily in R&D activities. The private sector in low-income countries often has few high-technology industries, resulting in low overall R&D spending and therefore low R&D/GDP ratios (figure O-24figure.).

Countries have different investment levels for national defense and associated R&D. The ratio of nondefense R&D to GDP reflects the portion of R&D that is more directly tied to scientific progress, economic competitiveness, and standard-of-living improvements. On this indicator, the United States falls below Germany and just above Canada (figure O-25figure.). This is because the United States devotes more of its R&D than any other country to defense (16% in 2006), primarily for development rather than research. For historical reasons, Germany and Japan spent less than 1% of their R&D on defense. Approximately 10% of the United Kingdom's total R&D was defense related in 2004.

Basic research plays a special role in developing new technologies.

Basic research generally has low short-term returns but builds intellectual capital and lays the groundwork for future advances in S&T.[6] High basic research/GDP ratios generally reflect the presence of robust academic research centers in the country or a concentration of high-technology industries with patterns of strong investment in basic research.

Investment in basic research relative to GDP indicates differences in national priorities, traditions, and incentive structures with respect to S&T. Among OECD countries with available data, Switzerland has the highest basic research/GDP ratio at 0.8% (figure O-26figure.), significantly above the U.S. and Japanese ratios of 0.5% and 0.4%.

Switzerland devoted almost 30% of its R&D to basic research in 2004 (figure O-27figure.). This small, high-income country boasts the highest number of Nobel prize winners, patents, and science citations per capita worldwide and an industrial R&D share comparable with the United States and Japan. The higher Swiss basic research share reflects the concentration of chemical and pharmaceutical R&D in Swiss industrial R&D and the "niche strategy" of focusing on specialty products adopted by many Swiss high-technology industries.

China, despite its growing R&D investment, has one of the lowest basic research/GDP ratios (0.07%), below Romania (0.08%) and Mexico (0.11%). With its emphasis on applied R&D aimed at short-term economic development, China follows the pattern of Taiwan, South Korea, and Japan whose basic research is 15% or less of total R&D (figure O-27figure.). Singapore's basic research share, 12% in 2000, has risen to 19%, on a par with that of the United States.

Multinationals' R&D outside their home countries is growing in the United States and elsewhere.

Industrial R&D activities ceased long ago to be national in scope. Their increasingly international scope in the search for useful innovations is reflected in growing direct R&D investments by foreign-based MNCs in the United States and by U.S.-based firms abroad. Much of this work is supported by firms' foreign direct investment (FDI) to majority-owned affiliates abroad, reflected in the data shown in figure O-28figure..

Since 1990, R&D expenditures by U.S. affiliates of foreign companies have increased faster than total U.S. industrial R&D, and for the past decade they have exceeded R&D performed overseas by majority-owned affiliates of U.S. parent companies (table O-5 table.). U.S. affiliates of European companies accounted for three-fourths ($22.6 of $29.9 billion) of U.S. affiliates' R&D.

Overseas R&D by U.S. MNCs has started shifting away from Europe, Canada, and Japan, which received 90% of all such funds in 1994 but only 80% in 2001. Increasingly, such R&D FDI is located in emerging Asian markets. This has led to considerable shifts in the region (figure O-29figure.), where Japan's share remains the largest but has fallen from 64% in 1994 to 35% in 2004. In contrast, the Asian R&D shares of U.S. foreign affiliates located in China (including Hong Kong) and Singapore reached 17% and 14%, respectively, in 2004. U.S. affiliates' R&D expenditures in India doubled from $81 million in 2003 to $163 million in 2004, pushing India's Asia share just above 3%.

In 2004, three manufacturing industries accounted for 70% of U.S. foreign-affiliate R&D: transportation equipment (28%), chemicals including pharmaceuticals (23%), and computer and electronic products (19%) (table O-6 table.). Among nonmanufacturing industries, professional, technical, and scientific services (which includes R&D and computer services) expended an additional 8%. The same three manufacturing industries accounted for 58% of the R&D performed by foreign affiliates in the United States: chemicals (34%), transportation equipment (13%), and computer and electronic products (11%).

R&D in the United States is robust and dominated by industry.

R&D growth in the United States was robust after the recession-related slowdown of 2001–02. After declining in 2002 for the first time since 1953 to $277 billion, U.S. R&D surpassed $300 billion in 2004 and is projected to increase to $340 billion in 2006.

The industrial sector, including manufacturing and services, accounts for the largest share of both U.S. R&D performance and funding (figure O-30figure.). Its share of U.S. R&D performance increased from 66% in the early 1970s to a high of 75% in 2000. Following the 2001–02 recession, many firms curtailed R&D growth, and industry's share fell to 69% of the U.S. total before rising again to 71% in 2006. Industry funding shares behaved similarly, rising from about 40% in the early 1970s to a 2000 peak at 70%, dipping to 64% in 2004 and reaching 66% in 2006.

Four manufacturing and two services industries account for more than three-fourths of all industrial R&D: computer and electronics products, chemicals, aerospace and defense manufacturing, automotive manufacturing, computer-related services, and R&D services. Their aggregate R&D intensity (R&D/net sales) was 7.7% in 2005; the comparable figure for all other industries was 1.3% (table O-7 table.). In the manufacturing segment, nine automotive companies reported R&D expenditures of more than $100 million in 2004, representing more than 80% of this industry's R&D.

The federal government had for nearly three decades supplied half or more of the nation's total R&D funds, but in 1979 its share fell below 50%. It continued to drop to a low of 25% in 2000 but is projected to reach 28% in 2006 (figure O-31figure.). This recent recovery mainly reflects increased health-related research spending and, more recently, rising development spending related to defense and counterterrorism. The federal government's performance share, about 20% of U.S. R&D in the early 1970s, has been declining and was 11% in 2006.

Defense-related R&D has accounted for at least half of the federal R&D funding portfolio for the past three decades. It increased from 50% of the federal R&D budget in 1980 to almost 70% in the mid 1980s, declined to 53% in 2001, and increased steadily to a projected 60% in 2008. Nondefense R&D is dominated by health support (52% of the proposed FY 2008 nondefense R&D budget) (figure O-32figure.). Health R&D has accounted for the single largest share of federal nondefense R&D since at least 1980, when its share was 25%.

U.S. R&D performance is dominated by the development function (figure O-33figure.), which has fluctuated between 58% and 65% since 1970. Development of new and improved goods, services, and processes is dominated by industry, which funded 83% and performed 90% of all U.S. development in 2006. The federal government funded most of the remaining development performed in the United States, mostly in defense-related activities.

Basic research provides the essential underpinning for a vibrant and flexible S&T system. In the United States, well over half (58%) of all basic research is conducted at universities and colleges. Two-thirds of the funding is supplied by the federal government, but the academic institutions themselves provided 17% in 2007, the second-largest share. An additional 5% to 6% each is provided by industry and state and local governments. A key product of academic basic research, in addition to new knowledge, is the production of young researchers through the strong ties of graduate training and research.


[5] Data in the overview are more current than those available in chapter 4.

[6] Distinctions between basic and applied research often involve a greater element of subjective assessment than other R&D indicators, and about 40% of the OECD countries do not report these data at the national level. Nonetheless, where these data exist, they help differentiate national innovation systems in terms of how their R&D resources contribute to advancing scientific knowledge and developing new technologies.

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