More than just a multiplier: quantifying the macroeconomic impact of government innovation policy
New report from the UCL Institute for Innovation and Public Purpose (IIPP)finds that mission-oriented innovation policy has much greater economic impact than capital investment spending
It’s widely accepted that not all government spending is equal in its economic effects. Capital investment — e.g. building roads or housing — is often considered to generate higher economic returns over a longer time period than public consumption spending (e.g. on education and health), for example. By increasing such spending during economic downturns, well-managed fiscal policy can smooth out the ‘business cycle’ that characterises capitalist economies. Many economists called for more infrastructure spending as a means to boost advanced economies in the aftermath of the financial crisis of 2007–08.
But what if government spending was directed in such a way to not only boost the economy in the bad times but also steer growth more generally, creating and shaping new markets where investment is most needed? This is the ‘mission-oriented’ innovation policy that IIPP has been advocating since the Institute was set up in 2017. Recent outputs include the final report of the UCL Commission on Mission Oriented Industrial and Innovation Strategy (MOIIS)– focusing on the UK’s industrial strategy — and the launch of a new report on Governing Missions in the European Union earlier this month.
Measuring the impact of innovation policy — such as spending on R&D — is challenging. As we’ve shown in previous work, typical approaches such as cost-benefit analysis are too static and narrow to capture the potentially economy-wide and long-term effects of innovations that can affect the demand side as well as the supply side of the economy, including through dynamic spill-over effects on multiple sectors. In a previous working paper we developed a theoretical economic model of a ‘supermultiplier’ to capture these effects.
In our latest policy report,we make a first attempt to quantitatively measure innovation policy. To do so, we carry out econometric research on different types of government spending in the U.S. since 1947 (the UK lacks data going back this far). As a proxy for ‘mission-oriented’ innovation spending, we use US spending on military R&D which is widely recognised as stimulating innovations — such as the Internet and GPS — with structural economic impacts.
We use two different measures to capture the macroeconomic impact of different policies. The first is the ‘GDP multiplier’. This shows the impact — via both public and private spending– on the national economy of a £1 (or $1 in the US case) increase in the respective type of public spending. So, a multiplier of 1.5 means that every additional £1 spent by the government generates an increase of £1.50 in total national output.
Secondly, we show a ‘private sector R&D multiplier’. This shows how much private R&D spending is generated by £1 of public spending of different types. These multipliers are lower because they only capture spending on R&D in the private sector. To take an example, we find that an additional £1 of military R&D spending generates £0.51 in additional private sector R&D spending.
Table 1. Economic multiplier of different types of government spending (based on quarterly US data from 1947–2017).
As expected, public investment spending (including R&D) generates a higher multiplier than public consumption spending. But R&D spending generates a much higher GDP multiplier than investment. And mission-oriented, directed innovation spending generates the largest ‘supermultiplier’ effect, around ten times higher than standard government spending excluding R&D. Mission-oriented spending would also appear to generate the highest expectations of growth and therefore the highest private sector R&D multiplier: it ‘crowds in’ private investment, rather than crowding it out. These results confirm our previous theoretical model based on the notion of a ‘supermultiplier’.
The report provides a first systematic quantitative assessment of the effects of directed innovation spending within an industrialised developed country. Our findings suggest the impact on this type of spending may be significantly higher and with longer term effects than other forms of government spending. In addition, such policies would appear to produce permanent rather than temporary effects on the level of output and could have major economic benefits anywhere in the economic cycle and not just during recessions as counter-cyclical measures.
There are important differences between the US and British economy that mean one cannot assume these figures translate exactly to the UK case. Nevertheless, the large orders of magnitude differences in the multipliers clearly demonstrate the potentially enormous value of mission-oriented innovation policy in leveraging in spending from other sectors of the economy. They also suggest the need for further research into how to appraise and evaluate such policies more effectively. This will likely be aided by greater coordination between government departments in charge of fiscal policy and industrial policy.
You can read ‘The macroeconomic impact of government innovation policies’ report here.
This report was funded by Innovate UK, as part of UK Research and Innovation, for a research project undertaken by the IIPP and UCL Institute for Sustainable Resources.
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