Is R&D Exuberance Rational?

Do I and Mark Thoma need to purchase Rational Exuberance to understand what Michael Mandel is trying to say? Perhaps this will give us some clue.

Mandel’s first post drew my fire as he seemed to be suggesting economists like Paul Krugman and Mark Thoma did not realize the importance of intellectual capital – defined as education and R&D to promote technological improvements.

His next two posts indicate Mandel is frustrated that the Clinton years had Federal nondefense R&D spending fall as a share of GDP. I was a little surprised at this complaint for several reasons. The following graph shows public education spending as a share of GDP indicating that it rose during the Clinton years. But Mandel’s focus is on R&D so the next graph shows total R&D as a share of GDP and nondefense R&D including civilian R&D. Federal nondefense R&D was only 11% of total R&D in 1992 and only 9.1% of total R&D in 2000, while civilian R&D was 63.2% of total R&D in 1992 and 75% of total R&D in 2000. Why does Mandel focus on the former and not the latter?

Before we address this question, let’s address this comment:

The other problem is that economists, who you might think would love the idea of fast growth, are not very comfortable with technology. It’s a real blind spot in the profession. Economists are more comfortable talking about thing like tax rates, budget deficits, or monetary policy. They’re much less comfortable talking about technology. They tend to ignore it or dismiss it, which is especially funny because very good economic research shows that over the long run, technology is the major driving force behind economic growth … In the book I discuss the relationship between growth, technology, financial markets, and politics. What I point out is that politicians do a lot of wrangling over budget deficits, but they pay far too little attention to technology.

Mandel seems to be suggesting that some economists are posing a false trade-off. Reducing budget deficits does not necessarily mean less investment in R&D. While the preference of the Clinton Administration was to raise taxes to reduce private consumption, the preference of fiscally responsible Republicans such as Phil Graham was to lower government consumption. But Mandel seems to suggest other economists view a world where total (private and public) consumption is fixed, which implies a fixed amount of savings to be allocated to investments in physical capital versus intellectual capital.

Economists are guilty, however, of wanting to weigh the prospective benefits of R&D against their costs. Free market economists might argue that the private sector properly weighs these two, but we should note that the social benefits of R&D often exceed private benefits. For this reason, a good case of policy interventions to encourage if not publicly fund R&D can be made. On this score, I agree with Mandel. But here is the key question – how does the allocation of public funds weigh the opportunity cost of publicly funded R&D against the prospective benefits. A classic example is Star Wars where liberals often emphasize the costs and conservatives often discuss the possible benefits of a missile defense shield. If one believes that the probability of success of Star Wars is very low, then the costs likely exceed the expected benefits. But given the propensity of the Bush Administration to pretend we can cut taxes even as we increased defense spending, do our policymakers even recognize there is an opportunity cost?