Why small firms’ R&D efforts deserve more public support

Despite the fact that our three erstwhile giants—Bausch + Lomb, Eastman Kodak, and Xerox—are mere shadows of their former enviable selves, Rochester is anything but a dying city. Leslie Eaton and many others have pointed out that even though Rochester was a company town, it is now, and has been for a while, a town of tiny companies.

Many of the small firms in the Rochester area, such as SunDensity, are technology firms that conduct research and development, often a rather costly undertaking with uncertain benefits. So, given these two disincentives, if we want to see these R&D-conducting small firms thrive, then a key public policy issue that we need to ask is whether these firm conduct the right amount of R&D.

Normally, a private firm will conduct the right amount of R&D if it is able to exclusively capture all the benefits arising from this investment. On the other hand, if there are spillovers from R&D, which means that some of the benefits from R&D that a firm conducts flow to other firms, then there is a clear disincentive and a private firm will have a definite reason for not conducting the right amount of R&D. This state of affairs raises two interrelated questions. First, are there spillovers from the R&D conducted by small firms? Second, if such spillovers do exist, are they large in magnitude and hence worthy of attention from policy makers?

Interesting new research by the economists Kyle Myers and Lauren Lanahan directly addresses these two questions. These researchers analyze the U.S. Department of Energy branch of the Small Business Innovation Research program. This funding agency announces priority technologies that it would like to see developed and then awards competitive grants to the most promising small firms that apply. Examples of such technologies include light sensors and high-performance computing software. Patenting rates in the U.S. Patent and Trademark Office are the basic measure of inventive output that these researchers examine.

The specific research question studied involves estimating how SBIR grants result in new patents produced by firms that are located farther and farther away from the grant receiving firm (geographic spillover) and focused on technologies more and more different from the technologies targeted by the SBIR program (technological spillover). The analysis undertaken leads to thought-provoking results. Myers and Lanahan demonstrate that for every one patent produced by an SBIR grant recipient, one can expect three more patents to be produced by other inventors and firms throughout the United States and the rest of the world even though these additional patent producers received no funding from the SBIR.

What this significant finding means is that there are clear spillovers from the conduct of R&D. Moreover, these spillovers are large in magnitude. This existence of large spillovers suggests that the small firms that are conducting the risky R&D are not able to exclusively capture the full benefits from their R&D. This suggestion too is borne out by the research. Myers and Lanahan point out that the SBIR-funded small firms are capturing only between 25 and 50 percent of the net patent-based value that their R&D is generating.

Since these results are general, the policy implication is that without sufficient public support, small firms in Rochester and elsewhere will conduct a suboptimal amount of R&D. Perhaps this is why some states such as Massachusetts and Rhode Island provide additional funds to small firms that win SBIR awards. Unfortunately, the Empire State does not.

The Buffalo-Rochester-Syracuse region was recently named a federal “tech hub.” This is certainly a desirable designation and it could make our region eligible for large amounts of federal money. Although it is nice to be a part of America’s semiconductor superhighway, we should keep in mind the point that the semiconductor-related R&D conducted by our region’s small (and large) firms will almost certainly lead to spillovers, and potentially large spillovers. This calls for an activist course of action by the powers that be in Albany. We cannot let our region’s fate be determined solely by federal munificence.

Amitrajeet A. Batabyal is a Distinguished Professor, the Arthur J. Gosnell professor of economics, and the interim head of the Sustainability Department, all at Rochester Institute of Technology, but these views are his own. The Beacon welcomes comments and letters from readers who adhere to our comment policy including use of their full, real name. Submissions to the Letters page should be sent to [email protected].