What Are the Most Effective Policies for Stimulating Technological Innovation?

By TAP Staff Blogger

Posted on September 29, 2019


Several reports are cautioning that technological innovation is slowing in the United States.


In “Innovation Is Slowing Down,” Stanford economist Nicholas Bloom shares findings from research he conducted with colleagues Charles Jones and Mike Webb, both also with Stanford, and John Van Reenen, MIT, on the growth rate of people creating ideas. Professor Bloom argues:


… ideas productivity — the productivity of science and discovery — has been falling for decades. Scientific discoveries and technical advances are getting harder to find, and spending on R&D has not been increasing fast enough to offset these declines in productivity. Innovation is slowing down.


Professor Bloom goes on to say that “The creation of ideas is central to economic growth.”


In another report, the Council on Foreign Relations (CFR) recently emphasized that while the United States had been a leader in innovation and technological development since World War II, “that leadership is now at risk.” In “Absent a New National Strategy, the U.S. Risks Losing Its Edge to China in Technology and Innovation, Warns Task Force,” the CFR shares the following findings:


Federal spending on research and development (R&D) as a percentage of the economy has declined in the United States from 1.2 percent of GDP in 1985 to 0.66 percent in 2016. China, meanwhile, is catching up, having increased its R&D expenditures by an average of 18 percent annually since 2000. Assuming current rates of growth, China will likely equal or exceed the United States in overall R&D expenditures after 2030.


The CFR-sponsored report, “Innovation and National Security: Keeping Our Edge,” argues that the United States needs to develop a “national security innovation strategy to ensure it is the predominant power in a range of emerging technologies such as AI and data science, … fifth-generation cellular networks (5G), quantum information systems, and robotics. Failure to do so will mean a future in which other countries reap the lion’s share of the benefits of technological development, rivals strengthen their militaries and threaten U.S. security interests, and new innovation centers replace the United States as the source of original ideas and inspiration for the world.”


In “A Toolkit of Policies to Promote Innovation,” Professors Nicholas Bloom, Heidi Williams (also with Stanford University), and John Van Reenen (Massachusetts Institute of Technology) outline the trending slowdown of productivity growth:


The US economy has experienced a slowdown in productivity growth since the 1970s, which — except for an upward blip between 1996 and 2004 — has been remarkably persistent. Other developed countries have also experienced this disappointing productivity trend. Moreover, slow productivity growth has been accompanied by disappointing real wage growth for most US workers, as well as rising wage inequality.


Professors Bloom, Van Reenen, and Williams emphasize that “Innovation is the only way for the most developed countries to secure sustainable long-run productivity growth. For nations farther from the technological frontier, catch-up growth is a viable option, but this cannot be the case for  leading-edge economies such as the United States, Japan, and the nations of Western Europe.”


What Are the Most Effective Policies for Stimulating Technological Innovation?


In “A Toolkit of Policies to Promote Innovation,” Professors Bloom, Van Reenen, and Williams provide policymakers with a number of the main innovation policy levers: tax policies to favor research and development, government research grants, policies aimed at increasing the supply of human capital focused on innovation, intellectual property policies, and pro-competitive policies.


Below are a few excerpts from “A Toolkit of Policies to Promote Innovation:”


We do not claim that innovation policy is the only solution to America’s productivity problem. Indeed, even within the United States, many firms are well behind the technological frontier, and helping these firms catch up — for example, by improving management practices — would likely have very high value. Nonetheless, we believe that sensible innovation policy design is a key part of the solution for revitalizing leading economies and will lead to large, long-run increases in welfare.


Tax Incentives for Research and Development


The OECD (2018) reports that 33 of the 42 countries it examined provide some material level of tax generosity toward research and development. The US federal R&D tax credit is in the bottom one-third of OECD nations in terms of generosity, reducing the cost of US R&D spending by about 5 percent. This is mainly because the US tax credit is based on the incremental increase in a firm’s R&D over a historically defined base level, rather than being a subsidy based on the total amount of R&D spending. In countries with the most generous provisions, such as France, Portugal, and Chile, the corresponding tax incentives reduce the cost of R&D by more than 30 percent.


Do research and development tax credits actually work to raise R&D spending? The answer seems to be “yes.”


Government Research Grants


A variety of government programs seek to encourage innovation by providing grant funding, either to academic researchers — such as through the US National Institutes of Health (NIH) — or to private firms, such as through the Small Business Innovation Research (SBIR) program.


Looking beyond academic output, public research and development grants may affect private firms in several ways. First, public R&D grants to academics can generate spillovers to private firms. Azoulay, Graff Zivin, et al. (2019) exploit  quasi-experimental variation in funding from the National Institutes of Health across research areas to show that a $10 million increase in NIH funding to academics leads to 2.7 additional patents filed by private firms.


A substantial share of public R&D subsidies goes to universities, which makes sense from a policy perspective, as spillovers from basic academic research are likely to be much larger than those from  near-market applied research. There certainly appears to be a correlation between areas with strong science-based universities and private sector innovation.


Human Capital Supply


Many policy tools are available that can increase the supply of scientific human capital. In terms of frontier innovation, perhaps the most direct policy is to increase the quantity and quality of inventors. There have been many attempts to increase the number of individuals with training in science, technology, engineering, and mathematics (commonly known as STEM).


Overall, most of the available evidence suggests that increasing the supply of human capital through expanded university programs and/or relaxed immigration rules is likely to be an effective innovation policy.


Product Market Competition and International Trade


In our view, the policy prescription from this literature seems reasonably clear: greater competition and trade openness typically increase innovation. The financial costs of these policies are relatively low, given that there are additional positive impacts associated with policies that lower prices and increase choice. The downside is that such globalization shocks may increase inequality among people and places.


Targeting Small Firms


To the extent that financial frictions are impactful, removing constraints on the development of an active  early-stage finance market (like angel finance or venture capital) might be a reasonable policy focus. In addition, focusing on subsidized loans for young firms, rather than general tax breaks or grants, may be more desirable.




In the short run, research and development tax credits and direct public funding seem the most effective, whereas increasing the supply of human capital (for example, through expanding university admissions in the areas of science, technology, engineering, and mathematics) is more effective in the long run. Encouraging skilled immigration has big effects even in the short run. Competition and open trade policies probably have benefits that are more modest for innovation, but they are cheap in financial terms and so also score highly. One difference is that R&D subsidies and open trade policies are likely to increase inequality, partly by increasing the demand for highly skilled labor and partly, in the case of trade, because some communities will endure the pain of trade adjustment and job loss. In contrast, increasing the supply of highly skilled labor is likely to reduce inequality by easing competition for scarce human capital.


Read the full article: “A Toolkit of Policies to Promote Innovation” by Nicholas Bloom, John Van Reenen, and Heidi Williams (Journal of Economic Perspectives—Volume 33, Number 3—Summer 2019—Pages 163–184)