Federal Reserve Papers Focus on TBED

Four recently published papers from the Federal Reserve Banks of Philadelphia, San Francisco and Chicago center around TBED issues including the role of cities in the 21st Century, the biotechnology industry in the Midwest, state R&D tax credits, and R&D spending during recessions. Links to these papers and more than 1,000 additional TBED-related research reports, strategic plans and other papers can be found at the Tech-based Economic Development (TBED) Resource Center, jointly developed by the Technology Administration and SSTI, at http://www.tbedresourcecenter.org/.

21st Century Cities Have Transformed into Centers for Consumption

Senior economic advisor and economist from the Federal Reserve Bank of Philadelphia, Jerry Carlino, discusses some of the economic functions of cities, focusing on economic activities that make firms in cities more productive and more attractive to urban households. In The Economic Role of Cities in the 21st Century, Carlino says agglomeration economies are increasingly concentrated on the consumption side and quality of life issues have become a more important determinant of where people choose to live. Large cities with more choices will inevitably attract high-income households, who tend to be high-skilled workers as well. Their presence, Carlino says, supports the cities' new function as incubators of new ideas and innovation.

The rise in real income also has led to more demand for goods and services, according to the paper. The author points to a 2004 study by Sanghoon Lee, which contends that the demand for variety may increase more than proportionately with income. For example, a 1 percent increase in income leads to more than a 1 percent increase in the demand for variety. The study suggests that since high-skill workers earn more than low-skill workers, they will account for a larger share of the workforce in large cities and a smaller share in small cities and rural areas.

Research indicates that local policymakers need to focus on lifestyle issues because they are important in attracting and retaining highly-skilled workers who want more consumption options. Public policy can play a significant role in this goal, according to the paper, by providing good public schools, focusing on reducing urban crime, and providing amenities such as clean streets and public parks.

Midwest Can Become Thriving Biotechnology Hub

The Midwest is home to a number of large drug and medical manufacturers, although none of the nation's most prominent biotech companies are based there, says a new paper from the Federal Reserve Bank of Chicago, High-technology in the Midwest - Biotech and Beyond. The paper reports the findings from a series of meetings designed to analyze the potential in the Midwest for building a biotech region and advancing technology commercialization.

Cities such as San Francisco, Seattle, Boston, and Austin already have industry sectors centered on emerging technologies that have contributed significantly to the local economy, according to the paper. In the field of biomedical science, Chicago's degree of new firm formation seems undersized given the significant R&D dollars flowing to the area universities, hospitals, and federal labs. The author poses the question, "If this spending implies significant potential for technology-driven growth in an area, then what efforts from the public and private sectors might help bring about full development?" Building clusters is offered as one possible suggestion, as well as the presence of key business service activities including a venture capital community and specialized legal firms.

In terms of technology commercialization, the issue of Midwest states' performance is examined as well. One necessary condition for a thriving biotech industry is a large local research base, something the Midwest already has. Therefore, why are the states not performing better? According to Dan Broderick, principal of a Milwaukee-based venture capital firm, research activity in the Midwest may be too geographically dispersed to easily generate the interactions among firms and with potential investors that ultimately lead to clusters. Broderick argues that Midwest states should focus on policies that tie their activities together and otherwise encourage existing biotech industry associations and government incentive programs.

The author notes that biotech is only one of several promising technologies that could either create new industries or revive an existing economic base. Midwest policymakers also are excited about nanotechnology, the author adds. Participants of the meetings volunteered staff to form smaller task forces in order to explore more specific technology and policy directions and to make recommendations to policymakers and industry associations throughout the Midwest.

State R&D Tax Credits: Socially Beneficial or Socially Wasteful?

In The Rise and Spread of State R&D Tax Credits, the author provides an overview on recent research that quantifies the development of state tax credits for R&D -- a challenging task due to historical information not being readily available in a single data source and because of the variations within each state's law regarding deductibility and other specifics, according to the author.

State R&D tax credits work similar to federal tax credits and have become more widespread and valuable to firms over the past two decades, according to the author. The average generosity, or value of a tax credit, also has grown over time. This value is measured by calculating the effective credit rate for firms in a given state, the author explains. Results from research conducted by Daniel Wilson indicate that state tax credits are almost as important in terms of the cost of conducting R&D.

Wilson finds evidence that a reduction in the after-tax cost of R&D for a given state has a detrimental impact on the average R&D spending in other states. Since companies appear to be willing to move R&D activities from one state to another, states do not have an incentive to compete via R&D tax credits for that footloose R&D, the paper states. This may be socially beneficial if the overall, national level of R&D subsidization is too low as the competition provides an incentive for states to help make up the shortfall.

On the other hand, according to the author, if there are substantial deadweight losses caused by companies moving R&D from state to state, by companies calculating the tax implications of R&D in each of the 50 states, or by state tax agencies administering R&D tax credits, then the tax competition may be socially wasteful.

R&D Spending Tends to Fall During Recessions

The modern formulation of economist Joseph Schumpeter's idea that economic downturns play an important role in promoting long-run productivity growth builds on the observation that production is less profitable during recessions and as a result, recessions are ideal for firms to engage in activities that enhance productivity but interfere with production, says a report from the Federal Reserve Bank of Chicago. This may include retraining workers, upgrading equipment, or experimenting with providing better products at a lower cost.

The paper, Why Don't Recessions Encourage More R&D Spending, examines how recessions affect R&D spending -- one such channel for growth during times of reduced profits, according to Schumpeter. If production suffers during recessions while R&D does not, then recessions should be an ideal time to seek out and develop new ideas and products. However, empirical evidence shows that R&D tends to fall during recessions, not rise.

Schumpeter proposes two possible explanations for this finding. One involves credit restraints. While firms may ideally like to concentrate on R&D activity during recessions, it entails expenditure that, if paid off, would only do so in the future. Unless the firm has the cash reserve to pay for R&D, it will have to borrow against future profits, and R&D activity will depend on credit market conditions, the author says. Since firms tend to have less cash at their disposal during recessions, they often have to turn to outside funding to finance R&D. The author analyzes data on the R&D expenditures of individual firms to gain further insight into this explanation.

Another possibility relates to a firm's tendency to act in a shortsighted manner, according to the paper, focusing on immediate profits they can reap from a successful innovation. Entrepreneurs, fearing they will only earn profits on an innovation over a short time period may be reluctant to allocate significant resources to R&D during a recession. According to this logic, growth-enhancing activities that do not involve spillovers to other companies would be concentrated in recessions.