Research and development (R&D) is an important contributor to economic growth, through its effect on innovation and total factor productivity (TFP). Improvements in technology through industrial innovation have been the driving force behind the inexorably rising standards of living in the developed world over the long run. Therefore, any policy affecting R&D or innovation is of the utmost importance in the long term.  This study attempts to quantify the effects that R&D spending has on economic growth and productivity, and discusses relevant policy options and impacts.

We study the impact of R&D on output and TFP in the United States during the period 1963-2007. Knowledge generally cannot be contained within borders. Firms in one state benefit from industrial knowledge produced by R&D performed elsewhere, and therefore also from policies in other states that encourage R&D.  Our methodology allows for and measures such R&D externalities. 

There are three key features of our study. First, ours is the first study to our knowledge to examine the impact of total private R&D on the aggregate economies of the US states, and therefore also the first to be able to quantitatively examine the import of state policy toward R&D.  Second, our analysis looks not only at the direct effect that private R&D spending has on output and productivity at the state level, but also quantifies the spillover effect of R&D across states. As Jaffe (1989) and Jaffe et al. (1993) note, a proper foundation for public policy requires knowledge of the social rates of return to R&D at different levels of geographic aggregation. We find the spillover effect across states to be sizeable.  Third, we choose empirical methodology to assess the long run effects of R&D in the economy.  This leads us toward methods for estimating cointegrating relationships among the levels of the R&D stock and output or TFP. 

Our analysis shows that the R&D stock has a positive, sizeable, and significant long-run effect on output and TFP. The own-returns to GDP in a state to R&D spending range from 83% to 213%.  We also find that there are positive R&D spillovers across states in the long run: on average, about 77% of total GDP created from R&D investment spills over to other states.  There are several policy implications of these findings.  Given the large amount of spillovers across state lines, it appears that multistate cooperative or federal efforts are warranted to encourage R&D.

Regarding implications for US state policy makers in particular, our results suggest that R&D spending contributes strongly to the economic growth of nearby states.  Therefore, coordinated R&D incentives in a region across states, either from multistate policy cooperation or federal policies, can increase economic growth of the entire region.  Furthermore, our analysis provides evidence for synergy between human capital and the impacts of own-R&D and R&D “spill-ins” from other states.  This highlights the continuing need for states to seek to improve opportunities and attainment in education, particularly in the STEM areas that are necessary for R&D.