Why the Singapore governement is increasing its spending on Research and Development (R&D).

When research and development (R&D) is done, it creates a kind of positive externality known variously as a knowledge spillover or technology spillover. The technological advances made by a firm's R&D has an impact on other firms' productive efficiency and helps improve their profitability.

Society is able to gain from the positive externality caused by R&D in the private sector because the knowledge gained from the R&D is non-rivalrous. Since one of the government's roles is to maximize the welfare of society, it would want to encourage R&D in industries that yield large spillovers such as the biomedical science industry. The Singapore government does this through methods such as offering special tax breaks for expenditures on R&D and even outright subsidies for certain industries with large spillovers. This form of governmental intervention in the economy is called industrial policy.

If the government decides to use subsidies, tax breaks and other forms of industrial policy to encourage R&D, the supply curve would shift rightward equal to the amount of the reduction in the cost of production due to the policies. To ensure that the market equilibrium is at the social optimum, the shift in the supply curve caused by the governmental intervention should equal the value of the spillover.

Firms may apply for patents to grant them property rights to their breakthroughs for a limited period of time in which no other firms are able to benefit, hence giving firms more incentive to engage in R&D. This would cause a rightward shift in the private cost curve and cancel out the positive externality caused by the R&D. However, society will still benefit in the long run as when the patents eventually expire the breakthroughs will become non-excludable knowledge that can be used freely by other firms.


Above: A supply-and-demand diagram illustrating the positive externality of R&D. Note that the private cost > social cost.

A potential stumbling block for industrial policy is the indeterminate nature of the size of the spillovers from different markets, i.e. it is impossible if not extremely difficult to accurately predict the magnitude of the positive externality caused by R&D. Without accurate information about the benefits of the R&D of the various industries, the government is unable to determine the amount of subsidies and/or tax breaks to give out and may even cause a negative externality if the amount given is too great.

In conclusion, Singapore is increasing its spending on R&D because doing so would maximize the welfare of society as R&D has a large spillover effect that is beneficial to the industrial development of the country.

~Nicky(:

Labels: Research and Development