In today’s Finshots, we explain how Research & Development (R&D) spending could affect economic outcomes.

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Indian companies don’t spend money on R&D. They don’t want to innovate!

At least that’s what Business Standard indicated last week. It looked at the 500 biggest companies in India and found that they spent a measly 0.3% of net sales on R&D in FY23.

But what if we expand the number of companies? Maybe the smaller ones are innovating more so that they can one-up rivals.

Well, one way to analyze that is by looking at the ratio of Gross Expenditure on R&D (GERD) to GDP in the country. This includes spending by private companies as well as government entities such as the Defence Research and Development Organisation (DRDO). And since the government has its fingers in lots of businesses, maybe this will give us the entire picture.

But even then, as per a recent report by the Ministry of Science & Technology, the GERD to GDP spend is just 0.64% in India. For context, China spends around ~2.5% and the US still spends nearly 3.4%.

Before we dive into why this could be a problem, we’ll preface by saying that not everyone agrees that we’re so far behind in R&D.

As per Reji Joseph, who teaches at the Institute for Studies in Industrial Development (ISID), we might be actually underestimating our R&D spending.

You see, we seem to take R&D data from the Department of Scientific and Industrial Research (DSIR). So companies have to be registered here first. But when the folks at ISID parsed through some data of companies getting foreign investment for R&D, only 11% of them had registered with DSIR. So data might be slipping through the cracks.

Another theory is that companies in tech may not report their R&D accurately because it’s hard to separate between daily activities and specific research activities. It’s something that Amazon faces too. The US tech giant does not report its R&D separately. And when the US regulator asked them to do it, Amazon simply said “our business model encourages the simultaneous research, design, development, and maintenance of both new and existing products and services.” Basically, it made no sense to show it separately because it was part of the business model itself.

Could it be that Indian companies simply don’t bucket R&D spending correctly?

We don’t know for sure.

But anyway, let’s assume for a moment that the estimations are fair. That we are low R&D spenders. It is something that even the Reserve Bank of India has flagged earlier.

So how does it really affect us? After all, our GDP is growing by leaps and bounds, no?

Okay, bear with us and some basic economics.

So back in the day Adam Smith, who’s pretty much known as the father of economics, had a pretty straightforward idea of how to grow the output (O) of the country. He said it’s a function of two things — labour and capital. Or if you put it into an equation, it will look like this:

O = f (K, L)

But then in 1956, an American economist named Robert Solow realized that may not be enough for economic growth. If you want to improve output, you need technical progress (A). This way, we become more efficient. And by using the same amount of labour, we can squeeze out more output. He tweaked Adam Smith’s idea and added technical progress as the third factor. And the equation looked like this:

O = A f(K,L)

But what is technical progress, anyway?

Well, three decades later, another American economist Paul Romer further tweaked this idea to define it. According to him, it includes R&D. And also human capital which is nothing but the experience and skills of a person.

In summary, if we truly want economic growth, we need to focus on innovation too.

But let’s forget what’s happening with aggregate GDP for a moment. Instead, let’s look at the GDP per capita figures instead. Because many experts say that the aggregate number isn’t key. What matters is whether the people living in a country are faring better. After all, our population is rising at a fast clip too.

As per a report by NITI Aayog in 2021, there’s a clear link between R&D and per capita GDP. If we spend less money on R&D, the per capita GDP remains low too. It’s no wonder that China’s per capita GDP (adjusted for purchasing power) is around 3 times greater than ours. It’s because they spend more on innovation.

Source: NITI Aayog

So yeah, if we want to be a developed or high-income country by 2047 as Prime Minister Narendra Modi hopes, then we need to increase our per capita GDP. It should rise 10x to hit $21,700 by then. And maybe increasing spending on R&D could be one way in which we can get there.

How do we fix this then, you ask?

Well, there definitely isn’t a magic wand we can wave.

The usual idea is to dole out incentives. We already allow certain tax deductions for R&D. So maybe it’s about doubling down on that.

Or maybe, strengthening India’s intellectual property rights will also work. We come at a lowly 42 out of 55 countries in IP rankings. Meaning that we don’t protect innovative products. And the problem with this is that companies may not be motivated to innovate in India if they can’t be sure their creations will be protected.

And as a former member of the Finance Commission pointed out, the Monsanto case is one example. A few years ago, the US agrochemical company pulled out of the Indian market. They’d created a genetically modified cotton seed. And the Indian courts ruled that it wouldn’t be granted a patent.

So maybe, IP rules could help on this front.

And hopefully, the next time we write about R&D spends, it’ll be good news for India.

Until then…

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