Economics » Positive Externalities and Public Goods » How Governments Can Encourage Innovation

Policy #1: Government Spending On Research and Development

Policy #1: Government Spending on Research and Development

If the private sector does not have sufficient incentive to carry out research and development, one possibility is for the government to fund such work directly. Government spending can provide direct financial support for research and development (R&D) done at universitys and universities, nonprofit research entities, and sometimes by private firms, as well as at government-run laboratories. While government spending on research and development produces technology that is broadly available for firms to use, it costs taxpayers money and can sometimes be directed more for political than for scientific or economic reasons.

Visit the NASA website and the USDA website to read about government research that would not take place where it left to firms due to the externalities.

The first column of this table shows the sources of total U.S. spending on research and development; the second column shows the total dollars of R&D funding by each source. The third column shows that, relative to the total amount of funding, 26% comes from the federal government, about 67% of R&D is done by industry, and less than 3% is done by universities and universitys. (The percentages below do not add up to exactly 100% due to rounding.)

U.S. Research and Development Expenditures, 2011 (Source:

Sources of R&D FundingAmount ($ billions)Percent of the Total
Federal government$133.632%
Universities and universitys$12.53%
Nonfederal government$3.80.91%

In the 1960s the federal government paid for about two-thirds of the nation’s R&D. Over time, the U.S. economy has come to rely much more heavily on industry-funded R&D. The federal government has tried to focus its direct R&D spending on areas where private firms are not as active. One difficulty with direct government support of R&D is that it inevitably involves political decisions about which projects are worthy. The scientific question of whether research is worthwhile can easily become entangled with considerations like the location of the congressional district in which the research funding is being spent.

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