Bad economic times often signal a downturn in companies’ research & development activities

For the past century, the accepted wisdom has been that economic downturns are the great incubators of innovation. This theory, originated by famed economist Joseph Schumpeter, contends that as companies make less money, they turn their focus to improving their processes through retraining workers, upgrading equipment and finding more efficient ways of making goods. But in today’s reality, innovation usually takes a backseat to fear and survival.

“If you are talking about new products and improvements to products, there is some truth to the idea that innovation is stifled in a recession,” says Jack Miller, founder of Quill Corporation (which he sold to Staples for $700 million in 1998), owner of Successories, and author of Simply Success: How to Start, Build, and Grow a Multimillion-Dollar Business the Old-Fashioned Way (John Wiley & Sons, 2008), a book based on his experience running companies through six recessions.

R&D as the sacrificial lamb

Recent data also supports the argument that innovation suffers when times are bad. A 2005 study by Gadi Barlevy, senior economist at the Chicago Federal Reserve Bank, found that corporate R&D spending fell dramatically in every post–World War II recession except for 1982. One explanation is a factor that we’re feeling particularly acutely now: Banks tighten credit, making it harder to secure funding for higher-risk, higher-reward efforts. Yet strangely, Barlevy also found that large companies with significant internal resources and easier access to credit still slash R&D—even more dramatically than smaller companies. This happens because firms tend “to act in a shortsighted manner,” the economist explains, and he suspects there is a peculiar logic at work: Entrepreneurs of all sizes appear to believe that any good idea has only a limited period of profitability before competitors copy and improve upon it, stealing away profits. For that reason, businesses wait until times are good to innovate, when the profit window is potentially larger.

Regardless of the reason for R&D cutbacks, signs are already indicating that 2008 will be the same: A report at the start of the year by Batelle R&D Magazine predicted sluggish R&D growth of just 3.4 percent, an inflation-lagging forecast taken before the recent roiling of the stock and credit markets.

The cost of cutting innovation budgets

To everyone’s benefit, the federal government has often acted as the bulwark in downturns, supporting innovation in bad times. But this time, at least, federal research spending is also taking a hit. The National Science Foundation and NASA, the two most prolific innovators in the government, saw their 2008 budgets cut from last year. NASA is projected to have its funding for 2009 slashed again—no small matter at an agency whose innovations have improved everything from breast-cancer screening to highway safety to wildfire control. Even the Department of Defense, which has a tradition of translating its innovations into civilian boons like the Internet and the Global Positioning System (GPS), will see its non-Iraq war budget cut below 2007 levels next year. Overall, the 34 long-term research centers run by federal agencies have seen a 2.8 percent cut in funding in 2008, with more expected in 2009.

Good ideas aren’t always expensive

The good news is that trimming R&D budgets does not necessarily bode poorly for companies and agencies. Booz Allen Hamilton researchers, in their “Global Innovation 2007” report, found—as in 2006—no statistically significant connection between the amount of money a company spent on innovation and its financial performance. Even with the deck stacked against them, businesspeople must figure out a way to survive, says Miller. “You have no choice but to innovate.”

—Brendan Coffey