A number of very careful econometric studies have been interpreted as showing that publicly funded research and development conducted by private firms has had little discernable impact on firm level profits or productivity. In contrast historical studies have shown that military and defense-related research development and procurement conducted by private firms has been an important source of technology development across a broad spectrum of U.S. manufacturing industries. Careful narrative analysis represents a more effective way of capturing the complementarities between military and defense-related research, development, and procurement on commercial technology development than econometric analysis.Political Economy, Productivity Analysis, Research and Development/Tech Change/Emerging Technologies,

Ruttan, Vernon W.

English

Research Papers in Economics

 
Staff Paper P07-12             September 2007 
 
 
Staff Paper Series 
 
Military R&D:  The Productivity Puzzle 
by 
Vernon W. Ruttan 
 
 
 
 
 
 
 
 
 
  
Staff Paper P07-12           September 2007 
 
 
 
Military R&D:  The Productivity Puzzle 
Vernon W. Ruttan* 
 
 
 
 
 
 
*Vernon W. Ruttan is Regents Professor Emeritus in the Department of Applied 
Economics and the Department of Economics, University of Minnesota, St. Paul, 
Minnesota. 
 
The analyses and views reported in this paper are those of the author(s).  They 
are not necessarily endorsed by the Department of Applied Economics or by the 
University of Minnesota. 
 
The University of Minnesota is committed to the policy that all persons shall have 
equal access to its programs, facilities, and employment without regard to race, 
color, creed, religion, national origin, sex, age, marital status, disability, public 
assistance status, veteran status, or sexual orientation. 
 
Copies of this publication are available at http://agecon.lib.umn.edu/.  Information 
on other titles in this series may be obtained from: Waite Library, University of 
Minnesota, Department of Applied Economics, 232 Classroom Office Building, 
1994 Buford Avenue, St. Paul, MN  55108, U.S.A. 
     
Copyright (c) (2007) by Vernon W. Ruttan.  All rights reserved.  Readers may 
make copies of this document for non-commercial purposes by any means, 
provided that this copyright notice appears on all such copies.  
Abstract: 
A number of very careful econometric studies have been interpreted as showing that 
publicly funded research and development conducted by private firms has had little 
discernable impact on firm level profits or productivity.  In contrast historical studies 
have shown that military and defense-related research development and procurement 
conducted by private firms has been an important source of technology development 
across a broad spectrum of U.S. manufacturing industries.  Careful narrative analysis 
represents a more effective way of capturing the complementarities between military and 
defense-related research, development, and procurement on commercial technology 
development than econometric analysis.  
  1 
How important has publicly funded military research and procurement been as a source 
of technology development and productivity growth?
1  In a recent book I present 
historical case studies of the role of military and defense-related research, development 
and procurement of commercial technology development for a series of general purpose 
technologies.
2  These industries include interchangeable parts and mass production, 
military and commercial aircraft, nuclear energy and electric power, computers and 
microprocessors, the internet and the space industries.  
The case studies demonstrate that military and defense related R&D has been a 
major source of technology development across a broad spectrum of industries that 
account for an important share of U.S. industrial production.  These results are in direct 
contradiction to a number of very careful econometric studies that show that measured 
private and social rates of return to military R&D have been very low and have had no 
discernible effect on industrial productivity growth in the U.S. 
Economic Benefits from Research 
  There is a long history of studies of private and social rates of return to R&D.  
These studies trace back to the now classic studies of rates of return to agricultural 
research by Griliches and to industrial research by Mansfield and Beardsley.
3  The results 
of the large body of firm-level, sector-level, and economy-wide studies, combined with 
studies of the sources of productivity growth, have supported a view that the social rates 
of return to R&D have generally exceeded by a substantial amount the rates of return on 
almost any other form of investment available to the U.S. economy.
4  
 These high social rates of return contributed to a consensus that the U.S. was 
substantially under investing in R&D—and that this under investment was a substantial  
  2 
constraint on economic growth.  Because of the spillover of R&D benefits in the form of 
consumers and producers surplus, even privately funded R&D shared the characteristics 
of public goods—the economic unit that generates the new technology captures only a 
portion of the social benefits from its research.  The policy implication that was generally 
drawn is that the U.S. should expand public sector support for R&D to correct private 
sector under investment. 
The generality of the above conclusion has been challenged, however, by studies 
by Lichtenberg that have attempted to measure the private rates of return to firms that 
conduct publicly funded research and technology development.
5  These studies failed to 
find significant private or social rates of return from publicly funded R&D conducted by 
private firms.  However, R&D in manufacturing industries more generally has been 
found to yield  social rates of return that substantially exceed the private rate of return 
from ‘own productivity improvements’ derived from R&D performed with government 
funding.”
6 
Bias in Measurement 
It has been suggested that one explanation for these results may be that a high 
percentage of firm-level federally funded industrial research has been conducted by 
defense or defense-related firms.  Neither the R&D nor the products resulting from such 
R&D are subject to a market test.  The design of technology, firm-level costs, and returns 
are heavily influenced by bilateral bargaining.  Research results and technology 
development information are usually classified.  Prices and compensation are frequently 
renegotiated following project completion.  A substantial share of the products derived 
from the federally funded R&D are often sold back to the government.  Under these  
  3 
institutional arrangements conventional measures of profitability and productivity may 
not be appropriate.
7 
Even if market transactions were not distorted by defense contract provisions the 
impact of federal funding on firm-level R&D or profitability of performing firms would 
not represent an adequate test of the effects of public sector, and particularly of defense 
sector, R&D on economic performance.  Public funding is often a complement (rather 
than a substitute) for private R&D and thus may enhance sector-level or economy wide 
profitability and productivity.  In addition, as Lichtenberg himself notes, defense or 
defense-related procurement of services and products resulting from R&D may represent 
a substantial stimulus to firm-level research and technology development.
8 
In an attempt to test the substitution hypothesis Paul David and his colleagues 
conducted a critical review of the large body of econometric research studies that 
attempted to shed some light on the issue of whether public sector R&D has been a 
substitute for, or a complement to, private sector R&D.
9  After sorting out the subset of 
studies that were adequately designed to test the substitution hypothesis, they found that 
the results from about one-third were consistent with the substitution hypothesis, while 
two-thirds were consistent with the complement hypothesis.  I find it particularly 
significant that almost all of the higher-level aggregate studies were consistent with the 
complement hypothesis.  The implication is that the more aggregate studies were able to 
capture elements of complementarity that could not be detected at the individual firm 
level. 
 
  
  4 
Perspective 
My own view is that we do not yet have, and perhaps cannot have, a body of 
rigorous econometric evidence against which to evaluate the economic impact of defense 
and defense-related R&D and procurement.  David and his colleagues explicitly 
eschewed any effort to assess the magnitude of the economic effect of complementarity.  
What are the implications for attempts to assess the significance of military procurement 
on the development of commercial technology?  My answer is that careful narrative 
analysis of individual cases is a more effective method of capturing the effects of 
complementarity than econometric analysis.  David has also pointed out that narrative 
analysis may be better able to capture the long-term or lagged effects of the public R&D 
investments that are the source of major general purpose technologies.
10  In the late 1970s 
Robert Solow famously observed that “computers are found everywhere but in the 
productivity data.”
11  It was not until the late 1990s that research by Dale Jorgenson and 
several colleagues were able to produce firm estimates of the contribution of computers 
to U.S. economic growth.
12 
It is particularly important to assess the extent to which military procurement has 
induced both demand and supply-side forces that have shortened the process of transition 
from initial concept to commercialization of new general purpose technologies.  The 
Semi-Automatic Ground Environment (SAGE) program and the Apollo space mission 
drove computer and microprocessor technology and satellite communications and earth 
observing technology rapidly down their learning curves.
13   The effect in both cases was 
to advance the development and adoption of commercial technology by at least a decade.  
In the absence of defense and defense related R&D it is doubtful that I would have sent a  
  5 
draft of my book manuscript to my editor in New York or have flown by wide bodied jet 
airplane to annual professional meetings to meet him. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
  6 
                                                                                                                                            
1 I am indebted to Frank R. Lichtenberg and Paul A. David for comments on an 
earlier draft of this paper. 
2 Vernon W. Ruttan. Is War Necessary for Economic Growth? Military 
Procurement and Technology Development (Oxford 2006). 
3 See, for example, Zvi Griliches, “Research Costs and Social Rates of Return: 
Hybrid Corn and Related Innovations.” Journal of Political Economy 66 (October 1958): 
419-439; Edwin Mansfield and George Beardsley, “Social and Private Rates of Return 
from Industrial Innovations.” In The Production and Application of New Industrial 
Technology, pp. 144-146, Edwin Mansfield (ed.). New York, NY: Norton 1977. 
4 For an extensive literature review see Colin G. Thirtle and Vernon W. Ruttan, 
The Role of Demand and Supply in the Generation and Diffusion of Technical Change. 
Chur, Switzerland: Harwood, 1987. 
5 Frank R. Lichtenberg, “The Relationship Between Federal Contract R&D and 
Company R&D.” American Economic Review 74 (May 1984): 73-78; “The Private R&D 
Investment Response to Federal Design and Technical Competitions.” American 
Economic Review 78 (June 1988): 550-559; “Impact of the Strategic Defense Initiative on 
U.S. Civilian R&D and Industrial Competitiveness.” Social Studies of Science (May 
1989): 265-82.  For a more extensive literature review see Frank R. Lichtenberg, 
“Economics of Defense R&D,” in Handbook of Defense Economics. Keith Hartley and 
Todd Sandler, (eds.), pp. 431-457. Amsterdam, Netherlands: Elsevier, 1995. 
 
  
  7 
                                                                                                                                            
6 Paul A. David, Brownwin H. Hall and A. Toole, “Is Public R&D a Complement 
or a Substitute for Private R&D? A Review of the Econometric Evidence.” Research 
Policy 29 (April 2000): 497-529. 
7 Zvi Griliches, “R&D Productivity, Econometric Results and Measurement 
Issues.” In Handbook of Innovation and Technical Change, ed. Paul Stoneman, pp. 52-
89. Oxford, UK: Blackwell, 1995. 
8 Lichtenberg, op cit. 1984. 
9 Paul A. David, et al., “Is Public R&D a Complement?”  pp. 497-529. 
10 Paul A. David, “Letter to Author.” April 11, 2004. 
11 Robert M. Solow, “We’d Better Watch Out.” New York Times Book Review. 
(July 12, 1987): 36. 
12 See particularly Dale W. Jorgenson and Kevin J. Stiroh, “Information 
Technology and Growth.” American Economic Review 89 (May 1999): 109-115; Dale W. 
Jorgenson, “Information Technology and the U.S. Economy.” American Economic 
Review 91 (March 2001): 1-32. 
13 Vernon W. Ruttan, Is War Necessary for Economic Growth? Chapters 2 and 7. 

Military R&D: the productivity puzzle

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