FRBSF Economic Letter
2004-32; November 12, 2004
Does Locale Affect R&D Productivity? The Case of Pharmaceuticals
As the U.S. economy
becomes more "knowledge-based," the decisions that policymakers
and firms make about spending on research and development (R&D)
take on increasing significance. In making those decisions, an
important dynamic of R&D to consider is that most innovations
borrow heavily from prior or related work; this implies that enhancing
the potential for such "spillovers" from one researcher's
innovative efforts to another's could make R&D more productive.
A fundamental question for managers of firms and
for policymakers, then, is whether such spillovers are more likely
when R&D centers are geographically close. If so, then a firm
manager may choose to locate R&D laboratories near other labs
doing similar work; likewise, policymakers may want to encourage
the development of industrial clusters in order to foster productivity
gains.
In this Economic Letter, I describe
recent research (Furman et al. 2004) that attempts to identify
and quantify spillovers in a single industry: pharmaceuticals.
Large pharmaceutical companies may locate R&D labs in a variety
of ways. Many have several drug discovery labs, generally located
on at least two continents. Others, such as Eli Lilly, which conducts
most of its research in Indianapolis, have R&D facilities far
from most other pharmaceutical R&D labs and near few major
research universities. Yet others, such as Glaxo, which has a lab
in Research Triangle Park, locate R&D facilities close to several
large academic institutions as well as a number of other drug labs.
Therefore, this study explores both the effects of locating R&D
facilities geographically near other such facilities as well as
whether spillovers emanating from "public" sources, such
as academic and government institutions, differ from those emanating
from "private" sources, such as other firms in the same
industry
What are "knowledge spillovers"?
Economists use the term "knowledge spillover" to
describe the uncompensated (and perhaps involuntary) transfer of
ideas or information from one inventor to another which can enhance
the productivity of R&D efforts. This is also referred to as
a knowledge or technological externality. It has long been thought
that the transfer of knowledge becomes more costly with distance;
that is, it may be easier to learn from someone in the same country
than from someone on the other side of the world, and it may be
easier to learn from a next-door neighbor than from someone hundreds
of miles away. If so, then knowledge spillovers should have a geographic
component.
In exploring whether geographic proximity matters,
one must develop a measure of productivity for R&D. In general
terms, productivity is defined as the quantity of output divided
by the quantity of input. To determine R&D productivity at
the level of an industry, firm, or business unit, we need to identify
a reasonable measure of R&D outputs. A common measure in many
settings is the count of patents generated.
In pharmaceuticals, patents are a particularly
good measure due to the strong intellectual property protection
they provide, especially compared to other industries. Furman et
al. (2004) use the number of patents granted to a firm in at least
two of the three major global markets, the United States, the European
Union, and Japan. While only a low percentage of patented compounds
discovered prove to be safe and effective treatments that are brought
to market, the number of patents is still highly correlated with
the number of products ultimately developed
Pharmaceutical R&D
Furman et al. (2004) focus on the productivity
of R&D in nine large pharmaceutical companies from 1981-1990
using detailed data on each firm's expenditures on drug discovery
in various therapeutic areas, such as cancer or cardiovascular
disease. With these data, one can isolate differences in output
due to knowledge spillovers from those due to increased effort
or spending, as well as from those that result from focusing on
different therapeutic areas.
Of course, this industry has undergone large changes
since 1990, including consolidation among many of the largest pharmaceutical
companies and significant growth in the number of biotechnology
companies. But, by examining the period before the growth of the
internet, we can gain some key insights. A potential benefit of
the internet and other advances in information technology is that
knowledge may now be shared almost instantaneously and at very
low cost. To assess the relevance of this potential benefit, it
is important to understand whether knowledge spillovers have historically
been localized, or limited by geography.
It is also important to distinguish among the sources
of spillovers—that is, spillovers from R&D facilities at pharmaceutical
firms and those from public research institutions, such as universities,
medical centers, and government laboratories. Both types of research
units have much in common. Drug discovery is highly dependent on
understanding "basic" science, or the underlying biological
or chemical mechanisms that drive diseases and treatments, so pharmaceutical
companies employ people with advanced degrees in biology, chemistry,
and related fields to conduct basic research. Like scientists and
scholars at public institutions, these researchers in the private
sector often publish their work in scientific journals and monitor
advances made by other researchers in their fields.
However, public and private research units differ
in the incentives they face in generating knowledge spillovers.
Universities and other public entities (like medical centers and
government labs) are not generally seeking to secure the full value
of the knowledge they create, and are likely to encourage the dissemination
of their work. The reason is that university researchers in general
are "rewarded" for publishing their work in professional
journals and for the influence that work has on the course of research
in specific areas. (Note, however, that incentives for researchers
in these scientific fields at public institutions have been changing
in recent years, and many now patent their ideas in addition to
publishing them (Murray and Stern 2004)). In contrast, a private
firm has a greater need to appropriate the knowledge it generates
through R&D, because it uses that knowledge to develop products
it will sell. Therefore, a private firm is less likely to reveal
valuable information from its R&D efforts to competing firms.
The amount of research conducted in a locality is quantified by
the number of scientific publications authored by individuals living
in the area; this measure is also broken down by therapeutic area
Do spillovers matter for productivity?
Are they truly local?
The answer to both questions is "yes." At
least as measured by patent counts, pharmaceutical firms benefit
from science generated around the world as well as locally. The
local effect, though, is nearly twice as strong. That is, firms
around the world are better off when researchers in the London
area publish more articles related to cardiovascular disease, but
the firms with drug discovery labs in the London area realize the
most gains.
There is an important qualification to note, however.
While "public" science does appear to generate knowledge
spillovers that result in more patents granted to a firm, "private" science
does not. The effect of public science is quite important. On average,
exposure to an additional 1000 scientific papers authored in a
locality by individuals at public institutions has about the same
effect on a firm's patent count as an additional $1 million of
R&D expenditures. This finding suggests that firms with R&D
facilities in areas with a high concentration of research facilities,
such as the greater Boston area and the San Francisco Bay Area,
realize a substantial boost to their productivity from local knowledge
spillovers.
In contrast, proximity to the labs of competing
drug firms that are publishing many scientific papers does not
provide a similar boost to productivity—in fact, the measured
effect is negative. There are at least two possible explanations.
One is that publications by a competitor signal that the competitor
has the lead in a technology race. Realizing it is behind, a firm
may cut back on its patenting efforts and reallocate its drug discovery
expenditures from patenting to other functions. An alternative
theory is that spillovers do not simply fall from the sky: they
are a result of collaboration between researchers at different
institutions. It may be that a competitor can lock up scarce coauthoring
resources at local universities, preventing other firms from benefiting
as much from these spillovers.
Together, these findings suggest that knowledge
spillovers are substantial, at least in the pharmaceutical industry,
but a nuanced examination is important. If what really matters
is knowledge generated by public sources such as universities rather
than by other local firms in the same industry, then public funds
may be more usefully devoted to development of area academic institutions
rather than to the development of industrial parks or clusters
(at least if increased productivity is the aim of public spending).
Other researchers (Zucker et al. 1998) have noted that growth in
biotechnology firms is largely related to the presence of "star" scientists
at universities.
Looking beyond pharmaceuticals
and ahead in time
It is interesting to speculate whether these effects
have changed in the years since the data analyzed here, and whether
these results apply to other sectors. Outside of changes to the
structure of the pharmaceutical industry, there have been two forces
at work that could affect how important localized spillovers are
and how important public research institutions are. First, the
advent of the internet has greatly reduced the cost of accessing
scientific work performed far away. Search engines and electronic
publication of articles may have mitigated the effects of distance,
so that if this analysis were repeated in the period after 1995,
it might reveal that the relative importance of local spillovers
has diminished. Second, universities are devoting more resources
to technology transfer, explicitly fostering spillovers from academics
to the private sector. If their efforts are successful, then the
relative importance of exposure to public science may have increased.
It does appear that pharmaceutical firms have recently been relocating
to areas around major research universities and medical centers.
In terms of similarities to other industries, there
is some evidence that other sectors of the economy also benefit
from localized knowledge spillovers, particularly from academic
sources. Jaffe (1989) found that university research has a positive
effect on the productivity of local firms across industries, and
Branstetter (2003) finds that in California, industrial patents
have been increasingly citing academic science in recent years.
Some firms, such as Intel, have chosen to fund university research
and foster ties with academics rather than having their own central
research laboratories. If other R&D-intensive industries are
similar to pharmaceuticals in the importance of the local academic
institutions, it would not be surprising to see the highest growth
rates in innovative activity around major research universities.
In addition, if geographic knowledge spillovers
are important, then assessments of the impact of outsourcing should
include considerations about how relocation affects not only employment
but also the productivity of nearby organizations. In pharmaceuticals,
most relocation has recently been into the U.S., not out
of the country. This movement provides jobs and also, perhaps,
a boost for the R&D efforts of surrounding firms. Correspondingly,
if firms relocated their R&D labs to countries outside the
U.S. because of restrictions on research or a shortage of U.S.
scientists, then the U.S. would lose jobs as well as these knowledge
spillovers, making the remaining firms less productive
Margaret Kyle
Assistant Professor of Management,
Fuqua School of Business, Duke University,
and Visiting Scholar, FRBSF
References
[URLs accessed November 2004.]
Branstetter, Lee. 2003. "Exploring the Link
between Academic Science and Industrial Innovation: The Case of
California's Research Universities." Working Paper, Columbia
Business School.
Furman, J.L., M.K. Kyle,
I. Cockburn, and R. Henderson. 2004. "Public and Private Spillovers, Location, and the Productivity
of Pharmaceutical Research." Mimeo. Duke University. http://www.duke.edu/~mkyle/Spillovers%20Location%20Productivity%20-%20Sept-04.pdf
Jaffe, A.B. 1989. "Real
Effects of Academic Research." American Economic Review 79, pp. 957-970.
Murray, F., and S. Stern.
2004. "Do Formal
Intellectual Property Rights Hinder the Free Flow of Scientific
Knowledge? An Empirical Test of the Anti-Commons Hypothesis." Mimeo.
MIT Sloan School. http://web.mit.edu/ewzucker/www/econsoc/Murray.pdf
Zucker, L., M. Darby,
and M. Brewer. 1998. "Intellectual
Human Capital and the Birth of U.S. Biotechnology Enterprises." American
Economic Review 88(1) pp. 290-306.
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