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13 March 2013

On Monday, 11 March 2013, President Obama[1] secretly asked us to explain the dynamics of how cuts in R&D spending might affect the nation's economic growth.

Here's the proof, as documented by StatCounter:

StatCounter Detail 11 March 2013 - Executive Office of the President visit to Political Calculations' November 2009 post - The Link Between Intangible Investments and GDP

Here are the key points of what the President learned about how R&D cuts in the private sector can affect the economy, which we've tweaked from the material we originally presented for greater clarity:

In practice, when a company anticipates that it will not be able to afford its current level of new product development into the future, its management will begin a process of winnowing the list of research and development projects that it is willing to develop. That process occurs well in advance of the layoffs of the people who actually carry out the work involved with them.

Development projects are often reviewed and ranked according to their prospective return on investment (ROI) in that process. Here, projects that fail to meet a certain ROI threshold are discontinued, with the people engaged in those projects initially reallocated to other projects. In addition, the company's management may also kill a high ROI project, should they judge it to involve too much risk to continue developing in the fading economic climate it foresees.

Following this phase, the company's management evaluates its staffing needs to support the "winning" projects it will continue and this may lead to the resulting layoffs of its creative staff. Then the process repeats until whatever cost reduction target the company's leadership has set for its intangible investments has been met.

Before those layoffs occur however, it is the termination of the low ROI and high risk projects that may negatively impact GDP in the current timeframe, since the cancellation of the projects also terminates the relationships established between the company and its suppliers, vendors and customers to support them, to the extent that their businesses were relying upon the cancelled R&D projects for their revenue.

That change then ripples into the larger economy and also into the future, as the parties involved in these projects alter their own efforts to compensate for the loss. This contraction of economic activity then only subsides once sufficient new work makes it possible to reverse the process or when their costs have been brought in line to support their new level of revenue.

And from there, it's a question of whether those who might have been laid off have the skills needed for the new economy that forms. If there's a massive mismatch between the skills of the creative people who were let go and the opportunities available to them, the downturn for them can drag out for a very long time, especially for those employed in the industries that went from being the most high-flying to the most distressed.

Now, here is what the President has not yet learned, courtesy of MyGovCost, where the relative impact of government spending cuts and tax increases on the economy was recently discussed:

To understand why spending cuts like those of the sequester are considered to be so much less harmful to the economy than increasing taxes, let’s consider the real nature of government spending and taxes.

Here, when government raises taxes to support its discretionary spending, what it is doing is hurting a lot of people a little to benefit just a handful of politically-connected people, who just coincidentally happen to benefit a lot from government contracts (wink-wink). Because the harm is so widespread and the benefit limited to so few, the general economy suffers quite a bit as a result. Those effects are worse when the threat of additional tax increases remain after tax rate hikes are implemented.

But when a government cuts its spending, those dynamics work in reverse. Instead of lots of people being harmed a little, only a handful of people are. And since those people are significantly less likely to be engaged in sustainable economic activity in the first place, the economy at large is barely affected when their access to taxpayer money to fund their business income is reduced.

And that, in a nutshell, is why spending cuts are better for the economy than tax hikes for balancing a government’s budget.

The bottom line: Cuts in the U.S. government's R&D expenditures will have much less of an impact upon the U.S. economy than cuts in corporate R&D investments, thanks to the government's bizarre strategy of "investing" in wasteful, politically-driven, high-risk, low-return R&D efforts, such as those associated with "green" energy programs.


[1] Or more likely, one of the President's lowly minions trying to drum up arguments to oppose the spending cuts affecting government-funded R&D programs that are being negatively affected by the spending cuts mandated by President Obama's proposed budget sequester agreement from 2011.

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