debacle of the Clinton health care plan, we should not rule this out over the long term. In the interim, government will play a critical role through its management of Medicare and Medicaid. In each of these cases, the outcome will have an effect on which technologies are developed and commercialized.
It should not need stating that the overall health of the U.S. economy will affect the pace of innovation across all industries and technologies. A strong economy increases the pool of capital available for the purchase of new technology and for investment by companies in R&D. The 1990s illustrate this point in microcosm. During the first half of the decade, the economy grew at an annual rate of 2.4 percent, and capital investment grew by 0.7 percent annually. When GDP grew by 4.3 percent a year in the latter half of the decade, capital investment soared to 1.3 percent of GDP. Much of this new capital spending went to information technology, stimulating growth and innovation in that sector. Many economists believe that this helped create what was then called the “new economy,” in which IT was stimulating innovation and productivity growth in all industries.
Although most Americans were pleased with the performance of the economy in the late 1990s, not all of the news was good. In 1985, the United States spent more than 2.9 percent of GDP on R&D. That percentage fell to about 2.5 percent in 1994, and although it rose in the late 1990s, it was less than 2.8 percent in 1999. It is worth noting that the compound annual growth rate in R&D was 4.37 percent during the economic expansion of 1975 to 1980 and 4.39 percent during the expansion of 1982 to 1990, but it reached only 3.43 percent during the expansion of 1991 to 1999. In other words, the growth in R&D during the 1990s, though impressive, was not that high for a period of economic expansion. And if R&D spending was relatively low during a period of expansion, what can we expect during a contraction?
The primary source of funding for product research is internal capital, and companies have been increasing their research budgets in recent years. During the late 1990s, while the federal R&D investment was declining, industry R&D was growing steadily. In the mid-1980s, industry and government spent about the same amount on R&D. By 1999, industry was spending twice as much as government. About two-thirds of industry spending is for product development and the remainder for basic and applied research. The percentage devoted to basic and applied research dipped slightly in the early 1990s, when growth was slow, but recovered quickly in the second half of the decade. Will that continue?
The most recent survey by the Industrial Research Institute conducted in the fall of 2000 found that companies plan to hold steady the percentage of sales allocated to R&D even though the economy has cooled somewhat. The survey also uncovered some other significant trends. Companies are increasing their R&D related to new business projects and reducing spending geared to existing