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How long can Google keep investing in outlandish science projects?

Doug Griswold illustration of artifical brains the tech giants are racing to develop. (Bay Area News Group/MCT via Getty Images)
Doug Griswold illustration of artifical brains the tech giants are racing to develop. (Bay Area News Group/MCT via Getty Images)

America's largest companies are investing way less in science than they used to. Decades ago, firms like AT&T and IBM ran massive labs where scientists could dream big and pursue the sort of research that won Nobel Prizes — even if it didn’t translate immediately into new products. (AT&T’s Bell Labs famously helped invent the laser and the transistor.) But that’s increasingly a rare sight.

And to see why, just look at Google.

Google, after all, is still a company where scientists pursue long-shot ideas. The firm's semi-secret research lab, Google X, has been exploring everything from self-driving cars to Google Glass to balloons that can beam down internet to poor countries. The company expects that most of these ideas will fail. But a few might succeed — and prove world-changing.

Yet to many of Google’s investors, this bet is starting to look iffy. As Conor Dougherty reports in an excellent New York Times story, Wall Street is getting antsy about many of Google’s moonshot projects — particularly after the recent failure of Google Glass:

After patiently abiding a steep increase in research and development spending on efforts that range from biology to space exploration, Wall Street is starting to wonder when — and if — Google’s science projects will pay off.

"We want companies to continue to push the envelope, but there has to be some financial responsibility around that," said Ben Schachter, an analyst at Macquarie Securities. "We have no real insight into what’s going on."

For a long time, Google could resist these pressures because it dominated the search and advertising business. The company was doing spectacularly well, and investors didn’t mind if Google tinkered with offbeat ideas like self-driving cars that had a small shot of being wildly lucrative. It also helps that Google's unusual corporate structure gives founders Larry Page and Sergey Brin majority control, leaving them better-positioned to fend off Wall Street's demands.

But now Google’s advertising revenue is growing more slowly, and analysts are increasingly second-guessing the company’s spending on wild dreams that may never pan out, like jetpacks or wind power from kites.

Many US firms face pressure to invest less in science

A prototype of Google's custom-built self-driving car. (Google)

A similar tale happened throughout corporate America during the late 20th century. When companies like AT&T and IBM dominated their respective fields, they could afford to run wide-ranging research labs. The scientists in these labs were given immense freedom, and some of their discoveries ended up being transformational. Bell Labs racked up eight Nobel Prizes for things like the transistor or the discovery of cosmic background radiation.

The problem is that this R&D work didn’t always pay off for the companies that had invested in it. Researchers at Xerox’s Palo Alto Research Center famously invented the graphical user interface. But it was Apple that harnessed the idea to create the Macintosh. The same thing happened to Texas Instruments: its research lab helped develop the integrated circuit, only to watch Intel get rich off the idea.

So, over time, the labs shrunk. Modern-day tech companies still spend a lot on R&D, but they focus far more on short-term commercial applications than on fundamental research. As The Economist reported in 2007, the R&D budgets of companies like Microsoft, IBM, and Hewlett Packard mostly go "into making small incremental improvements and getting new ideas to market fast."

A recent NBER working paper led by Atish Arora, a professor at Duke University's Fuqua School of Business, quantified the trend. Basic research makes up a much smaller portion of corporate R&D than it used to:

National Science Foundation/Division of Science Resources Statistics, Survey of Industrial Research and Development: 2007. (Arora et al 2015)

Arora and his co-authors point to a number of possible factors, such as the fact that firms are no longer as diversified as they used to be (giving them less incentive to research widely, the way companies like DuPont did). But the trend appears real.

In recent years, Google had stood out as an exception — a company that still shot for the moon. But even Google’s now facing calls to show more immediate results by investors with shorter time horizons.

As Dougherty reports, the company is trying to placate Wall Street by pointing to some of its computer-science research like Google Brain, a neural network that helps computers read text and will have more obvious practical implications. Google officials told the Times that the company's R&D efforts — which now amount to 12 percent of revenue — have paid for themselves with this breakthrough alone.

Economists predict firms will under-invest in basic research

Broadly speaking, this is what economists have long predicted will happen. The value of basic research is greater to society as a whole than it is to any one individual company. So, in theory, companies are likely to invest less in this sort of research than is socially optimal. It’s quite hard for corporate research labs like Google X to persist over time.

That’s a potential problem because science and basic research has long been a huge driver of US economic growth. So if private companies are investing less in it, someone else needs to pick up the slack.

In the United States, that slack has been picked up since the 1980s by universities and the federal government, which are bearing more of the research load. (Indeed, Google owes its existence to a page-rank algorithm developed at Stanford University under a federal research grant.) The only hitch is that Congress has been reining in federal spending on basic research in recent years.

(AAAS)

Experts are still debating what this potential cutback will mean for the future. Will it mean less innovation going forward? Will China and other countries fill in the gaps as they spend more? Is it possible that we’re now investing in R&D more efficiently than we used to? Whatever the case, it’s a big change in how American science gets financed.

Further reading: American companies are investing way less in science than they used to