U.S. Firms Are Investing Heavily in Innovation, Yet Economic Productivity Has Slowed. Why?
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Economics Jun 1, 2021

U.S. Firms Are Investing Heavily in Innovation, Yet Economic Productivity Has Slowed. Why?

The answer may lie in how pharmaceutical companies are targeting their R&D spending.

US one dollar bill as puzzle with missing pieces

Lisa Röper

Based on the research of

Efraim Benmelech

Janice C. Eberly

Joshua Krieger

Dimitris Papanikolaou

For the past 30 years, economists have faced a stubborn puzzle. Firms have increasingly invested in innovation—in the form of research and development, software, and patents—but those investments have not produced a corresponding rise in overall economic productivity. In fact, by some estimates, productivity growth since 2006 has been slower than any in decade of recorded American history.

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This mismatch “doesn’t accord with intuition,” says Kellogg finance professor Janice Eberly. Historically, major innovations have accelerated productivity growth. The mass adoption of electric power, for example, made machines and the workers who operated them more efficient, and the widespread availability of antibiotics improved the quality and size of the labor force. “When we look at past productivity booms, they can often be traced to fundamental innovations,” Eberly says.

So why isn’t this the case with the present economy?

“We know there’s a lot of software being written. There are patents being granted and implemented. There was an increase in productivity in the late 1990s, and then productivity growth has been weak ever since,” Eberly says.

Eberly and her Kellogg School colleagues Efraim Benmelech and Dimitris Papanikolaou, along with Joshua Krieger of Harvard Business School, wondered if a parallel trend might be related. Namely, during those same decades, Americans were living longer, and the share of older Americans in the population has risen, as the baby boomers age. Average male life expectancy increased from 70 to 76.3 between 1980 and 2018. Yet men were still retiring from the workforce at roughly the same age (66) as they had been for decades.

How might living longer and having more seniors in the economy relate to the puzzle of declining productivity growth in the U.S.? Perhaps, the researchers posited, the benefits of firms’ increased investment in innovation were somehow transferring to aging Americans. Their quality of life might have improved, but since they are retired, that wouldn’t translate into productivity growth in the economy at large.

What kind of firms invest heavily in patents, software, and R&D—but also target older customers? Pharmaceutical companies. The researchers hypothesized that a significant portion of these companies’ innovation-driven investments over the past two decades was directed at developing treatments for diseases common in people aged 65 or older.

After examining data on pharma firms’ drug-development efforts and comparing them to overall spending on R&D, the researchers found that this was exactly the case. Pharmaceutical companies were focusing a third of their innovation investments on people who were no longer in the workforce.

“It might be very good for those patients’ welfare,” Eberly explains. “But it’s not going to help productivity.”

To Eberly, the productivity-growth puzzle is more than academic. “When economies grow, they can usually achieve improvements in standards of living,” she says. But if productivity growth continues to lag, those standards of living could lag, too—which will affect everyone, not just longer-living retirees. What’s especially compelling is this connection between two very large trends that will have a profound impact on our future.”

Innovating for the Elderly

The researchers began by establishing that senior citizens do, in fact, consume more prescription pharmaceuticals than other age groups.

After analyzing a survey of medical expenditures for tens of thousands of patients between 1996 and 2015, the researchers found that patients over the age of 65 spend the most per capita on prescription drugs: $2,531 in 2015, compared with $1,758 spent by the 45–64 age group. That consumption has steadily grown over time, too.

Next, the researchers wanted to see if pharmaceutical companies were increasing their R&D investments during the same period that overall productivity growth was declining. Again, the data bore out the researchers’ hunch. In 1970, pharma firms represented less than 10 percent of total R&D spending among publicly traded companies. But by 2018, that share had jumped to 24 percent. In other words, nearly one out of every four dollars spent on research and development was coming from a pharmaceutical company.

The researchers’ last step was to find evidence tying these two trends together. If senior citizens were consuming more drugs, and pharma firms were putting more effort into innovation, how much of that effort was actually directed at producing drugs for seniors?

They analyzed the development histories of over 50,000 drugs—including clinical-trial dates and which diseases the drugs were designed to treat. They cross-referenced this information against data describing the specific drugs that different age groups were buying over time. The result was an evolving portrait of pharma firms’ drug portfolios: which medications, developed with specific amounts of R&D, were designed to combat diseases that disproportionately affected certain age groups.

“Our main finding was that new drug candidates were increasingly targeting older people,” Eberly says. Indeed, between 1995 and 2013, more than half of new drug development was dedicated to producing what the researchers dubbed “elderly drugs.” During that time, the share of firms’ total R&D spent on these elderly drugs increased by 15 percent.

Figuring out how to get more work years out of aging citizens isn’t the point of solving the productivity puzzle.

The pharma firms’ investment in innovation is “tracking the change in demographics,” Eberly explains. “There are more older potential patients, and so more drug candidates are following that potential demand.”

Why Productivity Growth Matters

Eberly doesn’t believe that pharmaceutical companies’ innovation spending is solely responsible for the drag on productivity growth. She and her coauthors consider their initial findings to be a proof of concept validating further, more detailed research.

“That’s why this is a five-page paper and not a fifty-page paper,” Eberly says. The researchers want to also explore the effect of elderly drugs on retirement patterns.

“If you have improved health later in life, maybe you’ll postpone retirement and stay in the labor force longer,” she says. “But as for the retired workers who are already benefitting from these drugs, those people are pretty unlikely to go back into the labor force.”

She adds that figuring out how to get more work years out of aging citizens isn’t the point of solving the productivity puzzle. What matters is understanding the fundamental connections among innovation, productivity growth, and standards of living.

“Let’s say I’m a shoemaker, and last year I produced a thousand pairs of shoes at my job. Then my firm upgraded its technology, so now I can produce 1,500 pairs. I should get paid more because I’m more productive, and my standard of living goes up,” Eberly explains. But if productivity growth continues to lag, the standard of living in the U.S.—measured by indicators like income disparity, housing affordability, and healthcare access—could also stagnate.

Pinpointing elderly focused pharmaceutical innovation as one potential cause of this stagnation could suggest ways to offset it, Eberly says. One method would be to increase medical R&D in the public sector, which has been declining for decades.

“If we’re trying to stimulate productivity, we could focus on nudging government spending toward the type of medical research that benefits a broad spectrum of ages, like antibiotics, which was a major historical breakthrough,” she says. “The private returns on investment in innovation will follow market demand. But that need not always provide the social returns we need from productivity growth.”

Featured Faculty

Henry Bullock Professor of Finance & Real Estate; Director of the Guthrie Center for Real Estate Research

James R. and Helen D. Russell Professor of Finance; Senior Associate Dean for Strategy and Academics

John L. and Helen Kellogg Professor of Finance

About the Writer

John Pavlus is a writer and filmmaker focusing on science, technology, and design topics. He lives in Portland, Oregon.

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