Conservative economists often criticize government involvement in private markets, arguing that at best it is inefficient and at worst is counterproductive. However, even the great conservative economist Milton Friedman often pointed out that government intervention is necessary when markets fail to allocate resources efficiently.
Even the most conservative economists should support the Small Business Innovation Research (SBIR) program – a scheme in which 11 federal agencies with external research and development budgets of more than $100 million must allocate 2.8 percent of those budgets to grants or contracts with small businesses undertaking projects that both have commercial potential and meet the R&D goals of the funding agency. The SBIR program overcomes the failure of private markets to fund innovation when the benefit to society exceeds the benefits to the private firms undertaking it. By overcoming this market failure, the SBIR program makes all of us better off, facilitating the allocation of resources to the development of new materials, medical technologies, software, and the like.
Private businesses fail to allocate resources for early-stage technological innovation at the level society desires because new technologies are often too uncertain for their future prospects to be judged and because they are too far from commercialization for companies to capture the benefits of providing them.
Moreover, private capital markets are often reluctant to fund companies that undertake early-stage technological innovation. New and small firms conduct much of the breakthrough technological innovation that occurs in this country because the incentive of ownership (which is much easier to provide in young and small businesses) is generally necessary to get people to put in the effort and take the risks necessary to develop fundamentally new ideas. But private capital markets often fail to provide sufficient financing to the new and young companies trying to develop early-stage technologies because venture capitalists and business angels find it difficult to assess their potential financial returns and the time horizon necessary to produce those returns. As a result, new and young firms frequently fail to obtain the capital they need to undertake early-stage innovations, leading to less innovation than what society desires.
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In the absence of schemes like the SBIR program, the federal government’s R&D needs would not be met. Often the government itself lacks the capability to develop new technologies on its own. Moreover, the private sector generally does not find the government’s R&D problems to be a worthwhile investment because the solutions to those problems frequently cannot be turned directly into commercial products in the marketplace.
SBIR grants mitigate these market failures by providing small business owners with a source of capital that does not depend on private-market allocation. Analysis by both academics and policymakers shows that the scheme works. Numerous studies show that the SBIR program makes possible innovations that would not have been developed in the absence of government intercession.
While the SBIR program involves policy makers’ intervention in private markets, it’s the type of intercession that should satisfy even conservative economists. The economic benefits of funding SBIR projects greatly exceed the costs of doing so because the program allows new and small businesses to use government funding to develop early stage technologies to the point that they can be evaluated and supported by private capital markets. By overcoming market failure in the development and financing of early stage technology, the SBIR program makes possible commercial activity that would not otherwise have occurred, helping to produce otherwise absent innovations that benefit society.