Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / How Stagflation Is Reshaping Corporate R&D Spending
Transcript
- Lucas: When you think about stagflation, the image is usually one of retrenchment — companies slashing costs, freezing capital spending, hunkering down. But the data on corporate R&D tells a different story. The National Science Foundation reported last month that U.S. businesses spent a record $800 billion on research and development in 2025, up 9% year-over-year. Luna: That's counterintuitive. We're sitting here in late May 2026 with inflation still sticky, consumer sentiment at a fresh record low, and real GDP growth barely at 2%. Why are companies spending more on R&D now? Lucas: It's a bet on the future, but it's also a hedge. Look at the labor market — job openings fell to 6.87 million in March, down from nearly 7 million. Companies are finding it harder to hire, and when they do, wages are up about 2.8% year-over-year. So instead of adding headcount, many are investing in automation and new products that can boost productivity. Luna: Right, because in a stagflation environment, your input costs are rising — energy, materials, labor — but your pricing power is fading. The only lever left is efficiency. Lucas: Exactly. And the data backs that up. The sectors with the biggest R&D increases are industrials, healthcare, and information technology. For example, one large industrial conglomerate I follow boosted its R&D budget by 12% last year, specifically to develop energy-efficient equipment that helps customers lower their own costs. Luna: So it's almost a defensive move. If you can't pass on higher costs to customers, you need to reduce your own cost structure through innovation. Lucas: That's part of it. But there's also a strategic element. During the 1970s stagflation, many companies cut R&D to protect earnings, and they paid for it later when the economy recovered and they had no new products. The ones that kept investing emerged stronger. I think management teams today are very aware of that history. Luna: Let's talk about the risks though. We're seeing real GDP growth at 2% annualized, and the 10-year breakeven inflation rate is at 2.39%, down a hair but still elevated. If we slip into a recession, those R&D budgets could get slashed fast. Lucas: True. But the timing matters. R&D spending is typically a lagging indicator in downturns because projects are already in the pipeline. The second half of 2026 could be the test. If consumer demand keeps weakening — and with the Iran war fueling energy inflation, that's a real possibility — then we might see some pullback. Luna: The Fed's Kashkari said this morning that the inflation fight takes priority, and the labor market is in decent shape. That suggests rates stay higher for longer, which makes R&D financing more expensive for smaller companies. Lucas: Absolutely. The R&D surge is concentrated among large firms with strong balance sheets. Small businesses are actually pulling back. The NFIB survey last month showed that the share of small firms planning capital expenditures dropped to a three-year low. So the R&D story is really a story of divergence. Luna: It's a tale of two economies. Big tech and industrials are placing long-term bets, while Main Street is hunkering down. Lucas: Precisely. And that has implications for productivity growth down the road. If the large firms succeed in automating and innovating, they'll come out of this period with higher margins and market share. But if demand collapses, all that R&D could turn into a sunk cost. Luna: So what's the signal for investors? How do you track whether this R&D spending is paying off? Lucas: Look at patent filings as a leading indicator, and then revenue per employee as a lagging one. Also, watch the ratio of R&D to sales — if that number is rising but gross margins are stable, that's a good sign. If margins are compressing, it suggests the R&D isn't translating yet. Luna: That's a useful framework. And speaking of the broader context, we've been talking about how the economy is reshaping corporate strategy, and honestly, episodes like this are exactly why we keep this show ad-free. Lucas: Yeah, we want to be able to dig into data like the NSF numbers or the JOLTS report without any pressure to sell something. If you find that valuable, and you want to support the choice to stay ad-free, you can do that at buy me a coffee dot com slash fexingo. Luna: It's a small gesture that helps us keep the lights on and the content independent. No obligations, but we appreciate it. Lucas: So back to the R&D divergence. Another interesting angle is that some companies are using their R&D budgets specifically to mitigate supply chain risks. We've talked about reshoring in previous episodes, but the R&D spending is often the precursor to that. Luna: You mean developing new manufacturing processes that can be done domestically? Lucas: Exactly. For example, in the semiconductor space, a lot of the R&D going into advanced packaging is aimed at reducing reliance on overseas fabrication. The CHIPS Act provided some incentives, but the private R&D spending is multiples of that. Luna: So it's a long-term competitiveness play. And that's particularly relevant given the geopolitical tensions we're seeing. Lucas: Right. The Iran situation is adding energy cost uncertainty, which makes supply chain resilience even more valuable. Companies that can produce more efficiently with less energy will have a clear advantage. Luna: Let's zoom out. If this R&D boom continues, could it actually break the stagflation dynamic? I mean, productivity gains could boost potential GDP without adding inflation. Lucas: That's the optimistic case. The Fed's preferred measure of core PCE is still running at 2.8% year-over-year, but if productivity accelerates, it could help bring that down. The challenge is timing — R&D takes years to translate into productivity. We might not see the payoff until 2028 or later. Luna: And in the meantime, we're stuck with slow growth and high prices. Lucas: Exactly. That's the stagflation trap. But the fact that corporate America is investing through it is, at least, a sign that the private sector sees a way out. Whether that confidence is justified depends on demand holding up. Luna: One final thought — we mentioned small businesses cutting back. Could that create a bifurcation where large firms capture even more market share, leading to higher concentration? Lucas: It's already happening. The R&D spending gap between the top 100 firms and everyone else has widened significantly. That could lead to more pricing power for the biggest players, which might actually keep inflation stickier than it otherwise would be. Luna: So the R&D boom might be a double-edged sword: good for productivity in the long run, but potentially reinforcing some of the inflationary dynamics in the near term. Lucas: That's the tension. And it's one we'll be watching closely in the quarters ahead.