Microsoft (NSDQ: MSFT) is downsizing its high-profile Live Labs group, which was created three years ago to speed up innovation in the company’s online business, paidContent.org has learned.

The group, whose mission has been to hatch new ideas and eventually pass them on to product teams at the company, voted twice a year on what projects team members should work on for the next six months. Team members also devoted a week each quarter to a project of their own choosing. Projects didn’t necessarily always have direct applications to Microsoft products.

Microsoft spokeswoman Stacy Drake McCredy said the economy had forced the company to rethink the group’s mission. The death of Live Labs as it has existed, combined with Google’s decision to cut some of its more experimental products, raises the question of whether these kind of futuristic initiatives are falling out of fashion among leading internet companies, or are just a victim of this recession.

Moving forward, about half of the Live Labs group will remain but will focus solely on search, while the other half will join product groups within Microsoft, including Windows Mobile and the company’s online services division, says McCredy. Splitting up the group is an about-face for Microsoft, which had argued that it made sense to have a separate internet-specific applied research group that worked outside of its online product teams.

“Economic conditions are imposing constraints that challenge the original Live Labs model by diminishing the group’s ability to transfer innovations to business groups who’re understandably giving priority to “needs” vs. “opportunities,’” she said. “The move is also part of an effort to ensure innovation investments aren’t spread too thin, increasing the likelihood that those investments will achieve critical mass and have a positive impact on the company.”

Live Labs’ best-known success has been Photosynth, a 3-D photo stitching application, which was launched last summer, and has since been folded into Microsoft’s MSN business.