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June 05, 2006

Public Goods and Private Money

It’s a long standing argument. Must public goods be provided by public money? Or can we get the same or even better returns by having private money supplying public goods (and thus not having the distortion caused by the taxation process to pay for it)?

One area where the argument seems to have been won in favour of public provision is in basic science: clearly the private sector will not finance it so the public must. Terence Keally begs to differ:

In 2003 the Organisation for Economic Co-operation and Development (OECD) published a comprehensive survey that reviewed all the known factors that could explain the different growth rates of member countries. The report found, unexceptionally, “a significant effect of research and development (R&D) activity on the growth process” (that is, research powers economic growth). But then it found, explosively, that it was only “business-performed R&D . . . that drives the positive association” (only private research powers economic growth).

Even more explosively, the OECD found that the public funding of R&D appeared to damage economic growth because it “crowds out resources that could be alternatively used by the private sector, including private R&D” (ie, the public funding of research does indeed displace the more useful private funding).

Contrary to myth, the private sector does tons of science — because it is so profitable. Consider IBM. The Times Higher Education Supplement’s survey last year showed that Harvard University’s science papers are the most cited globally (20.6 citations per paper on average) but coming in second was IBM (18.9), outranking all other universities and research bodies. And because IBM invests so much in science, it has for the past 12 years been awarded more patents (3,000 annually) than any other institution. And by its patents IBM earns more than $1 billion annually in licence fees.

The scientists will not easily surrender their faith in government funding, but because public money crowds out private money it tells us that science is not the public good of Bush’s book. Science is not a field of endeavour on which taxpayers’ money need be spent.

Fighting words, eh? Sould be noted that Keally is the Vice-Chancellor (in UK terms, the guy who really runs the place) of the only private University in the country. One possible reaction to his saying this is "Well, he would, wouldn’t he?" but perhaps a supporter or two of public funding of science might like to make a more substantial defense of the necessity for it?

June 5, 2006 in Your Tax Money at Work | Permalink


Steady now, steady. Let's not spoil our case by conflating "science" with "technology". IBM unarguably does a lot of science research, but the vast majority of its patents concern advances in technology. The volume of patents isn't a good measure of the amount of private research into basic science that isn't close to commercial exploitation.

Posted by: Martin Audley | Jun 5, 2006 9:58:03 AM

Might it not be that private organisations are better placed to identify areas of research likely to generate profit? Compare and contrast the CEO of a large corporation with a minister in charge of doling out government research dosh.

The CEO will, hopefully, have some incling about business and the fields in which his company works. He is also answerable to the shareholders who simply want to see a good return on their investment. He should be able to give direction to the mad scientists his company employs and is in a position to demand results either by cutting unproductive lines of research or rewarding breakthroughs.

The minister on the other hand is an expert in getting elected and keeping his party leader happy. It is highly unlikely he will have any business or scientific background. He is thus more likely to believe the blandishments of every Tom, Dick and Frankenstein; especially if their field of research is one that has caught the media's attention. He has very little knowledge or even power to demand results or reward success. The scientists, once on the gravy train, have very little incentive to produce definitive results that may have the effect of shutting off their revenue stream.


Posted by: The Remittance Man | Jun 5, 2006 9:58:37 AM

Often the argument for public investment rests on the market failure arising from positive externalities being generated for society at large from private expenditure on R&D - in the end acting as a disincentive to private sector, or justifying public sector intervention. That's the kind of classic argument often used.

Some (public) effort is made towards encouraging private enterprises to engage in R&D more.

Difficult also to capture an accurate assessment of private R&D activity - some of it is very hard to measure or account for.

My main finding, working in this area a little bit - is that there's a lot of theory about market failure but very little hard evidence. Too much is driven by politics - e.g. shiny new campuses and research institutes look nice when you have your photo taken cutting the ribbon, you are fighting against Britain's "Brain Drain" etc.

Much progress has been made to try and establish public-private funding of applied research institutes. Jury is still out on their success or not, as the case may be.

Posted by: angry economist | Jun 5, 2006 11:14:45 AM

In defence of Keally, he argued along the same lines when he was at Cambridge.

Posted by: dearieme | Jun 5, 2006 12:33:44 PM

Before considering whether private money could adequately fund "big science", we first need to question whether basic research is in fact the public good that it is usually assumed to be. IMHO, some projects, e.g. string theory, are so far from bearing technological fruit that it is hard to justify public funding for them.

University physics departments in the UK are awash with research cash at the moment. At the same time, the number of physics graduates is in decline. Result: there's a lot of uninspiring research being carried out by mediocre postgrads at the public's expense. (I know this because I was almost one of them - I was offered a relatively well-paying PhD position despite my poor 2:1 and lack of interest and expertise in the topic). Don't know if this is mirrored in the other sciences, but if it is, we ought to be seriously rethinking the scale of public investment.

Posted by: Jon | Jun 5, 2006 3:15:56 PM

PhD positions pay reasonably, but only because the stipend does not attract tax. From the point of view of the employer, they are very cheap.

Actually, from the point of view of the University, a PhD student actually has negative cost - the University is awarded a certain number of studentships by PPARC, and if it fails to fill them, it tends not to be given so many the next year. Thus there's a pressure to fill the places with medicore students in an off year in order to have places available for good students in a good year. Failing to graduate students within 4 years is also grounds for losing PhD places, so there is a pressure on Universities to, shall we say, be careful in their choice of examiners for the weaker student.

As I said, though, students are free to the University, and pretty cheap to PPARC, so if you hire a bunch of average 2:1s, and half of them go on to do something useful, you're still on a winner. Don't get stuck on "lack of expertise" - no incoming PhD student has expertise. Expertise is what you're supposed to leave with, not arrive with.

If you look at the things in Physics which actually cost real money (experiments and senior people) you find that there is not a glut of faculty jobs in Physics. There are quite a lot of postdoc jobs around, but again, postdocs are fairly cheap (though not nearly as cheap as students), are expected to work 80-hour weeks, and you can afford to hire several in order to get a couple of good ones (it's not always easy to predict which postdocs will be useful and which won't.) There is also not a glut of money available for physics experiments. There's plenty of money for anything that can be described as "e-science", which has lead to, frankly, shocking amounts of pointless time-wasting masquerading as "research", but actual science is not so well supported (although it's a bit better now than it was a few years ago).

There's certainly an argument about whether taxpayers should fund basic science at all. It's probably true that nobody other than the taxpayer will ever fund an LHC, or an ILC, so the effect of no taxpayer funding is likely to be that those things don't get done. You can certainly argue that.

I should point out, though, that we're not actually talking about a large fraction of government spending here. The entire ILC will cost significantly less than the new NHS computer system, and will actually work as intended (I'll let you decide whether its goals are useful or not).

You might be interested in the report recently written for the US Congress by Norm Augustine (entitled something like "rising above the gathering storm") that adresses the question of whether the US should fund basic science.

Posted by: Sam | Jun 5, 2006 6:21:03 PM

In the whole public vs private debate, I begin to think of turbojets vs high bypass turbofans. The turbojet is a noisy gas guzzler, tremendously inefficient. A turbofan is much quiet and far more fuel efficient. You would normally think that a turbofan should do it all. But there are some cases where the turbofan won't work like at supersonic speeds. Only a turbojet can power a supersonic aircraft. So while the turbofan is better most of time, the turbojet has its own important uses.

Public spending is like the turbojet. It is inefficient, but there are some circumstances when only it will do. Private spending is like the turbofan. Far more efficient and practical most of the time, but it can't do everything.

Posted by: Josh | Jun 5, 2006 6:31:55 PM

Lots of non sequiteurs in that piece in The Times.

The US may well have become the richest country in the world before WW2 in terms of per capita GDP despite the federal government spending little or nothing on supporting R&D because of other factors. After all, Britain had pioneered industrialisation in the early 19th century as the result of private initiative, not state direction of, or investment in business. The relative affluence of the US c. 1940 depended on abundance of natural resources plus the labour skills brought in by European migrants, including capital market trading skills. Unlike Europe, the US suffered relatively lightly from WW1. It is well documented that commissioned officers were disproportionately represented among Britain's battlefield casualties of c. 900,000 in that war, a total that was at least twice as great as Britain's total WW2 casualties.

Recall too that before the entirely accidental discovery of Penicillin in 1928, precious few effective pharmaceutical medications had been discovered by private investment in R&D - aspirin being among the very few counter-examples. What the discovery of Penicllin demonstrated was that there existed a class of antibiotics which could be effective in treating a wide range of bacterial induced diseases. That discovery reduced downstream technical and market risks of investing more in pharmaceutical R&D to discover more antibiotics - and that reduction of risk was and is a "public good".

(Pure) public goods have two properties of which only one is crucial. The two properties are:

(A) the good is non-rivalrous in consumption, meaning that the amount remaining available for consumption is undiminished if an individual increases their personal consumption - a typical example: if I turn on the radio or TV that doesn't reduce the amount of radio or TV you can listen to or watch whereas if I buy another loaf of bread there is then less bread to go around for everyone else.

(B) it is not possible to apply the exclusion principle, meaning that access to the good cannot be be made conditional upon payment by the individual consumer.

It turns out that (B) is crucial, which is demonstrated by the example of conditional access to TV channels. Of course, public goods can be supplied as the result of private, profit-seeking investment but there will be no incentive to do so unless it is possible to earn returns from doing so - which is why satellite TV applies conditional access and software companies like Microsoft beat the drum trying to prevent circulation of counterfeit copies of their software.

The point is that unless investors in innovation can fully capture the additional net social value generated by innovating investment there is a diminished incentive to invest more. However, the Penicillin example shows that the value of the public good created in that case will not be fully captured.

The Times piece also cherry picks in selecting IBM to make its case about private funded R&D. IBM for profit-seeking motives concluded that investment in cutting edge science was and is necessary to maintain the company's competitive advantage in the semiconductor and computer services markets. But then Dell is able to maintain its lead in the global PC market by a very low ratio of R&D spending to corporate sales compared with other electronics companies because its competitive advantage is with PC assembly and marketing, not cutting edge science or technology. And btw IBM made record profits around the mid 1980s from PC assembly and sales but the PC was essentially (and intentionally) low-tech - IBM made its money from establishing a new de facto standard for microcomputers which came to dominate the global market.

Posted by: Bob B | Jun 5, 2006 7:03:21 PM