1. Economics of Science Address to the Baker IDI Heart and Diabetes Institute Sinclair Davidson

2. Economics of Science Economic interest in Science: –Science is a source of economic growth. –This is an argument about innovation and R&D. –Scientific labour markets. –Science and the private/public good divide. –“What goods and services should a community supply publicly through political-government processes rather than privately through market processes?” James Buchanan. RMIT University © 2012 Economics, Finance & Marketing 2

3. Australian Investment Source: Health of Science Report RMIT University © 2012 Economics, Finance & Marketing 3

4. Australian Investment Source: Health of Science Report RMIT University © 2012 Economics, Finance & Marketing 4

5. Australian Investment Source: Health of Science Report RMIT University © 2012 Economics, Finance & Marketing 5

6. Australian Investment Source: Health of Science Report RMIT University © 2012 Economics, Finance & Marketing 6

7. Australian Investment Source: Health of Science Report RMIT University © 2012 Economics, Finance & Marketing 7

8. Australian Investment Source: ABS Cat. 8112.0 RMIT University © 2012 Economics, Finance & Marketing 8

9. RMIT University © 2012 Economics, Finance & Marketing 9 Australian Investment Source: ABS 8104.0 (various)

10. RMIT University © 2012 Economics, Finance & Marketing 10 Australian Investment Source: ABS Cat. 8112.0

11. RMIT University © 2012 Economics, Finance & Marketing 11 Australian Investment

12. RMIT University © 2012 Economics, Finance & Marketing 12 R&D as a Public Good Vannevar Bush –Drove the huge growth in publicly funded science in the US. –Promoted the linear model.

13. RMIT University © 2012 Economics, Finance & Marketing 13 Francis Bacon and Adam Smith on innovation Linear Model (Francis Bacon) Academic Science → Technology → Wealth Adam Smith –Project Hindsight (1969) –A US government analysis of 700 ‘research events’ in the development of 20 weapon systems –2 out of 700 were due to basic science.

14. RMIT University © 2012 Economics, Finance & Marketing 14 R&D as a Public Good Vannevar Bush –Promoted the linear model. –Drove the huge growth in publicly funded science in the US. Arrow (1962) associated with market failure. –Indivisibility. –Inappropriability. –Uncertainty. –Romano (1989), “In the frictionless perfectly competitive market, with no barriers to the use of information, the market will provide no R&D investment.”

15. RMIT University © 2012 Economics, Finance & Marketing 15 R&D as a Public Good Public goods have two characteristics: –Non-excludable (indivisible) –This is a function of property rights –Non-rival (inappropriable) –This is function of technology –Can be an innate part of the product –Information is (usually) non-rival

16. RMIT University © 2012 Economics, Finance & Marketing 16 R&D as a Public Good

17. RMIT University © 2012 Economics, Finance & Marketing 17 R&D as a Public Good The legal system and intellectual property rights operate to exclude and protect R&D activity. –Legal system may be over-excluding: Patent thickets and FTA with US, EU. R&D can be rival. –“have you cloned an organism recently? Or etched a silicon chip? Nor have I.” Terence Kealey “Over time progressively fewer references have been made to the empirical evidence, and more to the standard theorems of welfare economics. Whilst it might be advantageous in the economics classroom to assume that basic science is instantly applicable and easily transferable, … such assumptions are empirically invalid, and have effectively restricted debate.” Keith Pavitt 1993 R&D is not a public good.

18. RMIT University © 2012 Economics, Finance & Marketing 18 What about uncertainty? The impact uncertainty has on the real economy, as opposed to theoretical analyses is oversold. “Actually, most economic actions are taken under conditions of imperfect knowledge and under circumstances where the outcome cannot be known with certainty. In this respect applied research does not differ from other forms of economic activity.” Gordon Tullock 1966.

19. RMIT University © 2012 Economics, Finance & Marketing 19 The modern case for public science Science is a public good. –Science will be underprovided by the market. –Not Convinced. Science has positive externalities (spillover). –Science is associated with market failure. –Government can correct that failure by investing in science. Public science is an important part of the education system.

20. Basic Model RMIT University © 2012 Economics, Finance & Marketing 20

21. Basic Model RMIT University © 2012 Economics, Finance & Marketing 21

22. RMIT University © 2012 Economics, Finance & Marketing 22 Basic Model How big is the gap? –William Boumol: 80 percent –Jones and Williams: 2 – 4 times current investment Is this plausible? –Does the gap represent net or gross investment? –Are these competitive or monopolistic firms? What about social costs?

23. RMIT University © 2012 Economics, Finance & Marketing 23 Basic Model

24. RMIT University © 2012 Economics, Finance & Marketing 24 Basic model is flawed Hayek’s Information Problem –“how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know.” –It is impossible for government to estimate the societal benefits from R&D in advance. –The social benefit curve can only be established ex post. Buchanan’s Cost and Choice –Choice-influencing cost is subjective, “that which the decision-maker sacrifices or gives up when he makes a choice.” –“That which happens after choice is made is what economists seem to be talking about when they draw their cost curves on the blackboards and what accountants seem to be concerning themselves with.” –The cost curves cannot be observed.

25. RMIT University © 2012 Economics, Finance & Marketing 25 Basic model is flawed Coase’s Black Board Economics –“The analysis … floats in the air.” –“This is, of course, blackboard economics, in which with full knowledge of the curves (which no participant in the actual economic process possesses), we move factors around (on the blackboard) so as to produce an optimal situation. This may well be a good way of teaching the tools of economic analysis but it gives students a very poor idea of what is normally involved in deciding on economic policy.”

26. RMIT University © 2012 Economics, Finance & Marketing 26 Basic model is flawed Adam Jaffe: “the extreme difficulty of observing the actual spillovers except anecdotally”. Zvi Griliches: “ideas borrowed by research teams of industry i from the research results of industry j.” –What does it mean to ‘borrow’ an idea? –Borrow – ‘obtain the temporary use of’

27. RMIT University © 2012 Economics, Finance & Marketing 27 Basic model is flawed

28. RMIT University © 2012 Economics, Finance & Marketing 28 Basic model is flawed Adam Jaffe: “the extreme difficulty of observing the actual spillovers except anecdotally”. Zvi Griliches: “ideas borrowed by research teams of industry i from the research results of industry j.” –What does it mean to ‘borrow’ an idea? –Borrow – ‘obtain the temporary use of’ Richard Nelson: “External economies result from two facts: firstly, that research results often are of little value to the firm that sponsors the research, though of great value to another firm, and, secondly, that research results often cannot be quickly patented.”

29. RMIT University © 2012 Economics, Finance & Marketing 29 When Should Government Fund Activity? “… though they may be in the highest degree advantageous to a great society, [they] are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals.” Adam Smith 1776. – advantageous –could never repay the expense

30. RMIT University © 2012 Economics, Finance & Marketing 30 When Should Government Fund Activity?

31. RMIT University © 2012 Economics, Finance & Marketing 31 What is the cost of public funds? Long-term government bond rate –Should government pay the equity risk premium? Cost of private funds scaled up by deadweight costs of taxation. –Deadweight costs of taxation may be very high! –Henry Review –Corporate income tax 40% –Personal income tax 24% –The notion that government funding is ‘cheaper’ than private sector funding is simply wrong.

32. RMIT University © 2012 Economics, Finance & Marketing 32 What is the return to publicly funded research? This is a eleven billion dollar question. Estimated returns are very high –Australian Research Council Study –Top-Down approach = 50 percent pa (?) –Bottom-Up approach = 39 percent over 4 – 10 years Problems Look-back Bias & Survivorship Bias Crowding out

33. RMIT University © 2012 Economics, Finance & Marketing 33 What is the return to publicly funded research?

34. RMIT University © 2012 Economics, Finance & Marketing 34 Can government pick winners? Private sector performance: –Edwin Mansfield et al. success rate = 13% –Edwin Mansfield et al. success rate = 27% –Thomas Astebro, median return = -7% –Private sector is not very good Arthur M Diamond Jr. –Chemistry papers from 1985 Science. –‘the most straightforward interpretation is that private funders are more successful than the government at identifying important research.’ Brian Jacob and Lars Lefren (2007) –Look at the impact of US National Institute of Health grants 1980 – 2000 –Result is one additional paper over five years.

35. RMIT University © 2012 Economics, Finance & Marketing 35 Does Public Science lead to economic growth? OECD (2003) The sources of economic growth in OECD countries

36. RMIT University © 2012 Economics, Finance & Marketing 36 Does Public Science lead to economic growth? “The negative results for public R&D are surprising and deserve some qualification. Taken at face value they suggest publicly-performed R&D crowds out resources that could be alternatively used by the private sector, including private R&D. There is some evidence of this effect in studies that have looked in detail at the role of different forms of R&D and the interaction between them.”

37. RMIT University © 2012 Economics, Finance & Marketing 37 Myths of Public Science The Myth of Infinite Return: –There is a notion that money spent on science and innovation automatically, at some point, translates into economic growth. –This is an argument about stocks and flows of knowledge. The Myth of Unfettered Research: –This myth argues that not only will basic research have some long-term value, but any curiosity-driven research is likely to have some long-term value. –This myth rejects any notion that public funding of science be subject to a cost-benefit analysis – the more public science the better. The Myth of Accountability: –All researchers need do is deliver research that is ‘scientifically sound’. In other words, scientific excellence is social accountability. –This myth suggests that because science is a self-regulating self- correcting process that it is best left to the scientists. –This myth has been sorely tested over the ClimateGate emails scandal.

38. RMIT University © 2012 Economics, Finance & Marketing 38 Myths of Public Science The Myth of Authoritativeness: –Contrary to the myth, science cannot resolve political controversy. The notion that politicians can simply make decision by recourse to ‘the facts’ is nonsense. –Political controversy revolves around value-judgements and cost-benefit analysis, not just scientific fact. –Scientists cannot predict the future any better than economists (who are pretty bad at it too).

39. RMIT University © 2012 Economics, Finance & Marketing 39 Myths of Public Science The Myth of the Endless Frontier: –The myth that new knowledge has no moral consequence. –Science should not push too far against societal mores. –Greater danger for public science – private science has a profit motive and must find willing customers. –Stem-cell research. –Irrational hypocrites? –Genetic slavery? –Informed consent. –Nelson and the rejected ARC grants.

40. RMIT University © 2012 Economics, Finance & Marketing 40 Conclusion Government should only fund R&D as a consumer of research. R&D is not a public good. The costs of public funds are high. The returns to public R&D are low. Government is poor at picking winners. Public R&D has negative impact on economic growth. Standard economic model is flawed.

41. RMIT University © 2012 Economics, Finance & Marketing 41 Conclusion This is a huge topic –I have just scratched the surface It is not clear that government can achieve its stated objectives for public science To be blunt; it isn’t really a lot of money –So should we do nothing? –Tinker around the edges? –Stop most of it now?

42. RMIT University © 2012 Economics, Finance & Marketing 42 Suggested Reading Terence Kealey, 1996, The scientific laws of scientific research. Terence Kealey, 2009, Sex, science and Profits. Thomas Barlow, 2006, The Australian miracle. Sinclair Davidson, 2006, Back to basics, Institute of Public Affairs. Productivity Commission, Public support for science and innovation (chapter 4) Health of Australian Science report, available from http://www.chiefscientist.gov.au/2012/05/health-of-australian-science-report- 2/ http://www.chiefscientist.gov.au/2012/05/health-of-australian-science-report- 2/ Daniel Sarewitz, 1996, Frontiers of illusion. Daniel Greenberg, 2001,Science, money, and politics.