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Do we still need public research funding?

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This article was written by Dr Federica Rossi from Birkbeck’s Department of Management and Professor Aldo Geuna from the University of Torino

r-and-dThe last few decades have witnessed the increasing privatisation of the public sphere – even in the realms of education and research, which, until recently, almost exclusively pertained to the public sector. Evidence from Organisation for Economic Co-operation and Development (OECD) countries shows that the slow but steady increase in private sector Research & Development (R&D) expenditure as share of GDP has been accompanied by a parallel drop in public R&D expenditure since the 1980s. A mere handful of economies buck the trend, such as that of South Korea. This has recently been referred to by Birkbeck’s Professor Daniele Archibugi and Dr Andrea Filippetti in their new paper as the “retreat of public research”. In the most advanced economies this retreat might seem, at face value, to support the claim that public intervention in research is unnecessary, if not completely counterproductive to sustain technological progress.

Most economists agree that public research funding is crucial for economic growth…

The mainstream view that public funding of basic research is necessary for technological progress to occur, relies on two, intertwined arguments that were first put forward in the 1940s and 1950s, and have been reiterated in various forms ever since. The first is the argument, which is embraced by scientists but originated in management schools, that innovation is a linear process whereby basic research discoveries pave the way for subsequent applied research and technological development. The second is the argument put forward by economists that basic research is characterised by large externalities and extreme uncertainty in the timing and nature of its outcomes, which make the computation of returns extremely difficult and discourages private companies from investing. Basic research outcomes tend to be very abstract and codifiable; this vulnerability to copying further discourages private investment in their production.

Together, these arguments suggest that, in order to sustain a rate of technological progress that is sufficient to drive continuous growth, the economy needs to produce a continuous amount of basic research outcomes, which would not occur in the absence of public funding.

…but some think that public research funding is unnecessary…

Those calling for a reduction in government funding of science have, in turn, put forth several arguments to oppose the mainstream view. The first is that the linear model of innovation is not only too simplistic, but wrongly organised: throughout history, technological developments have more often than not originated from efforts to solve practical problems without prior scientific basis. Rather than underpinning technological development, basic research has a habit of following promising technological developments. As Matt Ridley interprets in a recent article on the Wall Street Journal: “The steam engine owed almost nothing to the science of thermodynamics, but the science of thermodynamics owed almost everything to the steam engine.” The second is that basic research effectively crowds out private funding. In the absence of public funding, private companies would still invest in basic research to further consolidate their knowledge of how previously invented technologies actually work, which assists further innovation, and would want to do so in-house, rather than free ride on competitors’ basic research outcomes, to generate tacit knowledge which would give them a competitive advantage over rivals. Indeed, free from the crowding-out effect of public funding, private companies might have invested in basic research, which may have yielded more productive outcomes than the basic research funded by government.

…The middle ground: public research funding for the knowledge economy

As  is the case for most complex social phenomena, the nature of technological progress is probably best understood by combining different theoretical perspectives. Suggesting that all technological developments would have occurred in the absence of prior scientific knowledge is just as simplistic as the opposing argument – that basic research is always the first step of a linear innovation process. While the rich history of technology can be mined for examples of each of these extremes, most innovations tell a complex story of coevolution between basic research and technological development, where both private and public research funding play a role. For example, Dosi and Nelson (2010) have suggested that, while the development of the steam engine in the early 18th century preceded scientific developments in thermodynamics and the theory of heat, this technology was indeed built on the foundations of earlier scientific developments (the understanding of the properties of atmospheric pressure investigated by Torricelli, Boyle and Hooke in the 17th and 18th century). This coevolution between science and technology would explain why the steam engine was not invented in China, where all its components (pistons, cylinders, etc,) were known and employed.

Basic science and technological development coevolve, and the problem begins to look like the chicken and egg situation. Nonetheless, there are several compelling reasons for continued public funding of basic research. On the one hand, private companies in the main cannot commit to continued funding of a research programme in the long or even medium term; not only because they tend to respond to short term investor concerns, but also because their very survival is not guaranteed. Even if some companies committed to keep their lines of inquiry open in the absence of early promising research outcomes (something which few companies appear willing to do) there is no guarantee that that programme would not be destroyed by business failure – an increasingly frequent and rapid occurrence even in larger corporations. Public funding provides a buffer to research exploration, which opens up to society a range of research avenues that simply would not occur in its absence, and whose results may be reaped many decades later, benefitting the economy in unexpected ways. Sometimes, basic research is so distant in time and origins from the innovations it contributes to, that such contribution goes unnoticed; current developments in text mining and even speech recognition technology owe a huge debt to many decades of obscure publicly funded research carried out in linguistics departments but this contribution is hardly something that springs to mind when thinking of Siri or Alexa bots. On the other hand, as Archibugi and Filippetti point out, private companies and governments have different incentives in the dissemination of research outcomes: private companies as a rule will give away as little as possible or will only give away knowledge under certain conditions, which again limits the range of research avenues that can be explored starting from existing research.

What the knowledge economy needs is a functioning ecosystem where both public and private research contribute to the creation of new knowledge, its dissemination and commercial exploitation, and create the conditions for further knowledge production. The better interconnected the two spheres, the better the system can promote an efficient division of labour between privately funded and publicly funded research, and the better it can discourage the duplication of research effort. Moreover, the better it can ensure that knowledge can be freely disseminated as much as possible without hurting commercial interests. The economic impact of the “retreat of public research” might not be negative if it has been accompanied by the growth of a more interconnected research system in which public research has become a more efficient complement to private research. However, this is a rather unexplored hypothesis at the macro level – and even if this were the case, it would still not imply that the latter can replace the former. Public research continues to play a vital role in the knowledge economy.

Professor Aldo Geuna and Dr Federica Rossi are the authors of The University and the Economy Pathways to Growth and Economic Development Cheltenham: Edward Elgar (2015). Now available in paperback.

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Trump and Brexit: why it’s again NOT the economy, stupid

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This post was written by Professor Eric Kaufmann from Birkbeck’s Department of Politics. It was originally published on the LSE British Politics and Policy blog

As the final votes are counted, pundits and pollsters sit stunned as Donald J. Trump gets set to enter the White House. For anyone in Britain, there is a sharp tang of déjà vu in the air: this feels like the morning after the Brexit vote all over again. Eric Kaufmann explains that, as with Brexit, there’s little evidence that the vote had much to do with personal economic circumstances.

For months, commentators have flocked to diagnose the ills that have supposedly propelled Trump’s support, from the Republican primaries until now. As in Britain, many have settled on a ‘left behind’ narrative – that it is the poor, white, working-class losers from globalization that have put Trump over the top. Only a few clairvoyants – Michael Lind, Jonathan Haidt – have seen through the stereotypes.

But, as in Britain, there’s precious little evidence this vote had much to do with personal economic circumstances. Let’s look at Trump voting among white Americans from a Birkbeck College/Policy Exchange/YouGov survey I commissioned in late August. Look at the horizontal axis running along the bottom of figure 1. In the graph I have controlled for age, education and gender, with errors clustered on states. The average white American support for Trump on a 0-10 scale in the survey is 4.29.

You can see the two Trump support lines are higher among those at the highest end of the income scale (4) than the lowest (1). This is not, however, statistically significant. What is significant is the gap between the red and blue lines. A full two points in Trump support around a mean of 4.29. This huge spread reflects the difference between two groups of people giving different answers to a highly innocuous question: ‘Is it more important for a child to be considerate or well-mannered?’ The answers sound almost identical, but social psychologists know that ‘considerate’ taps other-directed emotions while ‘well-mannered’ is about respect for authority.

People’s answer to this question matters for Trump support because it taps into a cultural worldview sometimes known as Right-Wing Authoritarianism (RWA). Rather than RWA, which is a loaded term, I would prefer to characterise this as the difference between those who prefer order and those who seek novelty. Social psychologist Karen Stenner presciently wrote that diversity and difference tends to alarm right-wing authoritarians, who seek order and stability. This, and not class, is what cuts the electoral pie in many western countries these days. Income and material circumstances, as a recent review of research on immigration attitudes suggests, is not especially important for understanding right-wing populism.

Figure 1.

1

Now look at the same graph in figure 2 with exactly the same questions and controls, fielded on the same day, in Britain. The only difference is that we are substituting people’s reported Brexit vote for Trump support. This time the income slope runs the other way, with poorer White British respondents more likely to be Brexiteers than the wealthy. But income is, once again, not statistically significant. What counts is the same chasm between people who answered that it was important for children to be well-mannered or considerate. In the case of Brexit vote among White Britons, this represents a 25-point difference around a mean of 45.8 per cent (the survey undersamples Brexiteers but this does not affect this kind of analysis). When it comes to Brexit or Trump, think successful plumber, not starving artist or temporary lecturer.

Figure 2.

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Some might say that even though these populist voters aren’t poor, they really, actually, surely, naturally, are concerned about their economic welfare. Well, let’s take a look at the top concerns of Trump voters in figure 3. I’ve plotted the issues where there are the biggest differences between Trump supporters and detractors on the left-hand side. We can start with inequality. Is this REALLY the driving force behind the Trump vote – all that talk about unemployment, opioid addiction and suicide? Hardly. Nearly 40 per cent of those who gave Trump 0 out of 10 (blue bar) said inequality was the #1 issue facing America. Among folks rating the Donald 10 out of 10, only 4 per cent agreed. That’s a tenfold difference. Now look at immigration: top issue for 25 per cent of white Trump backers but hardly even registering among Trump detractors. Compared to immigration, even the gap between those concerned about terrorism, around 2:1, is not very striking.

Figure 3.

3For Brexit vote, shown in figure 4, the story is much the same, with a few wrinkles. The gap on immigration and inequality is enormous. The one difference is on ‘the economy in general,’ which Trump supporters worry about more than Brexiteers. This could be because in the graph above I am comparing extreme Trump backers with extreme detractors whereas the Brexit-Bremain numbers include all voters. Still, what jumps out is how much more important immigration is for populist voters than inequality.

Figure 4.

4Why is Trump, Brexit, Höfer, Le Pen and Wilders happening now? Immigration and ethnic change. This is unsettling that portion of the white electorate that prefers cultural order over change.

The US was about 90 percent white in 1960, is 63 percent white today and over half of American babies are now from ethnic minorities. Most white Americans already think they are in the minority, and many are beginning to vote in a more ethnopolitical way. The last time the share of foreign born in America reached current levels, immigration restrictionist sentiment was off the charts and the Ku Klux Klan had 6 million members – mainly in northern states concerned about Catholic immigration.

Ethnic change can happen nationally or locally, and it matters in both Britain and America. Figure 5, which includes a series of demographic and area controls, looks at the rate of Latino increase in a white American survey respondent’s ZIP code (average population around 30,000 in this data). The share of white Americans rating Trump 10 out of 10 rises from just over 25 percent in locales with no ethnic change to almost 70 percent in places with a 30-point increase in Latino population.

The town of Arcadia in Wisconsin – fittingly a state that has flipped to Trump – profiled in a recent Wall Street Journal article, shows what can happen. Thomas Vicino has chronicled the phenomenon in other towns, such as Farmer’s Branch, Texas or Carpentersville, Illinois. There are very few ZIP codes that have seen change on this scale, hence the small sample and wide error bars toward the right. Still, this confirms what virtually all the academic research shows: rapid ethnic change leads to an increase in anti-immigration sentiment and populism, even if this subsequently fades. The news also spreads and can shape the wider climate of public opinion, even in places untouched by immigration.

Figure 5.

5Now let’s look in figure 6 at Brexit, and how White British voters in wards with fast East European growth in the 2000s voted. With similar controls, it’s the same story: when we control for the level of minorities in a ward, local ethnic change is linked with a much higher rate of Brexit voting. From under 40 percent in places with no ethnic change to over 60 percent voting Brexit in the fastest changing areas. Think Boston in Lincolnshire, which had the strongest Brexit vote in the country and where the share of East Europeans jumped from essentially zero in 2001 to the highest in the country by 2011.

Figure 6.

6

The Trump and Brexit votes are the opening shots which define a new political era in which the values divide between voters – especially among whites – is the main axis of politics. In a period of rapid ethnic change, this cleavage separates those who prefer cultural continuity and order from novelty-seekers open to diversity. Policymakers and pundits should face this instead of imagining that old remedies – schools, hospitals, jobs – will put the populist genie back in the bottle.

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Examining the economy: Forecasting the Osborne’s summer budget

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This post was contributed by Charles Shaw, 4th year BSc Financial Economics student, and member of the Birkbeck Economics & Finance Society

Emergency-budgetOn the 8th of July, the Chancellor of the Exchequer will announce his summer budget, and with it the next stage of cuts.

The latest official estimates indicate that the Government will announce an additional £30bn of austerity measures, with substantive cuts in FY 2016 and 2017, to stabilise in 2018 and rebound in 2019. Although the impact of such cuts will largely depend on how they are allocated across UK Government departments, the Chancellor has already signalled that £12bn of these cuts will come from welfare spending.

This should, if delivered, be sufficient to meet the George Osborne’s own key fiscal targets i.e. to have debt falling as a share of GDP in 2016-17 and to achieve a cyclically adjusted current balance in 2018-19 without having to resort to tax rises.

This trenchant commitment to eliminate the deficit by the end of the decade echoes the pledges made in the Conservative Party manifesto, which set out to “balance the books” and to have “the government taking in more than it is spending for the first time in 18 years.”

Figure-1

UK recovery

This is an ambitious task, considering other manifesto-related spending commitments, such as the doubling of the free childcare allowance, Dilnot reforms, extension of income tax breaks for those on minimum wage, and a freeze on VAT, income tax and NI contributions. An additional constraint is the subdued nature of the UK recovery, which so far has meant that growth in tax receipts has been slower than the UK Government anticipated when it set out its fiscal consolidation plans in 2010.

The current macroeconomic outlook is seemingly benign. Aggressive monetary policy has done its job of stimulating demand in the UK and, as tail risks fade, we can continue to expect growth around 2.5% at low inflation, supported by strong tailwinds of cheap oil and weak euro.

The situation in Europe

At the same time, the Chancellor must be keenly aware of the situation – both economic and political – in Europe. Despite the fact that relations between the United Kingdom, the EU and the City of London have become more fraught since 2008, much of the EU’s economic agenda overlaps with United Kingdom’s. What happens in Europe is and will continue to be vitally important to Britain’s economic interests.

We may bear witness to the fact that the moderate recovery in the Eurozone is ongoing, buoyed by the OMT programme, while QE, oil and the euro should continue to add momentum. The latest macroeconomic projections from the staff at the Eurosystem – the monetary authority that is made up of the ECB and the national central banks of the EU Member States whose currency is the euro – indicate that the euro area will see its annual real GDP increase by 1.5% in 2015, 1.9% in 2016 and 2.0% in 2017.

Figure-2

The global economy

So far so good? Not quite. Perhaps economists are by nature pessimistic, but one cannot escape from the fact that recent growth numbers for the global economy have been disappointing. The details of the growth figures should give pause for thought, too. Lost trend output is not regained, not least in developed economies; growth dynamics, in emerging markets and elsewhere, have dampened; ECB could have done much more to stabilise confidence and demand.

The fact that the UK has seen its growth rate shrink does not augur well for prospects of a full recovery. To make matters worse, it has become patently obvious that the lower crude price is less of a driving force for the global economy than had been previously anticipated. Perhaps, against this background of disappointment, the optimists should start to wonder whether a slowdown is under way.

Critics of the Chancellor’s plans say that the scale of the spending cuts set out in the previous Budget significantly exceeds what is required to meet the UK Government’s own fiscal targets. We shall need to wait and see if the summer budget heralds the return of animal spirits.

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Skills are a risky investment

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This post was contributed by Dr Frederick Guy of Birkbeck’s Department of Management.

A shortage of skills is a source of perpetual anxiety within Britain’s political class. Here’s Tory backbencher Dominic Raab, a few months back in the Telegraph:

The next great problem is our chronic skills gap, which saw Britain plummet down the international rankings in maths, literacy and science. Labour’s arbitrary goal of getting 50 per cent of youngsters into university led to the proliferation of what one of its ministers called “Mickey Mouse” courses, which have benefited neither the students nor the economy. A 2005 Ofsted report found that almost half of those in their twenties said their education had not prepared them for their first job. Far from blaming Europe for this, Michael Gove is rightly learning from it – promoting innovative Swedish-style free schools and a more German emphasis on vocational training.

If we put aside the sniping at Labour and the currying of Gove’s favour, most of this could actually have been written by any of hundreds of politicians from any party at any time in the past thirty years: the schools aren’t delivering the goods, and we don’t do near as good a job at vocational training as the Germans. The skills gap feeds an endemic collective anxiety, the root of the county’s endless obsessive-compulsive re-engineering of its education system – because, surely, finding the right curriculum, the right way to teach, to test, or to select and motivate and cull teachers, is the key to setting this situation right. As for vocational education and apprenticeships, the on-going, multi-party failure in that area could lead one to believe that our Oxbridge-educated leaders can’t bring themselves to really care about something so far from their collective experience: true, perhaps, but like the anxiety about primary and secondary education it misses the point.

The lack of a risk insurance system 

The real problem, which no party in recent decades has even tried to face up to, is that investment in skills is risky. Britain does not have a good system for insuring against this risk. At the root of the skills crisis are the benefit system for those who lose their jobs; and the financing of further and higher education, especially for mature students.

Learning a skill is an investment, and a choice: it takes time that could have been used earning money, or in learning something different. A sensible young person, offered the opportunity to train in some specialist area, might frame the risk like this: “if this skill becomes obsolete when I am forty-five, or if the jobs in this industry get off-shored, who will support me and pay for retraining so that I can get another good job? Will I lose my house?” In many countries on the Continent – Denmark and the Netherlands are actually better examples of this than Germany – the answer is that the social welfare system and the education system will work together to see that you have a new opportunity, and that you don’t have to go through a personal financial crisis before you get to your new career.

The benefits debate

Britain’s ongoing domestic quarrel over the benefit system focuses on people who use it for the long term: are they scroungers, or do they deserve our compassion and support? Lost in this debate is the fact that the system, while too generous to some long-term claimants, is too mean with people who need serious midlife re-training in order to again be productive members of the workforce. The UK benefit system is unusual in allowing so many people to stay on benefits for so long. But for a benefit system to move people on to good jobs, it needs to provide for adequate training and education; and, if we want young people to take risks when they select their educational paths, the jobless benefit needs also to provide income insurance which is adequate to make that the investment in skill attractive despite the risk: during the re-training period it needs to be generous, and proportional (up to some cap) to the individual’s prior income.

The differences between Britain and the rest of Europe

Britain’s benefit system does not do that, and for that reason it leads people here to make different choices about what skills to obtain than do people of Germany, Scandinavia, Switzerland, and the Low Countries – the high-skill manufacturing and exporting engines of Europe. The skills employees have then affect such things as the investments companies make in innovation, a question Andrea Filippetti and I address in a study available here.

This difference between Britain and its continental neighbors is long standing: with respect both to welfare systems and skills, it has roots going back at least to the 1920s. In recent decades, however, the riskiness of investment in skill has been greatly amplified by the globalizing knowledge economy. More rapid technological change is making skills obsolete more quickly. Rapid technological change and shorter product life cycles have also increased the volatility in company financial results, and in the size of the typical company’s workforce; this undermines not only “jobs-for-life”, but also employers’ willingness to share the workers’ risk by providing training, and re-training, internally. Offshoring (made feasible by the combination of modern communications and transportation technologies, and trade liberalization) can shift whole industries from one country to another in very short periods, and that produces extreme uncertainty about the demand for the skills associated with those industries. The risk of offshoring can, in the absence of insurance, actually make offshoring inevitable: if risk depresses investment in skills an industry needs, this in itself can make the industry uncompetitive, and offshoring proceeds apace. As if all that were not enough, climate change is now making its own contribution to the volatility of demand for skill, a contribution which will grow as the needs of adaptation and mitigation will compel rapid change in the technologies we build, install, and use. As long as Britain’s social insurance system cannot compensate for the increased riskiness of investment in skill, the skills of Britain’s workforce can be expected to deteriorate in relative terms.

Skills investment from pre-school to university

Skills that are risky investments are found not only in vocational and technical training, but among university subjects. Wang et al find that students view STEM subjects (science, technology, engineering and mathematics) in that way. In response, students flood degrees in Business and Management – they are not Mickey Mouse, they are Low Risk. They are, for those who can’t go to Oxford, the modern and democratic equivalent of PPE or Classics, qualifying one to work in any industry, in a wide range of roles, up to a point. Often we pretend that this is a virtue, labeling low-risk skills as “transferable”. We do all need some transferable skills, but in education, as in entrepreneurship or in battle, some things can only be accomplished by taking risks.

Risk aversion shapes not only the choice of subjects to study, but also the way in which particular subjects are learned and taught. British employers complain that they can’t find skilled computer programmers, despite years of policy directed at improved IT training at all levels (and I do mean all: six years ago, when my son started nursery at the age of eleven months, that little institution was scrambling to deal with the one black mark in their Ofsted report – a lack of IT training. For better or worse, they fixed the problem.) Part of the problem, infamously, is that UK IT training has emphasized the use of shrink-wrapped software, the administration of Microsoft packages at the expense of the skills needed to program, and to customize collections of open-source software. This dismal offering is actually what many students want, because it economizes on investment in risky skills. In industries from banking to race cars to computer graphics, the skill shortage then shows.

Why don’t children in Britain learn enough math and science? It’s common to blame the schools, but however good the teaching a child could be expected not to concentrate on those subjects, if her literacy skills are sufficient to read the writing on the wall of the job market: knowledge of math and science may be transferable but, as we have just seen, many of the skill sets that benefit most from math and science are relatively risky investments. Universities teach a lot of overseas STEM students, in part because UK students don’t fill the places. Many of those foreign students stay on; through this avenue, and others, the UK relies on imported skills. The supply of imported skills, however, is insufficient to the task, and skills shortages remain.

All of these problems could be substantially alleviated by a generous, earnings-linked, time-limited jobless benefit, conditional on participation in an education or training program. But, even if we had that, who would pay for the training itself? Tuition fees and loans shift the risk inherent in educational choices from the state to the student, and that compounds all of the problems addressed here. The problem has been magnified by the Equivalent Learning Qualification (ELQ) rule, a foolish Treasury decision late in the last Labour government, which removed state funding (and subsidized loans) for students earning a qualification at or below a level they had already attained, with exceptions for certain subjects. There is now a good prospect that the ELQ rule will be reversed, which would be a small improvement, but still the fees remain.

One solution would be to include full fees for the duration of the approved programme, along with the jobless benefit: support the jobless as full time students. A drawback to that approach is that it punishes people who anticipate the need for re-tooling, rather than hanging on to a precarious job until they are sacked and thus eligible for benefit; it’s also not clear how it would apply to the self-employed, and if it can’t be it punishes entrepreneurship. The best way to avoid these perverse incentives would be simply to eliminate tuition fees or, short of that, to do so at least for students over some age threshold – 25, say.

Today’s educational choices are affected by expectations about what social insurance will give, and what tuition fees will take, at some unknown moment ten, twenty, or thirty years from today. The hard part of all this, for Britain, is that its majoritarian electoral system is given to extreme policy swings, making it hard to produce confidence in social policy decades hence. Short of a constitutional earthquake in favour of a more consensual system of government, it seems unlikely that the skills shortage can be solved unless there somehow emerges a cross-party understanding that a combination of good social insurance and affordable continuing education are needed if we want young people to take chances when investing in skills.

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