EEP 143 Lecture 22 Institutions and Innovations

1. EEP 143 Lecture 22Institutions and Innovations • Outline: • First: a note on quiz Q4 • Linear model of innovation • Federal R&D • University R&D • EBI Initiative • Benefits of the “Industry-University Complex”

2. Quiz Q4: Drastic process Innovation • What are increases profits due to process innovation? • If inventor monopolized the production process? • If the pre-invention process is available at marginal cost c? P pm Π c p'm Π' c' D Q MR

3. Quiz Q4: Drastic process Innovation P pm Π c p'm Π' c' D Q MR • What are increases profits due to process innovation? • If inventor monopolized the production process? Π' – Π • If the pre-invention process is available at marginal cost c? Π'

4. Innovation:The traditional Linear Model Simple Version • Basic research • Applied research • Invention • Development • Commercialization

5. Innovation:The traditional Linear Model: More detail • Science and technology base • Basic research • Applied research • Invention • Prototype • Development • Commercialization • Diffusion

6. Example of traditional Linear Model: New Drug • Science base: state of the art in chemistry, biology, etc. • Basic research: • chemistry, microbiology, genetics • Applied research: • synthesize and screen compounds • Invention • Identify compound with desired effect in lab • Prototype • Compound formulated for lab testing • Development • Phase I clinical trials • Phase II clinical trials • Phase III clinical trials • Commercialization • Formulation, dosage choices, packaging, marketing • Diffusion • Sponsor trials, conferences, detailing MDs, consumer advertising

7. Example of traditional Linear Model: New Drug • Science base: state of the art in chemistry, biology, etc. • Basic research: • chemistry, microbiology, genetics • Applied research: • synthesize and screen compounds • Invention • Identify compound with desired effect in lab • Prototype • Compound formulated for lab testing

8. Example of traditional Linear Model: New Drug 6. Development • Phase I clinical trials • Phase II clinical trials • Phase III clinical trials 7. Commercialization • Formulation, dosage choices, packaging, marketing 8. Diffusion • Sponsor trials, conferences, detailing MDs, consumer advertising Where are the largest expenses?

9. Example of traditional Linear Model: new software • Basic research • mathematics, queuing theory • Applied research • Cryptography, data storage methods, sorting algorithms • Invention • Idea of program, design, basic features • Development • Programming, alpha testing • Commercialization • Beta testing, marketing • Diffusion • Advertising, other communication

10. Caution: Traditional Linear Model does not necessarily hold! • Can you think of exceptions?

11. Caution: Traditional Linear Model does not necessarily hold! Look up backward links to science progress from these applied technologies:: • Pumping water from mines • Steam engines • Improved yeast for beer making • Search for a synthetic version of malarial drug quinine (careful, 2 steps here!) • Radio reception and radio noise (2 here too) • Transistor/semiconductor

12. Caution: Traditional Linear Model does not necessarily hold! But for now we assume it holds Where does government get involved, and why?

13. Why government funding of R&D?Economic arguments • Pure public goods: • Standards, national defense, national (global?) environment • Externalities beyond scope of firm or consumer • Public health, vaccinations • Agriculture (consumers gain from cheaper food, farmers too diffuse to fund research) • Local environmental externalities • Education (including mothers’ education) • Encourage “strategic industries” (?)

14. For industry: Why gap between private and social return at given level of R&D? • Knowledge spillovers • Public goods: remember 2 characteristics? • Market (“pecuniary”) spillovers • Drastic innovations benefit users beyond cost • Network spillovers • Tech. or consumption externalities

15. Why government funding of R&D?Economic arguments $ Social return Private return Marginal cost M. Soc Retn. M. Priv Retn. Rc R s R&D spending How can government move research to the optimal level?

16. Industry spillovers: Nature of gap between private and social return • Less leakage in larger economies • Singapore v. China • Differs by industry • Car parts v. telecoms • Differs by technology • Basic v. applied research • Vaccines v. heart surgery • Network spillovers • Tech. or consumption externalities

17. Why government funding of R&D?Economic arguments $ Social return Private return Marginal cost M. Soc Retn. M. Priv Retn. Rc R s R&D spending How can government move research to the optimal level?

18. How can government move research to the optimal level? • There are several ways: • What are they?

19. How can government move research to the optimal level? • There are several ways: • Internalize externality • Merge firms • Patent system, other IPRs • Farmer co-ops for research (Hawaii pineapples, South American rice research) • Subsidize research • Australian market assessments for ag. research, matched by govt. • Tax deduction • Tax credit • Public funding of research • Public provision of research Can you see any problems with these solutions?

20. Federal R&D • In this case we should examine through the lens of political economy • Government is interested more in R&D that is • directly beneficial to voters, and • attracts the imagination or attention of voters • For instance after Sputnik, the R&D was directed in aeronautics • For the same reason as above the government doesn’t want to take projects that are risky and lengthy • Also, there is a knowledge gap between policy makers and universities • In addition, government is more likely to favor projects that are classic public goods • e.g. military projects • Health research • Basic research

21. Source: National Science Board 2006

22. Private R&D • Private sector accounts for most of the R&D: • spends 63% of total R&D expenditures • Some of this is Federal tax credits and expenses • produces 72% of total R&D

23. University R&D • In contrast to the private sector universities have been relying more and more on federal funds

24. Source: National Science Board 2006

25. Source: National Science Board 2006

26. University R&D • Faculty are encouraged to engage in R&D and publish the results (tenure-track appointments) • Since 1980 (Bayh-Dole Act) the motives for for-profit R&D increased dramatically: • The act allows universities to patent and license innovations produced with Federal funding • Even innovations that have been funded by the government

27. University R&D • An important effect of the act is that it led universities to pursue industry funds with the commitment that any potential innovation could be licensed exclusively by the sponsor • Federal government keeps free option for license

28. University R&D • Start-up companies are the major means of technology transfer from universities to private sector • The university licensing offices don’t assign IPRs but they receive a royalty, or an equity share (MIT) • The main asset of the companies is the knowledge they have created • only 7% of university R&D is privately sponsored • National Labs (such as Lawrence Berkeley Lab) • 50% of projects have private partner • Royalties only 1%of ?

29. Federal R&D • federal government • accounts for 30% of total funds that go to R&D • produces only 8% of R&D. • So it funds almost four times more R&D than it actually does • Of course, private sector accounts for most of the R&D: • It spends 63% of total R&D expenditures and engages in 72% of total R&D • In contrast with the private sector universities have been relying more and more on federal funds

30. Problem with collaborative R&D • Privately-funded research may bias the research process in favor of the sponsor • For instance tobacco industry sponsors pressed scientists not to publish results that were against the tobacco industry • Canadian brewing industry capture government barley research by sharing 11% of the cost • Diverted focus from feeding animals to beer production • RA Fisher, statistics pioneer, claimed there was no proven link of smoking to cancer • Evidence on pharma-sponsored research

31. Happy Thanksgiving!

33. Benefits of the “Industry-University Complex” • So far we have focused on the dangers of the university-industry cooperation • However, it takes place because there are benefits for agents in both sides • Faculty: • Funds for research is the primary benefit obviously which can be used for future agenda, support more students etc. • Also they are exposed in new areas of research and increase their human capital (they are in the cutting edge) • Industry: • They obtain access to new research • They have the opportunity to patent new research • They can maintain good relationships with universities • They can acquire knowledge to solve technical problems