We do not know how much basic research is desirable from a national and global perspective, and in which industries. This column describes the insights from a new multi-country, multi-industry framework with international trade. It shows that global investments in basic research are too low, too heavily concentrated in industrialised countries, and not sufficiently targeted towards high-tech industries.

"Applied research directed towards immediate social benefit is essential. So is basic research. It increases our wealth of knowledge – an end in its own right – and generates transformational technologies. Basic science yields fantastic returns on investment, but we cannot predict which investment will pay off, or when. It took almost a century to apply the theory of relativity to correct the time signals from satellites, thus enabling the global positioning functions on smartphones." (Ramakrishnan 2017)

Venki Ramakrishnan, Nobel laureate and president of the Royal Society, argues that at least some basic research is essential. But how much basic research is desirable from a national and global perspective, and which industries or areas should be the targets of this research? These issues have always occupied policymakers, but they have received particular attention in the low-growth environment of recent years, which has been also a period of digital transformation.

Basic research generates the new knowledge and understanding needed for innovation. It is well-known at least since Nelson (1959) and Arrow (1960) that basic research has the characteristics of a public good, and so it needs public engagement. Indeed, the major part of basic research is funded and provided by national governments (Akcigit et al. 2013, Gersbach et al. 2019b) that want to foster private innovation in the domestic economy.1

Our investigation starts with the observation that the national costs and benefits associated with these investments critically depend on a country’s integration in the world economy. On one hand, innovative domestic firms benefit from supplying products to the world market, and their profits depend on competition in their industry (and thus on innovation in the rest of the world). On the other hand, innovation combines insights and ideas from basic research with industry-specific know-how (Nelson 1959, Arrow 1962, Akcigit et al. 2013, 2016). This know-how is mostly acquired through production, and there is a rationale for a close proximity of innovation and production activities (Pisano and Shih 2012, McKinsey Global Institute 2012).

A country’s current specialisation in international trade will therefore affect its potential to innovate in different industries. Ceteris paribus, the more advanced and the more diverse the domestic economy, the higher its potential to innovate and the larger the domestic gains from investments in basic research.

The left bar of Figure 1 shows the fraction of country-industry pairs with revealed comparative advantage (RCA) in patenting greater than one when RCA in exporting is smaller than one (Balassa 1965). The right bar shows the fraction when RCA in exporting is greater than one.

Figure 1 Fraction of country-industry pairs with revealed comparative advantage in patenting greater than one, 2013

Patents from the OECD 'Patents by Technology' dataset.
Image: Exports from CEPII BACI.

We asked what these interdependencies would imply for basic research investments at national levels and worldwide (Gersbach et al. 2019a). To do this, we developed a multi-country, multi-industry general equilibrium model with endogenous innovation and international trade that could rationalise the distributions of basic and applied research, and the national shares of global profits, in today’s world.

We were able to show that from a global perspective investments in basic research by national governments are inefficient along three dimensions:

  • There is typically too little global investment in basic research.
  • Basic research is too heavily concentrated in industrialised countries.
  • Basic research is potentially insufficiently directed to support innovation in complex high-tech industries.

These findings suggest that coordination among countries, for example among EU members, could lead to welfare-improving policies.

The model

We used a static version of a multi-country, multi-industry expanding varieties model following Romer (1987, 1990), with basic and applied research, international trade, and knowledge diffusion. The innovation process is at the heart of our framework, and its model representation is guided by facts that are important for the understanding of basic research in a global economy:

  • Basic research is a public good. And it is, to a large extent, provided by national governments.
  • There are important cross-country knowledge spillovers. National governments invest in basic research because it has important local effects on innovation (Jaffe 1989, Jaffe et al. 1993, Audretsch and Lehmann 2004), but ideas from basic research will eventually diffuse globally.
  • Insights from basic research are typically embryonic. They need to be commercialised in private applied research to harvest the gains from basic research.
  • Applied research combines the insights from basic research with industry-specific know-how. Countries tend to innovate more in industries with stronger domestic production. This has important feedback effects on countries’ incentives to invest in basic research, especially as it is difficult to predict which insights will emerge from basic research, in which industries these insights will be most valuable, and when they will occur. And while there is some scope for targeting basic research efforts to certain industries, for example by prioritising particular fields of science (Cohen et al. 2002), this targeting is imperfect.

Therefore investment decisions made by national governments are interdependent. Basic research policies and innovation in the rest of the world will yield positive spillovers to the domestic economy and also feed back into the gains from innovation in different industries. To obtain a coherent picture of public basic research in a global economy, we used a multi-country, multi-industry general equilibrium framework with international trade. We chose a Ricardian free-trade environment that allowed us to isolate frictions arising from the innovation process. In the model, countries differ in their economic development, which captures anything that fosters a country's economic prosperity such as technologies, human capital, or institutions. In equilibrium, richer countries are more diversified in terms of their exports, and poorer countries tend to be systematically excluded from exporting complex goods (Imbs and Wacziarg 2004, De Benediktis et al. 2009, Cadot et al. 2011, Hausmann and Hidalgo 2011, Parteka and Tamberi 2013, Schetter 2019). This has important implications for basic research policies.

Key results

The equilibrium in our economy is consistent with key facts on innovation in today’s world. In our model, governments of industrialised countries face both higher costs and higher benefits.

Wages for scientists are higher in industrialised countries, as the outside option of working in production yields higher wages in these countries. On the other hand, the domestic economy is more diversified, which allows it to commercialise ideas in a large set of industries.5

Scientists are also potentially more productive in more developed economies. We show that more developed countries invest a higher fraction of their GDP in basic research as long as basic research is at least as skill-intensive as production. In addition, thanks to their broad industrial base, these countries benefit more from knowledge spillovers from the rest of the world, and thus are highly innovative. Their high level of innovation allows these countries to capture a disproportionate share of global profits, as we find in the data (see Figure 2).

Figure 2 Basic research investments relative to GDP, 20-year average from 1995 to 2015

GNI and GDP is 2015 OECD data.
Image: OECD dataset

We compared investments by national governments to the optimal solution of a global social planner, that is to create optimal policies with international coordination. Coordinated basic research policies would yield welfare improvements along three dimensions.

  • The social planner would distribute investments in basic research more equally across countries. The basic intuition is that developing countries invest little in basic research because their domestic economy is not effective in science-driven innovation, implying that they suffer more from knowledge spillovers to the rest of the world compared to industrialised countries.
  • In spite of the high concentration of basic research investments in industrialised countries, global investments may not be targeted sufficiently towards high-tech industries. This counterintuitive result emerges from the endogenous distribution of basic research investments across countries, and their optimal targeting of basic research investments to industries. It is rooted in the importance of tacit know-how for innovation and the fact that industrialised countries are more diversified, and tend to successfully export varieties in both simple and complex industries, while developing countries tend to systematically specialise in simpler industries. Interestingly, inefficient targeting is particularly likely to occur if new industries – or products, for that matter – are relatively complex high-tech industries.
  • Aggregate investments are typically too low when each country decides on basic research investments individually.

Conclusion

Our work shows how international coordination of basic research can improve welfare through higher aggregate investments, and a more efficient distribution of basic research investments across countries and industries. This offers a global perspective on the Bayh Dole Act that incentivises university researchers to become more engaged in the commercialisation of their work.

These incentives arguably lower researchers’ productivity in terms of pure science. Yet, they may be welfare-improving, as they allow countries to capture a larger share of the gains from their own basic research, which may contribute to closing the gap to globally efficient levels of investment in basic research.