Should Students Pay for the Creation of Knowledge?

Filed Under (Other Topics, U.S. Fiscal Policy) by Jeffrey Brown on Jun 20, 2011

To briefly summarize this long post: the creation of knowledge through fundamental research is a public good.  Economic theory is clear that public goods will be under-provided without government funding.  And as government funding for higher education continues to shrink, it is increasingly the students and their families who are paying for the provision of a good that benefits everyone.  Is that really what we want? 

First, some background.  When economists speak of “public goods,” we have something specific in mind: goods that, once produced, are “non-rival” and “non-excludable.”  In plain English, “non-rival” simply means that one person’s consumption of the good does not diminish other people’s ability to use the good.  For example, the fact that I get to enjoy a fireworks show or the protection of a missile defense system does not prohibit my neighbor from also enjoying benefits from these goods.  This is in contrast to most usual consumption goods – for example, if eat a candy bar, it is impossible for someone else to then eat the same candy bar.  “Non-excludable” means, roughly, that once the good is made available, it is available to everyone.  A classic example of a public good is clean air in a city: my breathing the clean air does not prevent you from also enjoying it, and it is also difficult to exclude people from breathing the clean air when they are in the city.

A many-decades old and quite famous result in economic theory is that public goods are under-provided in a private market.  In essence, I might be able to contribute a little bit to the creation of clean air insofar as the net benefits to me of my efforts are positive.  But in making that calculation, I will fail to take into account the benefits on everyone else.  They will do the same.  So we will effectively end up with too little clean air.  It is a special case of market failure where – (tea partiers should cover your ears) – government intervention can actually do a better job of approximating the efficient market solution than free markets.     

Universities are in the business of creating several goods that are, at least partially, public goods.  The most obvious of these is the creation of knowledge.  Indeed, the mission statement here at the University of Illinois lists “creating knowledge” as one of the three central tenants for our existence.  In contrast to applied research – such as pharmaceutical company investing in R&D for a new drug – most of the knowledge created in our universities is “fundamental research” – sometimes called “basic research” (although basic is meant to mean fundamental, not easy!)  What distinguishes this type of research is that the ultimate goal is not a marketable product, but rather the advancement of knowledge itself.  While this knowledge often leads to tangible benefits that can be commercially viable down the line (e.g., two famous Illinois examples include the MRI and web-browser technology), much of the cutting edge research does not have commercial applications.  But it is extremely valuable nonetheless.    

A great competitive advantage of the U.S. over the past century has been its system of public and private research universities.  Indeed, this is one of the “secret sauces” that launched the United States into a world economic powerhouse over the past century.  Universities have been responsible for much of the technological and intellectual innovation that has shaped the world in which we live.  The fact that our standard-of-living is many times higher today than it was a century ago is due – in part – to our outstanding research universities.

Historically, much of this research has been supported by public dollars.  At public and private research institutions, much direct research funding has come from federal agencies such as the National Science Foundation, the National Institute of Health, as well as research funding from other cabinet agencies (e.g., Department of Energy, Department of Defense).  At public institutions, support has also traditionally come from state appropriations to support both the teaching and research missions of public universities.  For example, state funding has long been an important source of funds to pay faculty salaries, and it is those faculty who are, in turn, creating knowledge.

That model, however, is coming under increasing strain.  Thanks to enormous fiscal imbalances at the federal and state levels, many traditional sources of public support for higher education are declining.  Perhaps the most notable of these is the decline in state appropriations that support public research institutions.  Here at Illinois, our Chief Financial Officer, Walter Knorr, remarked in March that the,  “the state’s direct appropriation to the university is 26 percent below what it was 40 years ago, when adjusted for inflation.”

One of the leading experts on the economics of higher education, Ron Ehrenberg of Cornell University, has written extensively on changing nature of higher ed funding over the decades.  In a 2003 paper titled, “Who Bears the Growing Cost of Science at Universities,” he notes that ”while undergraduate students may benefit from being in close proximity to great researchers, they also bear part of the growing costs of research in the form of larger class sizes, fewer full-time professorial rank faculty members and higher tuition levels.”

 Since his paper was written, tuition rates have continued to climb, largely in an attempt to offset declining public sector support. In essence, students and their families are footing a larger share of the bill for the creation of knowledge. 

To be clear, I am not saying that students are getting a bad deal for their tuition dollars.  Indeed, every study of the returns to a college education reinforce that – at least on average – a college degree continues to be one of the best investments an individual can ever make.  This remains true even as tuition rates climb.  And it is also the case that students enrolled at research institutions benefit from interacting with faculty who excel at knowledge creation.  Clearly, students and their families agree that an Illinois degree is still a phenomenal investment, as indicated by the fact that applications to the University continue to jump, even in the face of tuition hikes.

Nonetheless, these are troubling trends.  If knowledge creation is central to our national well-being and economic growth, then we need to ensure it is supplied at the optimal level.  It should not be limited by the willingness and ability of students and their families to pay to for a university education.

The Ethanol Mandate and Technological Innovation

Filed Under (Environmental Policy) by Dan Karney on May 20, 2011

Recently, I had the opportunity to visit Iowa State University’s new, multi-million dollar BioCentury Research Farm (BCRF) that is the “first-in-the-nation integrated research and demonstration farm devoted to biomass production and processing”.  While the BCRF has many different on-going projects sponsored by a variety of research grants and corporate funding, I am going to focus on technological innovation regarding biofuels and specifically cellulosic ethanol (aka “advanced biofuel”).

The Energy Independence and Security Act of 2007 introduced an expanded Renewable Fuel Standard (RFS) that mandates the blending of ethanol into transportation fuels.  The mandate requires a total of 36 billion gallons of ethanol blended by 2022, where 16 billion gallons comes from cellulosic ethanol (link).  However, the United States currently produces limited amounts of cellulosic ethanol due to its high cost of production, yet the mandate has spurred investments by industry in the form of research at the BCRF in order to lower costs and increase output.

Cellulosic ethanol is a biofuel – that can be used similarly to gasoline – made from the non-edible parts of plants.  The United States is a world-leader in the production of corn, so particular focus has been on cellulosic ethanol derived from “corn stover” that includes the stalks, leafs, husks, and cobs left-over from the harvest of the corn kernels.  A key step in that process is the efficient collection of the corn stover.

Traditionally, corn stover has been collected in a multi-pass system, where the corn is harvested on the initial pass(es) and the stover later.  The multi-pass system leads to high ash (i.e. dirt) content in the stover.  With prototypes from industry, the BCRF is conducting demonstration tests of a new harvesting system called the “single-pass” that collects and bales the corn stover while kernels are harvested simultaneously.  While the single-pass system is not yet perfected and has some disadvantages, the major innovation comes from significantly decreased ash content levels in the stover.  The purer stover can then be processed into ethanol at reduced cost and greater scale.

The point here is that the ethanol mandate led to technological innovation.  Although, academic economists often talk about innovation, it seems a rare occasion that one actually gets to see technological development.  I do not know if single-pass harvesting will become viable or the industry standard, but I do know from talking to the researchers at the BCRF that they are learning form their experiments driven by the profit-motives of self-interested companies to lower costs and increase production.  As an economist, a sight to behold!

Why Low-Carbon Technology Innovation is Not Enough

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Mar 19, 2010

Nobody likes new taxes.   When policy wonks like me talk about addressing the problem of global warming by introducing a carbon tax, nobody listens (even though all of the tax revenue could be returned by cutting OTHER distorting taxes on labor or on investment!).  Instead, policymakers like to use the Manhattan Project analogy, essentially saying that we can solve the whole global warming problem just by research and development (R&D), innovation and diffusion of new technology.  We’ll just throw money at the scientists, and they will solve the problem for us.  Policymakers want to subsidize or require wind power, solar power, and other low-carbon technologies.

Here is why that idea will not work, for reasons based on some new research in a book called “Accelerating Innovation in Energy: Insights from Multiple Sectors”, edited by Rebecca Henderson and Richard G. Newell.     To see what might work for energy, they look at technology innovation in all the other sectors where R&D has been successful (the internet, chemicals, agriculture, and semiconductors).  They find that three elements were key in ALL of those success stories: “(1) the substantial, differentiated, end-user demand that enables private firms commercializing the technology to anticipate healthy returns; (2) the sustained funding and effective management of fundamental research; and (3) the development of an institutional environment that includes robust mechanisms to promote the widespread diffusion of both knowledge and technology and that favors vigorous private-sector competition.”

My point is all about #1: there has to be demand in the market for the technology.  No matter how much money Congress throws at the problem of research into new energy technologies, the program will not be successful unless people want to USE those new technologies.  And people will not particularly want to use those new low-carbon technologies, unless they face a carbon tax!  The researchers and developers of new low-carbon technologies might have great ideas, but those ideas will not come to fruition unless people are chomping at the bit to get those new technologies and use them to increase their profits or reduce their carbon tax burden.

My own thinking about this problem relates to the fundamental reasoning for any government policy intervention: the private market works fine unless you can point to a fundamental market failure.  One market failure is the pollution externality from carbon emissions, and that can be addressed by a carbon tax.  A different market failure is that any private firm might not have sufficient incentive to undertake R&D if they don’t capture all the benefits from it.  Patents only last for 17 years, not all ideas can be patented, other firms can see those ideas, and other firms can get similar patents for similar technologies.  These “knowledge spillovers” are a possible justification for government intervention to subsidize basic research, the kind of research that private firms would not undertake sufficiently.

But we still have two different market failures!  Two different market failures require two different policies to address them.  Subsidies for research might help address the knowledge spillover problem, but we still need a carbon tax to get people to want to use those technologies.

That is why we can’t solve the global warming problem by just throwing money into research.

Betting on American Innovation over EPA Mandates

Filed Under (Environmental Policy) by Don Fullerton on Nov 7, 2009

In 2007, the Supreme Court ruled that the Environmental Protection Agency (EPA) has the authority to regulate greenhouse gas (GHG) emissions under the Clean Air Act (link).  This fall the EPA announced its plan to regulate GHG emissions, including carbon-dioxide, by requiring large emitters to adopt state-of-the-art, best-practice pollution abatement technologies (link).  Yet the EPA’s new regulatory plan may rely upon costly methods of reducing GHG pollution.

Under the Clean Air Act, the EPA can only promulgate rules or “mandates” to control pollution.  Requiring every emitter to adopt best-practice pollution abatement technology is an example of a mandate, where the regulator dictates how the emitter must reduce its pollution.

In contrast, economists have long advocated market based approaches to pollution abatement – either a carbon tax or a cap-and-trade system.  Indeed, it is a cap-and-trade policy that passed the House during the summer and is currently being debated in the Senate.

The “cap” sets a hard limit on total pollution, and it then gets tighter and tighter over time, reducing emissions gradually.  Meanwhile, the “trade” part of the policy allows private markets to allocate pollution rights (permits) efficiently among thousands of emission sources.  Capping emissions causes pollution rights to become scarce, and thus the ability to pollute has economic value.  This value is the price at which permits are bought and sold.  If a company holds permits and can reduce GHG emissions more cheaply than the prevailing price, then it sells permits and makes money on the difference; otherwise it may buy permits.  This allows for companies with only expensive pollution abatement options to buy the right to emit at a price lower than they would otherwise incur, thus reducing the cost to society.

In addition, the explicit price on pollution induces profit-maximizing firms to research and implement new and cheaper ways of reducing GHG emissions.  This is a key difference when comparing cap-and-trade vs. mandates.  The price signal of the market based approach induces innovation.  Individual entities acting in their own self-interest will have the incentive to find new and cheaper forms of pollution abatement.  Those future innovations cannot be foreseen, and thus the cost projections of current legislative proposals cannot take them into account.  The costs of reducing GHG emissions are real, but under a cap-and-trade system, U.S. ingenuity and innovation will lower the cost of compliance relatively to current projections.  Why am I confident?  It has happened before.  The cap-and-trade policy to reduce sulfur dioxide pollution from coal-fired power plants cost one-fourth of the project price tag precisely due to unanticipated adaption and innovation by U.S. businesses (link).