A Theoretical Analysis of Public Funding for Research

Gianni De Fraja

A casual observer of the manner in which public money destined to scientific research is used might well feel confused. The recipients are very different: public universities as well as private ones, much of whose research is publicly funded, but also dedicated research centres within the government and the armed forces, and firms, non-profit and possibly other organisations, which receive direct subsidies or tax incentives. These institutions vary widely in their reputation and potential for successful research. This casual observer might wonder whether there is an underlying rationale for this variety. An attentive observer might also notice that the constraints imposed on the use of funds are also varied: in the UK, roughly 2/3 of the total government funding is distributed to institutions in consideration of past achievements, to spend as they see fit, the remaining 1/3 is grant funding, firmly linked to specific research projects. Moreover, the latter is more concentrated in the high quality research institutions. A further dimension of variability is the directness of the link between research and its use: applied research benefits society in a concrete and tangible way; while basic research improves the "scientific climate" in society without an identifiable explicit benefit. This observer might then wonder if there is a rational explanation for this variety along many dimensions, but she would be unable to find it in the existing theoretical economics literature.

In his Nottingham School of Economics working paper, soon to appear in the Rand Journal of Economics, Gianni De Fraja aims to fill this gap in the literature. He offers a comprehensive theoretical analysis of public funding for research building. If the government uses taxes to fund scientific research, the paper shows that high quality institutions do more applied research than they would like, and they are offered an incentive to do so with the carrot of public funds which they can use in any way they want, but which they will choose to fund basic research. This leads to some of the regularities observed in practice, such as the higher concentration of grant funding to better institutions, and the preference shown in practice to established institutions, and those with better reputation. The paper also sheds light on some of the mechanisms used in practice to allocate research funding. For example, government agencies typically award research grants on a "cost-plus" principle, whereas charitable bodies require co-funding of research activities. The latter can be justified on the basis of the analysis of the model, whereas the former cannot. The article also shows that distribution of government funds should depend on past success: the funding opportunities available to more prestigious institutions should be wider than those that less prestigious one can draw from.

RAND Journal of Economics, "A Theoretical Analysis of Public Funding for Research", by Gianni De Fraja.

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