Economics 101: Privately funded research and development leads to the most useful innovation

Many people, including the scientists themselves, urge the GCC governments to spend more money on research and development. Why might this be a bad idea?

The prevalence of open-source software illustrates a broader point that in many situations, patents are unnecessary for innovation, even in for-profit organisations. Getty Images

How can the GCC improve innovation? Amandeep Sandhawalia, US

Less than 1 per cent of the UAE’s GDP is allocated to research and development (R&D), compared with the world average of more than 2 per cent. Economists agree that innovation is critical to economic growth, so how can the GCC countries become more innovative?

There are two main methods that governments use to encourage innovation: patents and subsidies. Each has its own pros and cons.

Patents are the exclusive right to reap the economic benefits associated with a new idea. They spur innovation by increasing the benefits accruing to an innovator. In some industries, such as pharmaceuticals, copying a successful drug is cheap while developing a new drug is expensive. Consequently, patents provide innovators with the assurance that they can recoup their investments by making the profits that they need to innovate in the first place.

Should the GCC countries consider lengthening patents or enforcing them more stringently? A key problem is that almost all innovation builds on previous innovation and so if you increase the restrictions on the accessibility of previous innovations, you can inadvertently impair future, derived innovation.

Software is an excellent example: regular software is closed-source, meaning that nobody can inspect or use the code without the original developer’s permission; in contrast, open-source software adheres to the philosophy that the code can be accessed and used freely by anyone.

In many situations, we see open-source software improving at significantly higher rates than closed-source software because anyone can fix bugs and develop improvements. That is why many prefer Mozilla Firefox (open source) to Microsoft Internet Explorer (closed source).

The prevalence of open-source software illustrates a broader point that in many situations, patents are unnecessary for innovation, even in for-profit organisations. Many of the organic benefits associated with innovating are exclusive to the innovator because the innovator has a head start on people trying to imitate (reverse-engineering takes time), and because it is only by being an innovator that you acquire some subtle types of knowledge, such as the hundreds of things that you tried that didn’t work.

An alternative to patents is subsidising research and this is the primary reason why so many universities inside and outside the GCC are publicly funded. In fact, many people, including the scientists themselves, urge the GCC governments to spend more money on R&D. Why might this be a bad idea?

The basic problem with government funding is that it undermines the mechanism that ensures that innovators pursue useful ideas. Government funding tends to be unconditional, meaning that scientists are not penalised for frivolous discoveries. A college dean could probably convince a civil servant to fund an endowed chair in Ancient Greek, but a private investor would probably prefer an endowed chair in bio-engineering. Generally speaking, innovations that are commercially valuable cause the economy to grow, whereas commercially useless ones do not.

In the case of the GCC countries, what little R&D occurs is almost exclusively publicly funded. Thus, the governments should consider policies that will encourage subsidy-free, privately funded research. Improving the education systems is a good starting point, as people are the key input to innovation.

Lastly, the UAE does seem to be making progress – it rose to 41st from 47th in the latest global innovation index from the World Intellectual Property Organisation, which suggested that the country is turning to innovation as part of the effort to diversify the economy.

Further reference: Marginal Revolution University: Patents, Prizes, and Subsidies

Omar Al Ubaydli is the programme director for international and geopolitical studies at the Bahrain Center for Strategic, International and Energy Studies, and an affiliated associate professor of economics at George Mason University in the US.

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