Science Investment and The Horizon Problem (Updated)

Apparently, it’s “economics of higher education” day here at Uncertain Principles. This time out, we have Steve Hsu on Larry Summers.

(Update: I should also link to this post by Brad DeLong discussing the same article, with good stuff in the comments. And while I’m bashing free-market advocates, here’s Jonah on the worst assumption in economics, and Dave on funding research with prizes.)

Steve quotes Summers saying:

In today’s economy an outstanding graduate of a leading business school earns a substantially higher salary than a potential Nobel prize winner graduating with a PhD in biology. Several years after graduation the differences are even more pronounced. It should not be a surprise that in light of this economic reality more of our talented young people are not headed towards careers in basic research in the life sciences.

and asks:

Gee, is there a market failure? If life sciences are so important to society, why doesn’t the market reward researchers the way it does hedge fund managers? Does government really need to interfere? Obviously I agree with Summers, but I don’t think strong believers in markets as resource allocators for society can do so without questioning some of their beliefs.

I’m not a strong believer in markets as resource allocators, but I agree with him. I don’t think the current arrangement is at all surprising, though. The market doesn’t reward researchers like hedge fund managers due to the same structural flaw that killed Bell Labs.

Bell Labs, for those who aren’t steeped in science myths, was the original source of a surprisingly large number of the things that make modern life what it is– in addition to obvious developments in telecommunications technology (the fax, wireless networking), and electronics (the transistor), Bell Labs researchers pioneered fields from radio astronomy to laser cooling, and invented a host of computer-related technologies, including Unix. It was a large and well-funded research operation run by the Bell Telephone company for much of the previous century, and basically collected really smart scientists, gave them tons of money, and set them loose to invent whatever they could.

It was a fabulous engine of innovation, and it’s gone now. There’s still something calling itself Bell Labs, but it’s a shell of its past glory, and much more tightly focussed on commercial applications. The old system was dismantled years ago, for market-based reasons– Bell shelled out a huge amount of money to keep the operation going, but didn’t necessarily reap the profits of the inventions made in their labs. That doesn’t look good on the balance sheet, and so it was more or less gutted in the 80’s and 90’s, to make the company more profitable. Nobody else has stepped into the gap for the same reason– there’s no way to ensure that a research lab will turn a profit, and thus the investment is really hard to justify to narrowly focussed business managers.

The problem here is that the market system as currently constituted is an absolutely miserable way of allocating resources for long-term projects. The horizon for most corporate evaluations is much to short– an investment that might pay off in the next five years will be discussed in the finanacial pages as a gigantic gamble, and most decisions appear to be made based on what the effect will be on the stock price this quarter.

That’s why a hedge fund manager gets ten times the money (at least) of a top researcher. If a hedge fund manager does his job really well, somebody gets a billion dollars right now. If a researcher does his job really well, his employer gets ten billion dollars ten, fifteen, even twenty years down the road. If the standard for performance evaluation is how much money you made for the company in the past year, it’s obvious that the hedge fund guy is going to get paid more, even though his net benefit to society is almost nil. Basic research might transform society for the better down the line, but in the short term, it’s all investment and no return.

I don’t disagree that market systems are a good way of allocating resources in principle, but the way we’re going about it at the moment is badly broken. The short horizon has decimated private research, and is among the root causes of the fact that the US health care system is a joke, and is largely to blame for a number of environmental catastrophes in the making.