How can the private sector fund more long-term R&D?
The question above uses the word "more" for a reason. Since the 60s, US R&D spending as a % of GDP has stayed between 2-3%, but with one twist - In the 60s, the government spent all of that, now the government spends slight more than 0.5% with the rest of the tab picked by the private sector. A recent Time magazine article laments this trend, and the apparently consequent slowing rate of US patent filings and publications in engineering and science journals. So, the private sector has picked much of the slack, but can it do more?
The problem, of course, is that no one knows if and when R&D will payoff (in most cases). Today, Google is a massive R&D engine and out-innovates most in computer science, but how much of that has been monetized? Turns out targeted advertising and Adsense comprise 90% of Google's revenues, so some great recent innovations in machine learning, operating systems and algorithms may have little or no marginal revenue impact.
A simple insight might suggest one way to get more funding into R&D. The payoff from R&D looks exactly like a call option - essentially, the same insight that has driven recent work in real options. There is much criticism of real options, something I will not delve into as it's less relevant to the question at hand. Consider a project funded entirely by writing options on R&D.
This could be a project in academia, or an entire firm. Let such R&D options be tradeable and liquid in a market-place, and let a new breed of analysts emerge that can value such options. Along with new standards around the disclosure of the progress of R&D projects, such analysts are critical to ensure liquidity in the market, and hence the viability of R&D options.
Assuming R&D options mimic European calls, an interesting corollary is that the price of the option increases with the risk of the underlying asset. This provides a perverse incentive to fund projects that are more risky, exactly the kind of projects that find funding hard in the current system.
As a global leader in science and engineering, the US might well consider investigating this route to draw more funds into risky R&D. Thoughts?
The question above uses the word "more" for a reason. Since the 60s, US R&D spending as a % of GDP has stayed between 2-3%, but with one twist - In the 60s, the government spent all of that, now the government spends slight more than 0.5% with the rest of the tab picked by the private sector. A recent Time magazine article laments this trend, and the apparently consequent slowing rate of US patent filings and publications in engineering and science journals. So, the private sector has picked much of the slack, but can it do more?
The problem, of course, is that no one knows if and when R&D will payoff (in most cases). Today, Google is a massive R&D engine and out-innovates most in computer science, but how much of that has been monetized? Turns out targeted advertising and Adsense comprise 90% of Google's revenues, so some great recent innovations in machine learning, operating systems and algorithms may have little or no marginal revenue impact.
A simple insight might suggest one way to get more funding into R&D. The payoff from R&D looks exactly like a call option - essentially, the same insight that has driven recent work in real options. There is much criticism of real options, something I will not delve into as it's less relevant to the question at hand. Consider a project funded entirely by writing options on R&D.
This could be a project in academia, or an entire firm. Let such R&D options be tradeable and liquid in a market-place, and let a new breed of analysts emerge that can value such options. Along with new standards around the disclosure of the progress of R&D projects, such analysts are critical to ensure liquidity in the market, and hence the viability of R&D options.
Assuming R&D options mimic European calls, an interesting corollary is that the price of the option increases with the risk of the underlying asset. This provides a perverse incentive to fund projects that are more risky, exactly the kind of projects that find funding hard in the current system.
As a global leader in science and engineering, the US might well consider investigating this route to draw more funds into risky R&D. Thoughts?
posted by Mukul Chawla at 10:45 PM
3 comments
