Public Funding of Universities: Why and How?

Ideas are the source of economic growth and improvements in well-being. A large share of new innovations rest on ideas created by science. As knowledge is non-rival, we face a dilemma in terms of incentivizing the creation of new ideas on the one hand, and allowing the diffusion of created knowledge on the other hand. Two key tools in solving this dilemma are to give academic scientists nonfinancial incentives, and to use public funds for (basic) research. (Almost) non-conditional base funding is needed because science is long-term and unpredictable, and because without such funding there would be nobody applying for competitive funding. Competitive funding is needed to complement base funding by providing incentives to continue doing research, and to allocate resources to the most promising researchers and research projects. While these arguments apply at the global level, it is less clear why they should apply at the national level. The key reason to use public funds for science even in small nations (regions, locations) is to develop and maintain absorptive capacity as, while new ideas may be freely available, the ability to evaluate and apply them as well as the ability to pass them on requires individuals who (at least attempt to) produce frontier research themselves. To ensure that frontier knowledge and absorptive capacity diffuse throughout the economy speaks for funding universities as research and teaching are natural complements in this process.