Despite difficulties with public finances, a cut in RD spending would be counterproductive, writes Gerry Boyle
IN TIMES of stringency in the public finances, the first casualty is usually public capital expenditure. This is despite protestations from all sides that curtailment of investment in public capital is usually counterproductive. In time, the capital invested will typically yield returns that often more than pay back the taxes used to fund the initial investment. This is not to suggest that simply by labelling expenditure as "capital" that it will yield long-run returns.
There are too many past examples to support this fallacy. Public-capital investment should only be contemplated if it satisfies basic public-finance principles.
First, the investment incurred should be unlikely to have been undertaken by the private sector. In such circumstances, the market may fail to deliver the necessary public resources and thereby justify a role for State intervention. Second, if the investment is judged to address a market failure, it still needs to pass rigorous cost-benefit appraisal. It is axiomatic that for living standards to grow in all economies, a constant level of capital investment is required.
This view underlines the recommendation in the recent NESC report that public capital investment be retained at 5 per cent of GNP. All forms of capital investment generate returns in terms of higher levels and rates of economic growth. But what is often less appreciated is that the form that capital investment takes is, if anything, more important than its level.
Capital can take on many forms, such as physical capital in the form of the plant and machinery; public capital in the form of infrastructure; human capital in the form of education, training and work experience and "knowledge capital" which refers to the accumulation of ideas in the form of scientific publications, patents that enable new products and services to be developed or that outline new and more cost-effective production systems.
The focus on "knowledge capital" (or the "knowledge economy") in recent years derives from the realisation that much higher rates of return can be generated from investment in this type of capital. The reason for the much higher anticipated rates of return from investment in "knowledge capital" is due to its unique attributes.
Once a piece of knowledge is generated and made available publicly, as a published scientific paper or a patent, for example, it can then be used in a potentially infinite number of places at the same time. Moreover, the marginal cost of using this knowledge over and over again in different circumstances is virtually zero. No other form of capital shares these attributes.
Consequently, investment in knowledge capital is likely to generate much higher rates of economic growth than what we might call conventional capital.
The returns on investment in the creation of knowledge capital are exceptionally high in circumstances where the knowledge is publicly available or where access to this knowledge cannot be prohibited. But this also implies that the private sector will tend to underinvest in this form of capital because in general, it is difficult for it to fully appropriate the benefits. As a consequence, the State will need to invest in knowledge capital, either on its own or in the form of public-private partnerships, to ensure that the economy-wide returns that can accrue to investment of this type can be maximised.
In recent years, the State has recognised the potentially enormous role that investment in knowledge capital has to transform our living standards and quality of life. The previous National Development Plan committed a huge quantum of public resources to investment in the knowledge economy through initiatives such as the programme for research at third-level institutions and Science Foundation Ireland.
The current NDP reaffirms this commitment to investment in knowledge capital and sets out an ambitious programme of investment amounting to over €6 billion up to 2013. Over €0.6 billion of this amount is earmarked for the agri-food sector.
It would be a great pity if this programme were to be significantly curtailed to ameliorate the current difficulties in the public finances. Just as the potential rates of return to investment in knowledge capital are substantially greater than returns to other forms of capital, any curtailment in investment will incur even greater losses on a euro-per-euro basis.
These potential losses, by not proceeding with the full commitment to invest in knowledge capital, may be compounded over time because of the rapid pace of technological change. Even a slowdown in the required investment over a one-to-two-year period can create immense and sometimes insurmountable catch-up difficulties. These difficulties relate to the obsolescence of equipment and skills, apart from the headstart that might be given to our competitors in the knowledge-intensive sectors.
It is important, therefore, that policymakers make a firm resolve to adhere to their commitment to invest in knowledge capital. That commitment will be rewarded in time though a handsome pay-off in higher productivity and thus living standards.
For example, the international and national evidence in the case of investment in the agri-food sector reveals that the median rate of return from a range of studies is well over 40 per cent in real terms. This compares with a long-run real return on Government bonds of 4-5 per cent and a real return on equities of 7-8 per cent. This level of return implies that roughly every euro spent on agricultural and food research returns about €10 worth of benefits to the economy.
Prof Gerry Boyle is director of Teagasc