02 Knowledge as a Public good

No there is no clear cut definition of knowledge.

• codified (explicit)

• tacit (implicit)

Polanyi, 1967

In scientific publications as well as new products (science-technology relationship)

Internal (coming from in-house R&D effort)

or

external (e. g. from other industrial companies)

• Is associated with the exchange of knowledge within networks of innovators and imitators

• It describes the diffusion within the group of innovators and imitators

• Human capital

• new technologies (or intermediate and capital goods)

1. Indivisibilities

2. Uncertainty

3. Externalities

1. Uncertainty (don´t know how much you get back)

   • Creates problems for market allocation processes (agents conflate devisions to produce and/or invest with decision to bear risk)

   • Often leads to too low levels of production and/or investments

   • Seperating risk-bearing from producion and/or investment is difficult because of moral hazard (actions designed to transfer risk undermine incentive to prodce or invest efficiently)

1. Indivisibilities

   • Cause non-convexities in production functions, drive marginal costs (MC) below average costs (MC pricing becomes economically unviable)

   • Create strong incentives for firms to monopolize markets (drives a further wedge between MC and market prices)

Externatilities

• Unpriced actions of one agent affect profits of another

  • consequences of decisions of one agent are not compansated for the others.

• Externatilities are central problem for the provision of public goods, i. e. goods and services for which consumption is not destructive (e. g. know-how)

• Providers of public goods are likely to create many externalities.

Knowledge has the character of a public good

• non-rival (use by one agent does not preclude use by another)

• non-excludability (producer of new knowledge cannot prevent non-payers from using it)

Problem:

Returns of innovator may be much smaller than commercial sucess of innovation, undermines incentives to invest in R&D

Because of the appropriability problem

• Agents are able to use new knowledge generated by other agents relatively costlessly.

—> R&D programs often incur substantial fixed set-up costs

• Economics of scale, due to extensive division of highly skilled labor

• Knowledge is inherently discrete (i.e. it is likely to exhibit economies of scale in any particular use, and maybe economies of scope)

—>Technological Uncertainty as additional problem

• How to make a new product, or how to make it work, is additional to usual problem of “market uncertainty”

• Moral hazard problem particularly acute, since it is difficult to ascribe failure to innovate to a lack of effort or a natural consequence of the inherent scientific difficulty of an R&D project

  • Bank has to decide how much money they invest, but cannot know how big the risk is.

Creates two problems:

1. Use of knowledge by one inividual does NOT preclude its use by others

   • Sale of information by monopolist inventor automatically destroy its monopoly

   • Knowledge remains in circulation no matter how many people consume it, whoch undermines attempts to create artificial scarcity

1. Difficult for potential buyer to properly value an innovation

• If seller reveals too much of the idea, then the buyer has no more need to pay for the innovation

—> Sellers are unlikely to realize full value of innovation, leads them to underinvest in R&D

• Discovery (=recognition that something exists which will not automatically be reealed by events)

• Foreknowledge (=advance knowledge that something will happen)

• Problems of buyer valuation are attenuated and the market may be easier for the innovator to control

• Problems of appropriability are dependent on cost of information transmission

• There are two ways to commercially benefit from an innovation if it cannot be sold

Foreknowledge enables one individual to gain at expense of others (i. e. its private rate of return may exceed social rate of return)

• Innovator is a discoverer that also brings foreknowledge – imperfect appropriability of technical knowledge may be solved by reaping the benefits which follow from release of new information

• Alternative: new information is embodied in output sold as new product (N.B.: output-embodied knowledge is typically more appropriable than non-embodied knowledge)

• Horizontal Strategies

  • Applied directly to the market where the failure occurs

  • alleviate appropriability problems, but often create their distortions

• Vertical strategies

  • applied to upstream supplier markets or downstream user markets, directly affecting supply and demand facing innovators

  • alleviate appropriability problems and can also create efficiency gains

1. Raising the expected returns by lowering the cots of doing R&D

   • Direct: subsides for R&D expenditures

   • Indirect: restructuring firms and marktes to facilitate exploitation of economies of scale in R&D

2. Raising the expecet returns by restricting the use of knowledge appropribility

   • Direct: patents, trademarks

   • Indirect: Allowing putatie competitors fo form cooperative R&D venturs (thus internalizing ecternalities they generate)

additional benefits:

• lowering entry barriers,

• increasing competition,

• lowering margins,

• improving allocative efficiency

Through the tax system

• to subsidize R&D expenditures

• to grant tax credits

• (self-financing) levy/grant systems - all girms of an industry pay into a fund whihc is redistributed to those firms whoe do more R&D (helps minimizing secondary distortions)

• Knowledge spillovers imply that R&D activities of one firm create externalities for others

• Natural remedy: subsidize activities for which market provides insufficient incentives (additional benefits: lowering entry barriers, increasing competition, lowering margins, improving allocative efficiency)

• In practice implemented through tax system

• Appropriate level of subsidies requires calculation of wedge size

• Tax-based grants reward creative-accounting practices

• Subsidies tied to R&D inputs create severe moral hazard problems

• Firms that are tax-exhausted are unable to benefit from R&D tax credits

• Price elasticity of R&D may be too low to enable much effect on firms’ R&D decisions (little additionality through subsidies)

• Subsidy use may not accurately target the problem (lack of demand, not costs which inhibit R&D activities) – public procurement policies may be more effective than taxes/subsidies, role of ‘smart users’ not to be underestimated for stimulating R&D

• cost sharing,

• risk pooling,

• exploitation of economies of scale in R&D,

• elimination of ‘excessive duplication’ of R&D projects

• pooling of complementary skills

Problem: introduction of a market failure to correct another one. Possible undesirable side-effects are:

• From national champions: Creation of monopoly in R&D market and output market (pricing distortion in output markets, lack of incentives to conduct R&D efficiently or to introduce new products created by R&D promptly)

• From cooperative R&D ventures: It may lead firms to invest less R&D than optimal, cooperative pricing, moral hazard problems

• ought to involve firms producing complementary products

• ought to focus more on the ‘R’ than the ‘D’

• ought not to restrict the independent R&D of participating firms

• at least some limited competition between cooperative R&D ventures ought to be encouraged

• Using the legal system to create property rights in ‘bits of knowledge.

• Overcoming the problem of non-excludability by assigning property rights to innovators, and encouraging the maximum diffusion of knowledge by making it public

• Policies to improve appropriability create costs, patents are designed to minimize these costs to the extent possible

• Patents are rent-seeking devices, i.e. competition for them may create distortions (‘common pool problem’)

  • firms invest too much into R&D to own the patents

Duration and scope

• award of prizes, direct contracting of research (esp. when there are few informational asymmetries between researchers and public and/or buyers)

• the costs for the public increases while the monopilts holds his patent

An optimal patent policy sees to it that the monopoly rent lure induces RD investment just sufficient to equate the marginal social gain from further cost reduction with marginal social cost