The Ideas Factory

Igniting the potential of humanity

Risk & Progress| A hub for essays that explore risk, human progress, and your potential. My mission is to educate, inspire, and invest in concepts that promote a better future. Subscriptions are free, paid subscribers gain access to the full archive, including the Pathways of Progress and Realize essay series.

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In our study of progress, we have learned that, through innovation, humanity’s ability to solve problems and overcome challenges has prevented the deaths of billions and given life to billions more. In the process, these innovations made us wealthier and more prosperous than ever before. The future, in this regard, will certainly be no different. Our ability, or lack thereof, to continue to innovate and solve problems, presents both an existential risk as well as an unfathomable opportunity. A bright future requires that we accelerate and enhance our capacity to innovate.

An Undersupply of Ideas

To overcome the challenges of the present and future, we need an innovation abundance agenda. We need more engineers, more scientists, larger particle colliders and telescopes, and ever more capable supercomputers; we need to create a “factory of ideas.” While I have often advocated for free markets in my writings, I also recognize their limitations. It is generally agreed that the free market will undersupply funding for science and R&D, leaving an immense gulf between what we should and what we do invest in ideas. The reason stems from a kind of market failure; the social returns to innovation are far higher than the private returns. Private players fail to capture most of the fruits of their work, leaving them under-compensated for the expense, effort, and risk.

Thus, to truly cultivate a global ideas factory, we must turn to sovereign governments to correct this market failure. Incentives for innovation should, in theory at least, breed more new ideas alongside the positive externalities that grow from them. To achieve the optimal level of R&D investment, government policy should aim to bring private incentives in line with the social rate of return. This is no easy feat. The difficulty is less in finding the funding and more in identifying the most effective and efficient means of utilizing that funding. Here, no single policy prescription is universally effective. Instead, we must turn to a “toolkit” of innovation incentives and these fall into four basic categories:

1. Grants/Direct Funding

2. Tax Incentives

3. Patents

4. Prizes

This essay will focus on grants and tax incentives, as they feed the inputs into innovation, while the latter two focus on the outputs.

The Entrepreneurial State

Direct research funding by sovereign governments has a mixed track record. That said we do not need to look far to find some examples of success. Take the iPhone, a product that revolutionized society by putting a supercomputer in the palm of our hands. As Mariana Mazzucato writes in her book, The Entrepreneurial State, many technologies that culminated in the iPhone began with government-funded research. For example, lithium batteries can trace their roots to research at the Department of Energy and National Science Foundation in the late 1980s. The microchip arose from an industry that was supported in its infancy by the US Defense Department and NASA in the 1960s. GPS was born out of a government-funded satellite network built for national defense.

Many, of course, disagree with Mazzucato’s conclusion that the state can be an effective innovation incubator, arguing that she cherry-picks a few tangential successes among a graveyard of failures. Indeed, it’s not clear that the government can reliably choose which ideas to nurture. In late 1970s America, for example, garage computer hobbyists invented the first desktop computers, kickstarting the PC era and an entirely new industry. Around that time, the Soviet Union also had garage tinkerers, but in the command economy, were unable to tap VC funding or start a business; they had to seek bureaucratic support instead. Like many at the time, bureaucrats could not see the value in a personal computer and predictably refused to provide funding. As a consequence, the computing industry took off in America and stagnated in the USSR.

I tend to agree that governments are often ineffective in fostering innovation but that doesn’t mean that all government efforts toward stimulating R&D are foolish. Indeed, research by Moretti, Steinwender, and Van Reenen suggests that a 1 percent increase in publicly funded R&D generates a 0.4 percent “crowd-in” of private R&D. In other words, more R&D from the government appears to beget more R&D from the private sector. That is, after all, the overarching goal.

If and when the government is to fund research, how might it do so most effectively? The single best example of success in government-led research is probably the Defense Advanced Research Projects Agency, or DARPA. For decades, research by DARPA has led to breakthroughs in stealth technology, autonomous driving, robotics…etc. DARPA has a staff of approximately 120 individuals and a pitifully small budget of just $3.5 billion annually. DARPA has an unusual ability to move mountains because the agency adheres religiously to a few basic principles: 1) Ambitious goals, 2) Temporary teams, 3) Independence from political interference, 4) Acceptance of failure 5) and a dedication to Pasteur’s Quadrant

DARPA’s ambitious goals attract the best and brightest from all walks of industry and academia, bringing together diverse talent that otherwise would not have the opportunity to collaborate. The transitory nature of those teams, typically 3-5 years, creates a powerful sense of urgency that accelerates progress. DARPA’s independence and flat organizational structure enable the agency to select and cancel projects at will, free from forces that might distract from the core mission. DARPA can maintain a portfolio of projects while remaining nimble, adaptive, and willing to fail.

Furthermore, DARPA’s research is dedicated to Pasteur’s Quadrant. Typically, research funding is divided by its perceived intent, with some funds going to “applied science,” research aimed solely at practical uses, while others going toward “basic science” the pure quest for fundamental understanding. But as Donald Stokes opines in his book, Pasteur’s Quadrant, this is a misleading dichotomy.

Rather than being opposed to one another, basic and applied sciences are orthogonal and there is a bridge between them known as Pasteur’s Quadrant. The quadrant is named after Louis Pasteur, a scientist who exemplified both the quest for understanding and how the acquired knowledge can be used in practical application. To the extent that the government is funding research directly it best adopts the DARPA model with a focus here.

Tax Incentives

R&D tax credits are another popular option for spurring the creation of more ideas. Indeed, the data suggests that tax incentives offered by governments do induce more private R&D spending, with some literature concluding that a 1 percent fall in the after-tax cost of R&D results in at least a 1 percent increase in R&D. It is for this reason that I advocate for the abolition of the corporate income tax. But at the very least, we ought to allow for the full and immediate deduction of corporate R&D expenses. Going further, eliminating taxes on capital gains would help direct more funding toward crucial investments in new technology.

We could, as some countries do, go further and offer a “super deduction” for R&D. The concept is straightforward. Imagine that the tax rate is 20 percent, and a company earns $100. With a 100 percent deduction, every dollar of R&D spent reduces the company’s tax liability by 20 cents. If, however, the government were to offer a 150 percent “super deduction,” then its tax liability would drop by 30 cents. Obviously, this is a strong incentive for companies to conduct more R&D. Unfortunately, it is also an incentive for them to “relabel” expenditures as R&D for tax purposes. For this reason, a super deduction is easily abused and I would not advocate for it. Better to allow full expensing or to eliminate the corporate income tax entirely.

Bringing It All Together

In the 21st Century, sovereign governments should be stepping up investments in transformative technology for the betterment of humankind. I propose the establishment of a UN-administered international agency loosely modeled on DARPA. This “super DARPA” would be tasked with advancing breakthroughs for the most pressing problems, from life extension, to renewable energy, to commercial hypersonic travel, and reusable rocketry. This agency, and others like it, would leverage the multiplier effect of the “triple helix.” In addition to tax incentives, this “super DARPA” would also allocate grants to research conducted within Pasteur’s Quadrant, either by bringing together international teams of scientists or funding research labs and universities directly via grants. It would also be tasked with selectively designing innovation prizes and administering a radical new approach to patenting for the 21st Century, topics that we will visit next.

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