A formal model of the determinants and effects of private investment in R&D: socially optimal incentives, and the fate of civilisations

Abstract: Improvements in the technological efficiency of production require investment in R&D.  Private investment will only occur in expectation of sufficient profits to offer the market rate of return to capital.  A "public good" market failure in R&D means that private investors will make no return if competition reduces the price of their discoveries to production costs.  Hence there would be no rational investment in R&D, and society would be deprived of the consequent benefits.  Technological improvement in pharmaceuticals offers a particularly clear example of this market failure, as the sunk costs of discovering a new medicine are typically very large in proportion to production costs.   Government intervenes to address this failure - both by funding research directly, and using intellectual property law to reward and incentivise private R&D, by providing companies with a period of market exclusivity in which they can set prices above production costs.  

The presentation will propose a formal explanation of how the net social benefits arising from industry-wide private R&D are determined by the proportion of the value of inventions that firms can expect to recoup as profits above the cost of production.  A model is presented which allows the quantity of total private R&D investment in a given time period, and the consequent benefits to society, to be calculated as a function of the share the value of inventions that firms expect to recover, through patents or other mechanisms.  This allows a theoretically optimal share to be derived, at which the benefits of R&D to society are maximised. 

The process of incentivisation of R&D described in the model is proposed as the fundamental determinant of long-run economic growth through technological improvement.  Preliminary indications suggest that positive feedback inherent this model will lead to accelerating economic growth in the long run, until improvement in technical efficiency is constrained by the exhaustion of scientific knowledge - at which point the theoretically maximal level of economic output will be approached.