Richard Holden and Brian Schmidt addressed the National Press Club jointly this week. The following are full transcripts of the speeches.

The Economic Value of Ideas

Beginning in the 1990s, economists developed a framework for articulating the economic value of ideas.

Paul Romer was at the forefront of this and was awarded the 2018 Nobel Prize in Economic Sciences for his contribution. This area of economics has become known as endogenous growth theory. Rather than taking the rate of technical progress as being given, or exogenous (as the then standard “neoclassical” model of economic growth did), Romer emphasised that the rate of technological progress is determined by the generation of ideas and scientific knowledge.

His key observation was that knowledge can be an important driver of long-run economic growth in a market economy. Before Romer, economists thought of economic growth as being determined solely by physical capital and labour. Romer expanded this to include knowledge and noted that the stock of knowledge is determined by research and development activities broadly conceived. This includes what universities refer to as both basic research and also applied research.

There are two things about “ideas” that are different from physical capital (like machines). First, they’re “non rival.” If one person is using Pythagoras’s Theorem, it doesn’t prevent anyone else from using it. In other words, once discovered, there’s no monopoly on finding the length of the hypotenuse of a triangle. This is very different from standard economic goods. If one person is eating a salad, it precludes other people from eating that salad. Second, some ideas can be made “excludable” – in the sense that others can be prevented from using them through policies such as patents, or through technologies like encryption.

The production of ideas often involves large fixed-costs — such as the initial research and development — and low marginal costs for the subsequent production of each unit of the good or service. Economists refer to this as increasing returns to scale. Excludability, such as through patents, is important for allowing firms to recover their initial fixed costs. Otherwise, ideas may never be developed in the first place. Balancing non-rivalness and excludability has been a major focus of economists’ work on economic growth.

One important insight is that decentralised, market-based solutions will not always lead to the right balance of excludability and non-rivalness. This points to a role for different forms of knowledge production. Romer himself emphasised the importance of universities. Universities have long been, and continue to be, a major source of basic and applied research. This makes university research a fundamental driver of economic growth.

In fact, endogenous growth theory is essential in explaining some basic empirical facts about economic growth. These facts only started to emerge in the mid-1980s with the rise of large, cross-country datasets on growth over time. The neoclassical growth model could not explain persistent differences between countries in the rate of economic growth.

It also predicted that poorer countries would grow faster than richer countries because of decreasing returns to physical capital. This wasn’t true in the data either. Endogenous growth theory provides a compelling explanation of the essential empirical facts about economic growth. Nobel Prize-winning economist Robert Lucas once observed that “once you start thinking about economic growth, it’s hard to think about anything else". Anyone who doubts that, would do well to compare and contrast the relative fortunes of Japan and the United States over the past three decades.

In 1995 Japan’s GDP per capita — a good measure of living standards — was US$44,000 per capita (in 2022 dollars). United States GDP per capita was just under US$29,000 in 1995. So Japan’s living standards were 54% higher than those in the United States. Fast forward to 2022 and the U.S. had grown to over $76,000 per capita. Japan, after a series of “lost decades”, had actually shrunk to $34,000 per capita – or 55% lower than the United States. The US had grown at 3.7% per annum while Japan had shrunk at 1% per annum.

So it’s not an overstatement to say that generating and applying knowledge is the cornerstone of rising living standards. Countries that consistently do it better can provide their citizens with more public goods like healthcare and high-quality education, more opportunities for social mobility, and better lives.

We are, thankfully, speaking more and more about productivity in Australia. This is where productivity comes from.

Funding Australia’s sovereign research capability

So how do we go about funding sovereign research capability in Australia?

Start with this.

We’ve become addicted to funding that research capability through international student income. In a time of global uncertainty and upheaval, this is a huge strategic risk. It places a ticking time bomb beneath Australia’s security and prosperity.

International student income pays for much of our research infrastructure. It pays for buildings, electricity, scientific equipment and a range of other overheads necessary to undertake scientific research that is partly funded by government.

Commonwealth grants provide an overhead rate of less than 20%. By contrast, in the cradle of innovation — the United States (pre-Trump 47, and I’ll come back to that) — universities typically get the true cost of about 55%. So every time an Australian university gets a grant, it has to find an additional 35% just to keep the lab’s lights on.

Actually, it’s worse than that. Our universities need to demonstrate “skin in the game” to win those grants. This involves everything from salary support for young scholars to comply with enterprise bargaining agreements, to matching money for the grant.

In the flagship ARC Centres of Excellence program — which has been behind Australia’s much-lauded quantum capability and its numerous high-tech spinouts — universities need to match government funding dollar-for-dollar.

The fields that are the most expensive require universities to stump up the most money. What are those fields, you may ask? Well, just look at the AUKUS Pillar 2 list.

Right now, the Department of Education funds overheads from a common pool — one that hasn’t been growing in real terms — not just for the research grants it manages, but for an ever-increasing list of research funding from philanthropy, business, state governments and other agencies. As more things get added to the pool, the overhead rate drops for everything, including the Commonwealth’s grants.

This is the very definition of a broken system.

A better approach would be for each funder to cover the overheads associated with their own research program. Education would be responsible for the ARC and the other programs it administers.

If other agencies, like Defence want to increase their research, they’d need to also find money for overheads, rather than drawing on the common pool. State governments, business, philanthropy and the Medical Research Future Fund would have responsibility to fund their own research agendas, and not rely on the Commonwealth to subsidise their overheads.

This would cost $1.2 billion a year.

The hard truth is that we’ve had 15 years of bipartisan disinvestment in research expenditure. Relative to GDP, Australian R&D spending was one third higher when Kevin Rudd was Prime Minister than in 2023. Over these 15 years business expenditure is down, and government expenditure is down. Only university expenditure on R&D has risen. And that increase has almost entirely been funded by foreign student fees.

Sovereign research capacity is built over decades, but can be lost in months. We must stop dithering.

Now I can stand here with a straight face and say that $1.2 billion a year in the context of a $700 billion federal budget and a nearly $3 trillion economy is, to be blunt, a rounding error.

But I’m also conscious that sounds an awful lot like I’m talking my own book. And I’m acutely aware that some of my friends in the university sector have stood at this very podium, told stories about what’s good about research, and asked for a blank cheque.

That’s ok. That’s their job.

But I’m here to do something different.

I want to emphasise that, yes, that $1.2 billion will earn a very high social and economic return for Australia. And in a tumultuous global landscape, where we can no longer rely on our most important ally the way we have in the past, we must secure our sovereign research capability. It’s essential for our economic and national security.

But funding research the right way, will also align the incentives of the sector much more closely with the goals of government and the desires of the Australian people.

As anyone in corporate life knows, cross subsidies are poison. Cross subsidies muddy the price signals that best guide resource allocation decisions. They produce a lack of transparency. And they create significant incentive problems.

In this instance, what is true in corporate life is also true in university life.

And right now, we use international student revenues to cross-subsidise research.

That doesn’t mean that international students aren’t incredibly valuable for Australian universities and for Australia. They are.

They help fund better instructors and more resources for teaching domestic Australian undergraduate students in an increasingly competitive and globalised tertiary-education landscape. They allow Australian undergraduates to get what is often a genuinely world class education for one-fifth of what it costs at comparable universities in the United States. They provide significant financial benefits across the economy – far beyond our university campuses.

But when we have a huge misalignment between the source of revenues and the use of revenues, well, we’re just asking for trouble. And trouble is what we’ve seen.

Funding research properly is not so much about “more money”. It’s about “the right money”. By better aligning the incentives of universities and the desires of the public, we can turn what has too often been zero-sum conflict into a mutually beneficial joint enterprise for the benefit of the nation.

The Trump challenge

Prime minister Jim Hacker once said: “May I remind the secretary of state for Defence that every problem is also an opportunity?” To which Sir Humphrey replied: “I think that the secretary of State for Defence fears that this may create some insoluble opportunities.”

What President Trump is doing to research funding in the United States is a bit like that.

Some of the world’s great universities are under direct attack. Harvard — the oldest university in the United States and the most important in the world — just had US$2.2 billion in funding stripped for having the temerity to resist the Trump administration’s push to intervene in their choices of faculty, students, and their curriculum. Now they’ve been banned from enrolling international students, including Australians.

The overheads on NIH grants have been slashed. And the government is simply refusing to reimburse expenditures on existing grants from the National Science Foundation and other sources.

I just came back from a week at MIT and Harvard and I heard directly the concerns faculty members have over what will happen to students, researchers and the pathbreaking research these institutions undertake.

Australia is not immune from the carnage in US higher education. The Australian Academy of Science estimates that more than $300 million of funding for research by Australian university researchers is already in jeopardy. This has serious implications not only for the research involved, but for Australian researchers – especially those at earlier stages of their careers. It will damage — perhaps shatter — longstanding and valuable collaborations between Australian and US researchers.

We will need to plug this gap. This is the “problem” part of the equation. But there’s also the “opportunity” part.

With the US stepping back from its leadership role, Australia has a chance to step up. In coming months and years, many leading US researchers may be looking to move their labs, their families and their lives abroad.

If we act decisively, Australia can be as, or more, attractive a destination for those researchers as Europe which — if we’re being honest, and there’s no reason not to be — has its own issues.

What’s happening to US research and researchers is shocking. But this act of American self-harm is our opportunity. And it’s an opportunity that has never arisen before and may never arise again.

In justifying his acceptance of a US$400 million aircraft from Qatar, President Trump invoked the words of legendary golfer Sam Snead: “When your opponent gives you a putt, just say thank you and walk to the next tee.” Now it turns out Sam Snead never actually said that, but that’s not important right now.

In destroying the US research ecosystem, President Trump is giving us a putt. A freebie. We should say “thank you” and walk to the next tee. Along with some of the world’s finest researchers.

A Future Made in Australia

The Albanese Government speaks of “a future made in Australia”. The prime minister seems to have in mind the manufacture of physical goods. I’ve made no secret of my scepticism about our ability to turn the clock back to the 1960s.

We have a better chance when it comes to advanced manufacturing – as I wrote about in my 2022 book From Free to Fair Markets with Rosalind Dixon. Germany has a long history and proud tradition in this area. But other leading countries in high-tech, high-wage, advanced manufacturing of precision goods include France, Italy, and the Netherlands. Surely Australia can compete with those countries?

But let’s not forget that “ideas” are things, too. They need to be produced as well. And, as I emphasised earlier, ideas are a crucial driver of economic growth and living standards.

A Future Made in Australia can, and should, be one where we manufacture ideas not just physical goods.

We live in a rapidly changing world. A world whose technological possibilities, economies, and social interactions will be determined by the ideas that we create and implement.

Evolutionary biologists have a concept called “punctuated equilibria” where evolution of a species can proceed in a leap, rather than gradually. And legal scholar Bruce Akerman has spoken of “constitutional moments” where there can be great change to constitutional arrangements in a short period of time.

We are living through a “technological moment.” We don’t know what this moment will bring. We don’t know all the challenges that will arise, or opportunities that will unfold. We don’t know what it will mean for Australia and our place in the world.

This might seem daunting, even scary.

But we should reflect on, and be comforted by, the words of Robert F. Kennedy in 1966: “Our future may lie beyond our vision, but it is not completely beyond our control.

”We have a choice. We can meet this technological moment, or miss it. We can embrace this moment, or evade it. We can secure our research sovereignty, or surrender it.

I hope we’ll do the former.

 

The views expressed in this article may or may not reflect those of Pearls and Irritations.