Basic research at universities has yielded huge social and financial returns. The cuts and taxes aimed at research universities will hobble them for decades. But universities can do better with reporting on the value they add to society.
An institutional bond investor asked me the other day, “How should we think about the moves to tax universities’ endowments and cuts to their funding?” Well, here is my attempt at sketching the tradeoffs in this debate. The objective is to try and understand the comparative advantage or disadvantage a university may have over other institutions in specific areas such as research, teaching, and patient care, and the consequences (intended and unintended) if the new administration were to go ahead with taxes on endowment income and cuts to NIH grants proposed.
The fundamental point I want to make is that money is fungible. Any enterprise that faces a cut in revenue can only do one of three things: (i) it cuts costs and shrinks its operations and/or investments for the future; (ii) it tries to raise prices to test how elastic the demand for its product can be; or (iii) it tries to sell products that it would be better off not selling.
One can talk about many applications of these ideas including financial aid to students, the implications for charity care but I will focus on basic research and how to pay for such work.
Basic research will tank
The comparative advantage that universities have over the private sector relates to basic research. The NSF defines basic research as work that aims to “acquire new knowledge of the underlying foundations of phenomena and observable facts, without any particular application or use in view.” Applied research focuses on work “to acquire new knowledge; directed primarily toward a specific, practical aim or objective.” A big third category is experimental research defined as “which is directed to producing new products or processes or to improving existing products or processes.” Think of the third category as the D in R&D.
The National Science Foundation (NSF) reports that R&D spending in the US totaled $885 billion in 2022, the last year for which I could find data. Of this, $109 billion goes into basic research, $135 billion into applied research and the lion’s share of $505 billion goes into experimental development. It goes without saying that development (D) is not possible unless someone spends money on the R (mostly basic research). In fact, the follow up D work can itself be a considered a return to basic research as someone in private industry thought the basic research was worth building on.
As an aside, US R&D spending is a tiny 3.4% of the US’s GDP of $26 trillion in 2022. The money spent on basic research is even smaller. China spent nearly $500 billion in R&D in 2024 or 2.68% of their GDP. So, we are still ahead of China, but their curve is going up. Cutting basic research funding will cost us long-term competitive advantage with China. China is now ahead of us in terms of patents and the lead is growing.
Coming back to the US, let us think about where basic research is done:
As seen, the higher education sector concentrates on basic research. I was surprised to find that businesses do a lot of basic research as well. But the nature of work they do, by definition, is different. A researcher interested in cutting edge basic research in AI is better off at a Google or a Microsoft or Open AI than at a university because we can hardly afford to pay for NVIDIA’s expensive GPUs. Private business, that is lucky enough to have bountiful free cash flows, will fund basic research that it can eventually monetize. Someone must work on basic research that may not be monetizable for decades. That’s what universities do best. Highly talented researchers voluntarily take discounts in compensation to work on basic research in universities.
In addition, it is not obvious that any private investor is looking for a business that is labor intensive (teachers, professors, doctors, teaching assistants), capital intensive (large campus, student facilities, lots of glass buildings, heating and cooling), earns low margins (tuition) and caters to customers (students) that take years to acquire knowledge and monetize it.
Bottomline, if we hobble universities with taxes and cuts, a lot of moon-shot basic research will either not get done or will simply migrate overseas. Moreover, private innovative businesses cannot thrive or even survive for long without basic research at universities. It is no accident that Silicon Valley is a success. It owes its riches, in no small measure, to Stanford, UC Berkeley, University of Washington, Caltech and many other such great universities. In contrast, Florida struggles to recreate a Silicon Valley because it does not have a Stanford or a Columbia or an MIT.
Basic research, by definition, has to be subsidized
The other point of confusion relates to how basic research is funded and how one should think about the return (either financial or social) on such investment.
In general, an activity that does not solve an immediately applied need in business is rarely supported by paying customers in that business. As a case in point, Bloomberg’s terminals enable the financial viability of long-form, investigative journalism. Universities, however, don’t have such robust funding streams outside of tuition and limited government grants. Increasing taxes on universities will lead to one or all of three undesirable outcomes: (i) tuition goes up; (ii) basic research does not get done; or (iii) relatively underpaid smart academic researchers, who can bring such research to classrooms, leave and in turn dilute the quality of education that our future set of students get.
Without basic research, applications in private sector do not emerge
For another take, consider the pharma industry that spends a lot of money on applied R&D with long term investments and low success rates. There is little doubt that public funding of basic science is a critical enabler of drug development. The National Institutes of Health (NIH) is the world’s largest government funder of biomedical research and makes financial and practical contributions to all stages of it, including pre-clinical scientific investigations, translational medicine, and clinical trials. Cutting this funding is harmful to future generations’ public health. Around 51% of NIH funding goes for basic research and most of that possibly goes to universities.
What about ROI on basic research?
This discussion informs the question of evaluating return on basic research. One must adopt a portfolio approach to returns like a venture capitalist such as Kleiner Perkins or a Sequoia would. One cannot use ROI metrics for basic research by project or by grant. Basic research such as that on the internet or mRNA vaccines has made billions for private sector companies such as Amazon, Microsoft, Google and NVIDIA. Scientists who were working on the internet back in the 1960s could not have foreseen that we will, one day, buy toothpaste and dish washing soap on the web via Amazon.
In one sense, this confusion over ROI is a classic accounting/reporting problem where the entity simply reports costs but does not attempt to calculate societal value add generated by incurring such costs. The costs sit on the universities’ books, the benefits show up as revenues on private sectors’ income statements. I have not performed this exercise, but I would be shocked if the returns to the US economy did not massively exceed investment in basic research incurred at universities.
What about bloat and wastage?
Implicit in the administration’s actions are concerns about bloat and wastage of taxpayer money. It would be naïve to argue that there is none of that. I am biased because I work for a university, but I try and take the other side of the debate and suggest two ways forward.
Targeted cuts
First, the government might want to consider targeted cuts instead of broad-based ones. Cuts can be based on a thoughtful analysis of past results of the research funding and an assessment of the potential for future benefits. I am no medical scientist, but I suspect research in certain areas have more tangible benefits than others. For instance, grant money for one project to explore whether a meteorite that hit off the coast of New Zealand caused a mass extinction event, which though interesting, may not have the same public advantage as grant money that leads to real benefits, such as exploring water quality concerns in various locations. Even that distinction between useful and non-useful basic research is not crystal clear.
Small grants to explore controversial topics may make headlines to cut NIH funding on the political right, but most of the money goes to areas that would likely have near universal support, even with the understanding that there might not end up being any breakthroughs from the research.
Better reporting for accountability
The second suggestion is better reporting. Universities put out audited financial statements, but they can be remarkably opaque. Universities might want to consider putting out stakeholder value add statements that forward thinking businesses like Amazon have occasionally published. Why not estimate the value the university adds to the region’s GDP, employment or taxes, akin to what Johns Hopkins has done? Why not try and estimate the societal payoffs to basic research done at the university?
Despite allegations of wastage, the US government’s investment in universities has been recouped many times over via the innovations and human capital universities have created. But universities can do a better job of communicating the tremendous value they add to taxpayers and society. Cutting funding puts us at competitive disadvantage to China and harms the health of future generations.