Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
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Nortel Sale to Ericsson Stirs Protest in Canada

Why Does Government Fund R&D?

What Is Government Entitled to in Exchange for Funding R&D?

 

 

Nortel Sale to Ericsson Stirs Protest in Canada

A recent article in the NYT, “Nortel Sale to Ericsson Stirs Protest in Canada” by Ian Austen, describes a conflict over the sale to foreigners of patents that were developed with government funding: Nortel, a Canadian company, is currently bankrupt and its assets are in the process of being dispersed. In particular Ericsson, a Swedish company, is interested in purchasing some of Nortel’s patents. However, several Canadian politicians are objecting to the sale of Nortel patents to foreigners, claiming that the patents resulted from publicly funded research, and as such belong to Canada.

The debate over Nortel has focused on exactly what remains of value at the company and, more broadly, what Nortel owes Canadians. “People are a bit miffed that a lot of government money went into Nortel through tax credits” for research and development...

“Nortel’s intellectual property and work force, devoted to next-generation wireless research known in the industry as L.T.E., or long-term evolution, is nothing short of a national treasure that Canada must not lose” … putting it in foreign hands could endanger Canada’s national security and make it more difficult for Canadian carriers to restore future network failures…

Several Canadian politicians, echoing Mr. Lazaridis, have emphasized the value of Nortel’s L.T.E. patents. But unlike its competitors, Nortel has found no carriers that are interested in buying its technology, and some analysts question the importance of what it has developed to date. “It may be the crown jewels of Canada, but it’s no longer a jewel of the wireless industry … It’s not like Nortel has the keys to L.T.E.”…

In response to the politicians’ objections, however, a wireless technology consultant in Denmark made an important distinction: Denmark has also lost government-funded technology to foreigners. However, it was the skilled Danish workers, not the technology they developed, that were the real assets for Denmark.

Several Danish companies were once leading makers and designers of handsets. Acquisitions and failures, however, either eliminated them or put those companies under foreign control. But subsequent investments by foreign owners in Denmark, Mr. Strand said, have made the country’s wireless industry bigger than ever and based largely around high-paying engineering, research and development jobs. “If you have the right people with the right skills, you have no problem.” 

The issue the lies at the heart of this debate is this: Why does government fund research and development? And in particular, what is the government entitled to in exchange for its funding of R&D?

 

Why Does Government Fund R&D?

Just as a rising tide lifts all boats, a larger base of knowledge benefits the entire community: 

(1) [Social Value of R&D] = [Private Value of R&D] + [Spillover Value of R&D]

However, a private funder of R&D cannot capture all the spillover benefits his R&D creates. The private entity will fund R&D until the last dollar spent on R&D just equals the incremental benefits he can capture.

(2) Private Entity: Fund R&D until

[Incremental Private Costs of R&D] = [Incremental Private Value of R&D] < [Incremental Social Value of R&D] 

But since the benefits he captures (the private benefits) are less than the total benefits to society (the private benefits plus the social benefits), he will end up funding too little R&D from a social point of view. If we aggregate this up to the national level, we see that the private sector will end up funding too little R&D from a social perspective; hence, the government steps in to help increase R&D from the privately optimal level to the socially optimal level.

(3) Society: Fund R&D until

[Incremental Social Costs of R&D] = [Incremental Social Value of R&D]

 

What Is Government Entitled to in Exchange for Funding R&D?

So the government provides private entities with government funds to increase the level of R&D to socially optimal levels. The private entities owns the assets it generates from its privately & publicly funded R&D, and it keeps the private benefits generated from the assets (company profits). Society benefits from the higher spillovers of knowledge created by the publicly funded R&D plus the taxes paid on the extra company profits resulting from the additional assets generated from government funded R&D.

Now, what would happen if a foreign entity were to buy the assets of the private entity? The IP and Tangible Assets of the private entity would move to the foreign owner. But the Human Capital, Spillover Knowledge, and Taxes generated from the government and privately funded R&D would remain in the country of origin. It is the contention of the Danish wireless consultant cited in the article that what's really of value is the human capital and spillover knowledge, more so than the IP and tangible assets. This is precisely what Leif Edvinsson maintained when he stressed the importance of intellectual capital. In contrast, Amar Bhide, in The Venturesome Economy, contends that what's least important is who develops the technology, what's important is who profits from the technology, but what's most important is who ultimately uses the technology. In either case, what's imortant is that whoever owns the assets, Canadian users will still benefit from products incorporating the technoogy. So in the end, it seems that Canadians shouldn't worry that the Nortel IP their tax dollars helped fund might end up in the hands of a Swedish company, because they will still benefit from the human capital, spillover benefits and end-user technologies their dollars helped create.

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