Change the incentives to change the economy

Incentives are a delicate thing.

As we learned from the former chief executive of UKRI, if you try to measure every single outcome, every pound spent, and direct every bit of the ecosystem toward something (whatever that something is) it’s possible to cause an enormous amount of damage. Get the input wrong, follow the wrong priority, or make a decision on a less than full picture amongst all of the complexities in an ecosystem and then enormous sums of money can be wasted.

The underlying assumption in the public theory of research is that directing research toward a clearer end is desirable, possible, and value for money. Intuitively this makes sense. The central feature of modern economic thought is that firms should specialise within a market. In doing so they develop expertise, market advantage, and the wider economy benefits from the most innovative and efficient firms. Market competition then dictates who gets to be the most profitable firms until new firms come along and old firms die through a process of creative destruction.

Advantages

In business R&D forms part of the critical advantage. In theory, the firms that can make the most use of the right R&D assets (tangible and intangible) should be the most innovative, secure the greatest market share, and then grow their profits. R&D spending has natural constraints within business. A defence firm is not going to spend money on research outside of defence any more than a carpenter is going to spend money on hypersonic missiles.

Universities do not face any such natural constraints. In fact, they have precisely the opposite incentive where to maximise income (not profitability) they should do as much research and research adjacent activity as possible. As long as a link between volume, income, and reputation exists, the rational seeking university should do as much as possible. As a secondary benefit is that it is also easier to tell staff, governments, funders, that universities will do more, not less.

The three major constraints in universities are capital, capacity (staff and facilities), and the direction of funding bodies. If the funding incentive is toward doing more then if the government wishes to introduce greater specialisation in the sector, as set out in the post-16 white paper, it must therefore introduce some new incentives. In particular, as purely from an incentive perspective, it makes very little difference to universities whether their research is economically useful or not.

The white paper sets out lots of things the government might do including moving teaching incentives through research, changing the REF, rewarding research potential, and encouraging universities to do fewer things better. Post white paper there have been two key research announcements that highlight the difficulty in setting out the right incentives. The funding allocations to UKRI which we will know more about in December and some mooted reforms of HEIF.

The reform of HEIF promises to introduce new accountability statements tied to a reform of the funding formula over the next few years. The first part of the reform is that universities will be expected to demonstrate how HEIF funding is contributing to economic growth amongst other goals. There is very little knowledge exchange activity where if you squint hard enough it does not contribute to economic growth. This isn’t a strong incentive but a useful nudge toward what universities should be doing. Over time, it is possible to see how the new methodology with a greater focus on causal links and inputs could lead to a different kind of HEIF.

Outcomes

If the HEIF is going to be “outcomes focussed” this implies that HEIF should be more actively driving university activity toward specialisation within a local, national, and regional context. This would align closely with the white paper but HEIf is only a small portion of the overall funding research mix. Should the government think there needs to be more economic-growth align university activity, and it thinks HEIF is a tool to do that, it should consider whether it can improve the HEIF incentives with greater funding.

The proof will be whether the changing accountability statements produce and new activity or whether universities simply account for their existing activity in a different way. Perhaps the more interesting reforms will come in 2027-28, at the earliest, where there will be a review to the funding formula to support contributions to economic growth.

It would be an error if this was carried out in isolation and not as part of a wider look at the incentives in research. HEIF cannot move the sector toward more useful economic research ends alone and nor will it change the underlying unit of resource which encourages universities to do everything all of a time. HEIF can be a message, a guide, a statement, but without shifting funding it will not be a bigger enough incentive to move the sector.

It would also be an error if HEIF’s accountability statements and any funding revisions flow to the same places to cover the same activity. Specialisation implies winners and losers but aggregate benefit across the sector and for the economy. The revision to funding formula could, for example, fund different kinds of economic activities differently, add regional multipliers, reward collaborations different, or any other number of useful economic objectives.

The challenge is that however the incentives are constructed they must be coherent with the wider direction of travel set out in the white paper. The opportunity is to use research funding to reward the places doing economically interesting things that aren’t always recognised in traditional research metrics.