Friday, November 03, 2006

Can Government save R&D?

Apparently today our PM got all warm and fuzzy about Science and Technology - reportedly, the British Government is keen to have more of it. A lot, apparently.

There are reports that ASBOs (those are Anti-Social Behaviour Orders, for the non-British readers: essentially, the British Government response to hapless parenthood) were considered against youngsters wishing to go into media studies and refusing to take Maths. That was deemed excessive, for the time being anyway.

Then, they considered dumbing down Science and Maths curricula (dumbing down exams, apparenly, seems not to be enough to convince the hard-core dimwits to take up the subjects). That was ridiculed by quite a few, aging, scientists - they, clever guys as they are, spotted the flaw that had escaped our valiant Education Ministry bureacrats: you can dumb down exams and curricula, Nature however is a tough nut and won't quite bend to being dumbed down.
You can't quite solve a differential equation using only your ten fingers and a ruler - nor would you want someone designing a nuclear reactor who can't quite get the hang of Nyquist stability circles...

Running out of ideas, the Government resorted to the usual solution they choose when taxes can't be used (you can't quite tax a kid for being none too bright, now, can you?): throw money at the problem. A lot, apparently. "We've got to invest in science far more as a country." said yesterday Tony Blair, "The government is tripling investment in science - to recruit better science teachers - which is why we're offering all sorts of incentives for that to happen." (source: the BBC)

Currently, Britain's investment (private and, much smaller, public) is at around 1% of GDP - set, apparently, to increase to 2.5% by 2015. That does not compare well with the US's 3%, but, seeking consolation where one can, it is at least a lot better than the rest of Europe (Italy, close to my heart as it is, at somewhere around 0.2% is a dismally pathetic basket case).
Unfortunately, the way the Public Sector goes about funding R&D is a particularly perverse way: instead of rewarding ingenuity, success and efficiency, most grant funding mechanisms encourage waste and over-management.

A case in point, the R&D Grants - once called SMART awards.

I have personal, direct experience having being granted one in 2002 for the princely sum of £45,000 (it turned out as a lot less than that, but we'll come to that). Apart from the re-branding and having taken them away from the hapless, hopeless, pathetic SBS (see the Financial Times, here) it is my understanding that they remain essentially unchanged.

The fundamental flaw in such schemes is that, instead of saying "Ok, mate, here's a pot of cash, those are the expected results, now you go and make them last!" as any investor worth its salt does, public sector grants are based on "Costs incurred" - ie, you create a budget of all expected costs, the grant is awarded "in principle," you then go off and spend the money (usually as quickly as possible) and then claim for a refund based on costs incurred.

I am grossly over-simplifying here, but you get the general drift. Can you spot the flaw?

It gets even more amusing - generally speaking, these grants are awarded only to cover a fixed percentage of costs incurred (it used to be 75% for a Smart Feasibility Study, it is now 60% and down to 30% for a Development grant): the entepreneur, scientist, mad inventor is expected to fund the rest. Which is fine as far a company is concerned, much less so for your "inventor in a shed" kind.

In fact, one cannot even contribute "in kind," eg by not paying oneself a salary: remember, costs have to be "incurred" to count.

Unfortunately, whilst this would not matter in the "old" economy (where costs are mostly related to capital and equipment costs and less for staff) it does matter a lot for 90% of today's early stage ventures: typically developing a software product or online service, where more than 95% of the costs are staff-related, and a close-knit small team of individuals could go very far with very little.

With a bit of belt-tightening, one could safely assume that three committed, experienced professionals could go about 12 months about with £45,000 - probably more -and achieve a lot for it. A big bang for your bucks, as our friends across the pond would say.

Here's how it works instead if you do get a Grant: you get £30,000 from the Government (well, not upfront, but will eventually) put up another £20,000 from your bank account (or, more likely, from re-mortgaging the house), and go about spending it about as fast as you can.
Assume that around 20% are in general costs and associated capital and software costs (this is probably a lot more than actually needed in these days of cheap computing and open-source software) and pay the rest out as staff salaries.

Because of NI costs (12.9% - thanks, Mr. Brown) and PAYE charges (assuming a marginal personal tax rate of about 30%), the £40k work out at around £24,400 - because you had put up £20,000, this is a net income of £4,400, which added to the £10,000 of genuine costs incurred work out a total of roughly half the original grant value.

Development grants, because of the much lower percentage funded (30%) actually are even worse and are really only worth for organisations who have already funding means and plans in place for innovation.

It is also worth noting that, as Government grants must be accounted for as Revenues, if one is not so keen on surviving on £4,400 annual salary and decides to augment income by, for example, providing consulting and/or contracting, those will be additional and the company will incur also a tax bill on profits (well, assuming there are any, that is).

Rather obviously, the "fix" would be rather simple: Government Grants should be tax-exempt, payments should be staged, against pre-agreed, demonstrable results
achieved, and not driven by costs incurred.

Ideally, staff salaries should be either taxed at a lower rate or, even better, be free of income tax - the way they work at present, it is like the Government takes away with the left hand what, inefficiently, gives with the right.

Unfortunately, the Treasury does not quite believe that "science will, in my judgement, today and for future generations, be as important as economic stability" (Tony Blair, again) - they only care about raking in as much money as they possibly can.

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