In the race to the top, quality R&D is a must - but who will pay for it?

Between 1977 and 1999, Hong Kong lost about 900,000 manufacturing jobs. They moved over the border into the lower-wage economy of Shenzhen, China, the population of which consequently grew from about 30,000 in 1980 to about 15 million today. But now, in turn, those manufacturing jobs are moving to inland China, where land is cheaper and wage rates are lower.

This is a perfect example of the process so well described in Lord Sainsbury's 2007 report The Race to the Top: A Review of Government's Science and Innovation Policies. It posits that economies have the choice of trying to win either a race to the bottom by continually lowering wage rates, or a race to the top by focusing on higher-level skills, a strong research and development base and high value-added jobs.

This is the reality facing all developed economies and it leads to a set of dilemmas, notably how to pay for a mass higher education system and how to spread the available funding for research. Recent policy decisions by the UK government must be understood in this context.

The fact is that higher education is the global powerhouse for knowledge economies. All analyses, from the United Nations Educational, Scientific and Cultural Organisation's work to that of the Organisation for Economic Cooperation and Development, conclude that the primary determinant of growth for developed economies is the level of R&D spending, and that it is public R&D spending that either leverages in or leverages out its private equivalent. The primary focus of public R&D spending is higher education.

As The Race to the Top argues, countries can either compete on lower wage rates or higher-level skills. It concludes, and subsequent UK governments have agreed, that there is only one choice: if you do not invest in higher-level skills or world-competitive research, you cannot enter, let alone win, the race to the top.

Knowledge economies engaged in the race to the top must appreciate that private companies locate themselves only where there is both an existing competitive public R&D infrastructure and abundant higher-level skills. Whereas public funding of university teaching can be replaced by other, private sources, private money never replaces public money in R&D; instead it moves to better-funded R&D environments.

A 2010 UK Trade and Investment report notes that "the international competitive environment to win high-value R&D investment is intense", with 80 per cent of the £400 billion annually invested by the 1,000 largest companies concentrated in just five countries (the UK, Germany, France, Japan and the US). Yet whereas the UK currently spends about 1.78 per cent of gross domestic product on R&D, the average spend of the other four competitors is 2.66 per cent.

This leads to two dilemmas. First, as an ever greater percentage of the population needs higher-level skills, who pays for providing them? You cannot fund a mass system by the methods used to fund an elite system. You have either high taxation and low student charges, or low taxation and high student charges. Second, to what degree do you concentrate research? How many world-competitive research institutions can a knowledge economy afford? You do not win the race to the top by having lots of medium-quality research.

All this explains the recent decisions about the funding of higher education in England. I am not simply talking about the decisions taken by the coalition government in the past six months, but also the direction of policy under the previous government. It was Labour, after all, that faced enormous problems containing student-support costs: hence the cuts to the Higher Education Funding Council for England's budget in 2009 and 2010 and the decision to set up the Browne Review.

Equally, it was the Labour government that continued the process of concentrating research funding. And although the rhetoric might suggest otherwise, the reductions in public funding of institutions (as distinct from funding students) planned by Labour are not very different from the reductions imposed by the coalition.

Are we to follow the example of Hong Kong, which reacted to the loss of its manufacturing industry by trying to reposition itself as a knowledge, financial and tourism hub - but one that spends only 0.7 per cent of its GDP on R&D? Or should we emulate the Shenzhen region, which has responded to the loss of its manufacturing sector by investing some 7 per cent of regional GDP in R&D?

In this light, Westminster's decisions must be seen as reactions to the higher education dilemmas facing all developed nations.