Why Markets Undersupply Knowledge

And what we can do about it

Today’s post is about knowledge—how it’s created, why it’s so valuable, and why markets alone don’t produce enough of it.

You might not think of “knowledge” as something that’s bought and sold, like shoes or smartphones. But in many ways, it is an economic good. We invest in creating it—through research, experimentation, and education—and it generates real benefits, in the form of things like better technology, medical breakthroughs, and higher productivity.

So why can’t we rely on private actors and markets to provide as much knowledge as society needs? Because knowledge is a public good. This has a very specific definition in economics: a public good is something that’s non-rival and non-excludable.

Non-rival means my use of it doesn’t reduce your ability to use it. If I know how to do calculus, that doesn’t stop you from learning it too. Another example of a non-rival good is the radio: if an additional 100 people tune into a radio station, my listening quality doesn’t change.

Non-excludable means it’s hard to stop people from benefiting once the good is out there. Once someone publishes a scientific discovery, others can build on it—even if they didn’t help fund the research. Another example of a non-excludable good is clean air outside: if I reduce air pollution, I can’t bottle up that clean air and sell it. It’s available for everyone.

Knowledge checks both the non-rival and non-excludable boxes: once it’s out in the world, anyone can use it without reducing its availability to others. That makes it incredibly powerful—but also problematic from a private market perspective.

Here’s the issue: if a firm or individual can’t easily capture the full benefit of creating new knowledge, they’ll invest less in doing it. Imagine a company spends millions developing a new technology. If their competitors can just copy it right away, the original innovator won’t earn enough to make that investment worthwhile. So, fewer companies try.

What this means is that, left to their own devices, private markets underprovide knowledge, because the private return to innovation is often smaller than the social return—what society as a whole gains.

So what’s the solution? Governments can step in to increase the amount of knowledge produced using one or more tools.

The first one is patents. These give inventors temporary monopoly rights to use their invention. That makes the innovation excludable—at least for a while—and helps inventors recoup their costs. The downside is that patents can lead to higher prices and less access to the relevant knowledge in the short run. But they also encourage the creation of new ideas, which is the goal.

The second tool to increase knowledge production is direct government R&D. That is, governments can do research themselves through agencies like NASA or the NIH. Ideally, these innovations would then be shared freely.

The third tool governments can use is to provide research subsidies and grants. For example, governments can fund basic research at universities and labs. This is particularly important for basic research, which often leads to long-term breakthroughs but is too uncertain or slow to be profitable for private firms. Governments can also provide private firms with tax breaks for research and development activities. Finally, they can also encourage or require knowledge sharing—for example, by mandating that publicly funded research be made freely available to the public.

In practice, it’s best to use all of these tools to some extent. It’s also a good idea to not impose very specific technical requirements on what kind of knowledge is eligible for funding or a patent because it’s hard for government officials—or anyone for that matter—to be sufficiently well-informed to know which solutions will end up being the best.

Governments aren’t always great at R&D, but it’s also important to keep in mind that innovation is fundamentally risky, and we should expect a decent failure rate. There have also been many major publicly-sponsored R&D successes in the history of the US. For example, much of the foundational technology behind the internet, GPS, modern vaccines, and even smartphones came from research funded or directly conducted by the government.

To recap, knowledge has been a huge driver of human progress and is one of the most valuable things a society can produce. But because it’s a public good, private markets alone won’t generate enough of it. That’s why smart government policy—whether it’s patents, public funding, or open access—is essential to encouraging innovation and spreading its benefits.