With society facing many urgent and complex challenges, deciding who is best-placed to deliver solutions has become an emotive and often political subject. We assess whether there is a better way to utilise the skills and resources of the public, private and third sectors for the greater good.
13 minute read
$1.5 billion average cost of a NASA shuttle launch
Blasting a shuttle into space is a costly business. With the National Aeronautics and Space Agency (NASA) at the controls, a single shuttle could burn US$1.5 billion taking matter into low Earth orbit.1
But NASA’s approach seems anathema today. Who would plan such a costly, complex operation and jettison parts after a single use? Today, US commercial operator SpaceX partners NASA in transporting cargo to the International Space Station over 400 kilometres above the earth, but it has a different vision, based around simplifying and re-using as quickly as possible.
Reusability is only relevant if it is rapid and complete
By using new approaches – like a floating platform to land a rocket booster as it returns to land, or a ship armed with nets to ‘catch’ jettisoned parts – the economics of space travel can be transformed. Targeting rapid parts turnaround means cost equations change entirely.
“Reusability is only relevant if it is rapid and complete,” explains SpaceX CEO Elon Musk. “You do not send your aircraft into Boeing in between flights.”2
Of course, the reality is complicated, and only small parts of the ‘re-use and re-cycle’ vision have been achieved. An insulated rocket nose cone could be larger than a bus, weighing in at around 800 kilos, and, even when slowed by a parachute, getting an ocean landing area cleared and a recovery boat in the right spot to ‘catch’ it will be challenging.
Figure 1: Costing progress
1. Who needs innovation ‘moonshots’?
It is a nice story, but it is reasonable to question why this is relevant in understanding who is best-placed to solve complex challenges in the long-standing public/private debate.
It could be argued no-one ‘needed’ President Kennedy’s ‘moonshot’ in the 1960s, but the US justified an enormous national investment as the Soviet Union was sabre-rattling. The space programme served a clear political objective – a direct challenge to USSR – and led to innovation in multiple fields simultaneously; defence, robotics, satellite technology, nutritional science, water purification and textile design.4
Since then, private companies have actively capitalised on those ideas. New communications technologies, drought warning systems, specialist fabrics for extreme climates, dehydrated foods, comfort foam beds… the list goes on. The value created from the original research drive has been immense, and whole new areas of commercial activity have emerged. A world monitored from space has few places to hide, but may have the infrastructure to deliver cheap, universal WiFi.5
Which of today’s problems need cutting-edge science, and who should deliver the solutions?
This raises several questions. Which of today’s problems need cutting-edge science, and who should deliver the solutions? Specifically, what should the role of the state be when resources are short but society’s wants and to-do lists are so long? And, if delivering solutions means pulling in capital and market discipline from the private sector, how can incentives be structured in ways that will genuinely benefit the wider community?
Setting the compass
An approach gaining traction involves re-imagining the role of the state; not as a sluggish Leviathan, but an important player directing growth. Professor Mariana Mazzucato from the Institute of Innovation and Public Purpose at University College London, believes innovation has two elements – pace and direction – and governments can influence both. In her view, an unfettered free market has benefits but is unlikely to deliver complex technical or social goals without at least some direction from the state. She argues it is naïve to think achievements that are often ‘claimed’ by the private sector – like the development of the smart phone – came about without any government involvement.
If you take apart the iPhone, every little bit of it is actually funded by the state
“If you take apart the iPhone, every little bit of it is actually funded by the state,” she said in a speech at the University of Sussex in 2012. “The state has not just funded the schools that have educated the workers that have done the research behind the iPhone. The state directly funded the internet, GPS, the touchscreen display and the communication technology behind the phone.”
This conviction in the state’s ability to make and shape underpins the mission-led innovation policy Mazzucato is actively promoting around the world. By setting targets and providing explicit incentives – like providing capital to the institutions that underpin research, offering tax breaks, income-contingent loans and credit guarantees – state involvement can be transformative.
Figure 2: The movement from broad challenges to speciﬁc missions
Time for more mission-oriented moonshots?
This line of thinking has put some ambitious moonshots on the European political agenda, including how to achieve 100 carbon-neutral cities by 2030, how to collect more than half the unwanted plastics in the marine environment by 2025 and how to decrease the burden of dementia through personalised health.6 They are ambitious goals, and it is too soon to judge how respective public and private roles will play out.
Science is a collaborative endeavour, but ultra-long term or speculative research and investment might never be made by listed companies
Significantly, Mazzucato says that without significant public infrastructure and established funding pathways in place, the private sector would likely struggle to make progress. Science is a collaborative endeavour, but ultra-long term or speculative research and investment might never be made by listed companies whose decisions may be overly influenced by the confines of a quarterly reporting cycle.
Instead, active providers of risk capital should step forward. Examples include Finnish innovation fund SITRA, or state investment banks like such as BNDES in Brazil and Germany’s Kreditanstalt für Wiederaufbau Bankengruppe. They have capacity to provide early-stage capital, and ‘pump prime’ directional technologies, and may be particularly helpful for backing innovative projects without proven financing or funding models.
2. Designing a healthcare remedy
Ultimately, though, the private sector may still capture the bulk of the gains from government-funded breakthroughs. “Because innovation is so cumulative, think of it as a curve, depending on where you position yourself along the curve, you can in theory ‘win’ the whole space underneath the curve, not just your marginal contribution,” Mazzucato said in her 2012 lecture.
We have not seen a truly new class of antibiotics for decades.
From this flows the idea an entrepreneurial state might be alive to capturing a larger share of the advantages that result from higher risk investments, beyond any tax receipts from successful ventures, particularly through equity stakes. Consider, for example, how SITRA’s decision to hold a stake in mobile phone provider Nokia paid off in the company’s glory days. Conversely, the users of the UK’s National Health Service will not benefit directly from royalties from the blockbuster cancer drug Keytruda, an immunotherapy treatment developed from the Medical Research Council’s intellectual property. These were recently acquired by the Canada Pension Plan Investment Board for US$1.3 billion.7 Users may, of course, be beneficiaries of other bioscience breakthroughs.
Beyond technology and innovation, how should we approach areas where society clearly has needs, but the private sector seems reluctant to engage?
The pharmaceutical sector is a case in point. As the use of antibiotics has become ubiquitous, the number of resistant microbes or ‘superbugs’ has grown.
“We need new drugs to replace the ones that are not working anymore because of resistance,” wrote leading economist Jim O’Neil in his review of the UK pharmaceutical industry in 2015.8 “We have not seen a truly new class of antibiotics for decades.”
A world without effective antibiotics is alarming, as the accounts of drug-resistant MRSA-sufferers attest.9 Chills, sweats, burning, itching, extreme tiredness; the symptoms of persistent bacterial infection are diverse. There were more than one million deaths caused by superbugs worldwide in 201810, and scientists at the University of Melbourne, Australia, have flagged the presence of staphylococcus epidermidis, a bacterium resistant to all known antibiotics, in ten countries around the world.11 If resistance grows, ten million people could die annually by 205012 and even common surgery may be threatened.
Nevertheless, some large pharma companies seem to be edging away from developing anti-infectives. Recently, both Sanofi and Novartis have chosen to focus their research efforts elsewhere, as have AstraZeneca and Allergan. That leaves a narrow field of big pharma companies active in this field, including Merck, Roche, GlaxoSmithKline and Pfizer.
Society and the markets are telling companies to prioritise sale volume over value
As for why, the structure of incentives is driving activity away from the areas of greatest health need. Bear in mind that it might take more than twenty years for a private company to shift from initiating research to achieving a profitable, marketable drug (Figure 3). There is pressure for modest pricing for treatments that might be used in high volume, but ‘last-line’ antibiotics are needed too. These are the drugs to be kept at the back of the medical tool kit, used rarely or not at all.
Figure 3: Cumulative profits from antibiotic research
Cumulative profits from antibacterial research
“Society and the markets are telling companies to prioritise sale volume over value,” says Sora Utzinger, socially-responsible investment analyst at Aviva Investors. “But you actually need a completely different model for antibiotics. The biggest barrier for companies is the regulatory burden. The costs of trials are so high, and society is not willing to pay the high price for antibiotics. That is the paradox.”
New antibiotics are likely to be tightly controlled to limit the risk of resistance emerging. On average, they cost no more than US$1,000 a day, and treatment times tend to be short, amounting to a total of around US$10,000 for a course. Cancer treatments might cost ten times more.13 So, the financial rewards for successful anti-infectives tend to be quite modest; only five of the 16 antibiotics introduced in the US between 2000 and 2015 achieved sales of over US$100 million.14 It is no surprise there has been more of a commercial impetus for developing treatments in oncology.
Creating the right incentives
There are now several potential solutions being aired to tackle these issues, and they all share the same challenge: incentive design. The ‘carrot-type’ approaches include tax credits for research and development into anti-infectives, ‘golden payments’ for significant intellectual property and early-stage funding guarantees backed by government and non-commercial sources.
A subscription-based model could see a hospital paying a flat fee for access to a certain number of doses of an important new anti-microbial,
Significantly, a role for charities or the third sector is now an important part of the mix.
“There are fledgling initiatives – for example CARB-X, that fund the initial phase of research for promising projects, using philanthropic donations and government subsidies,” says Utzinger. “The Wellcome Trust and the Bill & Melinda Gates Foundation are partners for CARB-X.15 They will fund research up to a point where the drug candidate is ready to be commercialised. At that point, if you have a government entity ready to step in and say: ‘Well, ok, we are going to promise X over a certain amount of time as a guarantee’, you would calculate the discount and agree the net present value for the drug. But that intervention is not necessarily from a private company. So, you already have an existing cross sectoral public/private model, but it’s the funding guarantee that is missing.”
Other possibilities include scaling up success payments, perhaps to around US$1-£1.5 billion per drug, to be funded by multiple countries collaboratively. There is also a new subscription model being mooted in the US and trialled by the UK’s National Health Service, which would involve antibiotic users paying to access to certain drugs.
“A subscription-based model could see a hospital paying a flat fee for access to a certain number of doses of an important new anti-microbial,” explains former Food and Drug Administration Commissioner Scott Gottlieb. “These fees could be priced at a level to create a sufficient return for the investment made in a drug with the appropriate profile. This should have the effect of creating a natural market for drugs that meet certain important specifications.”
Other options include sharing the private sector’s intellectual property more widely. “Pharmaceutical companies are under constant pressure to launch the next blockbuster drug and justify the billions of shareholder funds being ploughed into research and development. Consequently, the risk-reward trade-off with antibiotics often fails to meet strict investment criteria,” says Mirza Baig, head of investment stewardship at Aviva Investors.
“One possible option is for pharmaceutical companies to actively explore joint ventures with government agencies and development banks to house the development of antibiotics and treatment for neglected diseases,” he adds. “The joint venture structure would enable companies to offset the financial impact of developing lower margin drugs through risk-sharing development costs and enhanced distribution opportunities.”
More than one hundred years after they were first discovered, using viruses to destroy bacteria is moving back up the research agenda
Such risk-sharing arrangements are common in the energy sector and, ultimately, it seems collaborative arrangements involving multiple parties, perhaps sharing intellectual property through content hubs, may work better in the search for complex solutions.
“The problem with antibiotic drug discovery is that it is not a single problem to solve,” says Erin Duffy, chief scientific officer of US biopharmaceutical firm Melinta Therapeutics. “We like to think of the antibiotic problem in simple terms in terms of the Rubik’s cube, where you have multiple faces to figure out. You are not going to solve them all. It’s not impossible, but certainly not likely that just by randomly changing different pieces you will come up with the solution.”
Phages to the rescue?
True to form, the issues are morphing again, with microbiologists boldly talking of a post-antibiotic era, and showing greater interest in how viral bacteriophages might challenge superbugs (see Figure 4).16 More than 100 hundred years after they were first discovered, using viruses to destroy bacteria is moving back up the research agenda, but the ideas are not widely commercialised.
“Phages land on their host bacterium, infect it, then propagate themselves inside it until there are so many phage particles inside that it bursts,” explains Lorenzo Corsini, chief executive officer and head of research at emerging Austrian biotech company PhagoMed. “They can destroy or sterilise a whole bacterial population.”
This behaviour helps regulate the level of bacteria that occur naturally in the environment. Corsini believes it might be used directly in the treatment of persistent infections, supplementing or even replacing conventional antibiotics.
Currently, there are a limited number of phage treatments approved for human use, but the area is coming back into vogue as the cost of failing anti-infectives is becoming too large to ignore. One European Commission estimate puts the figure at EUR 1.5 billion annually from healthcare costs and productivity losses, potentially rising to trillions across the OECD by 2050.17
The first European clinical, randomised control trials into phage therapy were EU funded, involving the French Ministry of Defence and French small and medium-sized entities, including Pherecydes Pharma and Clean Cells.18 They ended in 2017. Since then, PhagoMed has received funding from FFG, the body promoting research and development in Austria, and the development bank Austria Wirtschaftsservice Gesellschaft (aws) to explore further pathways for commercialisation.
Meanwhile, the US Food and Drug Administration has accepted its first application for an intravenous phage therapy, run by AmpliPhi Biosciences.19 And corporate positioning continues elsewhere, for example, with Johnson & Johnson recently announcing partnerships with Locus Biosciences and the Israeli company, BiomX.20
Researchers in the field point out the mind-boggling number of naturally occurring phages to explore (1031 to 1032; that’s 10 to the power of 31 – 10,000,000,000,000,000,000,000,000,000,000 or more!), in addition to options from bioengineering.21
Figure 4: Research interest in antibiotics and phage therapy
3. Down to earth: Balancing public and private incentives
Significantly, these emerging therapies are highly specific and cannot be used in the way antibiotics are for mass or blanket applications. “Part of the reason phages have not been widely used to treat bacterial infections is because you need to know exactly what the pathogen is,” Corsini explains.
A large part of the capital required for building and maintaining public service infrastructure is expected to flow from the private sector
That suggests there is revenue potential in quite selective areas, such as the deep-seated infections that can set in after joint replacement surgery. In these cases, bacteria can form a film on new implants that inhibit the effectiveness of antibiotics. Any treatment that could break down the biofilm and address lingering drug-resistant bacteria could have significant commercial value. But there is a significant operational challenge in creating a diagnostic environment that is efficient and can be scaled up.
Research interest in antibiotics and phage therapy
Moonshots are also required closer to home. To keep pace with the changing world, providing infrastructure and other social goods will require governments around the world to muster some major resources. Whether to meet basic needs, improve resilience to climate change or provide new transport, power and data infrastructure, a large part of the capital required for building and maintaining public service infrastructure is expected to flow from the private sector. (See illustration below for the estimated gap between investment need and what is being achieved. It shows how far meeting the UN’s sustainable development goals raises the bar.)
Figure 5: Infrastructure investment at current trends and need
Global infrastructure funding gap
But a key part of the challenge is that the solutions are not yet agreed upon or proven at scale – for example, in energy battery storage, carbon capture and storage or nuclear power. There are also few commercial models to provide long-term stable revenue to support financing and investment.
Only when the measures and incentives are properly aligned is it likely that a true public-private solution can be delivered
Government has the option to support in any or all of three key ways: by providing clearly stated policy outcomes, intervening to support funding models and providing capital. The right mix might vary, depending on the nature of the conundrum. But only when the measures and incentives are properly aligned is it likely that a true public-private solution can be delivered.
Cost, quality, risk
For public-private collaborations to work, they need to address the sensitive areas of cost, quality and risk-sharing.
In many cases the private sector has simply failed to provide tangible evidence of value
When it comes to cost, any private-sector pathway is likely to have an initially higher cost of capital (as governments can simply borrow more cheaply). However, this could be offset by efficiencies achieved down the track – fewer cost over-runs, better risk management or achieving better asset quality overall.
The quality issue is contentious, as in the past the needs of service users –- the general public –- have not always been kept front of mind.
“In many cases the private sector has simply failed to provide tangible evidence of value,” says Darryl Murphy, head of infrastructure debt at Aviva Investors. “A lot of the dialogue around these issues has been focused on the public sector, rather than engagement with local users and communities. The industry needs to provide hard evidence, backed up by data, and focus on delivering better outcomes to the public.”
It’s really important to move away from the idea of a zero-sum game between private capital and public-interest projects
Perhaps this failure to involve the public and limited monitoring of outcomes explain why enthusiasm for collaboration has waned.
In terms of risk, the key is sharing. The general idea has been the party best qualified to manage the risk should be the one designated to take it on. But, significantly, the next generation of infrastructure challenges look quite different from the past. For example, the risks of financing data infrastructure with high obsolescence risk or nuclear power projects costing in excess of £20 billion per plant to smooth the transition to a low-carbon economy are clearly of a different scale to small-scale water projects.
Many new projects on the drawing board are large, do not have proven financing or funding models, nor will they generate stable, predictable cashflows from the outset – all features that appeal to institutional investors. The major question then is how the private sector can be encouraged to step forward, if governments do not have the appetite.
“These projects could really benefit from credit enhancement through flexible guarantees to address specific risks like complex construction or counterparty credit risk,” says Murphy. “In our experience, institutional debt investors mainly have appetite for investment-grade projects, particularly those investing to fund pensioners’ annuities. Using credit enhancement where there might be material illiquidity premia – say in single-A to BBB rated credits – could mobilise significant capital.”
He also highlights the potential for co-investing, to help take early-stage projects out of the starting blocks to the point where institutional investors, and even the wider community, want to be involved.
“It’s really important to move away from the idea of a zero-sum game between private capital and public-interest projects,” Murphy says. “There’s a need to collaborate and lots to gain; for the government in delivering on its commitments, for private sector stakeholders, who could make a genuine contribution to enhancing assets and services, and for the public, the users. But for that to materialise, there needs to be greater clarity around what ‘success’ is.”
This helps explain the interest in ‘people-first’ public-private partnerships, to ensure citizens’ needs are properly met, as well as using new, direct methods of data gathering to monitor public preferences and service outcomes (see box-out adjacent/below). In a similar vein, Carlo Ratti, Massachusetts Institute of Technology professor and director of the Senseable City Lab, talks of PPPPs - ‘public-private partnerships with people’. (The full AIQ interview with Ratti can be found here.)
Alternative ways to risk-share
In terms of future-model design, appetite for the old public-private partnership (PPP) models is lacking but it appears the regulatory asset base (RAB) model – used for financing the Thames Tideway Tunnel, London’s super-sewer – could play a more prominent role.
There are important differences between the PPP and RAB models in terms of risk transfer. Most importantly, the latter introduces the idea costs and risks borne by stakeholders and investors should be shared and monitored. By allocating risk more broadly, and guaranteeing an upfront, regulated return on investment for projects in development, the overall cost of capital can be reduced.
Ultimately, the model could be rolled out widely for large-scale projects where it is difficult to be certain on costs. Developing automated signalling and train controls on live railways, carbon capture and storage, nuclear power, and wider digital infrastructure are obvious examples.
A parting thought
While putting the final touches on this article, a headline flashed across social media. It referenced a partnership between Amazon and US police departments to leverage Amazon Ring’s doorbell camera for neighbourhood security purposes. Regardless of your view of whether this is intrusive, the inevitable privacy concerns and fears over the degree to which tech giants are infiltrating our day-to-day lives, it provides a timely reminder of just how wide the public and private collaboration debate extends. It demands our urgent attention.
Creating effective partnerships is not going to be easy. There is no standard template to cut and paste from; no one-size-fits-all approach that can be read across industries and sectors. Designing the right frameworks for public and private enterprise to operate and, more importantly, thrive in is something generations have tried and failed to do. It will require significant investment, rigorous governance, new definitions of what constitutes value and, in some cases, a complete rethink on the role of market forces in driving optimal outcomes.
However, the costs and risks associated with not figuring this out do not bear thinking about. Problems like climate change and inequality are not going to be resolved without serious intervention and changes in behaviour. It is time to harness one of the most powerful forces in behavioural psychology and, arguably, economics: incentives.
It will take close collaboration between stakeholders – in the public, private and third sectors – to find answers. But, as governance specialists John Donahue and Richard Zeckhauser point out, maximising the benefits of collaboration is a bit like riding a unicycle: there are multiple ways to fail. But for governments bold enough to set the direction and for collaborators that understand risk, a sustained effort could bring some real ‘win-win’ scenarios.