Can Japan reshape its research funding?

Takatoshi Ito October 26, 2023 14:49

Rightly concerned about a decline in Japanese universities’ research capabilities, the Japanese government has created a ¥10 trillion ($67 billion) fund to address the problem. While cash accounts for around 11% of the new University Fund of Japan (UFJ), the remaining 89% takes the form of a 20-year “loan” from the government, which borrowed the money from the market at a very low interest rate.

Overseen by a team of newly hired professional asset managers, management of the UFJ began in March 2022. The goal is to generate an annualized return of at least 3% above the rate of inflation, to offset the 3% of the principal (¥300 billion) that will be distributed to select universities each year. While many Japanese observers consider a 3% real return too high, most US and Canadian asset managers (such as those running pension funds and endowments) would see it as a rather low bar.

In any case, whether the target can be achieved in the long run depends on the portfolio. When I chaired the committee that laid the groundwork for the UFJ in 2021, we recommended a benchmark of 65% global equities (including alternative assets such as private equity, venture capital, and infrastructure funds) and 35% global fixed-income assets.

The strategy for the UFJ can be compared to Japan’s Government Pension Investment Fund (GPIF), which has about ¥200 trillion in assets. Its target return is 1.7% plus wage inflation per year, based on a benchmark portfolio comprising equal parts domestic bonds, foreign bonds, domestic equities, and foreign equities. Given its sheer size relative to the Japanese equity market, the GPIF is sometimes referred to as a whale in a pond, and many are wondering if the university fund will become a baby whale. But the answer is far from clear.

The creation of a highly leveraged national endowment fund for universities followed from the recognition that Japan’s research capacity had been severely eroded by budget cuts from 2004 to 2014. Moreover, owing to Japan’s growing elderly population, a rising share of the budget must be allocated to non-discretionary social-security payments.

The opportunity costs associated with these budget trends are increasingly apparent. The University of Tokyo is the only Japanese institution to make it into the top 50 in the Times Higher Education 2024 World University Rankings. (Four other Japanese universities made the top 200 list.) During the pandemic, Japan could not even develop its own COVID-19 vaccines. Though it is the world’s third-largest economy, it boasts very few “unicorns” (tech start-ups valued at $1 billion or more) compared to the United States, Europe, or China, which has translated into a lack of big companies on the Tokyo Stock Exchange, the natural home for Japanese retail investors.

To be sure, Japan ranks second in the number of Nobel Prize winners in the natural sciences this century. But most of the innovative research for which the prize was awarded was carried out decades ago. Today, some “Japanese” Nobel laureates, such as the physicist Syukuro Manabe, have moved to the US to avail themselves of its superior research environment.

Clearly, the UFJ is needed. Unfortunately, it reported a loss of ¥60 billion for its first accounting year (April 2022-March 2023), owing largely to an investment in foreign bonds and a currency hedge (a bet against yen appreciation). When long-term interest rates rose sharply in 2022, the mark-to-market value of long-term bonds in the US and Europe fell. Making matters worse, as the yen depreciated from 120 per dollar in March 2022 to 150 per dollar in October 2022, the fund’s currency hedge generated a huge loss.

Considering that the GPIF generated positive profit the same fiscal year, one hopes the university fund will move expeditiously toward the recommended long-term benchmark portfolio comprising 65% equities and 35% fixed income. It urgently must get on track to start generating long-term real returns of at least 3%.

Aside from these asset-management issues, another big question is how best to use the ¥300 billion allocation. Over the next several years, the Ministry of Education, Culture, Sports, Science, and Technology (MEXT) will select five or six universities to receive roughly ¥50 billion each. That is a significant addition to a university budget, and if it is spent wisely, it could be a game-changer for university research.

But to maximize the economic impact, the distribution should focus on STEM (science, technology, engineering, and mathematics) and the research and development frontier: artificial intelligence, biotech, data science, and quantitative research. Those allocating funds should aim to reward not only researchers with strong track records (in terms of citations), but also promising younger postdocs and tenure-track researchers with publication records. Tenured and tenure-track positions that had been reduced during the years of budget cuts should be restored, starting in frontier fields.

The MEXT should resist pressure to support various fields equally in the name of fairness. The focus must remain on scientific research with the potential to expand Japan’s foothold in strategic domains. The MEXT has a key role to play in identifying and creating the conditions for truly groundbreaking research. It should encourage universities to create English-language international research hubs, with competitive salaries to attract global talent. And it should not hesitate to attach conditions to funding to ensure that universities spend it well.

The UFJ undoubtedly faces greater challenges than the GPIF when it comes to asset management and various political and strategic considerations. The next several years will be critical for putting its asset portfolio on a better footing, selecting appropriate recipients, and setting conditions to shape how funds are deployed. If done right, the payoff could be massive.

Copyright: Project Syndicate

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Takatoshi Ito

A former Japanese deputy vice minister of finance, the writer is a professor at the School of International and Public Affairs at Columbia University and Senior Professor at the National Graduate Institute for Policy Studies in Tokyo.