Nations differ in the way in which they organise research and development and in the way they prepare innovations for the market. Germany has long been renowned for the strength of its basic research but breathtaking product innovations have been rare in the past decades. Japan, until recently, was known for its ability to apply existing knowledge for the creation of new products. The basic principles of the fax machine, for example, were invented in Germany, but it took Japan to turn the principle into a product.

It is something of a cliche that the production of knowledge has become a key factor in the global economy. Nevertheless, it is true: the way nations organise the structure of their research and development systems will have a major impact on national welfare.

For the analysis of national research systems, it is useful to distinguish between two dimensions - the degree of freedom of science on the one hand and the degree of public funding for research on the other. One end of the spectrum is represented by the public research university: in this kind of institution, public funding is prevalent and the freedom of science is high. The other end of the spectrum is represented by research and development departments in industry or business start-ups: research is privately funded and being conducted under close supervision and with clear objectives. In the middle, we have some freedom of science and mixed public-private funding of research and development.

At the end of the spectrum - where freedom of science is strong - basic and applied research should be conducted independently of interest groups such as political parties, the business community or unions. This type of research guarantees non-linear innovations which cannot be planned. In the German system, it is regarded as a public good. Germany supports basic research through the Deutsche Forschungsgemeinschaft (DFG), other government funds or private foundations working for the public benefit. Its traditional locations are Max Planck institutes, universities or national laboratories. The United States has the National Science Foundation, which is organised in roughly the same way as the DFG. Both have worked well and stimulate important basic research. Public funding, however, is not the only conceivable source of basic research. For a long time the Bell Laboratories and IBM have demonstrated that even in a private corporation, basic research on a large scale can be productive and possible.

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In the middle of the spectrum - where there is some freedom of science often mixed with public funding - market-orientated but non-competitive research is being conducted. Such research can result in prototypes, which may lead to products. In Germany, this kind of research is institutionalised in the Fraunhofer Gesellschaft, institutes at universities and national laboratories. In the US, the military sector has often been the vanguard.

At the other end of the spectrum where product of production innovation is taking place, market-orientated and competitive research and development is being conducted. In a market economy such research should be financed by the private sector, normally research and development departments of existing firms or business initiatives.

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So far, there has been little agreement on how exactly the production of knowledge is stimulated best. Two conditions, however, seem to be crucial to the national capability to innovate. First, nations have to be present at all three levels. In a modern economy, research accounts for only 25 per cent of innovation costs, product design for another 26 per cent, process innovation for 28 per cent and the preparation of production for 18 per cent. Japan, long renowned for its capacity to turn basic innovations developed elsewhere into marketable products, has invested a growing share of its gross national product into basic research in order to become a technology leader in various fields. Germany and the US, on the other hand, have increasingly devoted attention to product and production innovation. Even in the global economy, all links of the "research-value-chain" should be close together to create optimal synergy.

Second, it is of little help if all three levels of research co-exist without adequate communication. We have to organise the relationships between the three levels of research in such a way as to create the environment for a lively exchange of knowledge. Such exchange can be promoted by a variety of instruments: transfer agencies, science and technology parks, or special departments and corporations at universities to get research closer to the market.

This seems to be the major challenge for Germany. In past years the major source of product or production innovations have been smaller firms in traditional industries. Basic research has often remained secluded at the universities or national laboratories. As a consequence, Germany's position in future industries is slipping rapidly. Its industrial strengths are the same as 100 years ago: automobiles, machine tools, chemical products and electrical components.

The US, whose industrial decline was lamented by many in the 1970s and 1980s, shows remarkable strength. Product or production innovation is frequently coming from business start-ups or institutes at universities. Especially the latter provide a fountain of ideas for products and processes. Be it biotechnology, computing technology or aerospace: academics and academic departments have much to contribute to the US. Many universities are privately funded to begin with. Boards of trustees whose members are often from the business world watch over the performance of programmes and departments.

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The academic culture is much more entrepreneurial in the US than in Germany. It is not uncommon there for professors to leave academe to become entrepreneurs and return at some point. In Germany, this type of behaviour has been relatively rare but such a model could be exemplary.

Why should a professor conduct basic research for all his/her life? Various activities at various phases of a professional life can contribute significantly to the much-needed exchange between the different levels of research. Universities can also successfully promote entrepreneurship, as the examples of the industrial parks at Stanford University or Dortmund University demonstrate.

One central task must therefore be the strengthening of links between the different levels of research at the university. Ivory towers were justified when higher education reached 5 or 10 per cent of the population. Today, with 30-50 per cent benefiting from some kind of tertiary training, higher education has often become a consumer good in addition to an investment. In addition, the production of knowledge has often become a relatively standardised process. It is all the more important that we make standardised economic knowledge production socially responsible.

Academic freedom in basic research must be safeguarded. Basic research grants should be allocated by competitive procedures, for which the DFG or NSF offer good examples. There is a fine line between preserving academic freedom and getting academics out of the ivory tower. Yet walking this fine line will determine the social acceptance and social contribution of the academic profession in the next decades.

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Detlef Muller-Boling is director of the Centre for the Development of Higher Education, Gutersloh, Germany.