Tyler Cowen makes the case that a large, inefficient public sector can be a good thing:
we should not be trying to squeeze the entire economy into the shoebox of the dynamic but risky “Economy I.” For public choice reasons, as well understood by Karl Polanyi (an underrated public choice theorist if there ever was one), the polity requires some respite from Economy I, whether we like that or not… Furthermore the more “sluggish” Economy II, by operating under different principles, often serves as a useful R&D lab for Economy I. Think MIT and Stanford, or note that Adam Smith ended up as a customs commissioner, as his father had been. Goethe and Bach worked for governments for much of their lives. It’s about balance and synergy, though it is perfectly fair to see contemporary Western Europe, especially in the periphery, as a region which has far too much Economy II and too little Economy I.
The first point in particular reminds me of Dani Rodrik’s argument for the welfare state under conditions of globalization: the government sector is relatively “safe” and can buffer dislocations due to global markets. Cowen isn’t referring exclusively to the public sector as “Economy II,” since the latter also includes labor-intensive, service-sector occupations, but he does imply here that the university system is a desirable public subsidy in part because it is inefficient and gives researchers respite from the private market.
I never really grasped that argument from Rodrik, and I still don’t. It seems to me that if you want inefficiency as a risk hedge, you could just bury some boxes of money and set fire to some of it in good times, then dig up what’s left in bad times. Less facetious: why not invest in a global equities index? Even better: why not push for globalization as a solution to its own problems? After all, there’s nothing about the economies we live and work in that’s inherently national. I live and work in the Erie County, New York economy. It’s a highly open economy. Why doesn’t Erie County, New York have an even bigger welfare state than the U.S.? Because we can buffer risk by investing in or, in the limit, moving to other parts of the country. So labor mobility and capital mobility are themselves solutions to the very risks posed by globalization of the merchandise trade combined with volatility in the terms of trade.
And you don’t have to set fire to any money.
PILEUS 
I would ask Tyler by just what magic Economy 2 runs. Also, is it his contention that the denizens of Economy 2 are willing to provide aid, comfort and succor to the denizens of Economy 1 when Economy 1 gets too rough and tumble? I would also ask Tyler, just out of curiosity, why is it that the inhabitants of Economy 2 think it’s a great immoral travesty when their brethren do actually take a pay cut or get laid off, but when someone gets their pay cut or laid off in Economy 1, it’s like, “Hey, that’s the private sector for you.”
My parents were school teachers their whole lives and they would get positively indignant when anyone suggested that teacher pay and benefits might be re-organized for the better. I am self-employed, in the various times when business has not been good, their retort to my worries was always, “It sure is great we work for the schools, no one can touch us there.” In the meantime, I am still paying my property tax and sales tax which pays their salary. And I pay it whether I have the means to pay it or not.
One other quibble I have with Tyler is that while State Universities are administered state by state and that sounds like federalisms; federal science granting mechanisms have utterly destroyed the wide diversity of science research, in state univs that existed prior to the second world war.
There is no federalism in science research, there are only federal grants. Big state univ labs are controlled by a small minority of Prof’s who are very effective at getting federal grants. The grant money exists only in areas which fulfill a political imperative. This has caused most of the money in science to go to very few things, mostly cancer and AIDs in the last two decades. Those are worthy things to study, but it’s pretty sad when you have to tailor your research to some cancer or AIDs related problem if you have any expectation of getting a grant. A lot of other research gets left high and dry.