Monday, April 21, 2014

The Federal Government as Entrepreneur

Mariana Mazzucato is a professor from the University of Sussex whose field of specialty is the Economics of Innovation. She has written a book on the subject: The Entrepreneurial State: Debunking Public vs. Private Sector Myths. Her goal is to disabuse the reading public of the notion that the role of the public sector in innovation is mainly to avoid getting in the way of the private sector where all good ideas are thought to originate.

Jeff Madrick wrote a review in praise of Mazzucato’s effort in the New York Review of Books: Innovation: The Government Was Crucial After All. He summarized the issue quite succinctly.

"’The great advances of civilization,’ wrote Milton Friedman in Capitalism and Freedom, his influential best seller published in 1962, ‘whether in architecture or painting, in science or literature, in industry or agriculture, have never come from centralized government.’ He did not say what he made of the state-sponsored art of Athens’s Periclean Age or the Medici family, who, as Europe’s dominant bankers but then as Florentine rulers, commissioned and financed so much Renaissance art. Or the Spanish court that gave us Velázquez. Or the many public universities that produced great scientists in our times. Or, even just before Friedman was writing, what could he have made of the Manhattan Project of the US government, which produced the atomic bomb? Or the National Institutes of Health, whose government-supported grants led to many of the most important pharmaceutical breakthroughs?"

"We could perhaps forgive Friedman’s ill-informed remarks as a burst of ideological enthusiasm if so many economists and business executives didn’t accept this myth as largely true. We hear time and again from those who should know better that government is a hindrance to the innovation that produces economic growth. Above all, the government should not try to pick ‘winners’ by investing in what may be the next great companies. Many orthodox economists insist that the government should just get out of the way."

Mazzucato focuses on the concept of risk in discussing the appropriate roles to be played by the public and private sectors. The public sector has the duty to participate in the development of promising technologies when the timescale and/or cost of such development are too great for the private sector. This duty exists particularly in high-risk situations where the potential for payoff is very large, but the probability of success is low.

She uses the history of investment in "focused" basic research that has characterized the United States since World War II as an example of how the State can be effective in both supporting and encouraging private sector investment. Her book is focused on the United States, both to remind us that we have pursued effective policies even if we refuse to recognize the fact, but also to warn her European nations that they have not been as wise in their investments in the past, and seem to be headed in the wrong direction now.

"….in most parts of the world we are witnessing a massive withdrawal of the State, one that has been justified in terms of debt reduction and—perhaps more systematically—in terms of rendering the economy more ‘dynamic, ‘competitive’ and ‘innovative’. Business is accepted as the innovative force, while the State is cast as the inertial one—necessary for the ‘basics’, but too large and heavy to be the dynamic engine."

Mazzucato tells us in no uncertain terms that this view is false.

"….most of the radical, revolutionary innovations that have fueled the dynamics of capitalism—from railroads to the Internet, to modern day nanotechnology and pharmaceuticals—trace the most courageous, early and capital-intensive entrepreneurial investments back to the State….

She invites us to think in terms of the government and its "visible hand."

"….radical investments—which embedded extreme uncertainty—did not come about due to the presence of venture capitalists, nor of ‘garage tinkerers’. It was the visible hand of the state which made these innovations happen. Innovation that would not have come about had we waited for the ‘market’ and business to do it alone…."

"But how many people know that the algorithm that led to Google’s success was funded by a public sector National Science Foundation grant?"

"How many people realize that many of the most innovative young companies in the US were funded not by private venture capital but by public venture capital, such as that provided by the Small Business Innovation Research (SBIR) program?"

She is not impressed by the role of venture capital in driving innovation.

"In biotechnology, nanotechnology and the Internet, venture capital arrived 15-20 years after the most important investments were made by public sector funds."

She even suggests that the government is the entity that is driven by Keynes’s "animal spirits."

"Indeed, the discovery of the Internet or the emergence of the nanotechnology industry did not occur because the private sector wanted something but could not find the resources to invest in it. Both happened due to the vision the government had in an area that had not yet been fathomed by the private sector….It was—in these and many such cases—the State that appeared to have the most aggressive ‘animal spirits’."

What has made the US system so productive is that public investments were always viewed as collaborations between government, academia and the private sector—a "symbiotic" relationship. Mazzucato discusses in detail four public investment programs: DARPA (Defense Advanced Research Projects Agency), SBIR (Small Business Innovation Research), the Orphan Drug Act, and the National Nanotechnology Initiative. A brief description of DARPA will suffice to explain what is meant by a "symbiotic" relationship.

DARPA (originally known as ARPA) was formed in 1958 in response to the Sputnik excitement. It was tasked with pursuing more-novel, higher-payoff, and higher-risk technology development than was emerging from the DOD with its more incremental mindset. While DARPA has a significant amount of money to spend, it could hardly be called a vast bureaucracy. It has few permanent employees. It functions by recruiting ambitious and intelligent people from universities, government labs, and the private sector to serve as project managers in particular technology areas. These people serve for 4-6 years and then move on, usually back to the sector from which they emerged.

These project managers entertain proposals for technology development or demonstration from whoever has a good idea. They define the area of interest, but the proposals come from the three communities. The goal is to get industry, academia, and government working together on solutions and proposing specific projects which will further progress. Proposals can range from basic research to commercialization demonstrations of a product. Projects that are not making progress are defunded in order to provide more support to those that are more successful—clearly a good example to set.

"The main focus is to assist firms in developing new product and process innovations. The key is that the government serves as a leader for firms to imitate, in an approach that is much more ‘hands on’, in that public sector officials are working directly with firms in identifying and pursuing the most promising innovative paths. In so doing, the government is able to attract top minds—exactly the type of expertise that generates the dynamism that government is accused of not having."

To provide an example of how prevalent the fruits of government sponsored research are within our economy, Mazzucato produced this diagram illustrating the source of the technologies Apple packaged together to create its highly profitable IPod, IPhone, and IPad products.

Apple, as so many others, said thank you to the government by applying its creative talents to tax-avoidance schemes.

The lack of appreciation for the government’s contributions to the economy increases the risk that our ability to continue a mutually beneficial relationship between public and private sectors will be lost.

"Without a better understanding of the actors involved in the innovation process, we risk allowing a symbiotic innovation system, in which the State and private sector mutually benefit, to transform into a parasitic one in which the private sector is able to leach benefits from a State that it simultaneously refuses to finance."

Let’s finish with a quote provided by Mazzucato to produce an interesting perspective on our strange history. It is attributed to Erik Reinert (2007):

"….since its founding fathers, the United States has always been torn between two traditions, the activist policies of Alexander Hamilton….and Thomas Jefferson’s….maxim that ‘the government that governs least, governs best’. With time and usual American pragmatism, this rivalry has been resolved by putting the Jeffersonians in charge of the rhetoric and the Hamiltonians in charge of policy."

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