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The state or the free market? What a choice…

Yes, capitalists are increasingly risk-averse and lethargic – but let's not fantasise that the state has the cojones to reinvigorate innovation.

Rob Lyons
Columnist

Topics Books

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A typical episode of the UK version of Dragon’s Den runs something like this: an inventor or the owner of a small business comes along, cap in hand, asking for perhaps £50,000 to develop or commercialise an idea he has had. Most of the time the ideas are just mad, there is no commercial value to them, and the poor fool gets a mauling from the ‘dragons’.

Once or twice an episode, however, someone does a presentation that actually involves a commercially viable idea and the dragons start enquiring about the business in depth. Has the idea been fully developed? Who holds the patents? Have there been any sales as yet? What’s the current profit of the business?

This curiosity may then turn into firm offers of investment. But the dragons are generally only interested in buying into finished products that have already picked up some sales. Even then, they’ll still demand a hefty chunk of the company’s equity in exchange for their cash and their contacts. In other words, the dragons want something close to a ‘sure thing’ before they’ll cough up. It’s a long way from the vision of venture capitalists making daring decisions on innovative new ideas.

Venture capital doesn’t fare too well, either, in The Entrepreneurial State, a new report from UK think tank Demos written by Mariana Mazzucato, professor in the economics of innovation at the Open University. Mazzucato wants to deflate the puffed-up idea that the free market alone can provide the new products and services that Britain requires to produce new wealth. In fact, she argues that capitalists in general are – like the dragons – a pretty conservative bunch who expect a substantial return on their investment in a relatively short time. So she says that the state must play the role of entrepreneur, too.

One good thing about Mazzucato’s report is that she assumes that creating wealth is the proper purpose of economic policy; the only question is what policies should be pursued to achieve it. Compared to the relentless rise of what Daniel Ben-Ami calls ‘growth scepticism’, any book that asks how we achieve economic growth, rather than questioning why we should bother with it at all, represents a step forward.

The Entrepreneurial State is not simply about innovation per se, and it rightly makes the point that the real source of increasing wealth is the raising of productivity rather than simply churning out new kinds of products for their own sake. At that level, Mazzucato rejects the assumption that small is beautiful. ‘Productivity should be the focus, and small firms are indeed often less productive than large firms’, she writes. Young, small firms can often be very fast growing and entrepreneurial, but most small firms are not particularly dynamic. Often, the big improvements in productivity come when companies expand – or are bought out by bigger firms – so that they benefit from economies of scale.

Mazzucato’s report refuses to accept that the free market can always deliver. As Mazzucato illustrates well, much of the innovation that we now laud – in areas like the internet and pharmaceuticals – is actually based on state spending and innovation. Most forms of innovation today depend, for example, on state-funded basic research in universities. Moreover, in the US, there has been very active support for, and commissioning of, innovation through the Defense Advanced Research Projects Agency (DARPA) and the National Institutes of Health. The US state, despite appearances to the contrary, has identified socially important problems and endeavoured to seek out solutions.

Mazzucato writes that the state as entrepreneur ‘cannot be called “new” industrial policy because it is in fact what has happened, though in a “hidden way” to prevent a backlash, over the last three decades in the development of the computer industry, the internet, the pharma-biotech industry and more, including today’s nanotech industry’. If the market is so reliant on the state to do all the risky, early work in terms of innovation, she asks, why do we continue to provide such bumper returns to companies in areas like pharmaceuticals? What have these less-than-adventurous capitalists done to earn it?

The usual criticism of state intervention is that while it involves ‘picking winners’, the typical result is that politicians give in to a variety of pressures to prop up losers or spend a fortune trying to sustain ‘national champions’ in a variety of strategic fields that their country simply must be a player in. Mazzucato is aware of these failings with industrial policy, but looks to Japan and America as models of how these things can be done well. In Japan, for example, the Ministry of International Trade and Industry (MITI) played a key role in promoting companies and cooperation, making sure there were good links between developers and producers, and making sure lessons were learned from technological developments elsewhere.

Strangely, Mazzucato chooses to highlight Japan’s success in this regard by comparing it to the failings of the Soviet Union, a country that barely had a functioning economic ‘system’ worth talking about. That might be because Japan’s economy has stalled for the past 20 years when it was once touted as a rival to America. That economic failure is hardly a ringing endorsement of MITI or the entrepreneurial state.

It would be easy to go beyond Mazzucato’s discussion to show how state support has not been simply in the realm of research and development (R&D). From providing subsidies to doling out contracts paid for by government borrowing, the state was a major factor in keeping the UK’s long ‘boom’ (that is, steady anaemic growth) going for so long from 1993 onwards. Alongside that, state defence contracts have kept great chunks of industry going for decades on both sides of the Atlantic. With so many people in the West looking on enviously at the rapid development of China and South Korea, it should be noted that in both cases the state has had a very hands-on role.

But before we get all misty-eyed about state intervention, a little balance is required. The old criticisms of industrial policy do have some merit. British governments have indeed kept clapped-out industries on life support in the past. Political considerations all too easily get in the way of a hard-headed assessment of what works and what doesn’t. Lots and lots of money has been wasted on pet projects with little long-term merit.

As an article in The Economist noted last year, industrial policy has made a comeback, but it is driven as much by political demands to ameliorate the economic crisis as anything else, particularly in France. In Japan, interventionist politicians have sometimes held companies back rather than helped them, while China’s attempts at developing homegrown technologies have been a mixed bag. While the private sector seems less and less capable of delivering blue-sky research, and is so risk-averse that it’s even struggling with commercialising new ideas, much vital development and improvement occurs after products go to market, something that doesn’t get much of a look-in in this book.

Nonetheless, Mazzucato does offer some useful insights into how innovation can be encouraged by the state. The state can invest in R&D in a much more ‘blue-sky’ fashion than companies do, knowing that profitable returns on that research are simply not possible in the short term and may not be possible at all. The state can promote competition and cooperation between research groups or shape priorities that arise from society. With major companies increasingly outsourcing R&D and taking a worryingly short-term view about risk, the state may have to play an even bigger role in innovation in the future. For this to be fruitful, however, the risk-aversion of the state itself, the lethargy and precaution exhibited by many Western states today, will also have to be challenged.

Both the ‘free market’ and ‘state driven’ models of innovation are too one-sided. Moreover, they assume an illusory distinction between public and private sectors. As Mazzucato points out, the turning point was the Second World War, where whole societies were reorganised around the war effort. After that, we’ve become accustomed to states taking on wide-ranging powers to reorganise economic sectors, as had to be done after the financial crisis of 2008. While business leaders like to moan about the state, they’re reliant on it, too.

Then again, it’s their state, not ours. The biggest illusion of all is that somehow the state is the embodiment of society as a whole in a face-off against the might of money. This is an idea that Mazzucato encourages towards the end of the book in her demand that capitalists pay a fair share for exploiting the state’s innovation. In reality, the state is ultimately the expression of the interests of business in general, even if there are often many tensions in that relationship. The best the rest of us can hope for is that between them they actually manage to generate new sources of wealth, or we’ll all be worse off.

In that respect, The Entrepreneurial State offers a few more possibilities than simply crossing our collective fingers and hoping the market will provide.

Rob Lyons is deputy editor of spiked.

To enquire about republishing spiked’s content, a right to reply or to request a correction, please contact the managing editor, Viv Regan.

Topics Books

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