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The innovative State

Is the role of the State in creating and sustaining innovation underappreciated and unpaid for?

The innovative State

There was a time when capitalism, as an economic system, seemed to be the only game in town. This was just after the collapse of the USSR - a time which seemed to signal a demise of communism as a viable alternative to capitalism. In its success, capitalism seeded its downfall. As 'greed is good' became the only capitalist mantra, markets were manipulated to ensure lack of competition. Competition watchdogs, meant to prevent the creation of monopolies, used old definitions of market domination, while new markets emerged along with monopolistic companies. A 'winner-takes-all' market allowed serious income disparities to become entrenched, building resentment and a case for a pushback. Today, many young people who are facing grim job prospects in countries where jobs were abundant just one generation ago don't see capitalism as creating opportunities for a better future. This is providing proponents of a socialist form of government an opportunity to find a voice and become revisionists with regard to economic theory. Professor Mariana Mazzucato is one such voice we are likely to hear more of going forward.

Changing the language
Mariana Mazzucato is a professor at University College London. Upset with the characterisation of the State as slothful and wasteful, Mazzucato concluded that this perception needed to be challenged - starting with changing the language used to describe the State. Her work resulted in a book titled The Entrepreneurial State: Debunking Public vs. Private Sector Myths published in 2011 and translated into several languages. The book sought to reposition the State in the public mind - from a provider of support to private-sector innovation and enterprise to being a driver of innovation with the greedy private sector being dragged along by its coattails, yet reaping most of the economic rewards. As a part of the endeavour to change the 'language', Professor Mazzucato set up the Department of 'Economics of Innovation and Public Value' at her institute. Her work has attracted several politicians across countries starting with Britain but increasingly, American Democrats, from across the 'pond'. Her TEDx lecture here illustrates the crux of her argument.

The State as a venture capitalist
Mazzucato's thesis in the book is that the role of the State in creating and sustaining innovation is underappreciated and unpaid for. Private venture capitalists (VCs) take credit for innovations when the highest risk, at the early stage of every innovation cycle, is borne by the State. Once the technology has been established, VCs fund companies that benefit from these innovations and the State is left paying the bills with no return for the risk it has undertaken. To illustrate her point, she takes the case of Apple and the US pharma industry.

In the case of Apple, her contention is that all technologies incorporated into the iPhone or iPad - the internet, GPS, touch screen, etc. - were funded and developed by DARPA (the Defense Advanced Research Projects Agency). Apple put these together to make a product which earned billions but didn't even pay 'fair' taxes by squirrelling away its profits in tax havens globally. She also asserts that most path-breaking developments in pharmaceutical research over the past few decades have been funded by the National Science Foundation (NSF)/National Institute of Health (NIH) in the US and the science developed there is patented by private players. Consequently, even public-funded medicines are priced in ways that don't allow the general public to benefit from them.

Mazzucato's argument is that repeated claims of public-sector inefficiency have negatively impacted its image and led to demands that it should limit itself to providing the framework for innovations rather than engage in actively promoting innovation and research. In reality, it is the private sector that shies away from risk taking and needs the leadership of the public sector to coax it into taking on innovative paths.

Mazzucato's arguments carry some weight but also suffer from the 'survivorship bias'. She cherry-picks examples from those that help support her argument while ignoring those that would disprove the proposition. DARPA did not fund the development of any of the technologies mentioned for their use in consumer electronics. Steve Job's genius lay in designing a product and platform that consumers would pay money for. To claim that there was no innovation in creating the Apple App Store is to simply brush away the power of 'two-sided' markets. The technologies that Mazzucato claims were responsible for Apple's success were available for many others to use. An extension of Mazzucato's argument would almost suggest that Tesla's success as an automaker making a car that consumers want should be attributed to the roads built by the government. Using the US pharmaceutical industry as an example of private-sector inefficiency is unfair. It is known to be a price-gouging industry - not very well regarded for its innovative capacity. To use that as a proxy for the private sector is hardly fair. Even so, NSF allows its grantees to 'retain the entire right, title and interest' for any inventions. Mazzucato's solution of demanding 'return on' scientific grants runs several risks. It introduces an incentive to report lack of success while being funded by the government. It makes for audit requirements to be imposed on grants. Finally, if government funding of innovations is working, then why fiddle with what is not broken? If, on the other hand, it is not, then what is there to gloat over? And to suggest that changing the goalposts (demanding a share of a successful outcome) will not have changed the incentives of grantees is to be naïve.

Limited money availability
Mazzucato suggests that State investments should be made in a way that will 'socialise both risks and reward'. She suggests that public investment be targeted at audacious goals where the private sector will fear to tread and that successes should be shared by the government. In theory, it seems right especially if one accepts that there are no constraints on the amount of capital available to governments and that losses don't matter. Unfortunately, every investment has an opportunity cost and alternative use. Her suggestion is also only one short step away from concluding that public enterprises can also carry 'innovations' to market, thereby socialising all rewards.

Return of the public sector
From an Indian perspective, it would appear that we are already at the endpoint of where Professor Mazzucato suggests economies should go. We have a range of government enterprises - all set up at a time when the private sector would not have had the appetite to do so. We should, therefore, expect remarkable innovations and return on capital coming out of these. Alas, as we are so well aware, no public-sector company makes profit unless it operates in a heavily regulated market or has monopoly pricing. Even then, profits are made by price-gouging consumers, and the overall contribution of public investment is negative in most years. Mazzucato's views are likely to become more widespread over time as capitalism becomes less popular. Will it help increase societal welfare? Only time will tell.

Anand Tandon is an independent analyst.