Who needs the private sector?

The Entrepreneurial State: debunking private versus public sector myths, by Professor Mariana Mazzucato, paperback, 266 pages, ISBN978-0-85728-252-1, Anthem Press, 2013, £13.99. e-book £8.75.

Professor Mariana Mazzucato has made a fascinating study of the respective roles of the state and private enterprise in innovation. Her book challenges the false image that “Business is accepted as the innovative force, while the State is cast as the inertial one”.

 In recent decades there has been a massive withdrawal of the state from economies throughout the world. This is grounded on “the erroneous idea that the state is naturally bureaucratic, cannot pick winners and is incapable of taking entrepreneurial risk”.

Mazzucato dismisses as an illusionary myth the widespread contention that state programmes should be cut to make the economy more “competitive” and “entrepreneurial”. Instead she proposes that we reimagine what the state can do to sustain recovery.

“Most of the radical, revolutionary innovations that have fuelled 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 says.

Vision

Mazzucato purposely uses many examples from the US to show how it has one of the most interventionist governments when it comes to innovation. This contradicts its image as the country that most represents the benefits of the free market system. In particular, she shows how the state played an active role with vision and targeted investment beyond mere facilitation in innovation hotbeds such as the Silicon Valley knowledge economy in California.

‘The state is often more daring than the private sector.’

Mazzucato is forced by her research to consider the changing role over time of different types of capital – finance and production. As a result she stresses the importance of the role of the state in guiding for productive rather than purely speculative ends. The state, she finds, is often more daring than the private sector, willing to take the risks that businesses avoid.

Even during a boom most firms and banks would prefer to fund low-risk incremental innovations. They wait for the state to make its mark in more radical areas.

The search algorithm that led to Google’s success was funded by a public sector National Science Foundation grant. Molecular antibodies, which provided the foundation for biotechnology, were discovered in public Medical Research Council labs in Britain. Many of the most innovative young companies in the US were funded not by private venture capital but by public venture capital, such as the Small Business Innovation Research programme.

The state as creator

The state can and does act as creator, and not just facilitator, of the knowledge economy. It was the visible hand of the state which made these innovations occur. Other recent examples come from “emerging” economies. BNDES, the Brazilian state investment bank, has fostered bold risk taking in key new sectors like biotech and clean-tech. The bank is today earning record-level returns in productive, rather than purely speculative, investments. In 2010 its return on equity was an astounding 21.2 per cent.

One of the reasons that Italy’s growth rate has been so low for the last 15 years is not that it has been spending too much, but that it has not been spending enough on education, human capital or research and development.

The state can dare to think about the impossible: creating a new technological opportunity; making the initial large necessary investments; enabling a decentralised network of actors to carry out the risky research; and then allowing the development and commercialisation processes to occur.

Private firms are unwilling to invest in basic research, from which they cannot appropriate private profits because the results are a public good accessible to all firms.

And simply the risk of certain investments is too high for any one firm to bear alone. In biotechnology, nanotechnology and the Internet, venture capital arrived 15 to 20 years after the most important investments were made by public sector funds.

The Internet would never have happened without it being forcefully “picked” by DARPA, the US Defense Advanced Research Projects Agency. The same holds for nanotechnology which was picked by the NSF and later by the National Nanotech Initiative.

Risk

Those areas of risk that are defined by high capital intensity and high technological and market risk tend to be avoided by the private sector. These require great amounts of public sector funding, vision and leadership to get them off the ground.

Private firms take the benefits from a state that they simultaneously refuse to finance. Top pharma companies are spending a decreasing amount of funds on R&D at the same time that the state is spending more. For decades the most radical new drugs have been coming out of public labs. Private pharma is now concerned more with marketing and “me too” drugs, slight variations of existing products.

Such reductions in spending on R&D have coincided with an increasing “financialisation” of the private sector, in other words being concerned with finance rather than production.

The greatest growth effect in an economy comes from investments in technology for hardware and software that drive productivity in many industries. The addition of human capital and technology increases and furthers the engine of growth. To benefit, states must give attention to developing systems of production innovation rather than narrowly focusing on the level of R&D expenditure.

Mazzucato discerns the possible operation of a “Developmental State” (even in capitalism), where the state is active not only in Keynesian demand management but also leads the process of industrialisation.

The most typical examples are the East Asian economies, which through planning and active industrial policy, were able to catch up technologically and economically with the western countries. The Japanese State coordinated the finance system through the Bank of Japan as well as through the Fiscal Investment Loan Program, funded by the postal savings system.

Financial services are often focused on extracting value from the economy rather than supporting innovation in industry.

This book is of wide interest and contains more than this review can cover. It is relevant not only for understanding how to reverse decline under capitalism but also for how to generate a productive, scientific socialist economy.