October 2013 newsletter – Government investment; technology and growth

In this article, Mariana Mazzucato1 argues that the ‘austerity’ debate is missing the point. It is not the level of debt that matters, but what that debt is financing. Contrary to poular belief, it is often 'big' government 'mission oriented' investments that generate long-term economic growth.

Is government debt slowing economic growth, if not impeding it? The world-wide economic crisis that began in 2007 has kept that question alive, despite the fact that it was private debt that caused the crisis in the first place. But attempts to curb the crisis have indeed also led to an explosion of ‘public’ sector expenditures like bank bailouts and unemployment insurance that have ballooned debt levels. At the same time, lower tax receipts due to falling incomes have forced even more borrowing.

Yet amnesia and dogma have conflated the public debt that helped cure the crisis with the private debt that caused it. And although the Reinhart-Rogoff saga seems to have ended with evidence winning out over ideological fiction, countries across the globe are still being asked to slash spending in hopes of kick starting economic growth.

My own work shows the utter foolishness of such a strategy. What matters is not the absolute size of debt, but what that debt consists of. Throughout history, strategic government expenditures have played a key role in spurring economic growth. Indeed, by forcing the world’s weakest economies to cut public spending — in key areas like education, research and health-their potential for long-run growth is weakening. Spain, for instance, has cut its research spending by 40 per cent since 2009. Will this help it become as ‘competitive’ as Germany?

The key question is simple: what causes GDP growth? And the answer from economists is that at the very least, spending on education, human capital, and research are tightly related to it. Indeed, Robert Solow, who won the Nobel Prize in Economics in 1987, found that close to 90 per cent of growth is not explained by the usual suspects, capital and labor. They account for only 10 per cent. So Solow called the unaccounted-for 90 per cent the residual. And what drove the residual? It had to be technology. And how is technology fostered? More often than not, down through history, by government investment, from the roads of ancient Rome to the Internet of modern America.

However, things are not quite so easy. Which areas should the government fund? Traditional economic theory argues that government funding should be limited to areas where the free market is not working properly due to so-called ‘market failures’, some of which might be due to the existence of ‘public goods’ like basic research, which are hard to make proprietary and profit from since they’re quickly available to everyone. As a result, the private sector under-invests.

So if government nudges the private sector to invest, business will promptly respond by innovating. Thus policy makers have obsessed over different types of tax incentives (from R&D tax credits to recent tax cuts related to patents) in order to increase the amount which the business sector spends on R&D.

I have been arguing a very different view, as embodied in my recent book.2 I argue that businesses are typically timid — waiting to invest until they can clearly see new technological and market opportunities. And evidence shows that such opportunities come when large sums of public money are spent directly on high risk (and high cost) technological missions. This raises debt of course, but also GDP, keeping the ratio of debt-to-GDP in check.

These missions are expensive precisely because the government does much more than just solve market failures. It intervenes in both basic and applied research and even provides early stage seed finance to private companies. Indeed, Small Business Innovation Research (SBIR) grants have funded a higher percentage of early stage seed finance than private capital. This is because private finance is too risk-averse — afraid — to engage with industries characterized by high technological and market risk. The fear explains why we have seen venture capital entering, in industry after industry, only decades after the initial high risk has been absorbed by government.

Mission-oriented public investment put men on the moon, and later, lead to the invention and commercialization of the Internet, which in turn has stimulated growth in many sectors of the economy. Indeed, as I describe in the longest chapter of my book, the U.S. government has been a leading player in funding not only the Internet but all the other technologies that make the iPhone so ‘smart’: — GPS, touchscreen display, and the new SIRI voice-activated personal assistant — that make the iPhone, for example, a miracle of American technology. Indeed, it is not surprising that Apple is one of the least R&D intensive companies in the PC industry: it puts together existing technologies, it does not fund new ones.

Crucially, mission-oriented policies are needed today to tackle climate change and other large societal, technological challenges. But the fear that such investments will cause debt to rise too high and stymie growth —ignoring the potential positive effects on growth that these investments can make in the long run — is paralyzing governments throughout the world.

Furthermore, there is the general belief that the direction of investments should be determined by the market, not government. That the latter lacks the expertise — just a bunch of political bureaucrats. But this is a self-fulfilling prophecy. It is precisely in those countries that have been mission-led, and which have set up a decentralized network of well-funded state agencies, that the public sector has been able to attract the kind of expertise needed to steer ‘directionality’. And given that the spending ‘multiplier’ has been shown to be higher (in the long-run) when spending is ‘directed’ rather than just ‘digging ditches’, getting that directionality right (the IT revolution in the past, ‘green’ in the future) means the denominator of debt/GDP grows more. The US Department of Energy (DoE) was recently run by a Nobel Prize winning physicist. The atmosphere in ARPA-E, the agency in the DoE which is trying to do for renewable energy, what DARPA did for the Internet, is just as dynamic and creative as Google. And historically it is investments driven by such agencies (including the National Science Foundation, National Nanotech Initiative, National Institutes of Health) that galvanize private sector investment. Indeed, when Pfizer recently closed down a large R&D lab in Sandwich, Kent, and transferred it to Boston, Massachusetts, it was not due to the lower taxes or laxer regulation for which industry is constantly lobbying. It was due to the large amounts of money that the National Institutes of Health (NIH) has been spending on research and the mission of improved health care in the United States: $792 billion from 1936-2011 (in 2011 dollars), with $30.9 billion in 2012 alone. And today the technological leadership being witnessed in countries like Singapore, Korea, China, Israel, Brazil, Finland, Denmark and Germany is also a result of the strategic well funded network of state agencies in those countries, that able to attract expertise, and drive change-working of course alongside the private sector but often leading it.

These lessons are important for policy makers interested in fostering ‘entrepreneurship’. While Steve Jobs was a genius in his ability to exploit existing government-funded technologies in new ways, he would have had little to work with absent massive public spending. And given the public spending cuts that are happening in most countries the world over, the question then becomes: will there be a future wave to surf in places like Silicon Valley, or is the technology tide destined to turn?

Furthermore, casting the public sector as the villain and business as savior has relieved the private sector from any obligation to increase its own commitment to the innovation process. There simply are not enough large businesses today playing the role that Xerox PARC (the Palo Alto Research Center) and ATT (Bell Labs) played in the past. Today’s big companies like Cisco and Pfizer spend almost as much on share-repurchase schemes (which enrich those who own stock) as they spend on research. Interestingly, the big ‘repurchasers’ (the biggest being in oil and pharma) often justify such buybacks with the claim that there are no other ‘opportunities’ for their investments. But really? No opportunities in health for pharma these days? Nothing for oil companies to invest in? Like safe and clean renewable energy?

When building innovation ‘eco-systems’, then, it is important to make sure the role of business is symbiotic, not parasitic. That means, if we want to rebalance the economy, we need to rebalance the story we tell about who the innovators really are. Not admitting the State’s role in the success of companies like Apple is what allows these companies to justify paying back so little tax to the public purse. And if taxes remain so low and easy to be avoided, perhaps we need to consider more direct rewards for government: when Google made billions, should it not have been asked to contribute to a government ‘innovation fund’. Should not something Interestingly, it was the venture capital lobby in the mid 1970s that pushed for the capital gains tax to fall by 100 per cent (from 40 per cent in 1976 to 20 per cent in the mid '80s). It has been falling ever since, based on the narrative that only thus will the entrepreneurial ‘risk-takers’ do their thing and enrich us all. And is it healthy or rotten Apples that will be falling from the trees?

But that narrative is false. The entrepreneurial state has funded the radical innovation behind much if not most of modern economic growth. Denying government today the resources to do its thing endangers us all.


1. Mariana Mazzucato (www.marianamazzucato.com), Professor in Economics of Innovation, Science and Technology Policy Research (SPRU), University of Sussex. She tweets on @MazzucatoM

2.The Entrepreneurial State: debunking private vs. public sector myths (Anthem, 2013)