Stating the Entrepreneurial State thesis

So far we have presented several criticisms of Mazzucatian arguments and interpretations of facts, but we haven’t really presented in a clear and systematic way what she is exactly saying, her theoretical framework. I shall do that in this post.

She draws inspiration from, at least,  Schumpeter, Keynes, Knight, and Polanyi, with some dashes of List and Chang, but here we won’t be criticizing these thinkers. Instead, we will just focus on the core parts of the Mazzucatian theory. First, I will let her present her points via some quotations from the book, then I will provide a synthesis of the argument. This summary does not present any critique of Mazzucato, but this fact should not be construed as agreement with her. As is evident from other posts in this blog, I disagree with her in many things.

The first point to note is that we should clearly see the difference between the Entrepreneurial State described by Mazzucato, and another, similar, concept which we may call the Funding State (The term is mine, not Mazzucato’s). The latter would be a state that just throws money at universities, businesses or entrepreneurs (‘market failure fixing’) so that they can innovate. In the Entrepreneurial State, as Carlota Perez puts it in the foreword

The role of the State is not limited to interventions into the macroeconomy as a ‘market fixer’ or as for the passive financer of public R&D. The State is also seen as entrepreneur, risk taker and market creator. Mazzucato’s argument goes well beyond the role played by government in the countries that recently forged ahead (Japan in the 1980s or South Korea in the 1990s) to focus on the role played by the public sector agencies of the United States – the wealthiest country in the world and an active promoter of ‘free markets’ – in making risky investments behind the Internet and in funding most of the crucial elements behind the ‘stars’ of the information revolution, companies such as Google and Apple. […]

Her key point is that the most radical new technologies in different sectors – from the Internet to pharmaceuticals – trace their funding to a courageous, risk-taking State. Her account of the US government’s investment in the Internet provides evidence for the complex set of actions that make such wide-ranging innovations happen. She highlights the importance of mission-oriented funding and procurement; of the bringing together of multiple agencies; and also of the creation of incentives for multiple sectors and the multiple financing tools deployed to make it happen.
Successful efforts do not stop at basic and applied research but carry out the work of achieving commercialization.[…]

In all cases and in all contexts – as Mazzucato convincingly shows – major innovations require time and patience. Private finance has become too short-termist and is increasingly dependent on government labs that engage in high-risk portions of the innovation chain before committing its own funds.

And if the State is, or ought to be, a Entrepreneurial rather than a Funding State,

There are at least three lessons vital for effective institutionalization of innovation that stem from Mariana Mazzucato’s analysis. There is a need to strengthen the funding sources of public R&D; a need to increase public commitment to ‘green’ technology innovation and direction setting; and a need to update the Keynesian responses to modern economic crises.
If State investment in R&D is a necessary first condition in generating private innovation later, then guaranteeing a steady flow of funds for such purposes is in everybody’s interest. Her account of the Apple story shows that, apart from ‘staying foolish’ as Steve Jobs recommended, what many successful entrepreneurs have done – including him – is to integrate State-funded technological developments into breakthrough products. Given the massive returns generated by their success, shouldn’t entrepreneurs then return some of the rewards to the government, so it can continue taking the big risks that can later be turned into market game-changers?

The other direction for public sector innovation relates to ‘green’ technology. It is my own conviction that other than saving the planet, the green direction can, if properly supported, save the economy.[…] Mazzucato holds that the ‘green revolution’ will depend on proactive governments.[…]

This brings us to the third lesson: we need the economic insights of both Keynes and Schumpeter. As Keynes rightly argued, government must become the investor of last resort when the private sector freezes. But in the modern knowledge economy it is not enough to invest in infrastructure or to generate demand for the expansion of production. If innovation has always been – as Schumpeter said – the force driving growth in the market economy, it is even more critical in the information age to continue to direct public resources into catalysing innovation. In her book, following the success of the mission-oriented experience of the United States for public R&D and innovation procurement, Mazzucato argues for the government to overcome recession by intensifying innovation efforts.

Indeed, Mazzucato again points out in her introduction that

The reason I call, both the DEMOS report and the current book, the ‘entrepreneurial’ State is that entrepreneurship – what every policymaker today seems to want to encourage – is not (just) about start-ups, venture capital and ‘garage tinkerers’. It is about the willingness and ability of economic agents to take on risk and real Knightian uncertainty: what is genuinely unknown.1 Attempts at innovation usually fail – otherwise it would not be called ‘innovation’. This is why you have to be a bit ‘crazy’ to engage with innovation… it will often cost you more than it brings back, making traditional cost–benefit analysis stop it from the start. But whereas Steve Jobs talked about this in his charismatic 2005 Stanford lecture on the need for innovators to stay ‘hungry and foolish’ (Jobs 2005), few have admitted how much such foolishness has been ‘seriously’ riding on the wave of State-funded and -directed innovations.
The State… ‘foolishly’ developing innovations? Yes, 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 capitalintensive ‘entrepreneurial’ investments back to the State.

And again, she stresses the differences between her idea and that of the Funding State:

But how have economists talked about this? They have either ignored it or talked about it in terms of the State simply fixing ‘market failures’. Standard economic theory justifies State intervention when the social return on investment is higher than the private return – making it unlikely that a private business will invest. From cleaning up pollution (a negative ‘externality’ not included in companies’ costs) to funding basic research (a ‘public good’ difficult to appropriate). Yet this explains less than one-quarter of the R&D investments made in the USA. Big visionary projects – like putting ‘a man on the moon’, or creating the vision behind the Internet – required much more than the calculation of social and private returns (Mowery 2010).
Such challenges required a vision, a mission, and most of all confidence about what the State’s role in the economy is. As eloquently argued by Keynes in the The End of Laissez Faire (1926, xxx), ‘The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.’ Such a task requires vision and the desire to make things happen in specific spaces – requiring not just bureaucratic skills (though these are critical, as pointed out by Max Weber) but real technology-specific and sector-specific expertise. It is only through an exciting vision of the State’s role that such expertise can be recruited, and is then able to map out the landscape in the relevant space.

She also says that if the State is not Entrepreneurial, that is, it is a passive rather than an active State, it will be captures by special interests, and won’t try to do innovative things, but just copy what the private sector is already doing. She also says that if the image we have of the State is that of an inefficient and bureaucratized organization, it won’t be able to attract talent, and therefore a self-fulfilling prophecy ensues:

An entrepreneurial State does not only ‘de-risk’ the private sector, but envisions the risk space and operates boldly and effectively within it to make things happen. Indeed, when not confident, it is more likely that the State will get ‘captured’ and bow to private interests. When not taking a leading role, the State becomes a poor imitator of private sector behaviours, rather than a real alternative. And the usual criticisms of the State as slow and bureaucratic are more likely in countries that sideline it to play a purely ‘administrative’ role.

So it is a self-fulfilling prophecy to treat the State as cumbersome, and only able to correct ‘market failures’. Who would want to work in the State sector if that is how it is described? And is it a coincidence that the ‘picking winners’ problem – the fear that the State is unable to make bold decisions on the direction of change – is discussed especially in countries that don’t have an entrepreneurial vision for the State, i.e. countries where the State takes a backseat and is then blamed as soon as it makes a mistake?

She is also an avowed Keynesian, and thus she can present her idea as an extension of the typical Keynesian policies:

Providing such leadership, the State makes things happen that otherwise would not have. But whether this role is justified given the characteristics of ‘public good’ and the role of ‘externalities’ (both critical to the market failure argument), or whether it is justified due to a broader understanding of the State as a courageous actor in the economic system makes all the difference. The former understanding leads to discussions about the possibilities of the State ‘crowding out’ (or ‘crowding in’) private investment, creating a narrow view of what the State is and what policy options are acceptable (Friedman 1979). The latter understanding leads to (more) exciting discussions about what the State can do to raise the ‘animal spirits’ of business – to get it to stop hoarding cash and to spend it in new path-breaking areas. […] the point here is that even in the boom (when in theory there is full capacity utilization), there are in practice many parts of the risk landscape where private business fears treading and government leads the way.

She also seems to like Karl Polanyi,

Rather than analysing the State’s active role through its correction of ‘market failures’ (emphasized by many ‘progressive’ economists who rightly see many failures), it is necessary to build a theory of the State’s role in shaping and creating markets – more in line with the work of Karl Polanyi (1944) who emphasized how the capitalist ‘market’ has from the start been heavily shaped by State actions. In innovation, the State not only ‘crowds in’ business investment but also ‘dynamizes it in’ – creating the vision, the mission and the plan. This book is committed to explaining the process by which this happens.

Now from Chapter 1, she recognizes that the State may fail in its entrepreneurial task, but

what is ignored is that, in many of the cases that the State ‘failed’, it was trying to do something much more difficult than what many private businesses do: either trying to extend the period of glory of a mature industry (the Concorde experiment or the American Supersonic Transport project), or actively trying to launch a new technology sector (the Internet, or the IT revolution).
Operating in such difficult territory makes the probability of failure much higher. Yet by constantly bashing the State’s ability to be an effective and innovative agent in society, not only have we too easily blamed the State for some of its failures, we have also not developed the accurate metrics needed to judge its investments fairly. Public venture capital, for example, is very different from private venture capital. It is willing to invest in areas with much higher risk, while providing greater patience and lower expectations of future returns. By definition this is a more difficult situation. Yet the returns to public versus private venture capital are compared without taking this difference into account.

Now, specifying her idea of State capture due to lack of vision, she says that

In the late 1970s capital gains taxes fell significantly following lobbying efforts on behalf of the US venture capital industry (Lazonick 2009, 73). The lobbyists argued before the government that venture capitalists had funded both the Internet and the early semiconductor industry, and that without venture capitalists innovation would not happen. Thus the same actors who rode the wave of expensive State investments in what would later become the dot.com revolution, successfully lobbied government to reduce their taxes. In that way the government’s own pockets, so critical for funding innovation, were being emptied by those who had depended on it for their success. […] Furthermore, by not being confident of its own role, government has been easily captured by the myths describing where innovation and entrepreneurship come from. Big Pharma tries to convince government that it is subject to too much regulation and red tape, while it is simultaneously dependent on government-funded R&D.

The private sector also is entrepreneurial, of course, but she complies that this is the only story that gets told. No one talks about the role of the State in this entrepreneurial activities,

The emphasis on the State as an entrepreneurial agent is not of course meant to deny the existence of private sector entrepreneurial activity, from the role of young new companies in providing the dynamism behind new sectors (e.g. Google), to the important source of funding from private sources like venture capital. The key problem is that this is the only story that is usually told.

She also thinks that the entrepreneurial State has really been with us all along. We do not need to build one (at least in the USA), but instead, improve the already existing one, not demolish it,

What we have instead is a case for a targeted, proactive, entrepreneurial State, one able to take risks and create a highly networked system of actors that harness the best of the private sector for the national good over a medium- to long-term time horizon. It is the State acting as lead investor and catalyst which sparks the network to act and spread knowledge. The State can and does act as creator, not just facilitator of the knowledge economy.
Arguing for an entrepreneurial State is not ‘new’ industrial policy because it is in fact what has happened. As Block and Keller (2011, 95) have explained so well, the industrial directives of the State are ‘hidden’ primarily to prevent a backlash from the conservative right. Evidence abounds of the State’s pivotal role in the history of the computer industry, the Internet, the pharmaceutical-biotech industry, nanotech and the emerging green tech sector. In all these cases, the State dared to think – against all odds – about the ‘impossible’: creating a new technological opportunity; making the initial large necessary investments; enabling a decentralized network of actors to carry out the risky research; and then allowing the development and commercialization process to occur in a dynamic way.

And again, she says she’s working beyond the typical market failure framework,

While this framework is useful, it cannot explain the ‘visionary’ strategic role that government has played in making these investments. 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 that the government had in an area that had not yet been fathomed by the private sector. Even after these new technologies were introduced by government, the private sector still was too scared to invest. Government even had to support the commercialization of the Internet. And it took years for private venture capitalists to start financing biotech or nanotech companies. It was – in these and many such cases – the State that appeared to have the most aggressive ‘animal spirits’.

Emphasis on the relations between actors is also something she focuses on. This is reasonable: One hundred research groups with the ability to communicate and share information will work much better than one hundred isolated groups.

systems of innovation (sectoral, regional, national) require the presence of dynamic links between the different actors (firms, financial institutions, research/education, public sector funds, intermediary institutions), as well as horizontal links within organizations and institutions (Lundvall 1992; Freeman 1995). What has been ignored even in this debate, however, is the exact role that each actor realistically plays in the ‘bumpy’ and complex risk landscape. Many errors of current innovation policy are due to placing actors in the wrong part of this landscape (both in time and space). For example, it is naïve to expect venture capital to lead in the early and most risky stage of any new economic sector today (such as clean technology). In biotechnology, nanotechnology and the Internet, venture capital arrived 15–20 years after the most important investments were made by public sector funds.

In fact, history shows that those areas of the risk landscape (within sectors at any point in time, or at the start of new sectors) that are defined by high capital intensity and high technological and market risk tend to be avoided by the private sector, and have required great amounts of public sector funding (of different types), as well as public sector vision and leadership to get them off the ground. The State has been behind most technological revolutions and periods of long-run growth. This is why an ‘entrepreneurial State’ is needed to engage in risk taking and the creation of a new vision, rather than just fixing market failures.
Not understanding the role that different actors play makes it easier for government to get ‘captured’ by special interests which portray their role in a rhetorical and ideological way that lacks evidence or reason. While venture capitalists have lobbied hard for lower capital gains taxes (mentioned above), they do not make their investments in new technologies on the basis of tax rates; they make them based on perceived risk, something typically reduced by decades of prior State investment.

Innovation based stimuli are not problematic, since she says that it would be problematic only in a period of full resource utilization, but that is never the case, and even if it were the case that the private sector had the resources, it would not invest them, so the State, doing things the private sector wouldn’t is necessary to do those things.

Keynesians have argued against the idea that State spending crowds out private investment, by emphasizing that this would only hold in a period of full resource utilization, a state that hardly ever occurs. However, the issues raised in this book present a different view: that an entrepreneurial State invests in areas that the private sector would not invest even if it had the resources. And it is the courageous risk-taking visionary role of the State which has been ignored. Business investment is mainly limited not by savings but by its own lack of courage (or Keynesian ‘animal spirits’) – the ‘business as usual’ state of mind. Indeed, firm-level studies have shown that what drives entry behaviour into industries (companies deciding to move into one particular sector) are not existing profits in that sector but projected technological and market opportunities (Dosi et al. 1997).

She argues than due to Knightian uncertainty, the R&D process cannot really be modeled within, or accounted for, standard economic theory, making the Schumpeterian approach a necessity,

But most importantly, in this perspective innovation is firm specific, and highly uncertain. The ‘evolutionary’ and Schumpeterian approach to studying firm behaviour and competition has led to a ‘systems of innovation’ view of policy where what matters is understanding the way in which firms of different type are embedded in a system at sectoral, regional and national levels. In this systems view, it is not the quantity of R&D that matters, but how it is distributed throughout an economy, often reflective of the crucial role of the State in influencing the distribution (Freeman 1995; Lundvall 1992). Schumpeterian economists criticize endogenous growth theory because of its assumption that R&D can be modelled as a lottery where a certain amount of R&D investment will create a certain probability for successful innovation. They argue that in fact innovation is an example of true Knightian uncertainty, which cannot be modelled with a normal (or any other) probability distribution that is implicit in endogenous growth theory, where R&D is often modelled using game theory (Reinganum 1984). By highlighting the strong uncertainty underlying technological innovation, as well as the very strong feedback effects that exist between innovation, growth and market structure, Schumpeterians emphasize the ‘systems’ component of technological progress and growth.4 Systems of innovation are defined as ‘the network of institutions in the public and private sectors whose activities and interactions initiate, import, modify and diffuse new technologies’ (Freeman 1995), or ‘the elements and relationships which interact in the production, diffusion and use of new, and economically useful, knowledge’ (Lundvall 1992, 2).

She criticices the linear model of innovation, where the process begins in basic science and continues, and defends a more nonlinear approach

The causation that occurs in the steps taken between basic science, to large-scale R&D, to applications, and finally to diffusing innovations is not ‘linear’. Rather, innovation networks are full of feedback loops existing between markets and technology, applications and science. In the linear model, the R&D system is seen as the main source of innovation, reinforcing economists’ use of R&D stats to understand growth. In this more non-linear view, the roles of education, training, design, quality control and effective demand are just as important. Furthermore, it is better able to recognize the serendipity and uncertainty that characterizes the innovation process.

And again, the role of the State is not just creating knowledge, for Mazzucato

The State’s role is not just to create knowledge through national labs and universities, but also to mobilize resources that allow knowledge and innovations to diffuse broadly across sectors of the economy. It does this by rallying existing innovation networks or by facilitating the development of new ones that bring together a diverse group of stakeholders. However, having a national system of innovation that is rich in horizontal and vertical networks is not sufficient. The State must also lead the process of industrial development, by developing strategies for technological advance in priority areas.

In Chapter 3, she returns to the theme of Knightian uncertainty

What is less understood is the fact that public sector funding often ends up doing much more than fixing market failures. By being more willing to engage in the world of Knightian uncertainty, investing in early stage technology development, the public sector can in fact create new products and related markets. Two examples include its role in dreaming up the possibility of the Internet or nanotech when the terms did not even exist. By envisioning new spaces, creating new ‘missions’ (Foray et al. 2012), the State leads the growth process rather than just incentivizing or stabilizing it.

¿What is an entrepreneur for Mazzucato? She largely draws from Schumpeter

According to the Austrian economist Joseph Schumpeter, an entrepreneur is a person, or group of people, who is willing and able to convert a new idea or invention into a successful innovation. It is not just about setting up a new business (the more common definition), but doing so in a way that produces a new product, or a new process, or a new market for an existing product or process. Entrepreneurship, he wrote, employs ‘the gale of creative destruction’ to replace, in whole or in part, inferior innovations across markets and industries, simultaneously creating new products including new business models, and in so doing destroying the lead of the incumbents (Schumpeter 1949). […] For Frank H. Knight (1921) and Peter Drucker (1970), entrepreneurship is about taking risk. The behaviour of the entrepreneur is that of a person willing to put his or her career and financial security on the line and take risks in the name of an idea, spending time as well as capital on an uncertain venture. In fact, entrepreneurial risk taking, like technological change, is not just risky, it is highly ‘uncertain’. Knight (2002, 233) distinguished risk from uncertainty in the following way:
The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known… While in the case of uncertainty that is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique.

In the case of drug development,

When successful, often the search for one product leads to the discovery of a completely different one, in a process characterized by serendipity.1 This of course does not mean that innovation is based on luck, far from it. It is based on long-term strategies and targeted investments. But the returns from those investments are highly uncertain and thus cannot be understood through rational economic theory (as was discussed above, this is one of the critiques that modern day Schumpeterians make of ‘endogenous growth theory’, which models R&D as a game-theoretic choice).

So she says that this causes R&D to be a case of market failure

The high risk and serendipitous characteristic of the innovation process is one of the main reasons why profit-maximizing companies will invest less in basic research; they can receive greater and more immediate returns from applied research. Investment in basic research is a typical example of a ‘market failure’: an instance where the market alone would not produce enough basic research so the government must step in. This is why there are few people, on all sides of the political spectrum, who would not agree that it should be (and is) the State that tends to fund most basic research.

But she also says that the analysis of state R&D goes beyond market failure

A key reason why the concept of market failure is problematic for understanding the role of government in the innovation process is that it ignores a fundamental fact about the history of innovation. Not only has government funded the riskiest research, whether applied or basic, but it has indeed often been the source of the most radical, path-breaking types of innovation. To this extent it has actively created markets, not just fixed them, a topic examined in depth in Chapter 4.

I think this quotes are enough to derive the points Mazzucato is trying to make, which for the first time ever someone puts in a handy, clean form:

  1. An Entrepreneurial State (takes knightian risk and uncertainty and is willing to convert a new idea or invention into a successful innovation, product, market, process, etc. )does the following
    1. Fosters the development of radical, new technologies through
      1. Mission-oriented funding and Big visionary projects (e.g. Apollo Program)
      2. Procurement (e.g. military)
      3. Bringing together multiple other agents (e.g. sponsoring consortia, sponsoring talks, helping research partners collaborate, coordination in general)
      4. Commercialization, or steps towards commercialization of State-funded tecnology
      5. Raising companies’ animal spirits
      6. Creation of markets, thinking of products and idea the private sector didn’t even conceived before.
  2. We find signs of State intervention in most, if not all, innovative activity (Existence Thesis)
  3. Private actors won’t invest enough in R&D because (Insufficiency Thesis):
    1. Private sector is profit-oriented, and
    2. R&D, and especially basic science is subject to Knightian uncertainty
      1. So no rational cost-benefit analysis can be carried out.
      2. Only if you are ‘a bit crazy’ you will invest in uncertain R&D, or basic science
      3. Companies try not to be crazy
      4. Therefore, they will not invest
    3. R&D is subject to market failure (public good)
      1. R&D is non-excludable
      2. R&D is non-rivalrous
      3. As per standard economic theory, underinvestment occurs
    4. Private sector is too short-termist
  4. State entrepreneurial activity is necessary for innovation to occur (Necessity  Thesis) because
    1. The State can more easily invest in risky and/or long term projects
    2. The State has access to taxation: need not worry about bankruptcy
    3. The State can capture the benefits from innovation (not only via taxation, but also via holding shares in companies that benefit from it, and other measures)
  5. We must make sure an Entrepeneurial State exists and works properly (Desirability Thesis), so
    1. IF (any of this)
      1. We want innovation to occur
      2. We want to benefit from innovation
      3. We want to avoid the consequences of climate change
    2. THEN
      1. A positive image of the State as courageous entrepreneur is required to attract talent and avoid regulatory capture and rent seeking
      2. Acknowledge that the State may fail in it entrepreneurial task, but that in this, it is similar to every entrepreneur, plus the State is doing particularly risky investments, so more failure is to be tolerated.
      3. Things described in point 1. must be done
  6. Because of the role of the State in innovation, it deserves rewards that are currently accruing to the private sector (Risk-Reward Nexus Theory)
    1. This motivates a set of policies we need not analyse here, in order to make State rewards match State risk taking.
  7. Why not a Funding State? (Superiority Thesis)
    1. Knightian Uncertainty, even if private sector had the money, it wouldn’t invest it in the riskiest areas, but in safer, more applied ones instead.
    2. Need to envision and shape markets
    3. Innovation is nonlinear: just investing in basic science is not enough. Also, need to diffuse innovation across different agents.

So what she is arguing can be shortly put: The Entrepreneurial State has Existed for a long time, that it is Necessary for innovation because the private sector is Insufficient, and that it is Desirable for the Entrepreneurial State to exist, instead of a mere Funding State because of the former’s Superiority. For it to properly function, an adequate Risk-Reward assignment must prevail.

So that’s Mariana Mazzucato’s Entrepreneurial State. For her to be wrong, mistakes have to be found in the points laid out above. You need not thank me for putting her points more clearly than herself.

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1 Response to Stating the Entrepreneurial State thesis

  1. Pingback: Extinguid al diplodocus, de Juan Ramón Rallo en vozpopuli.com | Caffe Reggio

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