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A problem with the Entrepreneurial State

If you haven’t read The Entrepreneurial State, you should. It’s a great read, and its headline message – that you can’t write the government out of the story of innovation – is timely and powerfully expressed. Public money backed the Internet, the graphical user interface and the self-driving car; it launched GPS satellites and gave the semiconductor industry its vital first customer; the list goes on.

So far so good. But when it comes to Prof Mazzucato’s main recommendations for how government can make more innovation happen, I’m less convinced – in fact, I’d argue they’re totally unworkable.

The main recommendation of The Entrepreneurial State is that the state should find ways to share directly in the profits of companies that benefit from government innovation spending. A repayment system needs to “reward [the government for] the wins when they happen so that the returns can cover the losses from the inevitable failures” (p187).

The book suggests three ways of doing this: “golden shares of IPR and a national innovation fund”, “income-contingent loans and equity” and “development banks”. Essentially, they all involve the government retaining a financial interest in companies that develop innovations based on public funding, with the idea that this money can be recycled to back more radical innovations.

As far as I can see there are three problems with this idea:

  1. It would be nightmarish to administer
  2. It imposes costs on exactly the wrong businesses, creating both a presentational and a practical problem
  3. It’s worse than an already existing option – funding innovation from general taxation

1. An administrative nightmare

The first problem of the proposal is that it would be very hard to administer, and possibly impossible to administer well.

The idea that the government would take a share in companies based on public investments might be straightforward for, say, a biotech company developing a single drug based on a molecule discovered with an government grant. In this example, the research is a necessary and significant condition for the firm’s business.

But in more complex cases of innovation, it quickly becomes hard to measure. Rolls-Royce plc relies on hundreds of pieces of research, many of which have been funded in part by the UK taxpayer. Some may be vital to Rolls-Royce’s profitability, some may be marginal.

What should Rolls-Royce owe the government? Will it be agreed when the IP is handed over, or ex post? Will there be a flat rate, or will it depend on the quality of the IP? If so, who will work it out? We know that most innovation is complex and relies on combining lots of different ideas, not from the linear development of a single discovery. So we should expect this problem to be very common.

It’s also unclear how such a system would treat procurement. A clear lesson from the American government’s support for technology companies is the importance of procurement schemes like SBIR in providing money to growing businesses. Indeed, The Entrepreneurial State notes that this is a significant way government helps innovation flourish. Would these companies have to offer the government equity or repayments in return for contracts? And if the government did own a stake in companies it procured from, how would it balance its interests as a shareholder and as a customer.

It may seem churlish to ask these detailed questions – after all, all high-level policy proposals raise questions, and civil servants are there to deal with them. But in the case of The Entrepreneurial State’s gain-sharing policy, it’s hard to see how this could be done even in theory. History gives us little guide: most – perhaps all - of the US government’s most entrepreneurial acts of technology development did not involve companies in whom it had a financial interest.

This complexity would have two disadvantages: firstly, it would be a prodigious bureaucratic challenge. Secondly, to the extent that companies will worry that they are giving up too much for the privilege of working on innovation with the government, it will lead to less business-university collaboration, which as lots of people have observed is already a problem in the UK.

2. Hits the wrong companies

It’s also worth thinking about how the policy would look. In the name of innovation, a government enacting this policy would in some form be taking more money from R&D-intensive and high-tech companies.

Low-R&D companies wouldn’t pay this, since they don’t work directly with public researchers. (Although of course they benefit hugely from new technologies – the classic case being how in the 1990s Walmart benefited hugely from information technology by computerizing its supply chains.)

So the government would be charging a special levy on businesses like ARM, Rolls Royce or GSK, while exempting Tesco, Provident Financial and Paddy Power - with the stated goal of promoting innovation. Whether or not the money went to fund further research, it would be, as civil servants like to say, a “presentational nightmare” (i.e., it would look bonkers). The government would be accused of privileging low-R&D companies over high-R&D ones – further exacerbating what many people see as the problem with Britain’s economy.

R&D-intensive companies might ask (with some justification) why Tesco can drive its lorries for free along tax-payer funded roads, employ state-educated workers, and use public courts of law to prosecute shoplifters, but the public goods that high-tech and pharma companies benefit from must be repaid to the taxpayer. This is a good question.

One solution to this is to simply get all companies, not just innovative ones, to compensate the government for their use of public goods. You might be thinking that this could some sort of levy based on their profit – if so, then congratulations: you have just invented Corporation Tax! *

3. Worse than funding innovation with taxes

Taxes, of course, are the other way of paying for public innovation spending. Part of the reason The Entrepreneurial State advocates a gain-sharing process is because it argues that it would be better than funding innovation from general taxation, a policy it describes as “naïve”, mainly because of tax avoidance.

Two reasons are given, but each of them is problematic.

i) The first is that “the tax system was not conceived to support innovation systems, which are disproportionately driven by actors who are willing to invest decades before returns appear”. To be honest I don’t see why this is a problem. The tax system wasn’t conceived to fund healthcare, foreign aid or unemployment insurance either, but modern states use it for all those things. And states fund plenty of long-term investments already: education, for example, and infrastructure. Funding innovation doesn’t seem different.

ii) The second argument given is that people and companies avoid taxes, so they don’t provide enough money to the public research we need. This is sometimes true, and it is a bad thing. But although some taxes are avoided, some aren’t. Corporation tax still raises over £40 billion a year in the UK, against a science budget of about £5 billion; in the US the Corporate Income tax raises over $250 billion. The UK is not the Late Roman Empire. The tax system raises a lot of money, enough to fund generous innovation investment, even if we might like it to work even better.

The real question to ask is whether it’s easier for an amoral, innovative company (a) to avoid taxes or (b) to manipulate a novel system of golden shares and royalty arrangements.

As many small shareholders in start-ups have discovered, there are plenty of ways that an unscrupulous majority owner can dilute out or marginalize a minority partner. The government has virtually no experience of being a large-scale minority owner, and perhaps a few dozen staff with any experience of this. But it has thousands of tax inspectors, and, according to anti-avoidance campaigners, could get much better at collecting the tax it’s owed if it chose to.

Would it take political will to do this? Certainly. But surely less political will than to create an entirely new form of government ownership in innovative companies, which the innovative companies would be likely to oppose, and which would itself need to be carefully policed to prevent avoidance.

Conclusion

So where are we? The gain-sharing proposal is an administrative nightmare that would distort company behaviour in bad ways. It would be a tough political sell, not least because its burden falls on the high-R&D companies that the UK doesn't have enough of. And it would work less well as a way of funding innovation than plain old taxation, because it is likely to be more avoidable.

I’m aware this might seem like an intemperate rant about what is after all only one part of the argument of The Entrepreneurial State. After all, most people who have read it remember it primarily for its powerful counterblast against the libertarian mantra that government and innovation don’t mix and that entrepreneurs aren't the only thing that matters.

But because the book has been so widely read, the policy recommendations matter. Policymakers read the book, like it, and want to act on it, and if the recommendations they are following are bad ones, then we have a problem.

I say all this in sorrow rather than in anger. The overall thrust of The Entrepreneurial State - that without a government willing to take risks and to think big when it comes to technology, we are likely to have a pinched and uninnovative society – is one I heartily support. But without the right policies, we’re unlikely to get more than just talk.

* If your reaction is “well, we should charge companies based on the private benefit they make from each type of public good”, it is tempting to reply “why not charge individuals as well?”, since individuals also benefit privately from public goods. The end result of this would be a fee-for-service public sector, which most people, and certainly most readers of The Entrepreneurial State, would think was a terrible idea.

Author

Stian Westlake

Stian Westlake

Stian Westlake

Executive Director of Policy and Research

Stian led Nesta's Policy and Research team. His research interests included the measurement of innovation and its effects on productivity, the role of high-growth businesses in the e...

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