Book Review: The Entrepreneurial State – Debunking Public versus Private Sector Myths by Mariana Mazzucato (2013, Anthem Press)

Catherine Mitchell, 11th November 2014

Introduction

Mariana Mazzucato’s (MM) is an economist who has just received a New Statesman SPERI prize, from a short list including Ha-Joon Chang (University of Cambridge); and Thomas Piketty (Paris School of Economics). The 2013 book is an expanded version of a 2011 Demos report called The Entrepreneurial State anyone, so who wants a short version should look at that.

What MM is very good at explaining is what an entrepreneurial State is and why being an entrepreneurial State brings value to a country – both in terms of a conceptual overview and from detail examples of sector and technology development, from the US and China in particular. When she talks about the British State she is critical of their lack of ‘confidence’ in their actions and their de facto acceptance of what MM argues are the ‘myths’ of what the role of the State should be. MM is also clear that it is no good throwing money at innovation if the institutional basis for innovation is dysfunctional – for example, if the tax system is flawed or the risk reward basis of investment is inappropriate. In that situation, the State would be investing but receiving little reward for their risk taking, and this undermines the basis of the entrepreneurial State. The State innovation institutions have to become functional and aligned with the needs of the entrepreneurial State, if the State is to be successful.

The one gap I see in her book is that while her ideas are new, sensible, powerful and of the moment, she does not spend enough time explaining how a country, which is not entrepreneurial and does follow the myths she so ably debunks, can be transformed into one that want to become an entrepreneurial one. She rationally explains the benefits of being an entrepreneurial State. And, if States were rational, they would follow. However, of course, politics intervene, and this is the focus of the IGov project. It is clear that MM recognises this; she just does not deviate from the very powerful argument in the book in order to address this. However, a book cannot cover everything, and what she does cover, she covers thoroughly. Besides that point, this book review can do little beyond set out MM’s basic arguments and press everyone to read it (or the pamphlet) thoroughly.

The book is based on substantial amounts of research, with each chapter dealing with a new aspect of the topic. MM’s writing is powerful and full of analogies and visual phrases which light up the book, many of which are copied in their entirety below. The review is set out in the following way: the section below sets out her key arguments; the second section describes each Chapter’s contents; and the third section provides a little more depth on a few key points: the role of the State; the appropriate risk reward for all investors in the innovation cycle, including State investment; debunking various myths about which are the important investors; that the next big technological revolution will be the ‘green revolution’; and the difference between the ‘old’ and the ‘new’ business economy model.

Basic Arguments

In brief, the book:

• looks at the role of the State in investment/innovation and wealth creation;
• provides a fuller understanding of the public sectors centrality to risk taking activities and radical technological change;
• offers a very different description of the role of the State from that envisioned by present economic policymakers;
• challenges conventional industrial policy which unduly plays down its scope for pioneering and promoting new technologies;
• raises awareness of what public sector investments have done for the economies of several countries, but in particular the US;
• describes scenarios where the State has provided the main source of dynamism and innovation in advanced industrial economies, and where it has played the part of the lead player in what is often called the knowledge economy – an economy driven by technological change and knowledge production and diffusion. MM argues that it is, and has been, the State not the private sector that has kick started and developed the engine of growth of the most important technological sectors of our Age. These include, aviation, nuclear energy, computers, the internet, ICT, biotechnology to today’s development in green technology. This was achieved because of the State’s willingness to take risks in areas where the private sector has been too risk averse.

MM works through these areas by setting up the following argument:

• that, generally speaking, the current role of most States is too narrow – generally as a result of accepting ‘myths’ about what the role of the State should be, and this leads to a lack of confidence about what it can do and what its role should be;
• MM explains what an entrepreneurial State is and shows, from examples, what benefits they have brought to various economies and companies;
• MM then argues for a different risk reward relationship;
• once the State is able to take back more from its investments, the State is able to continue to invest in necessary new areas of the innovation cycle where private investors will not go;
• Finally, MM argues that the green revolution is the next big technological change, building on the ICT revolution. She argues that what is necessary now for the Green Revolution is what was necessary for the previous technological revolutions: kick starting and pushing by the State, but critiques a number of Governments (eg UK and US) for not pursuing this course.

Overview of Chapters

The Foreword (by Carlota Perez) and Chapter 1 are both very good overviews of the book.

In Chapter 2 MM argues that there is extensive literature to show that it is the rate and direction of innovation that drives the ability of economies to grow. She explains that two frameworks are generally used to underpin policies to stimulate innovation – both framed in terms of the role of the State as a corrector of different types of failures. The first is the market failure approach in which the State is remedying the gap in investment between predicted in private and social returns; and the second is the systems failure approach, where barriers are removed.

In Chapter 3, MM argues for a new framework to be the basis of successful innovation: the entrepreneurial State acting as a lead risk-taker, market shaper and source of ‘patient capital’. MM argues that by limiting the role of the State to fixing failures it has caused policies to be limited in nature and ideologically driven. Chapter 3 gives the pharmaceutical industry in US as an example of a successful entrepreneurial State innovation policy. In the US, 75% of new molecular entities (the basis of new drugs) trace their research not to private companies but publicly funded National Institutes of Health projects. She also shows how Venture Capitalists (VC) have not been prepared to give money to new technology areas, or keep that money invested for long enough to enable technological maturity to come through – in other words, their capital is ‘impatient’ (see below for a more detailed discussion). MM shows how they generally invest only after the State has undertaken the initial investment, based on the US biotech industry as an example.

In Chapter 4, she illuminates the key characteristics of an innovation policy for an entrepreneurial state by focussing on recent US industrial policy, including the Defense Advanced Research Projects Agency (DARPA) and the Small Business Innovation Research (SBIR) programme. The entrepreneurial State builds on the notion of the Developmental State (Block 2006) but goes deeper into the role of the State and the type of risk the public sectors have been willing to take on in some countries, and which MM argues they should be willing to take on more generally.

Chapter 5 explores the history of Apple, a company often argued to have revolutionised capitalism and often given as an example of Schumpeterian creative destruction. MM turns this argument on its head. She shows that Apple is a company which has received considerable early State finance from the Government. She also shows that there is ‘ not a single key technology behind the iPhone that has not been State funded’. While she does not dispute that Jobs an inspiring genius whose attention to detail and determination to make easy to use products was fundamental to Apple’s success, she does shown that Apple concentrated its ingenuity not on developing new technologies and components but on integrating them into an innovative architecture of Apple products.

MM then sets up the next stage of her argument: that Apple (and other companies in similar positions) should pay more tax and should repay the State in some way for the State’s early technological support, when other forms of capital were not available. This is not just because it is the ‘right’ thing to do but also because ‘it [Apple] is the epitome of a company that requires the public purse to be large and risk-loving enough to continue to make the investments that entrepreneurs like Jobs will later capitalise on’ (p11).

MM argues in Chapter 6 that the ‘next big thing after the internet’ will be the Green Revolution, and shows that this is today being led by (some) States, just like the IT revolution’. She argues that the countries which are leading this green vision have a clear role of the State as ‘patient finance supplied by State development banks creating the catalytical early and risky investments necessary to make it [the Green Revolution] happen’.

Rather than focusing on a sector as Chapter 6 did, Chapter 7 focuses on the role of an entrepreneurial risk- taking State , for wind and solar. Ch 5 emphasised the role of US entrepreneurial State in leading the IT revolution, establishing the foundation of the biotech industry and so on. Chapter 7, emphasises the role of countries like Germany, Denmark and China in developing wind and solar. It also sets about destroying 3 myths: that innovation is all about R&D (ie it is about more); that small is beautiful; and that VC is risk loving (it is not).

Having set out what an entrepreneurial State can do, MM then turns to the parallel and intertwined argument of how an entrepreneurial State should be rewarded. It is not just that the role of the State has to become accepted as being something more than a market fixer or a creator of system conditions without barriers. MMs second interwoven point is that its role is not represented adequately in the risk reward relationship. Chapters 8 and 9 discuss the conventional redistribution of returns from investment in the innovation cycle, as well as discussing how this conventional means can be altered so that the State can ensure that its risk-taking earns back a direct return.

MM concludes in Chapter 10 with the three key points:

• there is a need to build entrepreneurial States;
• if the State engages in the world of investment uncertainty with inevitable wins and losses, it is only right that when the wins arrive the State gets some of the benefits; and
• her analysis in the book has better informed policies directed at actors in the innovation process so that the hyping down of State and Hyping up of VC and private investment actors is better understood; so that a more appropriate risk reward distribution is better understood, and hopefully established; and so, by rebalancing distribution of risk rewards, inequality will also be reduced.

Analysis – Key Points

The Role of the State

The book is a challenge to the conventional role of the State, and tries to link Government actions directly to technology, innovation and growth. She argues that the role of the State should not only be limited to intervention into the macro-economy as a ‘market fixer’ (to overcome market failures) or as a passive financier of public R&D – as is the ‘normal’ view put forward by conventional economic arguments. MM argues that the State should be seen as an entrepreneur, risk taker and market creator; a key partner with private investors, often taking risks that the private sector will not; in other words the State should not be afraid to drive a Vision.

Understanding the unique nature of the public sector – as more than an inefficient version of the private sector – will impact on the nature of the public private collaborations that emerge, as well as the rewards the State feels justified to reap. An entrepreneurial State does not only de-risk the private sector but operates to make things happen. MM argues that major socioeconomic challenges – such as climate change or aging – require an active State.

An entrepreneurial State invests in areas that the private sector would not invest in even if it had the resources; and by providing this leadership, the State makes things happen that otherwise would not. She argues that it is a critical difference if this role is justified given the characteristics of public good and the role of externalities (both central 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. MM argues that somehow the idea of the State ‘intervening’ or ‘meddling’ in an inefficient way has taken hold. Yet she shows, in very deeply argued case studies that this is not the case: that aviation, nuclear energy, computers, the internet, ICT, biotechnology have all resulted from public investment where private investment would not go until they could make sufficient, quick returns.

Discussion about the appropriate risk reward for all investment in the innovation cycle, including for the Public Investment

MM argues that the received wisdom is that bankers take on high risks, and when those risks reap a big return, they should be rewarded. A similar logic is used to justify high returns of shareholders. The logic here is that shareholders are the biggest risk takers since they only earn the returns that are left over once all the other economic actors are paid (ie the residual (if it exists)once workers etc are paid their salaries etc). Shareholder value ideology is based on this notion of shareholders as residual claimants, and when there is a large residual shareholders are the proper claimant. MM does not disagree that all investors should make an appropriate return but argues that the Shareholder value framework assumes that other agents in the system (ie State / taxpayers, workers) do receive their appropriate return first, when in fact this is generally not the case with the State.

As MM shows, public investment is vital for much innovation, and certainly for the technological revolutions that have altered our Age. Generally, the State does not benefit from this, other than through tax. She is critical of companies which benefit from State investment, and not only give no return on that investment but also try to reduce their tax receipts. MM argues for a much better understanding of the division of innovative labour in capitalism and the role public and private investment can, and does, play in creating, producing and diffusing innovations. This would include the development of an appropriate system of reward to the State for their investment, as with any other actor in the innovation process. Parallel to this, she also argues that there needs to be innovation in the tax system to ensure that the high-risk public spending can continue to guarantee future private innovation (discussed further in Old versus New Economy section below).

MM argues for ‘a functional risk reward dynamic which replaces the dysfunctional socialised risk and privatised rewards’. This is a rebalancing of risk rewards, and the positive side effects of this are:

• The State will be able to continue to invest in these areas with their ‘patient capital’
• If the distribution of rewards occurs by contributions to the innovative process, innovation tends to reduce inequality

Debunking Myths

MM’s book is also attempts to debunk various economic and policy myths. She tries to show that not only can the State be a powerful pusher of beneficial change for society, but if they don’t they tend to be ‘captured’ and lose confidence in themselves. She tries to debunk the myth that somehow States are meddlers which always gets things wrong, and that private companies do better. On the contrary, she shows in fact that it has been the State which has put up the money for Visions or for the early stages of idea, and kept the funds coming to those early, risky times of technology development, and which ultimately led to major technological changes over our lifetimes. One of the myths she debunks is that private Venture Capital is available for these risky investments. On the contrary, she shows that Venture Capital has not been forthcoming for either the early stages of technological development; nor for technologies outside of the ‘core’ interests of the VC. By its nature, revolutionary technologies are in new, different core areas. In both ways, VC has not been prepared to take the risk. Moreover, she shows that the risk reward balance has become inappropriately skewed towards private investors – which investment in generally less risky areas when the possibilities have become clearer because of State investment. MM argues that this risk reward nexus has to be reviewed and re-balanced appropriately.

Green Revolution

MM holds that the next big technological revolution will be the ‘green revolution’, and that its success, as with the previous technological revolutions, will depend on proactive governments. Big visionary project like putting a ‘man on the moon’ or the vision behind the internet, MM argues, requires far more than a calculation of social and private returns. As in the US, with the development of information technology (IT), it is those countries willing to accept the high risks and that are determined to support their entrepreneurs that are likely to lead the world markets in green technologies. Her analysis suggests that success is met by those countries that have been able to reach a strong national consensus and can therefore maintain the level of funding and sustained policy support through the ups and downs of the economy.

MM argues that the green industrial revolution, being pushed by States effort (which she goes through in detail) should be viewed as an attempt to transform one of the most massive infrastructures already in existence – the energy infrastructure. Understanding how businesses transform the government support mechanisms into lower cost, higher performance products through the innovation process is typically the missing link in discussions of appropriate energy policy, and this missing link can undermine our desire, or ability, to push/succeed in an energy transition.

Old Economy Business Model versus the New Economy Business Model

In the modern knowledge economy, MM argues that it is not enough to invest in infrastructure or generate demand for the expansion of production. It is even more critical, in the information age, to direct public resources into catalysing innovation.

MM attempts to explain how a country like the US can become a leading market but fail to produce a leading manufacturer and conversely how a country like China can produce a leading manufacturer in the absence, until recently, of a domestic market (for wind and solar). What distinguishes these nations, MM argues, has nothing to do with ‘comparative advantage’; and it has nothing to do with national abundance of wind or sun. Historically, she argues, the developments of wind and solar power has reflected differences in government policies meant to foster these power sources.

However, along with this need to understand how State policies can lead to innovation, she also argues that economies are changing and that the role of the State, institutions and polices have to reflect those changes. There needs to be a recognition that innovation unfolds as part of a global process, not an individual or even organisational process. The past industrial age, where the nature of the production model and associated processes required some degree of embeddedness to the physical location of businesses, rarely exists today. The old economy business model was key in creating the golden age of the mass production / Fordist, technological revolution with capital, labour and the State all sharing its potential and benefits.

However, in today’s terms, capital moves much faster, much further and is even virtual. In today’s world, companies like Apple have a much bigger canvas (ie beyond nation states) to work with when driving down costs. The absence of regulatory institutions to govern globalisation makes it easy for companies like Apple to turn trade into a complex web of affairs which are difficult to unpick. The new economy business model has to find the means to transform itself to distribute the benefits of the ICT revolution, and any other revolutions coming along.

Posted by: rhoggett

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