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The State and the Innovation Effort

Review

The State and the Innovation Effort

– What role should the public sector play?

Melanie Smallman, University College, London;

Edmund PHELPS. Mass Flourishing. Princeton, N.J: Princeton University Press, 2013

Mariana MAZZUCATO. The Entrepreneurial State. London: Anthem Press, 2013

Innovation has been a source of fascination for economists for decades. Seen as the engine of economic growth ever since Schumpeter’s work in the mid-20th century, the economic downturn following the 2008 financial crisis has shone the spotlight even more strongly on the potential of innovation to drive growth and create jobs. Mass Flourishing by Edmund Phelps and The Entrepreneurial State by Mariana Mazzucato – and the attention they have received – are two good examples of this post-crash interest in innovation. Both published in 2013, they set out to answer the question of what can be done to encourage innovation. Nevertheless, interestingly, each author comes up with a very different analysis of the problem and set of solutions. 

From Schumpeter onwards, the prevailing wisdom amongst economists and innovation experts alike has been that the most important role of the state with regard to innovation is to inject cash into the risky research phase and then to step out of the way for the private sector to do its magic. In line with this idea then, much work in innovation studies has looked at the details of how ideas are generated, how the transfer of ideas from the research phase to the innovation phase takes place, and the factors governing the survival and growth of startups.

Phelps’s Mass Flourishing follows very much in this vein, but sets out to ask a much wider question about innovation within our economy – why are some countries and time periods good at creating innovation and wealth while others are not? More specifically, he asks what has happened to the great periods of ‘mass flourishing’ that were seen in Europe and the US in the past, when people produced new ideas, products and wealth, but also had meaningful work and lives. And this latter point is key – in his mind, the kinds of economy that are innovative and wealthy also offer more fulfilling lives. The answer he suggests is that today’s economies lack dynamism, or the willingness and capacity necessary for innovation, as a result of a number of institutional, political and societal moves.

Rich in economic facts and figures throughout, the book is split into three parts: In part one, he takes a historical view to describe what he means by modern economies and how they achieved the dynamism that led them to mass flourishing in the past. He describes the birth of capitalism in the US and Europe in the early 19th century and argues that modernist values – such as thinking and working for yourself, self-expression, eagerness to work with others, take initiative, be intellectually challenged and engaged and the readiness to accept change caused or desired by others – were as important as the availability of new scientific knowledge or the institutional structures that allowed companies to be set up, trade and profit. 

In part two, he looks at the factors that, in his view, have destroyed such dynamism. In particular he points the finger at socialism’s attempts to own markets and ‘corporatism’ (the term he uses to describe the 20th century European model of social democracy) in intervening in the market to shield citizens from the anxieties around economic change. He argues that rather than developing indigenous innovation and dynamism of its own, any economic success seen in Europe in the post-war period was largely the result of ‘free-riding’ on the US’s dynamism.

Finally, in part three, Phelps turns back to the US to ask what has been the cause of the post-1960s economic decline. He points to three causes for this drop in dynamism – oversized government, institutional changes that encourage short-termism in investment and the rise of traditional, rather than modern, values. To solve this problem, he suggests a smaller state, the reform of institutions such as trade unions but also company structures to encourage CEOs to ‘care more about building companies than building their dream homes’ and cultural changes so that young people aspire to adventure, challenge and passion from their work rather than working to have nice things, enjoy financial security and build a family.

In contrast to Phelps’s plea for a shrinking state, Mariana Mazzucato in The Entrepreneurial State makes the case for a more active state. She argues that, historically, the vital role of the state has been misrepresented in stories of how innovation happens. Rather than seeing the role of the state as being limited to a passive financer of public research or intervening when markets go wrong – or even in some instances stifling innovation – Mazzucato uses a series of case studies to explain why the state should also be seen as an entrepreneur and a risk-taker – and often the biggest risk-taker in the innovation process. Some of the biggest innovations in 20th century technology have been developed as the result of industrial policy, rather than free markets.

Like Phelps, Mazzucato is an eminent professor of economics and The Entrepreneurial State draws on an array of economic facts and figures. They are, however, focused around a series of case studies that range from the development of the iPhone in the US to renewable energy technologies in China, making the book an engaging read.

The book begins with an introduction that makes a direct and explicit challenge to the mainstream economic wisdom and practice of encouraging the state to withdraw in order to make the economy more dynamic, innovative and competitive. Mazzucato argues that this presentation of the state as bureaucratic, inert and heavy-handed is ideological. While it has been effective in paving the way to wider political moves to attack and dismantle the state in favour of the free market, it is not accurate.

In Chapter 2, she paints the backdrop to this discussion, explaining the two frameworks that economists commonly use for understanding the role of the state in innovation-led economy growth: First, market failure, where the state steps in to fix the gap between private and social returns; Second, systems of innovation in which R&D spend is seen within a system in which knowledge is produced but also diffused throughout an economy. While both these frameworks have justified increased government spend on innovation, they nevertheless force the state into the role of facilitator of innovation with responsibility simply to create the conditions for innovation.

The book then goes on to develop the evidence to back up her claims that this is a misunderstanding and misrepresentation, in the form of a series of case studies showing how effective the state has been in offering direction and taking risks where others will not go. In Chapter 3 she describes how the UK Government’s Medical Research Council in the 1970s led the way to developing monoclonal antibodies, which today make up to one third of new drug treatments. In contrast, the venture capitalists – traditionally portrayed as the innovation chain risk-takers – only stepped in once the risks were clear. This, she argues, shows how the public (rather than private) sector sometimes leads the way and bears the risk.

In Chapter 5 she describes how, while Steve Jobs was successful in creating a powerful story about how individual genius, play and a focus on design led to the origin and success of Apple products, none of this would have been possible without a massive amount of public sector investment into the computer and Internet revolutions; Chapters 6 and 7 take the examples of wind and solar power industries to illustrate how important the role of the state is – not just in enabling technological developments but in promoting their uptake too. Rather than simply offering tax credits and stepping out of the way, in these examples the state has become and stayed involved in every aspect of the business.

Bringing the arguments to a conclusion in Chapter 10, Mazzucato makes one final point – the state’s ability to fulfil its role in directing and pushing innovation is dependent upon the talent and skills it can draw on. Yet access to such expertise is more difficult in nations where the state takes a back seat. She concludes that challenging the myths of the role of the state in economic development is essential if we are to produce the economic and technological change we need for long-term sustainable growth in the 21st century.

At a time when politicians are looking for new ways to boost innovation and economic growth, Mazzucato’s book has made waves across governments of various complexions. Indeed it is widely considered to be one of the most challenging and influential books on innovation for a decade or more. Phelps’s Mass Flourishing however also offers a challenging perspective for policymakers – most notably around his suggestions for reforming finance and company structure. While these might appear to  be ‘tweaks’ to the system, encouraging a move towards more ‘patient capital’ – a move called for from many corners of the economic literature – could be transformational.

Perhaps as a reflection of the way in which the world has moved on since the publication of these books in 2013, what is now missing in both books is a deep consideration of the kind of economies that we are building with innovation. Phelps alludes to this with his discussion of ‘the good life’ and Mazzacato touches upon it when she raises the question of whether US taxpayers have benefitted in terms of jobs and tax receipts from the investments made and risks taken with their tax dollars. But at a time when the effects of innovations such as the Internet are being felt in a dramatic drop in corporate tax receipts, stateless profits and low wages, and with these phenomena set to accelerate with the rapid advent of Artificial Intelligence, making sure that the innovations we create in turn create the kind – not just the size – of economy we want must be a key issue for innovation policy now. 

 

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