Entrepreneurial_State

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OpenResearchOnlineTheOpenUniversity’srepositoryofresearchpublicationsandotherresearchoutputsTheEntrepreneurialStateAuthoredBookHowtocite:Mazzucato,Mariana(2011).TheEntrepreneurialState.London:Demos.ForguidanceoncitationsseeFAQs.c2011DemosVersion:VersionofRecordLink(s)toarticleonpublisher’swebsite:http://www.demos.co.uk/publications/theentrepreneurialstateCopyrightandMoralRightsforthearticlesonthissiteareretainedbytheindividualauthorsand/orothercopy-rightowners.FormoreinformationonOpenResearchOnline’sdatapolicyonreuseofmaterialspleaseconsultthepoliciespage.oro.open.ac.uk ‘‘Thestatehasnotjustfixedmarkets,butactivelycreatedthem…”THEENTREPRENEURIALSTATEMarianaMazzucato Thisprojectwassupportedby: Demosisathink-tankfocusedonpowerandpolitics.Ouruniqueapproachchallengesthetraditional,'ivorytower'modelofpolicymakingbygivingavoicetopeopleandcommunities.Weworktogetherwiththegroupsandindividualswhoarethefocusofourresearch,includingthemincitizens’juries,deliberativeworkshops,focusgroupsandethnographicresearch.Throughourhighqualityandsociallyresponsibleresearch,Demoshasestablisheditselfastheleadingindependentthink-tankinBritishpolitics.In2011,ourworkisfocusedonfiveprogrammes:FamilyandSociety;PublicServicesandWelfare;ViolenceandExtremism;PublicInterestandPoliticalEconomy.Wealsohavetwopoliticalresearchprogrammes:theProgressiveConservatismProjectandOpenLeft,investigatingthefutureofthecentre-Rightandcentre-Left.Ourworkisdrivenbythegoalofasocietypopulatedbyfree,capable,secureandpowerfulcitizens.Findoutmoreatwww.demos.co.uk. Firstpublishedin2011©Demos.SomerightsreservedMagdalenHouse,136TooleyStreetLondon,SE12TU,UKISBN978-1-906693-73-2CopyeditedbySusannahWightSeriesdesignbymodernactivityTypesetbymodernactivitySetinGothamRoundedandBaskerville10 THEENTREPRENEURIALSTATEMarianaMazzucato Openaccess.Somerightsreserved.Asthepublisherofthiswork,Demoswantstoencouragethecirculationofourworkaswidelyaspossiblewhileretainingthecopyright.Wethereforehaveanopenaccesspolicywhichenablesanyonetoaccessourcontentonlinewithoutcharge.Anyonecandownload,save,performordistributethisworkinanyformat,includingtranslation,withoutwrittenpermission.ThisissubjecttothetermsoftheDemoslicencefoundatthebackofthispublication.Itsmainconditionsare:·Demosandtheauthor(s)arecredited·Thissummaryandtheaddresswww.demos.co.ukaredisplayed·Thetextisnotalteredandisusedinfull·Theworkisnotresold·AcopyoftheworkorlinktoitsuseonlineissenttoDemosYouarewelcometoaskforpermissiontousethisworkforpurposesotherthanthosecoveredbythelicence.DemosgratefullyacknowledgestheworkofCreativeCommonsininspiringourapproachtocopyright.Tofindoutmoregotowww.creativecommons.org ContentsAcknowledgements11Preface13Introductionandsummary17Recommendations251Frominvisiblehandtomodernmyths292Beyondmarketfailures473Nationalsystemsofinnovation654TheUSentrepreneurialstate755LessonsfortheUK916Finalthoughtsonrisk-takingininnovation:109whogetsthereturn?7Conclusion115Notes117References137 11AcknowledgmentsIamgratefulforfundingfromtheOpenUniversityandtheEuropeanCommunity’sSeventhFrameworkProgramme(FP7/2007–13)undergrantagreementN°217466(FinnovProject,www.finnov-fp7.eu).IreceivedexcellentinsightsandcommentsfromDashaIvkina,WilliamLazonick,PaulNightingaleandAlanShipman,andresearchassistancefromOnerTulumandChristinaBermingham.Allopinions,anderrors,remainmyown.MarianaMazzucatoJune2011 13PrefaceInnovationpolicyinBritainhasbecometiredandisinneedofrefreshing.ThispamphletbyMarianaMazzucato,currentlyProfessorintheEconomicsofInnovationattheOpenUniversity,andsoontobethenewRMPhillipsChairinScienceandTechnologyPolicyattheUniversityofSussex,isthereforeatimelyandimportantcontributiontowhatisanecessarydebate.Overthelasttwodecades,ifnotlonger,theBritishGovernmenthasdefineditsroleineconomicpolicyasworkingtoensureamacroeconomyandinfrastructurethatisconducivetoprivatesectoractivity,onlyinterveningwherethereisasupposedmarketfailure;beyondthatitleavesthejobofwealthcreationtothemarket.Uptoapoint,thatworks.But,asthispamphletshows,opportunitiesarebeingmissedifrecentdevelopmentsininnovationliterature,economictheoryingeneral,andexperiencefromelsewhereintheworldarenotalsodrawnoninsettingUKpolicy.Thefirstinsight,describedinchapter3,isthatnetworksandconnectionsreallymatter.Thisisnotasurprisetothoseinvolvedinthegrowingdisciplineofcomplexityandbehaviouraleconomics,butitisafactthatdoesnotyetlieattheheartofUKeconomicpolicy.Weunderstandthatthereisvalueinacluster,andwesupportthebuildingofbusinessincubationunitsinscienceparks,butwedonotfullyaccepttheresponsibilityofgovernmentcontinuallytofosterhorizontallinksbetweenexistinginstitutionsinordertocreateaflatstructurednationalsystemofinnovationineverydiscipline.Thesecondinsightisthatevenwherethenetworkexists,ittakesanimble,interventionist,knowledge-hungrystatetocatalysethemintoaction.Ifitisinthepublicinterestforinnovationtooccur,thereisaroleforthepublicsectortorequireittohappen,ratherthansittingbackandhopingit Prefacewillhappenofitsownaccordprovidedtheconditionsareright.Countriesplayingeconomiccatch-upareabletodothisrelativelyeasilybyhavinggovernmentstrategiesthatcopywhathashappenedelsewhereintheworld.Atthefrontiersofknowledge,theroleofgovernmentishardertocomprehend.ThispamphletdrawsontheexperienceoftheUSAinparticulartoshowthatinnovationisfarmorelikelytohappenwhenitiscommissionedviaamultitudeofcontractsforparticularadvancesortechnologicalsolutions,ratherthanby—forexample—providingtaxcreditsforgeneralresearchanddevelopment,orbadgeringthebankstolendmoretocertainpartsoftheeconomy.Thisisnotsomuchnudgeasnecessity.Andscalematters.Thepoliticaldangeristhatinanerawheregovernments—andtoadegreethepublic—believethestatehasgottoobig,anytalkofaninterventionistapproachingrowthpolicywillbeintellectuallyfiledunderthesameheadingasthefailedpoliciesofthe1970s.Butthisisnotabouthand-outstounproductivenationalchampions,norisitKeynesiandemandmanagement.ItisaboutlookingatwhatworksandmakingitworkfortheUK.ThecomplexityeconomistWBrianArthurinhisrecentbookTheNatureofTechnologytalksabouttechnologyinafunctionalwayasameanstoapurpose,andaboutinnovationasthecombinationandDarwinian-styleevolutionofcomplementarytechnologies.1Radicalchangeoccurswhenanewunderlyingprincipleisinvokedinordertosolvethetechnologicalproblembeingconsideredwhenmoreconventionalsolutionshavefailed.Wehopethatthispamphletwill,initsownway,provokearadicalchangeintheunderstandingoftherolethatgovernmentcanplayineconomicpolicy.Wehopetosparkaconversationaboutwhatthestatecandotouseitspowertospecifytheproblemsitwishestosolvethroughtechnologicaladvanceandinnovation,therebyensuringthatthoseadvancesareabletotakeplace. 15Insummary,wesaywewantamoreentrepreneurialeconomy.Thatdoesn’tnecessarilyrequirethestatetowithdraw,buttolead.KittyUssherDirectorofDemosJune2011 17IntroductionandsummaryAcrosstheglobewearehearingthatthestatehastobecutbackinordertofosterapost-crisisrecovery,unleashingthepowerofentrepreneurshipandinnovationintheprivatesector.Thisfeedsaperceivedcontrastthatisrepeatedlydrawnbythemedia,businessandlibertarianpoliticiansofadynamic,innovative,competitiveprivatesectorversusasluggish,bureaucratic,inertial,‘meddling’publicsector.Somuchsothatitisvirtuallyacceptedbythepublicasa‘commonsense’truth.Forexample,inhisbudgetspeechofJune2010,amonthaftertakingoffice,theChancellor,GeorgeOsborne,statedthatthepublicsectorwas‘crowdingout’theprivatesector,providinganadditionaljustificationbeyondtheneedtoreducethedeficit,forarelativecontractionofthestate.Bothinthedocumentationthatsupportedthatemergencybudget,andsubsequently,theCoalitionGovernmenthasrepeatedlycalledforamore‘balanced’economy,withprivateactivitytakingupagreatershareofthetotalthanhaspreviouslybeenthecase.ThePrimeMinister,DavidCameron,adoptedamorepolemictoneinaspeechgiventotheCardiffSpringForuminMarch2011whenhepromisedtotakeonthe‘enemiesofenterprise’workingingovernment,whichhedefinedasthe‘bureaucratsingovernmentdepartments’.2ThisisarhetoricthatfitswiththeGovernment’sbroaderthemeoftheBigSociety,whereresponsibilityforthedeliveryofpublicservicesisshiftedawayfromthestatetoindividualsoperatingeitherontheirownorbycomingtogetherthroughthethirdsector.AnditisnotaviewthatisuniquetotheUKGovernment.TheEconomist,whichoftenreferstogovernmentasaHobbesianLeviathan,3recentlyarguedthatgovernmentshouldtakethebackseatandfocusoncreatingfreermarketsandcreating Introductionandsummarytherightconditionsfornewideastoprosper,ratherthantakingamoreactivistapproach.4Theestablishedbusinesslobbygroupshavelongarguedforfreedomfromthelongarmofthestate,whichtheyseeasstiflingtheirabilitytosucceedthroughtheimpositionofemployeerights,taxandregulation.Theright-wingAdamSmithInstitutearguesthatthenumberofregulatorsintheUKshouldbereducedtoenabletheBritisheconomyto‘experienceaburstofinnovationandgrowth’.5IntheUSA,supportersoftheTeaPartymovementareunitedbyadesiretolimitstatebudgetsandpromotefreemarkets.Whilebusinessasawholemaynotseethevirtuesofanythingthatdoesnothaveaclearandpositiveimpactonitsbottomline,andnorarguablyshouldit,thereisadangerwhenageneraldesiretoreducethesizeofthestatetranslatesintoweakandnon-ambitiouseconomicpolicy.Whenthathappens,wearealllosers:policyisnotaseffectiveasitcouldbeandthepotentialtocreategreaterprosperityisnotfulfilled.Thispamphletarguesthatthereisarealdangerofthathappeninginthefieldofinnovationpolicy,greatlylimitingitsimpactoneconomicgrowth.Theviewofthecurrentgovernment—sharedbyitspredecessor—isthattheroleofthestateinspurringinnovationissimplytoprovidethe‘conditionsforinnovationtoflourish’.6TheUKGovernmentstatesthatifitinvestsinskillsandastrongsciencebase,ensuresastronglegalframeworkwithinanamenablemacroeconomy,andsupportsentrepreneurialclusters,thenthemarketwilldotherestthroughtheincentiveoftheprofitmotive.Theevidencepresentedinthispamphletchallengesthisminimalistviewofthestateinthefieldofeconomicpolicy,arguingthatafarmoreproactiveroleisrequired.Thecasethatismadeinthesepagesisthattheroleofthegovernment,inthemostsuccessfuleconomies,hasgonewaybeyondcreatingtherightinfrastructureandsettingtherules.Itisaleadingagentinachievingthetypeofinnovativebreakthroughsthatallowcompanies,andeconomies,togrow,notjustbycreatingthe‘conditions’thatenableinnovation.Ratherthestatecanproactivelycreatestrategyaroundanew 19highgrowthareabeforethepotentialisunderstoodbythebusinesscommunity(fromtheinternettonanotechnology),fundingthemostuncertainphaseoftheresearchthattheprivatesectoristoorisk-aversetoengagewith,seekingandcommissioningfurtherdevelopments,andoftenevenoverseeingthecommercialisationprocess..Inthissenseithasplayedanimportantentrepreneurialrole.Ofcoursethereareplentyofexamplesofprivatesectorentrepreneurialactivity,fromtheroleofyoungnewcompaniesinprovidingthedynamismbehindnewsectors(egGoogle),totheimportantsourceoffundingfromprivatesourceslikeventurecapital.Butthisistheonlystorythatisusuallytold.SiliconValleyandtheemergenceofthebiotechindustryareusuallyattributedtothegeniusesbehindthesmallhightechfirmslikeFacebookortheplethoraofsmallbiotechcompaniesinBostonorCambridgeintheUK.Europe’s‘lag’behindtheUSAisoftenattributedtoitsweakventurecapitalsector.ExamplesfromthesehightechsectorsintheUSAareoftenusedtoarguewhyweneedlessstateandmoremarket:toallowEuropetoproduceitsownGoogles.ButhowmanypeopleknowthatthealgorithmthatledtoGoogle’ssuccesswasfundedbyapublicsectorNationalScienceFoundationgrant?7Orthatmolecularantibodies,whichprovidedthefoundationforbiotechnologybeforeventurecapitalmovedintothesector,werediscoveredinpublicMedicalResearchCouncil(MRC)labsintheUK?OrthatmanyofthemostinnovativeyoungcompaniesintheUSAwerefundednotbyprivateventurecapitalbutbypublicventurecapitalsuchasthroughtheSmallBusinessInnovationResearch(SBIR)programme?Lessonsfromtheseexperiencesareimportant.Theyforcethedebatetogobeyondtheroleofthestateinstimulatingdemand,ortheroleofthestatein‘pickingwinners’inindustrialpolicy,wheretaxpayers’moneyispotentiallymisdirectedtobadlymanagedfirmsinthenameofprogress,distortingincentivesasitgoesalong.Insteaditisacaseforatargeted,proactive,entrepreneurialstate,abletotakerisks,creatingahighlynetworkedsystemofactorsharnessingthe Introductionandsummarybestoftheprivatesectorforthenationalgoodoveramedium-tolong-termhorizon.Itisthestateascatalyst,andleadinvestor,sparkingtheinitialreactioninanetworkthatwillthencauseknowledgetospread.Thestateascreatoroftheknowledgeeconomy.Itcannotbecalled‘new’industrialpolicybecauseitisinfactwhathashappened,thoughina‘hiddenway’topreventabacklash,overthelastthreedecadesinthedevelopmentofthecomputerindustry,theinternet,thepharma–biotechindustry,andmanymoreincludingtoday’snanotechindustry.8Noneofthesetechnologicalrevolutionswouldhaveoccurredwithouttheleadingroleofthestate.Itisaboutadmittingthatinmanycases,ithasinfactbeenthestate,nottheprivatesector,thathashadthevisionforstrategicchange,daringtothink—againstallodds—aboutthe‘impossible’,creatinganewtechnologicalopportunity,makingthelargenecessaryinvestments,andenablingadecentralisednetworkofactorstoenabletheriskyresearch,andtoallowthedevelopmentandcommercialisationprocesstooccurinadynamicway.Thispamphletdrawstogetherrecentacademicliteraturetomakenewpolicyconclusions.IndoingsoitpresentsaverytimelycontributiontothedebatearounddeficitreductionintheUKandelsewhere.Andinpassing,itconfrontshead-onsomeissuesthathavecometobetakenforgrantedbymainstreampolicymakers,suchastheusefulnessofdataonpatentingandR&Dexpenditureasproxiesforwealth-creatinginnovation.Thepartplayedbythesmallfirmincreatinggrowthisalsoputunderscrutinyasistheroleofventurecapital.Thisisnotapamphletaboutinnovationpolicy.Manythemesonthatgeneraltopicaremissinghere:theskillsgap,diffusionofexistinginnovations,procurementanddeployment.Itisabouttheentrepreneurialrolethatthestatehasplayedindifferentinnovationcontexts,leadingratherthanfollowing.Thinkingoutofthebox,definingnewradicaltechnologiesandtheassociatederas(theknowledgeeconomy),ratherthanjustreactingtothem.Understandingthislessonforcesustorethinkwhatthestatebringsto 21theecologyofthebusiness-governmentpartnershipssodiscussedtoday.Themaintaskistounpacktheroleofthestateinfosteringradicalgrowth-enhancinginnovations,andsotomakerecommendationsthatwouldnotonlyimprovetheeffectivenessofeconomicpolicybutalsoensurethatthelimitedtaxpayers’moneythatisavailableismoreeffectivelyspent.Thefearisthatwithoutunderstandingtheproactiverolerequiredofgovernmentforaneffectiveeconomicpolicy,theUKeconomywillfailtoachieveitspotentialatpreciselythetimewheneconomicdynamismismostnecessary.Thereportisstructuredasfollows.Chapter1setsthescenebysummarisingtheacademicframeworkregardingthedebatearoundgrowth;whereasagenerationago,technologicaladvancewasseenassomethingthatwasexternallygiven,thereisnowextensiveliteraturetoshowthatactuallyitistherate,anddirection,ofinnovationthatdrivestheabilityforeconomiestogrow.Thisprovidesthejustificationforincreasedfocusontherolethatgovernmentcanplaytofacilitatepreciselythatinnovation,whileatthesametimeexplodingsomeofthemythsthataboundinWestminster,theEuropeanCommissionandWashingtonaboutwhatactuallydrivesinnovationandgrowth.Specifically,itdrawsonrecentacademicliteraturetoshowthattargetingresourcestowardsR&Dspend,patentingorsmallfirmsinisolationmissesthepointandthatsimilarlywaitingforventurecapitaltodoalltheheavyliftingislikelytobefutile.Chapter2describestheimportanceofthegovernment’sroleininvestingwheretheprivatesectorwillnot,inthemostuncertainriskyareas.Butratherthanunderstandingthisthroughtheusuallensof‘marketfailures’,theconceptofentrepreneurialrisk-takingisintroduced.Thepublicsectorhasindeedfulfilledanimportantroleinundertakingthemostriskyresearch,evenwhenthatresearchwasnot‘basic’.Privatesectorexamplesareprovidedfromthepharmaceuticalandbiotechindustrieswhereithasbeenthestate,nottheprivatesector,thathascreatedeconomicdynamism.Riskyresearch Introductionandsummaryisfundedbythepubliclyfundedlabs(theNationalInstitutesofHealthortheMRC)whileprivatepharmafocusesonlessinnovative‘metoodrugs’andprivateventurecapitalistsenteronlyoncetherealriskhasbeenabsorbedbythestate.Andyetmakeallthemoney.Inindustrieswithsuchlongtimehorizonsandcomplextechnologies,itisarguedthatreturn-hungryventurecapitalcaninfactsometimesbemoredamagingthanhelpfultotheabilityofthesectortoproducevaluablenewproducts.Chapter3arguesthatitisonlybycreatingaso-callednationalsystemofinnovationbuiltonsharingknowledgethatthenecessary,ifnotsufficient,conditionsstarttobeestablished.AnexampleisdrawnbycomparingandcontrastingthetwoexamplesofJapanandtheSovietUnion.Itthendevelopstheconceptoftheentrepreneurialstatewherenotonlyisthereafullyfunctioningnationalsystemofinnovation,butthissystemiscatalysedbyproactive,flexible,decentralisedactiononthepartofgovernment.Chapter4examinesaspectsoftherecentindustrialpolicyhistoryoftheUSA,andshowsthatdespitecommonperceptions,theUSstatehasbeenextremelyproactiveandentrepreneurialinthedevelopmentandcommercialisationofnewtechnologies.Fourexamples—theDefenseAdvancedResearchProjectsAgency(DARPA),SmallBusinessInnovationResearch(SBIR),orphandrugsandrecentdevelopmentsinnanotechnology—areusedtoillustratethispoint.Chapter5providessomereflectionsthatarerelevanttothesituationfacedbytheUKatthemoment,withpolicyrecommendationsforthedevelopmentofgreentechnology,andtechnology,generally.Greentechnologyhasthepotentialtobecomethenexttechnologicalrevolution,butasnoothertechnologicalrevolutionhassimplybeen‘nudged’bythestate,itisunrealisticthatthisonecanbewithoutthetypeoflargescale(thoughdecentralised)investmentsthathavebeenmadeinthecaseofotherimportantnewtechnologies.Andfinally,chapter6concludeswithsomereflectionsontheimplicationsoftheconceptoftheentrepreneurialstateforthedebatearoundfairnessanddistribution. 23Takentogether,thepamphletpaintsafullerunderstandingofthepublicsector’scentralitytorisk-takingandradicalgrowthfosteringtechnologicalchange.Itbuildsaverydifferentpictureofthestatefromthatenvisagedbypresenteconomicpolicy,whichdeniesitanyleadingroleininnovationandproduction,andthatofconventionalindustrialpolicy,whichundulydownplaysitsscopeforpioneeringandpromotingnewtechnologies.Incontrast,itdescribesscenarioswherethestatehasprovidedthemainsourceofdynamismandinnovationinadvancedindustrialeconomies,pointingoutthatthepublicsectorhasbeentheleadplayerinwhatisoftenreferredtoasthe‘knowledgeeconomy’—aneconomydrivenbytechnologicalchangeandknowledgeproductionanddiffusion.Indeed,fromthedevelopmentofaviation,nuclearenergy,computers,theinternet,thebiotechnologyrevolution,nanotechnologyandevennowingreentechnology,itis,andhasbeen,thestatenottheprivatesectorthathaskick-startedanddevelopedtheengineofgrowth,becauseofitswillingnesstotakeriskinareaswheretheprivatesectorhasbeentoorisk-averse.Inapolicyenvironmentwherethefrontiersofthestatearenowbeingdeliberatelyrolledback,thatprocessneedsmorethanevertobeunderstoodsothatitcansuccessfullybereplicated.Otherwisewemissanopportunitytobuildgreaterprosperityinthefuture. 25RecommendationsThisisasummaryofthemainrecommendations:•Reducegovernmentspendingondirecttransferstosmallfirms,suchassmallbusinessratesreliefandinheritancetaxrelief.Thisisacostsaving.•IftheSmallBusinessResearchInitiative(SBRI)isenhanced,asthegovernmenthasindicated,itmustbedoneinawaythatfocusesonhowtogetSMEstospendmoneyonnewtechnologies.Todoso,itwillneedtoincreasethesizeoftheprojectfinancingthatitadministers(toodilutedcurrently),andconcentrateonfirmsthatprovetheywillspendoninnovation.Thisiscostneutral.•AbandoninitiativestoestablishaUKpatentbox(apreferentialtaxregimeforprofitsarisingfrompatents),whichwouldnotincreaseinnovationandaccordingtotheInstituteforFiscalStudieswouldintimeleadtogreatertaxpayercosts.Thisisacostsaving.•ReviewR&Dtaxcreditswithaviewtoensuringthatfirmsareheldaccountableforactuallyspendingthemoneyoninnovation,andfailingthat,shiftawayfromblanketR&Dtaxcreditstofreeupresourcestowardsdirectcommissioningofthetechnologicaladvanceinquestion.Thisisapotentialcostsaving.•Enterprisezones,thatgiveregulatoryortaxationadvantagestofirmsinacertainarea,areadistractionastheydonotcauseinnovationtohappenthatwouldnothavetakenplaceelsewhere.Besttousethemoneyinotherways.Thisisacostsaving.•Whensuccessful,apartofthereturnfrominvestmentsmadewithsignificantpublicsupportshouldbereturnedtogovernment.Thisisapotentialcostsaving. Recommendations•Usethesefreed-upresourcestoengageinamassiveexpansionoftheTechnologyStrategyBoard,structuredinlinewiththemodeloftheUSDARPAtodirectlyenableinnovation(research,developmentandcommercialisation)throughabottom-upgovernment-directednetworkofagencies,inlinewithrecommendationsoftheConfederationofBritishIndustry(CBI)in2006.9Italsorequiresmoretransparencyaboutfundingdecisionsandclearerauditingofperformancesothatfailingperformanceareasarecutoff.Thiswouldincreaseexpenditure.•Adoptamoreproactiveinterventionistapproachtogreentechnologyinnovation,drawingontheUK’sspecificstrengths.Thiswouldincreaseexpenditure.•Thetimeanyprivateequity investmentmustbeheldbefore thegainsfromsalecanbeexemptfromcapitalgainstax,shouldberaisedintheUKtoatleastfiveyears(currentlyonlytwo,previouslytenin2002).Thiswouldhelppreventthe‘takethemoneyandrun’ingreentech,whichhascharacterisedinvestmentsinbiotechnologycompanies,mostofwhichremain‘product-less’.Thisisacostsaving.•Short-termismisespeciallyproblematicincontextsinwhichradicaltechnologicalchangeisneededandthereasonwhyventurecapitalandotherformsofprivateequityarenotplayingaleadingroleingreentechnology.Giventhelackofprivateinvestments,theUKgovernmentshouldstepupandincreaseits‘green’budget.TheGreenInvestmentBankisnotenough.Thiswouldincreaseexpenditure. 27 291FrominvisiblehandtomodernmythsTheviewofthecurrentUKGovernmentregardingitsroleinstimulatinginnovationistocreateanenvironmentwheretheprivatesectorcanflourish.AgrowthreviewbytheDepartmentforBusiness,InnovationandSkills(BIS)andHMTreasurysaiditisto‘providetheconditionsforprivatesectorgrowthandinvestment’.10ThecoreoftheBISandTreasuryplanoutlinesthewaythatgovernmentmustbelimited,reducingredtapeandbureaucracysotheprivatesectorcangetonwithwhatitdoesbest:investing,innovating,employing:AnewapproachtogrowthrequiresanewattitudeinGovernment.Governmentonitsowncannotcreategrowth.Itisthedecisionsofbusinessleaders,entrepreneursandindividualworkerswhichbuildoureconomy.WhattheGovernmentcandoisprovidetheconditionsforsuccesstopromoteaneweconomicdynamism—harnessingoureconomicstrengths,removingthebarrierswhichpreventmarketsfromsupportingenterprise,andputtingtheprivatesectorfirstwhenmakingdecisionsontax,regulationandspending.11InaspecialreportontheworldeconomyTheEconomiststated:Asmartinnovationagenda,inshort,wouldbequitedifferentfromtheonethatmostrichgovernmentsseemtofavour.Itwouldbemoreaboutfreeingmarketsandlessaboutpickingwinners;moreaboutcreatingtherightconditionsforbrightideastoemergeandlessaboutpromiseslikegreenjobs.Butpursuingthatkindofpolicyrequirescourageandvision—andmostofthericheconomiesarenotdisplayingenoughofeither.12 FrominvisiblehandtomodernmythsThisviewisalsoespousedbysome‘progressive’academics,whoarguethatthestateislimitedto:Creationoftheconditionsforinnovation…acceptingthatthestatewillhaveavitalroleinensuringthatmarketconditionsreachthe‘justright’balancewhichwillspurinnovationandthatadequateinvestmentisavailableforinnovators.13Thisistheviewthatjustifieslittlemoreofgovernmentthancorrectingmarketfailures—throughinvestmentinbasicscience,educationandinfrastructure,forexample.Thisisnotanewdebate,butitisonethatbenefitsfromagreaterunderstandingoftheacademicliteratureontheroleofinnovationincreatingeconomicgrowth.Morethan250yearsago,whendiscussinghisnotionofthe‘InvisibleHand’AdamSmitharguedthatcapitalistmarketsleftontheirownwouldself-regulate,withthestate’srolebeinglimitedtothatofcreatingbasicinfrastructure(schools,hospitals,motorways)andmakingsurethatprivateproperty,andotherinstitutionssuchas‘trust’,werenurturedandprotected.14Hisbackgroundinpoliticsandphilosophymeantthathiswritingsweremuchmoreprofoundthanthesimplelibertarianeconomicspositionforwhichheisusuallyacknowledged,butthereisnoescapingthathebelievedthatthemagicofcapitalismconsistedintheabilityofthemarkettoorganiseproductionanddistributionwithoutcoercionbythestate.KarlPolanyi,theacclaimedsociologistofcapitalism,hasinsteadshownhowthenotionofthemarketasself-regulatingisamythfromthehistoricalbeginningofmarkets:‘Theroadtothefreemarketwasopenedandkeptopenbyanenormousincreaseincontinuous,centrallyorganizedandcontrolledinterventionism.’15Inthisview,itwasthestatewhichimposedtheemergenceofthemarket.JohnMaynardKeynesbelievedthatcapitalistmarkets,regardlessoftheirorigin,needconstantregulationbecauseoftheinherentinstabilityofcapitalismwhereprivatebusinessinvestment(oneofthefourcategoriesofspendinginGDP)isextremelyvolatile.Thereasonitissovolatileisthatfarfrom 31beingasimplefunctionofinterestratesortaxes,16itissubjectto‘animalspirits’—thegutinstinctofinvestorsaboutfuturegrowthprospectsinaneconomyorspecificsector.17Inhisviewthisuncertaintycreatesconstantperiodsofunderinvestment,oroverinvestment,causingsevereeconomicfluctuationsduetothemultipliereffect(wherebyanincreaseorfallinspendingispropagatedthroughouttheeconomybysubsequentroundsofthefallorincrease).Unlessregulatedbyincreasedgovernmentspending,fallsinspendingcanleadtotheemergenceofdepressions,afactoflifebeforeKeynes’ideasfoundtheirwayintopost-SecondWorldWareconomicpolicies.Morerecently,HymanMinskyfocusedonthefinancialfragilityofcapitalism,thewaythatfinancialmarketscauseperiodiccrisestooccurduetocyclesofexpansion,exaggeratedexpectationsandcreditformation,followedbyretraction,causingbubblestoburstandassetpricestocollapse.Hetoobelievedthatthestatehadacrucialroleinpreventingthisviciouscyclefromhappening,andforgrowthtofollowamorestablepath.18KeynesandMinskyfocusedontheneedforthestatetointerveneinordertobringstabilityandpreventcrises,certainlyapressingissueintoday’scircumstances.Thepamphletfocusesontheroleofthestateinallowingprivateandpublicorganisationstointeractinsuchawaythatnewknowledgeisproducedanddiffusedthroughouttheeconomytoallowstructuralchangeandgrowth.Buttounderstandthedynamicsofsuchinvestmentsitisfundamentalfirsttobetterunderstanddifferentperspectivesonthetheoryofeconomicgrowth,andtheroleoftechnologyandinnovationinthisprocess.Wheredoesgrowthcomefrom?WhilegrowthandthewealthofnationshasbeentheleadconcernofeconomistssinceAdamSmith,inthe1950sitwasshownbyMosesAbramovitzandRobertSolowthatconventionalmeasuresofcapitalandlabourinputscouldnotaccountfor90percentofeconomicgrowthinanadvancedindustrialisedcountrysuchastheUnitedStates.19 FrominvisiblehandtomodernmythsItwasassumedthattheunexplainedresidualmustreflectproductivitygrowth,ratherthanthequantityoffactorsofproduction.Andstilltodaythereisimmensedebateamongeconomistsoverwhichfactorsaremostimportantinproducinggrowth.Thisdebateisreflectedinpoliticswheredifferentviewsaboutgrowthareespousedwithgreatvehemence,oftenignorantoftheunderlyingtheoreticalassumptionsandorigins,sowellputbyKeynes:Theideasofeconomistsandpoliticalphilosophers,bothwhentheyarerightandwhentheyarewrong,aremorepowerfulthaniscommonlyunderstood.Indeedtheworldisruledbylittleelse.Practicalmen,whobelievethemselvestobequiteexemptfromanyintellectualinfluence,areusuallytheslavesofsomedefuncteconomist.Madmeninauthority,whohearvoicesintheair,aredistillingtheirfrenzyfromsomeacademicscribblerofafewyearsback.Iamsurethatthepowerofvestedinterestsisvastlyexaggeratedcomparedwiththegradualencroachmentofideas.20Foryears,economistshavetriedtomodelgrowth.NeoclassicaleconomicsdevelopeditsfirstgrowthmodelintheworkofHarrodandDomar,butitwasRobertSolowwhowontheNobelPrizeforhisgrowth‘theory’.IntheSolowgrowthmodel,growthismodelledthroughaproductionfunctionwhereoutput(Y)isafunctionofthequantityofphysicalcapital(K)andhumanlabour(L),ceterisparibus—otherthingsremainingequal.Whatotherthings?Technologicalchange.Y=F(K,L)Changesinthesetwoinputscausechangesalongthefunctionwhereasupwardordownwardshiftsinthefunctionwouldbecausedbytechnologicalchange.WhenSolowdiscoveredthat90percentofvariationinoutputwasnotexplainedbycapitalandlabour,hecalledtheresidual‘technicalchange’.21 33Whatperhapsshouldhavehappenedatthispointisthatiftheunderlyingmodelisfoundtobesodeficientthatitcannotexplain90percentofthedependentvariablethatitismeanttoexplain,anewmodelshouldhavebeendeveloped.Thiswasindeedwhatmany,suchasJoanRobinson,hadbeenarguingfordecades,highlycriticaloftheproductionfunctionframework.22Insteadtechnicalchangewasaddedin.Solow’stheorybecameknownas‘exogenousgrowththeory’becausethevariablefortechnologywasinsertedexogenously,asatimetrendA(t)(similartopopulationgrowth):Y=A(t)F(K,L)Aseconomistsbecamemoreandmoreawareofthecrucialrolethattechnologyplaysineconomicgrowth,itbecamenecessarytothinkmoreseriouslyabouthowtoincludetechnologyingrowthmodels.Thisgaveriseto‘endogenous’or‘newgrowth’theory,whichmodelledtechnologyastheendogenousoutcomeofanR&Dinvestmentfunction,andasinvestmentinhumancapitalformation.23RatherthanassumingconstantordiminishingmarginalreturnsasintheSolowmodel(everyextraunitofcapitalemployedearnedasmallerreturn),theadditionofhumancapitalandtechnologyintroducedincreasingreturnstoscale,theengineofgrowth.Increasingreturns,whicharisefromdifferenttypesofdynamicbehaviourlikelearningbydoing,canhelpexplainwhycertainfirmsorcountriespersistentlyoutperformothers—thereisno‘catch-up’effect.Althoughnewgrowththeoryprovidedarationalargumentforgovernmentinvestmentitdidnotleadtoitexplicitly.Thisisbecauseinthisframeworkitwasideasthatwereendogenousnottheinstitutionalframeworkrequiredtotransformideasintoproducts.Nevertheless,theincreasingemphasisontherelationshipbetweentechnicalchangeandgrowthindirectlyledgovernmentpoliciestofocusontheimportanceofinvestmentsintechnologyandhumancapitaltofostergrowth,leadingtoinnovation-ledgrowthpoliciesintheknowledgeeconomy,atermusedtodenotethegreater Frominvisiblehandtomodernmythsimportanceinthecompetitionprocessofinvestinginknowledgecreation.24StudiesthatshowedadirectrelationshipbetweenthemarketvalueoffirmsandtheirinnovationperformancemeasuredbyR&Dspendingandpatentssupportedthesepolicies.25Atthesametime,therewasanemergingfieldcalledEvolutionaryEconomics.Intheirground-breakingAnEvolutionaryTheoryofEconomicChange,NelsonandWinterarguedthatinfacttheproductionfunctionframework(exogenousorendogenous)wasthewrongonetousetounderstandtechnologicalchange.Itarguedforan‘evolutionarytheory’ofproduction(andeconomicchange),whichdelvedinsidethe‘blackbox’oftheproductionfunctiontounderstandhowinnovationtakesplaceanditseffectongrowth.26Inthisapproach,thereisno‘representativeagent’butratheraconstantprocessofdifferentiationamongfirms,basedontheirdifferentabilitiestoinnovatebecauseofdifferentinternalroutinesandcompetencies.Competitioninthisperspectiveisabouttheco-evolutionofthoseprocessesthatcreateconstantdifferencesbetweenfirmsandtheprocessesofcompetitiveselectionthatwinnowinonthosedifferences,allowingonlysomefirmstosurviveandgrow.Inthiscontext,sinceinnovationisfirm-specific,andhighlyuncertain,thetypesofpoliciesthatemergeforsupportinginnovationaredifferentfromthosethatemergefromatheoreticalapparatusthatassumesawaytheheterogeneityanduncertainty,aswillbediscussedinchapter3,whenweconsidernationalsystemsofinnovation.R&DtargetsThefactthateconomicswasputtingsomuchemphasisoninnovationinthegrowthprocesscausedpolicymakers,sincethe1980s,tobeginpayingmuchmoreattentiontovariableslikeresearchanddevelopment(R&D)andpatents,asapredicatorofinnovationandthereforeofeconomicgrowth.27Forexample,theEuropeanUnion’sLisbonAgenda(2000)anditscurrentEurope2020strategy28setatargetfor3percentof 35theEU’sGDPtobeinvestedinR&D,alongwithpoliciesthattrytoencouragetheflowofknowledgebetweenuniversitiesandbusiness,thecreationofcreditandventurecapitalforSMEs,andotherfactorsidentifiedasimportantforinnovation-ledgrowth.29UKpolicyhasalsoputalotofemphasisonR&D,30butascanbeseeninfigure1,from1990to2003theUKrankedbelowaveragecomparedwithothermajorEuropeancompetitorsinitsbusinessR&D(BERD)spending.ThisisnotnecessarilyaproblemasthesectorsthattheUKspecialisesin—financialservices,constructionandcreativeindustries(suchasmusic)—arenotsectorsinwhichinnovationoccursnecessarilythroughR&D.32Therearemanyindustries,especiallyintheservicesector,thatdonoR&D.Yettheseindustriesoftenemploylargenumbersofknowledgeworkers Frominvisiblehandtomodernmythstogenerate,absorbandanalyseinformation.If,allotherthingsequal,theseindustriesrepresentedasmallerproportionofGDP,itwouldbeeasierforaneconomytoreachthe3percenttarget.Butwouldtheperformanceoftheeconomybesuperiorasaresult?Itdependsonhowtheseindustriescontributetotheeconomy.Arethese‘low-tech’industriesprovidingimportantservicesthatenhancethevalue-creatingcapabilitiesofotherindustriesorthewelfareofhouseholdsasconsumers?Orarethey,asisoftenthecaseinfinancialservices,focusedonextractingvalueformtheeconomy,evenifthatprocessunderminestheconditionsforinnovationinotherindustries?33OneoftheproblemsthatsuchsimpletargetsencounteristhattheydivertattentionfromthevastdifferencesinR&Dspendingacrossindustriesandevenacrossfirmswithinanindustry.TheycanalsomasksignificantdifferencesinthecomplementarylevelsofR&Dinvestmentsbygovernmentsandbusinessesthatarerequiredtogeneratesuperioreconomicperformance.AnevengreaterproblemwithR&D-basedinnovationpoliciesisthelackofunderstandingofthecomplementaryassetsthatmustbeinplacetoallowtechnologicalinnovationstoreachthemarket,eginfrastructureorcapabilitiesaroundmarketing.Myth-busting1:R&DisnotenoughTheliteratureontheeconomicsofinnovation,fromdifferentcamps,hasoftenassumedadirectcausallinkbetweenR&Dandinnovation,andbetweeninnovationandeconomicgrowth.Yet,surprisingly,thereareveryfewstudieswhichprovethatinnovationcarriedoutbylargeorsmallfirmsactuallyincreasestheirgrowthperformance—themacromodelsoninnovationandgrowthdonotseemtohavestrongempirical‘microfoundations’.34Somecompanylevelstudieshavefoundapositiveimpactofinnovationongrowth35whileothersnosignificantimpact.36AndsomestudieshavefoundevenanegativeimpactofR&Dongrowth,whichisnotsurprising:ifthefirmsinthesampledon’thavethecomplementary 37characteristicsneeded,R&Dbecomesonlyacost.37Itisthusfundamentaltoidentifythecompanyspecificconditionsthatmustbepresenttoallowspendingoninnovationtoaffectgrowth.Theseconditionswillnodoubtdifferbetweensectors.DemirelandMazzucato,forexample,findthatinthepharmaceuticalindustry,onlythosefirmsthatpatentfiveyearsinarow(the‘persistent’patenters)andwhichengageinalliancesachieveanygrowthfromtheirR&Dspending.38InnovationpoliciesinthissectormustthustargetnotonlyR&Dbutalsoattributesoffirms.CoadandRaofoundthatonlythefastestgrowingfirmsreapbenefitsfromtheirR&Dspending(thetop6percentidentifiedinNesta’sreport‘Thevital6percent’).39AndMazzucatoandParrisfindthatthisresult,oftheimportanceofhighgrowthfirms,onlyholdsinspecificperiodsoftheindustrylife-cyclewhencompetitionisparticularlyfierce.40Myth-busting2:SmallisnotnecessarilybeautifulThisfindingthattheimpactofinnovationongrowthisindeeddifferentfordifferenttypesoffirmshasimportantimplicationsforthecommonlyheldassumptionthat‘smallfirms’matter(forgrowth,forinnovation),andhenceforthemanydifferentpoliciesthattargetSMEs.Thehypearoundsmallfirmsarisesmainlyfromtheconfusionbetweensizeandgrowth.Themostrobustevidenceisnotontheroleofsmallfirmsintheeconomybuttheroleofyounghighgrowthfirms.Nesta,forexample,claimsthatthemostimportantfirmsforUKgrowthhavebeenthesmallnumberoffastgrowingbusinessesthatbetween2002and2008generatedthehighestamountofemploymentgrowthintheUK.41Andwhilemanyhighgrowthfirmsaresmall,manysmallfirmsarenothighgrowth.Theburstsoffastgrowththatpromoteinnovationandcreateemploymentareoftenstagedbyfirmsthathaveexistedforseveralyearsandgrownincrementallyuntiltheyreachatake-offstage.ThisisamajorproblemsincesomanygovernmentpoliciesaimtotargettaxbreaksandbenefitstoSMEs,withtheaimofmakingtheeconomymoreinnovativeandproductive. FrominvisiblehandtomodernmythsAlthoughthereismuchtalkaboutsmallfirmscreatingjobs,42thisisjustamythbecausewhilebydefinitionsmallfirmswillcausejobstoincrease,infactmanysmallfirmsalsodestroyalargenumberofjobswhentheygooutofbusiness.Haltiwanger,JarminandMirandafindthatthereisindeednosystematicrelationshipbetweenfirmsizeandgrowth.43Mostoftheeffectisfromage:youngfirms(andbusinessstart-ups)contributesubstantiallytobothgrossandnetjobcreation.Productivityshouldbethefocus,andsmallfirmsareindeedoftenlessproductivethanlargefirms.Recentevidencehassuggestedthatsomeeconomiesthathavefavouredsmallfirms,suchasIndia,haveinfactbeenpunished.HsiehandKlenow,forexample,suggestthat40–60percentofthetotalfactorproductivity(TFP)differencebetweenIndiaandtheUSAisduetomisallocationofoutputtotoomanysmallandlowproductivitySMEsinIndia.44Asmostsmallstart-upfirmsfail,orareincapableofgrowingbeyondthesoleowner-operator,targetingassistancetothemthroughgrants,softloansortaxbreakswillnecessarilyinvolveahighdegreeofwaste.BloomandVanReenanarguethatsmallfirmsarelessproductivethanlargeonesbecausetheyarelesswellmanaged,andsubjecttoprovincialfamilyfavouritism.45Furthermore,smallfirmshaveloweraveragewages,fewerskilledworkers,lesstraining,fewerfringebenefitsandaremorelikelytogobankrupt.TheyarguethattheUKhasmanyfamilyfirmsandapoorrecordofmanagementincomparisonwithothercountriessuchastheUSAandGermany.46Amongotherreasons,thisisrelatedtothefactthatthetaxsystemisdistortedtogiveinheritancetaxbreakstofamilyfirms.Somehaveinterpretedtheresultthatitishighgrowthratherthansizethatmatterstomeanthatthebestthatgovernmentscandoistoprovidetheconditionsforgrowthinnovation.BloomandVanReenanarguethatinsteadofhavingtaxbreaksandbenefitstargetSMEs,thebestwaytosupportsmallfirmsisto‘ensurealevelplayingfieldbyremovingentrybarrierstofirmsofallsizes,reducingbarrierstogrowth,enforcingcompetitionpolicyandstronglyresistingthelobbyingeffortsoflargerfirmsandtheiragents’.47Butas 39wewillseeinchapters3and5,oftenthemostinnovativefirmsarepreciselythosethathavebenefittedthemostfromdirectpublicinvestmentsofdifferenttypes,makingthecasemuchmorecomplex.Myth-busting3:Venturecapitalisnotsorisk-lovingIftheroleofsmallfirmsandR&Disoverstatedbypolicymakers,asimilarhypeexistsinrelationtothepotentialforventurecapitaltocreategrowth,particularlyinknowledge-basedsectorswherecapitalintensityandtechnologicalcomplexityarehigh.Venturecapitalisatypeofprivateequitycapitalfocusedonearly-stage,high-potential,growthcompanies.ThefundingtendstocomeeitherasseedfundingoraslatergrowthfundingwheretheobjectiveistoearnahighreturnaftertheIPOofthecompanyorsale.Venturecapitalfillsavoidoffundingfornewfirms,whichoftenhavetroublegainingcreditfromtraditionalfinancialinstitutionssuchasbanksandthusoftenhavetorelyonothersortsoffundingsuchas‘businessangels’(includingfamilyandfriends),venturecapitalandprivateequity.Suchalternativefundingismostimportantfornewknowledge-basedfirmstryingtoenterexistingsectorsornewfirmstryingtoformanewsector.Riskcapitalissoscarceintheseedstagebecausethereisamuchhigherdegreeofriskinthisearlyphase,whenthetechnologicalanddemandconditionsarecompletelyuncertain.Thefallingriskinthedifferentphasesfallsdramaticallywiththeseedfinancingoccurringwhenthereisthemostuncertaintyaboutthepotentialofthenewidea(table1). FrominvisiblehandtomodernmythsTable1Riskoflossfordifferentstagesatwhichinvestmentsaremade(%)PointatwhichinvestmentmadeRiskoflossSeedstage66.2%Start-upstage53.0%Secondstage33.7%Thirdstage20.1%Bridgeorpre-publicstage20.9%Source:Pierrakis48Figure2showstheusualplacethatitisassumedthatventurecapitalwillenterthestageoftheinvention-innovationprocess.Inrealitytherealpictureismuchmorenon-linearandfulloffeedbackloops.Andmanyfirmsdieduringthetransitionbetweenanewscientificorengineeringdiscoveryanditssuccessfulcommercialtransformationandapplication.Thusthethirdphaseshowninfigure2ofcommercialviabilityisoftenreferredtoasthevalleyofdeath.Source:GhoshandNanda49 41Figure2doesnotillustratehowtimeaftertimeithasbeenpublicratherthanprivatelyfundedventurecapitalthathastakenthemostrisks.IntheUSA,governmentprogrammessuchastheSmallBusinessInnovationResearch(SBIR)programmeandtheAdvancedTechnologyProgram(ATP)intheUSDeptofCommercehaveprovided20–25percentoftotalfundingforearlystagetechnologyfirms.Thusgovernmenthasplayedaleadingrolenotonlyintheearlystageresearchillustratedinfigure2,butalsointhecommercialviabilitystage.AuerswaldandBranscombclaimthatgovernmentfundingforearlystagetechnologyfirmsisequaltothetotalinvestmentsof‘businessangels’andabouttwotoeighttimestheamountinvestedbyprivateventurecapital.50Venturecapitalfundstendtobeconcentratedinareasofhighpotentialgrowth,lowtechnologicalcomplexityandlowcapitalinvestmentsincethelatterraisesthecostsignificantly.Sincetherearesomanyfailuresinthehighriskarea,venturecapitalfundstendtohaveaportfolioofdifferentinvestmentswithonlythetailsearninghighreturns—averyskeweddistribution.Althoughmostventurecapitalfundsareusuallystructuredtohavealifeoftenyears,becauseofthemanagementfeesandthebonusesearnedforhighreturns,venturecapitalfundstendtoprefertoexitmuchearlierthantenyears,inordertoestablishatrackrecordandraiseafollow-onfund.Thiscreatesasituationwherebyventurecapitalfundsthereforehaveabiastowardsinvestinginprojectswherethecommercialviabilityisestablishedwithinathreetofiveyearperiod.51Althoughthisissometimespossible(egGoogle)itisoftennot.Andsurely,inthecaseofanemergingsectorlikebiotechorgreentechtoday,wheretheunderlyingknowledgebaseisstillinitsearlyexploratoryphase,suchashorttermbiasisdamagingtothescientificexplorationprocess,whichrequireslongertimehorizonsandmorewillingnesstoriskfailure.TheroleofUSventurecapitalthatworkedwastoprovidenotonlycommittedfinance,butalsomanagerialexpertiseandensurethebuildingofaviableorganisation.52 FrominvisiblehandtomodernmythsTheproblemhasbeennotonlythelackofventurecapitalinvestmentinthemostneededearlyseedstage,butalsoitsobjectivesintheprocess.Thishasbeenstronglyevidencedinthebiotechindustrywhereanincreasingnumberofresearchershavecriticisedthemodelofventurecapitalinscience,indicatingthatsignificantinvestorspeculationhasadetrimentaleffectontheunderlyinginnovation.53Thefactthatsomanyventure-capital-backedbiotechcompaniesendupproducingnothing,yetmakemillionsfortheventurecapitalfirmsthatsellthemonthepublicmarket,ishighlyproblematicfortheroleofventurecapitalinthedevelopmentofscienceanditseffectonthegrowthprocess.Theincreasedpresenceofpatentingandventurecapitalisnottherightoneforallowingriskyandlongterminnovationstocomeabout.PisanoinfactclaimedthatthestockmarketwasneverdesignedtodealwiththegovernancechallengesofR&Dentities.54Mirowskidescribestheventure-capital–biotechmodelas:commercializedscientificresearchintheabsenceofanyproductlines,heavilydependentuponearly-stageventurecapitalandalaterIPOlaunch,derivingfromordisplacingacademicresearch,withmergersandacquisitionsasthemostcommonterminalstate,pitchedtofacilitatetheoutsourcingofR&Dfromlargecorporationsbentuponsheddingtheirpreviousin-housecapacity.55Theproblemwiththemodelhasbeenthatthe‘progressivecommercialisationofscience’seemstobeunproductive,withfewproducts,anddamagetolong-runscientificdiscoveriesandfindingsovertime.Myth-busting4:Apatentdoesn’tnecessarilymeanprogressAsimilarmisunderstandingexistsinrelationtotheroleofpatentsininnovationandeconomicgrowth.Forexample,whenpolicymakerslookatthenumberofpatentsinthepharmaceuticalindustry,theypresumeitisoneofthemost 43innovativeprivatesectorsintheworld.Thisriseinpatentsdoesnothoweverreflectariseininnovation,butachangeinpatentlawsandariseinthestrategicreasonswhypatentsarebeingused.Thishascausedtheirimportancetobegreatlyhypedup—mythologised.Theexponentialriseinpatents,andtheincreasinglackofrelationshipthisrisehashadwithactual‘innovation’(egnewproductsandprocesses),hasoccurredforvariousreasons.First,thetypesofinventionsthatcanbepatentedhaswidenedtoincludepubliclyfundedresearch,upstreamresearchtools(ratherthanonlyfinalproductsandprocesses)andeven‘discoveries’(ratherthanonlyinventions)ofexistingmattersuchasgenes.The1980Bayh-DoleAct,whichallowedpubliclyfundedresearchtobepatentedratherthanremaininthepublicdomain,encouragedtheemergenceofthebiotechnologyindustryasmostofthenewbiotechcompanieswerenewspin-offsfromuniversitylabswithheavystatefunding.Furthermore,thefactthatventurecapitaloftenusespatentstosignalwhichcompaniestoinvestinmeansthatpatentshaveincreasedintheirstrategicvaluetocompaniesthatneedtoattractfinancing.Allthesefactorshavecausedthenumberofpatentstorise,withmostofthembeingoflittleworth(egveryfewcitationsreceivedfromotherpatents)andwithoutresultinginahighnumberofinnovations,egnewdrugsinpharma(figure5).Thusdirectingtoomuchattentiontopatents,ratherthantospecifictypesofpatents,suchasthosethathavehighcitations,riskswastingmuchmoney(asarguedbelowforthepatentboxcase).Researchershavearguedthatmanyoftherecenttrendsinpatents,suchastheincreaseinupstreampatents(egpatentingof‘researchtools’),hascausedtherateofinnovationtofallratherthanincreaseasitblockstheabilityofsciencetomoveforwardsinanopenexploratoryway.56Theeffecthasbeenespeciallydeleterioustotheabilityofscientistsinthedevelopingworldtorepeatexperimentscarriedoutinthedevelopedworld,beforeundertakingtheirowndevelopmentsonthoseexperiments,thushurtingtheirabilityto‘catchup’.57 FrominvisiblehandtomodernmythsNotwithstandingthefactthatmostpatentsareoflittlevalue,andthecontroversialrolethatpatentsplayininnovationdynamics,theUKGovernmentinsiststhatpatentshaveastronglinktoongoinghigh-techR&DandmustthusbeincentivisedinorderfortheUKtohaveinnovation-ledgrowth.ThusinOctober2010Osborneannouncedapatentboxpolicy,duetobeginin2013,whichwouldreducetherateofcorporationtaxontheincomederivedfrompatents(to10percent).Thisofcoursefitswiththecurrentgovernment’sbeliefthatinvestmentandinnovationcanbeeasilynudgedviataxes.TheInstituteforFiscalStudies(IFS)hasarguedagainstthispolicy,claimingthattheonlyeffectitwillhaveistoreducegovernmenttaxrevenue(byalargeamount)withoutaffectinginnovation.ItisarguedthatR&DtaxcreditsareenoughtoaddressthemarketfailureissuearoundR&D,andthatthepatentboxpolicyisinsteadpoorlytargetedatresearch,asthepolicytargetstheincomethatresultsfrompatentedtechnology,nottheresearchitself(asimilarclaimwemakearoundR&Dtaxcreditswhentheyarenotsubjecttocontrol).ArecentreportbytheIFSclaims:Onceapatentisinplace,afirmhasamonopolyontheuseofthoseideas,andsocancaptureallofthereturnsandthereforefacesthecorrectincentivestomaximisetherelatedincomestream.Inaddition,totheextentthataPatentBoxreducesthetaxrateforactivitythatwouldhaveoccurredintheabsenceofgovernmentintervention,thepolicyincludesalargedeadweightcost.58Furthermore,theauthorsclaimthatthepatentboxpolicywillalsoaddcomplexitytothetaxsystemandrequireexpensivepolicingtoensurethatincomeandcostsarebeingappropriatelyassignedtopatents.Theyclaimthatthegreatuncertaintyandtimelagsbehindcreatingpatentabletechnologieswillcounteracttheincentives,andsinceinternationalcollaborationsareincreasinglycommon,thereisnoguaranteethattheextraresearchthatisincentivisedwillbeconductedintheUK.59 45Thischaptershowsthatmanyoftheassumptionsthatunderliegrowthpolicyshouldnotnecessarilybetakenforgranted.Overthelastdecadeorso,policymakerssearchingforproxiesforeconomicgrowthhavealightedonthingstheycanmeasuresuchasR&Dspend,patents,venturecapitalactivity,andthenumberofsmallfirmsthatareassumedtobeimportantforgrowth.Wehaveattemptedtodemystifytheseassumptionsandnowturntothelargestmythofall:thelimitedroleforgovernmentinproducingentrepreneurship,innovationandgrowth. 472BeyondmarketfailuresInresponsetothe2007/08financialcrisis,fiscalconsolidationisoccurringinnationaleconomiesacrosstheglobe.These‘cuts’havetwocorestatedobjectives.Thefirstobjective,mostcommonlyheardinthemedia,istoreducethefiscaldeficit.Thisisseenasadangertotheeconomy,puttingatriskthereputationofnationalbonds,givingrisetoincreasesininterestrates,whichthensetoffadownwardspiraloffallinginvestment,employmentandconsumption.Itisalsoseenasunfairtofuturegenerations,whichwillbeforcedtopayhighratesofinterestfortheirresponsibilityofthecurrentgeneration.Thesecondobjectiveisaboutmakingtheeconomymorecompetitive,entrepreneurialandinnovative.Theideaisthatwhilegovernmentspendingmaybeneededtoprovidebasicinfrastructure(schools,hospitals,roads)and—forKeynesians—tostabiliseGDP,bycuttingbackonpublicsectorspendingtheprivatesectorcan‘stepin’andallowtheeconomytotakeoff.Thisisnotjustbecausegovernmentspendingsupposedly‘crowdsout’thesavingsthatcanfundprivatesectorspending(aconceptwithlittlefoundationwhenaneconomyisgrowing),60butalsobecauseprivatesectorinvestmentisassumedtoleadtoamoreefficient,dynamicandinnovativeeconomy.Theassumptionisthatprivatecompaniesareinherentlymoreproductivethanstate-runinitiatives.Soexpandingtheformeranddownsizingthelatterwillmaketheeconomymoreproductiveandcompetitive.Thefiscaldeficitwillfallasaresultofthesmallersizeofthestate,butalsobecauseofthehighertaxreceiptsthatfollowfromtheensuinggrowth,evenwhereratesoftaxareloweredtopromotecompetitiveness. BeyondmarketfailuresInthisrespecttheBigSocietyprogrammeoftheUK’sCoalitionGovernmentisbasedontheideathatthestateshouldbemadesmallernotonlytoreducethedeficitbutbecauseitspresenceintheeconomyimpedesinnovationanddynamism.Byallowinglocalcommunitiestohavemorecontroloftheirresourcesanddecisions,freefromtheheavyhandofbiggovernment,initiativesundertheBigSocietyprogramme,forexamplefreeschools,whicharerunbylocalparentsandself-helpgroups,willleadtohigherquality,moredynamismandmorechoice.Schoolswillbecomemore‘innovative’.Withoutthisassumption,theBigSocietyisonlyaboutcuts,somethingthegovernmenthasinsisteditisnot.Therhetoricalassumptionbehindallofthisisthattheroleofthestateisnegativeratherthanpositive.Itdepictsthestateaslessproductive(bydefinition)thantheprivate—orvoluntary—sector.Thispamphletshowsthatthereisanalternativeinterpretationoftheroleofthestate,atleastininnovationpolicy,thathotlycontestssuchaview.Inthissectionweexploretheroleofthestatetopushforwardtheboundariesoftechnologicaladvancethroughinvestmentinbasicscience.Althoughlesscontested—theCoalitionGovernment’s2010spendingreviewprotectedthe£4.6billionsciencebudgetatleastincashterms—itshowsthatmanyoftheinnovationsthatwepresumetobeatributetothedynamismofthemarketareactuallytheproductofpublicsectorchoices.Thedebateaboutwhattypeofresearchisbestconductedbythepublicorprivatesectortendstocomedowntoadiscussionofthelongtimehorizonsnecessary(egfor‘basic’research)andthepublicgoodnatureoftheinvestmentinquestion(makingitdifficultforbusinessestoappropriatereturns),providingtherationaleforpublicsectorfunding.61Thisistheclassicmarketfailureargument.Whatislessunderstoodisthefactthatoftenpublicsectorfundingendsupdoingmuchmorethanfixingmarketfailures.BybeingmorewillingtoengageintheworldofKnightianuncertainty,investinginearlystagedevelopments,forexampledreamingupthepossibilityoftheinternetornanotechwhenthe 49termsdidnotevenexist,itinfactcreatesnewproductsandrelatedmarkets.Itleadsthegrowthprocessratherthanjustincentivisingorstabilisingit.Whattypeofrisk?Entrepreneurship,likegrowth,isoneoftheleastunderstoodtopicsineconomics.Whatisit?AccordingtotheAustrianeconomistJosephSchumpeter,anentrepreneurisaperson,orgroupofpeople,whoiswillingandabletoconvertanewideaorinventionintoasuccessfulinnovation.Itisnotjustaboutsettingupanewbusiness(themorecommondefinition),butdoingsoinawaythatproducesanewproduct,oranewprocess,oranewmarketforanexistingproductorprocess.Entrepreneurship,hewrote,employs‘thegaleofcreativedestruction’toreplaceinwholeorinpartinferiorinnovationsacrossmarketsandindustries,simultaneouslycreatingnewproductsincludingnewbusinessmodels,andinsodoingdestroyingtheleadoftheincumbents.62Inthisway,creativedestructionislargelyresponsibleforthedynamismofindustriesandlong-runeconomicgrowth.Eachmajornewtechnologyleadstocreativedestruction:thesteamengine,therailway,electricity,electronics,thecar,thecomputer,theinternethavealldestroyedasmuchastheyhavecreatedbutledtoincreasedwealthoverall.ForFrankHKnightandPeterDruckerentrepreneurshipisabouttakingrisk.63Thebehaviouroftheentrepreneuristhatofapersonwillingtoputhisorhercareerandfinancialsecurityonthelineandtakerisksinthenameofanidea,spendingmuchtimeaswellascapitalonanuncertainventure.Infact,entrepreneurialrisk-taking,liketechnologicalchange,isnotjustrisky,itishighly‘uncertain’.Knightdistinguishedriskfromuncertaintyinthefollowingway:Thepracticaldifferencebetweenthetwocategories,riskanduncertainty,isthatintheformerthedistributionoftheoutcome Beyondmarketfailuresinagroupofinstancesisknown…Whileinthecaseofuncertaintythatisnottrue,thereasonbeingingeneralthatitisimpossibletoformagroupofinstances,becausethesituationdealtwithisinahighdegreeunique.64JohnMaynardKeynesalsoemphasisedthesedifferences:By‘uncertain’knowledge,letmeexplain,Idonotmeanmerelytodistinguishwhatisknownforcertainfromwhatisonlyprobable.Thegameofrouletteisnotsubject,inthissense,touncertainty…ThesenseinwhichIamusingthetermisthatinwhichtheprospectofaEuropeanwarisuncertain,orthepriceofcopperandtherateofinteresttwentyyearshence,ortheobsolescenceofanewinvention…Aboutthesemattersthereisnoscientificbasisonwhichtoformanycalculableprobabilitywhatever.Wesimplydonotknow!65TechnologicalchangeisagoodexampleofthetrulyuniquesituationsinceR&Dinvestmentsnotonlytakeyearstomaterialiseintonewproducts,butmostleadtofailure.Inthepharmaceuticalsector,forexample,innovationtakesupto17yearsfromthebeginningofanR&Dprojecttotheend;itcostsabout$403millionperdrug;andthefailurerateisextremelyhigh:only1in10,000compoundsreachmarketapprovalphase,asuccessrateof0.01percent.Whensuccessful,oftenthesearchforoneproductleadstothediscoveryofacompletelydifferentone.Theprocessischaracterisedbyserendipity.66Thisofcoursedoesnotmeanthatinnovationisbasedonluck.Farfromit,itisbasedonlong-termstrategiesandtargetedinvestments.Butthereturnsfromthoseinvestmentsarehighlyuncertainandthuscannotbeunderstoodthroughrationaleconomictheory(aswillbeseenbelow,thisisoneofthecritiquesthatmoderndaySchumpeteriansmakeofendogenousgrowththeory,whichmodelsR&Dasagame-theoreticchoice).Furthermore,theabilityofcompaniestoengageininnovationdiffersgreatlyandisoneofthemainreasonsthatfirmsaresodifferentfromeachother,andwhyitisnearlyimpossibletofindfirmsdistributed‘normally’aroundan‘optimalsizefirm’ 51(the‘representative’agent),aconceptsodeartoneoclassicalmicroeconomictheory.Thehighriskandserendipitouscharacteristicoftheinnovationprocessisoneofthemainreasonswhyprofit-maximisingcompanieswillinvestlessinbasicresearchandmoreinappliedresearch,becauseofthegreaterandmoreimmediatereturnsfromthelatter.Investmentinbasicresearchisatypicalexampleofa‘marketfailure’wherethemarketalonewouldnotproduceenoughbasicresearchsothegovernmentmuststepin.Thisiswhytherearefewpeople,onallsidesofthepoliticalspectrum,whowouldnotagreethatitshouldbe(andis)thestatethattendstofundmostbasicresearch.FortheUSeconomy,forexample,figures3and4showthatwhilegovernmentspendingonR&Dmakesuponly26percentoftotalR&D,withtheprivatesectormakingup67percent,theproportionismuchhigherwhenbasicresearchisconsideredinisolation.Indeedpublicspendingaccountsfor57percentofbasicresearchintheUSA,withtheprivatesectortakingononly18percent.Source:NationalScienceFoundation67 BeyondmarketfailuresSource:NationalScienceFoundation68AcoredifferencebetweentheUSAandEuropeisthedegreetowhichpublicR&Dspendingisfor‘generaladvancement’ratherthanmission-oriented.MarketfailuretheoriesofR&Daremoreusefultounderstandgeneral‘advancementofknowledge’typeR&Dthanthatwhichismore‘mission-oriented’—R&Dinvestmentwhichistargetedtosupportagovernmentagencyprogramme,forexampleindefence,space,agriculture,health,energyorindustrialtechnology.AndwhilepublicR&Dspentongeneraladvancementusuallymakesuplessthan50percentoftotalR&D,in2003/04mission-orientedR&Dmadeupmorethan60percentofpublicR&DspendinginSouthKorea,theUSA,theUK,France,Canada,JapanandGermany.69Moweryarguesthattryingtocutandpastelessonslearnedfromonemission-orientedprogrammetoanotherisdangerousaseachonehasitsownspecificities(egdefencevshealth).Andforunderstandingthesedifferences,hearguestheinnovationsystemsapproach(reviewedbelow)ismuch 53moreusefulthanthemarketfailureapproach,becauseitisabletotakeintoconsiderationhoweachsectorandnationhasitsowndynamics,andhoweachmissionisdefinedbyspecificstructures,institutionsandincentives.AnotherimportantissueinthecomparisonbetweenEuropeanUnion(EU)countriesandtheUSAisthesocalledEuropeanParadox—theconjecturethatEUcountriesplayaleadingglobalroleintop-levelscientificoutput,butlagbehindintheabilitytoconvertthisstrengthintowealth-generatinginnovations.Dosi,LlerenaandLabiniprovideevidencethatthereasonforEuropeanweaknessesisnotthelackofscienceparksandinteractionbetweeneducationandindustry,asiscommonlyclaimed,butaweakersystemofscientificresearchandweakerandlessinnovativecompanies.70Policyimplicationsincludelessemphasison‘networking’andmoreonpolicymeasuresaimedtostrengthen‘frontier’researchor,putanotherway,abetterdivisionoflabourbetweenuniversitiesandcompanies,whereuniversitiesshouldfocusonhighlevelresearchandfirmsontechnologydevelopment.StateleadinginradicalinnovationAkeyreasonwhytheconceptofmarketfailureisproblematicinunderstandingtheroleofgovernmentintheinnovationprocessisthatitignoresafundamentalfactaboutthehistoryofinnovation.Notonlyhasgovernmentfundedtheriskiestresearch,whetherappliedorbasic,butithasindeedoftenbeenthesourceofthemostradical,path-breakingtypesofinnovation.Tothisextentithasactivelycreatedmarketsnotjustfixedthem.Wewillexaminethismoreindepthbelowinchapter4withexamplesoftheleadingrolethatthestateplayedfromthedevelopmentofinternettechnologytonanotechnology,butherewewillconsiderwhatitmeansforourunderstandingofthelinkbetweenR&Dandgrowth,andthepublic–privatedivide.Notallinnovationsleadtoeconomy-widegrowth.Thisisonlytruefornewproductsorprocessesthathaveanimpactonawidevarietyofsectorsintheeconomy,aswasthe Beyondmarketfailurescasewiththerisewithelectricityandcomputers.Thesearewhateconomistscallgeneralpurposetechnologies(GPTs)characterisedbythreecorequalities,pervasive,improvementandinnovationspawning:•Theyarepervasiveinthattheyspreadtomanysectors.•Theygetbetterovertimeand,hence,shouldkeeploweringthecostsofitsusers.•Makeiteasiertoinventandproducenewproductsorprocesses.RuttanarguesthatlargescaleandlongtermgovernmentinvestmenthasbeentheenginebehindalmosteveryGPTinthelastcentury.Heanalysedthedevelopmentofsixdifferenttechnologycomplexes(theUS‘massproduction’system,aviationtechnologies,spacetechnologies,informationtechnology,internettechnologiesandnuclearpower)andconcludedthatgovernmentinvestmentshavebeenimportantinbringingthesenewtechnologiesintobeing,andthatnuclearpowerwould,mostprobably,nothavebeendevelopedatallintheabsenceoflargegovernmentinvestmentsindevelopment.Ineachcaseitwasnotjustfundinginnovation,andcreatingtherightconditionsforit,butalsoenvisioningtheopportunityspace,engaginginthemostriskyanduncertainearlyresearch,andoverseeingthecommercialisationprocess.71Inchapter4wewillshowthishasalsobeenthecasefortherecentdevelopmentofnanotechnology,whichmanybelieveisthenextGPT.Atamoremicrolevel,BlockandKellerfindthatbetween1971and2006,77outofthemostimportant88innovations(ratedbyR&DMagazine’sannualawards)werefoundtohavebeenfullydependentonfederalsupport,especially,butnotonly,intheearlyphases.72Theseexamplesarefundamentalforunderstandingtheimpactofpubliclyfundedresearch.Itisnotjustaboutfundingblueskyresearchbutcreatingvisionsaroundnewimportanttechnologies.Toillustratethegeneralpoint,weturnnowtothespecificexamplesofearly-stagegovernmentinvestment 55intotheUSpharmaceuticalandbiotechnologysectors.Thepharmaceuticalindustryisinterestingbecauseofthenewdivisionofinnovativelabour.Largepharma,smallbiotech,universitiesandgovernmentlabsareallpartsoftheecology,butitisespeciallygovernmentlabsandgovernmentbackeduniversitiesthatinvestintheresearchresponsibleforproducingthemostradicalnewdrugs—thenewmolecularentitieswithpriorityratinginfigure6.Privatepharmahasfocusedmoreon‘metoo’drugs(slightvariationsofexistingones)andthedevelopment(includingclinicaltrials)andmarketingside.Thisisofcoursehighlyironic,giventhissector’sconstantbemoaningof‘stifling’regulations.Theex-editoroftheNewEnglandJournalofMedicine,MarciaAngell,hasarguedforcefullythatwhileprivatepharmaceuticalcompaniesjustifytheirexorbitantlyhighpricesbysayingtheyareduetotheirhighR&Dcosts,infactithasbeenstatefundedlabsandresearchthatareresponsiblefortwo-thirdsofthenewmolecularentitiesthathavebeendiscoveredinthelasttenyears.73Economistsmeasureproductivitybycomparingtheamountofinputintoproductionwiththeamountofoutputthatemerges.Inthissensethelargepharmaceuticalcompanieshavebeenfairlyunproductiveoverthelastfewyearsintheproductionofinnovations.Asfigure5showstherehasbeenanexponentialriseinR&DspendingbymembersofthePharmaceuticalResearchandManufacturersofAmerica(PhRMA)withnocorrespondingincreaseinthenumberofnewdrugs,commonlyknownasnewmolecularentities(NMEs).Figure6showsthatthisalsoholdsforpatenting:whilethenumberofpatentshasskyrocketedsincetheBayh-DoleAct(1980)allowedpubliclyfundedresearchtobepatented,mostofthesepatentsareoflittlevalue.Whenpatentsareweightedbytheamountofcitationstheyreceive(thecommonindicatorof‘important’patents),thefigureisrelativelyflat—therearefewimportantpatents. BeyondmarketfailuresSource:CongressionalBudgetOffice74Between1993and2004,ofthe1,072drugsapprovedbytheFDA,only357wereNMEsratherthanjustvariationsofexisting‘metoo’drugs.Thenumberofimportant‘priority’newdrugsisevenmoreworrying:only146ofthesehadpriorityrating(NMEwithPrating).Infigure7weseethatonly14percentwereseenasimportantnewdrugs. 57Source:Angell75Forthesakeoftheargumentbeingmadeinthispamphlet,whatisimportantisthat75percentoftheNMEstracetheirresearchnottoprivatecompaniesbuttoNationalInstitutesofHealth(NIH),publiclyfundedlabsintheUSAorotherpubliclabsacrosstheglobe,suchastheMRCintheUK. BeyondmarketfailuresSowhilethestate-fundedlabshaveinvestedinthemostriskyphase,thebigpharmaceuticalcompanieshavepreferredtoinvestinthelessriskyvariationsofexistingdrugs(adrugthatsimplyhasadifferentdosagethanapreviousversionofthesamedrug).Allafarcry,forexample,fromtherecentquotebyUKbasedGlaxoSmithKline76CEOAndrewWitty:‘Thepharmaceuticalindustryishugelyinnovative…Ifgovernmentsworktosupport,notstifle,innovation,theindustrywilldeliverthenexteraofrevolutionarymedicine.’77Biotechnology:publicleaderprivatelaggardIntheUK,theMRCreceivesannual‘grant-in-aid’fundingfromParliamentthroughtheDepartmentforBusiness,InnovationandSkills(BIS).Itisgovernmentfunded,thoughindependentinitschoiceofwhichresearchtosupport.ItworkscloselywiththeDepartmentofHealthandotherUKresearchcouncils,industryandotherstakeholderstoidentifyandrespondtotheUK’shealthneeds.ItwasMRCresearchinthe1970sthatledtothedevelopmentofmonoclonalantibodies—which,accordingtotheMRC,makeupathirdofallnewdrugtreatmentsformanydifferentmajordiseasesaroundcancer,arthritisandasthma.AsimilarstorycanbetoldfortheUSbiopharmaceuticalindustry.Itsgrowthwasnot,asisoftenclaimed,rootedinbusinessfinance(suchasventurecapital),butratheremergedandwasguidedbygovernmentinvestmentandspending.78Infact,theimmenseinterestofventurecapitalandbigpharmaceuticalcompaniesinbiotechwasparadoxicalgiventheindustry’sriskyandlengthyprocessofrecoupingitsinvestment.79AccordingtoLazonickandTulum,theanswertothis‘puzzle’istwo-fold.80First,therehasbeentheavailabilityofaneasyexitopportunityforearlyinvestorsthroughspeculativestockmarketflotationsinwhichinvestorsaremotivatedtoabsorbtheinitialpublicofferings(IPOs).Second,thereisthesignificantgovernmentsupportandinvolvementthathashelpedthisindustrytoflourishoverthelastseveraldecades. 59Infact,thedevelopmentofthebiotechindustryintheUSAisadirectproductofthekeyroleofthegovernmentinleadingthedevelopmentoftheknowledgebasethathasthusprovidedfirmsuccessandtheoverallgrowthofthebiotechindustry.AsVallas,KleinmanandBiscottieloquentlysummarise:Theknowledgeeconomydidnotspontaneouslyemergefromthebottomup,butwaspromptedbyatop-downstealthindustrialpolicy;governmentandindustryleaderssimultaneouslyadvocatedgovernmentinterventiontofosterthedevelopmentofthebiotechnologyindustryandarguedhypocriticallythatgovernmentshould‘letthefreemarketwork’.81Asthisquoteindicates,notonlywasthisknowledgeeconomyguidedbygovernment,but,strikingly,itwasdoneastheleadersofindustrywereontheonehandprivatelydemandinggovernmentinterventiontofacilitatetheindustry’sdevelopment,andontheotherhandpubliclydeclaringtheirsupportforafreemarket.Itisnowondergiventhishypocrisythatsomuchconfusionnowexistsamongpolicymakersandthegeneralpublicregardingthedevelopmentofeconomicinnovation,resultinginthefailuretorecognisethesignificanceofgovernmentinvolvement.GiventheeffortsofinternationalpolicymakersinseekingtoadvancetheirowneconomiesandinreplicatingthesuccessesoftheUSA,itisimperativenow,morethanever,thatthe‘real’storyofthisinnovationandeconomicgrowthanddevelopmentbetold.Summarisingtheirfindingsofthestrongroleofthegovernmentinthedevelopmentofthebiotechindustry,Vallas,KleinmanandBiscottiemphasisethesignificanceof‘massiveshiftsinfederalR&Dthatwereinvolved’.Theygoontoadd,‘Itisdifficulttoavoidtheconclusionthattheknowledgeeconomywasnotbornbutmade.’ThoughpharmaceuticalcompaniesspendmuchonR&D,supplementingtheseprivateinvestmentshasbeencompletelydependentona‘readysupplyofscientificknowledgethathasbeeneitherfundedoractuallyproducedbyfederalagencies’.82 BeyondmarketfailuresTheNationalInstitutesofHealth:creatingthewaveversussurfingitStatesupportandinvolvementinbiotechspanawiderangeofforms,themostsignificantbeingthattheenormousknowledgebasewhichbiopharmaceuticalcompaniesaredependentonhasdevelopedmorefromgovernmentinvestmentthanfrombusiness.Thisknowledgebasehasbeendevelopedfromthecriticalinvestmentthegovernmenthasgiventofundingbasicscience.AttheforefrontofthisliestheNationalInstitutesofHealth(NIH)andothergovernmentprogrammeswhichhaveinvestedinmanyofthekeyscientificachievementsthattheindustry’ssuccesshasbeenbuilton.DrawingonNIHspendingdatacompiledinLazonickandTulum,itiseasytoseehowcrucialthisfundingwasforbiotechinnovation.From1978to2004,NIHspendingonlifesciencesresearchtotalled$365billionin2004.Everyyearfrom1970to2009,withtheexceptionofasmalldeclinein2006,NIHfundingincreasedinnominalterms,incontrasttothewidelyfluctuatingfundsfromventurecapitalandstockmarketinvestments.83FromtheNIH’sformationin1938through2010,atotal$738billionin2010wasinvestedbytheUSgovernment,andbyextensionUStaxpayers,intothepharmaceuticalindustry.Morestrikingisthat,through2010, inthe35yearssincethefoundingofGenentechasthefirstbiotechcompanyin1976,NIHfunded$624billionin2010tothebiotechindustry.Asevidencedinthisdata,LazonickandTulumarguethattheUSgovernment,throughtheNIH,andbyextensionviatheUStaxpayer,‘haslongbeenthenation’s(andtheworld’s)mostimportantinvestorinknowledgecreationinthemedicalfields’.84Thisknowledgebasewas‘indispensable’andwithoutit,venturecapitalandpublicequityfundswouldnothavepouredintotheindustry.Theyhave‘surfedthewave’ratherthancreatedit.Throughasystemofnearly50,000competitivegrants,theNIHsupportsmorethan325,000researchersatover3,000universities,medicalschools,andotherresearchinstitutionsineveryUSstateandthroughouttheworld. 61Thesegrantsrepresent80percentoftheagency’sbudgetwithanother10percentusedtodirectlyemploy6,000individualsinitsownlaboratories.Theagency’s26researchcentresinMarylandserveaprominentroleinthebiotechindustry—onethatisincreasingasmorecentresandinstitutescontinuetodevelopwithinNIH.Beyondthese‘knowledge-creatingprogrammes’,tracesofgovernmentsupportcanalsobeseeninalmosteverysinglemajorbiopharmaceuticalproductintheUSA.85Althoughmanybiotechscholarsacknowledgetheimmensegovernmentsupportinthesciencebase,overalltheyfailtodrawthecausalrelationshipbetweenthesuccessfulgrowthofthisindustry,itsattractivenessandthelonglastinggovernmenteffortstodevelopandsustainthesubstantialknowledgebaseinthiscountry.Sowhydoesventurecapitaloftengetsomuchcreditforcreatingthebiotechrevolution?Thestoryofprivateandpublicinvestmentsinbiotechisperfectlydescribedbythefollowingnewspaperstory:DuringarecentvisittotheUnitedStates,FrenchPresidentFrancoisMitterrandstoppedtotourCalifornia’sSiliconValley,wherehehopedtolearnmoreabouttheingenuityandentrepreneurialdrivethatgavebirthtosomanycompaniesthere.Overlunch,MitterrandlistenedasThomasPerkins,apartnerintheventurecapitalfundthatstartedGenentechInc.,extolledthevirtuesoftherisk-takinginvestorswhofinancetheentrepreneurs.PerkinswascutoffbyStanfordUniversityProfessorPaulBerg,whowonaNobelPrizeforworkingeneticengineering.Heasked,‘Wherewereyouguysinthe50sand60swhenallthefundinghadtobedoneinthebasicscience?Mostofthediscoveriesthathavefuelled[theindustry]werecreatedbackthen.’86Thepointofthischapteristoshowthatthecaseforstateinvestmentgoesbeyondblueskiesbasicresearch.Infact,itappliestoallthedifferenttypesof‘risky’anduncertainresearchsincetheprivatesectorisinmanywayslessentrepreneurialthanthepublicsector:itshiesaway Beyondmarketfailuresfromradicallynewproductsandprocesses,leavingthemostuncertaininvestmentstobefirsttakenonbythestate.Sowhileblueskiesresearchisnecessaryforinnovationtooccur,itisfarfromsufficient,andindeedtheroleofthestategoesfarwider.Weexaminethebreadthanddepthofstateleadershipinproducingtheknowledgeeconomyinchapters3and4. 63 653NationalsystemsofinnovationInchapter1welearnedthattherelationshipbetweenR&Dandgrowthisdependentonfirm-specificconditions,withmostfirmsnotreceivinganygrowthbenefitifthoseconditionsarenotinplace.Oneofthemostimportantliteraturesthathaveillustratedwhy‘R&Disnotenough’istheworkonnationalsystemsofinnovation.InthisviewitisnotthequantityofR&Dthatmattersbuthowitisdistributedthroughoutaneconomy,andoftenthecrucialroleofthestateinachievingthis.Thisperspectiveemergesfromthe‘Schumpeterian’literatureontheeconomicsofinnovation,whichemphasisestheKnightianuncertaintythatcharacterisesinnovation,asdiscussedinchapter1.87SchumpetarianeconomistscriticiseendogenousgrowththeorybecauseofitsassumptionthatR&DcanbemodelledasalotterywhereacertainamountofR&Dinvestmentwillcreateacertainprobabilityforsuccessfulinnovation.TheyarguethatinfactinnovationisanexampleoftrueKnightianuncertainty,notabletobemodelledthroughanormalprobabilitydistributionthatisimplicitinthe‘R&Dgame’literature.88Byhighlightingthestronguncertaintyunderlyingtechnologicalinnovation,andverystrongfeedbackeffectsbetweeninnovation,growthandmarketstructure,Schumpetariansemphasisethe‘systems’componentoftechnologicalprogressandgrowth.89Systemsofinnovationaredefinedas‘thenetworkofinstitutionsinthepublicandprivatesectorswhoseactivitiesandinteractionsinitiate,import,modifyanddiffusenewtechnologies’,90or‘theelementsandrelationshipswhichinteractintheproduction,diffusionanduseofnew,andeconomicallyuseful,knowledge…andareeitherlocatedwithinorrootedinsidethebordersofanationState’.91 NationalsystemsofinnovationTheemphasishereisnotonthestockofR&Dbutonthecirculationofknowledgeanditsdiffusionthroughouttheeconomy.Institutionalchangeisnotassessedthroughcriteriabasedonstaticallocativeefficiencybutratheronhowitpromotestechnologicalandstructuralchange.Theperspectiveisneithermacroormicro,butmoremeso,whereindividualfirmsareseenaspartofabroadernetworkoffirmswithwhomtheycooperateandcompete.Thesystemofinnovationcanbeinter-firm,regional,nationalorglobal.Thenetworkistheunitofanalysis(notthefirm)inthemesoperspective.Thenetworkconsistsofcustomers,subcontractors,infrastructure,suppliers;competenciesorfunctions;andlinksorrelationships.Thepointisthatthecompetenciesforinnovationaredistributedthroughoutanetworkofactorsandtheirlinksorrelationships.92Thecausationisnot‘linear’—fromsciencetolargescaleR&Dtoapplicationsandinnovations.Ratheritisfulloffeedbackloopsfrommarkettotechnology,andfromapplicationstoscience.Inthelinearmodel,theR&Dsystemisseenasthemainsourceofinnovation,reinforcingeconomists’useofR&Dstatstounderstandgrowth.Inthismorenon-linearview,therolesofeducation,training,designandqualitycontrolarejustasimportant.Furthermore,itisbetterabletotakeintoaccountserendipityanduncertaintythatcharacterisestheinnovationprocess.Itisusefulforunderstandingtheriseandfallofdifferentpowersineconomichistory.ForexampleitexplainstheriseofGermanyinthenineteenthcenturytoitstechnologicaleducationandtrainingsystems,andtheroleofthestateinfosteringthese.AnditpointstotheriseoftheUSAinthetwentiethcenturyasrelatedtotheriseofmassproductionandin-houseR&D.AllofthesestoriesaredifferentinthespecificsbutshareacommonseedofhavingasystemofinnovationratherthanasimplefocusonR&Dspendinitself.ThegeneralpointcanbeillustratedbycontrastingtheexperienceofJapanwiththatofthethenSovietUnioninthe1970sand1980s.TheriseofJapanisexplainedbythewaythatnewknowledgeflowedthroughamorehorizontalstructure 67betweenministriesofscience,academiaandcompanyR&D.Inthe1970sJapanwasspending2.5percentofitsGDPonR&DwhiletheSovietUnionwasspendingmorethan4percent.YetJapaneventuallygrewmuchfasterthantheSovietUnionbecausetheR&Dwasspreadacrossawidervarietyofsectors,notjustmilitaryandspaceasintheSovietUnion.InJapan,therewasastrongintegrationofR&D,productionandimportoftechnologyattheenterpriselevel,whereasintheSovietUniontherewasseparation.Crucially,theSovietUniondidnothave,orpermit,businessenterprisesthatcouldcommercialisetheknowledgedevelopedbythestate.Japanhadstronguser–producerlinkages,whichwerenonexistentintheSovietsystem;andincentivestoinnovatewereencouragedthroughoutmanagementandtheworkforce,ratherthanfocusedonlyintheministriesofscience.ItwastheJapanesegovernment’sindustrialpolicythatcoordinatedtheseattributesguidedbytheMinistryofInternationalTradeandIndustry(MITI).EquallyimportantwerethelessonslearnedbyJapanesecompanies,whichsentpeopleabroadtolearnaboutWesterntechnologies.ThesecompaniesbenefittedfromtheUS‘developmentalstate’andthentransferredthatknowledgetoJapanesecompanies.JapanesecompanieswereamongthefirstforeigncompaniestolicensethetransistorfromBAT&T(BellLabs)intheearly1950s.KeyconnectionsweremadewithWesterncompaniessuchasGE,IBM,HPandXerox.Particularsectorslikeelectronicsweretargetedforcefully,andtheorganisationalinnovationembodiedintheflexible‘just-in-time’productionsystemwasappliedtoawidevarietyofsectors.Table2comparestheJapaneseandSovietsystemsofinnovation.ItisimportantinthiscontexttohighlightthatMITI’sindustrialpolicywasbeyondthe‘pickingwinners’ideathatsomanyopposerstodayofindustrialpolicycite.Itwasaboutcoordinatingintra-industrialchange,inter-sectorallinkages,inter-companylinkages,andtheprivate–publicspaceinawaythatallowedgrowthtooccurinaholistictargetedmanner.Thevertical‘Fordist’modelofproductionintheUSA,characterisedbyrigidityandtense Nationalsystemsofinnovationrelationsbetweentradeunionsandmanagement,causedamorerigidflowofknowledgeandcompetenciesintheeconomy,againgivinganadvantagetothemorehorizontallystructuredandflexibleJapanesefirms.Table2Contrastingnationalsystemsofinnovation:JapanandtheUSSRinthe1970sJapanUSSRHighgrossdomesticexpenditureonVeryhighGERD/GNPratio(c4%)R&D(GERD)/GNPratio(2.5%)VerylowproportionofmilitaryorExtremelyhighproportionofmilitaryspaceR&D(<2%ofR&D)orspaceR&D(>70%ofR&D)HighproportionoftotalR&DatLowproportionoftotalR&Datenterpriselevelandcompany-enterpriselevelandcompany-financed(approx67%)financed(<10%)StrongintegrationofR&D,productionSeparationofR&D,productionandandimportoftechnologyeximportoftechnologyandweakenterpriselevelinstitutionallinkagesStronguser–producerandWeakornon-existentlinkagessubcontractornetworklinkagesbetweenmarketing,productionandprocurementStrongincentivestoinnovateSomeincentivestoinnovatemadeatenterpriselevelinvolvingincreasinglystrongin1960sandmanagementandworkforce1970sbutoffsetbyothernegativedisincentivesaffectingmanagementandworkforceIntensiveexperienceofcompetitioninRelativelyweakexposuretointernationalmarketsinternationalcompetitionexceptinarmsraceSource:Freeman,199593Note:Grossdomesticexpendituresonresearchanddevelopment(GERD)areallmoniesexpendedonR&Dperformedwithinthecountryinagivenyear.Inthiscontext,regionalsystemsofinnovationfocusonthecultural,geographicalandinstitutionalproximitythatcreateandfacilitatetransactionsamongsocio-economicactors.Studiesfocusingoninnovativemilieusuchasindustrial 69districtsandlocalsystemsofinnovationhavedemonstratedthatconventionsandspecificsocio-institutionalfactorsinregionsaffecttechnologicalchangeatanationallevel.Specificfactorsmightincludeinteractionsbetweenlocaladministrations,unionsandfamilyownedcompaniesin,forexample,theItalianindustrialdistricts.Government’sroleinnotonlycreatingknowledge(throughnationallabsanduniversities)butalsomobilisingresources,andallowingknowledgeandinnovationstodiffuseacrosssectorsandtheeconomy,iskeyinthisview,eitherthroughexistingnetworksorbyfacilitatingnewones.Ourview,however,isthathavinganationalsystemofinnovation,richinhorizontalaswellasverticalnetworks,isnotsufficientinitself.Thestatehasafurtherroletoplaytoleadtheprocessofindustrialdevelopment,developingstrategiesfortechnologicaladvanceinpriorityareas.Thishasbeenacceptedasconsensusincountriesthatareattemptingtocatchupwithmosttechnologicallyadvanced.Thereisawholeliteraturedevotedtotheroleoftheso-called‘developmentalstate’,wherethestateisactivenotonlyinKeynesiandemandmanagementbutalsoinleadingtheprocessofindustrialisation.ThemosttypicalexamplesaretheEastAsianeconomies,whichthroughplanningandactiveindustrialpolicywereableto‘catchup’technologicallyandeconomicallywiththewest.94Instatesthatwerelatetoindustrialise,thestateitselfledtheindustrialisationdrive—ittookondevelopmentalfunctions,forexamplebytargetingcertainsectorsforinvestment,andputtingupbarrierstoforeigncompetitionuntilsuchtimeascompaniesinthetargetedsectorswerereadytoexport,andthenprovidedassistancetofindingnewexportmarkets.InJapan,forexample,JohnsonillustrateshowMITIworkedtocoordinateJapanesefirmsinnewinternationalmarkets.95Thisoccurredthroughinvestmentsinparticulartechnologies(pickingwinners),withspecificbusinessstrategiestowininparticularmarkets,domesticallyandinternationally.Furthermore,theJapanesestatecoordinatedfinancethroughtheBankofJapanaswellasthroughtheFiscalInvestmentLoanProgram(fundedbythepostalsavingssystem). NationalsystemsofinnovationChangofferssimilarillustrationsforSouthKoreaandotherrecentlyemergedeconomies.96Chinatoohasengagedinaverytargetedindustrialisationstrategy,whichshowedtheweaknessesoftheWashingtonconsensusondevelopmentbyonlyjoiningtheWorldTradeOrganizationonceitsindustrieswerereadytocompete,ratherthanaspartofanInternationalMonetaryFund-backedindustrialisationstrategy,whichoftendeniesthestatetheactiverolethatitplayedinthedevelopmentoftheindustrialisednations(USA,GermanyandtheUK).Ifthereisstrongevidencethatthestatecanbeeffectiveinpursuingtargetedcatch-uppoliciesbyfocusingresourcesonbeingdominantincertainindustrialsectors,whyisitnotacceptedthatthestatecanhaveagreaterroleinthedevelopmentofnewtechnologiesandapplicationsbeyondsimplyfundingbasicscienceandhavinganinfrastructuretosupportprivatesectoractivity?TheentrepreneurialstateTheargumentofthispamphletisthatthestatecanbefarmoreproactiveinspurringindustrialinnovationattheforefrontofknowledgethaniscurrentlyunderstoodbypolicymakers.JustasdevelopingnationscansuccessfullyplantocatchupwithWesternnations,soanystatecanspurthedevelopmentoftechnologicalsolutionsand/orthefurtheranceofpracticalknowledgeinagivensectorsimplybycatalysinganetworkedeconomytoengageinmultipleinnovations.Unlikeinadevelopingeconomy,wherethetechnologyisalreadyavailableelsewhereintheworld,anentrepreneurialstatedoesnotyetknowwhatthedetailsoftheinnovationare,butitknowsageneralareathatisripefordevelopment,orwherepushingtheboundariesofknowledgearedesirable.ThestatewelcomesandengageswithKnightianuncertaintyfortheexplorationandproductionofnewproductswhichleadtoeconomicgrowth.Ithasdonesonotjustbyfundingbasicresearch.Moreimportantly,ithastakentheleadbyformulatingavisionofa 71newarea(forexampletheinternetorthegeneticsequence);investingintheearliest-stageresearchanddevelopmentwhichtheprivatesectorisunableorunwillingtodo(forexamplewhenthemarketpreferstoinvestinsafe‘metoo’medicinesratherthanriskynewmolecularentities);identifyingandsupportingmultiplenewpathsandadjustingrulestopromotethem(forexamplechangesinregulationthatallowpubliclyfundedresearchtobepatented);creatingandfundingnetworksthatbringtogetherbusiness,academiaandfinance(forexampleSBIRintheUSA);andbeingconstantlyaheadofthegameinareasthatwilldrivethenextdecadesofgrowth(forexamplenanotechnologyandgreentechnologytoday).Itwillalso,atatimewhentheeconomiccrisishasgivenriskandspeculationabadname,distinguishbetweengoodspeculationandbadspeculation.Speculationisneededwhentheprobabilityoffailureissohigh.97ThestatehasinfactbeenanimportantsourceofSchumpeterianriskandspeculation—theboldcouragerequiredtodelveintotheworldofuncertaintyneededtocreatenewproductsandprocessesthatcantransformlong-runeconomicgrowth.Thusgoodriskisthespeculationneededforthesakeofinnovationandstructuralchangeratherthanspeculationfor…thesakeofspeculation—profitonshort-termpricechanges.This‘entrepreneurial’risk-takingroleissomethingthatneithertheeconomicsofKeynesianstimulusnorthepoliciesbehindtheSchumpeteriannationalsystemsofinnovationhaveelaborated.Andthisisoneofthereasonswhythecurrentinternationaldebateaboutpost-crisisrecoveryandgrowthisoftensofullofrhetoricabouttheprivate–publicdivide,onboththeconservativeandprogressivesidesofthespectrum.ThenextchapterarguesthatdespitetheperceptionoftheUSAastheepitomeofprivate-sectorledwealthcreation,inrealitythestatehasbeenengagedonamassivescaleinentrepreneurialrisk-takingtospurinnovation.Fourmainexamplesaregiven:therolesofDARPA,SBIR,theOrphanDrugActandtheNationalNanotechnologyInitiativeintheUSA(theEUpasseditsownOrphanDrugActin2001,imitatingtheUSActpassedin1983).Whattheyshareisa Nationalsystemsofinnovationproactiveapproachbythestatetoshapeamarketinordertodriveinnovation.Theinsightisthataswellasbeinganentrepreneurialsociety,aplacewhereitisculturallynaturaltostartandgrowabusiness,theUSAisalsoaplacewherethegovernmentitselfisentrepreneurial,commissioninghigh-levelinnovativeprivate-sectoractivityinpursuitofpublicpolicygoals. 73 754TheUSentrepreneurialstateSofarwehaveestablishedthatwhiletheleveloftechnologicalinnovationisintegraltotherateofeconomicgrowth,thereisnolinearrelationshipbetweenR&Dspend,sizeofcompanies,numberofpatentsandthelevelofinnovationinaneconomy.Whatdoesseemtobeclear,however,isthatanecessaryprecursorforinnovationtooccuristohaveahighlynetworkedeconomy,withcontinuousfeedbackloopsbetweendifferentindividualsandorganisationstoenableknowledgetobesharedanditsboundariestobepushedback.Thisiswhathasbeencalledintheliteratureanationalsystemofinnovation.Thischapterattemptstoillustratethatatthefrontiersofknowledge,simplyhavingthesystemofinnovationisnotenough.Overtime,moreimpressiveresultscanbeachievedwhenthestateisamajorplayeroperatingwithinthissystem.Thisdoesnotnecessarilyhavetotakeplaceatanationallevel(althoughitcan)andshouldnotinvolvelong-termsubsidiestocertaincompanies,asgaveabadnametothe‘pickingwinners’experience.Ratherthestate,throughitsvariousagenciesandlaboratories,canbenimble,usingitsprocurement,commissioningandregulatoryfunctionstoshapemarketsanddrivetechnologicaladvance.Inthiswayitactsasacatalystforchange,thesparkthatlightsthefire,inanetworkedsystemthatalreadyhasthepotentialtodisseminatenewideasrapidly.TheDefenseAdvancedResearchProjectsAgencyThehistoryoftheUSAdoesnotdifferfromothermoderncountriesintherolethatmilitaryengagementhashadforeconomicgrowthanddevelopment.ButintheUSA,theexperienceofrecentdecadeshasbeentoapplythoselessonstofargreaterapplicationinwiderindustrialpolicy.Therole TheUSentrepreneurialstateofgovernmentintheDefenseAdvancedResearchProjectsAgency(DARPA)modelgoesfarbeyondsimplyfundingbasicscience.Itisabouttargetingresourcinginspecificareasanddirections;openingnewwindowsofopportunities;brokeringtheinteractionsbetweenpublicandprivateagentsinvolvedintechnologicaldevelopment,includingprivateandpublicventurecapital;andfacilitatingcommercialisation.98IncontrasttotheemphasisplacedonFranklinDRoosevelt’sNewDealbymarketfundamentalistsasthecriticalturningpointinUSeconomichistory,BlockarguesthattheSecondWorldWarservedamoresignificantperiodforthedevelopmentofinnovationpoliciesintheUSA.ItwasduringtheperiodfollowingtheSecondWorldWarthatthePentagonworkedcloselywithothernationalsecurityagenciesliketheAtomicEnergyCommissionandtheNationalAeronauticsandSpaceAgency(NASA),whichledtothedevelopmentoftechnologiessuchascomputers,jetplanes,civiliannuclearenergy,lasersandbiotechnology.99Thewaythiswasdonewas‘pioneered’bytheAdvancedProjectsResearchAgency(ARPA),anofficecreatedbythePentagonin1958.Thisagency,alsocommonlyreferredtoastheDefenseAdvancedResearchProjectsAgency(DARPA)(andconsequentlytheacronymusedthroughoutthispamphlet),100engagedindevelopingcriticalinitiativesacrossabroadrangeoftechnologies.However,itwasthesupportfortechnologicaladvancementinthecomputerfieldthatledtotheestablishmentofanewparadigmfortechnologypolicy.DARPAwassetuptogivetheUSAtechnologicalsuperiorityindifferentsectors,mainlybutnotonlyrelatedtotechnology,andhasalwaysbeenaggressivelymissionoriented.Ithasabudgetofmorethan$3billionperyear,240staff,operatesflexiblywithfewoverheads,andisconnectedtobutseparatedfromgovernment.Ithassuccessfullyrecruitedhighqualityprogrammemanagerswhoarewillingtotakerisksbecauseoftheirshorttermcontracts,whichlastanywherebetweenfourandsixyears.Itsstructureismeanttobridgethegapbetweenblueskyacademicwork,withlongtimehorizons,andthemoreincrementaltechnologicaldevelopmentinthemilitary. 77AfteraSecondWorldWarvictorythatreliedheavilyonstate-sponsoredandorganisedtechnologicaldevelopmentsthefederalgovernmentwasquicktoimplementtherecommendationsofVannevarBush’s1945report,whichcalledforongoingpublicsupportforbasicaswellasappliedscientificresearch.101TherelationshipbetweengovernmentandsciencewasfurtherstrengthenedbytheManhattanProject(themajorscientificeffortledbytheUSA,withtheUKandCanada,whichledtotheatomicbombintheSecondWorldWar),asphysicistsinstructedpolicymakersonthemilitaryimplicationsofnewtechnology.Fromthispointon,itbecamethegovernment’sbusinesstounderstandwhichtechnologiesprovidedpossibleapplicationsformilitarypurposesaswellascommercialuse.AccordingtoBlock,duringthisperiodanincreasednumberofgovernmentworkersadoptedamoredirectroleinadvancinginnovationthroughencouragingresearcherstosolvespecificproblems,procuringadditionalresearchersandrequiringthatthoseresearchersmeetspecificobjectives.102Theinsightthatfollowedwasthatthiswassomethinggovernmentcoulddoforeconomicandcivilianpurposes,inadditiontothetraditionalmilitaryfunction.ThelaunchingofSputnikin1957bytheSovietsledtotheeruptionofpanicamongUSpolicymakers,fearfulthattheywerelosingthetechnologicalbattle.ThecreationofDARPAin1958wasadirectresult.BeforetheformationofDARPAthemilitarywasthesolecontrollerofallmilitaryR&Ddollars.ThroughtheformationofDARPAaportionofmilitaryspendingonR&Dwasnowdesignatedto‘blueskythinking’—ideasthatwentbeyondthehorizoninthattheymaynotproduceresultsfortenor20years.AsaresultofthismandateDARPAwasfreetofocusonadvancinginnovativetechnologicaldevelopmentwithnovelstrategies.Thisopenednumerouswindowsforscientistsandengineerstoproposeinnovativeideasandreceivefundingandassistance.103Goingwaybeyondsimplyfundingresearch,DARPAfundedtheformationofcomputersciencedepartments,providedstart-upfirmswithearlyresearchsupport, TheUSentrepreneurialstatecontributedtosemiconductorresearchandsupporttohumancomputerinterfaceresearch,andoversawtheearlystagesoftheinternet.ManyofthesecriticalactivitieswerecarriedoutbyitsInformationProcessingTechniquesOffice,originallyestablishedin1962.Suchstrategiescontributedhugelytothedevelopmentofthecomputerindustryduringthe1960sand1970s,andasavarietyofresearchreveals,manyofthetechnologieslaterincorporatedinthedesignofthepersonalcomputerweredevelopedbyDARPA-fundedresearchers.Anotherkeyeventduringthisperiodwasthenewinnovationenvironmentthatemergedafteragroupofscientistsandengineersin1957brokeawayfromafirmstartedbyWilliamShockley.104Thisrebelliousgroupofscientistsandengineersoftenreferredtoasthe‘traitorouseight’wentontoformanewfirmthatadvancedsemiconductortechnologyandcontinued‘aprocessofeconomicfissionthatwasconstantlyspinningoffneweconomicchallengers’.Thisspin-offbusinessmodelbecameviableandpopularfortechnologicaladvancementfollowingthe1957revolt.Anewparadigmemergedthatresultedininnovativeideasmovingfromlabstothemarketinfargreaterquantity.Beforethisgovernmentofficials’leverageingeneratingrapidtechnologicaladvancementwaslimitedaslargedefencefirmsstillwieldedtremendouspowerindeflectingpressureanddemandsforinnovation.Theleveragegovernmentofficialshadinadvancinginnovativebreakthroughswasalsolimitedbythesmallnumberoffirmswithsuchcapabilities.Bondedbyasharedinterestinavoidingthecertainrisksthataccompaniedfollowinganuncertaintechnologicalpath,thefirmsresistedgovernmentpressureforinnovation.However,inanewenvironmentwithambitiousstart-upstheopportunityforgeneratingrealcompetitionamongfirmspresenteditselfmorefully.ProgrammeofficersatDARPArecognisedthepotentialthisnewinnovationenvironmentprovidedandwereabletotakeadvantageofitfocusingatfirstonnew,smallerfirmstowhomtheycouldprovidemuchsmallerfundsthanwaspossiblewiththelargerdefencecontractors.Thesefirms 79recognisedtheneedforambitiousinnovationaspartoftheiroverallfutureviability.Withsmall,newerfirmsengagedinrealcompetitionandasthespin-offmodelbecamemoreinstitutionalised,Blocknotesthatlargefirmsalsohadtogetonboardwiththisquestforrapidinnovativebreakthroughs.105Bytakingadvantageofthisnewenvironment,thegovernmentwasabletoplayaleadingroleinmobilisinginnovationamongbigandsmallfirms,andinuniversityandgovernmentlaboratories.ThedynamicandflexiblestructureofDARPAincontrasttothemoreformalandbureaucraticstructureofothergovernmentprogrammesallowedittomaximisetheincreasedleverageitnowhadingeneratingrealcompetitionacrossthenetwork.Usingitsfundingnetworks,DARPAincreasedtheflowofknowledgeacrosscompetingresearchgroups.Itfacilitatedworkshopsforresearcherstogatherandshareideaswhilealsolearningofthepathsidentifiedas‘deadends’byothers.DARPAofficersengagedinbusinessandtechnologicalbrokering—linkinguniversityresearcherstoentrepreneursinterestedinstartinganewfirm;connectingstart-upfirmswithventurecapitalists;findingalargercompanytocommercialisethetechnology;orassistinginprocuringagovernmentcontracttosupportthecommercialisationprocess.Pursuingthisbrokeringfunction,DARPAofficersnotonlydevelopedlinksamongthoseinvolvedinthenetworksystembutalsoengagedineffortstoexpandthepoolofscientistsandengineersworkinginspecificareas.AnexampleofthisistheroleDARPAplayedinthe1960sbyfundingtheestablishmentofnewcomputersciencedepartmentsatvariousuniversitiesintheUSA.Byincreasingthenumberofresearcherswhopossessedthenecessaryandparticularexpertise,DARPAwasable,overanextendedperiodoftime,toacceleratetechnologicalchangeinthisarea.Intheareaofcomputerchipfabricationduringthe1970s,DARPAassumedtheexpensesassociatedwithgettingadesignintoaprototypebyfundingalaboratoryaffiliatedwiththeUniversityofSouthernCalifornia.Anyonewhopossessedasuperiordesignforanewmicrochipcouldhavethechipsfabricatedatthislaboratory,thusexpandingthepoolofparticipantsdesigningfasterandbettermicrochips. TheUSentrepreneurialstateThepersonalcomputeremergedduringthistimewithAppleintroducingthefirstonein1976.Followingthis,thecomputerindustry’sboominSiliconValleyandthekeyroleofDARPAinthemassivegrowthofpersonalcomputingreceivedsignificantattention,buthassincebeenforgottenbythosewhoclaimSiliconValleyisanexampleof‘freemarket’capitalism.Alsoduringthe1970sthesignificantdevelopmentstakingplaceinbiotechnologyillustratedtopolicymakersthattheroleofDARPAinthecomputerindustrywasnotauniqueorisolatedcaseofsuccess.Thedecentralisedformofindustrialpolicythatplayedsuchacrucialroleinsettingthecontextforthedramaticexpansionofpersonalcomputingwasalsoinstrumentalinacceleratinggrowthanddevelopmentinbiotechnology.BlockidentifiesthefourkeycharacteristicsoftheDARPAmodel:106Aseriesofrelativelysmalloffices,oftenstaffedwithleadingscientistsandengineers,aregivenconsiderablebudgetautonomytosupportpromisingideas.Theseofficesareproactiveratherthanreactiveandworktosetanagendaforresearchersinthefield.Thegoalistocreateascientificcommunitywithapresenceinuniversities,thepublicsectorandcorporationsthatfocusesonspecifictechnologicalchallengesthathavetobeovercome.Fundingisprovidedtoamixofuniversity-basedresearchers,start-upfirms,establishedfirmsandindustryconsortia.Thereisnodividinglinebetween‘basicresearch’and‘appliedresearch’,sincethetwoaredeeplyintertwined.Moreover,theDARPApersonnelareencouragedtocutofffundingtogroupsthatwerenotmakingprogressandreallocateresourcestoothergroupsthathavemorepromise.Sincethegoalistoproduceusabletechnologicaladvances,theagency’smandateextendstohelpingfirmsgetproductstothestageofcommercialviability.Thiscaninvolvetheagencyinprovidingfirmswithassistancethatgoeswellbeyondresearchfunding. 81Partoftheagency’staskistouseitsoversightroletomakeconstructivelinkagesofideas,resourcesandpeopleacrossthedifferentresearchanddevelopmentsites.Themainfocusistoassistfirmsindevelopingnewproductandprocessinnovations.Thekeyhereisthatthegovernmentservesasaleaderforfirmstoimitate,anapproachthatismuchmore‘handson’inthatpublicsectorofficialsareworkingdirectlywithfirmsinidentifyingandpursuingthemostpromisinginnovativepaths.TheSmallBusinessInnovationResearchprogrammeContrarytoconventionalwisdomregardingthedominationoffreemarketideologyduringtheReaganAdministration,theUSgovernmentinthe1980s,infact,actedtobuildonthesuccessesofDARPA’sdecentralisedindustrialpolicy.OneofthemostsignificanteventsduringthisperiodwasthesigningoftheSmallBusinessInnovationDevelopmentActbyReaganin1982,asaconsortiumbetweentheSmallBusinessAdministrationanddifferentgovernmentagenciesliketheDepartmentofDefence,DepartmentofEnergyandEnvironmentalProtectionAgency.TheActwasbasedonaNationalScienceFoundation(NSF)pilotprogrammeinitiatedduringtheCarteradministration.TheSmallBusinessInnovationResearch(SBIR)programmerequiredgovernmentagencieswithlargeresearchbudgetstodesignateafraction(originally1.25percent)oftheirresearchfundingtosupportinitiativesofsmall,independent,for-profitfirms.Theprogrammehasprovidedsupporttoasignificantnumberofhighlyinnovativestart-upfirms.107Inaddition,thenetworkofstateandlocalinstitutionsthatworkedinpartnershipwiththefederalprogrammeswasexpanded.AnexampleofthisisthedevelopmentoforganisationsthatwerefundedbystateandlocalgovernmentstoassistentrepreneursinsubmittingsuccessfulapplicationstotheSBIRprogrammetosecurefundsfor TheUSentrepreneurialstatetheirprojects.TheSBIRprogrammefulfilsauniqueroleinthisnewinnovationsystem,becauseitservesasthefirstplacemanyentrepreneursinvolvedintechnologicalinnovationgoforfunding.Theprogramme,whichprovidesmorethan$2billionperyearindirectsupporttohigh-techfirms,hasfostereddevelopmentofnewenterprises,andhasguidedthecommercialisationofhundredsofnewtechnologiesfromthelaboratorytothemarket.GiventheinstrumentalroleoftheSBIRprogrammeanditssuccesses,itissurprisinghowlittleattentionthisprogrammereceives,althoughtheUKhaslatterlyattemptedtocopyitssuccess,buttolittleavailsofar,aswewillseeinthenextchapter.BlockhighlightsthelackofvisibilityofSBIRinanefforttoillustratewhathedescribesas‘adiscrepancybetweenthegrowingimportanceofthesefederalinitiativesandtheabsenceofpublicdebateordiscussionaboutthem’.108Asindicatedintheintroductionofthispamphletandagainintheearlystagesofthischapter,thisdiscrepancyposesanexceptionalchallengetothepolicymakersandthepublicwhoareengagedineconomicdebatesandeffortstoaddressthecurrenteconomiccrisesandpavethewayforthefutureofinnovationanddevelopmentintheglobalisedworld.OrphandrugsAyearaftertheSBIRprogrammewasestablished,afurtherlegislativespurtoprivatesectorinnovationoccurred,thistimespecifictothebiotechindustry.The1983OrphanDrugAct(ODA)madeitpossibleforsmall,dedicatedbiotechfirmstocarveaslitherfromthedrugmarket.Theactincludescertaintaxincentives,clinicalaswellasR&Dsubsidies,fast-trackdrugapproval,alongwithstrongintellectualandmarketingrightsforproductsdevelopedfortreatingrareconditions. Ararediseaseisdefinedasanydiseasethataffectslessthan200,000peopleandgiventhispotentiallysmallmarket,itwasarguedthatwithoutfinancialincentivesthesepotentialdrugswouldremain‘orphans’.Theimpetusbehindthislegislationwasto 83advancetheinvestmentofpharmaceuticalcompaniesindevelopingthesedrugs.Theprotectionprovidedbytheactenablessmallfirmstoimprovetheirtechnologyplatformsandscaleuptheiroperations,enablingthemtoadvancetothepositionofbecomingamajorplayerinthisindustry.Infact,orphandrugsplayedanimportantroleforthemajorbiopharmaceuticalfirmssuchasGenzyme,Biogen,AmgenandGenentechtobecomewhattheyaretoday.Sincetheintroductionofthislegislation,2,364productshavebeendesignatedasorphandrugsand370ofthesedrugshavegainedmarketingapproval.109Inadditiontothegeneroustaxincentives,subsidies,accesstofast-trackapprovalandextensiveintellectualandmarketingrightsforproductsdesignatedas‘orphan’drugs,LazonickandTulumdrawattentiontothefactthatadrugcanbedesignatedas‘orphan’formultipleindications.110TheexampleofNovartisillustratesthispoint.InMay2001thecompanyreceivedmarketingapprovalbytheFDAwithmarketexclusivityforits‘chronicmyelogenousleukemia’drugGleevecundertheOrphanDrugAct.In2005overaspanoffivemonths,Novartisappliedforandwaslatergrantedorphandrugdesignationforfivedifferentindicationsforthissamedrug.Accordingtothecompany’s2010annualreport,Gleevecrecordedsalesgloballyin2010were$4.3billion,thusconfirmingthepointraisedbyLazonickandTulum,thatevenwhenthemarketsizeforadrugissmall,therevenuescanbeconsiderable.111Whenitcomestothesubstantialrevenuesthataregeneratedfromdrugsdesignatedas‘orphan’itisnotonlysmallfirmsthatappeartobebenefiting.Someoftheworld’slargestpharmaceuticalfirmssuchasRoche,Johnson&Johnson,GlaxoSmithKlineandPfizeramongothershaveappliedfororphandrugdesignation.TheNationalOrganizationforRareDisorders,anon-profitpublicorganisationlargelyfundedbyfederalgovernment,hasbeenencouraginglargepharmaceuticalfirmstosharetheirredundantproprietaryknowledge,throughlicensingdeals,withthesmallerbiotechfirmstodevelopdrugsfororphan TheUSentrepreneurialstateindications.LazonickandTulumexplaintheimportanceofthislegislationbycalculatingtheshareoforphandrugswithintotalproductrevenuesformajorbiopharmaceuticalfirms.112Thefinancialhistoriesofthesixleadingbio-pharmaceutical(BP)companiesrevealadependenceonorphandrugsasasignificantportionofthecompanies’overallproductrevenues.Infact,59percentoftotalproductrevenuesand61percentoftheproductrevenuesofthesixleadingdedicatedbiopharmaceuticalfirmscomefromorphandrugsales.Whenthiscalculationalsoincludesthelatergenerationderivativesofdrugsthathaveorphanstatus,thefigure(calculatedfor2008)goesupto74percentoftotalrevenuesand74percentoftheproductrevenuesforthesixleadingbiopharmaceuticalfirms.Comparingthetimingandgrowthofrevenuesfororphanandnon-orphan‘blockbusters’,LazonickandTulumshowthatorphandrugsaremorenumerous,theirrevenuegrowthbeganearlier,andmanyofthemhavegreater2007salesthanleadingnon-orphandrugs.113Thecentralrolethatorphandrugshaveplayedinleadingthedevelopmentofthebiotechindustryisundeniable,yetthisisjustoneofmanycriticalmovestheUSgovernmentmadeinsupportingthebiotechindustry.Itisalsoevidentthatbigpharmaplaysasignificantroleinthebiopharmaceuticalindustry,asillustratedinanalysesoforphandrugs.Thetwo(bigpharmaandthebiotechindustry)aresignificantlydependentononeanotherinthisarea,andthedistinctionbetweenbigpharmaandbigbiopharmahasbecome‘blurred’.However,theroleofgovernmentforboththeseareaswascrucialtotheirdevelopmentandsuccess.LazonickandTulumsummarisedthegovernment’sroleforbothduringthe2000s:TheUSgovernmentstillservesasaninvestorinknowledgecreation,subsidizerofdrugdevelopment,protectorofdrugmarkets,and,lastbutnotleast…purchaserofthedrugsthatthebiopharmaceuticalcompanieshavetosell.TheBPindustryhasbecomebigbusinessbecauseofbiggovernment,and…remainshighlydependentonbiggovernmenttosustainitscommercialsuccess.114 85Fromthisbriefoverviewofthesethreeexamples—DARPA,SBIRandorphandrugs—ageneralpointcanbedrawn:theUSAhasspentthelastfewdecadesusingactiveinterventionistpoliciestodriveprivatesectorinnovationinpursuitofpublicpolicygoals.Whatallthreeinterventionshaveincommonisthattheydonottietheshirt-tailsofgovernmenttoanyonefirm;noaccusationsoflame-duckindustrialpolicyhere.Insteaditisanimblegovernmentthatrewardsinnovationanddirectsresourcesoverarelativelyshorttimehorizontothecompaniesthatshowpromise,througheithersupply-side(DARPA)orthroughdemandsideandstartupinterventions(SBIRandorphandrugs).Eitherway,thegovernmenthasnotsimplycreatedthe‘conditionsforinnovation’,butactivelyfundedtheearlyradicalresearchandcreatedthenecessarynetworksbetweenstateagenciesandtheprivatesectortoallowthecommercialdevelopmenttooccur.ThisisveryfarfromcurrentUKgovernmentpolicy,whichassumesthatthestatecansimplynudgetheprivatesectorintoaction.TheNationalNanotechnologyInitiativeTheentrepreneurialrolethatthestatecanplayincreatingstrategicdecisionsinhowtofosterthedevelopmentofnewtechnologies,whichprovidethefoundationfordecadesofeconomicgrowth,hasmostrecentlybeenseeninthedevelopmentofnanotechnologyintheUSA.Thetypesofinvestmentsthatthestatehasmadehavegonebeyondsimplycreatingtherightinfrastructure,fundingbasicresearchandsettingrulesandregulations.Nanotechnologyisverylikelytobethenextgeneralpurposetechnology,havingapervasiveeffectonmanydifferentsectorsandbeingthefoundationofeconomicgrowth.However,whilethisiscommonlyacceptednow,inthe1990sitwasnot.Motoyama,AppelbaumandParkerdescribeindetailhowtheUSgovernmenthasinfactbeentheleadvisionaryindreamingthepossibilityofananotechrevolution—makingthe‘againstallodds’initialinvestments,andexplicitlyforming TheUSentrepreneurialstatedynamicnetworksbetweendifferentpublicactors(universities,nationallabs,governmentagencies)andwhenavailable,theprivatesector,tokickstartamajornewrevolution,whichmanybelievewillbeevenmoreimportantthanthecomputerrevolution.115Ithasevenbeenthefirstto‘define’whatnanotechnologyis.ItdidsothroughtheactivedevelopmentoftheNationalNanotechnologyInitiative(NNI).Motoyama,AppelbaumandParkerdescribehowitwassetup:ThecreationandsubsequentdevelopmentoftheNNIhasbeenneitherapurelybottom-upnortop-downapproach:itdidnotderivefromagroundswellofprivatesectorinitiative,norwasittheresultofstrategicdecisionsbygovernmentofficials.RatheritresultedfromthevisionandeffortsofasmallgroupofscientistsandengineersattheNationalScienceFoundationandtheClintonWhiteHouseinthelate1990s…ItseemsclearthatWashingtonselectednanotechnologyastheleadingfrontrunner,initiatedthepolicy,andinvestedinitsdevelopmentonamulti-billiondollarscale.116Thegovernment’sobjectivewastofindthe‘nextnewthing’toreplacetheinternet.Afterreceiving‘blankstares’,thekeyplayers(civilservants)inWashingtonconvincedtheUSgovernmenttoproceedtoinvestincreatinganewresearchagenda,andtoprepareasetofbudgetoptionsandacleardivisionoflabourbetweenthedifferentagencies.Itevenhadfirsttodefinenanotech.Theydidsobyarguingthattheprivatesectorcouldnotexpecttoleadapplicationsofnanotechthatwerestillsofaraway(10–20years)fromthecommercialmarket:Industrygenerallyinvestsonlyindevelopingcost-competitiveproductsinthe3to5yeartimeframe.Itisdifficultforindustrymanagementtojustifytotheirshareholdersthelargeinvestmentsinlong-term,fundamentalresearchneededtomakenanotechnology-basedproductspossible.Furthermore,thehighlyinterdisciplinarynatureoftheneededresearchisincompatiblewithmanycurrentcorporatestructures.117 87Thisquoteisfascinatingbecauseofthewayithighlightshowtheprivatesectoristoofocusedontheshortterm(mainlybutnotonlyasaresultoftheeffectthe1980sshareholderrevolutionhashadonlong-termthinkingofbusiness)anditsrigidstructures.Farfrombeinglessinnovativethantheprivatesector,governmenthasshownitselftobemoreflexibleanddynamicinunderstandingtheconnectionsbetweendifferentdisciplines(physics,chemistry,materialsscience,biology,medicine,engineeringandcomputersimulation).AsBlockandKellerdiscuss,governmentactionsaroundcuttingedgenewtechnologieshaveoftenhadtoremainveiledbehinda‘hidden’industrialpolicy.118Thepublicsectoractivistsaroundnanotechnologyhadtocontinuouslytalkabouta‘bottom-up’approachsothatitwouldnotseemtobetooheavily‘picked’andchampioned.Thoughintheend,‘Whilemostofthepolicymakingprocessinvolvedconsultationwithacademicsandcorporateexperts,itisclearthattheprincipalimpetusanddirection—frombackgroundreportstobudgetscheme—camefromthetop.’119TheapproachsucceededinconvincingClinton,andthenBush,thatinvestmentsinnanotechnologywouldhavethepotentialto‘spawnthegrowthoffutureindustrialproductivity’andthatthe‘thecountrythatleadsindiscoveryandimplementationofnanotechnologywillhavegreatadvantageintheeconomicandmilitarysceneformanydecadestocome’.120Intheend,theUSgovernmenttookaction.Itnotonlyselectednanotechnologyasthesectortobackmostforcefully(‘pickingit’asawinningsector),butalsoproceededtolaunchtheNNI,reviewrulesandregulationsconcerningnanotechbystudyingthevariousrisksinvolved,andbecomethelargestinvestor,evenbeyondwhatithasdoneforbiotechandthelifesciences.AlthoughthestrongestactionwascarriedouttopdownbykeyseniorlevelofficersintheNSFandtheWhiteHouse,theactualactivitybehindnanotechwas,asinthecaseoftheinternetandcomputers,heavilydecentralisedthroughvariousstateagencies(atotalof13,ledbytheNSF,butalsoinvolvingtheNIH,theDefenseDepartmentandSBIR).Acrossthesedifferentagencies, TheUSentrepreneurialstatecurrentlytheUSgovernmentspendsapproximately$1.8billionannuallyontheNNI.Nanotechnologytodaydoesnotyethaveamajorimpactbecauseofthelackofcommercialisationofnewtechnologies.Motoyama,AppelbaumandParkerclaimthatthisisduetotheexcessiveinvestmentsinresearch,andlackofinvestmentsincommercialisation.121Theycallformoreactivegovernmentinvestmentincommercialisation.However,thisraisesthequestion,ifgovernmenthastodotheresearch,fundmajorinfrastructureinvestmentsandundertakethecommercialisation,whatistheroleoftheprivatesector?Thischapterhashighlightedtheimportantrolethatgovernmenthasplayedinleadinginnovationandeconomicgrowth.Farfromstiflinginnovationandbeingaweighttothesystem,ithasfosteredinnovationanddynamisminmanyindustries,withtheprivatesectoroftentakingabackseat.IronicallyithasoftendonesointheUSA,whichinpolicycirclesisoftendiscussedasfollowingamore‘market’orientedmodelthanEurope.Thishasnotbeenthecasewhereinnovationisconcerned.ItistotheimplicationsofthisexperienceforUKpoliciesthatwenowturn. 89 915LessonsfortheUKOneofthecoremessagesofthispamphletisthatthehistoryoftechnologicalchangesuggeststhatthekeyroleofgovernmentisnotaboutfixingmarketfailures,butratheraboutactivelycreatingthemarketforthenewtechnologiesbyenvisioningtheopportunityspaceandallowingtherightnetworkofprivateandpublicactorstomeetinorderforradicalinnovationtooccur.Theroleofgovernmenthas,inthissense,beenmoreaboutfixing‘networkfailures’thanabout‘marketfailure’.Ithasalsobeenaboutpreventing‘opportunityfailures’—government’swillingnesstothinkbigandtakeriskshascreatednewopportunitiesandmarkets,whereastheprivatesectorhasshiedawaybecauseofthelongtimehorizonsandthehighfailurerates.AnarticleinTheEconomistrecentlyclaimedthatthe‘governmenthasaterriblerecordatpickingwinners’.122Alookatthemassiveimpactthatgovernment’stargetedlargeinvestmentsinindustriessuchassteel,railways,airtravel,siliconmicrochipmanufacturing,automotivemanufacturing,computer,biotechnologyandtheinternet,andnanotechnologyshowsthisisjustnottrue.Withoutthegovernmentpursuingatargetedinvestmentstrategy,noneoftheseindustrieswouldhavecomeintobeing.Andbeingfirstmattersbecauseofthestrongeconomiesofscale.Inthisrespect,Britainhasgotitsinnovationpolicyallwrong,withnegativeimplicationsforgrowthinthelongrun.Taxpayersupportismisdirectedandopportunitiesarebeingmissed.Innovationpolicyneedstofocusoncreatingtheconditionsthatallowinnovationtoflourish,butalso,andperhapsespecially,ondirectlycommissioningandprocuringinnovativesolutions.Historytellsusthatthesewillnothappenwithoutastrongpushbythestate.Herearesomesuggestionsofimprovementsthatcanbemade. LessonsfortheUKCostneutralopportunity:reformtheSmallBusinessResearchInitiativeprogrammeTheUKGovernmenthasrecentlytriedtocopythesuccessoftheUSSmallBusinessInnovationResearch(SBIR)programmebysettingupin2001aschemeentitledtheSmallBusinessResearchInitiative(SBRI),whichismeanttoactasacross-departmentalinitiativeimprovingthesuccessofsmallR&D-basedbusinessesinobtainingcontractsfromgovernmentbodies.Withatargetrateof2.5percent,theinitialobjectivewastoplace£50millionofgovernmentR&DcontractsperannumwithSMEsthroughtheSBRIwebsite.However,by2004,contractsworthonly£2millionperyearwerebeingadvertisedandnoneofthekeydepartmentsparticipated.123Followingpressure,inparticularfromCambridge-basedinnovationpolicylobbygroups,theSBRIwasrelaunchedthroughthesupply2.gov.ukwebportalbutasubsequentevaluationbytheRichardreportshowedthattwoyearslatertheschemestillbearsnorealresemblancetotheUSSBIR,mainlybecausehardlyanyoftheprojectsactuallyinvolveR&D(forexamplecontractstosupplyChinesebookstolocalauthoritylibraries),andmanywereresearchcouncilsseekinggrantproposalsfromacademicresearchers,andforwhichbusinessesareineligibletoapply.124Furthermore,themaximumsizeofcontractstypicallycoveredbythesupply2govdatabaseis£100,000,comparedwithatypicalsizeof$850,000underUSSBIR.TheUKSBRIhassufferedfromalackofministerialattentionandthefactthatitisatoddswiththecultureoftheprocurementofficesofnationalgovernment.The2011budgetincludedawelcomecommitmenttocommit£20millionoverthenexttwoyearstotheSBRI,halfofwhichwouldbeearmarkedforspecificcompetitionstomeethealthcarechallenges.However,thisisadropintheoceanandshouldbedramaticallyincreasedwithincurrentprocurementbudgetsinlinewiththeUSexample. 93Costsaving:cutblanketsupporttosmallfirmsInchapter1wesawthatthereisnotmuchofarelationshipbetweenbeingsmallandhavingpotentialtogrow.Yes,fastgrowingfirmsstartoutsmallbutplentyofothersmallfirmsarenotfastgrowing,nordotheywanttobe.Manysmallerbusinesseshavelowerproductivitybecausetheyarelesswellmanagedthanlargerfirms,sometimesbecausetheyaremorelikelytobefamily-ownedandfamily-run.Ratherthangivinghandoutstosmallcompaniesinthehopethattheywillgrowitisbettertogivecontractstoyoungcompaniesthathavealreadydemonstratedambition;itismoreeffectivetocommissionthetechnologiesthatrequireinnovationthanhandoutsubsidiesinthehopethatinnovationwillfollow.Thisapproachcouldyieldsignificanttaxpayersavingsif,forexample,directtransferstofirmsthataregivenjustbecauseoftheirsizewereended,suchassmallbusinessratereliefforsmallercompaniesandinheritancetaxreliefforfamilyfirms.125Costsaving:shiftfromR&DtaxcreditstocommissioningR&DSimilarly,whilethereisaresearchcomponentininnovation,thereisnotalinearrelationshipbetweenresearchanddevelopmentandeconomicgrowth.Whileitisimportantthatthefrontiersofscienceadvance,andthateconomiesdevelopthenodesandnetworkstoenableknowledgetobetransferredbetweendifferentorganisationsandindividuals,itdoesnotfollowthatitisthebestuseoftaxpayers’moneytosubsidisetheactivityofR&Dpersewithinindividualfirms.AlthoughitiscommonsensethatthereisarelationshipbetweenadecisiontoengageinR&Danditscost,qualitativesurveysoftheeffectivenessoftheR&DtaxcreditforbothlargeandsmallfirmsprovidelittleevidencethatithaspositivelyimpactedonthedecisiontoengageinR&D,ratherthansimplyprovidingawelcomecashtransfertosomefirmsthathavealreadydoneso.126ThereisalsoapotentialproblemunderthecurrentR&Dtaxcreditsystemthatitdoesnotholdfirmsaccountable LessonsfortheUKforwhethertheyhaveconductednewinnovationthatwouldnototherwisehavetakenplace,orsimplyundertakenmoreroutineformsofproductdevelopment.Intime,therefore,astheentrepreneurialstateisbuilt,itwouldbemoreeffectivetousesomeoftheexpenditureonR&Dtaxcreditstodirectlycommissionthetechnologicaladvanceinquestion.Costsaving:donotbedistractedbylow-taxenterprisezonesRelatedtothespecificissueaboutR&Dtaxcreditsisthemoregeneralpointthatinvestmentininnovationisgenerallynotverysensitivetotaxes.AsKeynesemphasised,businessinvestment(especiallyinnovativeinvestment)isafunctionof‘animalspirits’,thegutinstinctofinvestorsaboutfuturegrowthprospects.Thesearemoreaffectedbythestrengthofanation’ssciencebase,itssystemofcreditcreation,andqualityofeducationandhencehumancapitalratherthantaxes.Taxcutsinthe1980sdidnotproducemoreinvestmentininnovation,onlyaffectingincomedistribution(increasinginequality).Forthissamereason,‘enterprisezones’whicharefocusedalmostexclusivelyonbenefitsrelatedtotaxandweakenedregulationarenotinnovationzones.Besttosavethatmoneyortoinvestitinproperlyrunscienceparks.127Costsaving:donotimplementthepatentboxAsdiscussedinchapter2,firmsareincreasinglyproducingpatentsoflittlevalue.Inthissense,patentsareoverlyemphasisedasnecessaryforinnovationtooccur.Infact,evidencehassuggestedthatmanyfirmscanappropriatetheirinnovationsthroughothermeasures,andthattheincreaseinpatentinghasnotledtoanincreaseintherateofinnovation.128Notwithstandingthisevidence,theUKGovernmentclaimsthatpatentshaveastronglinktoongoinghigh-techR&Dandhasthussuggestedapatentbox—apreferentialregimeforprofitsarisingfrompatents—torewardpatentholders.ThisideahasbeencriticisedferociouslybytheInstitutefor 95FiscalStudiesasbeingawasteofmoneyandnotencouragingresearch.Thepatentboxwillnotstimulatethetypesofinnovationthatareneededbecauseitonlytargetstheincomeearnedfrompatentsnottheresearchitself(asimilarclaimwemakeaboveaboutR&Dtaxcredits,sincehistoricallytheyhavebeenbadlycontrolledsothatitisnotclearthatthemoneyhasbeenspentonresearch).ThepatentboxandmanySBRIprogrammesdirectreturnstopotentiallymediocreandnoninnovativecompaniesratherthantheleadersofinnovation.Furthermore,patentsareincreasinglybeingappliedtoupstreamareaslikeresearchtools,stuntingratherthanencouragingresearch(andreplication),puttingtheopensciencesystematrisk.129Additionalexpenditure:massivereformandexpansionoftechnologystrategyboardTheGovernmentshouldimplementtherecommendationstheCBImadein2006toreformtheUKTechnologyStrategyBoard(TSB)alongtheUSDARPAmodel.130Withamuchexpandedbudget,theTSBshouldthereforebecomemoreofadynamiccommissionerofinnovativesolutionsatthefrontiersofinnovationandresearch.Itshouldwelcome(ratherthanshyawayfrom)theriskyterritoryofblueskyresearch,facilitatingnetworkingbetweenbusinessandacademia,andengaginginpre-commercialprocurementtoafargreaterextent.TheUKGovernmentshouldcreateavisionwherebytheTSBcanbringtogethergovernmentdepartments,researchcouncils,localeconomicpartnershipsandotherpublicbodiestoaddressspecificchallenges,suchasthosearoundgreentechnology.IftheTSBfunctionedinthiswayitwoulddemonstratethatthecoreinnovationproblemisnotoneof‘marketfailure’butratheroneof‘networkfailure’,andshowitunderstandsthegovernment’sroleincreatingandleadingthosenetworks.AsDosi,LlerenaandLabiniemphasise,forsuchanetworktofunctionproperly,thedifferentagentsinthenetworkmustbestrongnotweak.131HencefundamentaltothisstrategywillbeastrongsciencebaseinUKuniversitiesand LessonsfortheUKpubliclaboratories.ThefactthatUKscienceisfallingbehindthatofitsmaincompetitorsisworrying.132AnenhancedmodelfortheTSBwouldbeemblematicofashiftoftheUKgovernmentawayfromasystemwheretechnologicalchallengesareshoweredwithtaxincentives,subsidiesandpricingdebates(thelatterinthecaseofpharmaceuticals)andmoretoasystemwherethegovernmentcommissionedsolutionstospecificproblemsandcatalysedpotentialopportunitiesfromtheprivatesector,withoutnecessarilyspecifyinghowtheseshouldbeachieved.TheTSBandotherBISschemesshouldfocusmoreonthoseprivate-publicecologiesthatwillenableradicalinnovationtoemerge.ItisespeciallyradicalinnovationthatembodiesthetypeofKnightianuncertaintythatprivateventurecapitalshiesawayfrom,anditisespeciallyinthisareathattheleadingroleofthepublicsectorisessential.Thisinvolvessupportingthefullspanofactivitiesthatwerediscussedinchapters3and4.Costsaving:retainproportionofownershipofstate-backedintellectualpropertyWheretechnologicalbreakthroughshaveoccurredasaresultoftargetedstateinterventions,thereispotentialforthestate,overtime,toreapsomeofthefinancialrewards,byretainingownershipoverasmallproportionoftheintellectualpropertycreated.Thisisnottosaythestateshouldeverhaveexclusivelicenceorholdalargeenoughproportionofthevalueofaninnovationthatitdetersawiderspreadofitsapplication—theroleofgovernmentisnottoruncommercialenterprises,buttosparkinnovationelsewhere.Butgovernmentshouldexplorewhetheritispossibletoownaslitherofthevalueithascreated,whichovertimecouldcreatesignificantvalueandthenbereinvestedintogrowth-generatinginvestments.Forexample,wesawinchapter1thatthree-quartersofthenewmolecularbio-pharmaceuticalentitiesowetheircreationtopubliclyfundedlaboratories.Yetinthepastten 97years,thetoptencompaniesinthisindustryhavemademoreinprofitsthantherestoftheFortune500companiescombined.Theindustryalsoenjoysgreattaxadvantages:itsR&Dcostsaredeductible,andsoaremanyofitsmassivemarketingexpenses,someofwhicharecountedasR&D.133AftertakingonmostoftheR&Dbill,thestateoftengivesawaytheoutputsatarockbottomrate.Forexample,Taxol,thecancerdrugdiscoveredbytheNationalInstitutesofHealth(NIH),issoldbyBristol-MyersSquibbfor$20,000peryear’sdose,20timesthemanufacturingcost.Yet,thecompanyagreedtopaytheNIHonly0.5percentinroyaltiesforthedrug.Similarly,whereanappliedtechnologicalbreakthroughisdirectlyfinancedbythegovernment,itshouldinreturnbeabletoextractasmallroyaltyfromitsapplication.Again,thisshouldnotbesufficientastoprohibititsdisseminationthroughouttheeconomy,ortodisincentivisetheinnovatorsfromtakingtheriskinthefirstplace.Insteaditmakesthepolicyofspendingtaxpayers’moneytolighttheinnovativesparkmoresustainable,byenablingpartofthefinancialgainsfromsodoingtoberecycleddirectlybackintotheprogrammeovertime.GreentechnologiesThereiscurrentlyaglobalracetobetheleaderingreentechnologies.Britainhasapotentialtodowellinthisracebutisindangerofbeingleftbehind.Theremainderofthischapterconsiderstheapplicationofwhathasbeenlearntsofartospurgreaterinnovationswithgreentechnologyapplication.IntheUSAthestimuluspackagesincluded11.5percentofthebudgetdevotedtogreeninvestment,butintheUKthefigureisonly6.9percent,farlowerthanChina(34.3percent),France(21percent)orSouthKorea(80.5percent).134Infact,inJuly2010theSouthKoreanGovernmentannouncedthatitwoulddoubleitsspendingongreenresearchtotheequivalentof£1.9billionby2013(almost2percentofitsannualGDP),whichmeansthatbetween2009and2013itwillhavespent£59billiononthistypeofresearch. LessonsfortheUKThisisnotanewproblem.Datafor2007showtheUKnearthebottomoftheleaguewhencomparinggovernmentinvestmentinenergyR&D,spendinglessthanUSandAsiancompetitorsandsomeotherEuropeancountries(figure8).Theproblemisthattheprivatesectorisnotcomingintofillthegapso,overall,theUK’sinvestmentof12.6billionin2009/10135is,accordingtoPIRC,‘under1percentofUKGrossDomesticProduct;halfofwhatSouthKoreacurrentlyinvestsingreentechnologiesannually;andlessthanwhattheUKpresentlyspendonfurnitureinayear’.136Source:CommitteeonClimateChange,2010137 99DespitethePrimeMinister’spledgein2010tolead‘thegreenestgovernmentever’,138inrealitythespendingcutshavecausedestablishedprogrammesintheseareastobescaledback.In2010/11,£85millionwascutfromtheDepartmentofEnergyandClimateChangebudget,including£34millionfromtherenewablesupportprogrammes.Furthermore,40percentcutshavebeenappliedtothe2011budgetoftheCarbonTrustand50percentcutstotheEnergySavingTrust:Combinedwithareluctancetoguaranteesourcesofgreenfinanceoverthelongterm—includingfailingtoguaranteegrantsforelectriccarsbeyondoneyear,andpledgingtoreviewtheFeed-InTariffstructurein2012—thesemoveshavenotcreatedanoptimumenvironmentforgreeninvestment.139AnApril2011revisionhasalreadyhalvedthefeed-intariffforcommercialinstallationsabove50kWinordertofundthepromisedsupportforsmallresidentialinstallations.Norhastheeffectofpreviousinitiativesbeenproven:theApril2009budgettriedtoaccelerateemissionsreductioninpowergenerationbyrequiringcarboncaptureandstorage(CCS)tobefittedtoallnewcoal-firedstations(andretrofittedtoallexistingstationsby2014);yetaccordingtotheHouseofCommonsEnergyandClimateChangeCommittee,thiscouldjustleadtoarenewedexpansionofgas-firedgenerationratherthansubstantialinvestmentinCCStechnology.140ThisfitsabroaderpictureofhowEUcountriesarerespondingtocurrenteconomiccircumstances.ErnstandYoungreportarecordglobalinvestment(includingprivateandpublicinvestmentsuchasfeed-intariffsforsolarprojects)intocleantechof$243billionin2010,butcommentthatthe‘marketisinflux’inthefaceofchallengingfinancialconditions,withbigvariationsininvestmentacrossgeographiesandtechnologies.141Chinareceivesmostinvestment,followedbytheUSA,withcountriesinEuropestrugglingtobalancefinancialcommitmentstodevelopingcleantechnologiesagainstmanagingnationaldeficit. LessonsfortheUKInasense,giventheargumentabovethatinnovationisabouthavingtherightnetworksintheeconomyandthencommissioningspecifictechnologies,itcouldbearguedthatscalingbackdirectsubsidiesandgrants,regardlessofthepurpose,isnottroublesomeifinnovativeforceswerecomingfromelsewhere.However,alookatrecentdataseemstoimplythatthisisnotthecase.Infact,theUKisatriskoffallingbehindinthisarea,havingbeenseenasacountrythatwascatchingupinthelastdecade.Sincegreentechnologyisstillinitsveryearlystage,whenKnightianuncertaintyishighest,venturecapitalfundingisfocusedonsomeofthesaferbetsratherthanontheradicalinnovationwhichissoneededtoallowthesectortotransformsocietyinthewaysthatthe20-20-20policiesarehoping.142GhoshandNandaclaimthatitisvirtuallyonlypublicsectorfundsthatarecurrentlyfundingtheriskiestandthemostcapitalintensiveprojectsingreentechnology—theonesintheupperrighthandcornerinfigure9.143Venturecapitalfundingisconcentratingvirtuallyonlyonsomeoftheareasinthebottomright.Thisishighlyproblematicsincetheearlystageofthesectormeansthatbydefinitionmanyoftheneededdevelopmentsarestillcapitalintensivesounlessthegovernmentmakesamark,theseimportantareaswillremainunderdeveloped.Source:GhoshandNanda144 101HistoricallytheUKhadbeenviewedasoneofthemostinnovativecountriesincleantechnologiesstartingsince2000,despiteitsroleasalaggardintheearly1990s,145withinvestmentsincleantechinfrastructureandR&Dincreasinginresponsetogovernmentcommitmentsof£405milliontocutdownthecarbonemissionsbyaroundone-thirdby2020.146ComparedwithothercountriestheUK’scleantechinnovationsourcedmorefromsmallerfirmsandacademiasowouldseemgenerallysupportiveofanenvironmentforventurecapitalinvestment.147However,whileventurecapitalinvestmentincleantechintheUSArecoveredduring2010,venturecapitalinvestmentactivityintheUKwasatitslowestlevelsince2003.148Althoughglobalinvestmentmaybeapproachingrecentrecordlevels,ErnstandYoung’sanalysisofthetotalinvestment(allsources)requiredtoachievetheEU2020target,of20percentofenergysuppliedbyrenewablesourcesby2020,estimatedanannualinvestmentgapof€35billionforEuropeanmemberstatestofindeachyear.149Suchlargeinvestmentrequirementsarerequiredatatimewhenventurecapitalistsbegintorealisethelimitationsoftheirinvestmentmodels.Forinstancein2009observersnotedventurecapitalfundsshiftingfocustofundingcleantechinvestmentswithlessthantwo-yearpay-backperiods.Moreincrementalinnovationsthatdealwithenergyefficiencyappeartobegivenpriorityoverthecuttingedgebio-fuelsoradvancedsolartechnologies.150AnalysisoftheinvestmentactivityofUKfirmsfundedbyventurecapitalistsfoundtwo-thirdsoffirmshadnopatents,suggestinginvestorshadnotprimarilyfocusedonradicalinnovations,andthatthoseinvestorssupportingpatentingfirmstendedtobelarger,withawidecoverageofindustries,suggestingalackofspecialisation.151Figure10showsthatJapaniscurrentlythegloballeaderinenvironmentaltechnologypatents,possiblybecauseitscorporatecultureandchronicallylowinterestratespromoteanunusuallylongpaybackhorizoncomparedwiththeAnglo-Americannorm.Theright-handsideofthescaleisthecountry’sshareinworldenvironmentalpatentsrelativetothe LessonsfortheUKshareofthecountryintotalworldpatents;anRTAgreaterthanonemeasuresspecialisationinenvironmentalpatents.So,forexample,Japan’shighglobalshareinenvironmentalpatentsiscombinedwithaninternalspecialisationinenvironmentaltechnologies;Chinahasalsopatentedmoreinenvironmentaltechnologiesthanothersectors,althoughthisisnot(yet)enoughtoachieveglobaldominance.Source:WIPO152Note:RTAistheshareofthecountryinworldenvironmentalpatentsrelativetotheshareofthecountryintotalworldpatents;RTA>1measuresspecialisationinenvironmentalpatents. 103LikewiseGhoshandNandahighlightthatventurecapitalistsareincreasinglytargetingincrementalinnovationsinestablishedtechnologiestoimproveenergyefficiency,movingawayfrommoreradicalformsofinnovationforenergyproduction.153Thepreferencesforfamiliartechnologyandquickpaybackaddtofearsofarenewed‘dashforgas’asthemostlikelywayfortheUKtotrymeetingitsemissionsreductioncommitments,eventhoughthiswilladdtodangersofenergyinsecurityandofsharplyrisingcostswhengasreservesbegintodeplete.Thefinancialandtechnologicalrisksofdevelopingalternativeformsofenergyproductionhavebeentoohighforventurecapitaltosupport,owingtothesizeanddurationoftechnicalrisksbeyondtraditionalproofofconcept.Forinstance,evenifproofofconceptisachieved,itmaynotbefeasibletoproduceatthescalerequiredforenergyproduction.Thefinancialrisksofsupportingafirmtoreachthestagewheretechnologyisscalableistoogreatformostventurecapitalfunds.InthissensetheabsenceofliquidIPOmarketsforcleantechfirmsrestrictsthetechnologythatventurecapitalistscansupport.GhoshandNandasuggestthat,intheabsenceofanappropriateinvestmentmodel,venturecapitalmaystruggletoprovidethetypesofrapiddevelopmentofradicalinnovationsolutionsrequired.154Theconclusionthatmightfollowisthatthegovernmentneedstobecommissioningthedevelopmentoftheriskiesttechnologies.Butthisisnothappeningeither.ThemaininitiativeoftheCoalitionGovernmentistoestablishagreeninvestmentbanktoprovideseedcornfundingforgreentechnologies.Itisbasedonthenotionthatthegreenrevolutioncanbeledprivately,simply‘incentivised’bythestate.Thisiswrong(noothertechrevolutionhasoccurredthisway),andthecurrentamountsbeingdiscussedaretooinsignificanttomakeanydifference.Thegreeninvestmentbankinitiativedoesnotlearnfrompreviousrevolutionsintheimportanceofactivestate-ledinvestments,allowingthecountryto‘befirst’andhencereapfutureincreasingreturns.ChinaisbuildingonepowerstationaweekandBritainisfiddlingwithplaymoney. LessonsfortheUKImprovingtheUK’sageingenergyinfrastructurewillrequiremassiveinvestments.Theproposedgreeninvestmentbankcouldhelptogetimportantprojectsoffthedrawingboard.However,asthecashforitisdependentonsellingoffstrategicassetsindifficultmarketconditions,itwilltakemanymonthsorevenyearsbeforethefundisabletomakeameaningfuldifference.Andthecurrentfiguresarepeanuts.However,expandedandbroadened, thegreeninvestmentbankcouldgrowintoastrategicinvestmentbank,liketheEuropeanInvestmentBankorGermany’sKreditanstaltfürWiederaufbau.Thosehaveaproventrackrecordofpromotinginfrastructuredevelopmentand returningaprofitforthetaxpayer—theUKhasalwayslackedacomparablesourceoflong-termfinance,andwouldgainfromdevelopingone.IfittookmoreofaninnovationfocusthantheEuropeanInvestmentBankandKreditanstaltfürWiederaufbau,itcouldbecomeanewtypeofpublic-sectorstrategicfinanceinstitution.Thiswouldbehelpfulparticularlytogetlargescaleprojectsofftheground.Butitwouldnotnecessarilyprovidetheincentiveforthehighriskinnovativebreakthroughstooccurinthefirstplace.TheinabilityoftheUKtoleadtheworldinthedevelopmentofgreentechnologiesistheresultnotofthelackofagreeninvestmentbanktoprovideseedcornfinancebutofanunderdevelopedecologyofnetworksandgovernmentprocurementsystemsdesignedtowrenchtechnologicalprogressoutofthatsystem.Oncethebreakthroughshaveoccurred,financewillneedtobefoundtotransformourexistinginfrastructuretoreduceitsenvironmentalimpact.Butthatisaboutimplementation,ratherthaninnovation.AcluetowhatisrequiredisagainfoundintheUSA,wheregovernmentfundedinitiativesarebusybuildingontheirunderstandingofwhathasworkedinprevioustechnologicalrevolutions. 105Obama’sgreentechinitiativeWiththepassageoftheAmericanRecoveryandReinvestmentActbythecurrentObamaadministration,theDepartmentofEnergy(DOE)wasallocatedtensofbillionsofdollarstodevelopalternativeenergytechnologiesandtoalterexistinginfrastructuretoreduceenergywaste.Thisrecentinitiativerepresentsanenormousexpansionofgovernmentspendingtoshapeinnovationinthecivilianeconomy,exactlytheoppositeofwhatisbeingarguedintheUK,wherethedebatecontinuestobethestaticonebetween‘pickingwinners’and‘creatingtherightconditions’whilebeingineffectualinallowingtheUKtobecomeleaderinanysector.Inaddition,thecurrentUSadministrationcreatedanewprogramme,ARPA-E,whichismodelledspecificallyontheDARPAmodel‘tofocuson“outofthebox”transformationalresearchthatindustrybyitselfcannotorwillnotsupportduetoitshighriskbutweresuccesswouldprovidedramaticbenefitsforthenation’.155Theagencyischargedwithbringingforthanew,excitingdirectiontoenergyresearchthat‘willattractmanyoftheU.S.’sbestandbrightestminds—thoseofexperiencedscientistsandengineers,andespecially,thoseofstudentsandyoungresearchers,includingpersonsintheentrepreneurialworld’.156UsingtheDARPAmodelARPA-E’sorganisationis‘flat,nimble,andsparse,capableofsustainingforlongperiodsoftimethoseprojectswhosepromiseremainsreal,whilephasingoutprogrammesthatdonotprovetobeaspromisingasanticipated’.157Withafocusonnetworkexpansion,theagencywasalsoestablishedtodevelopa‘newtooltobridgethegapbetweenbasicenergyresearchanddevelopment/industrialinnovation’.158In2009theDOEawarded$377millioninfundingfor46newmulti-milliondollarenergyfrontierresearchcenters(EFRCs)locatedatuniversities,nationallaboratories,non-profitorganisations,andprivatefirmsthroughouttheUS.Spanningaperiodoffiveyears,theDOEhascommitted$777milliontothisinitiative.159ThescaleoffundingsignalsthattheDOEiscommittedtomovingproductsthroughtechnologicalmaturityandintothestageofbroadproductionand LessonsfortheUKdeployment.Hundredsofmillionsofdollarsisbeingallocatedtofirms(throughmatchingfundsandloanprogrammes)bytheDOEtosupportthedevelopmentofproductivefacilitiesforsolarpanels,batteriesforelectriccars,biofuelprojects,alongwithprogrammesfocusingspecificallyonadvancingthedeploymentofphotovoltaicsonhomesandbusinesses.160TherecommendationtotheUKgovernmentisclear.Tomaintainaleadincleantechandgreentech,theGovernmentshouldbecommissioningthedevelopmentofbreak-throughtechnologiesinareaswhereithasacomparativeadvantage,creatingapullfactorforinnovationstoflowthrough.Thereisnoavoidingthefactthatthiswillcostmoney,whichiswhywealsoproposethatresourcesbedivertedfromflatsubsidiesofR&Dactivityandsmallbusinesses,whichmayormaynotleadtoinnovationandgrowth. 107 1096Finalthoughtsonrisk-takingininnovation:whogetsthereturn?Thispamphlethasattemptedtohighlighttheactiverolethatthestatehasplayedingeneratinginnovation-ledgrowth.Ashasbeenargued,thishasentailedveryriskyinvestments—speculationfor‘creativedestruction’.Infinance,itiscommonlyacceptedthatthereisarelationshipbetweenriskandreturn.However,intheinnovationgame,thishasnotbeenthecase.Risk-takinghasbeenacollectiveendeavourwhilethereturnshavebeenmuchlesscollectivelydistributed.Often,theonlyreturnthatthestategetsforitsriskyinvestmentsaretheindirectbenefitsofhighertaxreceiptsthatresultfromthegrowththatisgeneratedbythoseinvestments.Isthatenough?Thereisindeedlotsoftalkofpartnershipbetweenthegovernmentandprivatesector,yetwhiletheeffortsarecollective,thereturnsremainprivate.IsitrightthattheNationalScienceFoundationdidnotreapanyfinancialreturnfromfundingthegrantthatproducedthealgorithmthatledtoGoogle’ssearchengine?161Cananinnovationsystembasedongovernmentsupportbesustainablewithsuchasystemofrewards?Thelackofknowledgeinthepublicdomainaboutthecentralentrepreneurialrolethatgovernmentplaysinthegrowthofeconomiesworldwide,beyondKeynesiandemandmanagementand‘creatingtheconditions’forgrowth,iscurrentlyputtingthesuccessfulmodelinmajordanger.ThiscontrastiswelldepictedbytheexampleofferedinVallas,KleinmanandBiscotti:Anewpharmaceuticalthatbringsinmorethan$1billionperyearinrevenueisadrugmarketedbyGenzyme.ItisadrugforararediseasethatwasinitiallydevelopedbyscientistsattheNationalInstitutesofHealth.Thefirmsetthepriceforayear’sdosageat Finalthoughtsonrisk-takingininnovation...upwardof$350,000.Whilelegislationgivesthegovernmenttherighttosellsuchgovernment-developeddrugsat‘reasonable’prices,policymakershavenotexercisedthisright.Theresultisanextremeinstancewherethecostsofdevelopingthisdrugweresocialized,whiletheprofitswereprivatized.Moreover,someofthetaxpayerswhofinancedthedevelopmentofthedrugcannotobtainitfortheirfamilymembersbecausetheycannotaffordit.162Thesocialisedgenerationandprivatisedcommercialisationofbiopharmaceutical—andother—technologiescouldbefollowedbywithdrawalofthestate,ifprivatecompaniesusedtheirprofitstoreinvestinresearchandfurtherproductdevelopment.Thestate’srolewouldthenbelimitedtothatofinitiallyunderwritingradicalnewdiscoveries,untiltheyaregeneratingprofitsthatcanfundongoingdiscovery.Butprivate-sectorbehavioursuggeststhatpublicinstitutionscannotpasstheR&Dbatoninthisway.Andthatthestate’srolecannotbelimitedtothatofplantingseedsthatcanbesubsequentlyreliedontogrowfreely.ManyoftheproblemsbeingfacedtodaybytheObamaadministrationareindeedduetothefactthatUStaxpayersarevirtuallyunawareofhowtheirtaxesfosterinnovationandgrowthintheUSA,andthatcorporationsthathavemademoneyfrominnovationthathasbeensupportedbythegovernmentareneitherreturningasignificantportionoftheprofitstothegovernmentnorinvestinginnewinnovation.163Theyaresoldtheideathatthisgrowthoccursasaresultofindividual‘genius’,toSiliconValley‘entrepreneurs’,toventurecapitalists,towhattheythinkisa‘weak’statecomparedwiththeEuropeansystem.ThesebattlesarealsobeingplayedoutintheUKwhereitisarguedthattheonlywayforthecountrytoachievegrowthisforittobeprivatelyledandforthestatetogobacktoitsminimalroleofensuringtheruleoflaw.Animplicationofthispamphletisthattheonlywaytomakegrowth‘fairer’andforthegainstobebettersharedisforeconomists,policymakers,andthegeneralpublictohaveabroaderunderstandingofwhichagentsinsocietytakepartofthefundamentalrisk-takingthatisnecessarytobring 111oninnovation-ledgrowth.Ashasbeenargued,risk-takingandspeculationareabsolutelynecessaryforinnovationstooccur.TherealKnightianuncertaintythatinnovationentailsisinfactthereasonthattheprivatesector,includingventurecapital,oftenshiesawayfromit.Understandingthedynamicsofinnovationmustbebroughtinlinewithourunderstandingofdynamicsofinequality.TheseareasofeconomicthoughthavebeenseparatedsinceDavidRicardo’sstudyoftheeffectofmechanisationonthewage–profitfrontier—distribution.Recently,therelationshiphascomebackinvoguewithstudiesonhowskill-biasedtechnologicalchangeaffectswages.ThisworkexplainsinequalitythroughhowwagesareaffectedbytechnologieslikeITthatfavourskilledoverunskilledlabourbyincreasingitsrelativeproductivityand,therefore,itsrelativedemandandwages.Inequalityisthusexplainedhereasaresultofhoweconomicincentivesshapedbyrelativeprices,thesizeofthemarket,andinstitutionscreatebiasesinfactorsofproduction,whichthenaffecttheirreturns.164Whilethisworkprovidessomeimportantinsights,itdoesnotexplainmanydynamicsofinequality,includingwhywithinasector,thedifferentagentsthattakepartofproductionandinnovationreapsuchdifferentbenefitsfromtheinnovation.Inequalityisindeedjustashighwithinsectorsasitisbetween.165Theideaofanentrepreneurialstatesuggeststhatoneofthecoremissinglinksbetweengrowthandinequality(ortousethewordsoftheEC2020strategy,between‘smart’and‘inclusive’growth)liesinawideridentificationandunderstandingoftheagentsthatcontributetotherisk-takingrequiredforthatgrowthtooccur.Bankbonuses,forexample,shouldnotlogicallybecriticisedusingargumentsagainstthegreedandunderlyinginequalitythatisproduced(eventhoughthesegeneratepowerfulemotions).Rathertheyshouldbearguedagainstbyattackingtheunderlyinglogicalfoundationonwhichtheystand.Thereceivedwisdomisthatbankerstakeonveryhighrisks,andwhenthoserisksreapahighreturn,theyshouldinfactberewarded—theydeserveit.Thesamelogicisusedto Finalthoughtsonrisk-takingininnovation...justifytheexorbitantlyhighreturnsthatpowerfulshareholdershaveearnedinthelastdecades,whichhasbeenanotherprimesourceofincreasinginequality.Thelogichereisthatshareholdersarethebiggestrisktakerssincetheyonlyearnthereturnsthatareleftoveroncealltheothereconomicactorsarepaid(the‘residual’ifitexists,onceworkersandmanagersarepaidtheirsalaries,loanspaidoff,andsoon).Hencewhenthereisalargeresidualtheyaretheproperclaimant—theycouldinfacthaveearnednothingsincethereisnoguaranteethattherewillbearesidual.Howeveranunderstandingofriskthatgivescredittotheroleofthepublicsectorininnovativeactivitiesimmediatelymakesitlogicalfortheretobeamorecollectivedistributionoftherewardsthatshouldexist.Centraltothisquestionistheneedtobetterunderstandhowthedivisionof‘innovativelabour’mapsintoadivisionofrewards.166Theinnovationliteraturehasprovidedmanyinterestinginsightsontheformer,forexamplethechangingdynamicbetweenlargefirms,smallfirms,governmentresearchandindividualsintheinnovationprocess.167Butthereisverylittleunderstandingonthelatter.Yet,asLazonickhasargued,governmentsandworkersalso(andperhapsmoreso)investintheinnovationprocesswithoutguaranteedreturns.168Thecriticalpointistherelationbetweenthosewhobearriskincontributingtheirlabourandcapitaltotheinnovationprocessandthosewhoappropriaterewardsfromtheinnovationprocess.Asageneralsetofpropositionsontherisk–rewardnexus,whentheappropriationofrewardsoutstripsthebearingofriskintheinnovationprocess,theresultisinequity;whentheextentofinequitydisruptsinvestmentintheinnovationprocess,theresultisinstability;andwhentheextentofinstabilityincreasestheuncertaintyoftheinnovationprocess,theresultisaslowdownorevendeclineineconomicgrowth.169AmajorchallengefortheUKandforEurope2020istoputinplaceinstitutionstoregulatetherisk–rewardnexussothatitsupportsequitableandstableeconomicgrowth. 113Toachievethisitisessentialtounderstandinnovationasacollectiveprocess,involvinganextensivedivisionoflabourthatcanincludemanydifferenttypesofcontributors.Asafoundationfortheinnovationprocess,thestatetypicallymakesinvestmentsinphysicalandhumaninfrastructurethatindividualemployeesandbusinessenterpriseswouldbeunabletofundbecauseofacombinationoftheamountoffixedcoststhatinvestmentininnovationrequiresandthedegreeofuncertaintythatsuchinvestmententails.Thestatealsosubsidisestheinvestmentsthatenableindividualemployeesandbusinessenterprisestoparticipateintheinnovationprocess.Academicresearchersofteninteractwithindustryexpertsintheknowledge-generationprocess.Withinindustrythereareresearchconsortiathatmayincludecompaniesthatareotherwiseincompetitionwithoneanother.Therearealsouser–producerinteractionsinproductdevelopmentwithinthevaluechain.Andwithinthefirm’shierarchicalandfunctionaldivisionoflabour,thereistheintegrationintotheprocessesoforganisationallearningoftheskillsandeffortsoflargenumbersofpeopleinvolvedinthehierarchicalandfunctionaldivisionoflabour.Identificationofwhobearsriskcannotbeachievedbysimplyassertingthatshareholdersaretheonlycontributorstotheeconomywhodonothaveaguaranteedreturn—acentral,andfallacious,assumptionoffinancialeconomicsbasedonagencytheory.Indeed,insofaraspublicshareholderssimplybuyandsellshares,andarewillingtodosobecauseoftheeasewithwhichtheycanliquidatetheseportfolioinvestments,theymaymakelittleifanycontributiontotheinnovationprocessandbearlittleifanyriskofitssuccessorfailure.Incontrast,governmentsmayinvestcapitalandworkersmayinvestlabour(timeandeffort)intheinnovationprocesswithoutanyguaranteeofareturncommensuratewiththeirinvestments.Forthesakeofinnovation,weneedsocialinstitutionsthatenabletheserisk-bearerstoreapthereturnsfromtheinnovationprocess,ifandwhenitissuccessful. 115ConclusionAcorelessonofthispamphletistheneedtodevelopanewindustrialpolicywhichlearnsfromthepastexperiencesinwhichthestatehasplayedaleading,entrepreneurial,roleinachievinginnovation-ledgrowth.State-fundedorganisations(mainlydecentralisedonessuchasDARPA,SBIRandsoon)havebeenfundamentallyinvolvedingeneratingradicallynewproductsandprocesses,whichhavechangedthewaythatbusinessesoperateandcitizenslive—transformingeconomiesforever,fromtheinternetrevolutiontothebiotechrevolutiontowhat(itishoped)willbethegreentechrevolution.Ithasalsobeenarguedthatacorewaytotacklesmartandinclusivegrowthtogetheristoensurethatthegainsfrominnovationarejustascollectiveastherisk-takingunderlyingitis.Inseekinginnovation-ledgrowth,itisfundamentaltounderstandtheimportantrolesthatboththepublicandprivatesectorcanplay.Thisrequiresnotonlyunderstandingthedifferentecologiesbetweenthepublicandprivatesector,butespeciallyrethinkingwhatitisthatthepublicisbringingtothatecology.Theassumptionthatthepublicsectorcanatbestincentiviseprivatesectorledinnovation(throughsubsidies,taxreductions,carbonpricing,greeninvestmentbanksandsoon)—aclaimbeingpropagatedheavilyintheUK,especiallybutnotonlyinthefaceoftherecentcrisisandensuingdeficits—failstoaccountforthemanyexamplesinwhichtheleadingentrepreneurialforcecamefromthestateratherthanfromtheprivatesector. 117Notes1ArthurWB,TheNatureofTechnology:Whatitisandhowitevolves,NewYork:FreePress,2009.2SeeWheelerB,‘DavidCameronsaysenterpriseisonlyhopeforgrowth’,BBCNews,6Mar2011,www.bbc.co.uk/news/uk-politics-12657524(accessed7Jun2011).3‘TamingLeviathan:howtoslimthestatewillbecomethegreatpoliticalissueofourtimes’,TheEconomist,17Mar2011.4Specialreportontheworldeconomy,TheEconomist,9Oct2010.5AmblerTandBoyfieldK,‘Reformingtheregulators’,AdamSmithInstitute,2010,www.adamsmith.org/files/reforming-the-regulators.pdf(accessed7Jun2011).6BISandHMTreasury,ThePlanforGrowth,London:DepartmentforBusiness,InnovationandSkillsandHMTreasury,March2011,http://cdn.hm-treasury.gov.uk/2011budget_growth.pdf(accessed6Jun2011).7BattelleJ,TheSearch,NewYork:Penguin,2005.8The‘hidden’natureofUSindustrialpolicyisthecorethemeofBlockFandKellerM(eds),StateofInnovation:TheUSgovernment’sroleintechnologydevelopment,Columbia:Paradigm,2011. Notes9CBI,‘Innovationandpublicprocurement:anewapproachtostimulatinginnovation’,CBIInnovationBrief,London:ConfederationofBritishIndustry,2006.10BISandHMTreasury,ThePlanforGrowth.11BISandHMTreasury,ThePathtoStrong,SustainableandBalancedGrowth,London:DepartmentforBusiness,InnovationandSkillsandHMTreasury,2010,www.bis.gov.uk/assets/biscore/corporate/docs/p/10-1296-path-to-strong-sustainable-and-balanced-growth.pdf(accessed6Jun2011).12Specialreportontheworldeconomy,TheEconomist.13KentAandLockwoodM,‘Creativedestruction:placinginnovationattheheartofprogressiveeconomics’,IPPRdiscussionpaper,Dec2010.14SmithA,AnInquiryintotheNatureandCausesoftheWealthofNations,ECannaned,5thed,MethuenandCoLtd,1904[1776].15PolanyiK,TheGreatTransformation:Thepoliticalandeconomicoriginsofourtime,Boston:Beacon,2001[1944].16Asarguedattheendofthepamphlet,theinsensitivityofinvestmenttotaxesisthereasonthatthe1980sstyle‘supply-side’economicshadlittleeffectoninvestmentandhenceGDP,andalargeeffectonincomedistribution(no‘trickle-down’effect).17KeynesJM,TheGeneralTheoryofEmployment,InterestandMoney,NewYork:Harcourt,BraceandCompany,1934.18MinskyH,‘Thefinancialinstabilityhypothesis’,JeromeLevyInstituteworkingpaperno74,1992. 11919SeeAbramovitzM,ResourceandOutputTrendsintheUnitedStatesSince1870,NewYork:NationalBureauofEconomicResearch,1956;andSolowR,‘Acontributiontothetheoryofeconomicgrowth’,QuarterlyJournalofEconomics70,1956.20Keynes,TheGeneralTheoryofEmployment,InterestandMoney(1934ed).21Abramowitz,whoknewmuchmoreaboutthesocialconditionsthatsupporttechnicalchangethanSolow,famouslycalledtheresiduala‘measureofourignorance’.SeeAbramovitz,ResourceandOutputTrendsintheUnitedStatesSince1870.22RobinsonJ,‘Theproductionfunctionandthetheoryofcapital’,ReviewofEconomicStudies21,1953–54.23GrossmanGandHelpmanE,InnovationandGrowthintheGlobalEconomy,CambridgeMA:MITPress,1991.24MasonG,BishopKandRobinson,BusinessGrowthandInnovation:Thewiderimpactofrapidly-growingfirmsinUKcity-regions,London:Nesta,2009.25GrilichesZ,HallBHandPakesA,‘R&D,patentsandmarketvaluerevisited:isthereasecond(technologicalopportunity)factor?’,Economics,InnovationandNewTechnology1,1991.26NelsonRRandWinterSG,AnEvolutionaryTheoryofEconomicChange,CambridgeMA:BelknapPress,1982. Notes27InnovationisessentialtotheUK’sfutureeconomicprosperityandqualityoflife.Toraiseproductivity,fostercompetitivebusinesses,meetthechallengesofglobalisationandlivewithinourenvironmentalanddemographiclimits,theUKmustexcelatalltypesofinnovation.SeeDIUS,InnovationNation,London:DepartmentforInnovation,UniversitiesandSkills,2008.28EuropeanCommission,Europe2020:Astrategyforsmart,sustainableandinclusivegrowth,http://ec.europa.eu/europe2020/index_en.htm(accessed13Jun2011).29DIUS,InnovationNation;Nesta,FromFundingGapstoThinMarkets:UKgovernmentsupportforearly-stageventurecapital,London:Nesta,2009,www.nesta.org.uk/library/documents/Thin-Markets-v9.pdf(accessed7Jun2011).30DIUS,InnovationNation.31OECD,MainScienceandTechnologyIndicators,2005/2,Paris:OrganisationforEconomicCooperationandDevelopment,2005,citedinNesta,‘Theinnovationgap:whypolicyneedstoreflecttherealityofinnovationintheUK’,PolicyBriefing,2006,www.nesta.org.uk/library/documents/innovation-gap-pb.pdf(accessed7Jun2011).32Nesta,‘Theinnovationgap’;PierrakisY,VentureCapital:Nowandafterthedotcomcrash,London:Nesta,2010,www.nesta.org.uk/library/documents/Venture_Capital.pdf(accessed7Jun2011);DIUS,InnovationNation.33SeeMazzucatoMandLazonickW,‘Thelimitstothe3%R&DtargetinEurope2010:therolesofinstitutions,industries,andbusiness—governmentcomplementaritiesinachievingequitableandstablegrowth’,FINNOVpositionpaper,May2010,www.finnov-fp7.eu/sites/default/files/FINNOV_POSITION_PAPER_MAY_2010_3Percent_RD.pdf(accessed6Jun2011). 12134GeroskiPandMazzucatoM,‘Learningandthesourcesofcorporategrowth’,IndustrialandCorporateChange11,no4,2002.35GeroskiPandMachinS,‘Doinnovatingfirmsoutperformnon-innovators?’,BusinessStrategyReview3,no2,1992;GeroskiPAandTokerS,‘TheturnoverofmarketleadersinUKmanufacturingindustry,1979–86’,InternationalJournalofIndustrialOrganization14,no2,1996;YasudaT,‘Firmgrowth,size,ageandbehaviorinJapanesemanufacturing’,SmallBusinessEconomics24,2005.36AlmusMandNerlinger,EA,‘Growthofnewtechnology-basedfirms:whichfactorsmatter?’,SmallBusinessEconomics13,no2,1999;BottazziGetal,‘Innovationandcorporategrowthintheevolutionofthedrugindustry’,InternationalJournalofIndustrialOrganization19,no7,2001;LööfHandHeshmatiA,‘Ontherelationshipbetweeninnovationandperformance:asensitivityanalysis’,EconomicsofInnovationandNewTechnology15,no4–5,2006.37BrouwerE,KleinknechtAandReijnenJON,‘Employmentgrowthandinnovationatthefirmlevel’,EvolutionaryEconomics3,1993;FreelMSandRobsonPJA,‘Smallfirminnovation,growthandperformance:evidencefromScotlandandNorthernEngland’,InternationalSmallBusinessJournal22,2004.38DemirelPandMazzucatoM,‘IsR&Dworthit?’,IndustryandInnovation,2011,forthcoming.39SeeCoadAandRaoR,‘Innovationandfirmgrowthinhigh-techsectors:aquantileregressionapproach’,ResearchPolicy37,no4,2008,andNesta,‘Thevital6percent:howhighgrowthinnovativebusinessesgenerateprosperityandjobs’,researchsummary,London:Nesta,2009. Notes40MazzucatoMandParrisS,‘R&Dandgrowth:whendoesvarietymatter?’,FINNOVworkingpaper2.8,2011.41Nesta,‘Vitalgrowth:theimportanceofhighgrowthbusinessestorecovery’,researchsummary,London:Nesta,March2011.42‘TheGovernmentisalsogettingbehindthebigbusinessesoftomorrow.TheUK’s4.8millionsmallandmedium-sizedenterprises(SMEs)arevitaltotheeconomy.Theyprovide60percentofprivatesectorjobsandaccountforhalfofallprivatesectorturnover.TheGovernmentiscommittedtoensuringthattheUKhasanenvironmentwhereitiseasierfornewcompaniesandinnovationstoflourishandwherepeoplewhoaspiretobeentrepreneursareencouraged.’SeeBISandHMTreasury,ThePathtoStrong,SustainableandBalancedGrowth.43HaltiwangerJ,JarminRandMirandaJ,‘Whocreatesjobs?Smallvs.largevs.young’,NBERworkingpaper16300,CambridgeMA:NationalBureauofEconomicResearch,2010.44HsiehCandKlenowPJ,‘MisallocationandmanufacturingTFPinChinaandIndia’,QuarterlyJournalofEconomics124,Nov2009.45BloomNandVanReenenJ,MeasuringandExplainingManagementPracticesAcrossFirmsandCountries,London:CentreforEconomicPerformance,2006.46Ibid.47Ibid.48Pierrakis,VentureCapital. 12349GhoshSandNandaR,‘Venturecapitalinvestmentinthecleantechsector’,HarvardBusinessSchoolworkingpaper11-020,2010.50AuerswaldPEandBranscombLM,‘ValleysofdeathandDarwinianseas:financingtheinventionofinnovationtransitionintheUnitedStates’,JournalofTechnologyTransfer28,no3–4,2003.51GhoshandNanda,‘Venturecapitalinvestmentinthecleantechsector’.52LazonickW,SustainableProsperityintheNewEconomy?BusinessOrganizationandHigh-TechEmploymentintheUnitedStates,NewYork:UpjohnInstitute,2010;BottazziLandDaRinM,‘VenturecapitalinEuropeandthefinancingofinnovativefirms’,EconomicPolicy34,April2002.53CoriatB,OrsiFandWeinsteinO,‘Doesbiotechreflectanewscience-basedinnovationregime?,IndustryandInnovation10,2003;LazonickWandTulumO,‘USbiopharmaceuticalfinanceandthesustainabilityofthebiotechbusinessmodel’,ResearchPolicy2011(forthcoming);MirowskiP,Science-Mart,CambridgeMA:HarvardUniversityPress,2011.54PisanoGP,‘Cansciencebeabusiness?Lessonsfrombiotech’,HarvardBusinessReview84,no10,2006.55Mirowski,Science-Mart.56MazzoleniRandNelsonR,‘Thebenefitandcostsofstrongpatentprotection:acontributiontothecurrentdebate’,ResearchPolicy27,1998.57Forero-PinedaC,‘Theimpactofstrongerintellectualpropertyrightstechnologyindevelopingcountries’,ResearchPolicy35,2006. Notes58GriffithT,MillerHandO’ConnellM,‘TheUKwillintroduceapatentbox,buttowhosebenefit?’,IFSworkingpaper5362,London:InstituteforFiscalStudies,2010.59Ibid.60Thecrowdingoutargumentclaimsthatsincegovernmentspendingandbusinessspendingultimatelyrelyonthenation’ssavings,publicsectorspendingtakesawayapieceofthepieofthatsavingsfrombusiness,hencecrowdingitout.AsKeynesianshavelongargued,thisisonlytrueifthepieofsavingsisfixed.If,instead,itisgrowingasaresultofagrowingeconomyandthemultipliereffectofgovernmentspending,thenpublicsectorspendingcanactuallyincreasethepieofsavingsfortheentireeconomyandhenceincreaseratherthandecreasebusinessinvestment.Furthermore,givenallthecapitalthatisrushingaroundtheworld,lookingforspeculativereturns,itisdifficulttomaketheargumentthatthereisashortageofcapital.Ifanything,thereisashortageofproductiveinvestmentopportunities,thecreationofwhich,aswillbearguedbelow,requiresgovernmentinvestmentintheknowledgebaseandcomplementarybusinessinvestmentintechnologicalcapabilities.61BushV,Science,TheEndlessFrontier:AreporttothePresident,Washington:USGovernmentPrintingOffice,1945.62SchumpeterJ,Capitalism,SocialismandDemocracy,NewYork:Harper,1975[1942];SchumpeterJ,‘Economictheoryandentrepreneurialhistory’,reprintedfrom‘Changeandtheentrepreneur’,Cambridge:HarvardUniversityPress,1949,inRClemence(ed),EssaysonEntrepreneurs,Innovations,BusinessCycles,andtheEvolutionofCapitalism,NewBrunswick:TransactionPublishers,1989. 12563SeeKnightF,Risk,UncertaintyandProfit,NewYork:AugustusMKelley,1921;DruckerP,Technology,ManagementandSociety,[Oxford]:Butterworth-HeinemannLtd,1970.64Knight,Risk,UncertaintyandProfit.65KeynesJM,TheGeneralTheoryofEmployment,InterestandMoney,London:Macmillan,2007[1936].66Innumeroushistoricalinstancesscientifictheoryandexplanationshaveemergedafterthetechnologiestheyareseekingtoexplain.TheWrightbrothersflewbeforeaerodynamicswasdevelopedandthesteamenginewasoperationalbeforethermodynamicswasunderstood.Technologyoftenadvancesslightlyaheadofscience,andindustrialinnovationprovidesproblemsforacademicstosolve.SeeNightingaleP,‘Technologicalcapabilities,invisibleinfrastructureandtheun-socialconstructionofpredictability:theoverlookedfixedcostsofusefulresearch’,ResearchPolicy33,no9,2004.67NSF,NationalPatternsofR&DResources:2008,dataupdate,ArlingtonVA:NationalScienceFoundation,2008.68Ibid.69MoweryDC,‘MilitaryR&Dandinnovation’inBHHallandNRosenberg(eds),HandbookoftheEconomicsofInnovation,Amsterdam:North-Holland,2010.70DosiG,LlerenaPandLabiniMS,‘Therelationshipsbetweenscience,technologiesandtheirindustrialexploitation:anillustrationthroughthemythsandrealitiesoftheso-called“EuropeanParadox”’,ResearchPolicy35,2006. Notes71RuttanV,IsWarNecessaryforEconomicGrowth?:Militaryprocurementandtechnologydevelopment,NewYork:OxfordUniversityPress,2006.72BlockFandKellerM,‘Wheredoinnovationscomefrom?’inFBlockandMKeller(eds),StateofInnovation:TheUSgovernment’sroleintechnologydevelopment,Columbia:Paradigm,2010.73AngellM,TheTruthBehindtheDrugCompanies,NewYork:RandomHouse,2004.74CBO,ResearchandDevelopmentinthePharmaceuticalIndustry,Washington:CongressionalBudgetOffice,CongressoftheUnitedStates,2006,www.cbo.gov/ftpdocs/76xx/doc7615/10-02-DrugR-D.pdf(accessed14Jun2011).75Ibid.76GSKdoesbiotechacquisitionsandhaslicensingagreementsintheUSthatenableittotapintotheNIH-fundedknowledgebase.77AndrewWitty,CEOofGlaxoSmithKline,quotedin‘Theworldin2011’,TheEconomist,22Nov2010.78MazzucatoMandDosiG(eds),KnowledgeAccumulationandIndustryEvolution:Pharma-biotech,Cambridge:CambridgeUniversityPress,2006.79Pisano,‘Cansciencebeabusiness?’.80LazonickandTulum,‘USbiopharmaceuticalfinanceandthesustainabilityofthebiotechbusinessmodel’.81VallasSP,KleinmanDLandBiscottiD,‘PoliticalstructuresandthemakingofUSbiotechnology’inBlockandKeller(eds),StateofInnovation. 12782Vallas,KleinmanandBiscotti,‘PoliticalstructuresandthemakingofUSbiotechnology’.83LazonickandTulum,‘USbiopharmaceuticalfinanceandthesustainabilityofthebiotechbusinessmodel’.84Ibid.85Vallas,KleinmanandBiscotti,‘PoliticalstructuresandthemakingofUSbiotechnology’;BlockF,‘Innovationandtheinvisiblehandofgovernment’inBlockandKeller(eds),StateofInnovation.86HendersonNandSchrageM,‘Therootsofbiotechnology:governmentR&Dspawnsanewindustry’,WashingtonPost,16Dec1984.TheauthorthanksWilliamLazonickforbringingthisarticletoherattention.87SeeFreemanC,‘The“nationalsystemofinnovation”inhistoricalperspective’,Cambridge,JournalofEconomics19,1995,andLundvallB-Å(ed),‘Nationalinnovationsystems:towardsatheoryofinnovationandinteractivelearning’,London:Pinter,1992.88ReinganumJ,‘PracticalimplicationsofgametheoreticmodelsofR&D’,AmericanEconomicReview74,no2,1984.89Theemphasisonheterogeneityandmultipleequilibriarequiresthisbranchoftheorytorelylessonassumptionsofrepresentativeagents(theaveragecompany)anduniqueequilibria,sodeartoneoclassicaleconomics.RatherthanusingincrementalcalculusfromNewtonianphysics,mathematicsfrombiology,suchasdistancefrommeanreplicatordynamics,areused,whichcanexplicitlytakeintoaccountheterogeneity,andthepossibilityofpath-dependencyandmultipleequilibria.SeeMazzucatoM,FirmSize,InnovationandMarketStructure:Theevolutionofmarketconcentrationandinstability,NorthamptonMA:EdwardElgar,2000. Notes90FreemanC,‘The“nationalsystemofinnovation”inhistoricalperspective’.91LundvallB-Å(ed),‘Nationalinnovationsystems’.92FreemanC,‘The“nationalsystemofinnovation”inhistoricalperspective’.93Ibid.94AmsdenA,Asia’sNextGiant:SouthKoreaandlateindustrialization,Oxford:OxfordUniversityPress,1989.95JohnsonC,MITIandtheJapaneseMiracle:Thegrowthofindustrialpolicy1925—1975,StanfordCA:StanfordUniversityPress,1982.96ChangH-J,KickingAwaytheLadder:Themythoffreetradeandthesecrethistoryofcapitalism,NewYork:Bloomsbury,2008.97Withoutuncertaintytherewouldbenopointineventryingtoformcompetitivestrategies.ThisisindeedwhatKnightmeantwhenhesaid,‘Withoutuncertaintyitisdoubtfulwhetherintelligenceitselfwouldexist.’SeeKnight,Risk,UncertaintyandProfit.98BlockF,‘Swimmingagainstthecurrent:theriseofahiddendevelopmentalStateintheUS,PoliticsandSociety36,no2,2008;FuchsERH,‘Rethinkingtheroleofthestateintechnologydevelopment:DARPAandthecaseforembeddednetworkgovernance,ResearchPolicy39,2010.99Block,‘Swimmingagainstthecurrent’.100TheliteraturereferstobothARPAandDARPA.101Bush,Science,theEndlessFrontier. 129102Block,‘Innovationandtheinvisiblehandofgovernment’.103Block,‘Swimmingagainstthecurrent’.104Block,‘Innovationandtheinvisiblehandofgovernment’.105Block,‘Swimmingagainstthecurrent’.106Blockusesthistocharacterisehisconceptofa‘developmentalnetworkstate’.SeeBlock,‘Swimmingagainstthecurrent’.107LernerJ,‘Thegovernmentasventurecapitalist:thelong-runimpactoftheSBIRprogram’,JournalofBusiness72,no3,1999;AudretschDB,‘Standingontheshouldersofmidgets:theU.S.SmallBusinessInnovationResearchProgram(SBIR)’,SmallBusinessEconomics20,2003.108Block,‘Innovationandtheinvisiblehandofgovernment’.109‘Searchorphandrugdesignationsandapprovals’,OfficeofOrphanDrugs,www.accessdata.fda.gov/scripts/opdlisting/oopd/index.cfm(accessed9Jun2011).110LazonickandTulum,‘USbiopharmaceuticalfinanceandthesustainabilityofthebiotechbusinessmodel’.111Ibid.112Ibid.113Ibid.114Ibid. Notes115MotoyamaY,AppelbaumRandParkerR,‘TheNationalNanotechnologyInitiative:federalsupportforscienceandtechnology,orhiddenindustrialpolicy?’,TechnologyinSociety,2011forthcoming.116Ibid.117President’sCommitteeofAdvisorsonScienceandTechnology,PCAST,November1999,citedinMotoyama,AppelbaumandParker,‘TheNationalNanotechnologyInitiative’.118BlockandKeller,StateofInnovation.119Motoyama,AppelbaumandParker,‘TheNationalNanotechnologyInitiative’.120PCAST,Lettertothepresidentendorsinganationalnanotechnologyinitiative,citedinMotoyama,AppelbaumandParker,‘TheNationalNanotechnologyInitiative’.121Motoyama,AppelbaumandParker,‘TheNationalNanotechnologyInitiative’.122‘AngstintheUnitedStates:what’swrongwithAmerica’seconomy?’,TheEconomist,28Apr2011.123Nesta,FromFundingGapstoThinMarkets.124RichardD,SmallBusinessandGovernment:TheRichardreport,2008,www.bl.uk/bipc/pdfs/richardreport2008.pdf(accessed6Jun2011).125Seeforexample,CentreforEconomicPerformance,‘Inheritedfamilyfirmsandmanagementpractices:thecaseformodernisingtheUK’sinheritancetax’,2006,http://cep.lse.ac.uk/briefings/pa_inherited_family_firms.pdf(accessed7Jun2011). 131126See,forexample,HMRC,AnEvaluationofR&DTaxCredits,2010,www.hmrc.gov.uk/research/report107.pdf(accessed13Jun2011).127MasseyD,QuintasPandWieldD,HighTechFantasies:Scienceparksinsociety,scienceandspace,London:Routledge,1992.128MazzoleniandNelson,‘Thebenefitandcostsofstrongpatentprotection’.129SeeDavidP,‘Understandingtheemergenceofopenscienceinstitutions:functionalisteconomicsinhistoricalcontext’,IndustrialandCorporateChange13,no3,2004.130SeeCBI,‘Innovationandpublicprocurement’.131Dosi,LlerenaandLabini,‘Therelationshipsbetweenscience,technologiesandtheirindustrialexploitation’.132‘OnOctober20th2010itwasannouncedthattheScienceBudgetwastobe£4.6bnforeveryyearofthespendingreviewperioduntil2014–15—ineffect,a“cashfreeze”.Thecashfreezewaswidelyreferredtoastranslatingintoanapproximately10%cutby2014–15intheScienceBudget.However,takingtheOfficeforBudgetResponsibility’sinflationestimates,theScienceBudgetwillactuallybe14.4%lowerin2014–15thanin2010–11—andthesettlementcouldbefurthererodedbyincreasesininflation.Germany,anationsimilartotheUKinmanyways,hasbeenforcedtoinstituteitsownausteritybudgetasaresultofthebankingcrisis.Overallfederalexpenditureisbeingcutfrom€319.5bnlastyearto€307.4bnthisyear,yetfundingattheMinistryofEducationandResearchisrisingby7.2%,whichincludes€327mforuniversityresearchexcellence,andsupportforresearchanddevelopment(R&D)attheFederalEconomicsMinistryisalsoincreasing.ThisiscongruentwithChancellorAngelaMerkel’spastargumentthat“theprosperityofacountrysuchasGermany, Noteswithitsscarcemineralresources,mustbesoughtthroughinvestmentinresearch,educationandscience,andthistoadisproportionatedegree”.’SeeHallN,‘Spendingreview2010:CaSE’sSelectCommitteeresponse’,CampaignforScience&EngineeringintheUK,13May2011,http://sciencecampaign.org.uk/?p=5260(accessed13Jun2011).133Mosttoppharmacompaniesspend2.5timesasmuchonmarketingandadministrationastheydoonresearch.134PIRC,TheGreenInvestmentGap:AnauditofgreeninvestmentintheUK,Machynlleth:PublicInterestResearchCentre,March2011.135Thefigureof£12.6billionofUKgreeninvestmentin2009/10comprisedthetotalpublicinvestmenttotheamountof£6.7billion(publicsubsidy,governmentloansandlevies)andthetotalprivateinvestmenttotheamountof£5.9billion(assetfinance,publicmarkets,venturecapitalandprivateequity).136PIRC,TheGreenInvestmentGap.137CitedinPIRC,TheGreenInvestmentGap.138See‘DavidCameronpledgesgreenestgovernmentever’,Telegraph,14May2010,www.telegraph.co.uk/news/newsvideo/uk-politics-video/7723996/David-Cameron-pledges-greenest-government-ever.html(accessed2May2011).139IRC,TheGreenInvestmentGap.140EnergyandClimateChangeSelectCommittee,ThirdReport:Thereviseddraftnationalpolicystatementsonenergy,18Jan2011,www.publications.parliament.uk/pa/cm201011/cmselect/cmenergy/648/64802.htm(accessed2May2011). 133141ErnstandYoung,RenewableEnergyCountryAttractivenessIndex28,Feb2011.142The20-20-20strategycomprisesa20percentcutinemissionsofgreenhousegasesby2020,comparedwith1990levels;a20percentincreaseintheshareofrenewablesintheenergymix;anda20percentcutinenergyconsumption.SeeEuropeanCommissionClimateAction,‘TheEUclimateandenergypackage’,http://ec.europa.eu/clima/policies/package/index_en.htm(accessed7Jun2011).143GhoshandNanda,‘Venturecapitalinvestmentinthecleantechsector’.144Ibid.145MartinRandWagner,U,‘Climatechangepolicyandinnovation’,London:CentreforEconomicPerformance,LondonSchoolofEconomics,2009,http://cep.lse.ac.uk/conference_papers/18_05_2009/martin.pdf(accessed7Jun2011).146DECC,TheUKLowCarbonTransitionPlan,London:DepartmentofEnergyandClimateChange,2009,www.decc.gov.uk/en/content/cms/what_we_do/lc_uk/lc_trans_plan/lc_trans_plan.aspx(accessed6Jun2011).147CullenSE,‘Alternativeenergypowersup’,Thomson-Reuters,2009,http://science.thomsonreuters.com/news/2009-10/8552060/(accessed6Jun2011).148BryantB,‘InvestmentinUScleantechnologyhighestsince2008’,Guardian,6Apr2011,www.guardian.co.uk/environment/2011/apr/06/investment-clean-technology?INTCMP=SRCH(accessed6Jun2011). Notes149ErnstandYoung,RenewableEnergyCountryAttractivenessIndex28.150BakerDR,‘Fundingforclean-techfirmsplunges33%in’09’,SfGate.com,2010,http://articles.sfgate.com/2010-01-07/business/17470394_1_venture-funding-cleantech-group-venture-capitalists(accessed6Jun2011).151ParrisSandDemirelP,‘Innovationinventurecapitalbackedclean-technologyfirmsintheUK’,StrategicChange19,no7,2010.152WIPO,‘PatentCooperationTreatyapplicationsrelatingtoenvironmentaltechnologies(2001–05average)’,WorldIntellectualPropertyOrganization,2009,citedinAghionP,VeugelersRandSerreC,‘Coldstartforthegreeninnovationmachine’,BruegelPolicyContribution,November2009.153GhoshandNanda,‘Venturecapitalinvestmentinthecleantechsector’.154Ibid.155SeeAdvancedResearchProjectsAgency—Energy(ARPA-E),http://arpa-e.energy.gov/About/About.aspx(accessed6Jun2011).156Ibid.157Ibid.158Ibid.159‘DOEawards$377millioninfundingfor46energyfrontierresearchcenters’,Energy.gov,USDepartmentofEnergypressrelease,6Aug2009,www.energy.gov/7768.htm(accessed6Jun2011). 135160BlockF,‘Innovationandtheinvisiblehandofgovernment’.161Battelle,TheSearch.162Vallas,KleinmanandBiscotti,‘PoliticalstructuresandthemakingofUSbiotechnology’.163MazzucatoM,‘UShealthcarereformisnotanactofmeddling’,Guardian,6Apr2010,www.guardianpublic.co.uk/us-healthcare-reform-innovation(accessed6Jun2011).164SeeforexampleAcemogluD,‘Technicalchange,inequalityandthelabormarket’,JournalofEconomicLiterature40,2002.165PerronsDandPlomienA,WhySocio-economicInequalitiesIncrease?:FactsandpolicyresponsesinEurope,EUR24471EN,Brussels:EuropeanUnion,2010.166TheremainderofthissectionhasbeendrawnheavilyfromtheworkIhavedonewithBillLazonickonourNEWPATHproject.167PavittK,‘Sectoralpatternsoftechnicalchange:towardsataxonomyandatheory’,ResearchPolicy,13,1984;AroraAandGambardellaA,‘Thechangingtechnologyoftechnologicalchange:generalandabstractknowledgeandthedivisionofinnovativelabour’,ResearchPolicy23,no5,1994.168LazonickW,‘TheUSstockmarketandthegovernanceofinnovativeenterprise’,IndustrialandCorporateChange16,no6,2007.169Lazonick,SustainableProsperityintheNewEconomy? 137References‘AngstintheUnitedStates:what’swrongwithAmerica’seconomy?’,TheEconomist,28Apr2011.‘DavidCameronpledgesgreenestgovernmentever’,Telegraph,14May2010,www.telegraph.co.uk/news/newsvideo/uk-politics-video/7723996/David-Cameron-pledges-greenest-government-ever.html(accessed2May2011).‘DOEawards$377millioninfundingfor46energyfrontierresearchcenters’,Energy.gov,USDepartmentofEnergypressrelease,6Aug2009,www.energy.gov/7768.htm(accessed6Jun2011).‘Searchorphandrugdesignationsandapprovals’,OfficeofOrphanDrugs,www.accessdata.fda.gov/scripts/opdlisting/oopd/index.cfm(accessed9Jun2011).Specialreportontheworldeconomy,TheEconomist,9Oct2010.‘TamingLeviathan:howtoslimthestatewillbecomethegreatpoliticalissueofourtimes’,TheEconomist,17Mar2011.‘Theworldin2011’,TheEconomist,22Nov2010.AbramovitzM,ResourceandOutputTrendsintheUnitedStatesSince1870,NewYork:NationalBureauofEconomicResearch,1956.AcemogluD,‘Technicalchange,inequalityandthelabormarket’,JournalofEconomicLiterature40,2002. 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Theprevailingopiniononpublicspendingisthatthestatemustbecutbacktomakeroomforentrepreneurshipandinnovation,topreventthepublicsector‘crowdingout’theprivatesector.Thisdrawsonthebeliefthattheprivatesectorisdynamic,innovativeandcompetitive,incontrasttothesluggishandbureaucraticpublicsector.TheEntrepreneurialStatechallengesthisminimalistviewofeconomicpolicy.Itfindsthatsuccessfuleconomiesresultfromgovernmentdoingmorethanjustcreatingtherightconditionsforgrowth.Instead,governmenthasakeyroletoplayindevelopingnewtechnologieswhosepotentialisnotyetunderstoodbythebusinesscommunity.State-fundedorganisationscanbenimbleandinnovative,transformingeconomiesforever—thealgorithmbehindGooglewasfundedbyapublicsectorNationalScienceFoundationgrant.Thispamphletforcesthedebatetogobeyondtheroleofthestateinstimulatingdemand,orcrudely‘pickingwinners’inindustrialpolicy.Instead,itarguesforaproactive,entrepreneurialstate:astatethatisabletotakerisksandharnessthebestoftheprivatesector.Itimaginesthestateasacatalyst,sparkingtheinitialreactionthatwillcauseinnovationtospread.MarianaMazzucatoisProfessorintheEconomicsofInnovationattheOpenUniversity,andEconomicsDirectorofthetheESRCCentreforSocialandEconomicResearchonInnovationinGenomics(Innogen).ISBN978-1-906693-73-2£10©Demos2011