Believe it or not–The Government is the source of true entrepreneurial innovation!

Posted on August 5, 2013 by



So says a new book reviewed by Martin Wolf in the Financial Times, The Entrepreneurial State.  The basic thesis is that

Yes, innovation depends on bold entrepreneurship. But the entity that takes the boldest risks and achieves the biggest breakthroughs is not the private sector; it is the much-maligned state.

Martin Wolf approves of this outcome, as does (not surprisingly) Keynesian economist Brad DeLong, concluding:

This book has a controversial thesis. But it is basically right. The failure to recognise the role of the government in driving innovation may well be the greatest threat to rising prosperity.

I have to confess, I have not read the book.  Yet the commendable reports do not engender support for the underlying thesis.  For example, Martin Wolf says:

Why is the state’s role so important? The answer lies in the huge uncertainties, time spans and costs associated with fundamental, science-based innovation. Private companies cannot and will not bear these costs, partly because they cannot be sure to reap the fruits and partly because these fruits lie so far in the future.

I find this conclusion to be simple opinion and assertion.  It is not clear that markets don’t fund entrepreneurial research for long term payoffs; that to me seems to be the essence of the biotech industry which has large amounts of private capital associated with it.  Wolf and Delong likewise share many of the examples from the book; almost any new great invention had some level of government spending supporting it.  Since government support was beneficial to the ultimate success (such as technologies embedded within the iPhone), we couldn’t have had smartphones without government!  But this is simple assertion.  What we’re asked to believe is that because the government consumed resources that ultimately proved to be useful, the private sector could not or would not, if the government had not.  This is a counterfactual, which of course is impossible to prove one way or the other.  But what is incredibly important is that while indeed the government has supported winners–they’ve supported a lot of losers too.  The relevant question is the counterfactual–if the government had not consumed the resources, what would the private sector have done?  What we see in general with government activity is that it is less productive than private capital.  In part because, contra Wolf and DeLong, the problem is NOT the bureaucrats are unwilling to take risk, but that they take the wrong risks–usually due to political influence.  I failed to see a single reference to Solyndra in the reviews.

Wolf notes that even the energy revolution was funded initially by government, but we should not be surprised that in a Rent-Seeking Society, big business would find ways to get government to pay for the research agenda.  This is classic crony capitalism; Indeed this is what Wolf and DeLong are really celebrating–Crony Capitalism works because sometimes it works!

Industrial policy is Crony Capitalism; when capital investment decisions are made by the government, by definition those capital allocations are made via the political process.  This inevitably leads to the “heads I win tails you lose,” or “privatize the gains, socialize the losses” crony capitalism we see everywhere.