More Support for the Government as the Source of Entrepreneurial Innovation

Posted on August 28, 2013 by


From William Galston in the WSJ today.  Mr. Galston is referring to the same book that we commented on after the Financial Times of London made a similar review earlier this month.  Mr. Galston picks up on the theme that government spending on R&D has historically resulted in a lot of winners, including some of the most risky, whereas private capital goes for safer investments.  Mr. Galston goes from fact to assertion; can you see why?

Second, the number of top innovations originating in federal laboratories, universities or firms formed by former researchers in those entities rose dramatically, from 18 in the 1970s to 37 in the 1980s and 55 in the 1990s before falling slightly to 49 in the 2000s. Without the research conducted in federal labs and universities (much of it federally funded), commercial innovation would have been far less robust.

Mr. Galston repeats the data of successful investing, but then avers that without government investment, we’d have less commercial innovation.  This conclusion is not necessarily true, although it could be.  The problem is that we have to do what is called a counterfactual, and imagine what would have happened if the government had not.  In the counterfactual, it is reasonable (but not necessarily true) to assume that the exact same investments would not have been made.  But Mr. Galston’s failure in analysis, as Mr. Wolf’s before him, is to ignore what the resources not spent by the government would have done, if the government had not invested.  Government R&D is not like the tooth fairy, it comes at an opportunity cost, just as any private investment does.  It is really quite speculative to make the case that the government expenditure of resources is necessarily more effective and leading to innovation than the private sector; it is a best an educated guess, certainly not a logical conclusion.  Mr. Galston explains why he takes this guess,

In the 1920s, University of Chicago economist Frank Knight made a seminal distinction between risk (where the probability of possible outcomes is known) and uncertainty, where these probabilities are not and cannot be known. When an action or situation is “in a high degree unique,” Knight said, decision makers face uncertainty rather than risk. That is the difference between investing in innovation and betting on roulette. According to Ms. Mazzucato, private capital tends to be averse to making commitments when the odds of success cannot be assessed, opening an innovation gap that only entrepreneurial government can fill.

I’ll simply repeat the arguments I made to the FT article.  1) it is not true that private capital won’t fund even uncertain investments; the modern biotech industry is proof of that, and 2) Of course private capital is more risk averse–it’s their money they’ll lose!  In the government sector, it doesn’t matter if the R&D pans out, after all “we’re advancing science!”, and 3) it should not be surprising in a crony capitalism world, the private sector is very happy to let government tax citizens to pay for research that the firms can use for free, and they’ll reduce their own investment.  Government R&D is just a softer form of crony capitalism.

This leads to Mr. Galston’s conclusion:

No doubt there are counterarguments, and we ought to assess them. But one thing is certain: Every U.S. government program that has contributed to innovation during the past half-century is subject to the budget sequester. We’re not even eating our seed corn; we’re throwing it away. Whatever rational economic policy may be, this isn’t it.

Hopefully you can see from the analysis above that his conclusion is not true–we’re not necessarily throwing our seed corn away.  With the sequester, we’re making sure the government cannot throw our seed corn away, although it also ensures that the government cannot invest efficiently in entrepreneurial innovation (at least to the level it could before).  It remains to be seen what the private sector will do with the resources.  Here is a question for all the gov’t R&D supporters:  since you argue that government funds the “uncertain” investment (the returns of which cannot be known, under what basis do you decide on the appropriate amount of investment?  If what we spend today is good, and less is clearly worse per Mr. Galston and Mr. Wolf, what amount would be better?  How would you know?  Of course, ex ante, you cannot, by the definition of uncertainty.

Mr. Galston makes a good point however, the sequester is a BAD way to cut spending.  I don’t doubt there are better ways to cut the budget.  The answer is to renegotiate the sequester to achieve the same level of spending cuts but in a more intelligent way.  I wonder why Mr. Obama is opposed to that approach?