The Entrepreneurial State

Sorry Milton Friedman, but innovation needs government support and intervention.

What if we’ve been translating Adam Smith wrong for the last three centuries? This is something that I’ve been mulling over lately, thanks to the immutable Mariana Mazzucato, professor and Chair in the Economics of Innovation and Public Value at University College London (UCL), and her book, “The Entrepreneurial State.”

Mariana’s controversial interpretation of Adam Smith’s works is this: Adam Smith’s definition of ‘free market’ meant free from ‘rent.’ In the 21st century, we have interpreted this to mean free from ‘state.’ We need public policy, she argues, to reduce rent-seekers.

She raises a few compelling arguments worth visiting and extending.

State-Funded Innovation Exists

When we think of innovation,we often create an artificial line between the public sector and the private sector. The private sector is where innovation happens (i.e. Silicon Valley) and the public sector is where innovation is stifled (through law and policy). But Mariana argues that is simply untrue.

In reality, venture capital is commonly raised after innovation has already begun. Private firms want to review the research in order to evaluate the risk. Who else then has the resources to initiate new, unproven research? The state.

States don’t need the ROI that venture capital demands. There is no trajectory of estimated profits or analysis of other competitors.

Consequently, states are willing to conduct more daring research, allowing progress to be its own reward, free from the demands of investors hungry to recoup their investment and take their share of the incoming profits. To this point, Mariana argues that venture capital focuses too much on short-term metrics (i.e. profit), while states are able to focus on large, long-term objectives (i.e. reducing global warming).

One obvious example of state-funded innovation that comes to mind was when the Obama government invested USD $500 million to Solyndra, a startup that made solar panels, which eventually went bankrupt. This led to a Republican congressional investigation, and a bill to end the loan program altogether. Republicans used this to argue that governments shouldn’t invest in new ventures, which is ironic given that the Trump administration is currently seeking to privatize the International Space Station by 2025.

Profound Research Breakthroughs Have Originated From State Organizations

Another example that Mariana offers is the creation of Apple. She argues that while the sleek design of Apple’s products were attributed to Steve Jobs’ genius, the actual technology found within Apple’s products were based on research achievements that were funded by the military and government.

As Nancy Peolosi famously stated during the Democratic Platform Drafting Committee Hearing:

“In this smartphone, almost everything came from federal investments and research. GPS, created by the military, flatscreens, … digital camera, wireless data compression, research into metal alloys for strength and lightweight, voice recognition — the list goes on and on… They say Steve Jobs did a good idea designing it and putting it together. Federal research invented it.”

Maintaining Innovation Through Antitrust Laws

In the forthcoming book The Curse of Bigness: Antitrust in the New Guilded Age, Tim Wu argues that antitrust laws were developed to break up the kinds of market concentrations that we see today. The title of the book is a quote from Louis Brandeis, who advised President Woodrow Wilson before being appointed to the Supreme Court, who claimed that the “curse of bigness” — that he associated with concentrated financial and state power — was a threat to liberty and democracy.

On an episode of the Vergecast, Tim Wu stated:

“We live in America, which has a strong and proud tradition of breaking up companies that are too big for inefficient reasons. We need to reverse this idea that it’s not an American tradition. We’ve broken up dozens of companies.”

Tim’s right. It doesn’t take much digging to see that the federal government has broken up companies from Standard Oil to the original AT&T. But that began to slow to halt as courts in the last few decades have taken a tough stance against disrupting private mergers, perpetuating a concept called the “consumer welfare standard,” which became the threshold for government interference. At the core of this concept, the government was required to show that prices would increase as a result of a private merger, effectively causing harm to the consumer.

But Tim argues that this becomes an impossible burden for the government, especially in the attention economy, where consumers are now the products, not the customers.

When companies like Google and Facebook are free to use, how can the government possibly satisfy that test?

Instead, antitrust law should shift their focus on a different kind of harm, such as loss of innovation. And since capitalism is an economic system predicated on competition, one could argue that innovation becomes stifled as market consolidation occurs. Facebook’s r&d strategy isn’t to necessarily create more progress towards connecting people, it’s to buy out competition and increase their market share. Apple’s strategy is similar: increase market share so that it can raise its prices due to lack of viable alternatives. As a result, innovation stagnates, quality suffers, and consumers are left with little choice but to pay large sums for mediocre products.

In response, the New Brandeis movement, named after Louis Brandeis, has gained steam, advocating against market monopolization and calling on laws that foster competition. Louis, who was an advisor to President Woodrow Wilson prior to his appointment to the Supreme Court, urged government regulation when it came to big companies, knowing that small businesses would effectively be wiped out.

Louis Brandeis credit: Brandeis University

In a speech at the Economic Club of New York, he stated:

We learned long ago that liberty could be preserved only by limiting in some way the freedom of action of individuals; that otherwise liberty would necessarily yield to absolutism; and in the same way we have learned that unless there be regulation of competition, its excesses will lead to the destruction of competition, and monopoly will take its place.

Conclusion

Radical “free market” supporters will not admit to such a conclusion, but progress fundamentally relies on state support and intervention. We needn’t look further than our history textbooks to see that the state has not only taken risks and invested in private actors, but have also developed groundbreaking research that companies have capitalized on. As Mariana argues, this is not necessarily a bad thing, but it does warrant a fair outcome: Equitable division of profits between state and private actors. With cash returning to the state, there can be greater reinvestment in the public infrastructure — the exact environment that fostered innovation in the first place.

To conclude, the more that we understand the state’s role in fostering innovation, the sooner we can shift our focus towards solutions: modernizing antitrust laws, electing good candidates into office, and creating incentives for small businesses. Competition begets innovation, and markets left unchecked only hinders that.

Productivity, craftsmanship, and the pursuit of excellence at work. Writing now at jennifertchan.substack.com.

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