Where do innovation and growth come from?

Mariana Mazzucato, Economist and RM Phillips Professor of Science and Technology, argues that to meet the twin objectives of achieving postcrisis growth and leading what will, over the years, become a 'green' economic revolution, we urgently need to re-evaluate the role of the 'entrepreneurial state' in the economy.

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Sources of business innovation

We often think of the private sector as being the home of entrepreneurs who drive innovation and growth in economic markets, with the state playing only a housekeeping role in fixing 'market failures'.

Based on this premise, in an age of austerity many governments are increasingly trying to cut back on public spending as means of reducing national debt, and making policy that encourages private enterprise.

But what if the state was also a major source of business innovation, and its repression meant an even greater economic downturn or the loss of inventive new technology?

Some of the most innovative economies in the world have been the direct result of state-led investments, which have both shaped and created new markets. By reappraising the role of the state in entrepreneurship, can we continue to foster innovation and market growth in a time of austerity?

A commonly held view is that private industry is the birthplace of the technological innovation required to grow new industries, and this perception particularly applies to small-to-medium enterprises that, spearheaded by maverick entrepreneurs, have grown into global giants (eg Apple, Google, Dyson).

By contrast, the state is often viewed as a cumbersome leviathan, shackled by bureaucracy, which stifles or, at the very least, is not the source of innovation.

If, however, one examines the origins of many growth industries from the last 50 years (energy, information technology, biotechnology, nanotechnology), the reality of the role of the state versus private enterprise belies this myth.

The fact that the state is often a key player in championing and providing early investment in much of the technology that we today take for granted is the current focus of Mariana Mazzucato, RM Phillips Professor of Science and Technology at SPRU – Science and Technology Policy Research in the School of Business, Management and Economics.

The topic of her recent publication The Entrepreneurial State – published in part as an advisory document to the UK Government and the Department of Business, Innovation and Skills.

Fearing the risk of innovation

Professor Mazzucato specialises in industrial economics and the economics of growth and innovation.

Commissioned by the European Commission, and directed by Mariana across seven EU universities, a recently completed three-year collaborative research project, Finance Innovation and Growth: Changing Patterns and Policy Implications (FINNOV), evaluated the relationship between financial markets and the economy and how financial markets reward or penalise innovation.

Companies that invest in innovation, research and development and human capital formation, by their very nature are high risk.

One of the findings of FINNOV was that financial markets often penalise innovation. Focus on stock prices has hurt spending on research and development, and bank credit scores often do not differentiate between high-risk investments in the form of innovation versus other types of risk such as companies having bad debt. Yet taking risks and investing in them are requirements for innovation and to drive technology forward.

It is often lamented that Europe does not produce innovators like Google and Apple, or dynamic technology areas like Silicon Valley, in anything like the same numbers as the US.

This is often attributed to the higher level of social government and state intervention in Europe compared with the US, the mother of all free-market economies.

But, it is little known or publicised that the US is one of the most interventionist states in the world, where many sectors have benefited from statefunded investment in early-phase research and development and from public-versusprivate venture capital.

Much of the early investment in the development of the internet came from the Defense Advanced Research Projects Agency, and the early investments in Apple, Compaq and Intel came not from private venture capital but from public funding via the US Small Business Innovation Research Programme.

Every core technology behind the iPhone (the global positioning system, the internet, the touch-screen display) owes its early conception and funding to state funding bodies.

The state as investor

The private sector is, naturally, designed to maximise return on investment and, therefore, more likely to be risk-averse. Early-phase development of new technology has often come from state sources, with private investment and venture capital entering later in the process to drive forward development at a point where maximal profits can be made.

This is not to say that private business and entrepreneurs are not hugely important in a growing economy, but we also need to recognise fully that the state plays a fundamental role in capitalism in terms of innovation and structural and transformational change – a role that has been ignored by economists who continue to think that the state's purpose is simply to correct 'market failures'.

Professor Mazzucato argues that we need to understand the role of the state as leading 'risk-taker' and also think about the risk-return relationship, because while the risk-taking has become more collective, the returns have not.

State spending on basic education and health should perhaps not expect a direct return (beyond tax income), but the state's high-risk investments should.

This could be done via income-contingent loans, and equity, as well as returns made by national investment banks. Such returns can then be used both for redistribution (to ailing parts of the economy) and for reinvestment, creating a virtuous circle that benefits both innovation and 'inclusive' growth.

Professor Mazzucato is currently developing the ideas put forward in The Entrepreneurial State into a larger theoretical project, supported by her two new grants from the Ford Foundation's Reforming Global Financial Governance initiative, and the Institute for New Economic Thinking.

FINNOV has been cited by both the European Commission and by the UK Department of Business, Innovation and Skills Growth Paper as a project with key lessons for innovation and financial market reform, and the UK Minister for Universities and Science, David Willetts, has cited The Entrepreneurial State in a recent speech on 'high-tech' innovation in the UK.

Mariana's perspective

Professor Mariana Mazzucato said: "Responses to the financial crisis, and discussions about the need for a post-crisis recovery by politicians, business and the media, reveal how politicised, and oversimplistic the debate about 'growth' is.

"Economic growth is the result of dynamics, in which public, and private-sector institutions interact in complex ways.

"Simplistic solutions that are being given to the weaker Eurozone countries will pose serious problems in terms of their abilities to grow in the future: structural reforms without investment don't lead to growth. Indeed investments in research, training, education and innovation are key factors behind economic growth, but not in a linear way.

"I recently joined SPRU – Science and Technology Policy Research, because it is one of the most interesting, vibrant and cutting edge research centres globally that is thinking about these interactions.

"SPRU breaks down myths, whether these are about the contribution of small and medium enterprises to innovation, the effect of research and development on innovation, or the importance of knowledge transfer institutions.

"SPRU researchers work closely together, and in partnership with top research centres all around the world, building an interdisciplinary approach to the study of innovation, and thinking about the non-linear interactions between different types of public and private actors, in different sectors and national contexts, as well as the different pathways that innovation might take within sectors, the choices that need to be made, and different strategies for dealing with the high "uncertainty", and unpredictability, inherent in innovation."