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Public risks, private rewards: how an innovative state can tackle inequality

The winner of the inaugural New Statesman/Speri Prize in political economy on how an innovative state can tackle inequality.

This autumn, the inaugural NS/­Speri Prize was awarded to Mariana Mazzucato of the Science Policy Research Unit at the University of Sussex. It rewards “the scholar who has succeeded most effectively over the preceding two or three years in disseminating original and critical ideas in political economy to a wider public audience” and includes the invitation to deliver a lecture. This is an edited extract from that speech.

What makes the iPhone so smart? Was it only the genius of Steve Jobs and his team and the visionary finance supplied from risk-loving venture capitalists? No. In my book The Entrepreneurial State: Debunking Public v Private Sector Myths, I tell the missing part of that story by analysing the public funds that allowed the smartphone to be created. The research programmes that made the internet, touch-screen displays, GPS and the Siri voice control possible all had government backing.

The point is not to belittle the work of Jobs and his team, which was both essential and transformational. But we must be more balanced in the historiography of Apple and its founders, where not a word is mentioned of the collective effort behind Silicon Valley. The question is this: who benefits from such a narrow description of the wealth-creation process in the hi-tech sector today?

Over the past year, inequality has risen up the political agenda, with the Organisation for Economic Co-operation and Development documenting just how bad inequality is for growth. But the current debate is often focused only on redistribution. If policymakers want to get serious about tackling inequality, they need to rethink not only areas such as the wealth tax that Thomas Piketty is calling for but the received wisdom on how to generate value and wealth creation in the first place. When we have a narrow theory of who creates value and wealth, we allow a greater share of that value to be captured by a small group of actors who call themselves wealth creators. This is our current predicament and the reason why progressive parties on both sides of the Atlantic are struggling to provide a clear story of what has gone wrong in recent decades and what to do about it.

Let’s start with some definitions. First, the market. The path-breaking work of the historian Karl Polanyi teaches us that talk of “state intervention” in “free markets” is a historical fallacy. In his 1944 book The Great Transformation, Polanyi argued: “The road to the free market was opened and kept open by an enormous increase in continuous, centrally organised and controlled interventionism . . . Administrators had to be constantly on the watch to ensure the free working of the system.”

The public sector’s active role in shaping and creating markets is even more relevant in today’s “knowledge economy”. Traditional economic theory, which guides policymaking worldwide, justifies state intervention only to solve market failures. But what the state has done in the few countries that have succeeded in producing innovation-led growth has been to create new markets. Sectors such as the internet, biotechnology, nanotechnology and the emerging green economy have depended on direct, “mission-oriented” public investments, creating a new technological landscape – not only facilitating existing ones – with business following only after returns were clearly in sight. So why have we accepted such a biased story of the state’s role when, as the story of Apple shows, it has done so much more than “fix” market failures? What is the relationship between this false narrative of who the real risk-takers are and increasing inequality? Here are three areas we need to look at.

 

Socialising risks and rewards

The pretence that government only spends, regulates, administers and, at best, “de-risks” or “fixes” market failures prevents us from seeing that it has been a lead risk-taker and investor. As a result, government has socialised the risks but not the rewards. Some economists argue that the reward for the state comes through taxation. This, in theory, is right. Innovation-led growth should lead to an increase in tax revenue – but not if the companies that benefit the most from innovations don’t pay much tax compared to the income they generate, not only as a result of loopholes but also because of their continual lobbying for tax incentives and tax cuts that they say they need to foster innovation. It’s not a coincidence that groups such as the National Venture Capital Association helped convince the US government to reduce capital gains tax by 50 per cent in only five years in the late 1970s – an “innovation policy” later copied by Tony Blair’s government. (A policy that even Warren Buffett has admitted has had no effect on investment but lots on inequality.)

Similarly, in the name of promoting innovation, different types of tax “incentives” are constantly introduced – such as the “patent box” system, which allows companies to pay virtually no tax on profits generated from patented goods and services. By targeting the income generated from patents (which are, in effect, state-granted monopolies for 20 years), rather than the research that leads to them, such measures have little to no effect on innovation.

 

More symbiotic innovation ecosystems

Sharing risks and rewards also requires making sure that private-sector commitment on innovation increases. Of course businesses invest in research and development (R&D) but the emphasis is increasingly on the D, building on earlier public-sector investment in R.

As Bill Lazonick and I have argued in our recent work, in areas as different as pharma, IT and energy, large companies are spending an increasing proportion of profits on share buy-backs, to boost stock options and executive pay. Fortune 500 companies have spent a record $3trn in the past decade on share buy-backs – greatly outpacing R&D. Thus, a serious “life-sciences” strategy should not only be about government increasing its financing of pharma’s knowledge base but should involve government being confident enough to ask Big Pharma to invest more of its profits in research and human resources to address skills shortages.

When countries ask Google, Apple and Amazon to pay more tax, this should not only be because they use public roads and infrastructure but also because a significant part of the technologies that drive their record profits was publicly funded.

We hear a lot about how new technology hurts those without the skills required by the modern economy and that this is the key link between innovation and inequality. But where do skills come from? They are the result of investment – and today we have a massive crisis of investment.

 

A New Deal . . . and a more serious deal

What we need to kick-start investment is not only a new Keynesian deal, investing in areas such as infrastructure, but also more serious “deals” between business and government that benefit both sides. For example, how could the patent system better reflect the collective public-private contribution to innovations? In the US in 1980, the Bayh-Dole Act aimed to increase the commercialisation of science by allowing publicly funded research to be patented. Lawmakers were rightly wary that this could lead to taxpayers stumping up twice: first for the research (the US National Institutes of Health spends $32bn a year) and then for high prices of drugs. So they suggested that government put a cap on the prices of drugs that were publicly funded. Yet the US government has never exercised this right.

We should also reform the tax system to reward long-run value creation over value extraction, opening up the debate about risks and rewards: are there other tools that might offer a better deal for publicly funded investments and innovations? This might come in the form of keeping a “golden share” of the patents, or retaining some equity in companies that receive early-stage financing from government, or giving businesses loans with income-contingent repayments just as we do to students.

My point is not to argue for or against any one of these mechanisms but to start a broader discussion that begins with the view of the state as a market-maker, not only a fixer. There should be a recognition of the huge risks that this involves: for every successful government investment in areas such as the internet, there are failures in areas such as Concorde.

Some, including the think tank Nesta in the UK, have argued that any direct non-tax-based mechanisms for the state to reap back rewards for its risk-taking are “problematic” and suggest that corporate taxes are sufficient. This defence of the status quo, particularly in these times of austerity, seems unsustainable when what is at stake is the ability of business to capture a disproportionate share of value that was created collectively. In a world of big data – so celebrated by the innovation enthusiasts – surely we can create better “contracts” and deals between the public and private sectors, even if this means putting a dent in the profit-wage ratio that is rising at record levels (no, profits are not related to managerial performance).

So how can we change the narrative of the left from one of “redistribution” to one that champions value creation, in which both risks and rewards are shared more equally? Let’s first agree that the market is not a bogeyman forcing short-termism but a result of interactions and choices made by different types of public and private actors. We need to stop talking about the public sector “de-risking” and facilitating “partnerships” and talk more about the kind of public risk-taking that led to all the general-purpose technologies and great transformations of the past, a change of language from general “partnerships” to more detailed commitment about the kinds of partnerships that will lead to greater, not lower, private investment in long-run areas such as research and development and human capital formation.

Changing our understanding of how wealth is created, not only distributed, is the first step in building a more confident mission-oriented government – one that both fuels innovation, and builds the right kind of “deal” with business that gives the word “partnership” real meaning again. 

Mariana Mazzucato is RM Phillips Professor in the Economics of Innovation at SPRU, The University of Sussex, and author of The Entrepreneurial State: debunking public vs. private sector myths. You can watch the full 2014 New Statesman SPERI Prize Lecture here.

This article first appeared in the 19 December 2014 issue of the New Statesman, Christmas Issue 2014