The State of Innovation

Economist Mariana Mazzucato is advising govenments to meddle more

Text by Lidija Haas

Photography by Studio 88

Styling by Bobby Hook

It has been a rough few years for economists in the UK. In 2009, a group of them had to write a letter to the Queen explaining why they hadn’t seen the crisis coming: it was, they wrote, “a failure of the collective imagination of many bright people”. Part of the problem, one of them conceded, was a resistance to unconventional ideas, and that hasn’t gone away. One of the strongest conventional wisdoms of our day is that of the state as a bureaucratic stick-in-the-mud: when it comes to big ideas and innovations, apparently, it should stay well back and let the private sector get on with it. The economist Mariana Mazzucato thoroughly debunked that myth in a 2011 report for Demos, which she wrote “in a style similar to the political pamphlets of the 1800s: quickly, and out of a sense of urgency”. Her new book on the subject, The Entrepreneurial State, exhorts governments to be bold and embrace their essential role as innovators.

Mazzucato was born in Rome and grew up in the US, where her father was a Princeton nuclear physicist. She trained at the New School and has spent more than a decade as professor in the economics of innovation, now at the University of Sussex. Her ideas are controversial enough to spark animated disagreement on Newsnight, but they have an ineluctable logic, and people are listening: Mazzucato has advised David Willetts, Andrew Adonis and the EC, among many others. She came to speak to us at Tank about failures of imagination and good sense across the political spectrum, and about what should change to open the way for the next great discoveries and real, sustainable economic growth.

The cliché that the state should “get out of the way” and set the dynamic private sector free is a surprisingly dominant one, but, Mazzucato says, “I’m almost not even talking to that group.” Even among those who accept that the state has an important role to play, she points out, there is a sense that that role is limited to facilitating, “de-risking”, “fixing market failures” – even the language used to describe it conjures up a cautious and sometimes blundering handmaiden to the private sector geniuses, the Zuckerbergs and Steve Jobses. In too many cases, Mazzucato insists, “we have not admitted what the state was supplying in the first place: we’ve just seen it as fixing little problems here and there, as opposed to being the lead engine.”

“I believe that economists on both the left and the right have really been blinded,” she says, “by certain assumptions that we have on what the role of the state is. The point of the book is to say that there’s this whole other thing the state has done all over the world in places where we’ve actually had innovation-led growth – smart growth – and that’s being the lead risk-taker, the courageous, entrepreneurial state. If you look at any technological landscape and ask who actually made the investments when it was really difficult, when it was scary – the internet, before the internet, nano-tech, before nano-tech, bio-tech, before bio-tech – what we see is that it’s been public sector investments: patient, long-term, committed, but courageous and kind of crazy investments.”

One of the most striking aspects of Mazzucato’s book is its patient breaking down of supposed private sector triumphs in business and tech to show the extent of their public sector foundations. Not only the early-stage funding the US government gave companies such as Compaq, Intel and Apple, but the extent of state contribution to particular inventions such as the iPhone. “If you ask yourself what actually makes the iPhone smart,” Mazzucato says, “the internet, GPS, touch-screen display, the Siri voice-activated system – it was actually state investments that went into the technologies that make the phone do what it can do, and this is really different from what we’re told. For example, the Economist in a recent special issue was asking what’s going to be the next really cool thing after the internet that will actually launch decades of growth. You know, we’re talking about nano-tech and green tech, and they were very explicit in what they said the state should do: fund the basics, education, research, the roads, infrastructure. But ‘leave the rest to the revolutionaries’. And the point of the book is that in Silicon Valley, and in places like Singapore, Korea, even Denmark and Germany and Brazil and China, the revolutionary energy and investments today are actually coming out of the state sector.”

For Mazzucato, image is crucial, and so is language: “Imagine how different the whole Obamacare debate would have been in the US, had Americans north, south, east, west known the data about what the state has done in their country. You were told that Obamacare is an example of the state meddling in your healthcare, but the state, throughout the last 50 years and still today, has been the lead investor in the pharmaceutical industry. If you divide the drugs up between new molecular entities with priority rating, versus small changes to existing drugs – say, Viagra with a different colour, different dosage – it turns out that 75 per cent of the most revolutionary new drugs are coming out of National Institute of Health funding. So this is taxpayer, public sector money producing the most innovative drugs. It’s not meddling in healthcare, it’s creating and shaping the healthcare market. But again, the narrative is that it’s the big pharmaceutical companies.”

The state’s image problem affects more than the political conversation: being seen as the house cat to the private sector’s tiger is a self-fulfilling prophecy. Mazzucato notes that the public sector can only make major strides in any field if it has the sense of mission that can attract the best minds. In China and Brazil, top economists are keen to work for the national development banks. The US Department of Energy, she points out, “was recently run by a Nobel prize-winning physicist. Tell me one Nobel prize anything that runs any public sector institution in Europe.” Europeans, she says, shouldn’t be so mystified by Silicon Valley. “You know, the big question in Europe is always, where are our Googles?” She points to the network of US agencies that make the difference: “the National Science Foundation, National Nanotechnology Initiative, the Department of Defence with its different programmes, including DARPA, which funded the internet, including the CIA, which provides huge amounts of venture capital money to US companies. Most people don’t know this but the CIA invests more than private sector venture capital. And the NIH, or the SBIR, the Small Business Innovation Research programme that does early stage finance.” Mazzucato says: “People will bend over backwards to work for ARPA-E: it’s an honour to be called into the Department of Energy and told: ‘You, scientist from MIT, would you like to join our forces for five years?’ Both ARPA-E and DARPA bring civil sector workers into government on secondment and they say: ‘Hey, be crazy! Do your thing.’ And you have to be crazy because in fact, if you think of innovation as a very linear process where you put in this amount of money and you will succeed and get this output – forget it. You have to welcome failure.” What Mazzucato makes clear is that it’s precisely the state sector that is capable of taking risks and tolerating failure. The much vaunted private venture capital firms, she notes, are in fact extremely risk-averse, looking to make a return on their investment within three to five years when any major discovery might not be profitable for 15 or 20. The wrong kind of finance is a big part of Mazzucato’s explanation for slower technological progress. “In the 1950s and 1960s, with Xerox PARC and Bell Labs, we used to have big private sector laboratories co-investing alongside the state. With deregulated markets and financialised capitalism, what we’ve had is a disinvestment in human capital and R&D. You have companies spending 115 per cent of their net sales on share buy-backs; this is true for top pharma and IT and, unfortunately, we’re seeing it already in clean-tech companies, which are really just thinking about their share price. In the previous era we had a much higher percentage of net profits being reinvested into the production process.”

Mazzucato is amused at the suggestion that there might be some natural plateau in terms of technological advances now compared with the 1960s. “In 1901, there was someone in the US patent office who actually said: ‘I think we should just close down – everything that could be invented has been invented.’ This is a recurring issue in a period in which we see telephones change so quickly, televisions, the internet: it makes us think, what else could we possibly invent? But there’s no basis for that. The real issue is whether the current relationship between the public and the private sector, and more generally the drastic financialisation we have, is in fact causing a lack of investment in the areas that create those opportunities of the future.”

We know about the dangers of financialisation, but Mazzucato warns against drawing false distinctions: “People talk as if there’s big bad finance, bad derivatives, credit default swaps, and what you need to do is rebalance away from the bad finance towards good industry. That ignores just how financialised industry itself has become: we shouldn’t mythologise investing in IT as somehow better – actually, what we need is for real industry to change its behaviour.”

One of Mazzucato’s most controversial suggestions for how things should change also seems disarmingly straightforward. Governments take big risks, and if we want them to take more, it might make sense to let them keep a share of the proceeds from those rare investments – Google, say, or Apple – that make huge returns. “Nine out of 10 investments fail, but that one winning investment like the internet, the nano-tech or bio-tech investments, makes a lot of money. When profits do arrive, you shouldn’t let them become completely privatised – you don’t just socialise the risks, you also try to socialise the rewards. And if you don’t, you’re really putting the innovation system itself under threat. Is it right that Google, whose algorithm was funded by the state, paid nothing back to the National Science Foundation, which today is under extreme stress in terms of its budget?”

It’s clear that the state hasn’t had much luck making any significant money back from the likes of Apple via taxes. Such companies have been “extremely successful in getting corporate income tax, capital gains tax, top marginal rates reduced massively. And what’s happened to tax for the last 30 years has co-evolved with a story that we’ve told about innovation. It was the National Venture Capital Association that in 1976 started to lobby government to reduce their capital gains tax. After just six years, you already saw it halve, it came down from 40 per cent to 20, and you know, when your capital gains tax falls by 50 per cent, you make a lot of money. The real problem is that companies talk about tax but walk where the public investments are. Just recently, we had Pfizer talking about tax constantly in this country, and then closing down one of the biggest R&D labs in Sandwich, Kent and going to Boston, not because of tax or regulation, but because of the $32 billion a year the US government spends in the area they need. This is the irony: they need that public sector spending, but then they talk, talk, talk about tax, so they themselves are hurting the base of what they actually require.”

Mazzucato is very clear about what’s happened to taxation in general. Under Eisenhower, a Republican, she points out, “the marginal top rate was close to 90 per cent”. The attack on taxes in the years since has been hugely successful. The message is: “Reduce tax for the really, really rich; you’re going to make them much richer and you know why that’s good? They’re going to reinvest all that money into the economy.” But, as Mazzucato says, “they don’t”. When you cut tax, “there’s no evidence, with the companies or the venture capitalists or the private equity guys, that it increases the amount of money they’re putting back into the process – it simply increases the amount of time they golf.” In fact, “what drives private-sector investment is what Keynes talked about, animal spirits, and he meant not just the stuff people are talking about today, herd effects and bandwagon effects. What drives investment is people’s gut instincts about where the exciting technological and market opportunities are.”

Of course, when it comes to gut instincts, few trust governments. Mazzucato notes the double standard: “Most people know the example of Solyndra, a solar company in the US that received a $500 million guaranteed loan from Obama. It went bankrupt. Headlines all over the world. Stupid government, stupid Obama! Unable to pick winners, making a choice that should have been left to the market. Another company, Tesla Motors, got the same amount of money from Obama, but today is extremely successful and is being used as the new example of Silicon Valley genius, and no one admits that Obama actually funded the early-stage finance.” What’s more, “the government doesn’t make any profits from the winning investment of Tesla – it’s all gone to Elon Musk and his shareholders.”

Things are different, Mazzucato observes, in Scandinavia, “where they are less ideological about these issues. Sitra, a public funding agency in Finland, invested in early-stage Nokia, and when Nokia made mega profits, Sitra made back a reward, which could fund the next round. So I often say that had the US thought about this and brought even just one per cent of the profits from the internet back to the state, we would have so much more money today to be funding renewable energy – instead, we have empty coffers.”

The constant emphasis on spending cuts strikes Mazzucato as “a real craziness”. “The weak parts of Europe are being asked to cut, cut, cut, but when you look at what Germany or the US did, they didn’t cut: Germany has increased its R&D spending by 15 per cent since the crisis. This is what we should be telling the weaker parts of the world to do.” Nor is she impressed by the UK chancellor’s recent announcement that the numbers are recovering and austerity has started to work. “First of all, it’s very difficult to claim that this meagre growth we’re getting now is because of the austerity policies versus just the fact that at some point things were going to pick up. But also, the reason they have been able to pick up is that Osborne about a year ago did, without admitting it, start listening to the people who were saying, you’re absolutely crazy, interest rates are almost zero, public sector borrowing right now is almost free, you should be investing in all sorts of infrastructure projects, housing. He did actually go into reverse gear.”

Mazzucato’s view differs, though, from the neo-Keynesian argument common on the left, which emphasises the need for stimulus spending. She agrees that “we should have counter-cyclical spending, and the problem is that we have governments retrenching, clawing back precisely at the moment in which they should be kickstarting the economy.” Though that argument is correct, she says, it’s also limited: “It’s not just in a recession that you need the state to take this active, courageous role, it’s even in the boom. You hear very prominent Keynesians around the world being interviewed on TV, and the first thing some conservative presenters will say to them is, ‘Where were you in the boom, telling the state to claw back?’ And they don’t have an answer, they start changing the subject. What they should say is: ‘Oh, really? What would have happened if the state had clawed back in the 1980s – would we have the internet today? No.’”

Mazzucato believes we need to rethink our entire approach. “The biggest problem we have today is a capitalist system in which value extraction is being rewarded above value creation. We can’t just be attacking the speculators, the rent-seekers, talking about inequality – you really have to start from the question: ‘Where does value come from in the first place?’ What’s very interesting – this is actually the subject of a new book I’m starting to write – is that economists have stopped debating value theory. It used to be that on the left and right, even the titles on the big economics books had the word value in them. Go back to Adam Smith, The Wealth of Nations, he was really asking, where does wealth come from? We have gone from a debate that looked at the objective conditions behind value, the investments, the productivity, to a subjective theory, neo-classical economics, which is still taught today all over the world, and which explains things like wages as a result of subjective preferences. This really goes throughout all of economic theory, and it’s allowed all these agents, venture capitalists, Silicon Valley guys, to describe themselves as value creators. And you obviously have a whole discourse about welfare recipients as being the value extractors versus the investors.” Inequality, according to Mazzucato, has its specific effects on innovation too. “Your whole social fabric can start crumbling in countries that decide not to invest in education, healthcare, creating opportunities for all. That’s harmful because it reduces your pool of potential innovators, right? You don’t know who the innovators are going to be.”

Mazzucato wants to make clear to governments how much is at stake. “What I’ve been pitching and telling states all over the world to do is to think big, don’t just think of yourself as fixing little market failures. Be mission-oriented, and what I mean by missions are putting a man on the moon in the past, or tackling climate change today, or for example the ageing crisis – there’s very little innovation around that. I’m also telling policy makers to be less naive about how they could reap back a reward, including retaining a golden share of the intellectual property rights (where currently it’s a complete giveaway), retaining equity, or even things like income-contingent loans. We use it for students. Why not for companies?”

None of the financial reforms introduced in the US and UK since the crisis have addressed the problem: “They are not creating more patient, long-term finance.” In places such as China, she notes, “you have the kind of patient, committed finance that, for example, led to Huawei today being the number one telecommunications company.” The irony for Mazzucato is that this kind of finance is precisely what innovation requires, and it’s the kind that can’t be found in the private sector. Yet when state investment does take place, as with Huawei, “it’s accused of being anti-competitive.” China, Mazzucato notes, “is no longer achieving growth simply because of, say, low-cost labour. They’re investing massively in new areas, whether it’s IT, life sciences, green technology – they’re attracting capital due to their investments.”

Her biggest concern is to ensure that enough is invested in the right places. “What is going to be the next big thing after the internet?” she asks. “Well, who’s going to invest in it? If states are being forced to do austerity and the private sector just worries about their quarterly returns, of course you’re going to have a problem and be left wondering where are the big things? No shit, Sherlock.” §

  • The State of Innovation
  • The State of Innovation