Innovation is key to long-term growth and needs to be nurtured by active public-private partnerships. The countries that are suffering the most today are those that are hampered by both weak private spending in R&D and weak public spending in areas like education, research and new technologies. This is one of the reasons why blind austerity in many countries is hurting growth. Spain’s cuts of 40% to publicly funded research will hardly make it become as competitive as Germany.

For an “innovation nation” to emerge, systems of innovation need to flourish within sectors, regions and nations. For this to happen, we need flexible links between and within all the entities involved: from companies to financial institutions to education and research centres.

However, what is often ignored is the role that each of these entities can realistically play in a complex landscape of risks. Indeed, many errors in current innovation policy are due to misplaced expectations. It is naive, for example, to expect venture capital (VC) to lead in the early, most risky stage of any new sector, such as clean energy technology. In biotechnology, nanotechnology and the Internet, venture capitalists arrived 15-20 years after the most expensive and high-risk investments had been made by public sector funds.

Indeed, risky ventures with high capital intensity and high technological and market risk tend to be avoided by the private sector, and have required great amounts of public sector funding, as well as vision and leadership, to get off the ground. The funding for all the technologies that make the iPhone so smart – from the Internet to GPS, the touchscreen display and even SIRI, the talking personal assistant – can ultimately be traced back to public sector-backed research, and even sometimes to the early stage “seed financing” of firms (as in the case of Compaq, Intel and Apple).

Innovation policy is not only about correcting market failures, but about actively creating and shaping markets – what I call an “entrepreneurial state”. Entrepreneurial states are driven by “missions”, whether putting a man on the moon in the past or tackling climate change in the future; these missions require an overarching strategy to make many different sectors think big together. Thinking big requires the state to support radical change, but also to steer existing technologies and structures into new directions. For instance, if environmental issues are a meaningful priority, government policy must do much more than fund basic research: it must also make “more green” more profitable than “less green”.

Three key challenges emerge if the state is going to shoulder the risks involved in innovation:

  1. Overcoming myths. If the key role of policy is to “make things happen that otherwise would not” (as Keynes argued eloquently in The End of Laissez Faire), we need a more realistic and nuanced understanding of the risks and obstacles involved in supporting innovation. It is important not to create myths about things such as SMEs, VC or education; instead, we need to understand their specific role and how this differs between sectors. Currently, much SME policy is driven by myths, not facts: most SMEs do not create any net employment over a three-year period, and suffer from low productivity and low innovation. Innovation policy should not be driven by a romantic attachment to SMEs, but by the desire to encourage more SMEs to think big and demand finance to grow. Likewise, VC is often romanticized as an entrepreneurial force, when the reality is that many VC funds have become increasingly short-termist, wanting returns in three to five years when innovation requires much more time. In many industries (like biotechnology), the VC model has become the problem, not the solution.
  2. Organizational change. Of course not all states are entrepreneurial. But the habit of depicting government as an obstacle – which at best should pick up the pieces when markets fail, and at worst should simply get out of the way – does not help to build confident, smart and strategic states. For example, since innovation is by nature uncertain, it is fundamental to create government institutions that welcome exploration and failure, rather than fear it. Indeed, the success of DARPA (an agency in the US Department of Defense that funded the Internet) was largely due to its ability to attract expertise and its internal organizational culture, which welcomed trial and error – but still knew how to turn the tap off. This is also the case with the US National Institutes of Health, which spend £32 billion per year in the pharmaceutical and biotechnology fields. Rather than obsessing about reducing the size of government, we must transform the government from within, rendering it more entrepreneurial and mission-oriented.
  3. Risks and rewards. Given the state’s role as lead risk-taker in many sectors (e.g. biotechnology, nanotechnology, computers and clean energy), it is important to consider whether some investments should earn back a direct return, beyond corporation tax. That is, rather than worrying so much about the problem of picking winners, more thinking is needed about how to reward the winning investments so they can cover some of the inevitable losses and also raise funds for future investments. Put provocatively, had the state earned back even just 0.1% from the investments it made in the Internet, there would be much more today to invest in green technology. Is it right that the National Science Foundation got nothing back from Google, when it funded its algorithm? Ways to generate returns include equity, income contingent loans and the ability of the state to retain a golden share of the intellectual property rights. But this first requires an understanding of the collective risk-taking process that leads to innovation, so that it is not only the risks that are socialized, but also the rewards.

Author: Mariana Mazzucato is a Professor in the Science and Technology Policy Research Unit (SPRU) at the University of Sussex, UK, and the author of The Entrepreneurial State: Debunking Private vs. Public Sector Myths. Read reviews in the FT here and in the Economist here. 

She is taking part in the session Economics of Innovation with the Institute for New Economic Thinking at the Annual Meeting of the New Champions in Dalian, China.

Image: A man walks past a mural in Shoreditch, east London. REUTERS/Andrew Winning