The Investor State

The lagging rise of productivity despite enormous progress in information technologies is still the great conundrum of financial life in the West during the previous 20 years. This is definitely the most pressing issue of the time. Disappointing productivity growth translates to substandard growth in family income and the marginalization of all once-prosperous parts of the American population.
Philippe Aghion, CĂ©line Antonin, along with Simon Bunel have achieved a significant service by assembling a corpus of research on economic development in one volume, The Power of Creative Destruction. This compact, chart-filled tome will likely be heavy going for the normal reader, however, it belongs on the bookshelf of every public policy adviser and every member of Congress concerned with policy coverage. It summarizes the critical data and appropriate research on a broad assortment of topics with clarity and common sense, without tripping over governmental stumbling-blocks.
America has a long if limited convention of state intervention to public life. Alexander Hamilton, the father of American economic policy, urged”internal improvements” (what we now call infrastructure) in addition to protection to infant industries and inducements for entrepreneurs to adopt new technology. “Restricted” is the key word: By focusing government spending on infrastructure and fundamental R&D, the United States avoided a number of the traps of government interventionism. We still haven’t gotten the formula quite right.
The authors assert that the remedy to stagnation, when there is one, will require more government intervention, but of a highly selective kind, such as subsidies for key industries and anti-trust measures contrary to the prominent technological monopolies. Their capitalist qualifications are impeccable. (Prof. Aghion is currently a member of The Center on Capitalism and Society at Columbia University, headed by Edmund Phelps, the 2006 Nobel Laureate in Economics.) But they see that capitalism requires government actions under special conditions.
The Schumpeterian Contradiction
The authors distill Schumpeter’s complicated thinking into three straightforward statements. The first is that”the diffusion of knowledge have been in the center of the growth procedure.” The second is that”invention relies on incentives and protection of intellectual property.” The next is that”new innovations render former innovations obsolete… growth by imaginative destruction sets the platform for a permanent conflict between the old and the new.” They mean by this that”creative destruction thus creates a problem or a contradiction in the very heart of the growth procedure. On the one hand, rents are necessary to reward invention and thus motivate innovators; on the other hand, yesterday’s innovators shouldn’t use their rents to impede new innovations.”
Schumpeter’s limitation, as Edmund Phelps observes in his book Volume Flourishing, proceeded against the view of the German Historical School that”all material advances in a state [are] driven by the power of science.” He also”added just a new wrinkle to the institution’s model: the need for the entrepreneur to come up with the new process or good made possible by the scientific understanding.” What Phelps calls”mass-produced” appears when people throughout society are ready to innovate. Under these circumstances, the”contradiction” cited by Aghion will vanish.
By way of instance, American venture capitalists include powerful innovators who have an interest in shielding the rents by their previous innovations, but who still invest in new companies which may replace their earlier, successful ventures. In actuality, Aghion et al. include an fantastic chapter about the value of venture capitalists which emphasizes the decisive purpose of financial culture.
In the United States, the typical venture capitalist started out as a creative entrepreneur who received venture capital financing. The royal road is to get the entrepreneur to sell her business by way of an IPO. Her personal experience as an entrepreneur has provided her with the experience and know-how necessary to pick the most promising jobs and also to advise newer entrepreneurs pursuing those jobs.
An individual could add that the huge majority of venture capital returns accrue to some tiny percentage of VC investors. According to a poll, half of all venture capital funds eliminate money, an extra 35 percent of funds yield 1 to 2 times investors’ money, and 15 percent yield double or more. This lopsided distribution of outcomes underscores the value of entrepreneurial experience.
Rather than a virtuous cycle arising from Ricardian comparative advantage, since free-trade dogma predicted, the US entered a vicious cycle of decreasing incomes and reduced innovation.The authors add,”By comparison, In France, venture capitalists are most often fund professionals whose career has been in banking or insurance and who, therefore, have neither the entrepreneurial entrepreneurial expertise nor the technical knowledge to counsel a startup. This explains in part why, in 2009, French venture capitalists invested only 353 million euros in young innovative firms, in contrast to 4.5 billion euros in the United States.”
What Phelps calls economic dynamism avoids the so-called Schumpeterian contradiction because the owners of rents generated by previous invention spend the profits in future innovations. That is a political and cultural matter; France lacks the venture capital culture that predominates in the United States and Israel, for instance.
Schumpeterian antagonism involving owners of previous rents and would-be challengers has reappeared with a vengeance in the Information Technology sector. Aghion and his coauthors cite research that blame the”decline in dynamism of the economy since the beginning of the 2000s” on”that an increase in industrial concentration and in markups.” The dominant firms,”having already accumulated the many patents, are the ones that continue to submit the many patents. These same firms purchase the best variety of patents for defensive purposes, that is, to discourage brand fresh innovation by prospective entrants within their respective sectors.” This makes it more challenging over the years for the laggards to catch up with all the leaders.” Thus,”production ends up becoming more concentrated in the hands of these leaders, whose rents thus increase.”
They conclude,”It is thus critical to rethink competition coverage, particularly antitrust policy regulating mergers and acquisitions, and to ensure technological revolutions, such as IT and artificial intelligence, boost growth in both the brief run and the long run.”
An October 2020 report by the House Subcommittee on Antitrust, Commercial and Administrative Law saw exactly the same issue:
To put it simply, firms that were scrappy, underdog startups that challenged the status quo have been the types of monopolies we saw in the era of oil barons and railroad tycoons. Even though these firms have given clear benefits to society, the dominance of Amazon, Apple, Facebook, and Google has come at an affordable price. These firms typically operate the marketplace whilst at the same time competing inside a position that permits them to write one set of principles for others, even while they play by a different, or even to engage in a form of their very own personal quasi law that’s unaccountable to anybody but themselves. The impacts of the significant and durable market power are costly. The Subcommittee’s series of hearings generated significant evidence that these firms wield their dominance in ways that erode entrepreneurship, hamper Americans’ privacy on the internet, and undermine the vibrancy of their free and diverse media. The result is less invention, fewer choices for customers, and a weakened democracy.
The modern equivalent of starvation in the midst of plenty is stagnant growth in the presence of basic technology shift driven by the IT sector.
Targeted Intervention
Public policy may help, and not just in the form of anti-trust measures against monopolistic and predatory Big Tech. Republican dogma in the time held the cheap imports from China profited Americans by reducing the cost of consumer products. That isn’t the case, according to research cited by the authors. The higher the penetration of Chinese imports in any particular region of the United States, the more industrial jobs were lost. Nor was that the reduction of industrial projects the inevitable outcome of labor-saving investments. More than a fifth of manufacturing job loss may be credited to the China jolt. And worst of all,”The reduction of industrial jobs was not the only consequence of the Chinese import jolt. Wages also dropped. Hence the negative impact of imports on regional economies was even worse, because the fall in wages decreased the requirement for local agencies while raising the supply of labor available for service-sector jobs.”
Innovation also endured: US patent programs fell after Chinese imports to the US accelerated following China’s admission into the World Trade Organization in 2001. Rather than a virtuous cycle arising from Ricardian comparative advantage, because free-trade dogma predicted, the US entered a vicious cycle of decreasing incomes and reduced innovation.
America’s tech market has largely abandoned production in favor of software, which has inherently higher profit margins, devoting the hardware to Asian producers. That has contributed Americans cheap way of amusement but fewer industrial jobs.The question, then, is the way to react to trade shocks. “There are two approaches to manage foreign competitors: one would be to increase import duties (tariffs): another would be to segregate domestic firms to innovate , notably with subsidizing investments in R&D,” the authors observe. Tariffs try to defend existing industries against changes in the world market, whilst aid for R&D encourages domestic firms to leapfrog the competition and gain global market share. Citing research by Marc Melitz and many others, the authors note that tariffs suppress creation by eliminating the incentive for national firms to raise productivity to be able to deal with foreign competitors. Subsidies for research and advancement, though, help domestic firms to compete against imports, and help”expansionary innovation” on the part of firms that want to export more.
This general principle”doesn’t imply that protectionist policies must always be rejected,” the authors allow. But”tools like public investment in the information economy, infrastructure, and industrial coverage are more inclined to yield productivity benefits and long-term prosperity than a drastic increase in import duties.”
America’s high-tech industry is one of the beneficiaries of these subsidies; it has largely left manufacturing in favour of software, which has inherently higher profit margins, devoting the hardware to Asian producers. That has contributed Americans cheap way of amusement but fewer industrial jobs. R&D subsidies encourage invention, as Aghion et al. see, but it’s also the case that Asian funding subsidies suck production jobs from america. The apparent solution is a shift in the tax structure to favor capital-intensive investment (rather than equity buybacks, which in 2019 exceeded total capital expenditure among the S&P 500).
Immigration policy can be significant, as qualified immigrants contribute disproportionately to American innovation. One study of the period 1976-2012″shows that foreign-born individuals who came in the United States after the age of twenty were responsible for 23 percent of overall [creation ] output, which was their demographic weight of innovators (16 percent).” Immigration between 1995 and 2008″accounted for some 29 percent gain in the percentage of the US working population with a college diploma,” particularly in STEM fields.
The authors draw a bright line between the”investor state,” which supports invention, and the”policy say,” that utilizes state funds to keep the status quo. European welfare state and industrial coverage is a baleful example of the insurer condition.
“The DARPA model, they observe, is particularly intriguing because it”unites a top-down approach using a half-dozen approach. On top-down side, the Department of Defense funds the applications, selects the program heads, also hires them to get a three-to-five-year period. On the other hand, the program heads, who come from the private sector… have full latitude to define and manage their applications.” They notice that”DARPA has played a critical part in the creation of high-risk jobs with high social value, like the net… and GPS.”
That is exactly right, but doesn’t quite capture what DARPA accomplished. Two items characterized every one of those signature inventions of the digital era, from integrated circuits on the Internet to optical systems.
The semiconductor laser that powers optical networks and a huge number of other programs began with a Signal Corp project to illuminate battlefields through the night. CMOS chip production (mass manufacturing of fast, light, and energy-efficient custom processors ) began with a DARPA petition to permit fighter pilots to conduct weather forecasts in the cockpit but ended up powering lookdown radar. Famously, the net began as a means to secure communications in wartime and became the most universal medium of interchange.
The authors express the hope that peaceful financial rivalry instead of war will motivate rivalry among nations, and in doing so they miss a critical point about DARPA’s efficiency. Even the United States had to contend with Soviet discoveries, beginning with Sputnik but such as surface-to-air missiles that displayed devastating efficacy during the 1973 Arab-Israeli warfare. By supporting research at the frontiers of mathematics and computer science, DARPA motivated dozens of corporate labs and several thousands of scientists to push the envelope of mathematics .
Regrettably, peacetime industrial coverage is subject to the whims of governmental constituencies who want to procure jobs and profits to existing industries. Defense R&D requires investigators to tackle problems with no known solutions and make technology whose peacetime applications can’t be predicted. But the push to win wars has generated virtually all of the technology that altered civilian life through the past generation. Our excellent bursts of invention happened not because the right number of bucks came from Washington and also the right number of pupils came from universities, but because presidents like Eisenhower, Kennedy, and Reagan set good challenges facing us, like the Apollo Program and the Strategic Defense Initiative. Political leadership provided not just the resources, but the inspiration and dynamism to do things that nobody had envisioned before.