Section 14: Public Private Partnerships
Lerner, J. (2009). Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed--and What to Do About It. Princeton University Press. Author: Hamlin, Madeleine Rose; Editor: Creedon Jr, John Thomas
Chapter 4, “Things Get More Complicated”
In this chapter, Lerner reviews research about the effectiveness of government intervention in catalyzing innovation. He argues that while there are many reasons for government to play a catalytic role, government programs to boost venture activity have frequently fallen prey to incompetent decision-making or outright distortions by special interests.
1. Arguments for government intervention:
a. There is a “virtuous cycle” in entrepreneurship and venture capital: pioneers pave the way for subsequent generations. Government subsidies may spur the cycle of knowledge creation, and should be used to do so in the case of activities that generate positive externalities that will benefit wider society.
b. Government involvement can also provide a ‘stamp of approval.’ Government investments have a ‘certifying effect’ that venture capitalists themselves may not be able to provide. For example, if government programs can identify and support neglected firms, they might provide the stamp of approval that high-potential, underfunded firms need to succeed. This type of support will require governments to overcome information asymmetries to identify the most promising firms.
c. Public entrepreneurship may also result in knowledge spillovers, for example when innovations are not very profitable to a firm but prove very beneficial to society as a whole.
2. Arguments against government intervention:
a. Incompetence - Public officials may be inadequate to the task of managing entrepreneurial or innovative firms.
b. Capture – Entities, whether part of government or industry, may organize to capture the direct and indirect subsidies that the public sector hands out. In some cases, individuals or firms who are not the intended recipients of public funding may appropriate some of the funds for their own purposes.
Chapter 5, “The Neglected Art of Setting the Table”
Lerner argues that government initiatives meant to stimulate new venture activity can be divided into three broad categories: the first two (demand-side) interventions focus on creating a more hospitable environment for entrepreneurs and venture capitalists (a.k.a. “table-setting”), and one (supply-side) intervention that encompasses direct efforts to boost the availability of financing.
1. Enhancing the entrepreneurial climate
The most dramatic example comes from Singapore, which launched a variety of ‘indirect’ initiatives to attract investors, including: increasing spending for academic research, encouraging associations for small and new enterprises, subsidizing research expenses of corporations, and expediting paperwork for foreign entrepreneurs. The government also created the “Biopolis,” a seven-building research park with state-of-the-art labs and amenities, and which has attracted top researchers from all over the world.
a. To enhance entrepreneurialism, governments have to get the laws right. They must ensure that the legal system supports entrepreneurial activity—i.e. allowing investors to enter into complex contracts, where different outcomes can result if the company’s progress varies. In most cases, this has meant copying the American system.
b. Governments must also ensure access to cutting-edge technologies. This means encouraging development, transfer, and commercialization of university technologies.
c. Not all entrepreneurs come from universities, so governments should create tax incentives—such as lowering capital gains tax rates—to increase the attractiveness of becoming an entrepreneur. Additionally, policies that punish individuals who are involved with failed ventures can be counterproductive.
d. Providing education and training can also encourage entrepreneurialism. Entrepreneurial training programs have been launched in at least 30 countries.
2. Increasing the venture market’s attractiveness
Governments should make efforts to attract local entrepreneurs and domestic sources of capital, as well as international investors. In some cases, venture capital industries will be driven by investment from global players.
a. Governments must allow true partnerships between international and domestic actors by ensuring that local and national tax and partnership laws are in compliance with global standards. In particular, limited partnerships must be characterized by limited liability (outside investors can’t lose more than they invest) and tax flow-through (individual partners are taxed as if they had made the investments themselves).
b. Governments should enhance local markets for publicly traded firms, so there are nearby opportunities to take venture-backed companies public.
c. Entrepreneurship efforts should make use of human capital abroad. By leveraging human resources outside the nation, venture capital can overcome information gaps surrounding risky investments.
3. Direct interventions to increase the supply of capital for entrepreneurs and venture capitalists, which differ along many dimensions, including: who provides the funds (governments, universities, non-profits, or private sector organizations?), amount of funding (entire amount or matching funds?), structure of the funding (outright grants, or return on investment?), conditions of capital (extent to which government contracts have constrained the activities of the firms?), and relationship between the government and the firm (what level of oversight?).
Chapter 6, “How Governments Go Wrong: Bad Designs”
More government initiatives to promote entrepreneurship have been unsuccessful than successful. Why is this the case?
1. Failing to understand the venture market – Public efforts make three common mistakes when it comes to understanding the venture market:
a. Timing: Building a venture capital industry is a long-run investment, which cannot be rushed. Governments must not be daunted by initial failures.
b. Sizing: Programs can encounter difficulties if they are too small or too large. Programs that are too small may not be able to make a sizeable impact. Programs too large may crowd out or discourage private funding.
c. Flexibility: Flexibility is central to venture capital investment; young firms face tremendous uncertainties in technology, product market, and management. Changes of direction are thus an integral part of the investment process.
2. Not listening to the venture market – Decisions about how to allocate public funds may be distorted by a lack of understanding about how the market works, or by political rather than economic considerations. For example, if politicians feel the need to fund programs evenly across all fifty states, or if policymakers make decisions based on ‘buzz’ or incomplete information.
Overall, these two pitfalls reveal that “table-setting” alone will not prevent investment failures. Venture capital markets are complex, so any number of poor decisions can doom an effort. Additionally, taking a top-down approach, in which bureaucrats mandate which sectors or locations to fund without listening to the market, can be problematic. One solution is to utilize matching funds, whereby entrepreneurs receiving public funds have to raise matching capital from private sector sources, which helps ensure viability.
Chapter 7, “How Governments Go Wrong: Bad Implementation”
Even if an entrepreneurship program is well-designed, things can go wrong in the implementation phase. Three common errors include:
1. Not worrying about incentives – Governments should think carefully about incentives before establishing entrepreneurship initiatives. Otherwise, investments may be linked to the fund’s financial returns, but not to the broader objectives of the innovation.
2. The need for evaluation – Government officials should examine the track record of the venture capitalists and entrepreneurs who receive public funding. Public programs should also be evaluated on a periodic basis. Officials cannot rely on success stories alone as a measure of program effectiveness. Randomized studies are problematic; instead, “regression discontinuity” analyses exploit the fact that when program managers assess potential participants, some applications will fall just above or below the cut-off line. They can then compare these entrepreneurs, which are likely to be similar to each other except that some were chosen and others weren’t, and get a good sense of the program’s impact without randomization.
3. The need for a global perspective – Governments should encourage the development of strong connections with venture funds elsewhere.
Mazzucato, M. (2013). The Entrepreneurial state: Debunking Public vs. Private Sector Myths. Anthem Press. Author: Perez, Philip A; Editor: Tansits, Colin E
This article reviews the book by Mariana Mazzucato entitled The Entrepreneurial State: Debunking Public vs. Private Sector Myths.
The author begins by giving the reader an idea of Mazzucato’s argument, which is essentially that while Apple and other technology companies are widely considered to be the embodiment of a grassroots, bottom-up type innovation style, these companies would not have succeeded without help from the state.
The armed forces created the internet, GPS, and also provided early funding for Silicon Valley. The author provides other examples such as that publicly funded university scientists developed touchscreens and HTML, a government body lent Apple $500K before it went public, Google’s search engine algorithm was financed by a grant from the National Science Foundation, and that pharmaceutical companies benefit from research by America’s National Institutes of Health. The author notes that Mazzucato thinks it’s an injustice that Apple reduces its US tax burden by moving money overseas and assigning its IP to low-tax states such as Ireland.
The author notes one of Mazzucato’s arguments is that governments that invest in entrepreneurship do more than makeup for market shortcomings—they actually create and shape future markets. According to the author, Mazzucato thinks the U.S. government has successfully funded innovation by “talking like Jeffersonians but acting like Hamiltonians,” which essentially means the government has sought to be viewed as having a limited role, yet in reality has been involved in innovation. The author notes that the government has historically been involved in spreading existing technologies, such as railways, and in seeking scientific breakthroughs, as demonstrated by financing 60% of basic research.
The author states that Mazzucato failed to acknowledge that some governments invest in companies that fail, and whereas private capital will eventually stop funding such projects, governments may continue to set taxpayer money on fire.
The author suggests that Mazzucato’s criticism of private capital, that private businesses are too shortsighted, also applies to governments. The author also responds to Mazzucato’s suggestion that anti-statist ideology is preventing the government from making long-term investments by pointing to entitlement spending by the government—a highly expensive long-term program that diverts funds from being invested in entrepreneurship.
The author finds that Mazzucato offers an incomplete answer to the question posed by her book, which is “why are some states successful entrepreneurs while others are failures?” However, successful governments promote competition among those seeking funding and leave decision-making to experts rather than politicians.
The author concludes by acknowledging Mazzucato was right to argue that the U.S. government played a central role in fostering innovation, and that the government’s “contribution to the success of technology-based businesses should not be underestimated.” The author concludes by arguing that the government’s role in innovation justifies “moderni[zing] the state and bring[ing] entitlements under control.”
Mariana Mazzucato responds to the author’s review of her book in a featured comment. She clarifies three points and elaborates on her argument.
First, she clarifies that her point is that the government can be entrepreneurial, not that governments have always been entrepreneurial. She makes this point because there is a widespread ideological view that government inhibits business and technological innovation, despite the fact that no empirical data supports this idea.
Second, her argument is that the form of government assistance matters as to whether an investment is successful, as evidenced by the Silicon Valley example. Top down decisions are less successful than bottom up decisions made by decentralized, well-funded, and coordinated government agencies. To attract the top talent required to produce innovation, governments must create the right kind of missions and give the appropriate agencies major funding.
Third, the government must consider the risk-reward relationship in innovation, which does not mean seeking profits, but instead means avoiding ventures in areas being pursued by private capital, and investing in big ideas for which private venture capital is too risk averse.
The author suggests that the government’s role is to “make things happen that otherwise would not,” and that if the innovation is being funded by the taxpayer, then the rewards should also go to the taxpayer in the form of reinvestment in government innovation funding.
Case Study on Public Private Partnership