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Innovation and Society: are the Returns and Benefits Sufficient?

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Here is my latest contribution to Entreprise Romande. I return to a subject that is dear to me, Innovation and Society. (If you read French, the original version is certainly better…)

ER-Lebret-June2014

The Enterprise is more than ever at the core of the political debates through its role in the creation of jobs and wealth – both individual and collective. It is indirectly the source of populism and of protectionist temptations. Inside and outside of its walls, innovation is the subject of similar tensions: are the returns and benefits of innovation sufficient for society?

Mariana Mazzucato and the Entrepreneurial State

A recent book tackles the topic of the respective roles of business and government in innovation: Mariana Mazzucato, a professor at the University of Sussex, develops in The Entrepreneurial State [1] – a fascinating and quasi-militant book – the argument that the States have not collected the fruits not only of direct investments in their universities, and even indirectly from the help and support provided to businesses, investments and supports that are at the origin of the major innovations of the last fifty years.

Mazzucato brilliantly illustrates this through the example of the iPhone and the iPad, which integrate components initially financed by the public bodies: from electronics developed for the space and military programs to the touch screen or GPS, or even Siri, the voice recognition tool (which has sources at EPFL), the author shows that Apple has masterfully integrated technologies initiated by public money. Google is also the result of research done at StanfordUniversity. Mazzucato adds that clinical trials for new drugs are mainly made ​​in hospitals funded by public money, from molecules equally discovered in university laboratories.

Mazzucato therefore advocates major reforms both on the governance of the initial support and on taxation. She fights for a new tax system that would compensate the absence or insufficiency of direct returns to universities or from businesses, all the more that it is indeed undeniable that multinational companies easily optimize their taxation. She shows how Apple has taken advantage of international rules to create subsidiaries in Nevada or Ireland to minimize its taxes.

The English researcher is convincingly claiming that Apple has to pay more. But how to pay? Paying a license for the GPS, but to whom? I’m not even sure that the GPS is patented. And if the Internet had been patented, it would probably not have had the same development – I do not ned to go over the limitations of the French Minitel. By seeking more direct financial returns (which are not as insignificant as one might think – Stanford has received more than $300M for its equity shares in Google and over $200M of the first patents in biotechnology), the risk would be very high to discourage creators and stifle innovation. I doubt that the solution lies in more rigorous national rules.

Peter Thiel and the Individual Entrepreneur

Peter Thiel, an libertarian entrepreneur and investor, is so opposed to such views that he encourages youung people motivated in entrepreneurship to abandon their studies by providing them with $ 100,000 grants and he even imagines moving businesses to offshore vessels off California so they totally escape tax. He is afraid of any form of public support which, he considers, quickly becomes bureaucratic. It is worth adding that Thiel’s motto also shows his skepticism about the social benefits of innovation: “We wanted flying cars; instead we got 140 characters.” [2]

Upstream, there is therefore the question of direct returns and the actual role of the state. But without the incredible creativity of Steve Jobs at Apple, without the extraordinary ambition of Larry Page and Sergei Brin at Google, without the vision of Bob Swanson, a co-founder of Genentech, the world would probably not have experienced the same technological revolutions. Downstream, the question arises of how to create international rules on innovation. Let me make a wide digression. The Internet, another innovation initiated by public authorities, has become a major topic in the political, economic and fiscal fields. But “neutrality and self-organization are part of the libertarian options […] and are inconsistent with politics. Humanity must seize this opportunity to revisit what is considered important. […] The Internet enables the emergence of a global political space, but it is still to be invented. At the time of this invention, the Internet will probably be gone!” [3]

If from experience I lean more toward Thiel’s view on innovation as an individual act of exception, actually quite far from the public investment, even if it is its seed, yet, I cannot agree with abandoning the public good. It is the soil that allows the emergence of exceptional talent. Companies also have their share of responsibility in discounting the importance of the collectivity. Just like in any complex human activity, innovation is a delicate balance between private and public actors. But especially today, issues have become global. The question is not so much as Mazzucato says that the role of the state has been largely underestimated in this process, but rather that the tax return has largely been decreased by globalization and the lack of economic governance.

Tax as a single global solution?

Does society receive any return from the public money spent on schools, roads, security? No, because it’s not an investment in the true sense of an objective of financial gain. These are infrastructure provisions that allow citizens and businesses to exist and develop properly. And they 8should) pay taxes in return. When Darpa funds Stanford, it is not sure that a student from Korea will not benefit from it and later work for Samsung. The concept of ​​supporting national champions seems of another age.

We are left with Tax, in a renewed vision of its global governance. Whether innovation is in the public or private domain, the world globalization will soon prevent from hiding behind the argument of whom is basically at its origin. Not only individuals but states also must agree upom a greater share of its profits, at the risk of serious crises. At a time when Switzerland reviews its tax policy and its citizens think they can create barriers from its neighbors as its borders, it is important to be aware that the current tensions are an opportunity to revisit the status of innovation in society before new major crises emerge. Wishful thinking?

[1] The Entrepreneurial State – Debunking Public vs. Private Sector Myths. 2013, Anthem Press, http://marianamazzucato.com
[2] Peter Thiel. Zero to One – Notes on Startups or How to Build the Future. Sept. 2014, Crown Business press, http://zerotoonebook.com
[3] Boris Beaude. Les fins d’Internet. 2014, FYP Editions, http://www.beaude.net/ie

When Peter Thiel talks about Start-ups – Final Thoughts: Human After All

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As you noticed if you read my previous posts, I’ve been quite impressed by Peter Thiel’s notes about start-ups. I’ve written 7 long parts. I had been similarly impressed by Mariana Mazzucato’s The Entrepreneurial State even if with only 5 posts!

Thiel-Mazzucato

I said it already, I would have loved to attend their debate in a few days at the conference Human After All, Toronto 2014. But apparently they do not participate to the same roundtable anymore… (After reading what follows, I see that Taleb would have been a great addition).

– He will discuss “The Economics of Radical Uncertainty.”
How do human beings truly react when confronted with conditions of genuine “unknown unknowns”? According to Frank Knight, “Uncertainty must be taken in a sense radically distinct from the familiar notion of risk, from which it has never been properly separated…The essential fact is that ‘risk’ means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far – reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating… It will appear that a measurable uncertainty, or ‘risk’ proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all.” The economics literature from Knight onward is very good at laying out the propensity of markets to greatly overshoot and undershoot the fundamentals. However, economics does not adequately address the implications of “Knightean” uncertainty, because the discipline finds it hard to model this phenomenon. To get a full measure of this, one has to enter into the realm of psychology and neuroscience. That’s where the definition lies. Radical uncertainty, like so much else, is too important to be left to the realm of economics alone.

– She will be part of “Innovation: Do Private Returns Produce the Social Returns We Need?”
The machines of the first age replaced and multiplied the physical labour of humans and animals. The machines of the second age will replace and multiply our intelligence. The driving force behind this revolution will, argue the “techno-positivists,” exponentially increase the power (or exponentially reduce the cost) of computing. The celebrated example is Moore’s Law, named after Gordon Moore, a founder of Intel. For half a century, the number of transistors on a semiconductor chip has doubled at least every two years. But the information age has coincided with – and must, to some extent, have caused – adverse economic trends: stagnation of median real incomes; rising inequality of labour income and of the distribution of income between labour and capital; and growing long – term unemployment. Are the great gains in
wealth and material prosperity created by our entrepreneurs in and of themselves sufficient to produce desired social returns demanded in today’s world?

Start-ups are a great area to study the tension between individuals and society. A kind of chicken and egg situation… Indeed they might explain the growing gap between the USA and Europe in many dimensions. Mazzucato would be on the social side, Thiel closer to the individual. But do not see any provocative statement here. The thoughts of Thiel and Mazzucato are profound. I agree with most of what they say, disagree with smaller pieces, though most people could think their thinking can not be reconciled. I really think that combining their point of views is an interesting approach to what innovtaion really is…

PS (May 8, 2014): I just found that video of Thiel at SXSW.

The Entrepreneurial State (part5): conclusion on a great book.

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Again I have been very much impressed by the Entrepreneurial State but I also have some major doubts and even some disagreements. Maybe I have been brain-washed in the last 20 years of my life but my experience in Silicon Valley and venture capital and also my less than satisfying experience with planned innovation by the State convince me that entrepreneurship is crucial and maybe more important than the State role in the innovation part (not the research or even the R&D).

Now I fully agree that seed funding by the State of innovation through research and the taxes to be paid by companies are essential. I also agree that VC is less and less risk taking and that corporate R&D is just a D and the R has disappeared both in IT and pharma.

But let me finish with my notes on this excellent book. As a reminder, part 1 was about the innovation crisis, part 2 was about the respective role of the public and private sector in R&D and innovation, part 3 about the Apple iPhone, part 4 about the green revolution and risks and rewards.

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Chapter 9 – Socialization of risks and privatization of rewards.

“Innovation has a tendency of allowing those with high skills to prosper and those with low skills to get left behind.” [See also her comment on the New and Old economy in part 4] “Are these the same type of economic actors who are able to appropriate returns form the innovation process if and when they appear? That is, who takes the risks and who gets the rewards? We argue that it is the collective, cumulative and uncertain characteristics of the innovation process that make this disconnect between risks and rewards possible.” […] “When certain actors are able to position themselves at the point – along the cumulative innovation curve – where the innovative enterprise generates financial returns, that is close to the final product or, in some cases, close to a financial market such as the stock market. These favoured actors then propound ideological arguments, typically with intellectual roots in the efficiency propositions of neoclassical economics (and the related theory of “shareholder value”) that justify the disproportionate shares of the gains from innovation that they have been able to appropriate. [Page 186]

This was long but very true.

Finding a way to realign risk taking with rewards is thus crucial not only for decreasing inequality but also for fostering more innovation. […] Put provocatively, had the State earned back just one percent from the investments it made in the Internet, there would be much more today to invest in green tech. Many argue that it is inappropriate to consider direct returns because the State already earns a return via the tax system. The reality is, however, that the tax system was not conceived to support innovation and the argument ignores the fact that tax avoidance and evasion are common. [Page 187]

Mazzucato suggests 3 concrete proposals:
– A Golden share of IPR and a national “Innovation fund” by extracting a royalty. The government should retain a share of the patents; making sure the owner of patents behaves cooperatively, licensing broadly and fairly after an initial period of protection.
– Income contingent loans and equity. “After Google made billions in profits, shouldn’t a small percentage have gone back to fund the public agency that funded the algorithm?”
– Development banks. IF/when the State institution is run by people who not only believe in the power of the State but also have expertise understanding the innovation process, then the results produce a high reward.
[Well isn’t this at least partially what the US do through the Bayh-Dole Act?]

Conclusion

“Rather than relying on the false dream that “markets” will run the world optimally for us “if we just let them alone” policymakers must better learn how to efficiently use the tools and means to shape and create markets – making things happen that otherwise would not. State can do this by leveraging massive national social network of knowledge and business acumen. The State should “stay foolish” as Jobs said, in its pursuit of technological development. It can do so on a scale and with tools not available to businesses. Apple’s success did not hinge on its ability to create novel technologies, it hinge on its organizational capabilities in integrating marketing and selling those low-hanging technologies.

What is needed today is a “systems” perspective, but one that is more realistic on the actual – rather than mythological – role of the individual actors, and the linkages between actors, within and along the risk landscape. It is, for example, unrealistic to think that the highly capital-intensive and high-risk areas in clean technology will be “led” by venture capital. The history of new sectors teaches us that private investment tend to wait for the early high-risk investments to be made first by the State. Yet the returns from these “revolutionary” state investments have been almost totally privatized. While this is especially obvious in the pharmaceutical industry, it is also true in other high-tech areas, with Apple, which have received major benefits from public funds, both direct and indirect, managing to avoid paying their taxes.

First, it is not enough to talk about the “entrepreneurial” State, one must build it, with long-term strategies. There is nothing in the DNA of the public sector that makes it less innovative than the private sector. It is a self-fulfilling prophecy that it is more exciting and fun to work at Goldman Sachs or Google, rather than a State investment bank or a ministry of innovation. The only way to rebalance this problem is to upgrade, not downgrade that status of government. Second a need for a return to cover the losses, beyond the taxes and supply of skilled staff. A direct return. Third, this will have the potential to better inform policies that are directed towards other actors in the “ecosystem” of innovation. (Except the world is global and this may make efforts at the national level not sufficient)

Recommendations
– Reduce State direct transfers such as tax relief,
– Spend money on new technologies and concentrate on firms that can spend on innovation
– Abandon patent box
– Review tax credits so that firms are accountable on innovation, not just R&D
– Reduce enterprise zones
– Return of successful investment in part to government
– Use saved money for massive spending à la Darpa
– Adopt a proactive approach to green technologies
– (Not sure I understood the argument on time investment held before tax exemptions)
– Short-termism is problematic.

The Entrepreneurial State (part 4) – the Green Revolution – Unbalanced Risks and Rewards.

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– Part 1 covers the Innovation dilemmas and crises.
– Part 2 deals with the (forgotten or untold) role of the state in stimulating innovation through research.
– Part 3 is about the role of the State in the iPhone technologies.
Now chapters 6 to 8:

Chapter 6 – Pushing vs. Nudging the Green Industrial Revolution.

The Green technology is another very interesting situation. “Until wind turbines and solar PV panels can produce energy at a cost equal to or lower than those of fossil fuels, they will likely continue to be marginal technologies that cannot accelerate the transition so badly needed to mitigate climate change.” [Page 114] “Demand-side policies (regulations) are critical but they too often become pleas for change. Supply side policies (energy generation) are important for putting the money were the mouth is.” [Page 155]

Again I have been a cautious observer of green technologies with Germany subsidizing many companies which went bankrupt when China arrived with much cheaper products, with France or Japan claiming nuclear energy as the cleanest… Mazzucato rightly describes “the US with a fund-everything approach, hoping that a breakthrough disruptive energy innovation will sooner or later emerge. This has not been the case because many clean technologies require long-term financial commitment of a kind VCs are not willing or able to undertake”. In my ongoing analysis of recent IPO filings, I noticed 11 companies in green technologies out of the 165 filings I have built since 2002. The oldest one was filed in 2009. These companies had raised more than $2B or about $180M per company. They had more than 5’000 employees in total. It looked to me like a speculative bubble so Mazzucato is right when saying investors are impatient. I am not sure they are shy with their money though.

The US has been busy building on their understanding of what has worked in previous technological revolutions. (…) But while it has been good at connecting and leveraging academia, industry and entrepreneurship in its own push into clean technology, its performance has been uneven. (…) A key reason for uneven US performance has been its heavy reliance on venture capital to “nudge” the development of green technologies. (…) Since some clean technologies are still in early stages, when “Knightian uncertainty” is highest, VC funding is focused on some of the safer bets rather than on the radical innovation that is required to allow the sector to transform society. (Pages 126-127) The conclusion that might follow is that the government should focus exclusively on commissioning the development of the riskiest technologies.

Impatient capital can destroy firms promising to deliver government-financed technology. If VCs aren’t interested in capital-intensive industries, or in building factories, what exactly are they offering in terms of economic development? Their role should be seen for what it is: limited. (Page 131)

The expectation is that the opportunity to conduct high-risk and path-breaking research “will attract many of the US’s best and brightest minds – those of experienced scientists and engineers and especially those of students and young researchers, including persons in the entrepreneurial world.” (Page 134)

The history of US government investment in innovation, from the Internet to nanotech, shows that it has been critical for the government to have a hand in both basic and applied research. NIH is responsible for 75 percent of the most radical new drugs. So the assumption one can leave applied research to the business sector and that this will spur innovation is one with little evidence to support it (and may even deprive some countries of important breakthroughs.) (Page 136)

In reality government and business activities frequently overlap. Venture capitalists and entrepreneurs respond to government support in choosing technologies to invest in, but are rarely focused on the long term. In the absence of an appropriate investment model, VC will struggle to provide the “patient capital” required for the full development of radical innovations. It is crucial that finance be patient. (Page 138)

Public finance (such as provided by State development banks) is therefore superior to VC or commercial banking in fostering innovation, because it is committed and patient.

The financial and technological risks of developing modern renewable energy have been too high for VC to support. A key problem is that VCs are looking for returns that are not realistic with capital-intensive technologies. The speculative returns possible in ICT revolutions are not a “norm” to be replicated in all other high-tech industries. (Page 140)

My comments: I agree with the criticism on venture capital. Now the solution introduced of committed and patient development banks is new to me. I understand “patient”, I am less sure about “committed”. Does this mean hands-on, and competent?

But my main concern is again about the difference between inventing and innovating. I need to go back to Apple. According to Wikipedia, a classical definition of Entrepreneurship is “the pursuit of opportunity without regard to resources currently controlled”. The term puts emphasis on the risk and effort taken by individuals who both own and manage a business, and on the innovations resulting from their pursuit of economic success.

When Mazzucato describes the Entrepreneurial State, she describes as much an Inventing State as an Innovating State. There is nothing wrong with it. What Apple has been strong at is using inventions and mostly innovations to integrate them in new products. It is why Apple is doing so little R&D. Can the same company do research and explore new green fields and develop new technologies into new products. I am not sure this has been shown by clear evidence. But we should probably ask historians of technology.

There is one invention that shows how difficult the transfer from invention to innovation might be: the transistor was invented at Bell Labs in 1947. Some of the elements of the invention only were patented (as they had been prior art back in 1925.) By 1951 Bell Labs had licensed (under the government pressure) the technology to more than 40 companies and (then small firms) Texas Instruments and Sony are known for producing early commercial transistors. The inventors received the Nobel Prize in 1957 and one of them moved to Palo Alto and is probably at the origin of Silicon Valley because of his decision. Because of the threat of USSR as an emerging technology power, the US poured a lot of military and space money on the potential of the electronics of the transistor.

The difficulty with nanotechnologies and green technologies is that in the chicken and egg of pull and push, the market needs may be clear, but the technology push looks to me much less so. I am not sure to see where the equivalent of the transistor is for these “promising” fields.

Chapter 7 – Wind and Solar power

This chapter is about the history and current status of these two energies. Wind power players are GE and Vestra from Denmark. There is a long and interesting history. There is a similar long and painful history for solar power. First Solar, Solyndra, SunPower, Evergreen are described in details. Mazzacutto focuses on China’s long-term strategy vs. the more US short term one, as well as Germany’s innovative approach to the market. “Solyndra’s failure highlights the “parasitic” innovation system that the US has created for itself – where financial interests are always and everywhere the judge, jury and executioner of all innovations investment dilemmas.” “Clean technology is already teaching us that changing the world requires coordination and the investment of multiple States, otherwise R&D, support for manufacturing, and support for market creation and function will remain dead ends.” (Page 155)

A framework would include demand-side policies to promote increased consumption as well as supply-side policies that promote manufacture of the technologies with patient capital. (Page 159)

But McKay’s arguments on Sustainable energy – without the hot air makes me cautious…

Mazzacuto still reminds of us of some fundamental elements: coming back on Myth 2 (small is beautiful) “We should not underestimate the role of small firms nor assume that only big firms have the right resources at their disposal. (…) The willingness to disrupt existing market models is needed in order to manifest a real green industrial revolution. (…) It should be a subject of debate whether public support should be handed-off to large firms that could have made their own investments and it is also unclear how they would be willing to shift from the technologies which provide their major sources of revenues.“ As my friend Dominique (:- rightly mentioned as a reaction to a previous post on the topic: “Research funding and how early the research is funded by a company of course depends on its expectations but also on its margins. Back in the seventies large corporations could afford to fund early research because 1) they foresaw stable or growing markets and 2) because their margins were constantly high I believe. Today the speed @ which markets evolve is certainly a deterrent to early stage research by companies…”

Chapter 8 – Risks and rewards: from Rotten Apples to Symbiotic Ecosystems.

Risk taking has been a collective endeavor while the returns have been much less collectively distributed. [Page 165]

The story US taxpayers are told is that economic growth and innovation are outcomes of individual “genius”, Silicon Valley “entrepreneurs”, venture capitalists or “small businesses”, provided regulations are lax (or nonexistent) and taxes low – especially compared to the “Big State” behind much of Europe. [Page 166]

The real Knightian uncertainty that innovation entails, as well as the inevitable sunk costs and capital intensity that it requires, is in fact the reason that the private sector, including venture capital, often shies away from it. It is also the reason why the State is the stakeholder that so often takes the lead, not only to fix markets, but to create them. [Page 167]

Keeping that story untold has allowed Apple to avoid “paying back” share of its profits to the same State. Apple incrementally incorporated in each new generation of products technologies that the state sowed, cultivated and ripened. [Page 168]

Mazzucato has then a very interesting analysis of Old and New Economy Business Model with Old being about stability, generosity, equity and New about volatility, mobility, and low commitments. Jobs are not equal even at Apple, from R&D where products are designed, to China where they are produced, or back to the USA where they are sold by Apple-owned stores; but worse the mobility and globalization has enabled tax evasion and optimization. Apple has a subsidiary in Nevada, Braeburn Capital to avoid income or capital gain taxes. Then is has subsidiaries in Luxembourg, Ireland, the Netherlands and British Virgin Islands for low-tax advantages. Apple IP is owned by Irish subsidiaries, which receive royalties on Apple sales (!) and which ownership is co-owned by another Virgin Islands subsidiary, Baldwin Holdings… GE, Google, Oracle, Amazon and Intel are also famous for tax optimization and tax loss could be $60-80B for the US over a decade. [pages 168-175]

The ultimate purpose of putting tax dollars to use for the development of new technologies is to take on the risk that normally accompanies the pursuit of innovative complex products and systems required to achieve collective goals. [Page 176]

Mazzucato terminates this new chapter with “Where are Today’s Bell Labs?” “One of the reasons unveiled in a [recent MIT] study is the fact that large R&D centers – like bell Labs, Xerox PARC and Alcoa Research Lab – have become a thing of the past in big corporations. Long-term basic and applied research is not part of the strategy of Big Business anymore. What is not clear however is why and how this has changed over time. The wedge between private and social returns (arising from the spillovers of R&D) was just as true in the era of bell Labs as they are today. And what is missing most today is the private component of R&D working in real partnership with the public component, creating what I call later a less symbiotic ecosystem. It is crucial to understand not only how to build an effective innovation “ecosystem”, but also and perhaps especially, how to transform that ecosystem so that it is symbiotic rather than parasitic. [Page 179]

On one side, I see the success of former emerging countries such as Taiwan and Korea, but I was also in the country of the Concorde, TGV, Rafale and Nuclear Power Plants that France has been struggling in selling abroad.

And why is Tesla and Elon Musk such an (early) success if not money is available for disruptive green technologies…

Similarly why was (military and civil) nuclear fission such a success whereas civil nuclear fusion has not given any commercial output 50 years after the military use? I remember reading Richard Feynman about the Manhattan Project and the crazy (entrepreneurial) intensity of the project. Would entrepreneurship be missing at ITER? Innovation and entrepreneurship are very much related and still somehow a mystery.

Planned innovation is a very difficult challenge that Mazzucato is not pushing for and uncertainty remains. Just remember how artificial intelligence has been a disappointment for many decades not to say until now. I’d like to finish here with an interesting article form Newspaper Le Monde:

Innovation is not about planning.
LE MONDE | 30.09.2013 | By Armand Hatchuel.

On September 12, the French, Francois Hollande, and the Minister of productive recovery, Arnaud Montebourg, presented thirty-four “plans for reconquest” from “thermal renovation of buildings” to “the factory of the future” through the “airships for heavy loads”. This announcement was seen as the return of industrial policy planning, and aroused the usual criticism of public voluntarism.
The criticism is questionable because, in this case, it is not really about planning. The themes are primarily intended to stimulate innovation and new industries. However, numerous studies have shown that innovation policy – whether public or private – can only succeed if its design, control and evaluation is clearly away from a logic of planning (Philippe Lefebvre, researcher at the Ecole Nationale Superieure des Mines de Paris : ” Organizing deliberate innovation in knowledge clusters : from accidental to purposeful brokering brokering processes” [Organiser l’innovation dans les écosystèmes : au-delà de l’émergence accidentelle, un pilotage des interactions créatrices], International Journal of Technology Management , Vol. 63 , No. 3/4, 2013).

A LARGE PART OF UNCERTAINTY
For what is a “plan”? In order to guide future action, one builds representations. We “plan” our vacation, which route to take and the loss of a few pounds. Still, while conceding uncertainties, a plan assumes that the goal, the means and the partners are sufficiently known. We may, at the limit, think that the means and partners will be selected “along the way”. But we must at least specify the goal. Agricultural policy, telecommunications policy and housing policy are built as plans which aim is clearly displayed: for example, a quantified production or equipment amount at a national level.
This is not the case anymore for a genuine innovation agenda. One must admit that the purpose is necessarily largely unknown. It is not possible anymore to specify in advance the paths and the most interesting results of the project.
Paradoxically, this does not prevent an innovative concept from mobilizing resources. Who would want a car “consuming less than two liters per 100 km”? But we must recognize that we do not know how this value will be transformed to in effecient technologies and products: will these be small city cars? Intelligent control systems? New types of vehicles and fuels? And we ignore if new businesses or new markets will emerge in the adventure.
History confirms thoroughly the surprising rationality of major innovation programs . In 1854, Austria launched the Semmering Pass competition for the design of the first locomotive for mountains. Many solutions were proposed, but none could succeed. However, the major beneficiaries of the innovations were Semmering … new locomotives in the plains!

OPENING NEW PATHS
Closer to us, neither Toyota nor Apple have ever launched projects to produce the Prius or iPhone. Their success came from their ability to pilot open innovation programs (” green car”, man-machine “magic” interfaces) and take advantage, before their competitors, of the disappointments or discoveries encountered. It is important to open very contrasting paths and pay attention to the crossings and learning that each causes.
For uncertainty does not paralyze action: it prevents its management according to the rigid codes of planning. In recent years, research has clarified the cognitive and collective mechanisms that restrict or enhance the exploration of the unknown. One better understands the control rules adapted to innovation, whether innovative design approaches (expansion of alternatives, conceptual hybridizations, exploration prototyping…) or the management of the various values that emerge (new skills, new markets, new usages…). In this respect, classical rationality is often misleading.
In the logic of the plan, there is the project distinct from its “benefits”. The success of the project is the goal, the benefits being recorded afterwards. This distinction does no longer exist in an innovation program. A “benefit” may be more important than the project itself. Driving innovation is to be prepared for the changing identity of the project and actively cause unexpected “impact”. The indeterminacy between “project” and “benefits” multiplies the sources of value and minimizes financial risks.
Beyond the economic rationality that is optimized in the known world, the rationality of innovation is reflected in the ability of project managers to regenerate solutions, markets and partnerships.
Faced with the challenge of industrial revival, the question is not whether the State should use planning. It is especially important to ensure that major projects launched will be conducted by the State and its industrial partners in the most rigorous approaches and more consistent with the expected intensity of innovation .

Harmand Hatchuel is a professor at Mines ParisTech

The Entrepreneurial State (part 3) – the State behind the iPhone

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Mazzucato’s book is so important and interesting that it will take me many articles to cover it in a satisfying manner (to me at least).

– Part 1 covers the Innovation dilemmas and crises. The “6 myths” she introduces are great.
– Part 2 deals with the (forgotten or untold) role of the state in stimulating innovation through research. I had more disagreements with her on how far the State should act in the innovation ecosystem.
– In this part 3, I will focus on Chapter 5, about the role of the State in the iPhone technologies.
– Part 4 will deal with the chapters on Green technologies
– and I will need a part 5 to conclude and share thoughts.

Chapter 5 – the State behind the iPhone

Mazzucato shows here how “Apple concentrates its ingenuity not on developing new technologies and components, but on integrating them into an innovative architecture. […] Apple’s capabilities are mainly (a) recognizing emerging technologies with great potential, (b) apply complex engineering skills that successfully integrate recognized emerging technologies, and (c) maintain a clear corporate vision prioritizing design-oriented product development.” [Page 93]

Therefore “Apple received enormous direct and/or indirect government support derived from three major areas: (1) direct equity investment, (2) access to technologies, and (3) creation of tax or technology policies.” I mentioned already the first area and expressed my doubts. No objection and no discussion about the third area. I agree only partly with the second area: I have the feeling the access was through corporations, which themselves may have had access to government or academic research. Xerox PARC is the most famous examples, but Apple also acquired little-known start-ups which had developed products from such research. Mazzucato built her own “Origins of popular Apple products.”

Iphone Technologies origin

It is a very interesting drawing but I would have liked to see which “entity” developed the mentioned products. In some cases, it is a government related body, such as for the Internet for example (http://en.wikipedia.org/wiki/History_of_the_Internet) and in other cases it is a private entity funded initially with public money.

SIRI is an interesting example as it has some roots here at EPFL. The CALO program was funded by DARPA, but a start-up was launched with venture capital money in 2008, which was then acquired by Apple.

When it comes to displays, Mazzucato quotes Florida and Browdy and “The invention that got away” (1991) about the inability of private actors to build manufacturing capabilities. “The loss of this [TFT-LCD] display technology reveals fundamental weaknesses of the US high-technology system. Not only did our large corporations lack the vision and the persistence to turn the invention into a marketable product, but the venture capital financiers who made possible such high-technology industries as semiconductors and computers failed too.” The paper shows the higher efforts of the Japanese industry pouring hundreds of millions of dollars in the technology development. In my analysis of Stanford-related high-tech companies, I remember being stricken by the amount of funding of Candescent. On the Internet archive dated 1998, I could find the following:
“Candescent Technologies Corporation is a seven-year old company developing a revolutionary new flat panel display [which is] a dramatic improvement over the liquid-crystal displays. In 1991 Candescent formed a strategic alliance with Hewlett-Packard Company. As of May 1, 1998 Candescent had received more than $337 million in funding from investing strategic partners, venture capital firms, institutional investors, US Government-sponsored organizations, and capital equipment leasing firms.” In 2001, it had raised more than $600M with Compaq, Citicorp, Hewlett-Packard, J.P. Morgan, New Enterprise Associates, Sevin-Rosen, Sierra Venture Affiliates, and others. In June 2004, Candescent filed a Voluntary Reorganization case under Chapter 11 of the Bankruptcy Code in the San Jose Bankruptcy Court. In August 2004, Candescent sold substantially all of its assets, including its flat panel display intellectual property to Canon, Inc.”

Again, I do not have major disagreements with Mazzacuto but my experience with innovation is that it is a very uncertain activity and I am not sure it is due only to the lack of private sector support. In the end, neither Japan nor the USA won, but Korea with Samsung and LG.

I knew less about multi-touch screens and the interesting story of FingerWorks, which assets Apple bought when the company went bankrupt.
“The company’s products remained a high-end niche, and something of a curiosity, despite good press and industry awards. In early 2005, FingerWorks went through a rocky period, and stopped shipping new products. Outside reports indicated that they had been acquired by a major technology company. This company turned out to be Apple. In June 2005, FingerWorks officially announced they were no longer in business. The founders continued to file and process patents for their work through late 2007. And as of August 2008 they still filed patents for Apple, Inc.” (http://en.wikipedia.org/wiki/FingerWorks)
Again Apple also worked with Corning to develop ultra-robust screens called the Gorilla Glass (http://en.wikipedia.org/wiki/Gorilla_Glass).

On the microprocessor, I have two similar comments:
– Though there are many sources claimed for the microprocessor, it is often mentioned that Intel really launched the technology as a product and this came as an order from a Japanese company, not from public procurement.
– Much later, Apple bought P.A. Semi. which developed specialized microprocessors. Well even P.A. Semi. had strong links with the DoD so Mazzucato still has a strong point!

As an interesting comparison, the MIT technology review had a hacking session of the Apple I, iPhone and iPad, which shows the brilliance of integration. There were many computers and smart phones, but at Apple, there was the genius of Wozniak and others when Jobs came back – http://www.technologyreview.com/view/425238/classic-hacks-the-apple-i-computer-the-iphone-and-the-ipad-3g/

Iphone Technologies sketch

My reaction is that yes, many not to say most technologies have their roots with public entities, at least at the research stage, but the development is often concretized in small companies, with or without venture capital. Apple buys fewer VC-funded companies than Cisco’s A&D (Acquisition & Development) and clearly most big companies do not do much research. The challenge lies in the ability of translating research results into development, which many start-ups achieve. This is the Silicon Valley model.

I finish my notes on chapter 5 with Mazzacuto: “It is indisputable that most of Apple’s best technologies exist because of the prior collective and cumulative efforts driven by the State.” [Page 112]

The Entrepreneurial State: the important role of government in innovation (part 2)

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As I said in The Entrepreneurial State: the important role of government in innovation (part 1), Mariana Mazzucato has written an important book even if I do not agree with all her arguments.

We agree on the issue of funding of technologies, inventions and innovations. It has been generally understood that the commercialization of products and their prior development is the responsibility of the private sector in a capitalist economy. The funding of research (at least basic research) is generally the mission of the state, but applied research (though I never really understood what this is) might be done by the State as well as by the private sector.

Let me open a short parenthesis here: I am not of big supporter of the concepts of basic and applied research, but I understand better other concepts from an early to later stage. Here they are:
Public-and-private-sector

Research has no known output a priori, except knowledge, whereas at a later stage the objectives are a little clearer. This being said, I am not fully comfortable about the arguments Mazzucato brings on the table when she says the State is doing a lot in innovation. But she clearly shows there is a grey zone between the 3 stages I have above. I belong (at least for now) to the group of people who believe it is the mission of the State to be active in the first two ones, and the private sector being in the third. Nothing forbids the private sector to go earlier and the public sector to be more active later, but it is seldom the case. Here are my notes on Chapters 3 and followings:

Chapter 3 – Risk-taking state : from « de-risking » to « bring it on ! »

During a visit of President Mitterand to Silicon Valley, Thomas Perkins which fund started Genentech extolled the virtues of the risk-taking investors who finance the entrepreneurs. Perkins was cut off by Stanford Professor and Nobel Prize Paul berg. He asked, “Where were you guys in the 50’s and 60’s when all the funding that had to be done in the basic science?” [Page 57]

Entrepreneurship, like growth, is one of the least-well understood topics in economics. According to Schumpeter, an entrepreneur is a person willing and able to convert a new idea or invention into a successful innovation (i.e. product, service or process). Entrepreneurship employs the “gale of creative destruction” to replace, in whole or in part, inferior innovations, simultaneously creating new products including new business models. Each major new technology leads to creative destruction. [Page 58]

[Again I need to react: where I fully agree with the Entrepreneurship and Innovation definitions, I am skeptical about the comment on technology: some major new technologies never destroyed anything because they were not commercially successful (artificial intelligence, speech recognition for example and there are many others). I would say major new successful innovations lead to creative destruction. This is important because as Mazzucato rightly says, there is no linear process for innovation and a lot of uncertainty too.]

Entrepreneurship is about risk and is highly uncertain. R&D investments that contribute to technological change not only take years to materialize into new products, but most products developed fail. Silicon Valley model tells a story of “freewheeling entrepreneurs and visionary venture capitalists and yet misses the crucial factor: the military’s role in creating and sustaining it. [Mazzucato shows the same issues in Pharma where the big players develop me-too drugs and let the State fund radical innovations in universities, as is shown in the anecdote above with Mitterand, Perkins and Berg.]

R&D-Funding

Again, I have some concerns with this decription. First in the image above, I would have liked to see the R vs. D and not only the fundamental R vs global R&D. Mazzucato is right in the funding of research, no doubt about it. I used such data for many years where the funding of research in universities by the industry is 4-7% whereas the federal funding is around 60%! You can look at Figures 1 and 2 below. But then, when it comes to innovation, I do not see where the State produced the biotech or IT industry. It made inventions available. You still needed the visionary entrepreneurs and investors as I told about in the Genentech case on my blog a few years ago [see Bob Swanson & Herbert Boyer: Genentech
 and Robert Swanson, 1947-1999]

Federal-Private-Res-GEN
Figure 1: Federal and Industry funding of university research in the USA.

Federal-Private-Res-Stanford-MIT
Figure 2: Federal and Industry funding of research at Stanford University and MIT.

Chapter 4 – The US entrepreneurial state.

In this short chapter, Mazzucato shows through four examples how the US government fostered innovation. These are DARPA (the funding of American research by the military), SBIR (The Small Business Innovation Research), Orphan Drugs and Nanotechnologies.

On Darpa, “A series of small offices, staffed with leading scientists, are given considerable budget autonomy, … funding a mix of university-based researchers, start-ups, established firms and consortia… helping firms to get products to the stage of commercial viability”. [Page 78 ] Again the impact of DARPA in funding research is a no brainer. And Yes, I should be said. Mazzucato is right about too much silence on the role of the State. Check as a great reference Rebecca’s Lowen “Creating the Cold War University – the Transformation of Stanford”.

I am less convinced about the SBIR. “Government agencies designate a fraction of their research funding to support small, independent, for-profit firms.” Mazzucato claims Apple was funded with such a fund, Continental Illinois Venture Corp. but I checked Apple IPO document and CIVC was not at the origin of the company. Arthur Rock and Don Valentine convinced Markkula to help the two Steve and invested in January 1979. Even if CIVC invested that early, it was a minority and passive shareholder. Furthermore, CIVC was the VC arm of a bank, so not a purely State investment… She also quotes Lerner and Audretsch, leading professors as references. In a recent book (Boulevard of Broken Dreams – Pages 125-126), the same Lerner explains that the lack of flexibility of SBIR and ATP was detrimental (it had to be pre-commercial funding for ATP; start-ups had to be 51% owned by US citizens or residents, to the point that the presence of venture capital could exclude the firm from SBIR funding!) I have been struggling for years to find the real impact of SBIR and could never find convincing data of an important role. State direct role in VC funding has been a recurrent debate with unclear answers for years.

I do not know about orphan drugs, but I am skeptical about nanotechnologies. “Nanotechnology is very likely to be the next general purpose technology”. [Page 83] “It will be even more important than the computer revolution.” “Today it does not yet create a major economic impact because of the lack of commercialization of new technologies, due to the excessive investments made in research relative to the lack of investments in commercialization. […] This raises a question: if government has to do the research, fund major infrastructure investments and also undertake the commercialization effort, what exactly is the role of the private sector?” [Page 86]

Well again many things are unclear and somehow contradictory in the arguments. If nanotechnology was just another low hanging fruit thanks to the State investment, we should have already seen early results. The US initiative on Nanotech was launched in 2000. There has been a very visible start-ups such as Nanosys or A123 to a lesser extent. Next is Nanosys cap. table as of 2004. One can read the then and additional funding from private sources.

I am now reading chapter 5 and will come back on Mazzucato’s book in a part 3!

Nanosys

The Entrepreneurial State: the important role of government in innovation (part 1)

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Mazzacuto’s Entrepreneurial State is I think an important book. The author claims we have been unfair with the role in innovation of government and the public sector in general, which has provided funds for most not to say all R&D (Pharma, IT, Space). I share the blame as I am a strong supporter of start-ups, venture capital, Silicon Valley being the ultimate model. And the idea that the State should just provide the basics (education, research, infrastructure) and let the private sector innovate may have been a big mistake (of mine included). I will not take the blame on the second argument as I always shared with the author the idea that tax breaks and tax evasion makes the judgment even more unfair. Finally, the private sector is very risk averse so that there is less innovation (not only venture capital but corporate R&D, compared to the past when corporate R&D labs at IBM, Bell or Xerox were big or when VCs really contributed to innovation in semiconductor, computers and biotech in the 60s and 70s)

9780857282521_hi-res_2

Let me now quote Mariana Mazzacuto following her book linearly. You can also listen to her when she gave a talk at TedX.

While innovation is not the State’s main role, illustrating its potential innovative and dynamic character – its historical ability, in some countries, to play an entrepreneurial role in society is perhaps the most effective way to defend its existence. (Page 1.)

Entrepreneurship is not (just) about start-ups, venture capital and “garage tinkerers”. It is about the willingness and ability of economic agents to take on risk and real Knightian* uncertainty, what is genuinely unknown. (Page 2.)
Note: *Knightian uncertainty relates to the “immeasurable“ risk, i.e. a risk that cannot be calculated.

Even during a boom most firms and banks (would) prefer to fund low-risk incremental innovations, waiting for the State to make its mark in more radical areas. (Page 7.) Examples are provided from the pharmaceutical industry – where the most revolutionary new drugs are produced mainly with public, not private funds. (Page 10.)

Apple must pay tax not only because it is the right thing to do, but because it is the epicenter of a company that requires the public purse to be large and risk-taking enough to continue making the investments that entrepreneurs like Jobs will later capitalize on. (Page 11) Precisely because State investments are uncertain, there is a high risk that they will fail. But when they are successful, it is naive and dangerous to allow all the rewards to be privatized. (Page 12)

Chapter 1 – (The Innovation Crisis)

The emphasis on the State as an entrepreneurial agent is not of course meant to deny the existence of private sector entrepreneurship activity, from the role of young new companies in providing the dynamism behind new sectors (e.g. Google) to the importance source of funding from private sources like venture capital. The key problem is that this is the only story that is usually told. (Page 20)

It is naive to expect venture capital to lead in the early and most risky stage of any new economic sector today** (such as clean technology). In biotechnology, nanotechnology and the Internet, venture capital arrived 15-20 years after the most important investments were made by public sector funds. (Page 23) The State has been behind most technological revolutions and periods of long-term growth. This is why an “entrepreneurial” state is needed to engage in risk taking and the creation of a new vision.
Note: ** Well maybe not in the 50s to the 70s, certainly in the last 10 years.

Big R&D labs have been closing and the R of the R&D spend has also been falling. A recent MIT study (1) claims that the current absence in the US of corporate labs like Xerox PARC (which produced the graphical user interface technology that led to both Apple’s and Windows’ operating systems) and Bell Labs – both highly co-financed by government agency budgets – is one of the reasons why the US innovation machine is under threat. (Page 24) Rodrik (2004) states that the problem is not in which types of tools (R&D, tax credits vs. subsidies) or which types of sectors to choose (steel vs. software), but how policy can foster self-discovery processes, which foster creativity and innovation – the need to foster exploration trial and error (and this is the core tenet of the “evolutionary theory of economic change” in chapter 2)
References
[1] MIT 2013. Innovation Economic Report, web.mit.edu/press/images/documents/pie-report.pdf‎
[2] Rodrik, 2004. Industrial Policy for the 21st century. CEPR Discussion Paper 4767

Chapter 2 – Technology, Innovation and Growth.

Progressive redistribution policies are fundamental, but they do not cause growth. Bringing together the lessons of Keynes and Schumpeter can make this happen. (Page 31) Solow discovered that 90 per cent of variation in economic output was not explained by capital and labor, he called the residual “technical change”. (Page 33)

An “evolutionary theory” explains this as a constant process of differentiation among firms, based on their ability to innovate. Selection does not always lead to “survival of the fittest” both due to the effects of increasing returns and also to the effects of policies. Selection dynamics in products markets and financial markets may be at odds.

Innovation is firm specific and highly uncertain. It is not the quantity of R&D, but how it is distributed throughout an economy. The old view that R&D can be modeled as a lottery where a certain amount will create a certain probability of successful innovation is criticized because in fact innovation would be an example of a true Knightian uncertainty, which cannot be modeled with a normal (or nay other) probability distribution. (Page 35 – the Black Swan again)

Systems of innovation are defined as the “network of institutions in the public and private sector whose activities and interactions initiate, import, modify and diffuse new technology”. (Equilibrium theory cannot work; rather than using incremental calculus from Newtonian physics, mathematics from biology are used, which can explicitly take into account heterogeneity, and the possibility of path dependency and multiple equilibria.) (Page 36) The perspective is neither micro nor macro, but meso. The causation between basic science, to large scale R&D, to applications to diffusing innovation is not linear, but full of feedback loops. One must be able to recognize serendipity and uncertainty that characterizes the innovation process. […] Using Japan as an example, “the contributions of the development state in Japan cannot be understood in abstraction from the growth of companies such as Toyota, Sony or Hitachi aside from the Japanese State’s public support for industry”. (Page 38)

Regional systems of innovation focus on the cultural geographical, and institutional proximity that creates and facilitate transactions between different socioeconomic actors, including local administrations, unions and family-owned companies… The State does this by rallying existing innovation networks or by facilitating the development of new ones that bring together a diverse group of stakeholders. But a rich system of innovation is not sufficient. The State must develop strategies for technological advance.

Mazzacuto finishes Chapter 2 with 6 myths about innovation I totally agree with!

Myth 1: Innovation is about R&D. “It is fundamental to identify the company-specific conditions that must be present to allow spending on R&D to positively affect growth.”

Myth 2: Small is Beautiful. “There is confusion between size and growth.” What is important is the “role of young high-growth firms. Many small firms are not high-growth. […] Most of the impact is from age.” “Targeting assistance to SMES through grants, soft loans and tax breaks will necessarily involve a high degree of waste. While this waste is a necessary gamble in the innovation process,” it should be targeted on high growth and not SMEs, i.e. support “young companies that have already demonstrated ambition”.

Myth 3: Venture Capital is Risk-Loving. “Risk capital is scarce in the seed stage; it is concentrated in areas of high-growth potential, low technological complexity and low capital intensity.” […] “The short-term bias is damaging to the scientific exploration process which requires longer-term horizon and tolerance to failure.” “Rewards to VC have been disproportional to risks taken”, but Mazzacuto also recognizes that “Venture capital has succeeded more in the US when it provided not only committed finance, but managerial expertise.” Finally “The progressive commercialization of science seems to be unproductive”.

Myth 4: Patents. “The rise in patents does not reflect a rise in innovation”. [I will not come back here on the topic, read again Against Intellectual Monopoly]

Myth 5: Europe’s problem is all about Commercialization. “If the US is better at innovation, it isn’t because university-industry links are better (they aren’t) or because US universities produce more spinouts (they don’t). It simply reflects more research being done in more institutions, which generate better technical skills in the workforce. US funding is split between research in universities and early stage technology development in firms. Europe has a weaker system of scientific research and weaker and less innovative companies.”

Myth 6: Business Requires Less Tax. “The R&D tax credit system does not hold firms accountable as whether they have conducted new innovation that would not otherwise have taken place, or simply pursued routine forms of product development.” “As Keynes emphasized, business investment is a function of the gut instinct of investors about future growth prospects.” This is impacted not by tax break, but by the quality of the science base, education, credit system and human capital. “It is important for innovation policy to resist the appeal of tax measures of different kinds”.

More will follow when I have read chapters 3 and followings. Now I need to share some of my concerns, first by quoting again:

“Entrepreneurship by the State can take on many forms. Four examples: DARPA, SBIR, the Orphan Drug Act, Nanotechnology. (…) Apple is far from the “market” example it is often used to depict. It is a company that not only received early stage finance from the government (through the SBIC program) but also “ingeniously” made use of publicly funded technology*** to create “smart” products.” (Pages 10-11)
Note: *** Internet, GPS, Touch screen, Siri.

“Many of the most innovative young companies in the US were funded not by private venture capital but by public venture capital, such as that provided by the Small Business Innovation Research (SBIR) program.” (Page 20)

My concerns are that
– research is not innovation & the transfer is where entrepreneurship occurs so that investing in research is not innovating or even being entrepreneurial. This is at least my experience in the field.
– SBIR real impact unclear
– Green and nano-tech impact also unclear
But I have not finished reading yet…