Public risk taking in innovation (from “The entrepreneurial state” by Mariana Mazzucato)

I have found these piece quite relevant whle we consider the future of the EU´s research and innovation framework programme “Horizon 2020”.  When thinking about the role of public research in innovation economist Mariana Mazzacuco explains the “socialized generation and priviatized commercialization” of innovation, for example in the pharmaceutical sector. David Hammerstein

In finance, it is commonly accepted that there is a relationship between risk and return. However, in the innovation game, this has not been the case. Risk-taking has been a collective endeavour while the returns have been much less collectively distributed. Often, the only return that the state gets for its risky investments are the indirect benefits of higher tax receipts that result from the growth that is generated by those investments. Is that enough?
There is indeed lots of talk of partnership between the government and private sector, yet while the efforts are collective, the returns remain private. Is it right that the National Science Foundation did not reap any financial return from funding the grant that produced the algorithm that led to Google’s search engine?161 Can an innovation system based on government support be sustainable with such a system of rewards? The lack of knowledge in the public domain about the central entrepreneurial role that government plays in the growth of economies worldwide, beyond Keynesian demand management and ‘creating the conditions’ for growth, is currently putting the successful model in major danger.
This contrast is well depicted by the example offered in Vallas, Kleinman and Biscotti:
“A new pharmaceutical that brings in more than $ billion per year in revenue is a drug marketed by Genzyme. It is a drug for a rare disease that was initially developed by scientists at the National Institutes of Health. The firm set the price for a year’s dosage at upward of $350.000. While legislation gives the government the right to sell such government-developed drugs at ‘reasonable’ prices, policymakers have not exercised this right. The result is an extreme instance where the costs of developing this drug were socialized, while the profits were privatized. Moreover, some of the taxpayers who financed the development of the drug cannot obtain it for their family members because they cannot afford it.”
The socialised generation and privatised commercialisation of biopharmaceutical—and other—technologies could be followed by withdrawal of the state, if private companies used their profits to reinvest in research and further product development. The state’s role would then be limited to that of initially underwriting radical new discoveries, until they are generating profits that can fund ongoing discovery. But private-sector behaviour suggests that public institutions cannot pass the R&D baton in this way. And that the state’s role cannot be limited to that of planting seeds that can be subsequently relied on to grow freely.
Many of the problems being faced today by the Obama administration are indeed due to the fact that US taxpayers are virtually unaware of how their taxes foster innovation and growth in the USA, and that corporations that have made money from innovation that has been supported by the government are neither returning a significant portion of the profits to the government nor investing in new innovation.163 They are sold the idea that this growth occurs as a result of individual ‘genius’, to Silicon Valley ‘entrepreneurs’, to venture capitalists, to what they think is a ‘weak’ state compared with the European system. These battles are also being played out in the UK where it is argued that the only way for the country to achieve growth is for it to be privately led and for the state to go back to its minimal role of ensuring the rule of law.
An implication of this pamphlet is that the only way to make growth ‘fairer’ and for the gains to be better shared is for economists, policy makers, and the general public to have a broader understanding of which agents in society take part of the fundamental risk-taking that is necessary to bring
on innovation-led growth. As has been argued, risk-taking and speculation are absolutely necessary for innovations to occur. The real Knightian uncertainty that innovation entails is in fact the reason that the private sector, including venture capital, o????en shies away from it.
Understanding the dynamics of innovation must be brought in line with our understanding of dynamics of inequality. These areas of economic thought have been separated since David Ricardo’s study of the effect of mechanisation on the wage–profit frontier—distribution. Recently, the relationship has come back in vogue with studies on how skill-biased technological change affects wages. This work explains inequality through how wages are affected by technologies like IT that favour skilled over unskilled labour by increasing its relative productivity and, therefore, its relative demand and wages. Inequality is thus explained here as a result of how economic incentives shaped by relative prices, the size of the market, and institutions create biases in factors of production, which then affect their returns.164 While this work provides some important insights, it does not explain many dynamics of inequality, including why within a sector, the different agents that take part of production and innovation reap such different benefits from the innovation. Inequality is indeed just as high within sectors as it is between.165
????e idea of an entrepreneurial state suggests that one of the core missing links between growth and inequality (or to use the words of the EC  strategy, between ‘smart’ and ‘inclusive’ growth) lies in a wider identification and understanding of the agents that contribute to the risk-taking required for that growth to occur. Bank bonuses, for example, should not logically be criticised using arguments against the greed and underlying inequality that is produced (even though these generate powerful emotions). Rather they should be argued against by attacking the underlying logical foundation on which they stand.
The received wisdom is that bankers take on very high risks, and when those risks reap a high return, they should in fact be rewarded—they deserve it. The same logic is used to
Final thoughts on risk-taking in innovation…
justify the exorbitantly high returns that powerful shareholders have earned in the last decades, which has been another prime source of increasing inequality. The logic here is that shareholders are the biggest risk takers since they only earn the returns that are le???? over once all the other economic actors are paid (the ‘residual’ if it exists, once workers and managers are paid their salaries, loans paid off, and so on). Hence when there is a large residual they are the proper claimant—they could in fact have earned nothing since there is no guarantee that there will be a residual.
However an understanding of risk that gives credit to the role of the public sector in innovative activities immediately makes it logical for there to be a more collective distribution of the rewards that should exist. Central to this question is the need to better understand how the division of ‘innovative labour’ maps into a division of rewards.166 Thee innovation literature has provided many interesting insights on the former, for example the changing dynamic between large firms, small firms, government research and individuals in the innovation process.167 But there is very little understanding on the latter. Yet, as Lazonick has argued, governments and workers also (and perhaps more so) invest in the innovation process without guaranteed returns.168
The critical point is the relation between those who bear risk in contributing their labour and capital to the innovation process and those who appropriate rewards from the innovation process. As a general set of propositions on the risk–reward nexus, when the appropriation of rewards outstrips the bearing of risk in the innovation process, the result is inequity; when the extent of inequity disrupts investment in the innovation process, the result is instability; and when the extent of instability increases the uncertainty of the innovation process, the result is a slowdown or even decline in economic growth.169 A major challenge for the UK and for Europe  is to put in place institutions to regulate the risk–reward nexus so that it supports equitable and stable economic growth.