mercoledì 2 febbraio 2011

Serve una Banca per l’innovazione

“The hardest part about being an entrepreneur is that you’ll fail ten times for every success.” Adam Horwitz

Mercoledì 2 febbraio 2011
Ore 10.30
Palazzo Montecitorio – Sala della Regina
Franco Bernabè - Amministratore Delegato Telecom Italia
Enrico Letta - Vicesegretario del PD
Maurizio Lupi - Vicepresidente Camera dei deputati
Corrado Passera - Amministratore Delegato di Banca Intesa
Francesco Profumo - Rettore Politecnico di Torino
Irene Tinagli - Docente Università Carlos III Madrid
Gianluca Dettori - CEO Dpixel
Riccardo Luna - Direttore Wired Italia

Edmund Phelps
“L’esigenza di una Banca per l’innovazione”
The need for a “Bank for Innovation”

It is a very great honor to be invited here to speak at the Camera dei deputati. I am grateful to have this opportunity to express some of my ideas. It touches me, since I have been making substantial visits to Italy for nearly 30 years! I feel close to the Italian people.
My subject here is innovation, as you know. An innovation is always the extensive or significant adoption of some new practice in the society or in some community. It is never the invention of something that fails to be adopted. That is exactly how Joseph Schumpeter used the term. Another point: The same Schumpeter nearly destroyed the subject at birth by supposing that every innovation must originate out of some discovery by a scientist or navigator – by people outside the business sector; and all innovative projects are successful, because financiers have the uncanny ability to identify the projects that will succeed and reject the projects that would fail. In fact, scholars have found that the great bulk of economic change is the result of innovations, small and large, springing from inside the business economy. Medical practice is a stunning example. And, as people in business or the professions know, most new ideas are not developed and most newly developed products fail to effect an appreciable innovation in the industry.
It is paradoxical that the world is captivated by innovation when attempts to innovate have a high failure rate. Apparently we still feel that innovation is important and worthy of added support.

Innovation is apt to be important even from the perspective of an extremely conventional theory of what the economy’s structure is and how it works. Production of capital goods is the great employer, as the “Austrian” and Swedish capital theorists liked to suppose; in contrast, consumer good production makes heavy use of capital and little use of labor.

Looking at the waves of discernable innovation, such as the wave in the second half of the 1990s, we see that they achieve big advances in the way capital is used in producing consumer products. This drives down the prices of consumer goods – in other words, it raises the real prices obtainable by capital goods producers. So investment activity is stepped up. 

Also, wages and labor’s share are pulled up. Clearly, Washington economists are yearning for a return of that booming economic activity. For me, all of this strikes a good note. (It must be added, though, that the economy is complicated. A step-up of innovation could take an unusual and much less desirable direction: it could cheapen the production of some capital goods, which is what Intel did in the 1990s. At first, that might increase jobs making chips; but endless advances ahead might ultimately lower the price of chips so much as to contract jobs making chips.)

Innovation is vastly more important from my radically different perspective on what a good economy is about. A good economy – even the not-so-good economy of the United States these days – is all about the creation and application of new ideas: Humean businesspersons are imagining new concepts and novel departures, Hayekian entrepreneurs are attempting the developing of a new product embodying the new idea, on the hope that some consumers or managers will adopt it. Baconian technicians are experimenting with ways of producing the new product. Nelson-Phelps managers are assessing the possible value of adopting novel products coming on to the market. Bhidéan consumers willing to risk taking home the latest thing. This economy is shot through with the exercise and the expression of their creativity, their curiosity, their venturesomeness, their taste and their personality. It is obvious that in nations where there are not the economic institutions to enable and encourage innovation, there cannot be a good economy.

I can imagine you may say, fine, but with so many good causes to support why should the Italian government put enough value on your “good economy” to want to give support to innovation? My answer is that without such a “good economy,” the participants cannot have the prospect of a good life, and for that people need  to be stimulated by new developments, engaged by new problems, enlisted to meet new challenges, to find personal growth in the process and to have a chance (which is all anyone can ask for) to make a difference, to achieve something. (We are witnessing outcries of precisely these needs in the Arab states in recent weeks.) 

As I have been arguing ever since early 2006, a high-income country is not doing justice to the potentialities of its population for self-actualization, self-discovery, and inclusion if it does not examine its institutions, attitudes and beliefs for ways to shore up its dynamism.
I can also imagine it being asked whether there is really any link between the inherent innovativeness of the economy – its dynamism – and human satisfaction and sense of fulfillment. I have spent a lot of time attempting to understand intercountry differences in job engagement and job satisfaction among the high-income countries. 

To be brief: According to data from the 1990s, among the G7 nations, Canada ranked highest and next came the U.S. and U.K. with Japan in the fourth rank. France was at the bottom and Germany next to it. Italy was in both respects in the middle. 

Data from the year 2000, which do not include job engagement, job satisfaction was highest in the U.K., next the U.S., then Germany and France, with Italy having sunk to the bottom. 

 These results are consistent with my thesis that where we see among high-income countries boredom and a deficiency of engagement and satisfaction in the workplace, the explanation is usually a deficiency of innovation. Italy would appear to be a prime candidate for a boost to innovation. So would the United States, where job satisfaction plummeted in 2004 with the increased overseas competition and decline of innovation, which caused many companies to prune themselves of employees in fun jobs doing forward-looking work: product development, strategic planning and so forth.

Two points are of critical importance in the present discussion. Many neo-Schumpeterians are telling us that, even if those great navigators of the Mercantile era and those great scientists of the Enlightenment are no longer with us, the central government of the nation can – and ought to – recreate the days of Queen Isabella and the more recent days of the space agency, NASA, by instituting government-sponsored research projects in green technologies, alternative fuels, and pharmaceutical research. One drawback of this approach is that in a company placed under a government contract to do research or a research agency of government, radically new ideas – ideas that are “out of the box” – are unlikely to get the era of the government overseers. And the directions decided on by these well-funded organizations entities may crowd out competing visions. Perhaps the true genius of the modern economies that emerged in the 19th century was that they achieved mass innovation by encouraging the diverse business people to come up with new ideas, by requiring that these new ideas “make it” with the public, not the government, and by allowing these ideas to compete for the support of entrepreneurs and financiers possessing a pluralism of beliefs, so that ideas that were suspect because of their great novelty would have a chance.

I have to add that I was surprised to see it asserted last week in President Obama’s State of the Union Message to the U.S. Congress that the “Sputnik moment” in 1961, which sparked an outpouring of U.S. government money for research, basic and applied, over the 1960s and beyond, led with time to heightened innovation in the business sector.

The second point is that the Washington economists are nevertheless likely to be right in supposing that fewer business people are going to take the plunge of developing and, if getting that far, bringing to the market when the prospect for prosperity in the future has dimmed because of the slump and, more important, the structural problems that have beset so many western economies. So it makes sense to me that, in Italy and the U.S. as well, the government would be right to voice support for innovation and to throw its support into efforts to boost innovation in the economy. The symbolic significance of such a movement could help lift entrepreneurial spirits.
For two years now, I have been suggesting that the state could give a boost to business innovation by introducing into the financial sector new “banks” or other bodies dedicated to financing company projects in the business sector, including the formation of start-up companies, of a demonstrably innovative character.

I have been moving toward a proposal to establish banks of a new kind. It is not uncommon to see financial entities in a country that are dedicated to residential construction or to agriculture or to exports and so forth. This is curious and disturbing because little or no economic dynamism comes from [that]. … There is no awareness among the general public and its legislatures that most of the economic dynamism inherent in the structure of a country’s economy comes from the innovative inclinations of ordinary people making their careers in the business sector! To right the balance, I suggest to every country that its government establish a corps  of banks that are dedicated to lending to – or investing in – companies in the business sector. I like to remind audiences that Germany, with its famous Deutsche Bank, had just such aw financial institution serving its business sector during its brilliant economic development in the 1880s and 1890s, when the bank backed the new electrical engineering industries.

I continue to stand by this proposal. It will not be a panacea. But I believe it will be a step in the right direction and have some detectable benefits.

A concrete version of the idea emerged in discussions with Leo Tilman. In this blueprint, the state would make an initial capital contribution to a government sponsored enterprise (GSE) and the latter would create a system of new “banks”  or other bodies under its umbrella. We came to realize that this financial “system” – the Innovation Finance System – could be loosely modeled after the mission and structure of the U.S. Farm Credit System. 

Every one of the members of the System would be engaged in “relationship-based” investing in or lending for entrepreneurial ventures of various industries and regions. These entities would be properly chartered and capitalized to reflect risk/return characteristics of investing and lending to the targeted category of entrepreneurs. Through a dedicated funding arm, akin to the Federal Farm Credit Banks Funding Corporation, our System would raise funds in the global capital markets at the relatively attractive rates owing to its status as a government-sponsored enterprise and economies of scale. These funds would be passed onto entrepreneurs at rates commensurate with risks of their projects, as judged by experienced investment and loan officers. Finally, the “joint and several liability” of our System’s members, a separate insurance fund that protects debt holders, and proper oversight and transparency can all foster well-judged business decisions, rigorous risk management, and properly aligned incentives.

Another version of the basic idea would make available equity financing as well as lending, and the new institution’s finance could be concentrated on investments rather than loans. The “banks” in that case might better be called funds  for innovation.
I have come to see that it is better that the proposed fund invest in new ventures rather than to finance them only by lending. A lender is apt to find that there is no interest rate high enough to cover the losses from the loans that do not work out. The start-up entrepreneurs will welcome a partner taking an equity stake but will not welcome the same quantity of finance in the form of a loan.

I would like now to address some of the questions raised by this proposal. One question is what justifies committing the resources of the state to this initiative when there are so many other worthy initiatives that might be launched instead. My answer is that, as I have already said, is that the government owes its citizens, young and old, the dignity of work and the opportunity for realization of talents and discovery of one’s capabilities – and to have these primary goods in one’s own country rather than having to go abroad to get them.

Another question is whether this is not a time for the government to spend less rather than more. My answer is that most of the annual outlay of the new financial initiative is an investment that will bring back cash returns. Furthermore, cutting back on government expenditure is not a reliable way to increase employment; it might or might not do any good while costing something in other social dimensions. (I do believe that many initiatives of the welfare state are counterproductive: they sap incentives to work and to take business risks.

A worry among many economists is whether any investment-type expenditure by the government crowds out other kinds of investment expenditure – more or less dollar for dollar – so that the benefit, if any, is heavily offset by the loss of the benefits of some other government investments. My answer is that actions to enhance the attractiveness and financing of innovative projects does not significantly take away from the value placed on the other investment projects or add to the cost of undertaking them. Think of the business investment boom of the 1990s (the internet boom): yes, it may have dented residential investment in housing but it did not crowd out such investment to such an extent as to snuff out any rise in total employment.

Many financial people question whether it is a good idea to inject into the financial sector an investment fund for innovation that will do a poor job as compared to the good job that venture capitalists and other private investors do. My answer is, first, that it is not at all clear that venture capitalists do a very good job: they demand towering interest rates, so the most uncertain projects – even if visionary – never have a chance. 

Second, the VC industry is only a tiny bit of the financial sector, so it is preposterous to suggest that the VC industry should be depended upon to do the whole job of supporting a nation’s innovation. Third, we must not cling to the highest standards for financing innovative investments when the more important objective is to get a larger volume of innovative investment projects underway by boosting the availability of their finance and perhaps their cost of capital. Finally, we should welcome a new investor to the financial sector that, owing to its size, is willing to take risks that are unknown and quite possibly large for the sake of a comparably large payoff. We would welcome a Mickey Mantle to our baseball team in order to have his home runs even if he strikes out a lot. (Or we would welcome a Franco Corelli to our opera company even if there are many days when he declines to sing!)

This is a time of economic crisis for Italy as well as many other countries these days. In many of these countries, the restoration of a spirit of enterprise and of economic institutions to serve them is the key to a return of prosperity and the personal development of the people. Italy is fortunate that it has the economic culture that is required for a rinascimiento of creativity and adventure in the economy. What now needs to be put in place are the institutions that will enable Italy to regain its potential.

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