Podcast: How Public Financing Advances Innovation, With Richard Lipsey

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Throughout modern history, public financing has made possible some of the most important and impactful innovations society has enjoyed—from refrigeration to the Internet—and the spillover benefits have been incalculable. But what are the optimal ways for the public sector to intervene in the innovation process to maximize those benefits and solve big problems? Rob and Jackie explore these questions and the implications for science and industrial policy with Dr. Richard Lipsey, emeritus professor of economics at Simon Fraser University.

 

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Rob Atkinson: Welcome to Innovation Files. I’m Rob Atkinson, founder and president of the Information Technology and Innovation Foundation. And we’re a D.C.-based think tank that works on technology policy.

Jackie Whisman: And I’m Jackie Whisman. I handle outreach at ITIF, which I’m proud to say is the world’s top ranked think tank for science and technology policy.

Rob Atkinson: And this podcast is about the kinds of issues we cover at ITIF, from the broad economics of innovation to specific policy and regulatory questions about new technologies. And today we’re talking about industrial policy, a term that describes either all public sector activities, or either directly or indirectly, the ones that encourage technological innovation in key industries.

Jackie Whisman: Our guest is Dr. Richard Lipsey. He’s currently Professor Emeritus of Economics at Simon Fraser University. He’s authored several textbooks that are used worldwide and has published nearly 200 articles in journals and books on various aspects of theoretical and applied economics. One of the articles, “Industrial Policies: Common Not Rare,” caught Rob’s attention a few months ago, and he’s been dying to make this a podcast episode ever since. So we’re both glad you’re here, but Rob is especially excited. Thanks for being here.

Richard Lipsey: It’s a pleasure.

Rob Atkinson: I am especially excited because I’ve been following Richard’s work really for 30 years and inspiration to my work. And, Richard, as you recall, I think you were one of our first speakers when ITIF just started back in 2006. And we had a standing room only crowd when you were in D.C. for a conference. So I’m really thankful and grateful that you’re with us today.

Richard Lipsey: It’s a pleasure. And I still remember that meeting fondly. I didn’t realize that it was so early on your institution.

Rob Atkinson: Yeah, one of the first. So Richard, you and your longtime co-author Ken Carla, who’s also an academic in British Columbia. You submitted it for a book publication, the study where you looked at the financing of 12 of the most important innovations over the last few centuries, and then really did well. I don’t think anyone’s ever done before, you looked at what role public funding played and what role private funding played. Now, that’s a big question and lots of different stories there, but can you tell us more about what’s your main finding there?

Richard Lipsey: Yeah, well, let’s just say we studied the 12 technologies. I thought we were going to find quite a bit of public sector activity, I will admit, from the beginning. But we’re both like author and I would amaze to discover how pervasive public sector has been. Now, if you look at who does the research and development, which a lot of people have done, you will find more of the public-private sector. But when you look at where did the money come from, without which you couldn’t have done it, you find a much bigger part played by the public sector.

Now, the public sector, and we define it, is everything that operates not for profit, government departments or Department of Defense, NASA, NGOs, Bill Gates foundations, university research, really everything that isn’t doing their research with an objective of making profits. On the other side, you have private firms that do their work with the expectation of making profits.

Now, what we find, I guess, one of the most important results is that when the public sector does adopt a top-down approach without much consultation with the private sector, the results are generally poor, sometimes disastrous. And that’s the sort of thing that critic look for when they’re criticizing [inaudible 00:03:41] policy. The best results come from a cooperation between the two sectors. And that is much more common in any case. And virtually all of the successes that we studied came from that sort of cooperation.

I’m going to just quickly run through these chronologically taking just about five minutes, but let me give one of the most dramatic ones from modern times, which always really struck me when I first discovered it. We tend to think of Apple as one of the great paragons of the success of the private sector. If you ever saw the private sector operating, look at Apple, look at the iPhone. Well, not one technical aspect of the iPhone that did not originate from public sector research. Every single one of them came out of public sector research.

Here’s what one of the experts who studied it stated, “Apple’s organizational success in integrating complex technologies into user-friendly and attractive devices supplemented with powerful software and media should not be marginalized. However, it is indispensable that most of Apple’s best technologies exists because of prior collective and cumulative efforts driven by the state, which were made in the face of uncertainty. And often in the name of it, of national security and economic competitiveness.”

Okay, well now let’s just take a look at some of the technologies that we did look at and what are the lessons. Each one of them has an interesting lesson. Refrigeration way back, and one of the problems with refrigeration was there was a lot of uncertainty about the technology that would allow you to operate refrigeration. It was so much uncertainty that private sector people were not willing to spend the money discovering it. And it came out of public sector research. Once it was proven that how it would work, then the private sector could see what you can do with refrigeration, and they rushed in and applied it in many ways.

The railroads are an interesting example, and what they show you is that in many cases, as with the railroads in the United States, Canada, and Australia, there are enormous, what we call externalities, affects on the rest of the economy which can’t be captured by the people who make the original investment. That’s what we call an externality. And so there was a case for and there was great deal of public sector investment in the railroads, which would not pay off to the original investors, but to the economy paid off enormously because of all of the side effects that the railroad produced.

Craft, an interesting example was quite different, in fact. There the private sector did pretty well all of the early development until it was First World War came along and governments got into the act. But then in the 1920s, the Americans and NACA developed all kinds of very important things, including retractable landing gear and the capsule lever wing that was the basis of the famous DC-3.

And what you have here is an example of what we like to call a public good. If one private aircraft company developed that, it would be immediately reversible engineered so that everybody could do it. And so it wouldn’t pay a single company to make the investment, although the payoff to the industry was enormous. So again, when you get a situation like that, you can only get it done by public sector help. And then once you’ve got that, the private sector takes off and builds airplanes that are world winners.

Agriculture is another example. Many organizations within the States have contributed to agricultural technology. The last one being, of course, the green revolution. But many, again, of the gains were in the nature of public goods, just as with the railroads, that could not be captured as profits by a single company. So again, it wouldn’t have happened without the public sector’s work.

Now, we were talking earlier about the iron steamship, it’s a lovely counter example. The iron steamship, the Admiralty in England had to be dragged, kicking, and screaming by the private sector into iron ships and the screw propellers. They stuck with wood until the storm smashed up all of their wooden ships and left the one private sector metal ship intact. And then in another storm, a private sector ship with screw propeller behaved very well. So finally, the Admiralty agreed that this was a good, and then they financed, to a great extent, the development of the iron screw propeller. But it’s the opposite case where the private sector made the lead and the public sector followed. The reverse is so many cases where the public sector had to take the lead.

Electricity is a wonderful example because there was about 200 years of private sector development of scientists and sometimes amateurs in learning everything it was to learn about electricity before a [inaudible 00:09:31] into the second half of the 19th century, it was developed how to make electricity that could be used. Once that was over, once the private, public sector had developed it, then it was obvious to firms that you could do all kinds of things with electricity and the private firms took off, but they would never been able to finance the 200 years of development that went into it before.

Computers and the internet, well, it’s well known that the internet was effectively created by the public sector. The Department of Defense incidentally could virtually created the US software industry and impose common standards on them, again, it’s like the kicking and screaming. The laser, again, invented by the public sector in the mistaken attempt that they would get a military weapon out of it.

Another example of technology, you never know what you’re going to get, and often what you set out to do fails and, lo and behold, something else of enormous value occurs. And when you think of all the ways in which the laser is used today, not the military weapon, it’s quite amazing, but it was all really developed by the public sector. So that’s just a quick run through most of the people we looked at, there’s a lot of other lessons, but those, I think, are some of the main ones.

Rob Atkinson: You mentioned the internet, I always remember going to a lot of salon dinners in Washington to talk about things. And I was at one a few years ago where we were talking about the role of government and there was somebody there who was a free market person. And he said, “Well, look, we all know that the government didn’t play a role, it was the private sector. Just look at the internet.”

One thing I want to add just a quick question is, I thought it was interesting in your book, which I hopefully will be coming out in the next year, you talked about the difference between spillovers and externalities, which for people on the call, it’s kind of wonky. But tell us... Externalities are much bigger, they’re longer term, they’re more important. Can you say quickly, what is an externality and why does that matter for policymakers to think about?

Richard Lipsey: You’re one of my great students, but you get a D on that one [crosstalk 00:11:49] very well. The externality is the thing that economists talk about. It’s what you’re going to observe and measure. So why do something emit smoke that hurts you? We can measure that and compensate you for it. And that’s an externality. A spillover is something much broader. I do something with my thing-

Rob Atkinson: You’re right. I remember now.

Richard Lipsey: When you think of what happened with the railroads and the whole American economy suddenly became a single unified economy instead of a whole bunch of small broken up markets. And so you could explore the economies of scale that you couldn’t before, that’s a spillover. There was no way the railroad people could even have anticipated it, let alone charge somebody for what they’d done. So the spillovers on the distant thing is that have enormous advantage and is another reason why only the public sector finance can manage to reap those things. There’s no incentive for a private sector person to do it.

Jackie Whisman: Moving on, you also articulate four different trajectories or phases of the innovation process and how the public sector can play a different role in each trajectory depending on the nature of the innovation. Can you talk about these?

Richard Lipsey: The four trajectories that we distinguish are the invention trajectory with the electricity stretch for 200 years or more. And then once you get proof of concept that you have the efficiency of trajectory, very typically a new technology starts being very expensive and becomes more and more efficient in how it produces its services.

The applications trajectory, where a technology gets applied to a wider range of what’s happening. And the diffusion trajectory as it diffuses throughout the world. And what we found is that if you go back through the various technologies that we have just discussed, the public sector intervention was different for different technologies. Quite often, it’s at the invention before you actually do the invention, but has with, say the automobile, that was all done privately, but the diffusion of the automobile depended on public sector investment in roads and other transportation services. So quite often, the private sector invents the technology, but it won’t diffuse until infrastructure is graded by the public sector.

So it’s very important that when you’re judging a particular public sector intervention that you say what kind of technology is this and at what stage, which trajectory is the intervention going to be most effective?

Rob Atkinson: Yeah, what’s interesting to me from reading your work and a lot of other people’s work as well, there is a lot of literature out there about what makes sense, what are the theories, what are the principles, what are the actual case study experiences around the world. But most of that’s just ignored by conventional economists, what we would know or call neoclassical economic, which focuses largely on price-mediated interactions in marketplaces, not on technologies, not on institutions.

And there’s a different sort of version of economics that I think is making somewhat of a comeback, which some people call super tarion or new growth. How would you say, and, again, this is a big question, but just sort of quickly, what’s the difference between that and sort of conventional economics? And why should somebody like a typical legislative staffer care about the difference?

Richard Lipsey: Yeah, but before we get to that, just let me mention that conventional economics, as you say, puts all the emphasis on price as a signaling. And prices do signal scarcities and opportunities, but there’s all sorts of things that aren’t priced. There is no way you could have had a price that told you, you shouldn’t spend money developing a laser. When you talk about new technologies developed under high degrees of uncertainty, there is no price that will give you the advice as to what to do.

Now, conventional economics is very useful in dealing with certain situations. Typically, when the underlying structure of the economy couldn’t be taken as being fairly constant. For example, effective price controls typically lead to a shortage of the regulated commodity and pressure to develop a black market, whereas less useful isn’t dealing with situations in which the structure of the economy is changing due to the introduction of new technologies that cause many changes throughout the whole structure of the economy, such as when electricity replaced steam as the economy’s main mode of power.

In neoclassical economics, some changes such as a new tax will lead producers and consumers to respond by changing the qualities that they buy and sell. Whereas growth economics understands that such a tax may provide the incentive for research and development to change the production process of the commodity being taxed, a totally different result from the same incentive. An incentive that leaves, and both of these may happen, but neoclassical economics will stress the short-term price quality reaction.

And Schumpeterian classical economics will look for the longer term incentive to do research and development and as it were, and innovate your way around the problem. I like to say people are innovative animals, presented with a problem of best reaction is to innovate our way around it, don’t bother solving it directly. Let’s innovate around it. Let’s make it disappear. And so many of the inventions, if we see our phone by innovating around a problem and that’s Schumpeterian not neoclassical.

Rob Atkinson: Yeah, that’s a great way to frame it. And, unfortunately, I think in Washington not as anywhere near as well accepted as it should be. You mentioned innovating your way around it with prices. A good example of that is the climate debate. There’s a big sort of argument in the US, and I know in Canada and other places, we have the technologies, we just price things high enough, people will have to use these technologies. And sure, to some extent that’s true, but the way we look at the climate debate is you have to have innovation to solve the problem and price and other tools like R&D through programs like RPE can get you that way to innovate around the problem to solve the problem.

Richard Lipsey: That’s right. The price of carbon provides an incentive, but the innovation around the problem is going to cause the employment that will employ the people who lose their jobs when the old technologies disappear. And everybody talks about the green technology being job destroyers. Yes, they will destroy all jobs, but all the evidence from Europe and the countries that have gone furthest in greening their economies, is it creates more jobs through new innovations than it destroys the old jobs.

The other thing I just mentioned about the neoclassical versus Schumpeterian economics, neoclassical economics typically assumes that there’s certainty or certainty equivalents. You know what’s going to happen or, at least, you can make an informed guess as to what’s going to happen. What Schumpeterian emphasizes is innovation is an uncertain process. Uncertain means you don’t know what’s going to happen. You can spend vast sums of money and get nothing. You can spend almost nothing and invent something that’s worth millions.

So the idea that you can just have the best possible use of your resources with given prices and technology just doesn’t make any sense when we realize that uncertainty pervades all of the things we do, particularly with respect to growth and change.

Jackie Whisman: You’ve also pushed back on the reflective and frankly ideological view that government can effectively engage in industrial policy. Why do you think that it can do this effectively? And why do so many conventional economists continue to think that they can?

Richard Lipsey: The evidence is pretty clear that all events in all of them, industrial economies, this is the evidence that we’ve been looking at. The public and the private sectors have been cooperating actors in promoting economic growth. Economists who are in the neoclassical tradition, often emphasize the private sector’s activity. And they take the cases where the public sector has tried to do things on its own and generally failed, which uses this evidence against the more general place of the public sector in cooperating with the private sector. When the public sectors decided on its own to push some technology, this has usually been a failure. But when it’s worked in cooperation with the private sector, success has been more common than failure.

Over the 20th century, technologies have become more and more linked to science, this is critical. Earlier on, practical inventors did things and scientists had explained why what they did worked. That was the case with the steam engine. The theory of heat transfer came after the steam engine, but now scientists figured out what you can do, and then people in the private sector figure out how to apply what the scientists have discovered. And this is why public sector science is far more important in technology than it was 100 years ago. Even though it was important then, it’s vastly more important today because most of what we do, look at the laser and the computer, is basically science-based.

Rob Atkinson: One related question to that, there’s a big debate in the US now, as we debate particularly a bill called the Endless Frontier Act, which would put a lot of money towards NSF, but targeted really more around if you’re familiar with TRL levels. And the sort of TRL level three, four, and five, rather than just early stage basic research. And one of the debates as well, if we just fund more basic research that, that would sort of automatically go into kind of the key areas the US is going to need for sustain competitiveness and military advantage, frankly, over countries like China. And that’s goes back to this sort of the van of our Bush linear model and all. And while I get, and 100% agree with you, that science is critical to this, most countries that have done this have combined science policy with technology policy. Can you just sort of share your thoughts on that?

Richard Lipsey: Oh, absolutely. You can’t just invent some simple scientific principle and hope that this will suddenly lead to profit opportunities for the firm. I’ve already given you several of the reasons when we went through that survey. Often the payoff, you can see it’s going to be there, you knew it’s going to be big, but you don’t know how far away it is and how much it’ll be.

And as with bio and nanotechnology, when biotechnology was first discovered, when Crick and Watson first broke the genetic code, it was blindingly obvious to everybody there was going to be an enormous pay off, some of which we’re seeing today. But they knew it was going to be a while and it paid some firms to take a chance on it. But by and large, it was a case where you needed public sector investment because the payoff, although we knew it was going to be there and we knew it was going to be big, it was too far away and too uncertain.

And in those cases, you would need public sector to push the applications of these till you get to the point where it is fairly clear to private sector people that there are profit opportunities close enough to make it worthwhile. And then the private sector takes over. But it isn’t the first step time you prove the concept.

Jackie Whisman: And why should someone, especially if I’m a policy maker, why should I care about what many might see as an arcane academic fight? No offense to the academics that I’m talking to.

Richard Lipsey: Well, what we’re talking about is a very practical, not an arcane issue. For one example, we were to institute some measure that would make sense in a static economy, but would inhibit research and development and the resulting technological change with its long-run effects on living standards could be enormous.

For another example, believers in market competition often seek to break up large firms where two or three are in one industry, which we call an oligopoly. And these firms are in large profits. They want to get closer to the kind of automated atomic competition, which is called in the textbooks, perfect. But a look at history shows, for example, that none of the technological changes that transformed agriculture in the late 19th and early 20th centuries, such as a combine harvester were developed by small competing firms of the textbook sort. Instead, they were developed by large oligopolistic firms who used their large profits to pay for the R&D that created these transforming technologies.

So the debate about whether how we should look at the economy is critical to understanding how it works and what policies will make it work. Now, market economies are very effective when they’re compared with fully command economy, such as existed in Soviet Russia. There’s no question about that. If you have to choose, you’d rather have a pure market economy than a pure command economy. The problem is that in analyzing the benefits of a market economy, all too many economists come to believe that private initiative operating through unregulated markets is all what’s required.

A simple study of history, which we’ve talked about earlier, shows that the governments have exerted major efforts on economic development over the centuries. The trick is to allow both the public and the private sector to cooperate in doing what each can do best. Well, neither can do the whole job.

Rob Atkinson: Great way to end the conversation, we could go on for a long time because this is perhaps one of the most important questions that is facing the US, Canada, and certainly, the UK, many countries now around the world they need to figure out a way to that replace that old, more static thinking with a new kind of dynamic and innovation-based thinking. So thank you so much for being here. This was great.

Richard Lipsey: I’d like to make one more observation of you’ll let me.

Rob Atkinson: Sure.

Richard Lipsey: This is something that really worries me. Americans tend to believe their own mythology. “Hey, public sector,” a man in Canada said that to me once. Everybody has their mythology, the problem with Americans is they tend to believe or free mark their technology that private initiative working through free markets can do everything is just required to promote our prosperity. And if anything, the government is the enemy, rather than a friend of such developments.

We can understand this because so many Americans have an immigrant heritage coming from countries where governments were indeed oppressive and counterproductive. In contrast, for example, Canadians who come with a small population to the second largest company in the world, have come to believe that the government can be a friend rather than an enemy in helping you. Now, this American mythology is a danger of obscuring, and when certain political ideologies become prominent, actually inhibiting the productive cooperation between the private and public sector that characterizes economic growth.

The previous administration really did a major attack on scientists in the public sector. And although it was so bad in its own, it’s in the long run, enormously harmful because of the kind of thing we’ve just been discussing. Now, if they do nothing else, the cases that I have considered, we have considered in our book, reveal that those who would dismiss industrial policy with the statement, everyone’s kind of winners, are relying on an empty slogan to avoid detailed consideration of the complicated multifaceted relationship between the private and public sectors in encouraging the inventions and innovations that are the root of our economic growth.

Rob Atkinson: Absolutely, hear, hear.

Jackie Whisman: That is it for this week. If you liked it, please be sure to rate us and subscribe, feel free to email show ideas or questions to [email protected]. You can find the show notes and sign up for our weekly email newsletter on our website, itif.org, and follow us on Twitter, Facebook, and LinkedIn at @ITIFdc.

Rob Atkinson: And we have more episodes and great guests lined up. New episodes will drop every other Monday, so we hope you’ll continue to tune in.

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Podcast: How Public Financing Advances Innovation, With Richard Lipsey