172. Christian Sandström: Why Governments Can’t Act Entrepreneurially

A strange strand of thought has emerged in European political economy circles that has been given the name of The Entrepreneurial State. The headline claim is that the state (i.e., nation state governments) can and should intervene in the economy to bring about innovation, and that, indeed, it is absolutely necessary for grand, mission-driven undertakings such as climate change amelioration and the commercial development of next-generation technologies. Economics For Business talked to Christian Sandström, co-editor with Karl Wennberg, of Questioning The Entrepreneurial State, a compendium of analysis by thirty-two leading economists (including friends of E4B such as Peter G. Klein, Samuele Murtinu, and Saras Sarasvathy) to demonstrate the fallacies of the case for an entrepreneurial state. There’s a lot of sound economics to be learned from Professor Sandström’s book.

Key Takeaways and Actionable Insights

There’s a warm climate in Europe for government solutions to perceived economic problems. “The entrepreneurial state” is one of the forms these solutions take.

Entrepreneurship is well-developed in Europe, and recognized as a growth accelerator. Nevertheless, since 2008-9, country-level growth rates have been below expectations.

Professor Mariana Mazzucato originated the concept of “the entrepreneurial state”, telling fellow economists that they were all wrong in expecting growth to come from private entrepreneurship. Only government has the scope and scale to act entrepreneurially at the level of lifting the growth rate of the whole economy, overcoming the barriers to the introduction and commercialization of new technologies, and tackling the great missions such as climate change amelioration. Historically, she claims, this precedence has always applied: the state leads innovation and private entrepreneurs follow to fine tune the details of marketplace adoption and implementation.

The ongoing failure of Green Deals represents just one illustration of the errors of the entrepreneurial state.

One essay in Professor Sandström’s book spotlights what he calls Green Deals: directed investments in various technologies aiming at so-called sustainable development. Public funds distort incentives in the market, making it “rational” for firms to pursue technologies without long-term potential.

One of his examples is a municipality in northern Sweden that accumulated billions of Swedish Krona in debt investing in industrial plant aiming to create car fuel from cellulose, with the ambition of creating an environmentally friendly substitute for gasoline, which would also result in new jobs and a regional resurgence in competitiveness. The process of extracting ethanol from cellulose proved to be more difficult than promised, and no technological breakthroughs occurred. The 2008 recession resulted in falling prices for ethanol, yet more public money was poured in. The end result has been a high debt burden on the municipality, no new jobs, and no reindustrialization for the region.

As Professor Sandström and his co-author Carl Alm conclude, this case and other similar cases stand in stark contrast to ideas about an entrepreneurial state successfully taking on risk and pursuing new technological opportunities.

There are fundamental reasons why governments can’t act entrepreneurially.

First, governments don’t operate in markets and they are not subject to market tests, like going out of business if they fail to meet customer needs. They bear no genuine entrepreneurial risk. They have no competitors and so no process of competitive refinement and improvement. Their entrepreneurial actions can’t be evaluated. In effect, they want to achieve innovation without entrepreneurship, which is an impossibility.

Governments lack the required competence for the tasks they claim to be able to undertake.

Peter Klein, Samuele Murtinu and Nicolai Foss introduce and explain the economic concept of ownership competence. Entrepreneurs operating in competitive markets have strong incentives (i.e., their own property and their own funds) to allocate resources that they own or control to the most productive applications and to generating the value that the market prizes most highly. Knowing what to own, when to own it (or dispose of it), and how to create value through ownership, all under conditions of uncertainty, requires a skill set that bureaucrats and public actors don’t have and can’t exercise. Public employees can’t exercise the ultimate responsibility that comes with ownership.

Bureaucrats can’t reproduce the human factors of entrepreneurship.

Saras Sarasvathy introduced us to the entrepreneurial method of business innovation in episode #131 (Mises.org/E4B_131). Entrepreneurs self-select into the role of uncertainty-bearing, and then initiate projects and advance through a process of market co-creation, making commitments and then adjusting those commitments based on feedback loops and customer responses. They develop a lived experience that enables them to identify new goals to pursue and new means for pursuing them along the pathway. Creativity and adaptability are more relevant to success than investing acumen and planning.

Governments can’t operate in this way. They place big bets, with quantitative goals and illusions of predictability of outcomes, and they pay with other people’s money. They are not capable of finding the serendipity that guides the entrepreneur.

Governments don’t understand the innovative generativity of new technologies.

Professor Sandström’s book includes quite extensive examination of what is identified as the Digital Platform Economy (DPE) — the digital entrepreneurial ecosystem of platform access to markets, data, algorithms, and cloud computing capacity (There’s a useful report on the DPE provided in the book at the end of episode 131. Digital platforms are enablers for entrepreneurial creativity and business building as a consequence of the access that they give to new business tools and the interconnections to resources, both human and material. The platforms are provided by private companies, and the resulting value creation is user and customer co-generated.

Governments misunderstand the Digital Platform Economy. They see platform providers as monopolistic owners of excessive market power to be regulated and taxed, and totally miss the value generation of hyper-connectivity between buyers and sellers, the complementarity of firms on both sides of the platform, the open access and the lowered transaction costs.

These digital platforms will do much more to encourage entrepreneurial growth than any government ever could.

Governments’ errors are repeated because there is no genuine evaluation of their activities, initiatives, and “missions”.

Professor Sandström investigated the way that the results of government innovation expenditures and initiatives are assessed. He found that most evaluations are conducted by consultants, paid by the hour and mindful of the opportunity for future business if their work is well-received by the government that employs them. Some other assessments are conducted by the government departments themselves.

Perhaps unsurprisingly, Professor Sandström could find only 5% of these assessments that were critical in any way (mostly simply to say that the desired results were not achieved).

Moreover, the assessments were economically incomplete. There was no identification or discussion of opportunity costs (what better uses could the funds have been put to) or of administrative costs, which are high since bureaucratic infrastructure grows with each new initiative.

The government’s best role is to remove itself as a barrier, and possibly to help remove additional barriers (for which it often bears responsibility in the first place).

Is there such a thing as innovation policy? Professor Sandström says no. He does point out that, in the Austrian tradition, removing barriers to entrepreneurship can help to create the type of environment in which innovation can flourish. This might involve the elimination of legislation and regulation that gets in the way. It could also include nurturing educational institutions to bring the right kinds of thinking and learned skills into the marketplace.

Any such initiative should be general and non-selective. Picking winners should be left to markets.

Additional Resources

Questioning the Entrepreneurial State: Status-quo, Pitfalls, and the Need for Credible Innovation Policy, edited by Karl Wennberg and Chris Sandström (PDF and ePub): View The Book

“The Digital Platform Economy Index” (PDF): View The PDF

Chris Sandström on Twitter: @ChrisSandstrom