Friday, 13 November 2020

What Drives Progress: The State or the Market?

Two views of what drives progress dominate: that it is driven by state action, or by individual entrepreneurialism and innovation. A recent book tries to turn the division on its head, arguing for the benefits of the 'entrepreneurial state.' But as Ethan explains in this post, this reveals a complete misunderstanding of how innovation and economic progress happen.

What Drives Progress: The State or the Market?

by Ethan Yang

“History never repeats itself," declared Mark Twain, "but it does often rhyme.”

A little over a hundred years ago, U.S. President Woodrow Wilson kicked off a drastic expansion of government power and scope with the general assumption that the state can scientifically plan society. Other wartime leaders around the world followed his lead. Two decades later, U.S. President Franklin Roosevelt greatly expanded on this idea -- with more government programs promising to solve all manner of societal ills, to bring a level of centralised progress that the market couldn’t (allegedly) provide. 

From those who favoured market-based mechanisms, advocated by economists such as Ludwig Von Mises, this sparked caution and critique. They pointed out that the market was far superior to the state in organising society. That the market process begins with each individual choice for 'this over that'; that individuals' differing wants are harmonised by voluntary exchange; that the price system tells producers what is most (and least) valued; that 'the market' itself is simply the sum of each individuals' valuation, directing human action to making the best use of the most highly-valued resources. 

This is the story of humanity, a struggle between the individual and the state. Those who believe in statism on one side and, on the other, those who understand the power of liberty unleashed.

Many of the Wilson and Roosevelt type of statists either never got to grips with the mechanism by which the self-correcting system of market prices delivers progress (dismissing the very notion as some kind of magic-ism). And they simply  assumed that progress would always emerge from the maw of government action.

The Keynesian statist would go one better, preaching that prosperity will emerge out of the expanded use of the government printing press. After World War Two, Keynesians and other thinkers of the big state braced for economic turmoil as people returned from war and government spending plummeted. Instead, the exact opposite happened, and as war finished the economy boomed. 

Anyone with eyes to see could understand that the state does not drive economic growth. In the latter half of the 20th century, sweeping market reforms confirmed the story, deregulation and 'more market' bringing prosperity to countries all around the world and savaging poverty worldwide as never before. Another blow to the idea of state-run industry. 

Some thought that the free-marketeers won the intellectual argument against the Keynesian brand of statism in the 1970s. This is when stagflation completely upended the assumption that inflation and unemployment are always inversely related. It turned out that simply using expansionary monetary policy to drive economic growth was not as good an idea as many people thought. But the arguments for the benefits of big government did not go away.

In 2013 Dr. Mariana Mazzucato, a leading economist of the Keynesian persuasion, published the oxymoronic The Entrepreneurial State, which makes the case that the public sector can do far more than it is currently doing; that the private sector necessarily needs generous guidance and intervention from the state; and that in many cases the state is equal if not superior to the market in generating efficient and innovative services to society.

Well, here we go again!

Mazzucato and her allies posit that society can be so much better if we ditched market-based principles and delegated more responsibility to the state. Think people like Senator Elizabeth Warren.

In response, economic heavyweights Dr. Deirdre McCloskey and Dr. Alberto Mingardi teamed up to write The Myth of the Entrepreneurial State. The book stands on its own in the ongoing debate over the market and the state. The book also serves as an outstanding work of economic history. 

The Idea of the Entrepreneurial State

In her praise of the so-called entreprenueurial state, Mazzucato argues that it is big government itself that makes the market possible, that "capitalism, the system that is usually thought of as being 'market' driven, has been strongly embedded in, and shaped by, the State from day one."
“Mainstream policy conceptions and prescriptions” [she argues] are “normative postulations for a permanent state planning for more markets, mainly organising ‘deregulation cum privatization’ rather than deliberate sets of conditional recommendations based on pondering alternatives and paths.” 
Essentially this suggests that mainstream economic thought is dominated by ideas put forth by those like Milton Friedman, who advocate for more privatisation and deregulation to create growth. 

Mazzucato believes that this is unpredictable and suboptimal. Rather we should allow big goverment's experts to ponder better alternatives with a scientific level of precision. Mazzucato likes to reference government programs like DARPA and The Manhattan Project as examples that the government can be very innovative.

This is an odd assertion. I would agree that many economists hold the belief that privatisation and markets are good. However, McCloskey and Mingardi point out that
“In the past century, government expenditure as a percentage of GDP drifted up towards 50 percent, compared with its pre-Keynesian level of 10 percent”… “ Democratically elected politicians, and behind them their constituents in the voting public were finally convinced that budget balance carried little or no normative weight.”
Sadly -- and contrary to Mazzucato’s point -- amongst policymakers and the commentariat there is no widespread consensus about the wonders of privatisation, instead we see sloppy paeans to never-ending government spending, and calls for ongoing never-ending expansion. [See for example the latest idiotic call by Bernard Hickey for the Reserve Bank to turn the printers on full-speed to pay bigger benefits.] Once you embrace the idea that innovation and big progress may only emanate from big government, one quickly forgets the real sources of growth and progress, and blind to the destruction teh growth of government causes.

This is how government works, especially in democracies. It’s sloppy, it’s imprudent, it’s cumbersome and it is utterly desensitised to important market forces. If you empower the state to take on more and more planning of society, this problem will only exacerbate. Nonetheless, say McCloskey and Mingardi:
Mazzucato, a loyal daughter of the left, is suspicious of private gain, of the sort you pursue when you are shopping, say, and is therefore suspicious of people doing things for a private reward. She wants the State, advised by herself, to decide for you.
In essence that is what the idea of the entrepreneurial state ultimately boils down to. A rationalisation of leftist political economy that has politicians and university professors jumping for joy. A very mild form of central planning that says that great things are possible as long as I am in charge.

What Drives Innovation

One of the main premises of those who believe in an entrepreneurial state is that central-bank credit drives economic activity, and that public investment drives innovation. Mazzucato contends that the government should exert a sort of directionality over private businesses to drive them towards some optimal point determined by experts.

However, this is a false view of how innovation and economic progress happens. 

First, the experiment with central-bank-created credit has now proceeded for just over half a century, in which we have seen a rapidly declining marginal productivity of debt (however you measure it, one dollar of new 'counterfeit capital' creates very much less than one dollar of economic growth), and a steady increase in financial-market turbulence.

Second, innovation comes not from the top down but from the bottom up. Free people acting in spontaneous and self-interested ways create the innovative products of tomorrow. Private firms jockeying for supremacy in handheld communication gave us the genius of the iPhone. Tesla produces some of the most advanced electric cars in the world available for mass consumption. Tesla CEO Elon Musk is the antithesis of the pondering bureaucrats that Mazzucato believes drive innovation. A man who offers four car models named S, 3, X, Y, sells flame throwers, privatised the space race, and now just launched a line of tequila.

Elon Musk’s rambunctious personality would be one representation of how innovation happens. Not by deliberate planning by experts but by the rambunctious and oftentimes chaotic enterprise of free individuals failing and succeeding, often many times in many ventures heading in many different directions. Another would be a James Watt, driven to perfect the steam engine that would eventually come to power a whole Industrial Revolution. Neither are going to work well, or innovate, under a bureucrat's direction.

Mazzucato and others like her contend however that it is the state that drives innovation. The authors disagree and state that the ultimate source of innovation is 
the liberal idea and its emancipation of human creativity.”
As statists lament over the alleged “normative postulation” regarding privatisation, McCloskey and Mingardi feel exactly the opposite. Getting the state out of the way of free individuals unleashes the driving force behind innovation.

Does Government Investment Contribute to Innovation?

One of the few convincing observations made by Mazzucato and others like her is that the advanced military research agency known as DARPA [Defence Advanced Research Projects Agency] invented things like the internet. Therefore, they argue, the state may be capable of impressive feats of innovation. If we invested more, then we would get even more spectacular results.

McCloskey and Mingardi offer a rebuttal that can be summarised as “important if true.” They write
The question is whether the American government envisioned anything like the internet. The answer is obvious: of course it didn’t. There was no “mission-oriented directionality.” The investments by the military look like Christopher Columbus’ voyages: the entrepreneurial State discovered the West Indies having left for the East Indies.
Furthermore, even when it stumbled upon what became the acorn from which the internet grew, the bureaucratic state had no idea it had any value whatsoever.
In the 1960s the Air Force considered how a decentralised communications grid distinct from the traditional telephone might operate. But the Department of Defense then terminated the research and took no action.
McCloskey and Mingardi also go on to point out that one of the leading developers of ARPANET, the technical foundation for the modern internet, observed that
DARPA "would never have funded a computer network to facilitate email", because [in their view] the telephone already served person-to-person communications perfectly.
Any government contribution to creating things like the internet was not only wholly unintentional, it may even have been detrimental. Innovation is a chaotic endeavor that leans less on the approval of experts, but instead requires a genuine test in the marketplace. If invention and progress rested on the opinions of whether a room full of PhD’s (or bureaucrats) thought it would be productive, we might not have made it past the horse-drawn plough!

One famous example is the advent of airborne flight which, after a failed test, government officials and many others understandably believed was not obtainable. Looking back, these comments seem comedic but if we allow the state and its army of experts to impose “directionality,” innovation would grind to a halt. 

In fact, in 1903 the New York Times predicted that flight was approximately 1-10 million years away. Then just a couple of months later two bicycle mechanics, Wilbur and Orville Wright made the first functional airplane in their garage, proceeding to change the world forever.

Innovation happens in the absence of state direction. It’s not innovative if it was completely planned.

The authors go even further to point out that, as regulations bog down progress in various industries, oftentimes innovation takes place simply to outmanoeuvre the state . This can partially explain things like the emergence of private equity over public equity in the world of finance. One of the key benefits of private equity is not having to abide by the cumbersome regulations that govern public financial markets. 

Key Points

This debate between whether or not the state can be a competent and worthy driver of innovation is a necessary one. Although the state continues to grow regardless of who wins this intellectual argument, it was thought that proponents of limited government had won this discussion in the late 20th century when the world experienced a sweeping wave of liberalisation.

Today we find ourselves at a crossroads, with much of the Western world embracing or starting to consider a view of government that sees it as much more than just a steward of our rights. They see the state as a force of positive and competent change in a capacity that McCloskey and Mingardi believe is only possible through the market. That a more powerful and unrestricted government can reliably be a steward of society.

The idea of an entrepreneurial state as proposed by Mazzucato is a romantic one. It’s an idea that people can come together and through sheer will can make innovation happen. That some very smart people with fancy degrees and prestigious titles can steer society to an optimal location. The only problem with that is just about everything.

Ethan is an Editorial Assistant at the American Institute for Economic Research and a graduate of Trinity College. He received a BA in Political Science alongside a minor in Legal Studies and Formal Organisations.
He currently serves as Local Coordinator at Students for Liberty and the Director of the Mark Twain Centre for the Study of Human Freedom at Trinity College.
Prior to joining AIER, he interned at organizations such as the American Legislative Exchange Council, the Connecticut State Senate, and the Cause of Action Institute.
Ethan is currently based in Washington D.C.
This post is based on his article that first appeared at the AIER blog.

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