FINNOV conference 2011, Prague

All of my current projects focus on the economic dynamics of organisational and technological change and the effect this has on economic growth. In some I lead and in others I work as a collaborator.

One project, INNOGEN, focuses on the life-sciences industry. Another, FINNOV, concerns the relationship between financial markets and innovation. As all the projects have their own websites, if you are interested in learning more, please click on the links.

INET - Financing Innovation

an application of a Keynes-Schumpeter-Minsky synthesis

Principal Investigators: Mariana Mazzucato (SPRU) and L. Randall Wray (LEVY)

Introduction

It is through innovation (technological, institutional, organizational and cultural) that economic development – or the ‘capital development of the economy’ (in the words of Minsky) – occurs.

Background insights from Keynes, Schumpeter & Minsky

This project thus integrates two research paradigms. The first is the Keynes-Minsky vision that puts effective demand front and center of economic analysis, and the second is the Schumpeter-Minsky vision

Empirical focus

The empirical side of the project will focus on specific sectors, mainly biotechnology and the emerging green technology sector, as well as related macro aggregates.

Project members

The Financing Innovation project is a joint research effort of two leading institutions in the field of post-Keynesian monetary economics and neo-Schumpeterian evolutionary economics

1ST Project-Workshop: Value Creation vs. Value Extraction: the Role of Finance in the Capital Development of the Economy

The 1st Financing Innovation Workshop will be held at the Levy Institute of Bard College (Annandale-on-Hudson, New York) from Thursday, May 30th to Saturday, June 1st, 2013.

Public Engagement activities and project-related publications

It is through innovation (technological, institutional, organizational and cultural) that economic development – or the ‘capital development of the economy’ (in the words of Minsky) – occurs. In Schumpeter’s analysis of the capitalist economy, innovation comes about only if new purchasing power (credit) is made available to entrepreneurs willing to take the risk of innovating. Thus Schumpeter assigns a central role to bankers, whom he sees as the ‘capitalist per excellence’, because they create purchasing power by lending to risk-taking entrepreneurs. In Schumpeter, the prototypical function of the financial system (represented by ‘the banker’) is therefore to provide finance for innovative industrial activities and thus promote economic development.

Innovation, however, does not occur only in industry – it also occurs in the financial system itself. And Schumpeter’s ‘rosy’ view of finance, ignoring the ‘gambler’ speculative role –emphasized more by both Keynes and Minsky – has rendered the ‘Schumpeterian’ perspective obsolete to understand innovation in the financial sphere, which has a dynamics of its own. This is also due to the fact that credit in Schumpeter continues to be treated principally as greasing the wheels of capitalism. Indeed, a key goal of our Project is to bring together Schumpeter’s understanding of innovation, applying it to finance, but within a perspective where finance is more than just means of exchange, more than a veil blurring the real economy. It can have a dynamic of its own. And as such, it may not only promote but also hurt innovation.

In the past three decades, concomitant to the dominance of neoliberal ideology in economics and politics, important innovations changed the character of the global financial system. These financial (and institutional) innovations included the collapse of the Bretton Woods arrangements in the early 1970s and the establishment of a floating exchange rate regime, with the U.S. dollar emerging as the main reserve (fiat) currency; the growth of derivative markets and the publication and diffusion of the Black-Scholes option-pricing model (1973); the ‘Big Bang’ deregulation policies of finance (including derivative markets) of the 1980s in Europe and the U.S., which continued until the end of the 1990s; the incremental relaxation and ultimate repeal of key provisions of the Glass-Steagal Act of 1933, which had limited commercial banks’ speculative activities and separated investment from commercial banks; the replacement of merchant banking by investment banking and the refocusing of commercial banking on household lending; the move by nonfinancial corporations toward viewing cash management as a source of revenue; the rise of the shadow banking system (including hedge funds, private equity groups, venture capital and ‘business angels’); the move by nonfinancial giants like GE and GM into financial services; and the growth of securitization of debts and structured finance through innovative financial products (Asset-Backed Securities). The result was steep growth of the financial sector and a relative decline of industry, together with the financialization of industry practices targeted at short-term returns and maximization of market values. Using Keynes’ famous distinction, speculation came to dominate industry.

Paradoxically, while at the macro level there was ‘far too much’ finance supplied relative to the ‘real’ activities, at the micro level there was ‘far too little’ finance supplied to nonfinancial innovations. Thus, while many ‘industry’ (product and process) innovations also occurred in these decades, it is not clear whether the transformed financial system continued playing its crucial role of funding the capital development of the economy. On the surface, it appears instead that those financial innovations have led to simple ‘value extraction’ at the expense of ‘value creation’, with the collateral effect of income polarization. This has indeed been the view expressed by Minsky in his works post-1986. Putting Schumpeter’s theoretical analysis into perspective, Minsky argued that the financial system (and its profit-seeking innovations) contributes to the capital development of the economy only if the appropriate institutional and incentive structures are in place. In the absence of such structures, financial innovations undermine economic development, as it diverts credit from entrepreneurs and innovative activities of industry, and can ultimately lead to financial and economic crisis. The Great Financial Crisis that began in 2007 is a prime example of the destructive force of financial innovation and predatory practices of the financial services sector.

Because of the collective (i.e. the synergic combination of skills and resources), cumulative (i.e. history and experience matter) and uncertain (i.e. there is no guarantee of success) characteristics of the innovation process, the transformed financial sector was (and still is) able to extract more value than it creates in the form of economic rent. Indeed, in many of the financial arrangements, top management of financial institutions would “win” no matter what happened to the nonfinancial sector; and in some cases, money managers actually benefited from losses incurred by customers on both sides of the balance sheet. In other words, decision makers in the financial services sector have been ‘rewarded’ disproportionately to the risks they took in the innovation process, although in the process they destroyed massive amounts of the economy’s financial wealth that they had been trusted to manage When finance is geared to short-term, ‘certain’ returns, radical innovations struggle to flourish, because the time required from basic research, through invention and development to diffusion in markets is too long and uncertain. The biotech sector is a case to point, where investors are interested in easy, profitable exits for their investments in a narrow window of a few years. Another example are recent investments in renewable energy companies, such as Solyndra (solar energy), where the early exit of the ‘impatient’ venture capital backing it meant its bankruptcy. Some countries have shown that an alternative to private funding of radical innovations exist in the form of national development banks (such as BNDES in Brazil, KfW in Germany, or CDB in China), which are positioned to invest in long-term investments and able to bare the risk of failure.

The financial ‘eco-system’ needs to be rebalanced towards value-creating activities and innovations, so that it is rewarded for its right contribution to the capital development of the economy. Reforming finance is therefore crucial for the world-wide economic recovery to take off. While green technologies offer the potential to become the new growth-engine, their development and diffusion require long-term committed – or patient – capital, plus enabling policies to overcome barriers in e.g. the demand market. While the works of Schumpeter, Minsky, Keynes and others offer key insights into the changes needed to ‘heal’ the global economy, the new 21st Century context presents idiosyncrasies that may defy their theory and analysis. Standing on the shoulder of those ‘giants’, we hope that contributions to this workshop will update and combine their insights, thus helping address the pressing challenge of putting the world economy back into the path of smart, inclusive and sustainable growth.

This project thus integrates two research paradigms. The first is the Keynes-Minsky vision that puts effective demand front and center of economic analysis, and the second is the Schumpeter-Minsky vision that focuses on innovation and competition. We will bring the two visions together to provide rigorous and critical analysis of competition in the financial sphere and how it interacts with competition in the industrial sphere. This will enable us to make policy recommendations to reform finance to promote the capital development of the economy. Finance which helps to create value rather than just extract it: finance for creative destruction, not destructive creation.

We will use this synthesis to understand the current state of the global financial system and to assess its weaknesses. As discussed above, while the economy has become “financialized”, in many important areas projects cannot get financed. This is particularly true in the more innovative sectors of our economy. As a consequence we have poverty (underfunding) in the midst of plenty (tens of trillions of dollars of wealth in search of high returns). The policy problem, then, is to explore alternative ways to redirect existing finance, and to create new funding methods, to finance the innovation that we will need for the 21st century.

The first tradition is concerned with finding the point of effective demand in conditions of uncertainty. Expectations and what Keynes called monetary production in early drafts of the General Theory are the critical determinants. Disappointment is possible, which can change expectations and result in a different equilibrium. Macroeconomic identities and particular causal implications allow us to avoid fallacies of composition as the identities serve as a check on what is possible for individual behaviour. Kalecki augmented Keynes’s framework by distinguishing the capital- and consumer-goods sectors, and showing how investment generates profits at the macro-economic level, competitive firms’ pricing (and profit) can be a function of their internally-financed investment target, and innovation can determine the growth rate of capital through its impact on profits. Minsky followed Kalecki but formulated his financial theory of investment to introduce financial decisions and conditions into determination of the point of effective demand. All of this can be put in the context of growth, although the efforts to date are not satisfactory. At best, the Keynes-Minsky vision provides reason to believe that growth will not be steady and that it will normally be demand-constrained.

The second is concerned with evolution of the structure of the economy over time—those factors that disturb equilibrium, and can spur growth. Schumpeter introduced innovation into the analysis of competition, allowing the feedback between innovation and industry structure to cause the linear structure-conduct-performance (SCP) approach of industrial organization to fall apart. The Schumpeterian approach to competition is thus centred on understanding the co-evolution of those mechanisms that create differences between firms and the mechanisms of competitive selection that winnow in on the differences allowing only some firms to survive and grow. Innovation, births and deaths of firms are engines of growth and structural change. While some innovations allow incumbents to maintain their lead, radical innovations tend to destroy it. This is the essence of Schumpeter’s famous term creative destruction.

The banker, Schumpeter’s “ephor of capitalism”, plays an important role in helping to get innovations financed, and Minsky extended Schumpeter’s innovation to the financial sector itself. Like any other firm, a bank continually seeks to reduce costs and increase revenues, with innovations helping to do both while also changing the structure of the financial system and hence the structure of the nonfinancial system whose behaviour is heavily influenced by the structure of finance. As is well-known, he developed the “investment theory of the cycle and the financial theory of investment” to put the Keynesian model in the context of the business cycle. The first part of this is Keynesian, the second brings in Schumpeter’s ephor. Over the cycle, the structure of the economy and most importantly the structure of its finance changes in a manner that makes it fragile.

There are structures that are conducive to what Minsky called the “capital development” of the economy—which is broadly defined to go beyond privately owned capital equipment to include technology, labor productivity, and public infrastructure. Minsky believed that a high wage, high employment, “big government” economy would be more stable and would tend to channel finance in the direction of capital development. Further, finance needs constraints because of the inevitable thrust to innovation; that, in turn, is a problem because the “market” forces that direct finance toward capital development of the economy are not always operative, so the innovations in finance can actually hinder capital development. This appeared especially true in the Anglo-Saxon economies from the mid-1990s, when low capital costs linked to falling equity risk premiums led to a ‘search for yield’ in financial rather than real-sector innovation, so that strong corporate profitability did not translate into strong investment outside the financial sector, whose GDP share and indebtedness consequently grew.

What is relatively lacking in the Schumpeter-Minsky approach is the innovation and dynamism in the nonfinancial sector. However, there is an emerging literature that does build on Schumpeter’s work to examine innovation and structural transformation of the “real” sector: the new Evolutionary economics. The work of Richard Nelson and Sydney Winter (among others) is increasingly recognized as providing the possibility of a new theory of the firm, as well as a more dynamic treatment of market structure. While Schumpeterian-evolutionary analysis provides insights on the dynamics of structural/technological change in the real economy, Minsky’s insights can provide a theory of money and financial fragility, which is virtually lacking in Schumpeterian models. Indeed many of these do not include money and finance at all. Our synthesis seeks to fill this lacuna: we will link the real with the monetary as well as provide a theory of competition in both the financial and non-financial sectors.

The empirical side of the project will focus on specific sectors, mainly biotechnology and the emerging green technology sector, as well as related macro aggregates.

Core questions will centre around:

Understanding the relationship between financial markets and the real economy, specifically the degree to which financial markets penalize innovation and value creation rather than reward it;
Understanding the relationship between new investment flows and the value and rate of profit of the existing capital stock; investigating its implications for the profitability of new technologies, and their investment-attractiveness to firms and financial institutions;
Understanding the relationship between publicly funded early-stage research and development (R&D) and privately funded commercialization of innovative enterprise and its intellectual property rights;
Understanding the ‘external economies’ (of networking and clustering) which promote the growth of innovative companies and innovation-sponsoring investment groups, and connect the two; and
Evaluating the possibilities for world-wide economic recovery around a new green growth trajectory, and new financial institutions and instruments geared to it.

The goal of this project is to identify the micro-level obstacles to channeling of investment into new growth-promoting technologies and the macro-level effects of disruptive innovation, by applying Minsky’s insights on financial innovation and the Evolutionary-Schumpeterian insights on “real sector” innovations. Given institutional barriers worsened by the financial crisis, the role of the government must increase. However, exactly how the government can play that role, and how it can encourage private finance, is an open question to be addressed by this study. Finally, the role of government at the macro level for the generation of adequate demand and aggregate profits will be discussed. For example, in spite of subsidies provided to green tech we are currently witnessing failures due to the macroeconomic environment in which firms operate. This macroeconomic environment can, in turn, be destabilized by micro-level financial innovation around new technologies – as it was, for example, when finance mobilized behind ‘new economy’ enterprise which became the Dot-Com bubble of 2000-01, and when private equity groups evolved into highly leveraged shadow banks before the larger crash of 2008. The Keynes/Minsky approach (with input from Godley’s sectoral balance approach) will be used to assess the important role played at the macro level by government.

The 1st Financing Innovation Workshop will be held at the Levy Institute of Bard College (Annandale-on-Hudson, New York) from Thursday, May 30th to Saturday, June 1st, 2013. The Workshop is meant to be a place for new contacts and new research inspiration: a forum of discussion where Project members learn from (and critically engage with) each other, so as to contribute to and debate the Project’s mission and research to be furthered. It will centred around three interrelated ‘grand’ themes:

A) Rebalancing finance and reconstituting the financial sector to promote productive, nonfinancial innovation, value creation and the capital development of the economy.
B) Reforming the nonfinancial sectors away from financialization and predatory practices of value extraction, detrimental to innovation and other long term investments.
C) Recreating industrial policy and restructuring government to promote productive radical innovation, particularly in the green-tech sector.

The following (non-exhaustive list) list contains examples of more concrete issues to be addressed in the workshop:

Limitation of existing theoretical approaches, not only of mainstream economics but also e.g. neo-Schumpeterian theory and post-Keynesianism;
The implications of understanding money and credit—beyond greasing the wheels of commerce—for a Schumpeterian analysis of innovation in the financial sector.
The relationship between financial markets and the real economy, specifically the degree to which financial markets penalize innovation and value creation rather than reward it;
The relationship between national financial sectors and their institutional environments, investigating historical and contemporary examples of committed patient finance conducive to the promotion of radical innovations;
How different types of financial arrangements operate in promoting or stalling the innovative process, investigating the role played by e.g. venture capitalists, business angels, investment banks, pension funds, national and international development banks etc. We encourage the cross-country analysis of biotech and ‘green-tech’ sectors, including the micro- and macroeconomic settings, public policy and institutional structures in which they operate;
The relationship between new investment flows and the value and rate of profit of the existing capital stock, investigating its implications for the profitability of new technologies, and their investment-attractiveness to firms and financial institutions;
The possibilities – and policy requirements – for world-wide economic recovery around a new green, more inclusive growth trajectory, and new financial institutions and instruments geared to it.

Workshop-related (programme, papers, presentations etc.) material will soon be published here.

Mazzucato’s keynote lecture at the 2^nd Lundvall Symposium: Challenges for Europe in a New Age, in Aalborg, Denmark.

o Date: March 14^th, 2013

o Descriptive text: Mazzucato’s talk focused on the challenges that innovation scholars face in creating knowledge for transformational policies that bridge innovation policy with growth policy, render innovation ‘eco-systems’ more symbiotic, reform finance away from value extraction, direct the green revolution, and achieve solidarity between European countries for collective ‘competitiveness’ based on a new division of innovative labor.

o Link (Symposium Programme): http://www.innoresource.org/2nd-lundvall-symposium-challenges-for-europe-in-a-new-age/

Mazzucato’s presentation at the SPIDER Web workshop at the Brazilian Development Bank BNDES, in Rio de Janeiro, Brazil.

o Date: February 28^th, 2013

o Descriptive text: Mazzucato presentation focused on “State investments in innovation: fixing vs. creating markets”.

o Link (Presentation PDF): http://inctpped.ie.ufrj.br/spiderweb/pdf/Mariana_Mazzucato.pdf

Interview with Mazzucato on BBC Radio 4 about Creative Destruction.

o Date: February 10^th, 2013

o Descriptive text: As governments around the world are seeking innovation-led growth to kick start the recovery, BBC Radio 4 looked into Schumpeter's notion of ‘Creative Destruction’ – periods in which radical innovation upset the status quo of markets and entire economies. Mazzucato provided insights on the myth of the 'entrepreneur', by citing how all the technologies that make the iPhone so smart are state funded.

o Link: http://youtu.be/8ykntxKRXZ8

Interview with Mazzucato by the Dutch RTL news on the role of the State in economic growth.

o Date: January 28^th, 2013

o Link: http://youtu.be/f0S2_K3oCAE

Interview with Mazzucato by the Dutch Ministry of Economic Affairs on the role of the State in economic growth.

o Date: January 28^th, 2013

o Link: http://youtu.be/1B4q9uXpPAA

Mazzucato’s participation at the Innovation Debate 2012

o Date: November 20^th, 2012

o Descriptive text: Mazzucato was one of the panel members of Innovation Debate 2012, aimed at analysing the concept and role of Innovation. The panel comprised eight influential and respected figures from the worlds of science, technology, medicine, engineering, education, government, industry and the media.

o Link: http://youtu.be/0xuYBlA41Z4

Mazzucato’s presentation at the EC Expert Group Innovation for Growth (I4G) workshop: “Relation of research & innovation with smart, sustainable and inclusive growth”.

o Date: November 2012

o Descriptive text: Mazzucato prepared for the EC Expert Group Innovation for Growth (I4G) a policy brief on “Smart and Inclusive Growth: Reforming the risk-reward nexus in innovation”, which she presented in the workshop.