Counter-cyclical public venture capital: Debt-funding as an anti-austerity innovation strategy

Introduction

Although innovation policy usually follows the business cycle, it is both desirable and possible to reverse this trend. Perhaps the most telling commentary on contemporary Europe is the silence that met the presentation at the recent European Parliament Innovation conference of the Chinese research and development (R&D) spending curve passing the European Union curve in 2013. This intersection is a symptom of a deeper divergence in response to an economic downturn between societies committed to innovation and those committed to austerity. One response to a downturn is to double down on fiscal stimulus in order to increase spending in the short-term and create jobs, exemplified by the early Obama Administration’s relatively modest stimulus package. Another response is to pull back, decrease government spending or, at best, hold it constant, as in the UK. The optimal response, as exemplified by China’s continuing infusion of resources into higher education and advanced technology development, is for government to pursue fiscal expansion targeted towards innovation, providing short-term economic stimulus while accelerating the transformation from a manufacturing-based economy to a knowledge-based economy. This approach integrates the key insights of Keynesian and Schumpeterian economics, and could potentially draw supporters from across the political spectrum.

Both private venture capital and government innovation appropriations, absent strong countervailing measures and societal commitment, typically decrease in an economic downturn. Legislatively set R&D funding typically rises in the upturn and falls in the downturn of the business cycle, as a function of the political cycle cogwheel that operates with a brief time delay. Both developed and developing economies are affected by this dynamic, but we set forth the counter-intuitive hypothesis that developing countries, like Ecuador, Malaysia and China, may keep up and even increase their efforts to achieve knowledge-based innovation in order to catch up, leapfrog over and displace current leaders. The European Union’s promising Lisbon Agenda of projected R&D increase to 3% of gross domestic product (GDP), formulated in relatively good economic times as part of a strategy to make Europe the most innovative world region, was foiled by an economic downturn. Similarly, as part of its development strategy, Mexico committed to raise its public R&D funding to the level of 1% of GDP from less than ½%. Despite significant increases in the past few years, it is struggling to reach that goal, let alone to join world leaders like Sweden and Finland, who having learned from the early 1990s Scandinavian recession, have kept R&D spending above the 3% level (Benner, 2012).

This article outlines a counter-cyclical innovation strategy, derived from an innovative project, the California Institute for Regenerative Medicine (CIRM). CIRM was founded to provide an alternative source of support for stem cell research in the USA, in response to political strictures on this emerging scientific field (Etzkowitz and Rickne, 2015). CIRM’s novel feature is that it extends the physical infrastructure funding format of bond finance into the realm of intellectual infrastructure. We suggest that this innovative response to blockage of federal support for stem cell R&D has more general implications for innovation theory and practice. In the following sections, we discuss the negative effects of an economic downturn on innovation strategy and practice, and propose a methodology to turn it around. However, widespread application of this methodology requires a paradigm shift of mindset in response to an economic crisis that is as yet only modestly underway, especially in austerity-obsessed Europe.

The California Institute for Regenerative Medicine

When the George Bush Administration severely restricted federal government support for stem cell research in 2004, California stem cell scientists and their allies raised the banner of states’ rights and created an alternative science and technology policy at the state level that in the stem cell field is larger and more far-reaching than any initiative that has yet been taken at the national or supranational level. What was novel in 2004–05 California was that a coalition of citizens and scientists created an innovative R&D system from the ‘bottom up’ in response to the anti-abortion movement’s successful campaign to restrict federal government support of stem cell research. On passage of Proposition 71, $3 billion worth of bonds issued on the credit of the state created the California Institute for Regenerative Medicine (CIRM) to disburse R&D funds for a ten-year period to advance stem cell innovation (Etzkowitz and Rickne, 2015).

Research funds are distributed through peer review, carried out by out-of-state reviewers to reduce the potential for conflict of interest. A novel feature is that rejected applicants may appeal to a Citizens Review Panel, including patient advocates, to override a negative decision, and this has occurred in practice. CIRM-funded PhD training programs at universities across the state, in its specialized field, have been established on a larger scale than traditional National Institute of Health (NIH) programmes. CIRM funding has enabled academic institutions to scale up their clinical trials capabilities from Phase One to Phase Two, with academics recruiting project managers from industry to manage the process. The construction of research facilities supported by CIRM funding made it possible for stem cell research to be carried on in buildings separate from those that had been supported by federal funding where stem cell research was, for a time, disallowed. These building projects also provided naming opportunities and often received additional private support. Firm recipients of CIRM projects have been able to scale-up and speed up R&D projects, as well as undertake riskier projects than they might have otherwise. Through CIRM support, a third California concentration of stem cell research has been created as the Los Angeles basin has achieved critical mass in this research area, previously dominated by the San Diego and San Francisco biotechnology complexes.

California’s Constitution contains a direct democracy provision that, on collection of a requisite number of qualified voters’ signatures, mandates votes on ballot initiatives. When the first author initially heard about this initiative in California in 2004, it represented an intriguing change in the basis for public Science and Technology (S&T) funding, in shifting from a general appropriation model to a targeted debt finance model. We suggest that this exemplary instance has broader implications, as it has the potential to be extrapolated into a new model for the funding of scientific and technological innovation as the infrastructure of knowledge-based society, as a counter-cyclical innovation policy that stimulates the creation of new clusters.

This model stands in stark contrast to the European status quo, in which counterproductive austerity policy starves, or at best maintains a steady state, in the knowledge-producing institutions that are the source of future knowledge-based innovation and growth. Political paralysis, including a struggle over the national deficit, at the federal level has produced a similar result in the USA. A common element on both sides of the Atlantic is a belief that driving down public debt will induce a rise in private spending and thus trigger economic growth. The ‘expansionary austerity’ experiment has failed to produce positive outcomes and requires rethinking (Guajardo et al., 2014). The same logic typically used for financing physical infrastructure, selling bonds on the credit of the state to build roads or bridges, and then collecting a toll on the bridge and eventually paying off the accumulated debt, can be used to finance knowledge infrastructure. Here the hypothesis is that the science itself will produce tangible economic benefits, and that bondholders will be paid off both directly from earnings on intellectual property or equity in firms that have been funded, or indirectly through increased economic growth and a consequently expanded tax base.

The innovation paradox

The ‘innovation paradox’ is that the very point in the business cycle when legislators are tempted to view austerity as a cure for economic downturns and to reduce innovation spend, but when an increase is most needed to create new industries and jobs and innovate out of recession or depression (Etzkowitz, 2012). Theoretically, the downturn is a good time to invest in new firms and in new ideas. Traditional capital as embodied in machinery and technology, as well as human capital embodied in people are more available, and thus less expensive, during the downturn than in the upturn, when competition for these resources creates a shortage. However, the downturn is almost by definition the point at which so-called ‘animal spirits’ are deflated, and thus funds are least available. Although the political cycle does not have to follow the business cycle, there are strong ideological and practical pressures for the political cycle to conform to the business cycle, especially during the downswing.

The downturn will negatively impact start-ups as potential investors become more conservative while existing firms may reduce expenses and keep functioning unless the downturn becomes unusually severe, inducing bankruptcies. One illustration of this tendency is the extreme ‘gearing’ of venture capital investment to the economic cycle. When the economic cycle turns, and financial markets fall, the negative impact is even more pronounced on venture capital, a key source of finance for innovative ventures (Gompers et al., 2008).

Europe’s Innovation strategy has been more closely tied to the support of existing firms, in contrast to the USA where the encouragement of start-ups has been the implicit strategy. This distinction is relative: the USA is home to defence-related systems integration behemoths, while Europe increasingly encourages entrepreneurship and start-ups, especially as an employment strategy. Nevertheless, US Small Business Innovation Research (SBIR) programme funding has classically been a form of public venture capital for S&T-based start-ups from academic, industry and government labs, while the EU framework programs have classically subsidized and expanded upon the R&D programs of large firms (Etzkowitz et al., 2000).

The folly of austerity

Europe’s response to the economic downturn of 2008 has been singular. In contrast to the USA, China, Japan and other leading world economies that have engaged in various mixes of fiscal stimulus and pseudo-fiscal quantitative easing, Europe, led by Germany, has cut budgets in the hope that a reduced public sector would make room for an enlarged private sector. The negative effects increase in intensity, looking from northern to southern Europe, where unemployment levels are higher even than during the 1930s. All this, in spite of strong evidence suggesting that periods of near-zero short-term interest rates are precisely when stimulative fiscal policy has the lowest costs and highest benefits.

Central to our argument is our belief in one of Keynes’s most powerful insights, captured in his famous axiom: ‘The boom, not the slump, is the right time for austerity at the Treasury,’ (Keynes, 1936). Though this premise was widely accepted in the wake of the Great Depression of the 1930s, it took another economic cataclysm in the form of the recent Great Recession to wake economists and policymakers from their long post-Keynesian slumber. The economist David Romer singles out a number of false beliefs that congealed during the so-called ‘Great Moderation’, and concludes that there are four broad lessons to be learned from the crisis:

While these inferences from the recent crisis are valid, with the exception of number 4 they confine themselves to surface phenomena, rather than address the opportunities of the downturn: the creation of a pool of underutilized resources that may be utilized to fund innovation strategy. We believe that a demand-driven crisis of the private sector offers the ideal opportunity for the public sector to invest in innovation. Our policy recommendations, recently mirrored in an IMF working paper focused on Germany (Elekdag and Muir, 2014), follow from the following premises:

Debates over the effectiveness of counter-cyclical fiscal policy inevitably tend towards a discussion of the so-called ‘multiplier’. Though the multiplier was not invented by Keynes, he did bring great attention to the concept with the 1936 publication of his famous treatise The General Theory of Employment, Interest and Money. In Chapter 10, Keynes offers a detailed definition of the multiplier, and summarizes the concept as the change in aggregate demand induced by a given change in spending on a specific project. Keynes punctuates this discussion with the controversial pronouncement that ‘When involuntary unemployment exists … pyramid building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better’ (Keynes, 1936). Grandiloquent statements like this one have for decades delighted Keynes’s followers and frustrated his critics.

Keynes also offered the confident, if somewhat vague belief that ‘the multiplier, though exceeding unity, is not, in normal circumstances, enormously large’. More concretely he calls out Simon Kuznets’s estimates of the multiplier as the best available, which fell in the range between 2.5 and 3.0. These estimates and assertions proved highly controversial, and many subsequent studies concluded that the multiplier could indeed fall below unity, and often did. (Ramey & Zubairy, forthcoming)

Though the multiplier varies over time and place, with the particular project analysed, we now have strong evidence that the multiplier for government spending during a recession is, as Keynes believed, greater than 1.0. The best modern studies indicate that fiscal multipliers are elevated during recessions compared to periods of full employment (Baum et al., 2012). During steep recessions this effect is exaggerated, and the increase in the multiplier, if compared to non-recessionary periods, is even greater (Caggiano et al., 2015). Case studies of individual countries, including the United States (Blinder and Zandi, 2010), the Eurozone (Coenen et al., 2013) and Japan (Kuttner and Posen, 2002) reaffirm these basic principles.

The converse proposition also holds true, as austerity is particularly painful during recessionary periods (Jorda and Taylor, 2013). In fact, one of the traditional defenders of fiscal austerity, the IMF, saw fit to retreat from its belief in permanently low multipliers in light of overwhelming evidence provided by the crisis. Specifically, the IMF reported that contrary to previous estimates of multipliers in the range of 0.5, during the depth of the crisis ‘actual multipliers were substantially above 1’ (Blanchard and Leigh, 2013). The great irony of austerity undertaken in a slump is that the goal of improved budget balances is extremely difficult to achieve under the recessionary conditions exacerbated by austerity (Gechert et al., 2015).

Although Keynes and Kuznets may have been somewhat over exuberant in suggesting multiples well over 2.0, during recessions the range from 1.5–2.0 appears to be an appropriate estimate (Auerbach and Gorodnichenko, 2013). This is a fundamental point: so long as the multiplier is greater than 1.0, short-term government stimulus spending is just that: stimulative.

There is no doubt that the traditional criticism of fiscal stimulus, that government spending ‘crowds out’ private sector spending, is sometimes true. However, the evidence holds that it is not true during recessions when capital and labour are sitting idle and the private sector would rather not spend or invest. In short, Keynes may have exaggerated with respect to the multiplier, but his larger point holds. The boom, not the slump, is indeed the time for austerity.

Fiscal space

One important caveat must be noted with respect to counter-cyclical stimulus; sovereigns must have sufficient ‘fiscal space’ available, or additional borrowing can be counterproductive. Fiscal space refers to the ability of sovereigns to increase indebtedness without generating fears among market participants that debts are no longer sustainable and will not be repaid in full. Nevertheless, any meaningful policy to address the Greek situation and similar should open up room for investment in innovation. Fears over the potential for sovereign debt crises have been stoked both by the painful Greek example and Reinhart and Rogoff’s sweeping analysis elucidating the shocking historical frequency of sovereign default (Reinhart and Rogoff, 2009). Further, fears over the sovereign debt crisis are not idle, as sovereign defaults are associated with significant economic pain, especially in the short-term (Borensztein and Panizza, 2008; De Paoli et al., 2009).

Nonetheless, in our view sovereign debt sustainability fears have inappropriately led sovereigns such as the USA and UK to undergo austerity or forego further stimulus. Current interest rates of 1.88% on 10-Year Gilts and 2.15% on 10-Year Treasuries (with rates previously as low as 1.45% and 1.50%, respectively) indicate that bond market participants harbour no fears of sovereign default. These historically low rates are as clear a signal to borrow as could be imagined, and the most comprehensive recent analysis of fiscal space confirms that the USA and UK likely have significant space to stimulate before running up against possible limits, while Australia, Denmark, Germany, South Korea, Netherlands, Norway and Sweden almost certainly do (Ghosh et al., 2013). We recommend that fiscal space be used while resources are idle and rates remain low.

Fiscal policy in a low interest rate environment

Having established that counter-cyclical fiscal policy is in general a sensible proposition, it is worth expanding our analysis to the peculiarities of the present economic environment of persistently depressed interest rates. Recently, the economist Lawrence Summers has proposed that we may be caught in a period of ‘secular stagnation’ in which low rates, and deficient demand are a persistent condition rather than temporary deviations from full employment (Teulings and Baldwin, 2014). We offer no predictions on secular stagnation, but simply note that rates are depressed at present and may well remain so. Short-term interest rates have been floored by central banks at zero in both the US and Eurozone, and have not exceeded 1% in Japan in over 20 years. Longer maturity rates, which central banks can influence but not control, are also historically low across the globe as previously noted.

Low rates have two important consequences for our analysis. First, as long-term sovereign borrowing rates represent the main cost of borrowing for state-sponsored innovation spending, these costs are unusually low at present. In fact, given low interest rates and spare capacity, fiscal stimulus may be self-financing, with incremental production and associated tax revenues more than covering the costs of borrowing (DeLong and Summers, 2012). This is no different from corporate borrowing, or borrowing by households: all else equal, cheaper capital makes borrowing more attractive. Second, there are considerable doubts as to the effectiveness of stimulative monetary policy, the traditional alternative to stimulative fiscal policy, once the zero-lower bound for nominal interest rates are reached. In his seminal analysis, Milton Friedman singled out the Federal Reserve’s failure to stabilize the money supply through interest rate and credit policy as the chief cause of the Great Depression (Friedman and Schwartz 1963). This diagnosis became so well entrenched that Ben Bernanke, in commemorating Milton Friedman’s 90th birthday, saw fit to apologize on behalf of Central Bankers, ‘Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again’ (Bernanke, 2002).

Though Bernanke’s apology reflected a stable consensus in favour of the primacy of monetary policy as a stabilization tool, doubts have emerged as to the effectiveness of monetary policy at the zero lower bound in light of the modest impact of massive ‘large-scale asset purchases’ undertaken across the globe. It may be that monetary policy alone is not sufficient to counteract a large negative shock when short-term interest rates are stuck at zero (Wren-Lewis, 2010). Monetary policy and fiscal policy may even be complements, rather than substitutes under some conditions, amplifying each other’s impacts (Belinga and Ngouana, 2015). An analysis of recent studies is decidedly equivocal, noting that ‘the macroeconomic effects of asset purchases are at least twice as large as that for conventional monetary policy’ and concluding that ‘the estimated effects of asset purchases on the economy are subject to considerable uncertainty,’ (Williams, 2014). On the contrary, there is little doubt that fiscal stimulus is quite effective at the zero-lower-bound. In fact, economic theory suggests that fiscal stimulus is especially potent when monetary policy is constrained by the zero-lower bound (Christiano et al., 2011; Eggertsson, 2011).

These concerns are not just academic; central bankers themselves are now calling on fiscal policy to support monetary policy both in the USA:

Although long-term fiscal sustainability is a critical objective, excessively tight near-term fiscal policies have likely been counterproductive. Most importantly, with fiscal and monetary policy working in opposite directions, the recovery is weaker than it otherwise would be. But the current policy mix is particularly problematic when interest rates are very low, as is the case today. Monetary policy has less room to manoeuvre when interest rates are close to zero, while expansionary fiscal policy is likely both more effective and less costly in terms of increased debt burden when interest rates are pinned at low levels. (Bernanke, 2014)

and in Europe:

Turning to fiscal policy, since 2010 the euro area has suffered from fiscal policy being less available and effective, especially compared with other large advanced economies. This is not so much a consequence of high initial debt ratios – public debt is in aggregate not higher in the euro area than in the US or Japan. Thus, it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints. (Draghi, 2014)

Even without considering the potential long-term growth-enhancing effects of support for innovation, we feel the implications are clear. The need for counter-cyclical fiscal policy is urgent.

Austerity and the future of European politics

Economic policies do not operate in a vacuum; rather, politics and economics fuel each other in a constant feedback loop. Although voters are partially driven by ideology, they also take note of the success or failure of the incumbent party’s economic policies and vote accordingly (Duch and Stevenson, 2006). Austerity-augmented economic depression has begun to fuel political fragmentation, polarization and nationalism throughout Europe. Extremist parties of both the far left and far right have risen from the ashes to challenge the political status quo in comparatively well-performing creditor countries, such as Germany (Alternative für Deutschland) and Finland (Finns Party), and thoroughly depressed debtor countries, such as Greece (Syriza), Spain (Podemos) and Italy (Five Star Movement), not to mention the United Kingdom Independence Party’s (UKIP’s) successful campaign to withdraw the UK from the European Union based on economic populism and an outpouring of anti-immigration sentiment. Though some of these opposition parties thoughtfully oppose austerity, many bring to the table deeply held nationalist, anti-immigration, anti-EU and anti-trade beliefs, exemplified by UKIP.

Defenders of austerity had pointed to the UK Conservative party’s electoral victory in 2015 as an example of political stability and popular support for austerity. This is by no means an indisputable interpretation. We would note that the Conservatives increased their vote share by just 0.8% since 2010, compared to a 1.5% increase for Labour. This is hardly the electoral rout in favour of continued austerity that many media sources have trumpeted. Though the vote shares of the two largest parties have been static, there has been a dramatic reshuffling among the smaller UK parties that is emblematic of the populist fever sweeping across Europe. The centrist, pro-austerity Liberal Democrats collapsed from a share of 23.0% in 2010 to just 7.9% in 2015. On the other hand, UKIP, a right-wing party that campaigned primarily on the withdrawal of the UK from the European Union more than quadrupled its vote share to 12.6%. Similarly, the anti-austerity, pro-Scottish Independence, Scottish National Party swept Scotland, capturing 56 of 59 Scottish seats in parliament compared to just 6 of 59 in the 2010 election cycle. Clearly, in light of the fall of the Cameron-led government in large part due to the spectre of populism unleashed by austerity, the interpretation that austerity is politically sustainable is in retreat.

Each year of painful and counterproductive austerity increases the power and appeal of radical elements. This dynamic threatens both the centre-right and the centre-left as voters hold incumbent parties responsible for poor economic performance regardless of their ideology (Bartels, 2014). Hungary, Poland and Greece have been at the vanguard of populist political upheaval, and the results suggest that the costs of an analogous political breakdown throughout Europe are incalculable. Not only is Europe’s economic dynamism at risk; so too are the stable politics of European nation states, not to mention any hopes for increased European integration. Nor is this a purely modern phenomenon, a survey of systemic financial crises over the past 140 years shows that the extreme right-wing of the political spectrum has historically increased its vote share by 30% on average in the wake of a financial crisis (Funke et al., 2016).

The choice to pursue austerity policies rather than to invest in innovation is just that – a political choice, and not a reality dictated by economic necessity. Across Europe, this choice has been heavily influenced by the German economic ideology of ordoliberalism, which through the institutions of the Eurozone and the European Union has been transmitted through the whole of Europe (Blyth, 2013, pp. 57–58, 135–152). Through the ordoliberal lens, German fiscal rectitude has allowed its economy to thrive, and thus must be exported to struggling southern European economies to relieve their recessions. As noted by Blyth, this theory is expressed as a morality play, in which debt is immoral, and austerity serves as the cure for sinning debtor nations. This diagnosis suffers from the fallacy of composition: if all European nations pursue austerity, export-led growth becomes almost impossible and austerity proves self-defeating. In addition to German policy preferences, financial interests may have played an outsized role in the economic decision-making process. In one view, financial markets have altered the very goal austerity is meant to achieve: ‘austerity has become the objective of policy, rather than a policy whose objective is macro-economic stabilisation’ (Konzelmann, 2014). Whatever the cause, the past decision to pursue austerity has not foreclosed on the possibility of a counter-cyclical innovation strategy: so long as inflation remains under control, borrowing rates remain low, and spare capacity exists, the conditions remain ripe.

From physical infrastructure to knowledge infrastructure

When John Maynard Keynes analysed the causes and cure for the Great Depression in the 1930s, the US economy was based on a physical productive apparatus, focused on making artefacts like steel, automobiles, and the like (Janeway, 2012). The Keynesian model was based on putting people back to work by getting the existing productive apparatus to operate by government putting money into large-scale building projects such as dams and bridges, the Public Works Administration (PWA) approach, or simply putting people to work with picks and shovels, typewriters and cameras, the Works Progress Administration (WPA) approach. Employing 8.5 million people, public facilities such as schools, offices and roads were constructed, large numbers of trees were planted to avert ‘dust bowls’, murals were painted, theatres organized and state guidebooks written, employing visual artists, writers, actors and musicians as well as unskilled labourers (Etzkowitz, 2015).

Although Keynes held that even digging and filling holes was a better economic policy than allowing people to remain idle, in fact, the WPA approach, focused on generating employment, accomplished such diverse results as reforestation and public art (Taylor, 2008). Although significant resources were committed, it took additional massive public investment in rearmament and R&D to achieve full employment at the onset of the Second World War. Rather than crowding out the private sector, an enhanced public investment in innovation would allow growth in the private sector. This is due not only to the immediate short-run impact of increased aggregate demand and reduced spare capacity, but to the knock-on effects for privately funded R&D. In the USA, when federal procurement has skewed toward innovative sectors of the economy, the result has been ‘higher economy-wide returns to innovation, leading to an increase in the aggregate level of private RandD’, (Slavtchev and Wiederhold, 2016). Thus, rather than ‘crowding out’ private funding for R&D, government intervention actually reignites private investment in innovation. The problem of the contemporary economic crisis is how to put under-utilized brainpower and capital to work, in addition to under-utilized physical productive capacity (Leighninger, 2007). Thus, a new model for addressing, what may in the future be recognized as a second great depression, is required (Mazzucato, 2013). This model must recognize the importance of supporting entrepreneurial activity, which Schumpeter identified as the key driver to economic growth.

As we move from a physical apparatus to an intellectual apparatus that underlies much of the economy, what is especially under-utilized now is the brainpower that is being created. Graduates and PhDs are trained in ever-higher numbers. Whereas in 1940 only one in 20 US adults had completed bachelor degrees, one in four had such degrees or higher by 2000. Growth of higher education is a global phenomenon, transforming an elite into a mass experience. Resources in the form of under-utilized capital are hugely important, but the innovation conundrum is really a two-part equation, with idle brain power at least as important as idle capital. When nobody else wants to put their money on the line and invest, government must step in and utilize society’s resources by borrowing massively on the cheap.

Consider that the German government can borrow for ten years at an interest rate of 0.30%. The returns to traditional fiscal stimulus are clearly high enough to justify borrowing at these historically unprecedented rates, not to mention the added public goods created from investing in scientific research and innovation.

The influence of this intellectual transformation on the economy and of the role of knowledge in society was apparent by the 1970s, when it was conceptualized as the emergence of post-industrial society, characterized by the shift from manufacturing to services, the rise of science-based industries and the growth of technical elites (Bell, 1974). The departure of manufacturing to low-wage countries, the rise of the rust belt and shrinkage of employment opportunities for persons lacking higher education was concomitant with post-industrialism (Bluestone and Harrison, 1982).

Intellectual infrastructure has become the equivalent of physical infrastructure as government-issued bonds; a financial mechanism utilized primarily for roads, canals, bridges, and the like, is used to support research and innovation, as well. In the transition from industrial to knowledge society, science and innovation must be treated as infrastructure, like the roads and bridges that provided the underpinnings of industrial society. This basic recognition of scientific research as a public good was established more than six decades ago (Nelson, 1959), yet establishing government support remains challenging. Mechanisms that were heretofore utilized to fund long-term investments in physical infrastructure may similarly be applied to construct knowledge infrastructure. These investments will not only directly repay government through interest payments, but generate incremental growth and thus increased tax revenues.

What might the contribution to European innovation be if large-scale funding was targeted at mid- and longer-term strategic bets, managed by equivalent agencies to DARPA and NIH in the USA? But where will those funds come from if even the relatively modest Lisbon Agenda of increased innovation spend in national budgets could not be achieved? A transformative experiment in innovation potentially solves the problem of uncertain funding support tied to the ups and downs of the business cycle by reappropriating the traditional Keynesian logic of debt-financed government stimulus from physical to knowledge infrastructure. Large-scale projects, whose future benefits are expected to cover present costs including interest payments, justify borrowing against that future on the credit of the state. When these projects have the potential not only to stimulate short-run demand, but also to increase the long-run productive capacity of the economy through scientific discovery, the case is made even more compelling.

Another method to raise public funds is to increase taxes. In the wake of historical analysis (Piketty, 2014) and Occupy movements highlighting increasing inequality, tax policy is increasingly attractive to both those who wish to reduce inequality as well as those who wish to increase tax benefits for the wealthy. However, as New York’s Mayor de Blasio learned in the course of his recent successful effort to expand early childhood education, taxing the rich is a strategy fraught with difficulty, engendering blocking opposition even from among those within his own party who agreed with his social objective. On the other hand, in 2012, California’s Governor Jerry Brown managed to overcome the opposition to increase taxes by going directly to the state’s voters who passed a proposition that combined a regressive ¼% sales tax increase with a progressive income tax increase on residents earning more than $250,000 per annum. The proceeds were channelled to improve public education through the community college level.

Policy implications

The great American entrepreneurial universities rest on a national policy of funding the creation of new technology platforms in areas relating to defence and health. This is the source of the search and biotechnology industries, among others. Since the US is limited to ideological reason in a relatively limited set of technological areas, the way is open for others take initiatives in a plethora of fields, for example, photovoltaics and desalination of water, with macroscopic implications. China has taken up the challenge but Europe lags behind. A recent seminar at the Brodolini Foundation in Rome presented Europe’s IT intentions as a third mover strategy: using IT to raise the level of small and medium-sized firms and existing industries. This was not even a second mover strategy of carving out protected spaces for clones of Google, like Russia’s Yandox and China’s Baidu.

Europe should raise its game! It has the advantages of ability to raise enormous financial resources by borrowing at low interest rates and the R&D collaboration infrastructure at the European Union level. What it lacks is a strategy to focus resources and a selection mechanism, like the US DARPA program, to choose future potential advanced platforms for development. With high-level universities in the transition to an entrepreneurial model and a strong Civil Society, Europe has the ingredients that have produced Boston and Silicon Valley as well as rising innovation regions in Boulder, Colorado, San Diego, California, New York and elsewhere. In the next decades, the world will have multiple ‘Silicon Valleys’, regions that have gained the ability to innovate across successive technology paradigms, scattered across the USA, China, India, Brazil, Russia and elsewhere. Indeed, some of these future locations of innovation are already emerging. Europe should abandon austerity policies and create its share. One lesson from CIRM’s public input into an innovation focus is the necessity of ‘picking winners’ rather than spreading resources around in small amounts without a focus.

When Baron Haussmann was faced with a funding shortfall, based on what could be expected from current revenues, for his mid-19th-century plan to radically restructure Paris, he reverted to ideas that had earlier been mooted by Henri Saint Simon, one of the founders of European Socialism (Manuel, 1956). Haussmann arranged to issue bonds on the credit of government based upon expectation of future economic growth that would be unleashed by the vast municipal reconstruction project (Hall, 1998). Additional financial means to support the infrastructure project were generated by the sale of the development opportunities created by the broad avenues that were cut through the city. Although Haussmann was ousted as director in the early 1870s, the momentum of the project extended into the 1920s and has more recently been used as an urban model for redeveloping Paris suburbs. In a similar vein, the establishment of the United States Postal Service in the early 19th century provides an example of a massive government investment in the knowledge economy that allowed for the efficient dissemination and transfer of knowledge across the young nation. ¹ The results appear to have been quite successful, with the locations of post offices exhibiting strong correlation to future patenting activity (Acemoglu et al., 2016).

In the summer 2015 ballot for Labour Party Leader in the UK, MP Jeremy Corbyn, the long-shot winner, proposed People’s Quantitative Easing (PQE) to fund a nationwide infrastructure renewal. Directing the Bank of England to issue new currency to fund the plan is a variant of the debt-funding model we propose, essentially to achieve the same objective (Murphy, 2011). Indeed, ‘People’s QE may be unorthodox, but it is not new.’ As ‘monetizing public debt’, it was the method by which, in the 1930s, Keynes proposed to pay for public works in order to stimulate recovery from depression (Salsman, 2017). The main point of difference among QE proponents is over whether it is appropriate only as a desperate response to the downturn or whether it may be used in a more forward-looking version to drive upturn. Although proponents of the more daring PQE model believe it may offer an opportunity for the monetary authority to perform an end-run around austerity-beholden fiscal policymakers, we believe that, in countries in which political will can be mustered, the tried and true debt financing model is entirely sufficient. We hope that applying the traditional debt-financing model to an innovation agenda will further consolidate political support, even those who have endorsed the failed austerity agenda in the past. In addition to the focused R&D programmes, longer-term initiatives may be funded to fill gaps in national and regional innovation systems.

Founding entrepreneurial universities

The Res Publica think tank has called for an MIT-like university to be founded in England’s North, echoing the New York Innovation Forum’s 1990’s call for a similar institution to fill the entrepreneurial university gap in the city’s innovation system. Eventually adopted by the Bloomberg Administration towards the end of its tenure; a partial version of this vision is currently under construction on Roosevelt Island, the Cornell–Technion campus, supported by a combination of public and private resources. An IT master’s degree, designed to train potential start-up founders is the first degree program started, in space made available by Google in its New York City headquarters, while construction is underway.

The UK has learned how to create spin-offs and has support structures in place for this purpose; it has been less successful in creating growth firms, with the notable exception of Cambridge’s Arm, a chip design firm with customers across leading cell phone companies. ² A typical outcome is the sale to a major US high-tech firm, with the intellectual capital of the firm moved aboard, and even if it is kept in location as a subsidiary, as a result, the prospect for independent expansion and growth becomes foreclosed. A recent development at Oxford recognizes and attempts to remedy this gap in the UK innovation system.

Without any apparent awareness of its 1940’s Boston predecessor, the American Research and Development Corporation (ARD), the pro-bono venture capital firm, with a long timeframe, oriented towards regional development; Oxford has re-created and improved upon the model by addressing its major flaw; the lack of commensurate compensation if and when great success is achieved. This was the flaw in the ARD model, which had staff on modest salaries and did not expect the major success of DEC, which took more than a decade to achieve. However, when this overwhelming success took place, it created dissatisfied ARD employees who did not share appreciably in its success. As a result they left and modified the venture capital model, creating relatively short-term partnerships, solving their compensation issue, but narrowing the focus of the industry to fast growth firms with monopoly potential, like contemporary Uber. Thus, Oxford Venture Capital recuperates the original venture capital model focused on long-term high growth successes, rather than quick albeit profitable exits.

The Silicon Valley innovation model built upon the Boston Triple Helix regime, creating planetary systems of mega-firms, satellites and start-ups designed for the prospect of a takeover. Firm growth allowed a hyper-entrepreneurial ideology to take root, eliding the sources of growth in government investment in innovation and academic sources of new industrial paradigms. Nevertheless, periodic recessions, international challenges to the Valley’s technological dominance (e.g. Japan’s 1990’s semiconductor success, and national level blockages such as the Bush Administration’s human stem cell research policy), have tilted the Valley back towards classic Triple Helix coalition modes, instituting ‘Innovations in Innovation’ to enhance the conditions for success.

Conclusion

Nobody wants to spend in a recession or depression; everyone wants to save. This is evident both in stagnant GDP, and in historically low government bond yields (as more and more want to save, the yield on bonds falls ever lower). At a time when the economy needs stimulus, and when the government can borrow money at extremely low rates; what better policy could there be than to invest in innovation? After trial and failure, European austerity policies should be abandoned and replaced with innovation policies, making a bet that significant success downstream will more than cover the debts incurred. Debt funding mechanisms could speed the transition to a knowledge-based society, a transition that is hindered, even stalled, if not set back by an economic downturn left unattended, or deepened by counterproductive austerity policies.

Ecuador’s audacious $2 billion commitment to founding four entrepreneurial universities is an innovation beacon from a developing country to the rest of the world. Aalto in Helsinki, and Skoltech in Moscow, are two contrasting experimental bets on new foundations to which significant resources have been committed. It has been a half-century since the wave of so-called plate glass universities were founded in the UK, primarily intended to expand higher education opportunities to a larger segment of the population, an implicit equivalent of the GI Bill that expanded access to higher education in the USA. Moreover, exemplified by York University, they have made significant contributions to their local economies through spin-offs, replacing jobs lost in older industries. A new wave of entrepreneurial university foundation should be undertaken in the UK and across Europe. Amsterdam is following New York creating an MIT-like university through collaboration between Cornell and Technion, in filling the entrepreneurial academic gap in its intellectual infrastructure.

As industrializing and industralized societies alike attempt to make the transition to a knowledge-based regime, novel methods must be invented that supplement and support the venture capital format, a relatively limited model focused on potentially fast-growing firms, based on novel technologies and business models. ³ Instituted in Massachusetts during the early post-war period and transferred to northern California during the 1960s, the venture capital format spread more broadly in recent decades albeit with significant gaps even in its country of origin. Nevertheless, even given its recent extension into social and philanthropic realms, venture capital provides only a partial model for knowledge-based development (von Bergmann-Winberg, 2104). We submit that the CIRM experiment has potential for generalization into a general model for S&T and innovation support.