Entrepreneurs sit at the heart of a battle over how economies should operate (City AM)

Head of Economic Research Ryan Bourne writes for City AM, Tuesday 3rd September 2013. 

“FOLLOWING the financial crisis, an intellectual battle about the role of the state in “managing the economy” is opening up. The most recent evidence is The Entrepreneurial State, a new book by the economist Mariana Mazzucato. This contends that the big inventions and breakthroughs that determine prosperity and productivity growth are often produced by the state. Mazzucato produces evidence that governments helped develop key technologies – such as the algorithm that drove Google’s search engine, GPS and touchscreen. She argues that the state’s ability to think longer term and take bigger risks makes it an important driver of growth.

Of course, many of these inventions might have been developed in the private sector had resources been left there. And as the economist William Baumol has shown, there is also a difference between invention and innovation. Private entrepreneurs harness new technologies to meet wants and needs, putting together products (like the iPhone) no central planner would think to design. The state and private sector can both invent things, but the former is ill-placed to design and market technologies through society.

This is important, because at heart of this debate is a battle over how an economy should operate. On one side are liberal economists, who believe in small government and its separation from business. On the other are modern mercantilists, who want firms and government working together to create strategies and target objectives.

Liberal economists object to mercantilism on many grounds. You can’t deal with businesses that don’t yet exist, for instance. Corporatism thus tends to lead to cronyism, crowding out competition from innovative new firms and startups. But traditionally the big divide has been that liberal economists believe that production is valuable only because it gives us the resources to trade – and trade and exchange increase our well-being by allowing us to obtain things we want. Mercantilists, in contrast, value domestic production in itself. This was traditionally an obsession with improving the balance of trade, and now manifests itself in comments like “we need fewer people buying foreign holidays” and “we need to rebalance the economy”.

Neo-mercantilists clamber for the moral high-ground, with advocates like Harvard’s Dani Rodrik implying that liberal economics inevitably leads to consumerism and an unsound economy, while mercantilism emphasises high employment at good wages. But this is a distortion. Liberal economics doesn’t inevitably result in huge borrowing (public and private) or trade deficits. Adam Smith understood that production was the bedrock upon which we could trade, and wouldn’t celebrate borrowing from China to import their goods while promising to repay tomorrow. This arises because of individual and governmental decisions to borrow too much over a long period. And mercantilism was originally based around the idea that keeping workers poor was good for the nation (by keeping costs of production low and boosting exports), as The Idea of Antipoverty Policy, a recent paper by Georgetown’s Martin Ravallion has shown.

It was only the growth of liberal economics that highlighted how welfare was not just about national production levels, and produced the framework for the dignity of free choice and opportunity for the masses. And it’s only private entrepreneurship which can deliver innovative things we actually want.”

Date Added: Tuesday 3rd September 2013