About Nick: i am an economist based in malaysia. I write about ECONOMIC DEVELOPMENT AND POLITICAL ECONOMY, while sneaking in a pop culture reference or two.

In The Middle For Once: Markets, Government and Innovation

One of my favourite NBA commercials is Nike Basketball’s “Bring Your Game”. In the commercial, a group of four teenagers are trying to pick their favourite basketball players. To do so, they go around the US to meet some of basketball’s biggest stars — or at least the ones who signed with Nike — including Lebron James, Elena Delle Donne, Anthony Davis, Kyrie Irving, Kevin Durant, Paul George and the late great Kobe Bryant.

I rewatched the commercial a couple of days ago (it’s on YouTube) and one kind of throwaway line in the commercial really struck me. The teenagers are discussing the merits of Paul George and trying to decide if he is a “loud” player or a “quiet” player. And as they are discussing George on the subway, one of the teenagers yells out, “He’s in the middle for once!”

Maybe I’m reading more into it, and I’m certainly not sure if Nike meant it as such, but I do think the line is pretty profound. The line from the commercial basically says there may be a more nuanced position (“He’s in the middle…”) but that more nuanced position is typically ignored or completely set aside (…for once!”). So, in the context of the NBA, one might take a nuanced position to debate the merits of, say, Michael Jordan, Kareem Abdul Jabbar or Lebron James as the “GOAT” (greatest of all time) or, as is more common on Twitter, YouTube, Reddit and everywhere else such discussions happen, it’s all or nothing on a single player.

The thing is, just like how territorial we can get when we are discussing fandoms — be it the NBA, the Premier League, The Lord of the Rings, Harry Potter, whatever else — the same may also be true of our intellectual or ideological public policy positions. At present, there is plenty of debate on the topic of industrial policy and, more specifically, the efficacy of government-led attempts to change the composition of economic activity in a given country.

A common perspective is that government-led attempts to do business are necessarily sub-optimal and are ultimately doomed to failure. After all, what do bureaucrats know about running businesses? And how can governments “pick winners” when it doesn’t necessarily have skin in the game, nor is it sufficiently close to the pulse of the market and the consumers? In fairness, history is replete — Malaysia included — of governments picking winners only to see colossal losses and failures. And yes, while there are also successful cases of governments picking winners (see TSMC and Samsung in Taiwan and South Korea respectively), we can’t deny that governments don’t always do a good job of picking winners, even at the sectoral level. Chile, for example, experimented with a bunch of sectors before succeeding in developing a thriving salmon sector.

But here’s the catch, and here’s where I think there’s room for a lot more nuance. Government failures are common everywhere, but so are market failures. Are we so sure that the private sector or the market necessarily picks winners well? If that were the case, the venture capital model wouldn’t be firing a bunch of bullets in the hope that one or two ventures make enough money to cover the rest. And sure, it’s probably true that if a given venture capital fund’s hit rate is, say, one in 10, the government’s might be one in 20 or worse. But one in 10 is still not a great hit rate, especially if resources are scarce.

In a recent paper titled “Distorted Innovation: Does the Market Get the Direction of Technology Right?” Massachusetts Institute of Technology economist Daron Acemoglu provides evidence that distortions in the direction of market-driven innovation and technology — where the optimal direction is taken to be the most socially beneficial one — can be substantial. In the paper, he provides the example of antibiotics and dietary supplements, stating, “Both antibiotics and dietary supplements have resulted from new innovations and have led to products that have been consumed by billions of people around the world. But most would agree that antibiotics constitute a bigger technological breakthrough and have been socially more beneficial.”

Acemoglu argues that there are at least five factors that distort the alignment between market incentives and social objectives when it comes to innovation. The first is that some technologies generate negative externalities which, if unpriced, means more research and innovation being directed towards those technologies. The clearest example of this is in innovation in fossil-fuel technologies over time. Another example Acemoglu provides is the direction of technology towards automation of work, as opposed to worker-complementary technologies.

The second factor is strictly commercial — incentives for innovation are unsurprisingly tilted towards higher-markup sectors and technologies. This is the profit motive and shareholder value maximisation in action. The third is on social trends that may favour a particular direction ahead of others. For instance, many start-ups seem to advertise to be the “Uber” of something or other, providing incremental gains to market efficiency, as opposed to disrupting entire markets completely or even focusing on hardware technology. Fourth, as Acemoglu argues, when different technologies create distinct distributional effects (that is, inequality), the market isn’t built to redistribute these effects. Finally, the direction of innovation may be distorted because of coordination failures where firms or innovators stay too long with an inferior technology as entire ecosystems are built around that inferior technology.

Notice that these five factors are forms of market failure and can therefore prevent private sector firms and innovators from “picking winners” or pushing innovation and technology into socially beneficial ways. As such, while it’s certainly true that governments can’t always be relied on to make terrific business decisions, it’s also true that the private sector may not always get it right either (see Silicon Valley Bank’s asset management decisions). Innovations in financial derivatives in the early 2000s were a key contributor to the 2008 global financial crisis after all.

So where does this leave us? In the spirit of, “It’s in the middle for once!”, Acemoglu writes, “I assume that the market is best placed to experiment with new methods and carry out innovations, even if it is possible for systemic factors to distort the direction of technology.” The reality is that markets can fail and governments can fail. An ideological bent that the government should never be in business and thus, industrial policy is doomed from the start, is entirely unhelpful. In fact, for democratically elected governments, where the market is distorting the direction of technology away from socially beneficial ends, one might argue it is the responsibility of the government to intervene to shift economic activities back towards those socially beneficial ends.

Therefore, it’s never “only the private sector should be in business” or “the government should always intervene in business”. Reality is far more complex and there are certainly pockets of market failures where the government does have a more direct role in economic activities. Beyond the old chestnut of providing a secure policy and regulatory base, these include the provision of more long-term patient risk capital (de-risking new economic activities for the investors who may find it too risky to invest in completely new technologies or those with very high fixed capital expenditure, among others), taking on lower-than-commercial returns for crucial economic activities, and shaping the direction of technology and markets towards more socially beneficial ends. We really should view this market-government relationship in business as being in the middle, for once.

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