Translation: Shifting the risk to the taxpayer

By Matt Nolan 19/09/2013 13


I’m seeing a lot of this recently (via Twitter)

The Israeli model is successful because the Israeli government, rather than funding incubator managers, invest in start-up companies to the tune of $500k to $750k. The model integrates 85% government and 15% private first stage investment, with the government input reducing risk at the early stages of a company. The government is repaid through royalties.

Lets think about this model a bit.  This isn’t the risk “disappearing” – this is the government (read taxpayer) taking on the risk.

Furthermore, risk is not independent of the choice of the private individuals running the firm – depending on the way these contracts are structured the firm may take on more or less risk then they would have otherwise.  So not only does this involve putting risk on taxpayers, it also involves distorting the incentives for the firm itself … nice

More broadly this raises an interesting point for me – it is almost as if we do not believe firms should make any “rents” from innovation … unless the government explicitly decides to give them rents to innovate.  Isn’t this strangely perverse?  What sort of implied model of society does this make sense in?

Sure we can try building up some type of externality, but let us be a bit careful we are looking at the issue in an objective way rather than just trying to build up a ex-post justification for doing what we wanted to do in the first place ;)

From what I can tell, the problem is that we all tend to look at issues too much in isolation when we look at them quickly – there is too much static partial equilibrium (at best) logic used without thinking of the broader dynamic and general equilibrium effects … the ones economists are obsessed with.  I love comparmentalising problems to help understand them, but when it comes to policy we have to fit it all together!

And this is what CGE (Computable General Equilibrium) and other similar types of models are trying to do – and why they often surprise us relative to our raw intuition.

Note:  You may say that society should take on some risk as the firm is the one “making things”.  I would note that the firm, and their interactions with others, get the benefit from “things” – trying to get the rest of us to take on risk for firms their own private benefit is and then pretending “jobs” and “output” are somehow benefits to people uninvolved with the transaction is not a justifiable argument.


13 Responses to “Translation: Shifting the risk to the taxpayer”

  • Risk be damned. It seems to be an unknown factor in the rest of the world.

    There is oodles of evidence that can show government investment in R&D over the last 50 -75 years has produced the big breakthroughs that have been picked up – eventually – by entrepreneurs and businesses to develop niche products based on that research.

    There is oodles of evidence that suggests New Zealand is an outlier when it comes to government assistance to firms in the provision of funding and in-kind assistance with R&D. The rest of the world have been spouting the free market philosophy of “leave it to private business to do R&D” yet have been cheating us completely behind their backs. You poor market forced minds who think that all their R&D is privately driven – it is hogwash. The User Pays Syndrome is still infecting us with its drive to be as pure as the driven snow and attempting to force firms to cough for R&D far in excess of the rest of the world. IT hasn’t worked for the last 25 years – since DSIR (and later the CRIs) were forced to go commercial. It won’t work because all the funding sources are demanding too high a slice of private funding. The Powering Innovation report outlined the problem well. But the execution of the PI report’s recommendations leave a lot to be desired – it’s child is yet to get out of its shitty nappie.

    Oh to have a genuine Advanced Technology Institute at least as outlined here as recommended by:
    http://www.callaghaninnovation.govt.nz/sites/all/files/sites/all/files/pictures/Powering%20Innovation.pdf

    Here is a taste:

    “Funding barriers relate not only to availability of investment funds but also, and very importantly, to how the investment of government and private sector funds is prioritised.

    Barriers mentioned included:

    • A lack of integration in the HVMSS sector, and of identified niche areas and focus on unique products and processes to improve international competitive advantage.
    • Low level of R&D investment by government, and structure of government funding.
    • Under‐investment by the private sector, and a lack of risk capital for R&D led innovation, especially for small companies, to take projects from idea to commercialisation and complete the value chain.
    • A lack of integration among the public sector resources, a large number of intermediary
    organisations (such as NZTE, TechNZ, Business New Zealand, EDAs, Chambers of Commerce and so on) and high turnover of staff in these organisations. This linked to a lack of alignment around investment decisions that support companies or industry sectors.
    • Overseas ownership leading to use of New Zealand operation for manufacturing only and therefore an absence of drive for innovation.”

    Callaghan Innovation is charged to assist and:

    “We create and deliver innovative products and services that enable businesses to invest more in research, science, engineering, technology and design, so that they can be more successful in the global market.

    When we succeed, all New Zealanders will benefit from a stronger economy, higher value exports, more productive and sustainable resource use, more jobs and higher incomes.”

    I’m just surprised but it does appear a university is stepping pretty close to the same area that CI is supposed to fill. Who the hell is running this show?

    Just sayin.

  • Yes, this seems to be stomping on Callaghan Innovation with both feet. The government really needs to sort out it’s implementation of innovation and assistance to small businesses.

    I’d be first in the queue for some of the 85%, given that most NZ banks want small company owners to be highly motivated towards success. The banks and other commercial finance sources usually tie loans to mortgages on assets such as private home, just to increase the motivation.

    By the way, Israel innovation was/is well protected by tariffs, similar to NZ was in the 1960s ( Israel = about 80% tariff on cars ), as well as favourable tax treatment for new companies, such as 10 years tax-free on revenues from offshore.

    Given their track record, I wouldn’t stand behind AUT, MoBIE, or CI funders at the TAB and make the same racehorse choices in the hope they know how to pick winners – they’ve used other peoples’ money with minimal success.

  • Ross, you seem to be arguing at cross purposes to Matt a bit. Without chanting any mantras about free markets or high-value-added industries, or even innovation (which seems to have become a bit of a feel-good word), policy analysis needs to start by asking two questions: What is the problem that government policy is trying to fix? and What is the best policy to deal with that problem?

    So what is the problem in your view? Is it that small firms are not willing to take on the risk of R&D suggesting gains from risk sharing (the issue that Matt is addressing), or that firms don’t capture all the benefits of successful R&D since ideas can be shared (which I think is your point), or that firms don’t understand the benefits of innovation and need a governmental kick up the pants to act in their own interest? Depending on what your answer is to these questions, the Israeli model that Matt describes, R&D subsidies, or direct government investment in pure research might be the best response.

    Then the question becomes what is the evidence base in each case. and how applicable is that to New Zealalnd. You mention oodles of evidence that government investment in R&D has produced the big breakthroughs. But is that through subsidising firms, or through funding universities and research institutes through institutions like the NSF, and does that evidence come from small countries like New Zealand? If your argument is that firms won’t invest in R&D on their own becuase they can’t capture all the benefits, doesn’t that imply that small countries should simply free ride on the government funded R&D undertaken in large countries, except for areas where unique geographical features create unique problems and opportunities? When I was living in Canada there were a number of studies showing that government subsidies for R&D were a miserable failure in producing value for the country, which is not surprising given that it is a small country adjacent to a very similar but much larger country.

  • Stand by for a rant and a dump.

    Every firm is not going to get assistance from the govt. Even the Israelis realised this and their firms go through the hoops to make sure they able to fulfil the requirements to receive the assistance. NZs experience when the R&D tax break was emerging was to get consultancies leaping in and begging firms to “allow them to assist” and fiddle their accounts to allocate costs to R&D. I clearly remember seeing ads from these consultancies in the paper. There is no doubt that allowing all and sundry to game a universal R&D tax break this would be an outcome. But there is an industry in NZ who are very very good at doing this kind of gaming and it makes me sad, confused and truly pissed off.

    It appears there are two views to get “innovating”. One is that we want NZ firms to improve their productivity by utilising R&D. Two is to try and get firms to do their own R&D. I’ll stick my neck out and say that the vast majority of well managed firms who are willing and able to utilise practical, focused and intelligent R&D assistance will benefit. This is now quite a different risk.
    The govt wants to see more firms “succeed”. We can view this as concentrating on singular success, or, we can consider the social benefit of many successful firms to the whole country. I think I prefer the second view.

    The problem is how you get firms to take it up. The list of barriers in my post sums this problem up in five bullet points. But there is one that is clearly missing – the clear lack of science and engineering in the management of firms – especially SMEs – in this country. The only place this can be addressed is in the education system.

    “What’s Your Problem NZ” highlighted a list of problems firms faced at the time of the exercise. I am certain there would be more now because other firms would jump on the wagon. IRLs problem was there was no way of addressing them the next week or the next year. There was no funding model that could address it either. There was no doubt that if all these problems were able to be addressed, these firms productivity would have been enhanced. Many had less than 10 employees. They would benefit tremendously if they could easily tap into research institutions expertise. Because they don’t have the in house experts. (I spent less than 30 minutes on the phone to a SME yesterday who exports their product. My input has solved a major headache that could have killed their particular niche product. It cost nothing but my time to disseminate govt paid for education and training. I know there are plenty more out there looking for similar assistance. We need more opportunity for that to happen.)

    One issue I see is that the Giant Leap that this govt insists on pursuing to improve productivity in one hit will not happen. But why not take small steps beginning with manageable projects among SMEs – who must have the basics of good business and management practices – and would go a long way to enticing others to immerse themselves into adopting R&D. That is what IRLs vision of the ATI was – developing a progressive ability that enhanced these opportunities. A story was around that IRL had sorted 20+ “Good News Stories” which showed IRLs benefit to these firms. Only four would allow their names to be used. How was IRL to deal with that?

    Kicking firms up the backside is not the right way to go about it either but that is happening now already. The funding model today ignores SMEs who haven’t already shown a willingness to do some of their own R&D and it ignores those who haven’t got a high enough turnover. So the haves get more and we lose potential winners from the pool.

    Team NZ would not be sailing today in carbon fibre yachts if it wasn’t for a Japanese Government funded research establishment finding ways to efficiently produce higher quality carbon fibre. Once that hurdle was achieved – after years of trying by the original inventors and the British Govt – the entrepreneurs took over. The discovery of Nuclear Magnetic Resonance in the late 1940s resulted in…well… nothing for 10 to 20 years until a chemist decided that he could identify how a molecule was put together. Had an MRI lately? You can partially thank him and you can probably thank Paul Callaghan as well because he was into imaging NMR. Is HTS110 the beginnings of a multinational business? It could be. Grasslands DSIR spent decades breeding grass that was originally imported and found to be wanting in OUR country and the outcome is, still, the ability for NZ to out farm anyone else. Or Fisher and Paykel (still) benefiting from the years of Operations Research from the second world war and utilising – again – DSIR mathematicians (!) to assist with the design of their production lines. Or DSIR developing better hop varieties over 50 years or so. The irony was that yes, they were better hops but we don’t need so many growing them!! And now I read in the paper that boutique breweries are looking to develop even better ones! Who is going to do that? It sure as hell won’t be a private firm let alone a brewery giant. Or some idiot horse that touched a car with a high voltage attached kept the car unscratched by the horses arse for the owner. Gallaghers is the result. Fancy putting buildings on rubber blocks to protect them from earthquake? Bet Christchurch wished they had more than only one building sitting on them. Particle Physics and radiotherapy magnets – there would be Buckleys chance of doing this here in little ‘ol NZ. Or Plant and Food taking a weed from China and turning into a multibillion dollar export industry. And there lies an interesting story. We damn near killed that industry off because the regulators we held responsible for keeping NZ safe from nasty’s failed to do it. Why? Because the free market ruled and why shouldn’t it be allowed to import pollen from overseas for a few shekels less than it is available here in NZ? Utter Madness.
    Breakthroughs happen rarely. How anyone can say that they should happen more often if we try and pick research winners is pissing in the wind. I doubt anyone knows who will pick up on a NZ breakthrough and run with it. Your guess is as bad as mine. Someone worked out not that long ago that the increase in productivity from Grasslands research would be still paying for multiples of all yearly R&D investment in this country. If we accept that there just might be a few breakthroughs if we concentrate on research “relevant or even some that might not be so obviously relevant to NZ”, it might be an interesting approach to take. Accept it. Such an idea will return quids more than the cost in the long run. It has already, and it will do it again.

    If Israel is a good model surely the fact that it is a country a little bigger than the Hutt Valley and Wellington combined negates the argument that we must hang off the coattails of the big countries. More importantly, we are at the ends of the earth.
    Let’s use the untapped resource we already have. That is, the 15,000 SMEs who exist. They survive on the smell of an oily rag but they hang in there. I suspect there could be a few hundred of them who could be turned around to become some of the biggest in NZ in the future. A previous poster on “Dismal Science” was talking of allowing the unproductive firms to die off and only concentrate on those who have the highest productivity. It was noted that the highest productivity on the graph was oil and gas. And where do those profits go? Offshore. Yes, they are productive, but are they productive for NZers. How far down the productivity list do we need to go to find NZ firms winning the majority of the profits?

    Let’s start with small steps. Find those gems in the pool and polish them. But keep them here. And yes, this will take planned, efficient and purposeful govt intervention. It is a risk worth taking.

  • Ross. I agree with almost everything you wrote here (with the exception of the suggesiton that it matters whether firms are owned by New Zealanders or foreigners), but I am struggling to see what view to take of the appropriate stance for policy from this. Your view seems to be that basic research is extermely valuable, no matter where in the world it happens, that it is useful to have capacity in New Zealand to allow uptake of the best ideas around the world, that NZ-specific research can have a high payoff in areas where NZ is different, that the old DSIR model of having the goverment employ scientists directly was a good one (I totally agree here), that it would be good if more people (particularly those who become managers of SMEs) left school with a good grounding in science, that blanket R&D subsidies just lead to a lot of gaming, that trying to pick winners is pissing in the wind, and that we need to find gems and polish them and that will take “planned, efficient and purposeful government intervention”. I am having trouble converting that last statement into an actual policy recommendation given the previous statements, all of which I agree with.

  • Randomly from a non-policy person, here goes:

    Rebuild rather than disembowel an Industrial Research Establishment. By all means move it towards Applied Research but allow basic research to flourish within if it needs to. Universities would remain the dreamers. The IRE would be the doers. This WAS the way the DSIR was originally intended to work.

    This is the ATI but with IRL refocused rather than gutted, enhanced in flexible purpose rather than spread thinly, completely core funded rather than competitively, influenced by and influencing firms and business to utilise more and more R&D. Funding that allows research establishments to decide where it should be focused and spent. Rid the place of external competitive funding. It would have HR policies focused as an employee smoothing trowel rather than a management sledgehammer.

    It would provide regular seminars, courses, programmes designed to up skill the workforce and management in specialised areas in the practical use of research. Provide outreach and hands-on interactions with schools aimed at enthralling kids into science and engineering. This will be connected at the heart of the primary and secondary education system.

    The regular transplanting of people from/to industry/firms and to/from research establishments. Focused on assisting both to discover how the other works and to transfer knowledge and skills both ways. This can be for a temporary period depending on what needs are being met. Short term for a quick acquisition of knowledge or skill, to long term arrangements when transferring an idea into a commercial end use/product. Guaranteed employment in original firm/establishment on completion.

    Practically free use of science and engineering staff, equipment and expertise for short visits to assess, discuss and (hopefully) fix or sort out a problem. Funding to allow this with no strings attached. The opportunity to try more than one avenue of assistance if the first one didn’t work. Lets look for success as long as the intention remains feasible.
    Policies that reach sectors and attempt to break down the barriers of distrust between firms within the sector. In other words, attempt to transfer knowledge and ideas horizontally without allowing screwing of and between firms.

    IP developed from public funds and /or institutions that allow the free take up of the IP with provisos that include: License is free while the firm is completely NZ owned. License fees will be imposed on any buy in from overseas that removes NZ control that occurs within 10 years. IP must be actively used within 3 years otherwise license is revoked. BIG Tax breaks if manufacturing undertaken in NZ utilising this IP. IP is valued as 50.1% of any spun off company irrespective of any capital injections for a minimum of 10 years.

    PS – Remember, if I really was a policy writer, I would be paid a shit load more than most scientists in this country. This does say something about who we “value”.

  • I’d suggest that scientists’ salaries are based on supply and demand, every job advertised probably has heaps of well qualified and competent overseas applicants. Policy analyst’s salaries – who knows?.

    I’d also suggest that the apparent dislike for IRL by policymakers is because industry feedback was that IRL wasn’t supportive and effective. That only 20% of the selected IRL clients were prepared to have their names associated with IRL suggests that clients do not recognize the benefits IRL had provided.

    I’ve pushed clients towards IRL, only to be met with disinterest, and some clients also worry about the costs. One client recently employed somebody from the winner of “What’s your problem, New Zealand?”, and that individual strongly discouraged the company from working with IRL – because they were very expensive and took time to get up to speed. The client went to a CRI instead, who charged more than IRL would have – because they weren’t set up for the work.

    The model has changed, as much NZ corporate “Research” is a distress purchase ( something is no longer working, a product is off-spec., or a market share has been lost ), rather than longer-term strategic research.

    As recent quality fiascos have shown, large companies can brazen their way through the consequences of not following best practice, and still keep government enforcers at bay. Major companies can require suppliers to provide high level technical support, often by accessing overseas specialists. No matter how clever, scientists from outside the industry are unlikely to efficiently solve problems in specialized highly-complex areas.

    My perception is that CI exists, and needs to build a new reputation. As always, that involves regular visits to their peers in industry by competent scientists ( not market critters ) to just talk and learn about the client’s woes and to inform them about new science and techniques. It’s important that CI doesn’t take work better handled by others, and they should point the client to other organisations.

    As trust builds, the clients will call CI for help on both distress and strategic research. There’s no point in trying to sell petrol to a vehicle owner who has a full petrol tank, you need them to proactively drive to your service station before the fuel gauge reaches zero. CI should try to help clients perform novel strategic research, and government incentives to industry should focus on that, and also on some loner term national issues – eg best industrial use of cheap electricity, high value exports, etc.

    • Do you have any evidence on the “every job advertised probably has heaps of well qualified and competent overseas applicants” claim? It’s an important one. If we have tons of potential scientists for the advertised jobs, then all the STEM funding stuff is even more nonsense than I’d thought. Why shell out tons on more scientists when we can just import trained ones from abroad?

  • My personal experience as a former team manager at IRL was that when I advertised any scientist position, the minimum number of applicants was in excess 50, and up to 120.

    Another scientific company manager told me that they had over 200 applicants last time they advertised for a “Ph.D. minimum” position. I assume the situation is still the same, with obviously unsuitable candidates eliminated by HR prior to reviewing the remainder.

    Some parts of IRL have, until recently, had noticable numbers of overseas scientists filling junior-mid level research positions, with a significant number of them apparently on short term contracts, as they disappear back overseas after a couple of years.

    It’s not clear to me whether reviewing funding bids would show the use of short-term and/or overseas researchers, as bids tend to have principal and senior scientists all over them, rather than any indentured labour.

    There was/is a policy that most positions should be advertised within NZ first, but unfortunately often NZ candidates don’t have the experience, and I think employers still have to convince immigration that relevant skills are unavailable in NZ.

    • I’m going to cite this next time I hear Stephen Joyce arguing how we need to have massive subsidisation of bench sciences relative to other stuff in NZ. Many thanks.

  • Wow, quite a few comments here …

    The central idea is that the government is making risk “disappear”, they are changing who faces the risk, the incentives of those involved, and creating winners and losers.

    My point was that we should try to systematically analyse those points, and be transparent about what is going on, instead of following blind faith in business subsidies (in this case “dressed up” as subsidies for R&D).

    Also, another point that is pretty important to keep in mind is that we aren’t targeting some “GDP” variable – we are interested in the wellbeing of individuals in society. Even if we showed that subsidising R&D, or savings, or investment, would lift GDP it does not follow that this is the right thing to do. This is a very fundamental policy point.

  • Ross. Google the Diamond and Water Paradox to see why the pay rates for scientists doesn’t reflect how much we value them, just how much we value the last one of them. If we were to stop trying to create steer graduates into the STEM subjects at university, and instead put more effort into making sure everyone arrived at university with fundamental scientific literacy, you I suspect you would find that the payrates for scientists would increase considerably.

    But don’t bemoan the policy analyst pay. It is going to take a fair bit of policy intellectual firepower to design a set of rules for how much local ownership and how local location is needed to qualify for free access to the government IP that won’t simply be gamed.

  • Matt. I think I am in the court that says the country as a whole should be prepared to take the risk. It might be “blind faith” but the opposite is too isn’t it? If we start from ideology then either case can win.

    Eric, having 200 applicants doesn’t mean that there are 200 that would fit the job. The cull is pretty bloody high!!! If I was a Painter and House Decorator in China I would have a good go at shifting to NZ – even as an economist! I would, no doubt, be included in that cull.

    Seamus, yes, it is how plumbers can earn as much as the Prime Minister. A wag suggested that there must have been a dearth of right wing economists within the country lately. ;-))