Job Creation and State Capitalism

Stephen DeAngelis

March 09, 2009

State capitalism is defined as an economic system that is primarily capitalistic but in which there is some degree of government ownership of the means of production. With the huge stimulus packages being passed by Congress, the topic of state capitalism has made surprising inroads into the news — and for many people this is not good news [“State Capitalism comes to America,” by Nicholas Von Hoffman, The Nation, 8 September 2008]. Von Hoffman is both blunt and colorful in his assessment:

“Under state capitalism, the economy is manipulated to meet government set goals. Under state capitalism, Washington rules. … The Clinton-Bush II administrations finished the work of destroying and/or emasculating the regulatory framework inherited from the 1930s New Deal and replaced it with nothing. Their deregulation was the economic equivalent of opening the doors to a maximum security penitentiary and letting the most dangerous criminals in captivity out to feast on the civilian society. What a feast it was! And, oh, how we are paying for it. … The are making various state capitalist precedents which have no pattern or direction but will open us up to the depredations of every business lobby and special-interest group. … France has operated under a form of state capitalism since before its revolution. It is carried out with a modicum of planning and self-discipline. When the French state invests in a company, it has a plausible rationale for what it is doing. The United States has none. Without realizing it, we are ripping holes in our free-market system and filling them with a jumble of ineffectual expedients.”

This is not the first time I’ve written about state capitalism. In a post entitled State Capitalism and Sovereign-Wealth Funds, I discussed how large pools of money (mostly petro-dollars) were being invested by governments. Sovereign-wealth funds represent a new twist on state capitalism. What Von Hoffman is ranting about is old-fashioned state ownership but without any real direction. All of this hubbub is the result of the current recession and government efforts to stimulate the economy. As I’ve written before, countries must “work” their way out of the recession and that means creating jobs (see my post Globalization and Recovery]. Pete Engardio, a senior news editor for BusinessWeek magazine, has also provided his take on the rise of state capitalism, the creation of jobs, and whether public-private partnerships will create any lasting impact [“State Capitalism,” 9 February 2009 print edition]. The “state” in Engardio’s article is not a “nation-state” but smaller federal states, like New York. He begins his article in upstate New York.

“As staff at the College of Nanoscale Science & Engineering wait patiently in a conference room, a loud rumble shatters the silence. … Alain E. Kaloyeros has just pulled into a parking lot at the State University of New York’s Albany campus in his $220,000 red Ferrari F430 F1 Spider, the one with the ‘Dr. Nano’ license plates. … Fast and flamboyant, Kaloyeros epitomizes a new breed of entrepreneurial public servant. He has helped persuade the state of New York to inject $900 million in taxpayer money into research and development facilities, including one of the world’s most advanced clean rooms for making prototypes of next-generation chips.”

Obviously Kaloyeros believes that public-private partnerships have merit. He has personally profited from his efforts to establish them. According to Engardio, Kaloyeros “earns a high salary” and the operation he runs employs over 2,200 people in well-paying, cutting edge technology jobs. The operation has also managed to attract some $3.5 billion in R&D investment from companies like “IBM, Advanced Materials, Tokyo Electron, and the government-industry chip-research consortium Sematech, for whom mastering materials at the atomic scale is vital for future products.” As impressive as the R&D dollars are, the fact that Kaloyeros “helped persuade IBM to build a plant nearby to make silicon wafers, the material used to manufacture chips,” and convinced chipmaker Advanced Micro Devices to commit to building “a $4.5 billion wafer facility near Albany with help from Abu Dhabi” is just as impressive. Engardio reports that “New York is contributing $1.2 billion in tax breaks and cash rebates to help cover construction and equipment costs.”

This arrangement involves a little bit of everything — the private sector, the state government, and sovereign-wealth funds.

“SUNY Albany’s nanotech push marks a daring new direction in economic strategy sweeping U.S. states — one that is now being severely tested. States have lavished perks on private industry for decades. In recent years, though, some have brazenly crossed the line between the public and private sectors, designing strategies that look a lot like industrial policy. They have been targeting specific businesses and technologies and, alongside companies, investing big bucks in elaborate research centers, plants to test new technologies, and industrial parks whose occupants receive a special boost. States from Pennsylvania to Oregon have become increasingly important sources of early startup capital to technology companies.”

There is good logic behind this state “industrial policy.” Michael Porter, a renowned business consultant, has demonstrated how nation-states have become and remained competitive because they were able to identify and leverage highly differentiated “competitive clusters.” Targeting specific businesses and technologies through investments, infrastructure, and tax breaks is applying the lessons learned by nation-states. Considering the fact that every state in America is comparable in size and GDP to some nation-state in world, it’s not much of stretch to understand why state officials think that Porter’s strategy should work for them. The question is whether it will work during tough economic times. Some of Porter’s thoughts on the matter are mentioned later in Engardio’s article. The obvious dilemma is that many states are slashing budgets to try and stay out of debt. Constituents see the immediate effects of such cuts but not the long-term benefits of public-private R&D programs. Only the most courageous and visionary politicians will stick with the R&D programs knowing that they represent one of the most promising paths to a better future.

Obama’s nominee for Secretary of Health and Human Services, Kansas Governor Kathleen Sebelius, “has proposed cutting $35 million for a bioscience initiative and shutting an agency that offered financial and managerial help to promising tech companies. Indiana plans to slash $20 million for life sciences research and development, while budget cuts are forcing the Maryland Technology Development Corp. to close an incubator program for startups.” Of course, most states have gone hat-in-hand to Washington, DC, to beg for a piece of the stimulus pie. Even if they get money, state officials will face difficult choices about how to spend it. Promising R&D programs will be competing with urgent short-term priorities. Engardio notes that funding is tight from all sources.

“The natural partners of these experiments also are hurting. University endowments have shrunk, and corporations are hard-pressed to raise funds for ongoing operations, let alone risky new ventures. Such financial pressures are sure to mount in 2009. To add to the pain, a forceful advocate of these public-private partnerships, Governor Bill Richardson of New Mexico, had to turn down the job of Commerce Secretary in the Obama Administration because of an investigation linking him to possible campaign finance abuses. So far, though, most states are holding firm, saying these efforts are critical to creating new industries amid intensifying global competition. New York’s nano initiative remains largely unscathed — a $150 million corporate-funded research center just opened at the Albany campus. And even though IBM is eyeing layoffs at its chipmaking operations around the U.S., Kaloyeros says it is talking about expanding its R&D collaboration at SUNY Albany.”

In these difficult times, mixed news is about the best one can hope for. Although Richardson’s presence in Washington would probably have made a difference, Engardio believes that the Obama administration will likely contain enough champions of public-private partnerships to secure their future. He points to people like “incoming Small Business Administration chief Karen Gordon Mills, a venture capitalist [who] believe[s] that more federal dollars for research and development, workforce training, and business promotion should be channeled through successful public-private collaborations in the states.”

Engardio warns that betting the future on public-private partnerships is not a sure thing. He notes (as has The Economist) that “public officials can be bad at picking winners. State intervention can lead to cronyism and market distortion.” Having raised these concerns, Engardio enlists the thoughts of Harvard Business School competitiveness guru Michael E. Porter.

“‘The grassroots model, where regions get on with it without waiting for Washington, is one of America’s great strengths,’ Porter says. But he calls many state interventions unrealistic. ‘Subsidies are usually a sign you have no underlying advantage in an industry.’ Many state officials insist they are becoming more sophisticated about economic development. Rather than woo plants that could relocate to Mexico or China in five years, they are trying to build new industries in fields such as renewable energy, nanomaterials, and biomedical devices that could generate high-paying jobs for decades. That means first training the local workforce, supplying venture capital, and nurturing research and development. San Diego offers a promising model. There, government and local entrepreneurs have methodically cultivated a top biotech hub, now boasting some 700 companies. The effort began in the 1960s with investments in research institutes and the Torrey Pines Science Park.”

Porter makes an important point, one that we stress whenever we talk about Development-in-a-Box™ with government leaders — look for sectors in which you have a natural advantage. Trying to compete head-to-head with a region that has natural advantages when you don’t means that you can’t compete on a level playing field. Not a good idea. The big debate, Engardio reports, is whether state funding of competitive clusters represents an investment in the long-term economic health of the state or mere corporate welfare.

“Greg LeRoy, head of watchdog group Good Jobs First, has faulted such state efforts. He figures most of the $50 billion or more states spend annually on industrial incentives goes to ‘smokestack chasing’ — courting companies that shrewdly play states off against each other to win subsidies for factories, offices, and even retail stores. Kaloyeros says such criticism is misplaced. … ‘States are stepping up and doing what the federal government should be doing,’ says Kaloyeros.”

The reason that Engardio laments the fact that Bill Richardson’s campaign finance investigation derailed his appointment as Secretary of Commerce is because Richardson has overseen an ambitious public-private partnership scheme. The competitive clusters that Richardson’s team selected to pursue shortly after his election in 2002 included film production, renewable energies, financial services, and aerospace.

“To lure companies, New Mexico tapped multibillion-dollar trust funds set up by the state to invest the royalties on oil, gas, and minerals extracted from public lands. It set aside $600 million in venture capital for startups and has invested in everything from feature films to an aircraft maker and a $250 million ‘space port’ for commercial space travel. New Mexico reimburses companies for 10% of the wages and other costs incurred for each new job they create that pays at least $50,000 a year. … Despite the recession and controversy surrounding Richardson, … the strategy is holding up. Hewlett-Packard, Fidelity Investments, and Germany’s Schott Solar are going ahead with new manufacturing and services facilities in Albuquerque that will employ more than 1,000 each.”

Engardio reports that not all of New Mexico’s investments have paid off, but considered as a whole, “the strategy is creating jobs. A decade ago, New Mexico’s unemployment rate was the nation’s highest. As of December, it was 4.9%, well below the national average of 7.2%. And while film subsidies have been assailed as wasteful around the U.S., Ernst & Young says New Mexico’s film industry employs more than 2,000 and contributed $811 million to the economy in fiscal 2008.” Pennsylvania is another state which has had some success.

“Within walking distance [of the rusting Bethlehem Steel Works in Bethlehem, PA], office parks are filled with the headquarters of such companies as medical device maker Orasure Technologies, semiconductor-materials maker IQE, and business outsourcer PeopleForce. They are among hundreds of startups launched with the aid of Ben Franklin Technology Partners, a state investment vehicle. Founded in 1982 by then-Governor Dick Thornburgh, Ben Franklin began with grants to help local universities spin off technologies. Today it’s one of America’s biggest state-owned venture capitalists, parceling out sums ranging from $25,000 to $500,000 to help entrepreneurs develop prototypes, refine business plans, and expand production.”

Engardio notes that such programs now exist in every U.S. state, but they “account for a tiny portion of all U.S. private equity and venture capital.” As an entrepreneur, I applaud efforts to assist start-ups to get up and running. As a businessman, I expect those lending money to perform due diligence — especially when public funds are involved. Having detailed what several states involved in “state capitalism” are doing, Engardio asks the big question: “Do [such schemes] work?” His answer: The jury is still out. In the weeks and months ahead, how best to stimulate the U.S. and global economies is going to be written about and debated. Hopefully, those involved will not myopically focus only on the short-term. Entrepreneurial efforts, research and development programs, and emerging economic sectors all hold great promise for the future even if they have little impact in the near-term. Sound public-private partnerships make sense. I’m hoping that any money provided through stimulus packages is wisely spent so that we don’t have to look back and regret the opportunities we missed.