As tech advances ramp up, can policy really spur innovation?
There is a complex interplay between artificial intelligence and government innovation policies, which can have significant implications for both businesses and entrepreneurs
Significant technological developments are shaking up businesses across the board, with artificial intelligence (AI), in particular, poised to alter many industries. Meanwhile, renewed government efforts to boost national innovation are dovetailing with these changes in ways that could help or hamper the entrepreneurial spirit.
A historical look back shows that government intervention to support innovation through policy has sometimes “led to a flurry of innovation, and sometimes it seems to have had a really deterrent effect”, according to American economist Professor Josh Lerner. Speaking with Dr Elvira Sojli, Associate Professor in the School of Banking and Finance at UNSW Business School at the AIEA-NBER Annual Conference on Innovation and Entrepreneurship, Dr Lerner, the Jacob H. Schiff Professor of Investment Banking at Harvard Business School, explained that how a government chooses to enact innovation-supporting policies is crucial for their outcome.
“So, the jury is still out” on how these ongoing developments in innovation policy will interact with rapidly evolving technology, Prof. Lerner said. “We are basically seeing action and vibrancy, both in terms of technological change, at least in selected areas, and also in the policies themselves.”
The AIEA-NBER Annual Conference on Innovation and Entrepreneurship roundtable forum
New technologies, evolving policy
Prof. Lerner first explained how technological change has sped up recently, even before the advent of the AI wave. These changes will likely affect most businesses and sectors, often unanticipatedly. “Clearly, the dominant theme has been the wave of digitisation, which has transformed not just IT but many other industries as well,” Prof. Lerner said.
“When you think, for instance, about the impact on drug discovery, you might argue that, in many ways, it’s becoming an IT business like anything else. And we can think about many other examples along those lines. In some sense, the most recent manifestation of this has been the interest/frenzy/mania around artificial intelligence, which, like so many nascent, emerging technologies, has tremendous promise,” he added.
“But it’s probably going to be a long, complicated road to full diffusion, for all the reasons that new technologies have proven difficult to translate to real-world opportunities.”
Along with these changes, interest has also been building in innovation policy – how governments can support innovative economies and to what extent they should. As Prof. Lerner explained, some of the very different levels at which the government can intervene have been on display in recently enacted policies around the world.
Read more: Industrial policy: A double-edged sword for Australian innovation?
“One dimension is the more robust efforts to encourage innovative activities, whether that’s the big-bang approaches like the CHIPS and Science Act in the United States, very muscular efforts on the part of the Chinese government, or efforts to try to encourage venture capital and entrepreneurship in many nations,” Prof. Lerner said. The difficulty of getting the balance right shows how vital innovation policy can be.
“So, you’ve got the giving hand, funding basic research and breakthrough discoveries. On the other side, you’ve got the acts of the government trying to go after perceived monopolists or firms that are somehow behaving badly,” he added. “In many cases, these also turn out to be some of the most innovative firms in the economy.”
Swinging too far
The innovation policy spectrum also includes many examples of “where things have gone too far,” Prof. Lerner said. “The classic case is Europe, where there’s been a very heavy regulatory hand and where it has been a sad innovative landscape,” he said. “One does have a sense that it’s an environment where there’s an enormous amount of public intervention in the innovation space, and, in many cases, it’s not for the best,” he said.
In France, for example, the government has a significant role as a limited partner in most large active funds. “That’s led many of the firms to do a variety of things that reflect the government’s priorities that might not be value-maximising in creating a dynamic venture industry.”
“Clearly, you can swing too far in one direction,” he said. “And it’s fair to say there are probably many people in Washington who look enviously at Europe’s aggressive regulation and want to emulate it.”
But Prof. Lerner also cautioned against ‘hipster antitrust,’ which he characterised as “basically doing antitrust from the seat of the pants.”
“There may well be abuses out there, but this notion of just saying, ‘here’s something I don’t really like,’ and, without necessarily a lot of careful thought, just going after it, also seems very problematic.”
‘Politically correct investing’
In the case of China, Dr Sojli pointed out that the government invested heavily in fintech over the past five-plus years, only for that to stall and the “potential AI revolution” to take its place. The fact that the previous trend didn’t work out, despite government attention and support and questions over the AI bet, demonstrates the dangers of overly-interventionist policy.
“It’s certainly fair to say that the Chinese government has had a pretty heavy-handed involvement in the entrepreneurial finance space,” Prof. Lerner said. “That’s manifested in a variety of ways, but some of the interventions – especially in social media, e-commerce, fintech, education and edtech – have had a very chilling effect, not just in terms of that particular area or venture investment in that area, but also in the confidence of the venture sector more generally.
Read more: Should governments run venture capital and private equity funds?
“It’s a very tough time to be doing venture capital in China,” he added. “The government is promoting an ethos about politically correct investing – ‘Invest in stuff that the Chinese state wants, and we’ll take care of you’. But that landscape today seems fraught with peril.”
These policies also see municipalities or provinces providing much of the funding, creating pressure to deploy funding locally, Prof. Lerner noted. “It leads to something – but it may not be the optimal approach.”
The role of VCs
Beyond a government’s policy agenda, which is shaped by politics, entrepreneurs also have an interest in understanding what venture capital and private equity firms look for when they invest in startups. Prof. Lerner said this is “in some sense a very simple question to answer, and sometimes it’s complicated”.
“The simple dimension is that they’re looking to make returns for their limited partners, generate carry interest for themselves, and be able to raise capital for another fund, hopefully a larger fund, and so forth,” he said.
But there are also three general evaluation criteria, he said: the people and the calibre of a management team, the moat typically associated with technological innovation – in many cases, the patents and trade secrets that protect it, and the size of the market.
“When we introduce these ideas in class, we’ll talk about some of the legendary venture investors. While they all have been successful. their criteria for selecting firms are completely different. How can it be that these people are looking at the same problem, coming up with a completely different answer, and all being wildly successful?
“The answer is, of course, that there isn’t really one way to do it; that, in a way, this is an area where there’s tremendous uncertainty, where one is trying to get the one-in-10, home-run kind of investment, and there are many ways to ‘skin that cat.’”
The art of the pivot
Prof. Lerner also noted that recent research suggests most venture capitalists “would probably, if push comes to shove, say it’s ultimately about the people”. He pointed to American investor Arthur Rock’s claim that he’d “much rather have an A team with a C idea than an A idea with a B team”.
“That reflects the realisation that no real entrepreneurial business ever fulfils numbers that are in its business plan – they’ll either be, in a few cases, dramatically underestimated or, in many cases, wildly overestimated,” Prof. Lerner said.
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“A lot of entrepreneurial success is about pivoting – you come up with the initial idea, change it up a bunch and listen to the feedback, and so forth; just running experiments and trying to get feedback and adjust accordingly. “In a way, that insight feeds into Arthur Rock’s recognition that people are really important,” he added. “Teaching the skills that make great entrepreneurs is an important task.”