Reynard Loki is a Justmeans staff writer for Sustainable Finance and Corporate Social Responsibility. A co-founder of MomenTech, a New York-based experimental production studio, he writes the blog 13.7 Billion Years and is a contributing author to "Biomes and Ecosystems," a comprehensive reference encyclopedia of the Earth's key biological and geographic classifications, published in 201...
Neue Unternehmergeist: Sustainable Finance for Innovation and a New Entrepreneurial Spirit
Somewhere between Schumpeter and Keynes is a sustainable theory of economic growth through innovation finance, involving both the public and private sectors
In his 1934 book, The Theory of Economic Development, Austrian-American economist Joseph Schumpeter argued that the primary drivers of innovation and economic growth were entrepreneurs, almost heroic figures who created new products, markets and ways of doing business that propelled the economy boldly into the future. He disagreed with the neoclassical economists of the time, who saw economic life as a passive affair. Instead, he sensed "a source of energy within the economic system which would of itself disrupt any equilibrium that might be attained."
Schumpeter saw the transformational nature of entrepreneurial innovation as part of an adapt-or-die process he called "creative destruction," in which old ways of doing things perished in the face of the new. In his 1942 book, Capitalism, Socialism and Democracy, he argued that "the function of entrepreneurs is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on." To describe this élan vital, he coined the word Unternehmergeist, German for "entrepreneur-spirit."
COMPANIES BUILD ON UNCLE SAM'S RESEARCH FUNDING
Schumpeter's Unternehmergeist was reserved for the private sector; government intervention, he argued, could only lead to inflation that, if left unchecked, would ultimately devour all available capital. But Schumpeter, who died in 1950, would not live to see just how beneficial government spending would be to spurring modern innovation in a kind of financial assembly line system that can be seen as an unintended public-private partnership. A report published earlier this year by the National Research Council, for example, found that 30 of the largest IT firms, including Google, Yahoo!, IBM, Microsoft, Apple, Dell, Cisco and Intel, can attribute a portion of their revenuealmost $500 billion annuallyto government-funded research.
The report reinforces the well-known "tire tracks" graphic (so-called for its appearance) from a previous NRC report that "dispelled the assumption that the commercially successful IT industry is self-sufficient, underscoring how much industry instead builds on government-funded university research, sometimes through long incubation periods of years and even decades." It is worth remembering that the internet has its roots in ARPANET, a government system connecting the computers of the Department of Defense to its projects at various universities and research laboratories.
SUSTAINABLE FINANCE FOR INNOVATION REQUIRES PUBLIC AND PRIVATE FUNDING
In May of this year, Beth-Anne Schuelke-Leech, an assistant professor at the John Glenn School of Public Affairs at Ohio State University, published an excellent paper entitled "Innovation Finance: A Synthesis of Public Funding and Private Financing of Innovation," in which she argues that innovation finance "must integrate both public and private funding."
She points out that traditional research in this field is hampered by separating the four components of the innovation processresearch, development, demonstration and deploymentinto artificial silos. On one side, studies of public spending center primarily on research and development. On the other, studies of entrepreneurial finance focus on demonstration and deployment. She says that this separation is "misleading," arguing that "[f]or innovation to be successful, the whole process must be financially supported." And that support comes from both the private and public sectors.
SLASHING BUDGETS, REDUCING RESEARCH
But in the United States, public financing for innovation research is facing severe budget cuts. A study released last month by the American Association for the Advancement of Science found that automatic reductions in federal funding set by the Budget Control Act of 2011scheduled to go into effect in January of 2013amount to $38 billion less in non-defense discretionary spending. "Cuts of this magnitude could no doubt have significant impacts on federal funding of science, research, and innovation," the AAAS argues. "They also come at a time when federal R&D has already declined by 10 percent in real dollars since FY 2010."
Will the private sector pick up the slack? Considering the growing culture of risk aversion, the seeds of which were planted by the 2008 financial crisis, today's innovators shouldn't bet on it. Last year, venture capital investment in seed-stage deals declined almost 50 percent from 2010.
INNOVATION FUNDING: A HOLISTIC VIEW
Lawmakers and votersparticularly in an election yearmust look at public budgets with an eye to how the government's investments not only spur innovation, but connect to private sector investment to produce innovationand jobs. In the United States, the failure to recognize this will result in an "innovation drain" that is already seeing some American VCs head to China. As Greg Clydesdale, a professor of economics at the Department of Management and International Business at Massey University, New Zealand, put it in a 2007 paper about Chinese entrepreneurship, China's "organizational structure of 'government supervision-merchant operation' became a long-lived feature of the economy...[that] reflected the successful partnership being built between merchants and the state."[For more on this, see my article, "With Uncertain Financial Future, Cloudy Skies Ahead for American Cleantech."]
"Failing to consider the innovation process holistically," argues Schuelke-Leech, "results in a failure to understand budgetary decisions and their impact, the nexus of public-private funding on innovation, or to identify trends in one area that may impact the other." While Schumpeter saw entrepreneurs as the engine of growth, his longtime rival, British economist John Maynard Keynes, believed that it was government spending that boosted growth. Somewhere between the two is a sustainable theory of innovation finance that uses a holistic approach.
In the end, funding innovation remains within the realm of unintended, contract-free public-private partnerships. A more dedicated and transparent collaboration between corporations and governmentone that considers all four components of the innovation spectrumwould be a worthwhile pursuit. Perhaps a Neue Unternehmergeist, a "new entrepreneurial spirit," might see Schumpeter and Keynes not as rivals, but as collaborators.
 Joseph Schumpeter. Preface to the Japanese Edition of "Theorie der Wirtschaftlichen Entwicklung," 1937, reprinted in Joseph Schumpeter. Essays on Entrepreneurs, Innovations, Business Cycles and the Evolution of Capitalism, edited by Richard V. Clemence. (New Brunswick, N.J.: Transaction Publishers, 1989) pp. 165-168.
 Joseph Schumpeter. Capitalism, Socialism and Democracy. 1942. Reprinted by Taylor & Francis, 2003, p. 132.
 National Research Council. Continuing Innovation in Information Technology. Committee on Depicting Innovation in Information Technology; Computer Science and Telecommunications Board; Division on Engineering and Physical Sciences. ISBN 978-0-309-25962-0. p. 3-4.
 Ibid., p. vi.
 Beth-Anne Schuelke-Leech. Innovation Finance: A Synthesis of Public Funding and Private Financing of Innovation. The John Glenn School of Public Affairs. The Ohio State University. May 7, 2012. p. 1. Accessed October 10, 2012.
 American Association for the Advancement of Science. A Look At Sequestration: Potential Cuts to Federal R&D In the First Five Years. September 27, 2012. Accessed October 10, 2012.
 Chad Goldberg. 2011 Venture Capital Statistics. FindTheBest.com. January 30, 2012. Accessed October 10, 2012.
 Greg Clydesdale. Economic Decline and the Failure of Chinese Entrepreneurs. The Quarterly Journal of Austrian Economics. Vol. 10, No. 2 (Summer 2007) p. 66. Accessed October 10, 2012.
image: ARPANET logical map circa 1977 (The Computer History Museum, Wikimedia Commons)