NIB: good economics, bad politics

There's at least one aspect of Corbynomics which many mainstream economists accept - the case for a National Investment Bank. Even critics such as John Van Reenen and the Economist see no objection to it. Indeed, Corbyn is simply adopting an idea proposed by, among others, the LSE Growth Commission (pdf) and Robert Skidelsky.

However, I fear that this is yet another example of something that is good economics but bad politics.

To see my point, remember that the Corbyn's NIB will invest not just in infrastructure but also in "the hi-tech and innovative industries of the future."

This is good economics, because it's likely that the market under-supplies investment in innovation. As William Nordhaus famously pointed out, the social returns to innovation far exceed the private returns to producers. Innovation thus has a positive externality. This means private firms will under-invest in it and so there is a case for state intervention. As Mariana Mazzucato has shown, state investments in technology can have positive spillovers to the private sector.

A big reason why the private returns to innovation are low is that it is a very risky business. Many apparently attractive projects will turn out to be expensive dead-ends but it is pretty much impossible to spot these in advance. William Goldman's famous saying of the movie business - "nobody knows anything" - applies generally. Two big facts tell us this. One is that the performance of venture capital trusts has been massively variable, with some losing fortunes. The other is that the Aim index - home to some innovative firms as well as a lot of dross - has consistently under-performed for years, which suggests that a lot of apparently promising innovations have failed.

I suspect that one reason for low corporate investment now is that firms have wised up to the fact that innovation doesn't pay.

There is, therefore a sound economic case for a NIB.

However, the same things that stop the private sector innovating mean that a NIB is bad politics.

If the NIB does its job properly it will back a lot of failures. This isn't because the state is bad at backing winners but because pretty much everyone is. Even the best private equity investors back a lot of duds: Marc Andreesen has estimated that 15 of 200 tech startups a year generate around 95% of the total returns. That leaves a lot that lose money.

And here's my problem. Our biased press will focus upon the latter. "Corbyn's bank costs taxpayers" millions would be a regular story. This could be exacerbated by the fact that the planning fallacy will ensure that even "safer" infrastructure projects will often run over time and budget.  Even if the NIB is profitable on average - which perhaps it shouldn't be, given that it should be investing in projects with a high social return rather than private return - the media will present it as a failure.

Cynics might see in this a case for "people's quantitative easing". Picture the scene. Corbyn is being interviewed by some right-wing twat:

RWT: [Lists failed investments]. Your bank has cost the tax-payer millions.
Corbyn: It's not the tax-payers' money. We created the money out of thin air!

This exchange, though, merely reinforces my point - that good economics is bad politics. The NIB is therefore like immigration policy and tax policy and fiscal policy...

For this reason, I welcome Corbyn's refusal to kowtow to the media. It is only by refusing to play their silly games that we have any hope of a rational economic policy.

Comments

[Nicholas Gruen]

A fair summary as a description of first round effects in the world as it is now.

But it's in the framing - and governments - as opposed to oppositions have a lot of ability to frame what they're doing.

Before the failures arrive this can look like good politics. That's what the policy is in opposition.

If it's implemented then its champion is in government.

If the investment is framed as a portfolio investment and it's made clear that standard operating procedure will be that most investments fail then that should insulate a government with any skill in putting its case from most of the flak. One can imagine this being a bit dicey until there's some success, but if one can have some reasonable signs of success in the first couple of years, you just point to them when the failures are pointed out - together with reporting from the relevant agency managing the portfolio. And a lot of failures take quite a long time to fail!

So I would have thought this problem isn't too hard for a government seeking to develop a new narrative.

[e]

Do you think the not kowtowing to the media will catch on among Labour’s soft right? Little sign of it so far.

[Dave Timoney]

Clearly, some of the anticipated media reaction will reflect the peculiarities of British history, notably the dominance of the City. For all the talk of radical change, a UK NIB would probably not be very different in approach to Germany's KfW or France's Caisse de Dépots, both of which have managed to ghet on with the job for a while now.

One way of both neutralising the inevitable "men from the ministry" jibe and lessening the structural risks (e.g. too many funds being diverted via the City) would be to revive the Milibandite idea from a couple of years ago of a network of regional banks, but with a mandate for long-term investment as well as short-to-medium-term business support.

[jonathan]

Chris

I’m scratching my head trying to understand where this post is coming from.

Firstly, it’s pretty clear the “many mainstream economists” that you cite are only talking about a NIB to finance infrastructure spending. While I’m not personally convinced Govt can act more effectively than the markets to fund infrastructure, I acknowledge there are substantive issues and good supply side arguments. However, if they stuff it up, they should take all the criticism they will get.

The case for a govt role in picking and investing in hi-tech and innovative industries is frankly very weak and can’t be piggy backed off the infra-structure argument. Unlike infrastructure spending it’s pretty clear there is a massive and highly skilled industry already doing exactly that with private investment. Also, if I remember Nordhaus correctly, his point isn’t that the market under-supplies investment in innovation. Nor can that be reliably concluded (even indirectly) from his analysis of Schumpeterian profits as he never says anything like “A big reason why the private returns to innovation are low is that it is a very risky business”. Instead he studied successful inventions to show that only a small fraction of the social returns from technological advance can ever be captured by producers. If there is conclusion to be reached indirectly from Nordhaus’ analysis it is that investment in innovation isn’t really a great use of govt spending as most of the social returns flow globally.

[Metatone]

@jonathan - "massive and highly skilled industry" - where's your evidence for that statement.

The general consensus from studies and the evidence of how UK firms often end up trying to move to Silicon Valley is that the UK VC scene is small and weak. Now a NIB may not be the correct solution to that problem. But let's start from the facts, rather than some random belief of yours.

[Jonathan]

I think you have to be a bit careful in assuming that tech investment only happens through VC. There's been some pretty big tech investments by corprates and PE recently - especially in fin tech.

But even if you only look at VC, the picture you present is a bit out of date. It's been a huge growth area and the UK is now way ahead of any other European nation. Something like a third of all European VC activity is in the UK. Over £1bn a quarter. And almost all of that is in tech. Not US numbers (Q1 2015 c. $11bn) but still pretty chunky.

Even if the Government was to take the view that this growth trend still wasn't enough, and further private appetite couldn't be rustled up with some judicious tax breaks (because it would obviously be better to use private money if at all possible ), then it would still be daft for the Govt to use a NIB to make Govt funded tech investment when it could just make the existing VC industry compete for that investment.

[ThomasH]

Since there is no need to invest in risky startups as part of counter-cyclical policy, why not leave the NIB to just play the role of investing more and less over the cycle as discounted NPV varies as monetary authorities try to keep NGDP growth on trend?

[Richard]

An alternative interview a few years after 'printing' billions would be along the following lines:

RWT: So Mr Corbyn, you created all this money: now it's absolutely impossible to get a plumber this side of the next election and on average, builders make more than cabinet members. As you have capped rents it's impossible to find a house to rent privately, house prices have gone through the roof as people driven out of the rental market are forced to buy and so far 15 council housing department heads have been gaoled for taking bribes from people desperate for a home. Record numbers of under 30s have to live with their parents. There is a crisis in public services as hundreds of thousands of nurses, teachers and coppers have retrained to become bricklayers and sparkies.
Mr Corbyn: I think it's important to remember that I'll be 75 in 2025 and it'll be up to someone else to sort out this mess.

[jonathan]

Very good.

Was amused to see rent capping coming out the woodwork. He doesn't seem too confident about all those luverly, new People's Houses actually getting built.

[joe]

A lot of industry innovation investment is not blue sky but to solve real problems they have in their own industry. For example, suppose a potter of intricate items found that 20% were cracking during the kiln process. A huge waste of skilled time, energy and material. Then it can easily be decided what research expenditure would be beneficial to reduce cracking by 1%, 5% or 20%. The probability of finding any better method can also be estimated. For this type of investment there is no venture capital nor retail banking loans - they simply do not understand the issues of real businesses, whether they are financial, social or technical. Neither Government nor banking understands that productivity and profit can be raised by quite minor innovation investment. Far better that the fledgling UK companies are bought up and sold overseas.

Another area where innovation can actually be cheaper and faster than in the past is by computer virtual models. FI racing build all innovations within the computer - they test it virtually and only if it works do they build the physical components. Civil Engineers create bridges, dams etc within the computer they build the structure virtually on the site. Once optimised then the real structure is built with most of the snags ironed out before a spadesful of earth is moved.

For UK the problem is not the NIB it is the lack of innovation educated business minded people that would be available to staff it.