Government Venture Capital – Socialism or Pragmatism?

The Wall Street Journal reports today that the United States Federal Government is dwarfing private investors in providing venture capital for new high-tech startups – in particular in “clean technology”. Predictably, many (Americans) are worried that this is another step in the direction of a socialist United States. This is worrying too much.  There are abundant examples of governments successfully investing in industry – especially “infant industry” – in non-socialist countries with weaker constitutional safeguards than the U.S. If anything, it is a much more sensible way to do stimulate the economy during a recession than having people paint lamp-posts or pick leaves.

More importantly, the surge of public investments into high-tech business is probably very good for the private sector, both in the long and short run. Already, private venture capitalists are eager to invest in companies that receive loans or equity investments from the government. This, of course, can simply be attributed to the fact that more access to capital and concessionary interest rates should make lower risks and higher returns more likely. However, the much more significant effect – especially over time – is the establishment of strong intrasectoral networks that are necessary for any advanced industry to flourish. Such networks – prominent examples are Silicon Valley and (until recently) the car manufacturing clusters around Detroit – allow for specialized production knowledge to be developed and disseminated, specialized suppliers and consumers to gain sufficient economies of scale, and for consumers to “learn” new products; all necessary ingredients for dynamic economic growth. Notably, a high degree of geographic concentration is not always necessary, but a fairly large number of firms and a significant industry size is.

The network dynamic also highlights a particular reason why it may be appropriate for taxpayers to be venture capitalists. Because many of the benefits of venture capital investments – such as new innovations or other “network benefits” as outlined above – are external to individual firms and investors, but still benefit the economy as a whole, VC investment incentives are in some ways more symmetrical with those of taxpayers than private VC firms.

Of course, the establishment of strong dynamic intrasectoral networks can and has many a time been achieved without government intervention. However, it has not been achieved without plentiful financing – plentiful financing clearly not available in the wake of a financial crisis, especially for small firms. When the Federal Government is able and willing to make the necessary investments, why not be pragmatic rather than paranoid and let it? If anything, in five or ten years the U.S. might just find that they paid off.