Sunday, January 08, 2012

How Subsidized Capitalism Hurts Innovation

Last week I posted on our more active university blog about how subsidized capitalism damages both the funding and popular understanding of the central role of public services in building economies and societies.

The post was just a first poke for the new year into a huge hole in Anglo-American capitalism's theory of itself.  This theory ignores the extent to which it has spent the conservative 1980-2010 period absorbing public resources into its own revenues. Most of this theory's public apologists denounce public spending, which has helped massively reduce their tax obligations -- tax avoidance has become a major profit strategy -- while justifying private appropriation as putting public money to better use.

The New York Times has a good example of the problem.  Caterpillar is spending $426 million building a new factory in North Carolina.  It has gotten the state to pay $51 million in various incentives, including $5.3 million in direct costs to train future Caterpillar workers.  Since most of the training is being done by a local college called Forsyth Tech, the state is footing other costs as well.

This suggests serious weakness in the economic theory itself.  The co-founder and longtime CEO of Intel, Andy Grove, wrote a while back that "the U.S. has become wildly inefficient at creating American tech jobs." Intel spent $3600 in adjusted dollars for every job it had 10 years after its founding.  This cost has exploded to $100,000 per job at some of the country's most successful high-tech companies -- Genentech, Google, etc. Here's the chart that accompanied the article:

The cost of each new Caterpillar job in North Carolina is $130,000 - well above Google's cost.  But that is only the state of North Carolina's contribution.  Add in the company's own investment in the new facility, and you get an incredible $1.2 million per job.  Caterpillar is very inefficient at creating jobs, and has gotten North Carolina to pick up some of the excess cost.

The use of the chart above isn't entirely fair, since the 392 jobs is this Caterpillar plant's immediate workforce and not the workforce 10 years out.  But the point of the new plant is to use technology to suppress workforce growth, suggesting future growth will be limited. And the huge cost per job can only be justified, if at all, through some extraordinary and unlikely tech-fueled level of productivity.  These are not obviously sustainable jobs, and the article points out that some of the same workers in the new state training program have been burned before by hit-and-run companies.

The problem with the expected public subsidy of capitalism has several parts. The first is that U.S. federalism has put states and local jurisdictions in competition in a "race to the bottom" to offer the weakest union protects, weakest safety requirements, lowest wages, and highest subsidies. Yes there are practical limits to all this and no not all firms are slave-driving exploiters of labor and plunderers of the public purse.  But the downward spiral is the logic of the system, and a well-paying company with good labor conditions (that support creativity) in New Jersey or Minnesota is vulnerable to competition from cheap operators in states like, well, North Carolina.

The second problem is deeper, and Andy Grove points it out.  U.S. companies are less efficient at creating jobs, he says, because the country has spent the last few decades shipping manufacturing know-how overseas, attached to the jobs it has shipped over there.  Grove focuses on the capacity for "scaling," which is the way that a good invention becomes an industry that supports lots of employment. The million little problems that must be solved require complex knowhow that is housed in people. Solutions require an entire, "effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer." When this ecosystem is already established as it famously is in a place like Silicon Valley, new jobs are generally less expensive to create.  When you don't have that ecosystem, they cost a lot and, just as importantly, they are less secure.

Universities are central to an innovation ecosystem, and constantly cutting their budgets weakens the ecosystem as a whole.  But interestingly, cuts ironically drive up the cost of new jobs rather than lowering them (usually defined as lower taxes).   A weaker innovation ecosystem can destroy a new industry before it gets started.  Grove's example is lithium-ion batteries for the next generation of electric cars and trucks.
The U.S. lost its lead in batteries 30 years ago when it stopped making consumer electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies did not participate in the first phase and consequently were not in the running for all that followed. I doubt they will ever catch up. 
Subsidized capitalism conceals the real problem, which is the weakening of the overall social environment in which innovation and sustainability take place.   It has been weakened by social underinvestment.   Grove calls explicitly for jobs policy -- for "jobs-centric" leadership.

We won't get something that intelligent because both parties like to shovel public money toward private firms, even when it means taking public funds away from the social ecosystem on which the firms depend.

To wrap up, subsidized capitalism kills two birds with its one big stone.  First, it hurts public services. Subsidized capitalism has enabled the takeover of the charter school movement by education companies whose existence depends entirely on taxpayer funding.  The same goes for-profit university-company sector, which depends so totally on federal loan money that it pipes through its student-customers that the government has had to cap their receipt of federal funds as a share of total revenues at 90%.  This sector sells educational services, but makes its money by not spending revenues on education, and produces bad educational results.  The bad drives out the good, as the for-profit sector's existence convinces many policymakers that they can get away with spending less public money on real-thing public education.   The same has happened to transportation. A somewhat funny example is Chicago outsourcing its parking meters, which historically helped pay for street improvements.  More seriously, the UK House of Commons's Treasury Committee published a study last August, 20 years into its "Private Finance Initiatives" experience that included privatizing its rail system.  The committee found among other things that PFI deals typically added 40% to the service costs.

The second victim of subsidized capitalism is the private sector itself.  Demanding tax reduction with one hand and receiving taxpayer funding with the other, corporate America has ignored the role of public funding in building the advanced society on which its own survival depends.  After nearly 40 years of this, in 2012, it's not clear that the U.S. will ever catch up.