Government Investment--Key to America's Success


 A recent FT article (America tampers with the Chomsky trade at its peril, August, 2017) noted that most of America’s scientific research is publicly funded and that innovative companies leveraged this basic research. Actually, the symbiotic relationship between government and business goes beyond government funding of research and development (R&D). Starting with the Erie Canal, the government has been willing to undertake projects with uncertain payoffs deep in the future and often involving unproven technologies. These investments often opened pathways for businesses to build upon. Public-private partnership has been the foundation of America’s success.

Federal and state governments have been closely involved with constructing the transportation infrastructure since the 19th century, especially infrastructure that was either too big or too risky for the private sector. For the young American nation, the Appalachian mountain range posed a formidable obstruction to integrating the states on the Eastern Seaboard with the vast lands on the other side of the mountains. George Washington was one of the first persons to recognize the need to build a canal across the Appalachian. He organized a private venture called the Patowmack Company to convert the Potomac River into a canal running up to the mountains. The venture was a financial failure. Other efforts to bridge the mountains ended in failure, largely due to lack of financial capacity. So, when the Erie Canal was envisioned, the huge financial costs and the major engineering challenges constructed deterred private capital. At twice the length of any previous canal in Europe and going through mountains, it was an unprecedented engineering challenge. President Jefferson called it a “little short of madness.” When the State of New York took up the project, it was pejoratively called “Clinton’s Ditch,” reflecting the common view at that time that it was a foolish venture. Without the state taking it up, the Erie Canal would never have seen the light of day. Similarly, the Federal government played an active role in promoting the transcontinental railroad in the second half of the 19th century. In the 20th century, the Eisenhower Interstate System was planned, executed, and funded by the Federal government. The scale of the project was simply too enormous and the immediate financial returns for roads in many remote areas were too small to attract any private investment.

While the government opened the pathway, businesses and entrepreneurs eagerly seized the opportunities opened up by the Erie Canal to transform the nation in ways that was scarcely imagined by even the most ardent supporters of Canal. Freight rates dropped by 90%. As a result, trade grew explosively: in 1829, 3,640 bushels of wheat were transported down the Canal from Buffalo and it reached one million by the mid-1840s. In fact, agricultural products brought down the Canal found their way to Europe, which in turn freed up farm labor and spurred industrialization. Cities, such as Cleveland, arose from virtually nowhere as the Lake economy burgeoned. Businesses took advantage of distant markets opened up by the Canal to transform upstate New York from an agricultural economy to a manufacturing powerhouse. Explosive growth in industrialization also spurred innovation: patenting activity surged and New York led the nation in patents per capita. The Canal and the industrialization also fueled nationwide interest in engineering. Started at a time when there were no formal engineering schools, the Canal led to the founding of the nation’s first schools devoted to civil engineering—RPI in Troy. Similar to canals in the early 19th century, transcontinental railroads in the second half of that century was an example of successful public-private partnership. Railroads propelled the transformation of America from an agricultural nation to an industrial powerhouse. In the case of the Interstate System, businesses utilized the easing of long distance commute to develop suburban communities enhance the delivery of goods and services, especially fresh produce.

Federal government became the dominant supporter of research, directly and indirectly, during and after the Second World War. Federal government support for research increased dramatically during WWII and remained high for the next few decades. As the war loomed, the government mobilized science in multiple fronts. Initially, the government set up the National Defense Research Committee, which was then subsumed into the Office of Scientific Research and Development (OSRD). OSRD came to involve 30,000 scientists and technologists who worked on developing sonar, radar, and the atomic bomb. After WWII, the OSRD was dismantled, but the government started the National Science Foundation (NSF) in 1950 to support fundamental research by providing grants. Simultaneously, the funding for the NIH increased manifold in the mid-1950s and the agency was given the mandate to direct research in the life sciences. The NIH has been the main source of financing for basic and applied research in a wide array of areas that are related to the biological science. Meanwhile, the Cold War sparked renewed interest in research for security. The government created the Defense Advanced Research Projects Agency (DARPA) to advance the frontiers of technology and innovation, with a focus on security. The agency has been and continues to be a major funder of research projects in computing and space technology. DARPA has become the nation’s premier “idea factory,” and undertakes projects that the private sector is unwilling to fund. Later in the 1950s, the Federal government created the National Aeronautics and Space Administration (NASA) to explore space and has spent large sums on space research. Space exploration, especially in the early years, had no immediate financial returns and would not have taken off without government involvement. Despite cuts in government spending on research in recent years, the Federal government remains the largest supporter of basic research in the nation, accounting for over half of all spending nationwide.

Businesses have successfully built upon the research conducted under the aegis of government to deliver products and services that have enriched almost every aspect of our lives. The byproducts of space research are ubiquitous in everyday life—LEDs, ear thermometers, water purification systems, fire-resistant fabrics, energy-saving building materials, temper foam, freeze drying, enriched baby food, portable cordless vacuum all owe their existence to space research. businesses have taken many more applications developed by DARPA, such as GPS and artificial limbs, and brought them to common, everyday use. The pharmaceutical industry has leveraged basic research conducted by the NIH to positively impact our lives. A 2001 NBER study found that of the 21 drugs with the highest therapeutic impact on society introduced between 1965 and 1992, 14 resulted from key enabling discoveries funded by NIH.

An even better model of public-private partnership is the IT revolution that has and is still changing society. The Federal government incubated and spurred technologies for which there was no market, thereby laying the foundation for the IT revolution. The very first computer, called ENIAC, was funded by and built for the Army in 1943. At that time there was no private sector use for computers. Indeed, in 1943, the founder of IBM, Thomas Watson dismissed computers with the comment, “I think there is a world market for maybe five computers.” Department of Defense funding continued to drive the development and evolution of computers after WWII and through the 1950s. Even before the space program vastly increased funding for computers, the Department of Defense had already funded 20 projects to build digital computers. From semiconductor devices to software, government was the dominant source of demand in the early stages. Government support helped firms rapidly attain improvements in product quality and reduction of product cost that are necessary for successful introduction in mass markets. The government encouraged the entry of new firms and the exchange of technology between firms, thereby speeding up the diffusion of technology. For example, Texas Instrument, which is a household name today, was initially entirely dependent on defense contracts. By the 1960s, private businesses were ready to spread their wings and soar. Business demand for computers outstripped government demand by the early 1960s. The government THEN moved to the next frontier by laying the foundation for the Internet. The precursor to the modern Internet—ARPAnet—was developed by the Department of Defense, which initially linked a 100 universities and major research sites. However, businesses took the backbone created by the government to connect the whole world, unleashing the power of information and altering the way business, and indeed life, is conducted.


From the very beginning of our nation, government partnership with business has been vital for our progress. Government investment in education, infrastructure, science, and technology has laid the groundwork upon which business has been able to build. In that light, the scaling back of government spending on research and development over the past two decades is a cause for concern—it threatens our leadership and endangers our future standard of living. Indeed, the decline in broader government investment has played a major role in declining productivity.  



Comments

  1. Excellent post. A good lesson for evaluating the potential global growth effects of China's OBOR plan. I look forward to more of your thoughts.

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  2. Great post. This is also further elaborated on in Mariana Mazzucato's book “The Entrepreneurial State” https://econsynthesis.files.wordpress.com/2017/07/mariana-mazzucato-the-entrepreneurial-state-debunking-public-vs.pdf

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    1. I checked out Mazzucato's book from the library a few weeks ago. I'm trying to read some of it in between reading for school. It's superb. The government has been a derisk machine, helping the private sector in more ways than most people realize.

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  3. This was excellent. I've listened to a podcast and read maybe a couple of articles on declining federal capex, but I have not read anything on the history of US investment. The early history of federal infrastructure investment was particularly interesting.

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  4. When speaking of gov, business, and China, going anti global right now is a big risk. China is not only building strong gov - business links in China, but in almost every Asian, African, and Latin American country. They are investing billions, but it provides them cheap control of vast resources and political processes. US gov investment in alternative energy, new food production, energy savings technologies, and the like are vital for a successful economy in the future. China is doing this, while America can barely fix potholes in the roads.

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  5. Incredibly naive and simplistic version of history. Central planning and government investment does not arise out of a benevolent rule of philosopher kings that are more capable than the private sector, and this version of history where the state was required and so important is simply not accurate. We are so trained, and partisan, in these 0-sum biases of "pop socialism" vs "pop capitalism" arguments, that economists and armchair market commentators often fail to understand the complex system of interaction between actual government spending and capital markets. The truth is, the state needs private sector capital, taxes and debt (and private sector agents love trading and benefiting from the issuance and collection of this capital), and centralized capital markets needs the state; these projects are always mutually dependent on each other. Agents (be it banks, corporate management, hedge-funds or government) simply love spending other peoples money, and the fees and profit asymmetry they can collect off it. Sometimes this creates broader distribution of costs and benefits (interstate highways and other economic network arteries), sometimes the profit and benefit is highly localized where costs are broadly distributed (government contractors and private real estate developments, or private corporations benefiting from state spending or research). Anyway, we need to stop this simplistic 18th century debate of "capitalists" vs "state", and observe the broader cost and benefit complexity of centralized versus decentralized economy. And btw, highly centralized is almost always less efficient, less stable, and more corruptible, be it banks (and capitalists) or governments.

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  6. Excellent post. Considering the criticism one hears about malinvestments without clear cost-benefit analysis -- for instance, the build-out of ghost cities in China-- I wonder how one might view a moonshot like the Erie Canal. Was it an astute investment decision by earlier governments that may have looked like a reach then, but can be made sense of today? A fortunate outcome? Or, justified by VC-like economics -- invest in enough of them, and a few mega gains would outweigh the sum of all investment costs?

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