State vs. shareholder capitalism as engines for technological progress

State capitalism is on the rise, and those who defend a greater presence of the government in our economy are quick to point out botches by the private sector, such as the recent energy grid failure in Texas.

“We should not be so rash — shareholder capitalism and state capitalism are different systems of economic organization, and neither offers a universally perfect solution for every situation,” said Luiz Mesquita, an associate professor of management and entrepreneurship in the W. P. Carey School of Business at ASU.

Mesquita recently published with three other researchers on the role of state- and shareholder-owned companies in producing new technological inventions.

ASU News asked Mesquita some questions about the two kinds of systems and what they might look like going forward.

Luiz Mesquita

Question: Is there are a role for state capitalism in light of what just happened to Texas’ energy grid?

Answer: The recent Texas blackout quickly evoked calls for a reinvigorated entrepreneurial state, either working together or even controlling American Big-Corp. Critics argue that, as a system that favors the common good over wealth created for shareholders, state capitalism would have ensured better winterization of equipment at the expense of profits, therefore preventing the catastrophe that followed. Yet, whether taxpayers would truly have been better off is a wild guess at best. The common view shared by captains of industry is actually more pessimistic: state-owned-enterprises (SOEs) are bureaucratic and inefficient — and some say “corruption-stricken” — and cannot go head-to-head with shareholder-controlled-firms (SCFs). In fact, Texas enjoys much lower average electricity prices, which is good for consumers and industry, compared to, for example, California, where the system is under stricter government control.

But state and shareholder capitalism are two very different economic systems, and electricity price contrasts are hardly good tell-tales of what works. Indeed, a growing wave of top executives and intellectuals have been calling for new considerations on how the state can — in different ways — help solve society’s problems. In "Reinventing State Capitalism," Aldo Musacchio and Sergio LazzariniLazzarini, S.G., Mesquita, L.F., Monteiro, L.F., Musacchio, A.M. (2020) “Leviathan as an inventor: an extended agency model of state-owned versus private firm invention in emerging and developed economies”. Journal of Inter-national Business Studies, in press. examine just how governments can work with private investors to improve both corporate performance and societal welfare. State capitalism is less popular in the United States but has accelerated economic and technological advancements around the world, especially in key emerging markets like Brazil, India and China.

As these developing nations challenge American technological leadership, finding new ways to innovate is quickly turning to be the key to thrive in business and global trade. To be fair, this inquiry regarding the role of the state and shareholder ownership of firms is interesting because it questions the very soul of American entrepreneurialism.

Q: Give me a brief history of state capitalism and what are some of the best examples of this economic approach?

A: Let me first clarify that I am a big believer in free markets and shareholder capitalism. The very psyche of Americans evolved from the idea of free entrepreneurialism and industriousness. What I debate is not a replacement but simply ways to look dispassionately at what we might learn from other systems to build more vigorous industries and businesses. To uncritically adopt a there’s-no-business-for-governments-in-business argument can be a dangerous ideology that may mortgage away our technological future as a nation.

The idea that the state can be entrepreneurial is not as far removed from American success as one may think. Take NASA’s Apollo project. When (John F. Kennedy) said we would land a man on the moon by that decade’s end, many looked with a mix of excitement and incredulity. But what ensued was one of the largest centrally planned entrepreneurial efforts ever put together, pushing a myriad of technological frontiers unheard of at the time. People take for granted that core technologies quintessential to American entrepreneurialism in fact evolved from that era, like advancements in computers and telecommunication, satellite-launching rocketry, microwaves, electronic componentry, avionics and even naval equipment. American excellence in global trade and economic prosperity in the following decades were a direct result of this impulse. Also, consider that the internet was developed at the U.S. Department of Defense, and about 75% of all major chemical compounds created in the past two decades that today yield lucrative monopolies to American pharmaceutical firms were developed by the U.S. National Institutes of Health. Even Apple’s famous touch-screen technology emerged from research by government-sponsored scientists, while Google’s basic algorithm received federal research grants. It is not at all a coincidence that the most advanced weaponry technologies available today to defend countries, the United States included, are strategically built at the request, planning and financial sponsorship of their governments.

Of course, shareholder-led enterprises also play a key role in all this, so the point to be made is not whether state vs. shareholder capitalism is to prevail but the extent to which the two can combine to build technological prosperity.

Q: What are some of the pros and cons of state capitalism?

A: There are at least two theories advocating for state ownership of enterprises. One is that the state can effectively lead investments when these are needed to create more welfare for the people. Either because investment outlays are too risky or too large relative to returns, shareholder-owned firms are shy to allocate resources; and governments in such cases can tax, regulate or even directly own companies. The Texas electric grid is a good example, where shareholder investment to winterize the system was insufficient to prevent the catastrophe. Another theory proposing SOEs is that the state must play political strategies, where some industries are more “strategic.” Some may think this resembles communism, but even the U.S. government may deem critical to own or control productive assets in specific industries as it was in the case of space exploration in the 1960s and military weaponry and defense.

But SOEs are no panacea. Prior research shows that state ownership causes organizational disarray, like poor managerial incentives and monitoring, political favoritism and even wasteful cash-outlays. The resulting organizational sluggishness is obvious, so it is not surprising that most people see SOEs to be much less effective, less productive and less administratively prodigious compared to shareholder-owned firms.

Q: What sparked the writing of your recent paper, “Leviathan as An Inventor,” and how did you build the study?

A: In our recent paper, we questioned the entire “either-or” approach in this debate, by which SOEs are either paragons or parasites of public funding depending on the person’s ideological bend. Instead, we depart from the premise that SOEs indeed have these liabilities regarding how they function relative to shareholder-owned firms; but rather than just negating their value wholesale, we presume such “negatives” of state ownership may actually work to promote inventiveness. For instance, we wondered if the reduced pressure to realize short-term profits on R&D investments could translate into greater autonomy for scientists, engineers and other knowledge-workers. Left to operate at their own pace, these employees may prefer to break new technological ground, rather than stick to areas of proven marketability. All else equal, the resulting inventive output by SOEs could — we theorized — be higher in volume and novelty compared to that of firms that must answer to the quarterly pressure of shareholders.

So we set out to compare the inventiveness of SOEs and that of their SCFs peers. We tracked 15 years (1997 to 2012) of patent activity by 274 SOEs, either minority or majority owned by the state, and that of 247 similar SCFs. SOEs and SCFs were from 43 different countries and 22 industries. We observed how pioneering (i.e., original rather than incremental), frequent and impactful (cited by others) their respective inventions were. We found, surprisingly, that — under certain conditions — SOE patents were more frequent and pioneering than those of SCFs. We also found that patents across SOEs and SCFs were equally impactful.

Q: What are some of the more interesting conclusions you have come to, with this research?

A: The inventiveness advantage of SOEs is not universal. Instead, it is attenuated in countries where governments can intervene into the affairs of SOEs more freely. In many developing countries — e.g., Brazil, with 12 government-owned firms in our sample — the state can direct SOEs to fulfill political goals or serve missions to boost political careers. This problem of missing checks and balances against political intervention is not exclusive of developing nations. Italy and Greece are examples of advanced European nations with shaky protections against government interference.

When the boundaries between the state and its firms are too tenuous, there is greater risk of what we call political capture. The “helping hand” of the state, which we argue drive technological prowess, can in those instances turn into a “grabbing hand” that pillages public resources. In those cases, we observe that the autonomy of inventors can suffer if critical leadership positions are granted to individuals whose political connections overtake their technical qualifications, or if corrupt bureaucrats help themselves to cash earmarked for technological investments.

Another complicating factor is that some industries are especially invention-driven, like biopharma, defense and telecommunications. In such cases, the lack of constraints on the grabbing hand has less of a negative effect on SOEs’ inventiveness. In such cases, intervening politicians are kept in check, to some extent, when the industrial context demands a high degree of technological ingenuity. In such contexts, corruption is a luxury the state cannot afford.

In the end, in industries where risks are large and capital needs are deep, the private sector may fall short and be relatively less inventive, although in industries where risks are smaller and the prospect of profits more certain, shareholder capitalism can hold more advantage. The possibility for this combination is more pronounced in nations with advanced checks and balances against political intervention, of course. NASA may have launched us into our space venture, but it can step aside to now also welcome private enterprises. It behooves us to abandon one-sided ideologies and instead build up our future technological prowess by combining the advantages of each system.

Top photo courtesy of iStock/Getty Images.