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Technology, investment, risk and the state
Gerard Jackson
Interventionists push the line that if Australians lose control over their intellectual property, especially in the area of information technology, and were left with only land (in the economic sense of the word) they would lose their bargaining power and run up a huge deficit in yet another area of technology.
This argument is usually followed by the assertion that the country needs a long term view of investment in science and technology, overlooking the fact that however good the technology it will always need capital and entrepreneurship to translate it into a commercial success.
Without these factors new technologies with commercial promise will always gravitate to foreign shores. The question these interventionists never seem to ask is why this should happen in Australia and why Australian investors seem to eschew long term investments. To the socialist-minded the solution appears simple enough: more government action. That government action may have created the situation they abhor never occurs to them.
Interventionists seem incapable of grasping the fact that savings fuel an economy and entrepreneurship drives it. Cripple both or only one of these factors and you cripple growth. Although many interventionists recognise, for instance, the existence of risk they never really grasp its nature. Why else could they confuse risk with the reluctance to invest long term?
In a stable political environment where the rule of law prevails risk has no direct connection with any investment’s gestation period. If, for example, there existed two parallel states of general equilibrium that differed only in their rates of interest, it would be immediately be apparent that the state with the lowest interest rate undertook the investments with the longest gestation period, despite the fact that investment in both states would be risk free.
The reason is simple. Investment would be riskless because in a state of general equilibrium there are no profits or losses because there is never any change of any kind, one day is identical to every other day. Hence the future will be identical to the past. But because the rate of interest differs different investments will prevail.
The state with the lowest rate of interest, say half of the other state, will make significantly longer term investments because the saving ratio (social rate of time preference) which determines the interest rate is so high that it signals that savers will wait twice as long for a return on their capital than savers in the other state.
Longer term investments require more roundabout methods of production that in turn require more resources that in their turn can only be provided by increased savings. Low market rates of interest signal to businessmen that high savings have released the necessary resources for investing in long term projects. A crude example should suffice to clarify the matter somewhat.
There are two projects A and B and their respective gestation periods are one and two years; respective rates of return are 10 per cent and 5 per cent. If the quantity of savings is such that the rate of interest is 10 per cent then project B will not be considered. But if increased savings drive the interest rate down to 5 per cent then both will be undertaken. The fall in interest rates clearly means that savers are prepared to wait longer for a return on their investments.
In the real world of uncertainty risk is always factored in by the market in the form of premiums. If a country suffers from a lousy savings ratio and has a tax structure and an attitude to profits that penalises the supply of venture capital, the lifeblood of new ventures, it will have little or no growth. (This situation always reminds me of places like Bolivia).
The Committee for Melbourne appears flummoxed by reluctance on the part of superannuation funds to invest in venture capital companies. Perhaps the reason is that superannuation funds are not venture capitalists. In short, they are not risk-bearing capitalists. They are custodians of pension funds and will therefore tend to act in a way that minimises risk.
Venture capitalists, however, act on their own behalf and must directly bear the risk of any investment. It follows that venture capitalists are entrepreneurs while pension fund managers are just that – managers. It also follows that in the estimation of these entrepreneurs the hoped-for profit from any investment must greatly exceed the risk of any potential loss.
Entrepreneurs seek to maximise their returns, not minimise their risks. If it were otherwise risky investments would never be undertaken. Of course, where the pool of risk capital is small or shrinking the number of venture capital companies that will receive funding will fall. Heavy capital gains taxes are one of the greatest obstacles to not only attracting venture capital but also to accumulating it.
The problem is clearly more complex than interventionists realise, which is one good reason why they should remain silent on the subject — fat chance. The economic ignorance of interventionists was particularly evident when they related part of our “IT deficit” to lack of ownership of information technology and an absence of government leadership. Now the same people are complaining about lack of investment in biotechnology.
But the apparent problems they attack have been caused by government intervention, not market failure or “short-termism”. Calling on further government intervention to solve these ‘problems’ is akin to a doctor trying bleeding his patient to death.
This country needs more entrepreneurship, not more government meddling.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 27 June 2005