Business & Economics

To Promote Tech Hubs Across the Country, Governments Should Focus on Improving the General Business Environment

‘Boring’ fixes like streamlining permitting processes are more effective than grand targeted-development schemes

Tesla’s Giga Texas factory, under construction just outside Austin. Tesla is one of many Bay Area companies moving to or building campuses in Texas. Image Credit: Randy/Wikimedia Commons

This is the second of two essays on government efforts to promote the creation of technology hubs in other parts of the country. The first piece explains why government tech-promotion policies are generally unsuccessful at promoting regional tech clusters.

Despite the best intentions, government industrial policy schemes to promote regional innovation hubs and Silicon Valley-like technology clusters have generally failed. As political scientist Mark Zachary Taylor summarizes the evidence, “The consensus is that top-down policy interventions are almost always ineffective at successful cluster creation.” In particular, attempts to artificially create tech hubs where “a critical mass of infrastructure and skilled labor do not yet exist” almost never work. Harvard Business School’s Michael Porter, who helped pioneer cluster theory in the 1980s, is even more blunt: “Most clusters form independently of government action—and sometimes in spite of it.”

Despite a track record littered with cases of cronyism and costly boondoggles, policymakers persist in their attempts to incentivize new high-tech facilities and clusters because they obviously want to do whatever they can to attract new firms and job opportunities to their regions. This partially explains why, according to Mercatus Center research, “an estimated $95 billion is spent annually by state and local governments on economic development subsidies.”

Unfortunately, this spending encourages politicians to focus on short-term outcomes and repeatedly roll the dice on risky ventures that are unlikely to do anything more than leave taxpayers footing the bill for misguided attempts to pick technological winners. Worse yet, by their nature, these programs put politicians in the favor-granting business and let them pass out money and privileges to gain more influence and visibility. That opens the door to scandals and corruption, which undermines trust in government, and it is exactly the opposite of what policymakers should be doing to promote effective and lasting economic growth opportunities.

What, then, is the better approach? It comes down to focusing on “boring” instead of “fun” policies.

Why Boring Stuff Beats Fun Stuff

The boring approach to economic development seeks to promote an open innovation culture that is conducive to risk-taking, investment and growth without the need to extend targeted privileges to particular firms or industries. Such a culture comes down to a classic mix of simplified and equally applied taxes, streamlined permitting processes and sensible regulations, limits on frivolous lawsuits, and clear protection of contracts and property rights.

As Matt Mitchell and I argued previously, policymakers need to resist the urge to go for broke with splashy policies and programs. They need to appreciate the benefits of generalized economic development policy (a.k.a. the boring approach) as opposed to far riskier targeted development efforts.

In practice, this means that setting the table for entrepreneurial activity in a region should take priority over trying to figure out exactly what’s on the plate. Taylor suggests that “the best role for government might be to clear itself, and other obstacles, out of the way of natural cluster formation.” Likewise, Josh Lerner, author of “Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed—and What to Do about It,” stresses the importance of first creating what he calls “the right climate for entrepreneurialism.” Unfortunately, policymakers too often want to take a different approach. “Often, in their eagerness to get to the ‘fun stuff’ of handing out money, public leaders neglect the importance of setting the table, or creating a favorable environment.”

Lerner’s environmental analogy is apt, and similar metaphors have often been employed by other economists and historians when suggesting how governments should approach economic development. In his 1974 Nobel Prize acceptance speech, economist F. A. Hayek suggested that policymakers should aim to “cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.” Similarly, Porter has argued, “governments should strive to create an environment that supports rising productivity.” Finally, in “Lever of Riches: Technological Creativity and Economic Progress,” economic historian Joel Mokyr states that innovation and economic growth is best viewed as “a fragile and vulnerable plant” that “is highly sensitive to the social and economic environment and can easily be arrested by relatively small external changes.”

These scholars identify the core reason the boring approach is superior: Simplicity and predictability—of taxes, regulations and other policies—are ultimately more conducive to long-term investment and growth than the roller coaster of ever-changing subsidies and special favors that is at the heart of targeted development schemes.

The New High-Tech Pork Barrel

Alas, calls to try still more “fun” stuff are proliferating rapidly. At the national level, the specter of rising Chinese economic and military might has helped fuel a growing interest in crafting a competing set of national industrial policies.

As part of its new Build Back Better Regional Challenge, the Biden administration has called for $1 billion in pandemic recovery funds to create or expand “regional industry clusters.” Meanwhile, Congress is considering the 2,300-page United States Innovation and Competition Act of 2021, as well as new proposals to spend $7 billion to $10 billion on 10 to 20 federally funded regional technology hubs. Another new bill introduced in the Senate last month would establish the Industrial Finance Corporation of the United States to help America “build the factories of the future” to compete against China.

The latest push to promote regional tech clusters probably rests on the belief that governments have learned from past mistakes and that things will turn out differently this time. More likely, though, what’s past is prologue, and these new hubs will cause federal politicians to jockey for position to have their regions named one of the winners and get a big cut of all the new high-tech pork being served up by Washington.

Meanwhile, state and local lawmakers continually look to gain artificial advantages over other regions by gaming their political systems with lavish inducements to attract firms. The ugly competition between local governments for a new Amazon HQ2 headquarters, which witnessed a constant escalation of costly inducements to the online retailing giant, is an example of what’s in store. The idea that special inducements help local economies prosper has been shown to be wrong repeatedly, but that won’t stop lawmakers from spending still more money trying to attract new firms anyway.

Better Alternatives to Industrial Policy

But didn’t government seed money give us Silicon Valley? It is true that a certain amount of government investment—the presence of a vibrant university system, a set of federally funded research labs and a steady flow of Department of Defense contracts—all helped spur private innovation and investment in the 1960s and beyond. But there was no concerted plan to turn that area into a regional innovation hub, and many other factors played into its success.

A case can be made that a certain amount of government R&D spending and procurement is bound to have some payoffs, given the sheer volume of investment. But many scholars have pointed out that federal R&D spending (and especially procurement contracts) can be too top-down in character and driven by overly bureaucratic strictures.

Federal contracting and grant-making is not a frictionless nirvana, where money seamlessly flows to the best projects that are immediately implemented. A 2014 National Academies survey of over 13,000 leaders of federally funded projects explored the administrative burdens associated with federal research grants and contracts. The report revealed that “an average of 42% of their research time associated with federally-funded projects was spent on meeting requirements rather than conducting active research.” These findings were consistent with their previous 2005 survey.

Even the most basic forms of government-sponsored R&D assistance are riddled with various knowledge shortfalls in terms of predicting future economic or technological needs. One 2006 survey concluded that many federal R&D subsidies can be “an effective public policy instrument when knowledge spillovers exist, yet ex ante it is difficult to identify projects that have the greatest potential to increase innovation and economic growth.” Again, this reflects the crapshoot nature of so much government R&D: Some bets are bound to pay off, but they will likely be very difficult to foresee in advance. It often remains unclear how much public money was squandered on all the bad bets governments made.

For these reasons, many scholars and policymakers are increasingly turning to the idea of government-sponsored competitions and prizes as a superior way to distribute R&D assistance, at least compared with more targeted and bureaucratic programs. With competitions, governments can set broad goals to help facilitate the search for important societal needs. The prizes then create a powerful incentive for innovators to pursue those goals, not only to win money, but also to gain recognition from peers and the public.

Another alternative is just using lotteries to distribute R&D money instead of having agencies target grants. That at least avoids political shenanigans and paperwork delays, although it may not be a particularly effective approach.

People Are the Ultimate Resource

Other policy steps that can help spur tech clusters have less to do with traditional industrial policy efforts and more to do with other “boring” matters, such as housing policy, access to various educational or research institutions, labor mobility and especially openness to talent.

Technology analyst Caleb Watney has highlighted how perhaps the simplest way to strengthen existing clusters, or give rise to new ones, is to make sure America’s immigration policies are hospitable to the best and brightest minds from across the globe. Skilled immigrants have been a huge part of the Silicon Valley success story. A report this year by the National Venture Capital Association revealed:

One-third of U.S. venture capital-companies that went public between 2006 and 2012 had at least one immigrant founder. 44% of Fortune 500 companies (219 companies) were founded by immigrants or their children. And 60% of the most highly valued U.S. tech companies were founded by first- or second-generation Americans, accounting for 1.9 million employees.

America’s more open market for overseas talent and investment has given the U.S. a decided advantage in global competition for Digital Age talent. Many tech companies that are household names today—Uber, SpaceX, WeWork, Stripe, Peloton, Zoom—had at least one immigrant founder. Most of them came from Canada, Israel, India, the United Kingdom, China, Germany, France and Russia. Equally as important are the countless immigrants who came to the U.S. to study and then stayed to work for a domestic tech company. To the extent there is a global tech “race,” America’s immigrant workers give us a head start because more of the world’s most talented people are innovating here. As economist Matt Clancy put it, “More people leads to more ideas.”

Accordingly, the easiest way to increase America’s human capital advantage over the rest of the world is to make sure our immigration policies remain open, and then implement state and local labor and housing policies to ease the movement of immigrants and all workers throughout the country. Governments can improve these factors without engaging in the sort of targeted industrial policy efforts that have proven repeatedly to be costly failures.

Innovation Hubs Spread Naturally

Some good news is overlooked in today’s rush to make big industrial policy gambles: Venture capitalists and new startups are already spreading out naturally. A 2021 study on “The State of the Startup Ecosystem” by Engine, a research and advocacy organization supporting startups, revealed that “as Series A funding grew over the last fifteen years, more of that growth has started to shift to areas located outside of the largest ecosystems.”

Series A funding refers to the initial round of outside venture capitalist investment in startups. The report looked at Series A deals from 2003 to 2018 and found that “Series A rounds outside of the top five ecosystems grew nearly 900 percent, while the number of rounds outside of the top nine grew nearly tenfold.” Whereas Series A fundings outside of the top five ecosystems stood at 38% in 2003, they had jumped up to 43% in 2018. “The increase in deal location diversity over this period reflects an increasing spread in venture capital investment across the country and less centralization of investment in areas like Silicon Valley,” the report concluded.

This diversification of investment occurred without any sort of central direction or federal schemes to artificially force innovation hubs to grow where they were not ready to do so. In a sense, this mimics past tech hub success stories. As cluster scholars Aaron Chatterji, Edward Glaeser and William Kerr note, “While Silicon Valley and [Boston’s] Route 128 certainly benefited from federal research funds, neither arose as a result of a cohesive federal vision and plan, perhaps with not even much intentionality from any level of government or academic institution.” Similarly, North Carolina’s highly successful Research Triangle Park cluster arose primarily from private investment and direction starting in the late 1950s.

Meanwhile, tech innovators and investors are increasingly engaging in innovation arbitrage as they move to cities and states across the nation that are more hospitable to entrepreneurial activities. Joe Lonsdale, a general partner at 8VC and chairman of the Cicero Institute, is one of many major venture capitalists leading the exodus of tech investors and firms from Silicon Valley to Texas and other states. He argues that “there is talent everywhere and the rest of the country is catching up.”

Michael Lind of the University of Texas has written of the “Techxodus” currently underway. “Tech giants that got their start in the Bay Area like Oracle, Hewlett-Packard, Apple, Google, and Palantir have either moved their headquarters or are building campuses in Austin, Houston, or other Texas cities. Elon Musk is now an Austinite.” Lind argues that, in the next industrial era, “factories and suppliers will be scattered around the country in areas where commercial real estate and housing costs are reasonable.” This probably explains, as a new Hoover Institution report documents, “Why Company Headquarters Are Leaving California in Unprecedented Numbers.”

This migration points to the important role that jurisdictional competition still plays in the U.S. economy. Firms and investors are voting with their feet (and dollars) by flocking to areas where tech clusters can more naturally sprout because the general policy environment is sound.

Putting an End to the Fun and Games

Sadly, too many states and local governments still seek to play political games and compete by dangling special favors and inducements to private firms to lure them to their regions. Even Texas offered costly incentives to some tech companies such as Apple to try and lure them away from other states.

Writing with Matt Mitchell, Mercatus Center researcher Michael Farren has proposed stopping this ruinous race to the bottom by encouraging states to form an interstate compact “to help end the subsidy arms race.” Interstate compacts can be formed without federal involvement, and they allow states to craft joint policy solutions to limit economic targeting schemes that squander public resources on unfruitful investments. In recent testimony in Delaware, which is considering adopting legislation to authorize such a compact, Farren noted, “With the security offered by a compact, forward-thinking policymakers would be able to shift the paradigm to one where states create economic development by fully focusing on becoming great places to live, rather than wasting time courting corporations’ affection.” Again, that’s the general approach at work: Focus on the overall innovation ecosystem and not artificial inducements that waste public resources on risky gambits.

Perhaps it is naïve to believe these games will ever end, because although the general approach to economic development is a proven winner over the long haul, it lacks the political appeal associated with more targeted efforts. Politicians want results that are both immediate and flashy. They seek to spread favors around today and get featured positively in news stories today. Worse yet, other leaders who call for a more cautious general approach are held out as uncaring troglodytes who aren’t willing to “do whatever it takes” to help their states or communities right now.

But that doesn’t mean those efforts are going to work any better than they did in the past. Targeted industrial policy programs and state subsidy schemes cannot magically bring about innovation or widespread economic growth. The goal should not be artificial constructs like technocratically designed hubs, parks or whatever the gimmick du jour is. We need to think about how to create the policy prerequisites that enable bottom-up, organic innovation ecosystems that are more sustainable, productive and cost-effective over time.

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