Meet the Visionary Venture Capitalist Inspired by Marx and Keynes
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William Janeway is no ordinary businessman. In his view, waste can be good, efficiency is the enemy of innovation, and government investment builds the platform on which venture capitalists and entrepreneurs can “dance.” A Cambridge-educated economist whose career as a venture capital investor has spanned four decades, Janeway has been called a “theorist-practitioner” by the great Hyman Minsky. As an investor, he built and led the Warburg Pincus Technology Investment team that provided financial backing to some of the companies that sparked the Internet economy.
Janeway’s new book,Doing Capitalism in the Innovation Economy, reveals how the state, the market economy, and financial capitalism work together to create innovative technologies. As he sees it, innovation has stalled in America, and it’s time to get it up and running again, particularly in critical areas like clean tech/green tech that can help us fight climate change. Somewhat unusual among successful businessman, Janeway draws lessons not from Milton Friedman and Friedrich Hayek, but from Karl Marx, John Maynard Keynes and Joseph Schumpeter. He believes that if we can break free of the fetters of neoclassical economic theory, the U.S. can lead the way in innovation and provide more of the things that make for a good life for all.
Lynn Parramore: What does it mean to be a venture capitalist inspired by figures like Marx, Keynes, Schumpeter and Minsky?
William Janeway: My professional maturation came from a somewhat distinctive educational background. I left Princeton in 1965 with a Marshall scholarship to Cambridge University in Britain because I had been enormously influenced by reading Keynes – not just the General Theory, but other writings. What I took from Keynes was a broad vision of an economy in which people who knew they couldn’t know enough had to make decisions, and they would be held responsible for the consequences.
Keynes pointed out that knowing they couldn’t know enough, people would necessarily seek to respond to uncertainty in a variety of ways which most economists would have thought of as being irrational or self-destructive, when, in fact, they were doing the best they could in a world in which we spend half our time arguing about the meaning of the past that we’ve experienced, and the other half speculating about a future which we cannot know.
Perhaps the best-known aspect of Keynes’s work was his invocation of government as a necessary institution for offsetting and counterbalancing the instability inherent in the market economy. So you have the integration of money and finance, the role of liquidity, a necessary and occasionally positive role for government, and all of that in the context of inescapable uncertainty. You roll that into how venture capital actually emerged and has been practiced in the United States, and there is a remarkable resonance. First, venture capitalists are investing in ignorance. They cannot know the expected future cash flow from the start-ups that they’re funding. Second, it turns out on examination that the returns that venture capitalists have earned have been very directly correlated with performance of the stock market in general and, in fact, were dominated by the extraordinary speculative excess of the great dot.com/telecom bubble. One way to put it is that far from being an independent, distinct asset class, let alone a transformational instrument of policy, venture capitalists a whole have spent 25 years riding on the back of the greatest bull market in the history of capitalism. So Keynes’s understanding of the dependence of investment returns on speculative energy has proved to have been a critical lesson.
Finally there’s the role of the state: Over the 30 odd years since there has been a venture capital industry, 80 percent of all the dollars invested by venture capitalists in the U.S., and substantially more than that in terms of the profits earned, come in only 2 sectors: information and communications technology (ICT) and biomedicine (biotechnology and medical products and services). Now why is that? Well, it turns out that when you look at the post-war history of the U.S., those are the two sectors where the federal government committed vast quantities of resources -- not to correct the failure of the market economy, but in pursuit of missions that transcend economic calculation. The first, of course, was the Cold War, the competition with the Soviets that led to the U.S. government accounting for more than half of the research and development spending between 1933 and 1978.
LP: Half? That’s quite a figure. It would surprise our libertarian friends.
WJ: Right. The other mission, of course, was the empowerment of the National Institutes of Health to conquer disease, to invest in the science upstream from the clinic.
The way I like to put it is that the American government built a platform in those two sectors in which people like me, venture capitalists, and the entrepreneurs we backed, could dance. Our dance was rewarded by that great bull market and the culminating great bubble of 1999 and 2000. During the five years prior to the climax of that bubble, the amount of money in the hands of venture capitalists increased from barely 25 billion to almost 250 billion dollars. In five years! Since then, since the collapse of the bubble and the closing of access of the public markets to the initial public offering window, the returns to venture capital have decline hugely. The funds committed to venture capitalists have declined hugely – unsurprisingly – and it is possible to expect that the great American VC industry that seemed such a profoundly innovative force is reverting to a much smaller practice by craftspeople who, in good markets and bad markets, have demonstrated the ability to sponsor, support, initiate new companies that make a difference. But there aren’t very many of those.
We do have an amazing quantity of academic research analyzing the statistical data on VC returns, and they show 3 statistical facts. The first is that out of all the venture capital funds that have been launched in the U.S. over 35 years, a very small number, less than 10 percent, have accounted for all of the investment returned in excess of what you would have received by simply investing in the NASDAQ index. Second, there’s persistence in those returns, so it’s not just a small number of funds, which might be random – it’s a small number of firms that have repeatedly been successful. Finally, the correlation of those returns with the state of the public market and particularly the degree to which initial public offerings are available—that correlation is very large indeed. It’s a long way of explaining how one gets from Keynes to practicing as venture capitalist.
From Marx there is a deep insight, which is one of the animating insights of the first volume of Capital, and that is that money (cash) and the commodities that it controls are independent of each other. There is a cycle through which the capitalist uses money to buy commodities, to resell them at a profit, usually having done something to them to increase their value. Now if you substitute the word that begins with “c” – “company” for “commodity”—you have exactly what the mission of the venture capitalist is. I proposed that back in the mid-1980s to Hy Minsky, whom I had gotten to know, and he loved it. I wrote some papers for Minsky on how to think about the venture capital process and practice in the longer context of the dynamics of capitalism, broadly defined.
LP: A Marxist formulation for venture capital is certainly something you don’t hear often. In your book, you describe a “Three-Player Game” that drives innovation. What is it and how does it work?
WJ: As an apprentice venture capitalist, back around 1980, I realized that the industry that I was really interested in – the most exciting industry in the world, computers -- was deeply dependent on prior investment in science and technology by the Defense Department, by NASA, by the Atomic Energy Commission. That made me conceive of the government not just as a kind of backstop for when the market economy failed in a kind of simplistic Keynesian mode, but as an active player in a kind of dynamic game between the marketplace and political process.
Over the last 150 years, we’ve evolved two sets of institutions that have responsibility, in their own terms, for allocating resources and distributing income. In one of them, the marketplace in the most simplistic form, power is distributed according to one dollar/one vote. In the other, evolving from the 18th century through to 1928, when women in Britain finally got the vote (a little bit after women in America—and still not everywhere), the distribution of power is a function of one person/one vote. There is most obviously a potential for conflict.
The way I like to put it is that those who lose in one arena, in the marketplace – businessmen, for example, who lose because of competition from overseas, appeal to the political process for recourse, for protective tariffs. Those who lose in the marketplace as unemployed workers appeal to the political process for unemployment relief, for public works. Contrariwise, going back to the foundations of thinking about capitalism, those who lose in the political process, in the kind of political process that dominated in Britain in the 18th Century (it was referred to as an “aristocracy tempered by the mob”) appealed to the opening up of the political process by accumulating wealth and influence in the marketplace. The same thing is going on in China right now.
Those who have power in one arena always have a tendency to exploit that power in the other. It’s called “rent seeking” --if I have economic power, I can make political contributions and try to acquire political influence from my market power (and vice versa, if I have political power, I can seek a franchise, a contract). Remember those Halfway Houses in New Jersey? Adam Smith, I promise you, would have recognized exactly what was going on when Governor Christie’s best friend got the contract. So that’s two players: the market economy and the political process (the state).
But there’s a third player, and this I came upon in the mid-1980s through the work of one of the greatest historians of the 20th century, a Frenchman named Fernand Braudel, who wrote a three-volume, extraordinary exploration of the dynamics of preindustrial capital from the Middle Ages to the Renaissance and into the Enlightenment. His principle focus was on the financiers of long distance trade. In those days, the highest risk, but by far the highest return, came from financing the long distance trade between, for example, the spice islands of Southeast Asia and the metropolitan ports of Holland and Britain in Western Europe. The way in which Braudel identified the motives and the practices of those financial capitalists—in the manner in which they were always looking at the frontier for the superprofits available for pioneering, I recognized myself and my colleagues and what we were doing, where the frontier was defined by technology, rather than geography. That recognition led to my writing a paper called “Doing Capitalism” in 1985 or so for Hyman Minsky.
So the financial capitalists were the third player in the game. They are distinct from the market economy. Yes, there are financial markets, but financial capitalists who have liquid funds available to invest at their discretion are constantly looking for discontinuities in the market processes and the political process. They are looking for opportunities to disrupt the way things works, whether it’s George Soros breaking the Bank of England twenty years ago, or whether it’s venture capitalists attacking the great established enterprises that are paralyzed by the innovator’s dilemma, just as I and my colleagues did in the 1990s in breaking IBM’s monopoly control of commercial computing.
LP: How does a neoclassical economic framework hold back innovation and prevent us from understanding how it works?
WJ: It is an assertion of my book that trying to understand the dynamics of the innovation economy through the lens of neoclassical economics is difficult if not dangerous. The reason is this: At the core of neoclassical economics is the notion that competitive markets will generate an optimal allocation of resources over time, looking forward.
But the future cannot be fully projected from the current state, precisely because of innovations that not only produce a marginally better iPhone from one year to the next, but once in a while result in the construction of a network of railroads on top of which the innovation of mail order, of Montgomery Ward/Sears Roebuck, transformed the market economy to create a national marketplace with national brands and destroyed, in the Schumpeterian manner, established producers, lines of logistics, and patterns of consumption while enabling new ones to emerge. How is it possible prior to the railroad revolution to imagine what the optimal investment in railroads should be when you have no idea whatsoever of the economic returns from the speculative investments, which, by the way, always go to excess?
We built five trunk railroads between New York and Chicago in the course of thirty years in order to ensure that none of them would ever make any money. Similarly, with the Internet economy, how would it have been possible, through competitive markets, to mobilize the capital to deploy far too much for what was needed in the 1990s and also to fund the birth of the hundreds and hundreds of “hopeful monsters” (to use a Darwinian metaphor), to explore the new economic space being created by the Internet?
LP: You mention the Great Depression as the catalyst for the transition from small-state capitalism to big state capitalism. What has that change meant for innovation?
WJ: First, it’s not just the Great Depression, it’s also the Second World War. The historical fact is that at the time of the last global financial crisis (1931), the public sector as a proportion of the national economy was on the order, outside the Soviet Union, of about 10 percent. In the U.S., in 1929, the public sector was only 7 percent. Only 2 percent was in the federal government; the rest were state and local expenditures. Consequently, it was simply not possible for the public sector to offset the collapse of the private sector until there was a transcendent, politically legitimate mission on the basis of which the scale of the public sector would become substantially greater.
The first impulse was Social Security. But the second impulse, and the one that ended the Great Depression, of course, was mobilization for total war –which, by the way, is the most inefficient investment governments can make in narrow economic terms. We emerged from WWII in the U.S. with a limited welfare state (in Europe a much larger one). In the U.S., after the Korean War, we emerged with a hugely enlarged military - a warfare state (in Europe, much smaller). But collectively, even in the U.S., by the time we reached the most recent global financial crisis, the public sector was on the order of 35-50 percent of the national economy. You don’t need to know much more than that to understand why the last global financial crisis led to 25 to 35 percent unemployment and politics spilling into the streets, whereas in this crisis in the core countries – only the core from Germany to the U.S. -- unemployment was limited to “only” about 8 -10 percent. By the way, that can also explain the much less extreme regulatory response to the global financial crisis.
With respect to the effect on the innovation economy, I’ve said that efficiency, as defined in neoclassical economics, is the enemy of innovation. By insisting that government investments be measured and be justified on the same criteria as those of a well-managed business, even with substantial unemployment, those who pursue efficiency undermine the toleration of the necessary waste of the supply-side of the economy – of investing in potentially innovative science, technology. But that way of thinking does something else: it restrains and limits the government’s ability to respond to market failure and financial crises and encourages the toleration of the unnecessary waste on the demand side: unemployment.
Here’s the real nut of it: There’s an interaction between the two. The greater the degree of demand-side waste, what I call “Keynesian waste” or unemployment, the less investment there will be in innovating on the supply side. The process of creative destruction in a high-employment, high-growth economy, is going to be more creative and less destructive.
LP: Why does the innovation economy depend on sources of funding that aren’t connected to economic returns?
WJ: Remember, we’re investing in ignorance. We’re investing without possibly knowing the value of returns. If we only invest where we can estimate them, we’re not going to invest in the highest risk but potentially highest return –and we’re certainly not going to invest in the upstream science and the sort of skill that can create the kind of platform on which I dance.
There’s a long literature on market failure – on the failure of a competitive market economy to provide enough public goods, like lighthouses, and to compensate for the bad externalities like pollution. Nothing new there, and in fact, one of the failures that has been identified and explored is the failure to invest enough in research and development.
But my point is that in reading the political history, the history of our political economy, the argument to correct market failure has never proved adequate. What it needed is a larger politically legitimate mission. Once upon a time, there was national development. Hamilton’s Report on Manufactures, the Erie Canal, which transformed the economy in the northeast and the old northwest of the young American republic. The funding of the Erie Canal was guaranteed by DeWitt Clinton and the government of the state of New York. Without the New York state guarantee, the Erie Canal would not have been built. I’d roll that all the way forward. In overbuilding the railroads, in the name of national development, and initially, to bind the state of California to the Union during the Civil War, we took 9 percent of the landmass of the Continental United States and gave it to a gang of corrupt promoters, whose investments, in fact, did create a new economy. That’s the role of the state. Those investments could never have been made by green eye shades pursuing the accounting rigor of investment calculation.
Downstream, we’ve been dependent --again and again – on financial speculation. Wherever there are markets in which assets are freely traded --before the Industrial Revolution, the tulips bulbs, the South Sea Bubble, right on through the credit bubble of the late 2000s—wherever there are liquid markets and assets there will be bubbles. Most of the time, on the one hand, the object of speculation is some asset which is not going to change our lives for the better. It’s not going to radically improve productivity and living standards. It may be tulip bulbs, it may be gold mines, it may be the debt of nations newly introduced by the collapse of past empires, it may be beach houses in Nevada. On the other hand, every once in a while, it’s the canals, the railroads, electric power utilities, aviation and radio in the 1920s, and obviously, computers -- the Internet and all who sail on the Internet sea.
The kind of investment at a scale needed to improve the likelihood that from those hopeful monsters – you might say that you need a hundred Pets.com to wind up with one Amazon—only speculative excess will provide that funding, where the speculator can win even if the underlying project fails because the focus is not on the expected return of the underlying project. The focus becomes – can I sell this share of stock to someone more optimistic than I before I have to find out what the underlying economic value really is?
One last word on bubbles: It’s not just the object of speculation that matters. It’s also the locus – where the speculation is taking place. If it’s limited to the stock market, and the focus is on potentially productivity-enhancing, living standard-enhancing new stuff -- when it bursts, which it will -- the damage will be limited, because, on the one hand, it’s been limited to a market where shares trade freely and, on the other hand, we’re going to be left with those assets that were funded, even if they were funded to excess. When the bubble infects the banking system, when it corrupts the provision of credit to the ordinary, routine market economy where people work and earn and spend and save, then the consequences can be destructive, even catastrophic. And when the object of speculation has been beach houses in Nevada, we’re not left with anything good to show for it.
LP: You mention ICT and biotech as industries that have done very well as a result of federal funding of scientific research furthered by venture capital. What key industries might benefit from this pattern now?
WJ: We have a very evident set of frustrations. Back in the early 2000s, there was a kind of wave of venture capital investing in nanotechnology. It was way premature. We were too far away from the commercial frontier. Plus, where the innovation is a kind of general purpose material, the real return comes not from actually being able to produce it cheaply and reliably, which, in the case of nanotechnology, wasn’t ready yet, but also finding out what it was actually good for, which is a long-term and challenging process. Back in the ‘70s, for all who saw that great movie The Graduate, plastics were actually commercialized not by venture capital-backed start-ups, but by two of the great corporations of the global economy, General Electric and DuPont, who had the resources and the time to spend thirty years and billions of dollars investing in the manufacture and the exploration of the commercially-significant applications. Nanotech will, no doubt, over the next generation, be a pervasively innovative set of technologies, products, etc. But we’re not ready yet for that massive wave of commercialization.
The other elements of the frustration set are the clean tech/green tech/low-carbon technologies. Again, much science remains to be done (solar cells, batteries, carbon-absorbing materials). Here the frustration in most extreme. The U.S. seems to be the only country in the developed world or even the emerging world in which discussing policy responses to climate change is off the table. So until it’s on the table, we can’t even imagine mobilizing the kind of resources necessary to move that technology to the commercially competitive frontier.
Third, I have to say with great regret, I think the administration made a signal and destructive error in expanding the loan guarantee program and other programs that really cut against what the Defense Department did so well in the ‘50s and ‘60s. It made an error by making very large loan guarantees to high-risk start-ups like Solyndra; like 8123, the battery company; like Tesla, the automobile company -- in effect trying to pick winners. This has never worked well.
On the contrary, what DoD did so well in the digital revolution was the opposite -- not to provide capital to targeted, wanna-be winners, but to be a creative, collaborative customer. So it would set a specification and offer a request or a proposal (whether it was a microprocessor or today what would be called a battery with energy density of such-and-such) – and whomever could meet that spec, whether it’s General Electric or three young people in a garage—it would buy some, test it, see if it worked, buy some more, and pull the competitive sector down the learning curve. It would prove the technology to where it could be reproduced reliably and cheaply enough to be available to the commercial market economy.
That’s the kind of program that we need. The DoD has been doing a little bit of this with solar technology, for example, to equip the troops in Afghanistan, but it has been on a trivial scale compared to what was done in the 50s and 60s.
LP: You say that austerity policies are self-defeating. How does economic theory help us to understand that?
Keynes is the key figure in this. I wrote my doctoral thesis at Cambridge University on British economic policy (1929-1931) when Keynes was a very vocal and active player. Keynes won the logical argument against the establishment figures who were principally embedded in the British Treasury, the dominant department of British government then and today. They had said that even with ten percent unemployment, and going to 20 percent unemployment, that government programs to borrow and spend money would squeeze out private investment.
This was obviously nonsense. If you have 20 percent unemployment, the government borrowing and spending will put resources to work, which will generate new flows of profits back to private industry. So the logic of the argument was completely flawed, and Keynes won that argument. But he lost the policy debate because even if the logic were wrong, the opponent of any action (the proponents of the status quo) invoked the argument that because the government couldn’t be trusted to spend money efficiently, it would therefore scare businessmen and investors, invite what in more recent time have been called “bond market vigilantes.”
This was the same argument that Paul Krugman has characterized as the invocation of the “Confidence Fairy”: If we cut the government back and reduce the government's wasteful spending, then the Confidence Fairy will descend and bestow the confidence needed for businessmen to increase their investments. Well, we’re four years now into the post-crisis world and it’s perfectly apparent that the Confidence Fairy is fast asleep – or perhaps even worse—and none of our clapping will bring Tinker Bell back to save the economy.
Keynes wrote the General Theory in good part out of the loss of that policy debate, to demonstrate the powerful requirement for stabilizing an inherently unstable economy. If we persist in tolerating the waste represented by unemployment, it will reduce investment in research and development and innovative new technology.
LP: If you had to make an immediate policy change now that would help spur innovation, what would it be?
WJ: The available transformational turning point mission does relate to climate change. To take seriously getting invested upstream and in the deployment of the infrastructure that will reduce energy consumption, carbon consumption.
I can see two lines of attack. One is long-term structural investment – not just short-term corrections -- that can include public transit and the kinds of investments that will reduce carbon consumption. I’d like to see that at least get into the policy debate. The other concerns taxes. Nationally we have highly regressive tax policies. Suppose we could trade the payroll tax for a carbon tax? We have actually done something like this. We have a perfect model for this, which President Obama did invoke to get higher fuel consumptions standards, despite a lot of game playing and outrageous rent-seeking. I am an optimistic venture capitalist, and I think it may be possible to find paths forward that can raise the living standards for everyone.