Comment: How government funding can help or hinder growth

The gap in public and private research and development (R&D) spending is reputed by policymakers to be one of the main factors that is responsible for the slower growth rate that European economies have been experiencing with respect to international competitors. Although the relationship between R&D and economic growth is far from finding full support in the scientific literature and cannot be considered to be automatic, the need to increase R&D spending has been at the centre of the European Council’s policies since the Lisbon 2000 strategy. In this respect, one important cause that is individuated by the European Commission for explaining the European R&D gap is the low presence of high-tech rapid-growth entrepreneurial firms on the old continent. In the words of the Europe 2020 agenda (European Commission, 2010:p.10), “R&D spending in Europe is below 2% [of gross domestic product, GDP] compared to 2.6% in the US…. Our smaller share of high-tech firms explains half of our gap with the US.” One widely shared belief is that the creation of a florid pan-European venture capital (VC) market is a fundamental pre-requisite to bridging the above-mentioned gap and increasing the European Union (EU) performances in terms of innovation, job creation and economic growth. However, the development of VC markets in the EU member states has been dramatically different from the development that is experienced in the US. The overall value of the VC investments over the GDP is nearly three times higher in the US than in Europe. The recent financial crisis has further weakened the EU VC fundraising ability in the subsequent years. The need for an efficient EU VC market to spur economic growth is well understood at the policy level and has resulted in a series of initiatives (the most important one is the Risk Capital Action Plan in 1998) at various playing field-levels, for example measures that aim at increasing stock market openness and/or labor market flexibility or tax incentives, which targeted both the supply of and the demand for VC. According to market operators, even though some structural problems remain, such as thin and fragmented exit markets and limited fundraising ability due to different national regulatory regimes, these attempts contributed to strengthening the EU VC markets, especially after the dot-com bubble, according to the European Private Equity and Venture Capital Association in 2010. Such policy initiatives also led to a specific peculiarity of the EU context: the relative importance compared to other geographical contexts (the US primarily) of governmental VC (GVCs) funds. GVCs are not indirect government support programs to stimulate the supply of VC funds managed by independent companies (IVCs), and they are not public subsidies that are directed toward the assistance of high-tech entrepreneurial firms. Instead, GVCs are defined as funds that are managed by a company that is entirely possessed by governmental bodies. Public initiatives that fall into the definition of GVC are quite typical in many European contexts, for example Belgium, Finland, France, Germany, Italy, Spain and UK, and they share the same mission of nurturing through public equity(-like) investments the development and growth of interesting business projects. Using the VICO dataset, a novel firm-level longitudinal dataset sponsored by the European Union under the 7th Framework Program, we assess the impact of GVCs in comparison (and in conjunction) with IVCs on the growth of European high-tech entrepreneurial firms. Our results show that the main statistically robust and economically relevant positive effect is exerted by IVC investors on firm sales growth: +38% in the short term, +60% in the long term. Conversely, the impact of GVC alone appears to be negligible. We also find a positive and statistically significant impact of syndicated investments by both types of investors on firm sales growth, but only when led by IVC investors: +60% in the short term, +141% in the long term. Our results remain stable after controlling for endogeneity, survivorship bias, reverse causality, anticipation effects, legal and institutional differences across countries and over time and are stable with respect to potential non-linear effects of age and size of entrepreneurial firms. Overall, our analysis casts doubt on the ability of governments to support and lead high-tech entrepreneurial firms to a higher growth performance through a direct and active involvement in VC markets and a go-it-alone strategy in the choice and management of investments. The straightforward policy implication that can be drawn from our analysis is: if the European VC industry ever needed governmental aid (and our analysis is not intended to solve this question), public intervention would preferably create a favourable environment for private VC initiatives through indirect forms of support rather than adopt a ‘hands-on’ approach, such as through eliminating any unfavourable tax treatment to EU cross-border VC activities. On the other hand, if one wants to conserve the rationale for a direct public intervention to sustain the growth of high-tech entrepreneurial firms, these findings call for a deep re-consideration of the way that European GVCs are managed. In this respect, our analysis suggests that the inefficacy of GVCs in fostering the (sales) growth of European high-tech entrepreneurial firms is not only related to the scarce availability of financial resources but also might be due to a lack of value-added skills. A solution might be to replicate the design of the Australian Innovation Investment Funds (IIFs), a specific type of public-private co-investment model that resembles the US and the Israeli programs, which were proven to be effective in enhancing the investments in the startup and early-stage high-tech entrepreneurial firms and, more generally, in fostering the development of the local VC industry