How the state can foster innovation


How the state can foster innovation

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Prof. Rakesh Basant


Innovation and entrepreneurship are buzzwords in India today. Analyses of their potential roles not only permeate the discussion around Startup India, but also figure in discussions on Make in India and Skill India initiatives as the latter two are expected to benefit from innovation-driven entrepreneurship, especially new ventures. It is imperative that the synergies among these three major initiatives are systematically reaped. While a detailed understanding of various linkages across these programmes would require more rigorous analysis, it would be useful to focus on the role of the state and higher education institutions (HEIs) in creating an ecosystem where technology entrepreneurship can flourish.

The role of venture capital (VC) and incubation to support start-ups are increasingly seen as critical for fostering innovative enterprises. Historical evidence, however, suggests that in a healthy innovation ecosystem, while VCs and start-ups are important contributors for stimulating innovation, they can never be a substitute for other sources of innovation, namely vibrant higher education institutions and research and development (R&D) undertaken in the large corporate sector—both public and private. In this context, can the government effectively promote VC and innovation-driven entrepreneurship? Most argue, and rightly so, that the critical contribution of the government is to provide stable policies that make doing business easier. While there has been a lot of scepticism about the government being a source of innovation, many recent empirical studies have painstakingly documented the critical role that the state has played in fostering innovation and entrepreneurship, even in places like the Silicon Valley. It is being recognized that both state-supported research as well entrepreneurial capital are necessary (though not sufficient) conditions for innovation. The efficacy of state initiatives not only depends on the extant ecosystem but also on the nature of intervention.

Studies suggest that the financing of innovation is likely to be more successful in situations where: (i) the public sector spends large sums on education, research and those emerging sectors where high capital intensity and technological or market risks result in under-investment by the private sector; (ii) large companies reinvest their profits in human capital and R&D; (iii) the tax policy rewards long-run investments rather than short-run capital gains; and (iv) contestable markets along with a rigorous competition policy does not allow successful incumbents to become lazy.

But what should be the nature of state financing?

Apart from research grants, governments worldwide are also providing entrepreneurial capital. The centre has also announced a Rs.10,000-crore fund for start-ups that will be implemented by Sidbi. Innovation requires sustained support, and short-term perspective for financial markets is not conducive for the growth of innovation-driven start-ups. Private VC firms typically do not provide patient capital needed for radical innovations. In any case, the focus of VCs on early and profitable ‘exit’ results in limited investments by them in early-stage technology-driven start-ups. Such a tendency is more prominent in economies like India (though there are some signs of change) where financial markets are not mature enough to create several opportunities of exit. Therefore, the creation of a start-up fund by the centre is very welcome. However, the efficacy of this initiative would depend on how this money is deployed. There is some evidence to suggest that matching funds from the private sector often enhances the quality of due diligence and of mentoring and other support. Therefore, the deployment of these funds through a public-private partnership (PPP) vehicle may be desirable.

One such experiment, INFUSE, is currently underway to support innovative start-ups in the clean energy sector. This is clearly a sector where capital investments and technology and market risks are usually high, especially in comparison to information and communications technology enterprises, which dominate the start-up movement in India. The ministry of new and renewable energy provided resources to the Centre for Innovation, Incubation and Entrepreneurship (CIIE) at the Indian Institute of Management, Ahmedabad (IIMA) to seed a fund for supporting clean energy start-ups. The understanding was that CIIE at IIMA would raise matching funds from the private sector and operate a venture fund registered with the Securities and Exchange Board of India. CIIE surpassed expectations and raised more than matching resources from private entities to set up the INFUSE fund, which it now operates professionally, wherein the due diligence is overseen by an independent investment committee. This public-private academia partnership can potentially be a model for deploying the new start-up fund. Available resources can be used to seed the creation of venture funds for sectors where the market and technological risks apart from other types of market failures are high. Such a model to provide entrepreneurial capital for early-stage entities can bring in advantages of ‘syndication’ through its PPP element and also reduce the chances of government failures.

Externalities play an important role in creating and nurturing an innovation ecosystem. The ecosystem comprises individual inventors, large corporates, HEIs, entrepreneurs, VCs, angel investors, consumers, vendors, employees, service providers and governments. Start-ups and VCs not only benefit from the existence of their peers but also by the actions of others through what is referred to as a spillover effect. The role of HEIs as a source of research that can be taken to the market, skills as well as entrepreneurs has been stressed. One aspect that has remained under-emphasized is the nature of the universities in these innovative clusters. These are large, multi-disciplinary, research-intensive entities with spaces for different disciplines to interact. Innovation and entrepreneurship are multi-disciplinary activities; the interaction of science, engineering, design, management, humanities and other disciplines provide a fertile ground for nurturing and growing innovative ideas. Unlike the West, India does not have universities where such interactions happen. At a few universities where such possibilities exist, the silo culture and lack of interaction spaces come in the way.

In the short run, it does not seem possible to create such research-intensive and multi-disciplinary universities in India. But fortunately, there are several city clusters where high-quality HEIs representing different disciplines co-exist. In many of these clusters, other elements of the entrepreneurial ecosystem are also present. Efforts to bring these institutions together around innovation and entrepreneurship-related activities—joint courses, research, co-incubation, etc.—can be a potent force to unleash innovation-driven entrepreneurship. The policy of supporting incubation centres in specific institutions is administratively easier but does not exploit spillovers and economies of scale and scope. Policy instruments that provide incentives for joint activities among these institutions can go a long way in creating the requisite entrepreneurial culture.

For starters, can we have a dedicated transport service connecting these institutions in a few clusters?


Rakesh Basant is a professor of economics area at IIMA. A former consultant to the World Bank, his research interest includes technology change and management, intellectual property rights, industrial organization, public policy (especially competition and technology policies), inter-firm alliances, industrial clusters and labour markets.


First published in 'View from IIMA' column in Mint.