Growth and the Smart State
GAICIL Insights
The old argument over big government versus small government may be asking the wrong question.1 Growth and the Smart State, by Philippe Aghion and Alexandra Roulet, argues the central issue is the governance of the state. As countries develop, the main driver of growth shifts from imitation to innovation, calling for different policies and institutions and calling the old welfare state model into question. Growth in developed economies requires a strategic state acting as a catalyst, using selective and properly governed support for the market-driven innovation process.
The strategic state stakes out distinctive ground. It departs from the view of a state sustaining growth mainly through demand-driven policies, and from the view of a minimal state confined to core functions. The minimal state ignores knowledge externalities and credit market imperfections, which justify public investment in innovation. The old welfare states are ill-suited to an economy driven by frontier innovation. Between them sits a state acting primarily on the supply side, targeting investments on sectors or activities with higher expected growth potential. Call it the state as investor, positioned between nanny and night watchman.
Hard budget constraints discipline it. The strategic state reconciles investing in growth with a balanced budget. It examines governance carefully, both of the sectors it invests in and of itself as an investor. This applies across growth policy, from education to macroeconomic policy design over the business cycle. An investor that cannot say no is not an investor.
The authors face a criticism head on: the approach may seem to treat the state as a social planner, when governments may represent elites with vested interests. They recognize that governments represent interest groups and that conflict between incumbent interests and new entrants is central to their framework. They still believe pointing to more efficient forms of state intervention is valuable.
Here is where the paper meets the present. Artificial intelligence policy is where this framework bites. Governments everywhere are deciding how to support AI development and adoption. The strategic state approach implies effective AI policy involves selective, well-governed investment in high-growth-potential areas: research, education, infrastructure and support for innovative firms. Passive minimalism and broad spending without strategy are both unlikely to be optimal. The question for an AI ministry is how well it chooses.
Knowledge externalities justify the involvement. AI research generates knowledge spilling across firms and sectors, which private investment alone may underprovide. Credit market imperfections may constrain innovative AI startups, creating a role for public financing mechanisms. The strategic state targets these market failures directly.
Governance is the safeguard. Public AI investment is vulnerable to capture by incumbent interests seeking support that protects their positions. Attention to governance of both funded sectors and the state itself defends against this. Transparent criteria, competitive allocation and evaluation of results help ensure AI investments promote innovation. Capture is the default outcome of strategy without governance.
The budget constraint keeps strategies honest. Governments cannot fund every AI initiative. Targeting investments where expected growth is highest, and reallocating from less productive spending, supports innovation without unsustainable deficits. That discipline strengthens the credibility of public AI strategies.
Education is the long-run investment. The shift to innovation-led growth requires a workforce with advanced skills. Investing in education, from basic schooling to research universities, builds the human capital AI innovation needs. The strategic state prioritizes such investments.
Seen whole, the paper's message is plain: innovation-led growth requires a state that is strategic, selective and well governed. Moving beyond both the old welfare state and the minimal state, the strategic state invests in knowledge, supports innovation and maintains fiscal discipline. As AI becomes a central driver of growth, this framework offers a coherent basis for public policy that catalyzes innovation while guarding against capture and waste.
One question to put to AI strategies everywhere: judge them by their selection rules and their exit rules. A smart state knows when to stop funding a project as clearly as when to start.
Introduction
As countries develop, the main driver of economic growth shifts from imitation to innovation. These two sources of growth require different policies and institutions. In particular, in this article we argue that the transition from an imitation-based to an innovation-based economy calls the old welfare state model into question. It is not so much the size of the state that is at stake but rather its governance. What we need to foster economic growth in developed economies is not a reduced state but a strategic state, which acts as a catalyst using selective and properly governed support to the market-driven innovation process. This idea of a strategic state that targets its investments to maximize growth in the face of hard budget constraints departs both from the Keynesian view of a state sustaining growth through demand-driven policies and from the neoliberal view of a minimal state confined to its regalian functions.
Takeaway
“Above we argue that moving from catch-up (or imitation-driven) growth to innovation-led growth calls not only for investing more in the knowledge economy and for liberalizing markets more, but also for reforming the governance of the state. Although the old welfare states are not well suited to the needs of an economy in which growth is driven by frontier innovation, the minimal state advocated by neoconservatives is not the solution either, as it ignores the existence of knowledge externalities and credit market imperfections. This applies to various aspects of growth policy making, from education to the design of macroeconomic policies over the business cycle. In each instance, between the old welfare state and the neoconservative minimalist view, there is what we refer to as the strategic state, which acts primarily on the supply side of the economy and targets its investments on the sectors or activities with higher expected growth potential. It is a state that tries to reconcile the need to invest in growth with the need to achieve a balanced budget. And it is a state that looks carefully at governance, both of the sectors it invests in and of itself as investor. Our approach in this article may be criticized for being too Pigovian (i.e., for treating the state as a social planner rather than as the representative of an elite with strongly vested interests) (see Acemoglu & Robinson 2012).1
Although acknowledging that governments represent interest groups, and more generally recognizing the centrality of the conflict between incumbent interests and new entrants—our approach is Schumpeterian from the start—we still believe that pointing at more efficient growth policies and institutions is useful for several reasons. First, elites are not fully homogeneous, as argued by Banerjee & Duflo (2014).”
Notes
- Philippe Aghion & Alexandra Roulet, Growth and the Smart State, 6 Ann. Rev. Econ. 913 (2014), https://doi.org/10.1146/annurev-economics-080213-040759. Takeaway source: Philippe Aghion, Alexandra Roulet, Growth and the Smart State, Conclusion. ↩
Cite as: Philippe Aghion & Alexandra Roulet, Growth and the Smart State, 6 Ann. Rev. Econ. 913 (2014), https://doi.org/10.1146/annurev-economics-080213-040759
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