What are governments good for?

The global financial system began 2014 in a chaotic, volatile state, as the US Federal Reserve (Fed) finally began its “tapering” action – a reduction in quantitative easing. The impact has been felt hardest by emerging markets’ currencies, on the edge of the investment universe. Already knocked by the Fed’s warning in the summer of 2013 that it would begin tapering, emerging markets’ currencies remained under devaluation pressure going into the first quarter of 2014, as retail investment funds flowed heavily back to the Western world.

With this milestone passed, the global financial system would appear to be treading a bumpy, unwinding road, one which began with its rescue by governments and central banks from crisis point in late 2008. And “appear” is the right word here. Experienced credit market investors will tell you that they are working inside a credit bubble, reminiscent of 2007 -– the legacy of quantitative easing. Any geopolitical disturbance might lead to another systemic collapse, or at least a correction, they fear.

Some governments can congratulate themselves for their performance across this period, for having had “a good crisis”: Canada, for example, for never having got badly burnt in the first place, and the UK, for controlling its debts and staging an economic recovery – although that is under debate, going into general election in 2015.

With the global financial system apparently under control, and banks firmly under the thumb of regulators, the search is on for growth. Eyes everywhere are on governments to stage economic recoveries, not least to support the value of investments. In India, for example, where elections were held from April 7 to May 12, 2014, a post-election package of GDP-boosting measures is anticipated. In China, an immediate lull in GDP growth, which dropped to 1.4% quarter-on-quarter in Q1 2014 (its slowest pace since official records began in 2010) is seen as possible proof that long-term economic reforms are in fact being implemented, although there are concerns too over defaults in the country’s shadow banking system.

So what, then, can governments around the world do to stimulate new, innovative ventures – one source, surely, of economic growth? And as far as they have tried already, are governments really any good at it?

One government recently tried to answer these questions, by commissioning a business school to conduct a global review of academic and policy-orientated literature on the financing of innovative ventures, and more specifically, on the potential role governments could play in stimulating access to finance. Yes, the Walloon regional government within Belgium commissioned the study from the Vlerick Business School, via its think tank, the Walloon Institute of Evaluation, Futurology and Statistics (IWEPS).

Lead author Professor Sophie Manigart confesses to having been sceptical at the outset, that government intervention could ever be effective, particularly given the poor, financial returns on European government investments in venture capital over the past 30 years. However, to her surprise, the in-depth “review of reviews” unearthed mounting evidence that government intervention might, after all, be effective. She points, in particular, to studies on government venture capital activity in Australia as a turning point in data analysis.

Having completed the report, Manigart can now say that she does support government intervention. “Without it, there would be no early-stage venture capital in Europe,” she says, although she does caution that she is favourable to government investment only under certain circumstances, “more specifically, when co-investing with private investors.”

The 92-page report, “Literature review on the financing of young, innovative ventures”, delivers a handful of key policy recommendations, touching on the government’s role as a direct investor in risk capital but starting out with institutional measures. “A country’s institutional environment, including its legal environment, macro-economic policies and prevailing culture, strongly impacts both the demand and the supply of risk capital.”

The report’s recommendations are honed to Belgium – points about personal bankruptcy laws, capital gains tax exemptions, labour market rigidity and public research and development  spending – but Manigart believes that it is at this institutional level that governments need to rise to the big challenge if they are to help young, innovative ventures. Ultimately, governments should be – well – governments.