Venture capital as a tool of development policy?

28 giugno 2012

When I first heard a venture capitalist talk about the kinds of projects they are looking for and the kind of risk they take, I thought: “hey, this is very similar to what we should be doing in development policy”.  If only we could strike a well-devised agreement with these guys, we could let them manage a piece of our public funds, and have them select projects that meet simultaneously our criteria and theirs.   It seemed the perfect idea: (1)  VC funds are revolving and thus do not get dissipated in the investment process; (2) the effect of this deployment of money would be additional in the sense that, if we endow VC funds with more resources, additional projects would receive funding that otherwise wouldn’t; (3) the selection is not distorted by clientelism or inefficiency because the interest of the public is aligned with that of the private fund managers who seek to increase the value of their capital.

Is it really so? Given that Venture Capitalists, after all, are financial investors, I am afraid that such agreements would run into the same problems  that have arisen whenever policy has tried to pursue public goals through financial institutions. Interacting with the financial sector is nothing new for development policies.  Public economic development Banks have operated for a long time, both at the national and international level and run large budgets in the form of grants, loans to public bodies and firms.   Private banks intermediate public incentives to firms in exchange for fees.  However,  these institutions in general seem to be more interested in reaping better-than-market conditions for the resources that the State makes available, in earning the fixed fees in exchange for the transactions,  but seldom seem to change their behaviour in the way it is desired and required for  the agreement to work.

The operations of private financial institutions are not easily aligned with the interest of the state.  Theoretically this partnership should work.  In practice there seems to be something in the nature of these financial institutions that makes them unsuitable to work in the interest of the state, while pursuing theirs.

What is it? I am afraid what I am about to say will appear simplistic, naive, almost racist.  I am coming to the conclusion that the problem rests in  the  nature of the people that work in finance. I fear it is something that has to do with the character and motivation of the people that are attracted to finance, and that staff the financial institutions.  A recent article in the Guardian supports my view using stronger words, that I don’t necessarily endorse.

A personal anecdotal experience contributed to my forming of this view. A few years ago  I was talking to a friend who had been working in the financial sector in London and had been recently laid off during the crisis of 2008.   The subjet of our cionversation was the behaviour of financial institutions, derivative financial products, and other operations that potentially cause problems to the stability of markets.  Some words  that he pronounced made such an impression on me that I still remember them literally: “actually -he said – now  that you make me think about it,  the best operations I have been working on in my career are those that, while formally respecting the law, have circumvented the substance of its aims”. I leave anycomment or interpretation of this statement to the reader.

The general point is that without some degree of public mindedness, every agreement between the State and private intermediaries can be formally respected, but circumvented in practice by the private side to extract extra-profits shielded from the forces of competition, without producing the intended public good.

Are venture capitalists similar to other financial operators?  Are they all the same?