Picking Winners

Imagine objectively selecting companies to receive government support, without the bureaucrats or consultants?

Here in New Zealand, our local market is small so exports are critical to our economic success as a nation.

As a result, our government is keen to encourage exporting businesses to develop and grow. The theory is that more of these types of businesses we have, and the more successful they are internationally, the more money we will have to invest in the public services we all want (in order, based on current government spending: hospitals, schools, social security, law and order, transport and communications infrastructure, defence, etc).

This theory only holds if those companies, in aggregrate, eventually pay more tax than they have received in support. Given that very few startups are profitable and so paying income tax the bulk of this revenue to government is in the form of PAYE on salaries paid (only local employees count) and GST on operating expenses.

In practical terms this encouragement has come in many different forms, including subsidies for early-stage investors, incubator and accelerator programmes, co-investment funds, research and development tax credits and a long and growing list of direct grants to encourage companies to undertake product and market development. These interventions ask complex questions of public servants, not the least being: how to pick which companies are deserving of taxpayer support?

Actually, government agencies are damned if they do and damned if they don’t: either they try to pick winners, exposing their own biases; or they don’t try to pick winners, and instead provide general support to everybody, with the attendant risk that they waste public money on failed ventures.

As a consequence we’ve ended up with a very large and complicated system, spread across multiple different central and local government agencies, each trying to come up with a fair process for distributing their budgets. Each of these agencies employs people (many hundreds in aggregate!) to try and determine who does and doesn’t qualify for funding. Often this involves significant distraction for those companies who might benefit from this funding: both the hassle of jumping through the hoops of subjective application processes, and the distortions caused by the qualifying criteria. If an agency will fund activity A but not B, and the company was going to do B anyway, then it creates a perverse incentive to make the B look like an A, from an accounting perspective. In extreme cases, I’ve even seen consultants hired on lucrative terms to help companies successfully navigate the application process - and those best qualified to help in this role are typically recent ex-employees of the agencies, who know the right keywords to include in the right places on the right forms.

This seems crazy to me!

What would an objective process to select companies to receive support look like?

Here is one suggestion…

Every month1 all registered businesses in NZ are required to submit a GST return documenting their revenues and expenses. Using the data captured by this existing system, we could easily identify those companies that are exporting, that is: spending and investing money locally and earning revenue on sales internationally.

Then, if we wanted to, we could filter that list to narrow our focus on the specific types of companies we want to encourage.

That could mean, for example, targeting smaller companies rather than larger companies.

Or it could mean targeting fast-growing companies rather than more mature companies. By looking at the trends over time, we could easily separate those companies that are currently investing and/or expanding (that is, spending more than they earn in the short term in the hope that the reverse will be true in the longer term) and those that are not.

Or it could mean companies with higher rates of local ownership over internationally-owned businesses or companies with a higher revenue per employee rather than larger employers (in order to encourage higher productivity). Again, all of these details about businesses are already captured by the government.

Or it could be some combination of all of the above. The specific policy details are not really important, and are likely to be refined over time, the point is that all of these criteria could be published in advance and determined objectively, with limited additional administrative overhead.

From this list, the government could then decide how much to subsidise these companies. For example, in the simplest case a qualifying company could be entitled to a percentage back on every dollar spent.2 Again, the specific details and amounts are not important, the key is that every company could quickly work out for themselves what they are entitled to receive.

Currently nearly every growing exporting business receives a GST refund payment each month (because they claim back the GST they were charged on their local expenses, but don’t collect significant GST on local revenue to offset that, and are refunded the difference). So, we could even use this existing remittance system to transfer any additional funds the company would qualify for on top of that amount. It would be, effectively, a multiplier on the existing GST refund. And, as with GST refunds, could be paid in smaller monthly amounts rather than in one big hit each year (removing the rags-to-riches effect that grant payments can have for small companies).

An alternative system like this would bring a raft of advantages:

The government would spend vastly less administering the system. Officials would no longer be required to choose one-by-one who does and doesn’t qualify for assistance, and so don’t have to be scared that they will be blamed, either if a company is successful and sold offshore or if a company isn’t successful and shuts down. The policy settings would be much more transparent and could be debated on their merits.

Likewise, companies would waste vastly less time applying for grants and other types of support, and would have much more certainty about what they do and don’t qualify for, so they could plan accordingly. The simplicity would mean that the system would be better understood by accountants and bookkeepers, and so should have much greater take-up from eligible companies. The amounts paid to companies would scale in proportion to the size and success of the business. This would eliminate the too common situation we have currently with young companies failing after having received significant government support, but with little revenue to show for it.

But, perhaps most importantly, compared to the distortions created by the current system, the incentives could be much better matched to the intended outcome we all want - growing exports and higher productivity.

There are some who would argue that any system of corporate subsidies is unwarranted in an environment where schools and hospitals are underfunded and there are so many people living in poverty. I have sympathy with that view. However, the political reality is that we are paying subsidies today, but those payments are calculated subjectively and at significant expense. Perhaps in time we will collectively decide that priorities should be elsewhere, but in the meantime I’d much prefer a system that is efficient and fair. And, if it is successful in encouraging more companies to invest in growth and build export revenue, then the resulting stronger economy could invest further in those areas of need.

Positive feedback loops for the win!

I’d love some help to make this idea better:

What do you think? What am I missing? How am I wrong?

I’m not an expert in public policy, so I’m interested to hear from anybody who has done research that attempts to connect the various economic development programs that have been implemented in recent years with tangible results. Is there any evidence they are working today that I’m overlooking?

I’m also not an accountant, so I’d be interested to hear from somebody who understands the details of the GST system better than I do. Are there any traps that I’m overlooking in this suggestion?

Thanks to Josh Daniel for the conversation which led me to developing this idea.

A version of this essay was first published by The Spinoff.

  1. Or every two months or six months, for very small businesses. ↩︎

  2. This raises two interesting questions: Firstly what is the current subsidy level? This ratio could be relatively easily calculated using the total amount currently spent on grants, and the total amount currently spent by exporting businesses. Again, the government already has both of those numbers. And, secondly, what is the optimal level of subsidy in order to encourage investment and growth but retain the healthy market dynamics that naturally separates the winners from the losers? ↩︎

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