Macro Economy

The start-up policy rush

Praveen Chakravarty
October 20, 2015

The aim of creating fertile talent grounds for disruptive innovation is a lofty goal that is not easy to accomplish

While Congress vice-president Rahul Gandhi was engrossed in a meeting with start-up entrepreneurs in Bengaluru on the evening of 9 October, Rajasthan chief minister Vasundhara Raje held a press conference to announce her state’s “Innovation and Technology Startup Policy 2015″, proclaiming that Rajasthan was the first state in the country to announce a start-up policy.

The Karnataka government responded by declaring its intent to announce a start-up policy very soon. Even the otherwise nonchalant state of West Bengal seems to want to formulate a start-up policy. Seemingly, there is a “first-mover advantage” for a government start-up policy too, as the states jostle for Internet businesses.

Amid this competitive federalism, minister of state for finance, Jayant Sinha, said that the prime minister will announce a game-changing start-up policy in December, to complement his “Start-up India, Stand up India” slogan. As “less government, more governance” gives way to more government in new areas, it is important to ponder what the role of a government can be in the innovation economy.

The numbers and slang are now well known: ₹ 3 trillion invested in roughly 3,000 start-ups in the past decade. There are more than 15,000 start-ups in the country. Start-ups that are valued at more than $1 billion are called unicorns. More than 90% of this funding in start-ups is by foreign venture capital funds. Forty percent of these start-ups are in Bengaluru. Eight out of the 107 unicorns in the world are India-originated or domiciled. These start-ups range from food technology in idli (ID Fresh Food (India) Pvt. Ltd) to space technology (Lunar X).

While the current hoopla is about unicorns that are mere pawns in the “greater fool” cycle of valuations, some of these new innovative companies have made an impact on job creation in the economy. Start-ups using technology to aggregate taxi services to food delivery generate hundreds of thousands of “gigs”, if not full-time jobs. This “gig economy”, as popularized in the US, can be substantially more vital in economies such as India, where net new job creation is abysmal. If there has been such an explosion of start-up activity over the past decade, driven entirely by the private sector, is there a need for government support or intervention at this stage?

The Rajasthan government’s start-up draft policy is 17 pages long and littered with cliches, such as “startup-bootup-scaleup”, “e-platform”, “virtual incubator” and so on, true to the technology industry’s notoriety for such jargon.

Shorn of the jargon, the policy is about creating infrastructure (incubators), human capital development, facilitating funding and ease of doing business. Surely, one’s beef about this could well be that all these are needed for any business. It is true that special economic zones (SEZs) for factories or “accelerators” for start-ups are essentially about state support for infrastructure. Perhaps, in the area of human capital, there can be a case made for minimal government interventions to breed innovation talent.

In states such as Rajasthan, where such ecosystems of talent do not exist, a positive external catalyst can potentially help. To be sure, the aim of creating fertile talent grounds for disruptive innovation is a lofty goal that is not easy to accomplish. Even in the US, attempts to recreate Silicon Valley in other states have not succeeded.

These governments also want to offer funding for such risky businesses and innovations. The Rajasthan start-up policy proposes using taxpayer funds to invest in early-stage venture capital funds to finance start-ups domiciled in the state. This follows the ₹ 2,000-crore India Aspiration Fund model that was launched by the Union ministry of finance recently.

This public venturing idea has been tried in various countries over many decades with limited success. One of the first such public ventures was the United States Small Business Investment Company (SBIC), started in 1958. SBIC drew criticism for its low financial returns and squandering of taxpayer money with the inevitable frauds and scams that accompany these programmes.

In India, where there is a thriving private venture capital industry that has kicked off an innovation industry already, direct government funding using taxpayer money in venture capital funds will likely be a reckless use of the public exchequer. The extreme risk-reward payoff matrix associated with venture capital funding of these businesses is ill-suited for governments to indulge in, using the taxpayers’ funds. At best, the state can provide indirect financing in terms of tax exemptions to start-ups domiciled in its territory.

Global experiences have proved that more often than not, these public venture programmes breed inefficiencies and frauds that outweigh any societal benefits. While there can be a case made for some light-touch role for government in labour markets and easing of business rules for the innovation economy, this temptation to be a financier of innovation must certainly be resisted.

Praveen Chakravarty is one of India’s earliest angel investors and co-founder of Mumbai Angels. He is currently a visiting fellow in political economy at the IDFC Institute, a think tank.

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