Stephen Harper, state venture capitalist

Stephen Gordon: what's the problem the Venture Capital Action Plan is supposed to fix?

(Ryan Remiorz/CP)

To be blunt, Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments instead.

Prime Minister Stephen Harper, December 7, 2012

We will provide the resources needed to put Canada’s venture capital industry on the path to sustainability and ensure Canada’s high-potential firms have the resources they need to succeed.

Prime Minister Stephen Harper, January 14, 2013

Today’s announcement of the Venture Capital Action Plan (VCAP) is a great example of a policy solution in search of a problem. In point of fact, the Prime Minister’s announcement didn’t actually explain what the problem was that the new program was to solve; that was left to the press release issued by Canada’s Venture Capital and Private Equity Association (CVCA):

[T]he domestic pool of capital allocated and available for venture capital has decreased and significantly lags the demand for venture capital, and as a result, far-reaching measures, such as those announced today, are called for

Now, I was expecting a description of some sort of market failure — an externality, or some sort of institutional quirk — that government intervention could correct, and some sort of explanation of why the VCAP could be expected to do the job. But that’s not the case. An excess demand for venture capital (VC) is not in itself a market failure.

Especially since there’s a very plausible explanation for why venture capital is in such short supply. According to this recent report from the Kauffman Foundation:

[i]ndustry returns data show that VC returns haven’t beaten the public market for most of the past decade, and the industry hasn’t returned the cash invested since 1997

So there’s a perfectly sensible market-based reason for the shortage of venture capital: VC returns are too low. In a market economy, the excess demand for venture capital would be closed by a price adjustment: entrepreneurs would be obliged to accept smaller injections of capital, would have to offer more control of their firms, or some combination of the two. But in Canada, the gap between supply and demand is closed by the government.

This is my favourite part of the press release:

The Government is currently asking potential investors to signal their interest in co-investing in new or existing funds of funds

Uh, yeah. Let’s think about this for a minute. As I noted above, an important dimension of a VC agreement is the degree of control. Let’s also assume that a government that is so averse to governments — Canadian or foreign — having an ownership stake in Canadian firms will be uncomfortable demanding a controlling interest in the new firm. What sort of investor would give their money to a VC entity that chooses to negotiate with one hand tied behind its back?

There is no obvious problem with the VC market that a price adjustment can’t solve. Throwing $400 million at the market will provide a windfall for some lucky entrepreneurs — not to mention the consultants and lobbyists hired to steer the proposals through the bureaucracy — but that’s about it.

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