20 June 2014

Economic Panacea: Start with US Private Sector and UK Public Sector Policies to Promote Entrepreneurship

The International Monetary Fund and Federal Reserve have both made downward revisions to economic forecasts this week. The IMF doesn’t think the US will reach full employment until 2017.[1] If that’s right, it will mean that full recovery took nearly a decade.

It doesn’t have to be that slow.

A couple of years ago, the IMF warned the UK against austerity measures, predicting that the UK’s economy would grow by only 0.7% in 2013. Instead, actual growth came in at 1.7% and is, this year, predicted to hit 2.7%.[2]

So why, even as it was raising taxes and cutting spending, did the UK pull out of a double dip recession? Contemporary economic thought would predict what the IMF did: that sort of policy will drag GDP growth down.

Well contemporary, proven economics suggests that the best way to stimulate an economy in – or recovering from – recession is through a combination of fiscal and monetary policy. Cut taxes. Increase government spending. Lower interest rates. Have the central bank buy back bonds, putting more cash into the economy. And for the most part, the short-term evidence is pretty clear that this helps to stimulate an economy. To a degree.

Banks with more money might simply add to their reserves. Households with more cash from tax cuts might just pay down debt. Corporations with more money might just sit on it. And in fact, in the US these very things happened. Corporate cash and equivalents rose to nearly $5 trillion by the end of 2011[3]. $5 trillion. As of June 11, 2014, excess reserves at American banks was $2.6 trillion,[4] going up roughly $2 trillion since early 2009. And households were paying down debt, reducing their debt service to the lowest it’s been since the Fed began keeping track in 1980. [5] Economists use the image of pushing a string to illustrate the challenge of translating credit into spending. And of course if spending doesn’t go up, it’s hard to create new jobs.

The UK did something else. Or more precisely, something more.

It’s not that the British don’t understand the importance of credit and monetary policy. This is the country that gave the world the model for central banking. John Kenneth Galbraith said of the Bank of England that it is in all respects to money what St. Peter’s is to the Faith. The Bank of England was founded about a century before the Bank of France and about two centuries before the US Federal Reserve. The first to rely on monetary policy, the British may have become the first to realize that there are more direct ways to go after job creation, that while monetary policy matters it is not enough. Pioneers in patent law, central banking and the modern corporation, the British may once again be ahead of us in economic policy.

You can make credit easier, hoping that households and businesses will spend more, thus creating jobs. Or you can fund startups directly, cutting out the uncertainty and the middlemen. Rather than push the string you can pull it. This is what the UK appears to have done as they confounded the able economists at the IMF. It is what the US could do as well to beat forecasts.

Measured by startup activity, the US at the end of 2012 was still below its 2007 level. By contrast, the UK was up 29%.[6] Even during its second dip, its second descent into recession, the UK’s startup activity rose from 117% to 126% of its 2007 level. During that same time the US – even as it avoided a second dip – nonetheless had a drop from 98% to 95% of its 2007 level.

Even during the recession, the US media and pundits seemed critical of funding for startups or expansion. By contrast, by the end of 2013 the UK had help to fund 10,000 startups.[7] This in just its first 18 months of their startup program. The plan is to help fund 30,000 startups. The same ratio of startups in proportion to the US population would be a plan for 150,000 startups. If we had the same program, we’d have helped fund 50,000 startups through the end of 2013. This sort of stimulus would inescapably create jobs and increase spending. It could confound expert forecasts for economic growth.

Opponents of government funding for startups say that the government shouldn’t pick winners or losers. Well, it’s too late to avoid that. The government chooses which kids go to university and which kids go to jail. The government chooses which defense contractors become huge and which go out of business, which businesses get subsidies and which pay taxes. Governments inescapably choose winners and losers. But in the process of choosing which firms to help fund, they can directly create jobs and even industries.

Funding startups is just one tool that could be used for creating more entrepreneurs. There is good reason to believe that the limit to progress has shifted from a shortage of capital – the limit during the Industrial Economy – or shortage of knowledge workers – the limit during the Information Economy – to a shortage of entrepreneurs. If so, the economic lead will go to the communities that do the most to popularize entrepreneurship, making it more common. Last century in the West, economies popularized knowledge work, moving from an Industrial Economy based on child labor in 1900 to an Information Economy based on adult education by 2000. Something similar could happen in this century with entrepreneurship, but it will take a combination of private and public sector initiatives.

The private sector in the US is doing a remarkable job of popularizing entrepreneurship. An average of 325 crowdfunding campaigns start daily.[8] And that rate is doubling every couple of months. Few people realize that to create a net of 200,000 new jobs in a month, the American economy has to create about 4.7 million jobs given the gales of creative destruction are destroying 4.5 million jobs a month. Just as the capital of the Industrial Revolution freed up people from manual work, enabling – and requiring – them to take on knowledge work, the algorithms and software of the Information Economy have enabled (and yes, is increasingly requiring) modern workers to take on more entrepreneurial roles. Work has to change to keep pace. As the pace and scope of automation increases, so must the innovation that creates new products, new companies, and new industries that provide jobs even as automation destroys them. The American private sector – from venture capitalists to kickstarter – are helping to popularize entrepreneurship. Progress in the public sector seems less obvious.

This week the Obama administration has a week-long focus on innovation. Uber has recently made news for sparking riots in Europe. Uber uses information technology to match people with cars to people who need rides. Uber doesn’t need to buy cars, just offer a fee to drivers with cars. Taxi drivers are losing market share to Uber and are protesting. Airbnb does something similar, matching folks with a spare bedroom and folks who need a place to sleep. These businesses don’t require more investment. They use the spare capacity of existing investments. Obama is doing something similar to Uber and Airbnb, opening up federal facilities to entrepreneurs.[9] NASA wind tunnels and supercomputers are among the assets that could be used by folks who could never afford to make such huge investments but could benefit from their use. This could help to stimulate new businesses and products and – given it requires no new funding - is a fairly ingenious way to work around an obstructionist congress

This is nice but it isn’t much.

It is tempting to believe that de-regulation is one way to stimulate entrepreneurial activity. And it’s likely true that – all else being equal – a community that puts up fewer obstacles to starting a business will have more startup activity. But one study of 150 successful entrepreneurs within the US revealed that regulatory environment was mentioned as a factor by only 2%.[10] More important was access to a talented workforce and customers and a community they thought offered a high quality of life, typically measured by natural and cultural attractions. (And quality of life didn’t just make a place desirable for the entrepreneurs: it helped to attract and keep the talented workforce they seek.) San Francisco and New York are two metropolitan areas that are not only expensive but challenge entrepreneurs with expensive permits and require payments to dozens of tax authorities. By one measure, San Francisco’s regulatory environment is twice as onerous as Dallas. And yet, of course, San Francisco’s entrepreneurial activity is booming. And New York is second only to San Francisco in startup activity.

California’s Bay Area is not only number one in the US in terms of startups but it is increasing pay at a time when pay across most of the US is stagnant. In San Mateo County (located at the heart of startup activity between San Francisco and Palo Alto) employees not only saw their salaries go up by more than 10% between September of 2012 and September 2013 but within the IT sector, salaries went up over 100%. When Henry Ford doubled wages to $5 a day in 1913, it rightfully got a huge amount of press; by contrast, this doubling of wages a century later went oddly un-reported.

During the Industrial Economy, employees made products. During the Information Economy they designed them. Now, in Silicon Valley at the dawn of the Entrepreneurial Economy, employees are making equity. For a long time, New York had the highest wages in the country because of Wall St. Now, employees in high-tech – and venture capitalists on Sand Hill Road – have shifted coasts for highest salaries. 3 of the top 4 top-paying counties in the US are in California’s Bay Area.[11] While New York County’s average weekly pay is double the national average, in San Mateo County it is nearly triple (2.7X) the average.

There is another element as well. Invention depends on a disdain for tradition and respect for what works for the individual. Places like Santa Cruz, San Francisco, Austin, Texas and Boulder, Colorado lead the nation in patents per capita and in startups. These are places with a liberal bent and a high degree of tolerance for what we might call non-conformists. It's not just entrepreneurs and programmers who are happy here but hippies, communists and transgenders. This suggests that a community embraces innovation as package – whether it come in the form of same-sex marriage or an app. Entrepreneurship is a form of social invention and social conservatives who prefer the status quo aren’t comfortable with innovations that disrupt the norms they’ve known all their life, whether those norms define the role of women or how someone sends a letter.

In any case, de-regulation doesn’t seem like policy enough. It certainly isn’t what is driving up wages and startup activity in California’s Bay Area.

From The Fourth Economy: Inventing Western Civilization
Market Economy
Limit to Progress
First, Agricultural
Land, natural resources
1300 ~ 1700
Second, Industrial
Capital, Financial and Industrial
1700 ~ 1900
Third, Information
Labor, knowledge workers
1900 ~ 2000
Fourth, Entrepreneurial
2000 ~

It’s possible that a new, entrepreneurial economy is emerging, a new economy limited by entrepreneurship in the same way that the Industrial Economy was limited by capital. This new economy will be led by communities most intent on popularizing entrepreneurship, just as the Information Economy of the last century was led by communities most successful at popularizing knowledge work. Popularizing knowledge work took a mix of public and private sector policies and initiatives. The iniatives included social inventions (e.g., modern universities and corporations) and technological inventions (e.g., Information Technology from telegraphs to the Internet) that helped to create knowledge workers and make them more productive. The popularization of entrepreneurship will require a similar mix.

Judging from regions like Silicon Valley, the US seems to lead the world in terms of private initiatives to popularize entrepreneurship. But judging from stimulus policies like funding startups, the UK may well lead in terms of public policy. It would be nice to get a blend of the two.

In any case, the attention paid to entrepreneurship is miniscule in comparison to that paid to the more traditional tools of fiscal and monetary policy. Google’s Ngram’s demonstrate how little mention it gets.

In this first graph, two of the most frequently mentioned policies related to entrepreneurship are graphed since 1900. The great news is that there has been a sharp upturn in mention of “promoting entrepreneurship,” and “entrepreneurial education” in books in just the last few decades.

But to put things in perspective, here is a graph showing those same terms compared with mention of monetary and fiscal policy. As you can see, entrepreneurship barely registers.

Unsurprisingly, in Obama's most recent annual report, entrepreneur (or entrepreneurs or entrepreneurship) is mentioned only 6 times in 410 pages. One party largely ignores entrepreneurship. The other thinks the simple solution to more entrepreneurship is less regulation. In a country defined by polarized politics there seems to be one thing the two parties have in common: both seem to believe that benign neglect is the route to entrepreneurial success.

If entrepreneurship now limits progress just as capital did during the Industrial Economy, it only makes sense that communities at every level – from cities and small businesses to nations and corporations – and in every sector – from private to public and non-profit – embrace every experiment that promises to create more entrepreneurs and make employees more entrepreneurial. It might be time for us to watch entrepreneurial activity as closely as we watch the monthly jobs reports and quarterly GDP growth. Because now, more than ever, jobs and GDP are going to be the products of entrepreneurial activity. It’s not enough to hope that entrepreneurs will show up. We need to become as intentional about creating them as we did knowledge workers last century. And once we define the problem of economic growth that way, we’ll find a thousand ways to solve it and to make progress – just as we did during the earlier industrial and information economies.

[1] http://www.chicagotribune.com/business/sns-rt-us-imf-usa-20140616,0,6883507.story
[2] http://www.telegraph.co.uk/news/politics/10884632/Do-I-have-to-go-on-my-knees-grovelling-apology-from-IMF-head-for-incorrect-warnings-on-UK-economy.html
[3] https://www.stlouisfed.org/publications/re/articles/?id=2314
[4] http://www.federalreserve.gov/releases/h3/current/
[5] http://rwrld.blogspot.com/2014/05/spending-is-up-but-debt-is-down-this.html
[6] http://stats.oecd.org/Index.aspx?DataSetCode=TIMELY_BDS_ISIC4#
[7] http://startups.co.uk/start-up-loans-backs-10000th-small-business/
[8] http://www.entrepreneur.com/article/234426
[9] http://www.post-gazette.com/local/city/2014/06/17/Obama-to-tout-entrepreneurship-during-Pittsburgh-visit-today-1/stories/201406170142
[10] http://blogs.hbr.org/2014/06/deregulation-wont-improve-entrepreneurship/
[11] http://www.bls.gov/news.release/cewqtr.nr0.htm

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