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January 30, 2005

Entrepreneurship and Democracy

Entrepreneurs as the revolutionaries of our time. By Pitch Johnson.


Entrepreneurship and democracy are closely linked because they are two dimensions of personal freedom. These and the other freedoms that are widely agreed upon in many societies as ideals are related to and reinforce each other. These freedoms are not really separate concepts but are all facets of the same diamond and inseparable over time. Entrepreneurs are revolutionaries because they use economic freedom to challenge existing economic, social, and political structures.
Facets of Freedom
A difficult balance is required so that the exercise of one kind of freedom in a society does not unduly diminish the exercise of the others. Nearly every country has a constitution, and many have laws, that supposedly both protect individual freedoms and limit them. The people in a working democracy, however they express their will, play the ultimate role in defining the extent of those freedoms.
Entrepreneurs, by exercising their economic freedom to serve markets as they see fit, are key players in promoting the political freedom that brings and sustains democracy. They constantly challenge the economic status quo. They give consumers wider choices because of the constant flow of new products and services, and those consumers cast their economic votes as to which companies succeed and which fail.
Business skills and markets should be the primary determinant of the success of young companies, but societies often impose some restraints on which markets new companies are free to serve and by what methods. Although some limitations on entrepreneurs are necessary to curtail business activities that are counter to public safety, a minimum of such limitations is vital so that goods and services can come to market and individuals can decide for themselves what they want to consume and at what price. This activity is very much akin to having the ability to vote for the politicians who will make the laws that govern, one hopes to a minimum, daily lives. The existence of one of these facets of freedom inevitably leads, over time, to the creation of the other. Restrictions on one, likewise, will lead to restrictions on the other.
Although a minimum of restraint is desirable, governments often do inhibit entrepreneurial actions that their societies believe to be deleterious to the freedoms or safety of other individual citizens. Some limitations are obvious, such as laws against murder and robbery or, more mundanely, the protection of contracts with means of redress. Other inhibitors, such as antitrust laws, protection for the environment, and regulation of the sale of various substances, are widely adopted but remain the subject of continuing debate, particularly the degree to which economic freedom is vitiated and increases in public well-being are limited.
Governments that go much further and keep entrepreneurs out of markets, regulate heavily how they are served, or make starting a company a bureaucratic nightmare are not acting in the interests of the societies who create them. They are weakening the individual freedoms of their citizens by limiting their selection of goods and services and inhibiting the challenge of entrepreneurs to the existing order. Citizens of democracies should choose governments that will not take away their own freedom to make decisions and have those decisions made instead by “wise people” in a central place who approach their duties, from both left and right, often in the name of helping the poor or public safety.
In the end a society has to find a balance among the several facets of freedom, normally thought of as political, personal, and economic freedom. Other freedoms or rights sometimes asserted as fundamental, such as freedom from want or the right to education, health care, or equal opportunity, are important but derivative because they depend heavily on economic prosperity, itself partly dependent on entrepreneurial activity, a function of economic freedom.
A study by David Birch at MIT more than 20 years ago and recent data from the United States Bureau of the Census suggest that all the net new jobs in the United States come from companies less than 10 years old. Such young companies are the work of entrepreneurs.
Entrepreneurs Foster Democracy
Successful entrepreneurs create new wealth and economic power and make it more difficult for the older generation to maintain its economic power and the political influence that goes with it. Democracy works best when there is this kind of turbulence in the society, when those not already well-off have a chance to climb the economic ladder by using brains, energy, and skill to create new markets or serve existing markets better than their older competitors. These ideas were expressed long ago by von Mises, Hayek, and Schumpeter, and the laboratory of human experience has both suggested and proved their hypotheses.
In countries that have given up on government ownership of most businesses, including most of the old socialist states, the entrepreneurs have filled the market voids and are strong forces promoting the other aspects of freedom, especially political freedom. China, for instance, seems to be moving, although glacially, toward more political debate and open democracy, and its many entrepreneurs are a clear force behind such moves. However, many industries in China are kept in the hands of the state and thus off-limits to the new energies, capital, and skills of entrepreneurial groups. Although economic freedom and political freedom are linked, it often takes time for one to lead to the other, especially where there is an undemocratic, entrenched form of government.
Entrepreneurs are important in fostering democracy because the opportunity to create entrepreneurial companies is widely available to people at all economic levels, even though this is untrue in many countries and completely true in none. It is reasonably true in the United States, where, at least in technological start-ups, people from all economic levels who have been able to obtain good educations have been successful. In more than 40 years of observing new technology companies, I have observed little correlation, among educated people, between inherited family wealth and creating successful companies. Although there are many examples of people from difficult family beginnings finding a way to succeed, poorer people often cannot take advantage of educational opportunities. The United States needs to solve this problem so as to harness the talents of as many people as possible. Widespread education is one basic component of a good entrepreneurial environment in any country.
In Russia, the time from the rebirth of entrepreneurship in the 1990s to the present is too short to draw any firm conclusions, but it appears that the broadly based availability of good education has brought forth entrepreneurs from families of all levels of economic, political, and social status.
The Entrepreneurial Climate
Broadly based education, however, is just one element of an environment that fosters entrepreneurs. Another closely related one is the availability of a pool of talent and knowledge, which implies that there must be not only a good general education but education in science, engineering, and the various skills of business. A large fund of scientific and technical knowledge must also be available for potential entrepreneurs to draw on, which means active research in science by academic institutions, business, and government.
Another element is a moderate tax rate for businesses and individuals so that money earned can be kept and capital built. Venture capital is also vital to fostering the founding and growth of new businesses, providing not only money to young businesses but sophisticated help and advice. Commercial banks willing to lend to smaller businesses are also vital for short-term finance. An active investment banking sector, coupled with public stock markets, gives successful, growing companies access to large amounts of capital and entrepreneurs and their investors a pathway to liquidity.
Underlying all these elements is a system of laws and courts to establish and protect private property and contracts, create workable business entities, protect competition, and provide bankruptcy procedures for companies who fail.
One final element is a broad acceptance of the fact that entrepreneurs are engaged in an activity that is admirable and vital to the success and growth of a country.
Conclusion
Entrepreneurs will form companies if permitted and protected by the legal system. Other conditions foster entrepreneurial growth, and governments can play a role in establishing those conditions. By being able to exercise their economic freedom, entrepreneurs reinforce political and personal freedoms and are an important force in establishing and maintaining an open democracy. Entrepreneurs are the revolutionaries of our era.

Franklin Pitcher Johnson Jr. has been a venture capitalist in Palo Alto, California, since 1962 and is a lecturer in management at the Stanford Business School. He has been active in establishing venture capital and entrepreneurial activity in Central and Eastern Europe since 1990. Johnson served on the Hoover Board of Overseers from 1998 to 2001.


Adapted from a speech at the Russian Venture Fair in St. Petersburg on October 8, 2004.

Available from the Hoover Press is Property Rights: A Practical Guide to Freedom and Prosperity, by Terry Anderson and Laura Huggins. Also available is Leviathan: The Growth of Local Government and the Erosion of Liberty, by Clint Bolick. To order, call 800.935.2882 or visit www.hooverpress.org.