Start-Ups to the Rescue

by Jeffrey M. Jones
Thursday, January 14, 2010

We all wish the recession would go away. Unemployment remains high, the cascade of foreclosures continues, and, according to an ING Direct poll, even our love lives are suffering—nearly three in ten Americans (29 percent) report that economic woes have “added stress to,” “strained,” or even “ruined” their marriage or relationship.

It’s doubtful that the health care overhaul bumbling its way through Congress will improve the economy. Washington is distracted by visions of Obama Care when our focus should be on revitalizing business.

One remedy we can count on is entrepreneurship. Research by the Kauffman Foundation and others makes a clear case that entrepreneurs can help the economy.

Using U.S. Census Bureau data, researchers found that average yearly employment from start-ups accounted for 3 percent of total employment in 1980–2005. Without the introduction of new businesses, employment growth would have been negative during that same period. As national unemployment hovers around 10 percent, the value of entrepreneurship in providing jobs is clearer than ever.

Not only do start-ups deserve praise for alleviating unemployment, but they also are, on average, more productive than their established counterparts. Economist Joseph Schumpeter outlined the concept of “creative destruction,” in which firms that fail to innovate, cut costs, or become more efficient are replaced by new firms that increase productivity and drive long-term economic growth.

Entrepreneurs thrive in an environment where failure is tolerated. As Milton Friedman pointed out: “What we have is not a profit system; it’s a profit and loss system. The loss part is just as important as the profit part. An entrepreneur might have a really good idea, it may work. But remember, you’re gambling. That’s what makes it exciting, and that’s what makes it important. What rules out the mistakes is the possibility of making a loss.”

The forces of the marketplace that drive companies to compete and individuals to create are enhanced, not dampened, during recessions. According to a study titled The Economic Future Just Happened, “well over half of the companies on the 2009 Fortune 500 list began during a recession or bear market.” Economic downturns are fertile times for start-ups. Why?

High-skilled, unemployed people are willing to take risks in a start-up company because there are few other opportunities available. Recessions highlight inefficiencies in existing businesses and provide start-ups with a skilled labor pool seeking employment.

WORKING AT CROSS-PURPOSES

Entrepreneurship, if given priority, can help lead the United States out of the recession. But current government interventions work against entrepreneurs’ spirit and effort.

Recently, the federal minimum wage was increased to $7.25 (a 40 percent increase over the wage rate just three years earlier) and will disproportionately affect small businesses. Simultaneously, support for big business is increasing, and the government bailouts of General Motors and Chrysler have turned creative destruction into an uncreative scheme of subsidization, preventing the market from efficiently allocating resources.

It’s unrealistic to expect these policies to be reversed, despite their impact on entrepreneurship, but there are other innovative ideas for promoting entrepreneurship that stimulates growth.

Some of the most exciting work in entrepreneurship is taking place abroad. In an increasingly globalized world where ideas are not restricted by borders and free trade is more ubiquitous, this makes sense.

The Hoover Institution recently co-sponsored a conference titled “The How and Why of Promoting Entrepreneurship Abroad,” at which diplomats, economists, foreign-born entrepreneurs, and venture capitalists discussed the opportunities and barriers for starting businesses around the world. Several hopeful ideas surfaced.

First, in countries with minimal entrepreneurialism—where oligarchic regimes resist widespread reform—special economic zones are a viable option. In those zones, a different set of rules, institutions, and intellectual and physical property rights is created to encourage new businesses geared toward export production and driven by market forces. An ecosystem built for trade benefits entrepreneurs.

Second, where no legal framework for contracts and transactions exists, business languishes. Internet proliferation may address that barrier. Website owners have a vested interest in maintaining order on their sites and consequently create their own institutions to promote property rights and contract laws. Cell phones and laptops may do more for legal reform in developing nations than one could imagine.

Third, a unique model for promoting entrepreneurship in Italy has great potential for replication. The Partnership for Growth, spearheaded by the U.S. embassy in Rome, features four major initiatives designed to expand capital markets, strengthen intellectual property laws, connect entrepreneurs with academics whose profitable ideas and innovations currently remain undeveloped, and provide future entrepreneurs with internships in the United States during which they learn to emulate successful entrepreneurs.

Fourth, immigrants create a disproportionate share of start-ups in the United States. Under current laws, however, high-skilled immigrants are forced to return home if unemployed and are thus prevented from starting enterprises in the United States. This reverse brain drain hurts American interests and global welfare because many immigrants return to countries lacking political and economic environments conducive to entrepreneurism. Foreign-born nationals should be free to promote entrepreneurship both in the United States and abroad.

TRUTHS WITH GLOBAL SIGNIFICANCE

The key lessons about what works, what doesn’t, what helps, and what hinders entrepreneurship are equally true in the United States and around the world. The four proposals mentioned above are vital to our nation’s continued success in fostering markets, creating unprecedented prosperity, and stimulating innovation.

Special economic zones get at the imperative of establishing secure property rights. Internet proliferation demonstrates the necessity of rule of law. The Partnership for Growth highlights the impact of accountable institutions. Immigration reform acknowledges the significance of individual responsibility and liberty.

At the Hoover conference, Oracle president and keynote speaker Charles E. Phillips noted that “the first principle in government involvement in innovation should be to adopt the Hippocratic Oath: do no harm.” Set the ground rules and then let individuals create ideas, products, firms, jobs, and prosperity.