Scott Shane seems to delight in sharing harsh realities about entrepreneurship and economic development.
Shane, a Case Western Reserve University economics professor who authors a regular column for Business Week, castigates a culture that promotes a “naive view of entrepreneurship and starting businesses” in his 2008 book “The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By.”
The reality is very, very few entrepreneurs are successful. “We overinflate the positives and talk only about a small group of extremely successful start-ups like Apple, Google and Federal Express, but ignore the much larger number that fail,” he said in an interview with Case’s news center to promote the book.
The reality is older companies create more jobs than young ones. “Putting money into the typical new company is a worse use of resources than putting it into the typical older company,” he said. “Only 45 percent of new firms last five years.”
Those aren’t exactly the types of messages that startups seeking government handouts or politicians chasing easy votes like to hear.
In the Q&A below, Shane, whose title is the A. Malachi Mixon III professor of entrepreneurial studies, expands on his ideas on economic development and entrepreneurship.
Q: What policies do you advocate governments implement to best support entrepreneurs?
A: Most economists believe that the government should intervene in markets only when markets do not work properly. For instance, we need government funding of basic research because businesses cannot capture the full value of the returns to their investment in basic science. Therefore, they underinvest in basic research. If the government didn’t intervene, we wouldn’t have the basic research on which many new technologies are built. Without government-funded research, there would have been no Internet and no subsequent Internet-based businesses.
Q: What do you see as the major problem with government entrepreneurial support programs, such as Ohio’s Third Frontier?
A: The state government doesn’t limit its intervention to market failures. It responds politically to demands for help. Everyone likes a subsidy when it’s given to them. So policy makers hand out a lot of unnecessary subsidies to all kinds of entities when the private market is functioning just fine.
There are two problems with this strategy. First, every time the government intervenes, it distorts the market place. People may not notice but the angel capital market in Ohio doesn’t function normally because the state intervenes heavily in the market. The incubator market doesn’t function normally because the state intervenes. If you intervene to change a market transaction, there will be some cost, even if it is not obvious to those in the market.
Second, everything has an opportunity cost. If you subsidize something, the money had to come from somewhere. So if you spend money on organizations to promote startups, either you have to raise taxes and hinder entrepreneurial activity that way or you have to take money from some other program. No one ever says, “‘Let’s take money from early childhood education to create early stage investment companies.” But that’s what you do. And no one says, “If we educate X-number more kids how much more benefit would we get than by stimulating one additional start-up.” But that’s what’s actually happening.
Do we get more jobs created from spending money on the program or by eliminating the program and cutting taxes on startups by an equal amount? We don’t know because the state and the recipients of the money don’t measure the effect of programs. Instead of doing a proper analysis of the effect that funding a startup has on job creation, everyone relies on multipliers. The problem is that everything has an economic multiplier. (The fact that the state of Ohio is a presidential battle ground state has a high economic multiplier. Think of the economic impact that occurs when the president flies into town and goes to an ice cream shop as part of the campaign. The secret service has to come in and secure everything. Air Force One has to refuel. The reporters have to eat. The camera crews need to ship equipment here, and so on.)
What you really want to know is what the marginal effect of a dollar of government funding is on job creation. You will only get that if you carefully compare a matched sample of recipients of funding and non-recipients of funding and see how many more jobs the recipients create.
One reason that policy makers and the support organizations that receive funding resist these studies is that there is a good chance they will show that the programs have little effect. It’s politically more effective to use studies with poor research designs to justify government programs than to take a chance that a proper investigation will reveal the true value of the programs. Few people understand the difference, so there is little upside and a lot of downside to the champions of the programs. The big loser, of course, is the taxpayer.
Q: You argue it’s a myth that creating more startups will transform struggling economic regions, create innovation and job growth. Why is that, and how does it harm a region like Northeast Ohio when people buy into this myth?
A: It’s opportunity cost again. If we fund a bunch of programs that do nothing, and that comes at the expense of programs that do something, we’ve lost the opportunity to fund something valuable.
The evidence on startups indicates that greater volume of new companies does little to create economic growth or innovation. If you think about it for a minute, you can see why. Suppose everyone who worked for Eaton quit and started a business. We would have a lot more startups in the region because a lot of people work at Eaton. But that would reduce the value of Eaton.
For this trade-off to make sense, the people who work at Eaton would have to be more productive if they did not work for Eaton than if they did. But we know that there are benefits of economies of scale and scope, learning curve effects, and a host of other things that come from organizing big businesses as big businesses. After all, if replacing Eaton’s workforce with thousands of start-ups was more productive than keeping Eaton the way it is, then why aren’t Eaton’s shareholders, senior management, and board breaking the company into thousands of self-employed independent contractors?