The Bear's Lair: The entrepreneurship cult

By MARTIN HUTCHINSON  |  Sept. 13, 2004 at 1:53 PM
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WASHINGTON, Sept. 13 (UPI) -- Presidential candidates George W. Bush and John Kerry are agreed on very little, except on the one issue that has become the motherhood-and-apple-pie of modern U.S. politics: entrepreneurship. Both candidates seek to encourage it and offer micromanaging policies that would do so. Like most politicians' economics, this may be wrong.

Entrepreneurship is important to candidates in 2004 because of two factors: the Bush tax cuts and the long term budget deficit. Bush needs a surge in entrepreneurship to create jobs and thereby demonstrate that his cuts in marginal tax rates on high incomes weren't just a handout to the rich but achieved something beneficial for the economy. Both candidates think they need a surge in entrepreneurship because the only way the Federal budget can be brought back close to balance is by a surge in productivity growth, which causes the U.S. economy to grow and increases tax revenues, and entrepreneurship is thought by politicians to stimulate innovation and thereby productivity growth.

The cult of entrepreneurship was demonstrated this week at two meetings: at the Center for Global Development Wednesday, where Liliana Rojas-Suarez discussed on behalf of the Latin America Shadow Finance Regulatory Committee how to produce more entrepreneurship in Latin America, and at the National Economists Club Thursday, where Robert Litan of the Ewing Kauffman Foundation discussed how to develop more entrepreneurship in the United States. Both speakers see entrepreneurship as a "magic bullet" that produces economic growth and general welfare, and both believe in intense mechanistic activity by government and the non-profit sector as a means to create such entrepreneurship.

The behavior of U.S. multifactor productivity in the relatively un-entrepreneurial and high marginal tax rate environment of 1947-73, compared to its behavior in the entrepreneur-worshipping 1990s, demonstrates that entrepreneurship does not produce productivity miracles, and may not therefore be the solution to all life's ills. (Multifactor productivity is a better measure than labor productivity of the true contribution from innovation, because it strips out the contribution of capital, which of course was available in deluging, tsunami-forming quantities in the late 1990s.)

Multifactor productivity growth averaged 1.91 percent per annum in 1948-73, minus a tiny 0.01 percent per annum in the sluggish decade of 1973-83, 0.71 percent per annum in the recovery decade of 1983-93, and 0.76 percent per annum in 1993-2001, the latest year currently available. No great increase after 1993 in other words.

The drop in 1973-83 is readily explicable; one of the major inputs into the U.S. economy, energy, quadrupled in price in 1973, and it took a decade to rebalance the economy to fit the new circumstances. The most remarkable statistic is that multifactor productivity growth in the years of the "miracle" after 1993 was less than half that of the quarter century 1948-73.

You can also compare multifactor productivity across eras by looking at periods which stretch across similar parts of the economic cycle; multifactor productivity, as one would expect, tends to decline during recessions and to be highest in the early years of long expansions. Hence, for comparison purposes, we can use three seven-year periods which stretch over similar economic territory: 1992-1999, 1982-1989 and 1960-1967. All three of these periods stretch from near the bottom of a recession to near the top of the long subsequent boom; they are thus as far as possible comparable.

Across the whole economy, multifactor productivity grew at an annual rate of 2.72 percent in 1960-67. This annual rate declined to 1.46 percent from 1982 to 1989, and declined further to 0.81 percent from 1992 to 1999.

Thus the rate of multifactor productivity growth declined from the 1960s to the 1990s, even as the level of entrepreneurship rose. This may be surprising to policymakers, but should not surprise us. Entrepreneurs are not the main innovators in the economy, because the character traits needed for successful entrepreneurship are not those that lead to great innovations. If you examine the top 25 on the "Forbes 400" list of the richest people in the United States, you find a lot of entrepreneurs, and heirs of entrepreneurs, but few great innovators.

In the 2003 listing (the most recent available) Bill Gates and Paul Allen, the founders of Microsoft, are numbers 1 and 3, while Steve Ballmer, its current chief executive officer, is number 11. Microsoft is a huge business success story, in many ways a model to others, but a famously un-innovative company; its two great successes were DOS, bought for $50,000 from a third party vendor and Windows, heavily dependent on software developed at the Xerox Palo Alto Research Center in the 1970s. Gates and Allen are entrepreneurs; Ballmer is a manager -- he joined Microsoft in 1980, five years after its formation.

No. 2 is Warren Buffett, a genius investor but not an innovator; he got his start by managing money for contacts and friends of his father, a Nebraska Congressman.

Nos. 4 though 8 are the five heirs of Sam Walton, the founder of Wal-Mart. Wal-Mart's central idea, the low-price warehouse store, had been done many times when Sam Walton opened the first Wal-Mart in 1962 (the New York discounter E.J. Korvettes, for example, was founded in 1946.) Wal-Mart did it better than others, and was the first to focus on rural and small-town areas, but it's difficult to see any substantial novelty there.

No. 9 is Larry Ellison, founder of Oracle. Oracle was NOT the first database software.

No. 10 is Michael Dell. Dell was the first to sell computers through mail order, technically an innovation, but it is impossible to believe that, had Dell not existed, somebody else wouldn't have tried it.

Nos. 12 and 13 are the heiresses to Cox Communications, the cable TV company. No great entrepreneurial innovation there; success in the cable TV business consists mostly of developing good relations with local politicians.

No. 14 is John Kluge, owner of Metromedia. The company made its first successes by running television stations independent of the three major networks. New, but not innovative.

No. 15 through 17 are the three Mars heirs. I am only too fond of Mars products, but it's a stretch to define the invention of the Mars bar as a great leap forward for mankind.

No. 18 is the heiress to Fidelity mutual funds. Very successful business, but only modestly innovative (you could reasonably define John Bogle of Vanguard as an innovator, for pioneering the no-load index fund, but he's nothing like this rich.)

No. 19 is Sumner Redstone, majority owner of Viacom. Another media tycoon, not notably an innovator.

No. 20 is Charles Ergen, founder of EchoStar. Here at last is a plausible innovator; a former Frito-Lay financial analyst, he formed the company in 1980 to broadcast satellite television to rural areas. I think this counts as a genuine innovation, if a minor one.

Nos. 21 and 22 are the Newhouse publishing heirs, owners of USA Today, the U.S.'s first nationwide daily newspaper. Borderline case: Sam Newhouse, the founder of the family company, died in 1979, before USA Today was established.

Nos. 23 and 24 are the Pritzker heirs, owners of Hyatt hotels, among other things. I like Hyatts, but their distinctive feature, the central multi-story atrium, was invented by John Portman, the architect, and not by the Pritzkers.

No. 25 is Samuel C. Johnson, fifth generation heir of S.C. Johnson & Son. (Johnson Wax). S. C. Johnson is responsible for a number of innovations -- Raid insecticide, Off insect-repellant, Pledge cleaner -- but they were all developed after the company became well established and not by the original entrepreneur.

So there you have it, the 25 richest people in the United States, almost all of them entrepreneurs or heirs of recently deceased entrepreneurs (20 years ago there would have been much more "old money" in that list.) None of them, however, were great innovators, and only a few were significant innovators. Entrepreneurship is thus neither a necessary nor a sufficient condition for innovation.

If entrepreneurs are responsible for only a small fraction of the world's innovation, an excessive focus on entrepreneurship has substantial adverse side-effects on the economy as a whole. By increasing "churn" in the corporate environment, it reduces productivity in four ways. First, the fraction of time employees must spend worrying about their job security is greatly increased. Second, the periods of unemployment between jobs are sheer "dead weight" on the economy -- the unemployed produce very little -- and are very damaging indeed to the sufferer's financial security and retirement prospects. Third, the substitution of entrepreneurial "carrots," such as stock options, for universal benefits such as good health care and pensions is damaging to employee security and produces an unhealthy focus on short term accounting chicanery over long term growth.

Finally, the entrepreneurial culture is itself destructive of business ethics. Tony Soprano, the fictional Mob boss, is a typical entrepreneur in his ability to move quickly, his ruthless pursuit of financial gain and his willingness to cut ethical corners or even to ignore ethics altogether. William Shockley, the inventor of the transistor, failed at entrepreneurship -- Shockley Semiconductor was a marvelous incubator of future Silicon Valley talent, but failed financially and was sold within 5 years of its formation. Most successful entrepreneurs, in truth, are much closer in personality type and attitudes to Soprano than to Shockley.

The "hunger," aggression and flexibility so celebrated by writers on entrepreneurship frequently take the form of attempts to reap illicit rewards. For example since 1994 many high-tech companies, through stock option schemes, have diverted more than 100 percent of their profits from outside shareholders to inside management.

This does not generally happen in large corporations; internal control systems are good enough to prevent management from stealing from the company and (once the stock options accounting loophole has been closed) external public company control and accounting systems are generally good enough to prevent management from stealing from shareholders. The cult of entrepreneurship is however pernicious even within such corporations, since it results in excessive rewards for management and excessive insecurity for the workforce.

In Latin America, more entrepreneurship is desirable, to create jobs and build wealth. It will be achieved not by government programs, still less by aid agency loan schemes, but by a proper national regard for middle class savings, the source of almost all entrepreneurial capital in such societies, which have been consistently subject to looting and expropriation by Latin American governments. This prescription, which allows very little role for aid agency meddling, is unattractive to interventionist bureaucrats, but in the final analysis the rights of middle class savings, not entrepreneurship itself, are what a free market economy is all about.

In the United States, we have plenty of entrepreneurship, and too many entrepreneurs. Young people who would be much better employed as researchers and thinkers are being encouraged to take a route for which they are not well suited and dissipate their lives in entrepreneurship that wastes their unique skills and is unlikely to succeed. In an era when, as reported in Thursday's Wall Street Journal, a company can be sold to five successive private equity funds in a decade, each time at an increasing price, it is also clear that too much U.S. capital is being devoted to this silly game.

A lengthy recession, if moderate (thus, not involving a collapse of business confidence such as happened in the 1930s) will be highly beneficial. It will re-dedicate the human resources of entrepreneurship to productive research, and the financial resources of the venture capital industry to more economically useful and profitable outlets. A more balanced, more stable and more ethical U.S. economy will be the result.

(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2004) -- details can be found on the Web site

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