Commentary

Rethinking the Company We Keep

This aritcle appeared in the The Orange County Register, January 22, 2007.
“The movement that built the first national democracy was not triggered by an uprising of the masses; nor was it led by intellectual theorists. It was led by entrepreneurial men of means … . In fact, starting a business develops precisely the traits that make democracy work. It requires independence, much effort, and self-discipline – but also the ability to work with others and the recognition that you can only succeed by serving the needs of others.”

- Carl J. Schramm, “The Entrepreneurial Imperative,” p. 161

Carl Schramm’s thesis is that entrepreneurialism is as important to American culture as it is to our economic vibrancy. By the same token, in order to live in a congenial world, it is as important for the United States to export entrepreneurialism as it is to export democracy.

Compared with the United States, other developed countries, particularly in continental Europe, put up more regulatory impediments to entrepreneurs, particularly the important subset of entrepreneurs that I will define below as change agents. In underdeveloped countries, regulatory impediments are compounded by crime and corruption, creating an environment even less conducive to entrepreneurship.

Defining Terms The term “entrepreneur” has at least two connotations. The term could describe someone who launches a new enterprise. Alternatively, an entrepreneur could be defined as someone whose income is at risk in a business.

My preference is to require that a person satisfy both connotations in order to be called an entrepreneur. To my way of thinking, an innovator who develops a new product within the safe confines of a university, a government agency, or an existing corporation is an intrepreneur, not an entrepreneur. Someone who has a very high degree of risk and accountability but who did not launch the business is a hired executive, not an entrepreneur.

An important subset of entrepreneurs (and of intrapreneurs) might be termed change agents. A change agent’s new enterprise defies conventional wisdom and habits in some important way. Famous entrepreneurs, from Thomas Edison to Steve Jobs, are change agents. Change agents encounter resistance from people who are unwilling or unable to see the benefits of innovation.

Most entrepreneurs are not change agents. More typically, entrepreneurs own individual franchises, small retail stores and just about anything else that you would find in a typical strip mall. These businesses require dedication, risk tolerance, and hard work to operate, but they do not depend on or attract change agents to launch them.

Continental Europe

Edmund Phelps is the 2006 winner of the Nobel Prize in economics. Shortly after his award was announced, Phelps published an essay on how capitalism in the United States differs from the system in continental Europe. Phelps wrote:

“There are two economic systems in the West. Several nations – including the U.S., Canada and the United Kingdom – have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, as in pharmaceuticals, much comes from start-ups, particularly the most novel innovations.”

The other system – in Western Europe – though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of “stakeholders” and “social partners.” The system’s institutions include big employer confederations, big unions and monopolistic banks.

In continental Europe, large banks control the bulk of investment. The United States has a more vibrant stock market, many more banks, venture-capital firms and other financial channels.

In continental Europe, large established firms have access to funds from the large banks, but newer enterprises have a much more difficult time raising money. In the United States, the more competitive financial system gives more opportunity for entrepreneurs to raise start-up capital. In continental Europe, labor market regulations serve to keep small businesses small and to ossify the work forces at larger companies. In the United States, it is much easier for new businesses to expand and for old businesses to shed unnecessary workers.

European government policies sacrifice economic dynamism to other goals. For example, Joseph H. Golec and John A. Vernon recently wrote, “EU countries closely regulate pharmaceutical prices whereas the U.S. does not. … In 1986, EU pharmaceutical [research and development]exceeded U.S. R&D by about 24 percent, but by 2004, EU R&D trailed U.S. R&D by about 15 percent. During these 19 years, U.S. R&D spending grew at a real annual compound rate of 8.8 percent, while EU R&D spending grew at a real 5.4 percent rate. Results show that EU consumers enjoyed much lower pharmaceutical price inflation, however, at a cost of 46 fewer new medicines introduced by EU firms and 1,680 fewer EU research jobs.”

Continental Europe is set up to preserve large public sectors, large banks, and large corporations. For individuals, the promise is stable jobs, a stable business environment, and collective sharing of the costs of unemployment, retirement, and health care. For the economy as a whole, however, the result is stagnation, inefficiency, and a burden on the working population to support the unproductive sector that is becoming increasingly unsustainable.

Over time, Europeans with entrepreneurial inclinations will be increasingly tempted to emigrate to the United States or other English-speaking countries. Among the remaining Europeans, political support for welfare-state policies will solidify, even as the economic viability of those policies slips further.

Crime and Corruption

An entrepreneurial culture can emerge only in a setting where private property enjoys protection. When government fails to prevent crime, or when government corruption and expropriation serve the same functions as crime, the price for entrepreneurs is steep. A recent New York Times story summarized research done by a number of international agencies on the cost of crime in Latin America.

Years of rampant violent crime is not only robbing Latin America of significant private investment, but in some cases is stealing up to 8 percent from national economic growth, economists and World Bank officials say.

“You have money spent on guarding stuff rather than making stuff,” said Michael Hood, Latin America economist for Barclays Capital.

Much of the cost of government corruption is inflicted on start-up businesses. The World Bank and Canada’s Fraser Institute have both documented the difficulties of doing business in many underdeveloped countries.

The Ethics of Growth, Once Again

I have written that a nation’s prosperity depends on three ethics: a work ethic, a public service ethic and a learning ethic. The work ethic means that people believe that those who are willing to work deserve more rewards than those who are not. A public service ethic means that government officials are expected to protect private property, not to extort it. And a learning ethic means that people expect to learn, innovate and adapt, rather than to resist change.

In the underdeveloped world, the work ethic and the public service ethic have not flourished. Instead, crime and corruption sap the economy, and entrepreneurship is particularly frustrated.

Continental Europe does not suffer such severe problems with the work ethic and the public service ethic. However, an important part of the learning ethic is taking advantage of the decentralized, trial-and-error process of entrepreneurial success and failure. The continental European system attempts to replace the learning of decentralized markets with bureaucratic planning.

Ultimately, Europe’s corporatist, bureaucratic model impedes learning and retards innovation. With its barriers to entrepreneurship, which are particularly discouraging to change agents, European economic growth has lagged behind during the last two decades of rapid technological change.

America’s Natural Allies

If the United States is exceptional because of our entrepreneurial culture, then our natural allies may not be in continental Europe, in spite of its democratic governments and high levels of economic development. China seems more dynamic than Europe, but I would argue that China’s government-controlled financial system ultimately is not compatible with American-style entrepreneurship. Instead, we may have more in common with other English-speaking nations, as well as such entrepreneurial outposts as India, Israel and Singapore.

For the half century following World War II, the United States focused on democracy as the cornerstone of foreign policy. Democratic nations were our allies, and promoting democracy abroad was a top priority. However, it may be that American exceptionalism mostly reflects entrepreneurship. In that case, we have less in common with European social democracy than we thought previously. And, if our goal is to have more countries that look like America, then having them adopt a democratic political system may not be necessary and will certainly not be sufficient. Instead, our primary focus should be on fostering an entrepreneurial economic system. As Phelps put it:

“I conclude that capitalism is justified – normally by the expectable benefits to the lowest-paid workers but, failing that, by the injustice of depriving entrepreneurial types (as well as other creative people) of opportunities for their self-expression.”