Bolstering our entrepreneurial ecosystem
Peter Cohan and U. Srinivasa Rangan teach at Babson College and are authors of “Capital Rising: How Capital Flows Are Changing Business Systems All Over the World”. The views expressed are their own.
Since the “Great Recession” began, at least 8.5 million jobs have vanished. How will we create new ones? The answer lies in improving the entrepreneurial ecosystem (EE).
Everyone looks to entrepreneurs to create jobs. The Kauffman Foundation found that firms five years old and younger created most of the 40 million jobs in the U.S. between 1980 and 2005.
Our research offers a broader and more effective way to think about spurring entrepreneurship. We traced the flow of capital around the world and concluded that countries can boost their share of capital by changing the conditions that attract it. Since job-creating startups need capital, a government seeking to add jobs should make a country’s economic soil the world’s most fertile for capital to plant its roots and grow.
Government can manage what we call the country’s four elements of an EE: transparent and efficient financial markets, reliable and effective corporate governance systems, human capital development systems, and clear and supportive intellectual property protection laws. While the U.S. has a world-leading EE, it could do better.
- Immigration Reform: Researchers from Duke University and UC, Berkeley found that between 1995 and 2005, 52.4 percent of Silicon Valley startups had at least one foreign-born founder. Another report in 2007 found that many of the fastest growing technology firms had been founded by foreign-born (and often U.S.-educated) entrepreneurs. Recently, our broken immigration system has stopped many foreign-born graduate engineers and scientists educated here from staying here and starting hightech firms. This needs to change.
- Intellectual Property Reform: The U.S. has had one of the strongest IP regimes of any country, which draws in capital for technology-intensive investments. But conflicts between two goals – promoting competition and spurring innovation – have created a fog of uncertainty. To boost investment in innovation we ought to burn off the fog.
- Financial Market Reform: Our financial markets have veered from their purpose. Accounting for 70 percent of daily trading volume, high frequency traders – whose computers flip stocks after 11 seconds – have helped turn finance into the tail that wags the economic dog. Current congressional proposals may further impede the U.S. financial markets’ most important function – to help innovative startups find risk capital.
- Venture Capital Reform: Finally, the corporate governance resulting from VC-backed startup investing, while harsh for entrepreneurs who don’t adapt well to VC pressure, generally helps bring new technologies to market. Policymakers have slowed startups by imposing higher compliance costs (e.g., Sarbanes-Oxley requirements). The U.S. should add incentives that boost the odds that VC-backed startups can go public.
This is particularly important now because VC returns plunged in the 2000s as the Initial Public Offering market evaporated. As of June 1999, The National Venture Capital Association reported that VC funds earned 83.4 percent 10-year average returns. In the ensuing 11 years, returns have collapsed so far that the average VC fund is expected to report a 10-year return of negative 5.2 percent (through June 2010).
Before considering a VC business reboot, let’s look at how we achieved those high returns. Since the 1970s, each decade in the U.S. featured a wave of business investment into technologies and services from hundreds of VC-backed startups. Examples include mini-computers in the 1970s, networked PCs in the 1980s, and Internet-related products and services in the 1990s. In the 1990s, the vibrant IPO market let VC funds earn stellar returns while their startups helped create many of that decade’s 22 million new jobs.
How can the U.S. help create another such new wave? Green energy is one possibility.
- Germany created 300,000 jobs while saving 57 million tons of CO2, according to Deutsche Bank. The key for Germany was a so-called feed-in tariff that raises the price utilities pay for wind power and the like. This lowered the perceived risk of putting capital into renewable energy.
- By contrast, the U.S.’s renewable energy policies send a mixed message to investors. Only a few states offer temporary incentives, like production tax credits (PTCs), whose frequent expirations cause renewable energy production, like wind power, to plunge the year after the PTCs end.
- The U.S. could boost renewable energy capital flows. It could pass national level feed-in tariff legislation and institute a federal cap-and-trade system. Such financial markets changes would attract capital into renewable energy by signaling the U.S.’s long-term commitment to it.
The U.S. competes globally for capital flows. Countries that attract capital can build new industries that enhance the lives of their citizens. Winning the capital race depends on creating a virtuous cycle by strengthening the mutually reinforcing character of the EE elements we outlined above.