That's Why We Need More Entrepreneurs

Scott Shane recently joined the New York Times as a blogger for the site's new You're the Boss blog and in his most recent post used a series of charts to show that the United States is actually becoming less entrepreneurial than we would like to pretend.

Professor Shane, a professor of entrepreneurship, has been an outspoken skeptic of entrepreneurial capitalism, casting doubt on the extent and benefits of entrepreneurship. His latest line of research concerns genetics and entrepreneurship, identifying "the influence of genetic factors on the variation across people in opportunity recognition." This, Professor Shane purports to demonstrate, is heritable and independent of environment, as are occupational choices in general, such as teacher or manager or self-employment. (For a critique of opportunity recognition, see this recent paper: Download Creative Discovery Innovations June 2009.)

Notwithstanding potential sampling errors, the heritability of personality traits is a breeding ground for questionable claims. As the eminent Samuel Bowles has pointed out, "data from modern economies suggest that personality influences individual success, but the effects are quite modest." Moreover, "the correlations between parental and offspring measures of personality are strikingly low." The world periodically endures genetic determinism fads, and they rarely end well. 

Plus, if entrepreneurship is solely determined by genetic inheritance, why even have professors of entrepreneurship? 

In his latest post, however, Professor Shane is onto something: whether measured by the number of new employer firms started each year or the number of new establishments, the rate of entrepreneurship has fallen over the past two or three decades. Shane uses Census data that the Kauffman Foundation has helped fund, and I published charts on the falling establishment entry rate in a recent paper. And the share of Americans working in giant firms (those with more than 10,000 employees) has slowly but steadily risen in the past decade.

But there are a few points Shane fails to make. As one of his commenters notes, there has been a rebound in new firm and establishment creation since 2002. One of the datasets only runs through 2005 and when new Census data are released in August, we should know whether or not this rising establishment formation trend continued. With regard to new firm creation (nb, employer firms, not self-employed consultants or personal services), Shane's data run only up to 2007. But the Kauffman Index of Entrepreneurial Activity showed a slight uptick in new firm creation 2008. It will also be interesting to break all of this down by industry.

So what does this mean? We've actually seen a steady increase in the number of new firms started over the past few years. Shane's point is that while absolute numbers may increase, they fail to keep pace with population growth and so the rate, firm starts per capita, actually falls. That's right. But this only highlights the crucial need for more new firms, for more entrepreneurs. As we've noted before, using that same Census data, looking back over the past thirty years, if we had taken startups out of any given year, net job creation for the overall economy would have been negative in most years. No new firms, no new jobs. No one can escape, moreover, the great lesson of economic history that entrepreneurs are disproportionately responsible for radical innovations.

But the message is much broader than this: the real source of economic growth lurking in here is firm growth. This signals market success, generates jobs, and brings with it increasing returns to ideas. So even if the rate of entrepreneurship fluctuates on an annual or decennial basis, this doesn't mean that there aren't entrepreneurial firms growing to scale during that time. This, in fact, is precisely the pattern we would expect to see: a high rate of new firm creation followed by a period of falling entrepreneurship as firms fail, consolidate, and grow. This will (or should, provided barriers to entry are kept low) be followed by yet another period of high rates of entrepreneurial activity.

Comments

[Derek Ozkal]

I would think that at any given time we have the right number of entrepreneurs. Saying we need more entrepreneurs also implies that we need fewer people in established firms. It's a normative debate for the innovation and growth that accompanies entrepreneurship versus the seemingly more stable environment (albeit with less innovation and growth) that established firms provide. Regulations, taxes, health costs, etc. are making entrepreneurship less appealing and as a result innovation and growth suffer. I'd definitely agree that we "need" more entrepreneurs in the sense that innovation drives economic growth which leads to better lives, but it's a politically difficult time to promote policies that encourage "creative destruction"... it's a much easier sell to prop up established firms than promote new companies (many of which will fail - but that failure is a vital market signal to put goods and services into their most valuable places). Some of the important key components of capitalism (risk, success and failure) are a hard sell politically in tough economics times eventhough its times like this when we need entrepreneurship the most.

[Dane Stangler]

Derek: Good comments. I would slightly disagree with the assertion, "saying we need more entrepreneurs also implies that we need fewer people in established firms." If the rate of new firm creation has been falling because it hasn't kept up with population growth, despite rising absolute numbers, than an increase in entrepreneurship wouldn't really "take" from established firms as it would shift the incremental population growth.

[Derek Ozkal]

touche

[steve]

The rising share of Americans working for giant firms is likely part of the broader trend towards barbell industrial structures.

This structure - identified by McKinsey several years ago - consists of fewer and fewer global giant firms on one end and lots of smaller firms on the other.

Mid-sized firms tend to get acquired by larger firms - or they can't compete with the scale of the global giants or the agility of smaller firms.

We've looked at a lot industries (retail, general consumer products, software, finance,shipping etc.) and this structure is happening in almost all of them.

We cover this trend as it relates to the beer industy in two blog posts - http://bit.ly/iQCka and http://bit.ly/131bGG

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Tim: As I wrote on my blog, Truth on the Market, I think Tyler is pretty far off base with this one. See http://www.truthonthemarket.com/2009/04/28/what-does-tyler-know-about-law-and-economics-anyway/

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