Growthology

The Neutron Book?

The first thing you notice when you pick up Why Nations Fail: The Origins of Power, Prosperity, and Poverty is that it’s got five Nobel laureates vouching for it. (You can’t miss them. Blurbs occupy the first three pages in the book.) The second thing is that it’s 464 pages long. The third—if you take a look at the back flap—is that the authors are chaired professors at MIT and Harvard, respectively. One of them, Daron Acemoglu, was the 2005 recipient of the John Bates Clark medal, awarded annually to the most accomplished economist under the age of 40.     

These initial impressions create exceptionally high expectations for the content of Why Nations Fail. And there is an argument presented within the book that I think is essential to understanding the origin of prosperity in human society. Unfortunately, that idea isn’t really the one advertised as the central thesis of the book.

First, let me summarize what I think is the core argument in the book. That’s pretty easy to do, since the conceptual content is covered more or less in full by the second page of the preface, in the context of a discussion of the “Arab Spring”:

To Egyptians, the things that have held them back include an ineffective and corrupt state and a society where they cannot use their talent, ambition, ingenuity, and what education they can get. But they also recognize that the roots of these problems are political. All the economic impediments they face stem from the way political power in Egypt is exercised and monopolized by a narrow elite. This, they understand, is the first thing they have to change.

It turns out that this paragraph doesn’t just introduce the book. From a conceptual standpoint, I think it is the book. The remaining 460 pages offer an array of engaging illustrations, each containing the imperative of societal disruption as a core ingredient: favor incumbents less.

And in my view the idea that this paragraph conveys—the idea that defines the book—is an excellent one. It traces back to Joseph Schumpeter (who makes it into the text as the originator of the term “creative destruction”), Mancur Olson (who appears in a footnote), and Anne Krueger (who mysteriously doesn’t show up as a reference in the book at all).

To paraphrase Renée Zellweger in Jerry McGuire: You had me at “narrow elite.”

However, the advertised central thesis of the book (in contrast with what I think is the core idea in the book) is introduced a bit later, on page 42, when the authors state:

Economic institutions shape economic incentives… It is the political process that determines what economic institutions people live under, and it is the political institutions that determine how this process works… As institutions influence behavior and incentives in real life, they forge the success and failure of nations.

Institutions shape behavior, so institutions matter. Politics shapes institutions, so politics matters.

From that point forward, Why Nations Fail alternates awkwardly between lively storytelling and frequently unpersuasive attempts to shoehorn narrative nuance into conformity with The Point of the Book.

This isn’t to say, by the way, that the storytelling is always good. In fact, I found it a bit disconcerting that the stories with which I am most familiar were the least persuasive. (Francis Fukuyama seems to have encountered a similar problem in reading the book, as he indicates in his excellent, just-posted review.) Take this sentence from the book:

Current Chinese growth… results from a process of economic transformation unleashed by the reforms implemented by Deng Xiaoping and his allies, who, after Mao Zedong’s death, gradually abandoned socialist economic policies and institutions, first in agriculture and then in industry.

Yes, this is the standard story about the origins of China's growth. I refer to it myself my own recently-published book. But I also acknowledge—which these authors do not—that this emphasis on the role played by Deng Xiaoping in essentially mandating a new institutional structure for a country of 1 billion people is highly contested.

An alternative and very persuasive story about the origins of China’s development is that, during the two years of near-anarchy that prevailed in China in the two years after Mao’s death, but before Deng’s ascent, peasants abandoned collectivized agriculture and embraced household and market-based approaches—reforming the system on their own. Into this new reality stepped Deng Xiaoping, who had risen to power once before, in 1962, following the catastrophic failure of an effort at the mass collectivization of agriculture cruelly named "The Great Leap Forward." (When I say catastrophic, that's what I mean: 20 million people died.) What was Deng Xiaoping going to do at that point? Deploy the army to reinstate a system that had already been abandoned? Or simply validate the “facts on the ground” as national policy? Proponents of this view argue that he chose the second of the two options. (See great books by Yasheng Huang and Kellee Tsai for more on this topic; also an as yet unpublished draft by Iqbal Quadir.)

This may seem like nit picking, but it isn’t. It gets to the heart of why the story that authors are telling—about the importance of people in society pushing back against incumbent interests—doesn’t correspond with the supposed central thesis about the importance of institutions in Why Nations Fail.

As it stands, Why Nations Fail comes close to being a neutron book. It describes wondrous worlds full of clever people after then, after the detonation of The Point of the Book, leaves only the buildings standing. (Exhibit F—the title to Chapter 13, “Why Nations Fail Today: Institutions, Institutions, Institutions.”) The people: gone.

From my standpoint, the most interesting sentence in the book is this one on page 63: “Though institutions are persistent...in certain circumstances they do change rapidly.” Acemoglu and Robinson focus the next to last chapter of the book on how a few countries broke out of the vicious social cycles created by “extractive institutions” and set themselves on a trajectory toward prosperity. But, when it comes not only to understanding the origins of prosperity but also—and importantly—to informing action to bring prosperity about, the most interesting element of these stories is the way in which actual people, or groups of people, acted at particular points in time to push back against incumbent interests, change institutions, and in so doing move the arrow of history.

Yes, institutions matter. Yes, politics matters. But what matters most in human societies are human beings. Human beings who, by design or by accident, confront incumbent interests and distribute economic and political power. In politics, they are reformers, revolutionaries, and all manner of institutional innovators. In economics, they are entrepreneurs. Their story is the story of how institutions change, and why nations succeed. That, ultimately, is the more interesting story to tell. Among economists, it’s called agency. And, while not central thesis of the book, it is nonetheless the subtext that holds Why Nations Fail together.

 

Kauffman Sketchbook - I'm A Blogger

 

Today, the Kauffman Foundation is releasing a new sketchbook featuring Tyler Cowen's thoughts on blogging. The excellent production is embedded above.

This release coincides to formal changes being announced for growthology.org, with the addition of more bloggers. Learn more here.

Studying the Impact of the Crisis on Businesses

Unexpected things happen in the economy – take the recent Economic Crisis. Our national infrastructure of measurement would have looked quite different if we were prepared for such a possibility. We’d have asked homeowners and banks a lot more about collateralization and other aspects of the housing and mortgage markets. We’d have gathered different information about the unemployed and timelier information on a whole host of subjects. While we didn’t have the luxury of seeing the future and figuring out how to measure for it, several groups recognized opportunities in the midst of the Crisis to make data they had collected more meaningful.

• National Federation of Independent Businesses

I have so much respect for the survey work that Denny Dennis does over at NFIB. In the midst of the Crisis, they were a lifeline of information on small business finance issues, developing great surveys on finance that they have continued to collect annually since. This information is invaluable in understanding the lingering effects of the recession on small businesses today. And all of this was in the midst of a budget crunch that cut short other surveys in their program. If you haven’t seen some of this work, check out their most recent release from January 2012.

• Federal Reserve Board of Governors

While the Fed played a huge role during the recent Crisis, not many people are aware of their measurement role. I’ve faulted the Fed in other places for cancelling the Survey on Small Business Finance, but that’s not my focus here. Instead, I want to focus on the positive – the Survey of Consumer Finance. In the midst of the Crisis, the Fed realized that it had done its flagship collection on households in 2007 and that in 2009 it might be possible to go back to the same households and measure the differences. In doing so, the Fed captured for researchers a one-time panel of households that should allow for interesting research. The Fed just released this data to the public this week.

• Kauffman Foundation

It’s not good to toot one’s own horn, but in this case I think our Board should be recognized for doubling down on the Kauffman Firm Survey in 2008. Recognizing the Kauffman Firm Survey was in the midst of its longitudinal collections (a sample of 5,000 new businesses started in 2004) and that things were going well, the Board increased funding for the KFS project so the data could be collected into 2011. To my knowledge, this will allow for one of the biggest business research data sets that spans the Economic Crisis and includes a crucial pre-Crisis time period of observation. We got lucky that we were already in the field and things were going well. Data through 2010 was released this month from the KFS. 

 

Startup Weekend During GEW

As many people know, Global Entrepreneurship Week is held each November when tens of millions of people in more than 120 countries celebrate entrepreneurs and the ventures they create along with the economies they shape. 

Startup Weekend – a grantee of the the Kauffman Foundation – is very active throughout the two weekends during Global Entrepreneurship Week. They recently produced an infographic to provide some insight into the massive spike in events and activity during the week. Take a look here.

Most striking to me are the number of events (68) and number of participants (4,500+). In a mere two weekends – less than six full days – thousands of strangers around the world met each other, made decisions to work together, learned, created and built. The output was generally an application and some degree of customer validation, but the outcomes were much more significant. Thousands of people decided to try something entrepreneurial. Relationships were begun, skills were developed or honed and people learned about themselves – whether this 'entrepreneurship thing' is for them… and if it is, that they can't get enough!

This happened in two weekends in November, but the opportunity to meet people, build products and companies and change your life is in front of you every day, not just at a Startup Weekend. 

So what are you waiting for? Startup!

 

Unrestricted Consumption: Developments in Digital Rights Management

Via Mark Thoma, Joshua Gans reports on JK Rowling's Pottermore website and the planned distribution of Harry Potter eBooks. Rowling has negotiated with the big distributers (Apple and Amazon, etc.) to sell the eBook exclusively through Pottermore. There is clearly a strong profit motivation for Rowling, a superstar author with a large following, to try independent distribution and minimize revenue sharing. But the big deal for consumers is that when buying through Pottermore, the eBook will reportedly be transferable across devices. Comments to Gans’s post point to other examples of the transferability for eBooks, depending on the distributor. I think the real breakthrough is that Pottermore defaults the consumer to purchasing a device-independent file by forcing some distributors who don’t offer this to send the consumer to Pottermore, which does.

Rowling’s foray reminds me of comedian Louis C.K.'s experiment with independent distribution.

Traditionally, one of the ultimate career achievements for most stand-up comics has been to sign for an HBO (or similar) stand-up special. Under these arrangements, typically the performer is paid a fee for a performance, and HBO produces and pockets most of the profits from the sale of the show (the theatre tickets, the revenue from airing the taped special, and DVD sales). Unfortunately for comedy consumers, HBO puts a lot of restrictions on the consumption of the special (limited TV airings and typically high-priced DVDs with regional restrictions).

In 2011, Louis C.K. decided to try something different. He produced his own special and released it DRM-free on his website. For $5, anyone can download a video file of the special playable on any device, without restrictions—the file can be copied, burned to DVD, etc. Many warned that Louis’s distribution method wouldn't work without a studio backing the release, and that without any DRM, the video would quickly be pirated. C.K. reported the experiment being an overwhelming success, with the special generating over a million dollars of sales within 12 days. It has surely made more money since then (full disclosure, I purchased the special the day it was released and thoroughly enjoyed it).

I imagine Rowling will enjoy similar success. Both C.K. and Rowling have large, dedicated fan bases. C.K. stated that at least part of his motivation was to avoid DRM and make it simple for people to enjoy his production. I do not know if Rowling has similar motivations, or if it’s more about building the Pottermore brand.

I am hopeful that developments like Rowling and C.K.’s will further nudge industries that deal with electronic media to adapt to a world where marginal costs of delivery are low and consumers own multiple products designed for media consumption, needing easy transferability of content between them.

If you think of this in terms of entrepreneurs versus the incumbents, the C.K. and Rowling situations clearly are outliers due to their fame. But they can serve as needed reminders to startups, even if you have only a fledgling flock of customers. If you build good relationships with your customers and want to work around or outside an established industry structure, you can leverage your customer loyalty to deliver something you both want—for your customer, a higher quality product and service experience; for you, being able to do things your own way, and profiting because of it. Lean Startup is a recommended book from many of my colleagues here at the Foundation that talks about the importance of knowing your audience. Delivering Happiness, the Tony Hsieh and Zappos story, is a good read and an example specific to successfully revamping your product distribution and delivery model.

 

Don't Make It Official

We engage in formal market transactions daily. Every time we go to a restaurant, personal service provider, or gas station, we engage in structured transactions in which there are clear expectations. We expect food served in a restaurant to be sanitary, manicure equipment to be sterilized, and the gas to meet a certain standard. This expectation is due in part to the role government and agencies play in regulating and policing industry standards.

Yet, we also engage in a myriad of much less formal transactions with similar expectations. We buy food at a charity bake sales and eat at friends’ homes, for instance, knowing full well the cooks aren’t concerned with complying with industry food standards.

These informal markets function well despite being outside regulatory scope. Reputation, repeated transactions, and the specter of legal action in extreme cases implicitly guarantee a level of safety and competency.

Yet, increasingly complicated regulatory and licensing schemes are being advanced and enforced by government agencies large and small. Recently, the IRS instituted new rules upon those preparing tax returns requiring a license and continuing education requirements. Matthew Ygelsias points to “underground farmer’s markets” being shut down in San Francisco for not complying with regulations because the vendors produced their products in their home kitchens. 

In either of these cases I would argue that the regulator has a burden to justify such policies by proving there is a real, not potential, threat to public interest. As Kauffman has argued, our regulatory environment clearly overreaches in many cases, even those in which there is a compelling initial reason for regulation. This is not to say regulation and licensing aren’t often appropriate and necessary, but that such tactics should be used sparingly. Regulation and licensing can transform well-functioning implicit trust relationships into formal ones, at high cost to both agencies and entrepreneurs. 

Entrepreneurs and the Affordable Care Act

All eyes in Washington this week will be directed toward the Supreme Court’s oral argument in the case challenging the constitutionality of the Affordable Care Act.

Would-be and future entrepreneurs have stakes in the outcome, and not everyone is likely to be positioned the same way.

For many potential entrepreneurs, the most important issue is or should be access to affordable health care insurance. Prior Kauffman-supported research (carried out by Vivek Wadhwa) has established that the median age for successful high-tech entrepreneurs is 39, an age that is probably not too dissimilar for entrepreneurs in all industries. Entrepreneurs this age are thus most likely leaving established companies where they already have health insurance, taking only COBRA’s 18 months of insurance with them if they leave to launch another firm, or relying on their spouse’s health insurance if their spouse is working. In this uncertain economy, many would-be entrepreneurs may be deterred from launching the venture of their dreams either because their spouse is not working, is working but has no family health insurance, or the entrepreneur is fearful that his or her spouse could lose their job and thus health insurance for both of them in the future.

The ACA directly addresses this concern by providing subsidies for health insurance purchases through exchanges, and through the individual mandate. If the individual mandate is allowed to go into effect, theoretically it will keep health insurance premiums below what they would otherwise be because it will require healthy individuals without insurance who make little use of the health care system to purchase insurance, broadening the risk pool and lowering rates for all. If the Supreme Court invalidates the mandate, individual insurance rates are sure to go up and thus make it costlier for would-be entrepreneurs to leave their current jobs to start a new venture (though as long as the Supreme Court leaves untouched the “guaranteed issue” requirement under the ACA, at least those individuals will be able to purchase insurance at some price).

For current entrepreneurs with businesses employing less than 50 workers, the decision should have no immediate effect, because the law’s mandate that firms provide insurance or else pay a penalty of $2,000 per worker only applies to companies with more than 50 workers. But the continued presence of that mandate plus penalty, at the margin, should discourage growing firms from hiring more than 50 workers, and to contract out as much as possible to avoid the mandate/penalty. Any court decision that invalidates these provisions (which I understand not to be directly at issue though they could be struck down if the individual mandate is invalidated and the Court decides that the rest of the law is not “severable” from the individual mandate) would remove these disincentives.

So, along with the rest of America, entrepreneurs have a clear stake in the outcome regardless of their current positions or levels of activity.

Misused Statistics Do Not Help Entrepreneurs

The world is awash in bad, murky, misleading, and misused statistics, and nothing is going to change that. (Of course, the world is also awash in plenty of awesome statistics.) What we can try to do is point out when shoddy statistics affect public policy debates. 

Today, the Senate is debating the Jumpstart Our Business Startups (JOBS) Act and appears set to vote soon. Plenty of arguments have been in made in favor, against, and for amending the legislation, but that's not my topic here. The JOBS bill is part and parcel of a long-running debate about the IPO market in the United States and why IPOs have not returned to the levels of the 1990s. One of the statistics making the rounds on Twitter, the blogosphere, and in various reports recently is that "92 percent of job growth occurs after a company's initial public offering." The ultimate source is a study done by IHS Global Insight for the National Venture Capital Association and promulgated most prominently in last autumn's report, "Rebuilding the IPO On-Ramp," by Treasury's IPO Task Force. (Some of the JOBS bill proposals come from that report.)

In that report, the relevant chart is this:

Accordingly, measures taken to boost the number of IPOs will spur job creation.

This is bad, albeit seductive, statistics. The "92 percent" assertion horribly conflates causality--by attributing (implicitly by some, explicitly by others) job growth to the fact of going public, purveyors of this number mix together all sorts of causes and effects. If it was the case that IPOs do in fact cause job creation then, as my colleague Paul Kedrosky has observed, we could easily solve unemployment by--presto!--having every single private company go public. Job growth after a company has gone public occurs for all sorts of reasons, very few of which may be related to the fact of having gone public. 

Job growth at a specific company can also occur in different ways--either organically or through acquisitions. Organically, it counts as net employment growth for the economy. Via acquisitions, it doesn't, just a transfer from one company into another. Ideally, a merger or acquisition will end up creating value and thus more jobs in the long run, but initially it is counted statistically as the same number of jobs, not a net addition. Thus, citing a public company's job growth as net job creation for the economy as a whole is not entirely accurate.

Finally, the decennial trend in the chart above should offer a clue to its purveyors: post-IPO employment growth has been falling and pre-IPO employment growth rising. There are obviously many factors responsible for this, including the changing age at which companies go public, which went from 7 in the 1980s, to 8 during most of the 1990s, falling to 5 in 1999-2000, and jumping up to 12 years from 2001 to 2003. Older (and larger) companies will, predictably, be larger at the time of going public. It doesn't mean that the subsequent IPO is somehow less causal with regard to job creation, just that the firms are at different stages of growth. 

The IPO market is determined by many things--regulation, market conditions, technological change, etc. Jay Ritter and colleagues have recently shown that the fall in IPO volume is due more to changing market structures and falling profitability among small companies rather than regulatory burdens, which are the most frequent scapegoats. Such changes are often unnoticed (or ignored) by the "92 percent" purveyors. 

Yes, going public is expected to allow a company greater access to financing for expansion and innovation that, ideally, will create jobs. Boiling all of the underlying factors and changes into one number, however, and tangling all sorts of causal chains in the process, helps no one, least of all entrepreneurs.

Global Entrepreneurship Congress 2012

A couple of weeks ago, I raved about the 2012 TED conference in Long Beach, CA. In this post, I report back from a similarly positive experience at last week’s Global Entrepreneurship Congress held in Liverpool, England.

This GEC represented the third time that representatives from countries participating in Global Entrepreneurship Week met to plan for the upcoming weeklong series of events hosted around the world during the third week of November. From just two countries, the U.K. and the U.S., which started this movement four years ago, GEW and GEC have now grown to having over 120 countries participate. More than 500 people from these countries–entrepreneurs, members of NGOs that promote entrepreneurship and government officials with responsibilities for encouraging entrepreneurship–came to Liverpool (most paying their own way) and were joined by over 2,000 students, entrepreneurs, professors, and other interested citizens from the U.K.

They heard from an all-star case of famous entrepreneurs in the U.K.–led by Richard Branson of the Virgin Group–about their amazing rides to success. These stories alone made the trip worthwhile. But the most inspiring part of the trip was seeing, talking to, and hearing from the country representatives themselves. Many, if not most, had struggled against long odds to build their businesses. All were interested in learning from people just like them from other countries.

GEC was nothing less than a United Nations of entrepreneurship, but without the political and bureaucratic baggage of the UN. Unlike the diplomats at the UN, who are there to represent their countries’ interests, the entrepreneurs at GEC shared a common goal–the desire to build businesses, to learn from others, and to share their experiences. I came away from the activities with much the same optimism about the future that I had after leaving TED.

Entrepreneurship is clearly becoming a global movement, one that is in its infancy, but whose ultimate power is sure only to grow over time. It will take that power to remove many of the obstacles that governments in many countries put in the way of their entrepreneurs. During the two days before the GEC, Kauffman convened academic experts in entrepreneurship from around the world to present original research that identifies those obstacles, as well as more positive measures that governments might employ to encourage entrepreneurial growth. Look for those papers to be posted on the Kauffman website in several weeks, to be followed by a white paper summarizing the discussion at the pre-GEC conference and outlining a menu of policy options for governments to choose from if they want to encourage more entrepreneurship, especially the formation of high-growth firms that are key to generating sustained high growth in jobs and output in all countries. 

For an excellent snapshot of some of the highlights from the academic session, see this article that just came out in The Economist.

Auerswald on Equatorial Guinea, South Korea, the Meaning of Innovation, etc

Phil Auerswald on Forbes.com:

Because Equatorial Guinea is the winner of the global growth race, all countries seeking to prosper should adopt its economic and social policies. First, install a ruthless tyrant. Second, find a large deposit of oil. (It’s actually OK if you find the oil first; the tyrant will follow.) Then make sure that you concentrate wealth in the hands of few sick-minded lackeys. And finally, for good measure, deprive the overwhelming majority of your population of basic human rights and zero-out entrepreneurship.

Phil's point is that "prosperity" is not just growth in per capita income or even fast growth rates. Innovation is more fundamental:

Innovation, and its cousin, entrepreneurship, don’t just lead to prosperity; they are prosperity. The very process of imagining the new and making it a reality represents a significant pathway toward human satisfaction in the world. Innovation in its most fundamental form is the common language of human attainment.

The book, out soon, will be terrific.

Startup Monoculture

In his wonderful book, The Botany of Desire, Michael Pollan highlighted the perils of monoculture: "Very simply, a vast field of identical plants will always be exquisitely vulnerable to insects, weeds, and disease--to all the vicissitudes of nature." The proper alternative is not, as some would have it, all-organic agriculture, but diversity in what is planted, how it is mixed, different schedules, and so on. Where excessive monoculture has brought us is to an ever-escalating struggle with pests that has partly resulted in falling crop yields.

I was reminded of this in reading a short piece in The Economist just over a week ago that raised caution about the hype over promoting entrepreneurship that has taken hold in the United States. Home-grown companies are at the core of the idea of "economic gardening." The piece pointed out that, among policymakers who speak well of entrepreneurs, there remains linguistic confusion (thus likely indicating mental confusion) over just what qualifies as entrepreneurship. Is it brand-new companies? Young companies, somewhat imprecisely defined as those age 5 and younger? Businesses of a certain size? Government statistics give us "small businesses" as all those with up to 499 employees, another imprecise delineation. The Economist also noted that, according to Kauffman research, startups are providing less bang in terms of new jobs and growth.

Finally, it raised the possibility that too much hype over startups could end up as "the next variant of 'green jobs': worthwhile, but slightly overhyped."

Clearly, I subscribe to the idea that entrepreneurs are vital for economic growth. But there is continued uncertainty over how exactly to define the idea, and continued attempts to figure out how best to generate new companies and support their growth. Jared noted the other day that a new paper found underwhelming effects from entrepreneurship training programs. This certainly doesn't cast doubt upon all entrepreneurship programs, of which there is a huge variety, and it highlights the importance of experimentation and discovery in promoting entrepreneurship. That, after all, is how startups themselves operate.

The more important point is this: by moving entrepreneurship to the center of economic policy and lifting startups up onto a pedestal, do we actually risk hurting the very thing we are seeking to help? Can there be such a thing as startup monoculture? The risk of harm is probably low, and we are likely far from that point, but there is probably a very real possibility of low returns. That's unavoidable, and just because there will be failure and unfulfilled expectations is no reason not to try.

But the very nature of entrepreneurship is that, frequently, it is something that goes against the grain. Startups introduce new ways of doing things and challenge the status quo. This, even more than the job creation that is the raison d'etre of politicians' attention toward entrepreneurship, is why entrepreneurs matter to economic growth. They are outsiders--outsiders who displace old insiders and become the new insiders themselves, subject to another round of disruption. My colleague Paul Kedrosky, for example, likes to highlight the importance of alienation to fostering successful startups. Entrepreneurship may be sexy these days, but is sexiness antithetical to the phenomenon itself?

Developments in Crowd-funding

There’s a glimmer of hope that Congress and the Administration might be able to agree on one piece of legislation this year—the JOBS Act introduced in the House last week by Majority Leader Eric Cantor—that could do something significant for startups, and in turn the broader economy. This legislation combines a number of proposals that would change various SEC rules so as to lower the costs of raising capital by new businesses. Most of these have already separately passed the House by large bipartisan majorities. The Obama Administration also has endorsed most of the ideas in the bill, and reportedly is willing to work with Cantor and like-minded (on this issue) Democrats in the House to get the bill passed.

There is one provision in the proposed Act that is unusually controversial that I’d like to address in this post, because it sure to get some attention in the Senate (assuming the House passes the bill, which is a good bet at this writing). It is the “crowd-funding” idea championed both by the bill and the Obama Administration, which would exempt from SEC registration and disclosure rules investments up to $10,000 per individual in firms raising no more than $1 million per year through crowd-funding platforms like Kickstarter and more recently, Facebook (more on the latter below).  

Valid concerns have been raised that this provision would open the way for scam artists to fleece unknowing investors of a lot of their hard-earned money. That is a legitimate worry. So is the concern that investors who make these investments may be getting nothing more than “Green Bay Packer wall certificates”—pieces of paper like the stock issued to the fans of Green Bay to help fund their football team that pay out no profits and are essentially non-marketable.

Even my own initial reaction to the crowd-funding idea was a bit skeptical. Who would be crazy enough to part with up to $10,000 of their own money over the Internet to some little or unknown startup on highly uncertain terms?

What began to change my mind on these matters was a little noticed piece in the Wall Street Journal several weeks ago about Facebook’s fbStart program. Facebook is proposing to provide inside access to some of its platform to a select group of startup partners (startups housed in accelerators such as TechStars and Y Combinator) in exchange for Facebook staking some share of the startup's revenue. Imagine the possibility of these startups launching on Facebook and using the near 845 million users as a crowd-funding source. Such an initiative has the potential for turning crowd-funding into a really big breakthrough for companies needing several hundred thousand dollars to get off the ground, either without further funding or as a way station to more serious angel or venture financing.

As for the scam artist possibility, which is very real, I also think back to the early days of eBay when skeptics claimed that few would ever trust other people to deliver the goods they bought on the site. Then the market proved the skeptics wrong. eBay came up with a way of getting users to verify the trustworthiness of their counter-parties and the rest, as they say, is history.

I believe that if given the opportunity to take off through the proposed legislation, crowd-funding platforms and their users would develop similar, or perhaps very different, ways of giving would-be investors some comfort that the firms or individuals seeking to raise money aren’t crooks, and even cranks. I anticipate that, at a minimum, many firms seeking money will post YouTube-like videos on these platforms (or links to them) so that investors can see who they are investing in. Further, I suspect that many of these individuals will include others in their video, likely some respected individuals who can easily be checked out on the Internet, who will vouch for the entrepreneur. And perhaps the platforms will find ways of allowing or encouraging investors to vote thumbs up or down on entrepreneurs seeking money. I don’t know yet how the validation market will work in the crowd-funding space, but I strongly suspect that validation methods will emerge because there will be a market for them.

If nonetheless legislators remain worried about the scam problem, they might consider giving the crowd-funding exemption a limited time trial, perhaps two or three years, during which we and everyone else will be able find out whether people patronize the scam artists and whether the market will find ways of pushing them aside. The time trial might also give the SEC authority to abort the crowd-funding experiment if the scam problem proves very real, and with costs that outweigh the benefits of new firms funded in this way.

But at some point, it seems to me that the government should give new technologies a real shot at solving the very real funding problem that a lot of new companies face, especially now that banks pretty much have exited the market for funding them (either directly, or indirectly through credit card or home equity lines of credit, which have been cut back since the financial crisis). There is a compromise to be had here, if one is needed. 

Hope for the Future

I just returned from my first TED (Technology, Entertainment and Design) conference in Long Beach. My colleagues at Kauffman have been urging me to go for a number of years, but each year I had a different (valid) excuse. This year I didn’t have one. Admittedly, I was skeptical of spending an entire week listening to various speakers give speeches, but I went.

Wow! What an amazing line-up of incredible people doing incredible things with their lives to change the world. There were the usual networking opportunities that events of this kind always offer. But the true value of the conference was watching and then thinking about the implications of those on stage.

You can watch for yourself by going to ted.com, where you’ll find a combination of videos from this year’s conference and those from previous years. Watching them is the best antidote to the anxious worry I know is out there throughout the country about our best days behind us. The people on that stage as well as the roughly 2,000 in the audience surely don’t believe in that, and they are living their lives to prove the pessimists wrong.

I admit to having plenty of worries about the future myself, but when I am lucky enough to witness an event like what I just saw I count myself grateful to be living in a country and at a time that is capable of celebrating such awe-inspiring creativity, commitment, and inspiration. Go to the site and spend some time there; you’ll see what I mean.

Randomized Control Trials

Hasan Bakhshi, of the U.K.'s National Endowment for Science Technology and the Arts (NESTA), posts about randomized control trials for assessing the outcomes of innovation policy. I have long struggled with concerns over selection bias in evaluations of policy and education programs. This is a very important discussion. It is an especially salient thought when considering evaluation of entrepreneurship training programs or policies designed to increase the number of/success of entrepreneurs, as there are huge self-selection issues associated with entrepreneurial intent.

The Fairlie et al. GATE study comes to mind as an example of a recent randomized control trial on entrepreneurship training programs. Do you know of any others? Let us know in the comments.