The Government and the Entrepreneurs

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Entrepreneurship seems like the quintessential private sector activity.  An individual or a small group of colleagues decide to set up a business and raise some capital.  If things go well, sales grow and they can hire more people.  The business grows based on retained profits - or they may be able to attract funding from venture capital or some other risk-taking investors.  Success brings legitimate big rewards to the people who are willing to risk an equity investment, which could rise in value or become worthless, and to those who work hard to make the business growth possible.

What does any of this have to do with the government?

According to an authoritative series of reports on entrepreneurship around the world, the government has a key impact not just on how many new businesses are created, but also - and perhaps more importantly - on the nature of these firms and their ability to grow.

The reports in question are the Global Entrepreneurship Monitor series, which has been running since 1999. I’ll focus here on the 2012 Global Report (from which the quotes below are taken).

Tracking, monitoring and measuring entrepreneurship is not easy, and the Global Entrepreneurship Monitor team deserves a lot of credit for developing a sensible methodology and sticking to it.  They survey around 2,000 adults in a random representative sample, and they talk with at least 36 experts in each country.  Their goal is ambitious: “GEM provides a comprehensive view of entrepreneurship across the globe by measuring the attitudes of a population, and the activities and characteristics of individuals involved in various phases and types of entrepreneurial activity.”

The focus is on “the incidence of start-up businesses (nascent entrepreneurs) and new firms (up to 3.5 years old) in the adult population (i.e. individuals aged 18-64 years)” (see Page 14).

No measure is perfect, but the strength of this approach provides insight into some fascinating questions.  Where do people want to create new businesses?  And when do entrepreneurs seek to make these businesses grow, rather than lurk under the regulatory radar?

These are important questions not just for the United States, where we pride ourselves on new enterprises being created, but also in all countries.  All societies want jobs and preferably good jobs at high wages.  Ideally also, there is a process of productivity improvement, meaning the amount that people can produce goes up every year.  (This can be consistent with maintaining a sustainable environment or even using fewer resources, although I will readily concede that is not the path most of the world is currently on.)

The reports are rich in detail, but three points jump off the page regarding the role of government.

First, when the overall environment for business is bad, there are many entrepreneurs.  For example, while there is a great deal of variation shown by the data within Africa, it is also clear that this is a difficult place to do business, because, for example, regulation is unpredictable and property rights can be hard to defend against powerful people.

Lack of human capital is also a weakness.  You need capable engineers, managers and many others to help companies grow.  The education system in many African countries is not in good shape.

Yet, there are plenty of potential entrepreneurs in the study: “Sub-Saharan Africa reported the highest intentions of any geographic region (53 percent), which is consistent with their positive perceptions about opportunities and their belief in their capabilities” (Table 2.2).

The explanation is simple.  In such economies, entrepreneurship is a fallback option, when it is not possible to get a decent job in larger business.

“As per capita income increases, larger established firms play an increasingly important role in the economy,” the report says. “This provides an option for stable employment for a growing number of people, serving as a viable alternative to starting a business.”

Second, the negative effects of macroeconomic policy can crush new business creation even in places with plenty of human capital and good perceived opportunities.

For example, the prolonged recession in Southern Europe has reduced the perceived opportunities for potential entrepreneurs: “The Southern European countries show not only a consistently lower level of opportunity perceptions compared with the Nordic countries, but they have mostly showed declines,” the study finds.

Perhaps this will turn around - entrepreneurs are good at dealing with adversity (and that’s the point from Africa).  But it’s hard to break into a market when customers are squeezed and investors are cautious.

The Global Entrepreneurship Monitor reports make a fine but appealing distinction: do you see opportunities, and do you plan to do anything about it?  These are separate issues.  If your current job is good enough, you will stick with it.  Or perhaps you don’t have the skills necessary, in your own mind, to make the leap to start a company.

It would not be a surprise if entrepreneurs help countries like Portugal to recover from the euro crisis.  But this is going to take awhile.

Third, the most difficult question is for what the report calls the innovation-driven economies, most of which are already among the richest countries in the world.  What, if anything, should the government do to promote entrepreneurship?

Perhaps the answer is: not too much.  All kinds of plausible schemes are put forward to help entrepreneurs at various stages of their development.  No doubt some of these are effective, particularly when they involve private sector mentors and building networks of contacts.  Also, helping companies at an early stage reach foreign customers can be helpful, so, for example, a business in Portugal does not have to worry so much about local or even regional macroeconomic conditions.

But what strikes me from the report is its data on the fear of failure.  Part of what drives these numbers may be cultural, but there must also be economic incentives at work here, like the consequences of going bankrupt for a company or an individual.  Compared with other countries, the fear of failure is high in Japan and also in South Korea.  This fits with other evidence from those places.  (For further thinking on why this matters, I recommend “Entrepreneurship and the Stigma of Failure,” a paper by Augustin Landier.)

The fear of failure is even higher in Italy and Greece.  Although we should worry about how precisely we can compare such attitudes across countries, the United States has one of the lowest fears of failure among rich countries.

Reducing the fear of failure for potential entrepreneurs is not any kind of panacea for economic development. Malawi, a poor country, has a very low fear of failure.

Government is responsible for the overall infrastructure in a country, and this includes access to education, decent roads and other transportation links.  There is also a case for supporting basic technology development, like at the university level, for example, because of the spillovers or externalities throughout the economy. (I work at M.I.T., which benefits greatly from such support and which has had a major impact on new business creation.)

In innovation-based economies (as the Global Entrepreneurship Monitor classifies them), what governments really need to do is to encourage people - entrepreneurs and the equity investors who back them - to take risk and ensure that failure is seen in a positive light, rather than as some kind of stigma.

The message should be: Go out and start a business, based on your best idea.  Find a technology with a new application or develop a different way to make customers happy.  If it doesn’t work out, you have still developed important skills and made a major contribution to society.