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Good Cap, Bad Cap

Monday, June 4, 2007

Why don’t people take risks and start new businesses?

Good Cap, Bad Cap“The government and the regional authorities [in Russia] have failed to create conditions for small-and-medium-sized businesses to flourish. Everyone who opens a new business and registers a company should be given a medal for personal bravery.”

- Vladimir Putin
 

“In societies where individuals may become too comfortable – much of Western Europe, for example – people may be reluctant to take the risks inherent in any entrepreneurial endeavor. Indeed, in 2004, a French government employee wrote a best-selling book called Bonjour Paresse (Hello Laziness), which extolled the virtues of not working hard.”

- Carl Schramm, Robert Litan, and William Baumol

 

Entrepreneurs are the primary drivers of innovation, technical change and growth. As importantly, entrepreneurs keep large firms on their toes, forcing them to innovate or stagnate.

Why do people start new businesses? Or perhaps a better way to ask it: why don’t people take the risk involved in starting a new enterprise? 

One answer is that incentives matter. It’s trite to say so. But it’s also true. As the above quotes indicate, the right mix of incentives can make all the difference.

Russia today features an oligopolistic form of capitalism with more than a smidgen of gangsterism. This makes the entrepreneurial start-up of new businesses fraught with peril. Starting new businesses is always risky, since no new enterprise is guaranteed to succeed. But in Russia, as Putin acknowledges, success can make you a target of political elites backed by oligarchic firms. 

Western Europe has a different set of incentives in place. It is relatively rich and comfortable. It has a wide and deep social safety net. Entrepreneurial returns are culturally frowned upon. Growing businesses must work within a rigid labor market structure that makes it costly to fire or replace employees as market conditions change. Given this mix of incentives, when it comes to starting a new business, many would-be entrepreneurs are apt to conclude Bounjour Paresse! indeed.

Both quotes at the beginning of this essay come from an important new book, Good Capitalism, Bad Capitalism, and the Growth of Economics and Prosperity. The authors are all economists of some distinction. William Baumol teaches entrepreneurial studies at NYU. Robert Litan is a senior fellow at the Brookings Institution. And Carl Schramm is president of the Kauffman Foundation and a fellow at the Darden School of Business. One would expect economists to conclude that “incentives matter” when it comes to starting businesses. But their book does much more than that.

Good Capitalism, Bad Capitalism presents a smart and accessible overview of the relevant academic literature on growth and innovation. And the authors build a helpful conceptual framework for how to think about “capitalism.” 

The problem with state-guided and oligopolistic forms of capitalism is that they are inherently “replicative” and “imitative.” They tend to reward forms of “redistributive entrepreneurship” instead of genuinely creative and innovative forms.

Capitalism is not a monolith. Instead, they argue, there are several varieties of capitalism: state-guided capitalism, oligarchic capitalism, big-firm capitalism, and entrepreneurial capitalism. Most countries feature some mix of these forms. Big-firm capitalism, for example, can also be oligopolistic capitalism, as it is in many parts of Latin America. 

The authors make a compelling case that the best form for any nation is a mix of big-firm and entrepreneurial capitalism, of which the United States is the most prominent example. Large firms provide the productive capacity and economies of scale to service growing populations. Entrepreneurs are the primary drivers of innovation, technical change and growth. As importantly, entrepreneurs keep large firms on their toes, forcing them to innovate or stagnate.

The problem with state-guided and oligopolistic forms of capitalism is that they are inherently “replicative” and “imitative.” They tend to reward forms of “redistributive entrepreneurship” instead of genuinely creative and innovative forms. These models of capitalism can work for periods of time, but there are upper limits to their success.

Western Europe and Japan are dominated by the big-firm form of capitalism. While preferable to state-directed or oligopolistic capitalism, the authors argue that their economies need jolts of entrepreneurial capitalism to keep the economic engine humming. But institutional and cultural obstacles in Europe make this difficult.

As a guidebook for economic reform, the book helps policymakers understand how to characterize their economies and thus what their relative strengths and weaknesses are. And it helps them begin mapping realistic incremental reforms that might move undeveloped or stagnant economies in the right direction. 

The authors are quick to caution that success is not easy, pointing out that “in all of the rich country models where entrepreneurship flowered from scratch, the formation of the requisite institutions – enforceable contract and property rights to ensure that entrepreneurs would keep the fruits of their risk-taking, legal and other institutions to curtail corruption, and the development of human and physical infrastructure(education and public roads, in particular) – evolved gradually and incrementally. There wasn’t some ‘big bang’ event that instituted all of these preconditions at the same time.”

As China and India continue to pursue their growth miracles; as Western Europe seeks its way out of an economic funk that dropped France from the 8th wealthiest country in the world to the 17th; and as the United States wrestles with the tensions and opportunities created by an economy marked by entrepreneurial change; this book serves as an invaluable guide for where these countries and regions are coming from; and where, it is to be hoped, they are heading.

Nick Schulz, The American's Techno-Ideas col­umnist, is editor of TCSDaily.com

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