Voting for a more Entrepreneurial Nation

Entrepreneurship is important for the well-being of a country’s economy because it sustains competition in the marketplace, and it is the mechanism through which new knowledge is transformed into new products and services for our citizens. Entrepreneurship, however, has been on the decline in the United States for forty years.

Figure 1: New businesses as a % of total businesses in the U.S. 1978-2011

A substantial variance in the decline of entrepreneurship in the United States is explained by decades of public policy that favored incumbents over challengers. Steve Vogel, Political Scientist at U.C. Berkley, explained, “The irony is that the policy agenda adopted in the name of entrepreneurs- including lower taxes, lower social spending, less regulation, financial liberalization, and weaker antitrust enforcement- hurt entrepreneurs more than it helped them.” The 2020 election presents an opportunity to support public policy that makes entrepreneurship more inclusive and accessible as a career path. In doing so, we can both increase American prosperity and increase the degree to which new prosperity is meritocratically shared. 

According to economic research, the American economic system was closer to a meritocracy in the 1950s to 1960s, when the gini-coeffcient for income was closer to thirty, and the marginal income tax rate for highest earners hovered between 90% and 70%.  But creating a greater sense of distributive justice in our market system via tax system changes is only one step towards building a more entrepreneurial nation. The next step is investing new public revenue in areas that increase the entrepreneurial capacity of our citizenry. Below, I highlight the five most important issues voters can support in order to create a more entrepreneurial nation according to scientific research on the subject: Health insurance reform, easing student loan debt, increased access to higher education, public funding for scientific research, and reducing income inequality.  

Health Insurance Reform. Research shows that bundling health insurance to employment reduces entrepreneurial activity. Fairlie et al. (2011) used panel data from Current Population Surveys to conduct a difference-in-differences test of the interaction between having a spouse with employer-based health insurance and potential demand for health care. The authors found evidence of a larger negative effect of health insurance demand on business creation for those without spousal coverage than for those with spousal coverage. The authors also examined the question of whether employer-based health insurance discourages business creation by exploiting the discontinuity created at age 65 through the qualification for Medicare. Using a novel procedure of identifying age in months from matched monthly CPS data, Fairlie et al. compared the probability of business ownership among male workers in the months just before turning age 65, and in the months just after turning age 65. They found that business ownership rates increase from just under age 65 to just over age 65.  Oppositely, the authors found no change in business ownership rates from just before to just after for other ages 55–75. What’s more, the authors also found that other confounding factors such as retirement, partial retirement, social security and pension eligibility were not responsible for the increase in business ownership in the month individuals turn 65. In another study, Wellington (year) estimated conservatively that universal coverage could increase entrepreneurial activity in the workforce by 2% to 3.5%. The key mechanism driving the relationship between health insurance decoupled from employment and entrepreneurship is risk level. Entrepreneurship is simply less risky when the practice doesn’t disrupt healthcare coverage.  

Voters interested in supporting a more entrepreneurial and innovative economy ought to seek out candidates who support policies that unbundle health insurance from employment. 

Easing Student Loan Debt. Research also shows that high student loan debt hinders entrepreneurship and entrepreneurial success. Krishnan and Wang (2019) used exogenous change in Higher Education Amendments in 1998 and 1992 to conduct a natural experiment analyzing the impact of student debt on propensity to start a firm. Their results indicated that student debt was negatively related to the propensity to start a firm. What’s more the authors found that entrepreneurs with more student debt are more likely to fall behind on their student debt payments, hindering the success of the entrepreneur’s new venture. Together, the study revealed the role of student loan debt in the decreasing rate of entrepreneurial activity in the US from the 1990s to the present day. 

Easing, forgiving, and/or refinancing student loan debt for millions of Americans, therefore, is critical to making entrepreneurship more accessible to our citizenry. Several candidates have put forth plans to ease the burdens of student loans, and several pundits have critiqued these plans, erroneously calling them hand-outs that will weigh on economic growth. However, plans to ease student loan debt is a growth oriented economic policy because it provides both push and pull factors for entrepreneurship to occur. Lower debt burdens reduces the level of risk associated with entrepreneurship, and lower debt burdens increases consumer consumption thereby creating more opportunity for entrepreneurship. 

Increased Access to Higher Education. In addition to reducing the financial burden of Americans who seek out higher education, entrepreneurial activity can be spurred in the U.S. by increasing access to higher education for upcoming generations of Americans. Increased human capital is essential to sustain entrepreneurship because identifying new entrepreneurial opportunities requires knowledge, networks, managerial and organizing skill, and also social tolerance, all of which are acquired via education.

However, the U.S. is increasingly losing the human capital advantage it enjoyed for decades post-World War II. For example, a study by the Bureau of Labor Statistics found that the average wage increase for all U.S. workers from 2000 to 2007 was 11 cents per hour, but that the average wage that companies paid their workers increased by 22 cents per hour during the same time frame; that is to say, average American workers only realized half of potential gains because a larger share of the workforce in 2007 was in lower-paying jobs (Keller, 2009). Atkinson and Ezell (2012) summed it up best saying “To risk being flippant, the American workforce has increasingly moved from manufacturing high-technology products to manufacturing hamburgers.”

Part of the issue is that our citizenry increasingly lacks the human capital to compete for high-paying jobs in global labor markets. Among industrialized nations, the US ranks 20th in high school completion rates and 16th in college completion rates (OECD, 2009).  Literacy among college graduates is even low (Department of Education, 2006). This doesn’t bode well for our nation’s innovation capacity. Slipping educational attainment is one reason why the chief executive of the Joint Venture Silicon Valley Network stated, “I’m not telling you the sky is falling, but I have a duty to report that some of the indicators are not good.” (Abate, 2010).

Access to higher education is not only important for increasing supply of innovators and entrepreneurs, it’s also important for creating requisite consumer demand for innovations. Research shows that more educated consumers have higher demand for novel products and services compared to consumers who are less educated (Taylor, 2016).

Accordingly, voters should seek out candidates with plans to increase public investment in higher education including plans that include provide two years of free community college, and plans making tuition at public universities debt free. 

Public Funding for Basic Research. Under-investment from both public and private organizations is limiting our national capacity to produce and diffuse innovations. Contrary to popular perception, the public sector plays a pivotal role in producing and commercializing the innovations that we buy via firms in private sector. For example, the technological innovations included in smartphones were developed and funded by public institutions (See FIGURE 2 below).  SIRI, for example, has roots in federally funded research. In 2000, the Stanford Research Institute (SRI) was asked by DARPA to lead a team, consisting of scientists from 20 different universities, in developing a virtual office assistant for military personnel. When the iPhone launched in 2007, SRI recognized the opportunity to commercialize their technology, and created a venture backed company called SIRI, which was bought by Apple in 2010 (Mazzucato, 2016). 

FIGURE 2: Origin of Technological Innovations in Apple Products (Mazzucato, 2016:109)

In addition to benefiting from technological innovations developed using federal funding and public research organizations, in the 1980s Apple also received $500,000 (~$1.2 million today) in early stage equity investment from an organization backed by the Small Business Administration (a federal agency created in 1953; see Audretsch, 1995). In short, public organizations not only led the development of innovative technologies inside the iPhone, but also led the way in funding the start-up responsible for bringing those innovations to market. Apple products are not a unique case -Tesla, Google, and Genetech are other examples. In fact, 88% of the most important innovations between 1971 and 2006 were fully dependent on federal research (as rated by R&D Magazine’s annual awards; see also Block and Keller, 2011).  

Perhaps the most poignant example of the role of the public role in innovation is innovation in the pharmaceutical industry, an industry where we may have the closest thing to an experiment comparing innovation between public and private organizations. Public labs (such as Universities) receive large government grants to conduct research into new cures for disease, and pharmaceutical companies receive large subsidies from the federal government for their R&D activities. Studies show that 75% of new molecular entities (NMEs, i.e. actual new drugs and not just variations of existing drugs) are traced to public research labs; most drugs originating in the labs of pharmaceutical companies are variations of existing drugs (Angell, 2004). 

Paul Berg, a Nobel-prize winning engineer at Stanford University, summed it up best in a conversation with French President Mitterand, Thomas Perkins (a partner at a venture capital fund), and himself. Perkins was crediting brave venture capitalists for Silicon Valley’s success, but Dr. Berg pushed back on Perkins comment saying, “Where were you guys in the ’50’s and ’60’s when all the funding had to be done in the basic science? Most the discoveries that have fueled [the industry] were created back then” (Henderson and Schrage in the Washington Post, 1984).  The truth is, private investors tend not to contribute to funding innovations until they are 3-5 years away from commercialization, and public organizations tend to be those social actors that fund, develop, and even provide the carrot for private investors to throw some skin in the game of economic disruption (Mazucatto, 2016).

Despite the critical role of public investment in both the early stage development of technological innovations, and the emergence of the start-ups that bring them to market, federally funded R&D as a percentage of GDP has slowed to a crawl. Federal R&D grew at just 0.3 percent per year from 1987-2008, much lower than its average annual growth of 4.9 percent per year from 1953 to 1987, and it is ten times lower than the rate of GDP growth (National Science Foundation, 2010). What’s worse, the slow-down in public R&D investment is occurring at a time when other countries are rapidly increasing their public investments in science and technology research (Atkinson and Ezell, 2012).  We are running the risk of dismantling the social ecosystem that has continuously “wowed” the world with new products by continuing to under-invest in basic research as a nation. 

While the US entrepreneurial eco-system is underfunded, large American firms have spent over $7 TRILLION buying back their own stock since 2004 despite historical data showing that increases in the number of buybacks leads to slower economic growth over time (Foroohar, 2016: 124). Apple, for example, essentially returned about $112 billion dollars back to its investors from August 2012 to March 2015. While some of those gains enriched pension funds, it is important to note that the top 0.1% of Americans own 91% of all equities. Also important to note is that most of those investors did not put one penny towards investing in Apple’s original technology, and had nothing to do with the engineering, designing, or assembling of the final Apple products. What’s more, despite having a record amount of cash on hand, Apple borrowed most of the money to provide investors with record breaking payouts. These buybacks almost always boosts the company’s share price because “buybacks artificially decrease the number of shares on the market [but the issues is that buybacks don’t]… actually chang[e] the real value of the company via true strategic investments like research and development, worker training, or anything else that might bolster the underlying long-term prospects of the firm” (Foroohar, 2016: 124).

This is backwards organizational behavior. Prior to 1982 buybacks were considered unlawful market manipulation. The stock market was intended to be an avenue through which companies can raise capital to make strategic investments. However, companies like Apple (who don’t need to raise money in order to make strategic investments) are incurring debt to give money back to the stock market at the expense of productive organizational behaviors such as paying taxes into the public side of the social ecosystem that produced their core technologies, building a new factory, opening a new research lab, training workers, increasing their R&D budget, or giving their workers raises (thereby bolstering our consumer oriented economy!). Overall, buybacks are increasingly found to be an unproductive use of corporate funds that contribute significantly to our persistently slow-growth economy (Smithers, 2013).  What’s more, in addition to being unproductive for the wider economy, this type of organizational behavior damages the individual firm’s long-term viability (Collins and Porras, 1994; Collins, 2001).

We need a system that discourages organizational behaviors such as stock buybacks and short-termism (see Clayton Christiensen, 2014), and we need to build one that encourages productive organizational behavior (investments in R&D, capital equipment, worker training, or profit sharing with employees). Reducing the effective corporate tax rate via incentives for productive organizational behavior, and discouraging unproductive organizational behavior, is preferable to a blanket reduction of the statutory rate because the latter does nothing to prevent unproductive organization behavior or encourage productive organizational behavior that leads to higher growth in the real economy (Atkinson and Ezell, 2012; Cohen and DeLong, 2016; Mazzucato, 2016; Foroohar, 2016).

Voters should support candidates whose policies plans 1) reign in stock buy-backs 2) return corporate tax rates to their pre-2016 levels 3) expand business tax credits for R&D, employing Americans, manufacturing in the U.S., and exporting 4) increase funding to the NIH, NSF, DARPA, FDA as well as the arts and humanities, and 5)  support the ongoing construction of the renewable energy market by increased funding to the EPA, taxing carbon emissions, removing tax-credits for big oil. 

Reducing Economic Inequality. Research on community dynamics and entrepreneurship affirms that social trust increases entrepreneurial activity by reducing “transaction costs associated with creating contracts and monitoring compliance” (Kwon, Ruef, and Heflin 2013:982; Hiatt and Sine, 2014). For nascent firms with few resources, high transaction costs can serve as a barrier to entry that impedes venture foundings (Aldrich and Ruef, 2006). What’s more, research on economic inequality has shown that levels of social capital are higher in regions with greater income equality (Henrik, 2007; Barone and Mocetti, 2016). Taken together, these two distinct research streams suggest that reducing income inequality could increase entrepreneurial activity because rising income equality increases social trust, and higher levels of social trust will increase entrepreneurial activity by reducing the transaction costs of doing business (De Carolis and Saparito, 2006). 

We can reduce extreme income inequality in the U.S. by taxing all income the same, adding a distinct tax bracket for incomes over one million USD that is taxed at a higher rate, and by increasing the estate tax. Additionally, we can reform income tax deductions for mortgage interest payments and charitable giving. Reduced income inequality will increase social trust throughout our country, and the additional public revenue can be used to fund the previous three public policy areas I highlighted. 

My outline may seem like a diatribe of democrat talking points, but I assure you they aren’t. For the last 40 years we thought that entrepreneurship and innovation increase to the degree that taxes are reduced, spending on social programs is reduced, and to the degree that regulations are rolled back. Democrats also shared this understanding as they tended to pitch regulation and social programs as necessary for the greater good rather than as necessary for the entrepreneurial dynamism of the economy. Scientists studying entrepreneurship are increasingly finding that entrepreneurship is not a function low taxes, scaled back social programs, and deregulation. I know that the findings challenge preconceived notions of what constitutes public support for entrepreneurship for many readers. To those readers whose views are challenged, I want to say that the findings challenged my own views on the social foundations of entrepreneurship when I started my academic career around eight years ago. However, I have found greater satisfaction in changing my beliefs in the face of evidence rather than discarding evidence when it conflicts with my pre-existing beliefs. 

Let’s come together as Americans this November and vote for a more entrepreneurial nation.

References:

***Full references available upon request.