Category Archives: National Economy

Lost: $1 trillion

Today’s Wall Street Journal reports:  since 2005 productivity has declined 8% off its long-run trend, which has meant $1 trillion less in business output.  The reason?  Fewer start-ups.  From Behind the Productivity Plunge:  Fewer Start-ups

Lagging productivity growth is an enormous problem because virtually all of the increase in Americans’ standard of living is made possible by rising worker productivity. In our view, an important factor contributing to declining productivity growth is the large decline in the creation of new businesses. The creation rate of new businesses, as well as new plants built by existing firms, was about 30% lower in 2011 (the most recent year of data) compared with the annual average rate for the 1980s. (The data is the Census Bureau’s Business Dynamic Statistics.) The decline affected nearly all business sectors.

Steven Malanga coined the term startupicide – “suffocating regulations, inflated business taxes and fees, a lawsuit-friendly legal environment, and a political class uninterested in business concerns” – which gets sprayed on every business, large and small.  At the margins those factors clearly affect the viability of new businesses and new projects.  Here’s how we once put it, discussing just one of the four ingredients:

For Costco (one example) to build a new store, a 40% tax rate on the income will require much higher sales expectations for the store than if taxes were 30%, or 20%, or 0%.  It’s the same analysis regardless of who is making the investment decision: rich angel investor, venture capitalist, Fortune 500 CFO.  When taxes are higher, fewer stores get built and fewer companies get started.

The WSJ piece continues:

New businesses are critical for the U.S. economy to grow because a small fraction of today’s startups will become tomorrow’s economic heavyweights. Most of today’s workers are employed at older, established businesses, but the country cannot rely on existing companies to boost the economy. Businesses have a life cycle, in which even the largest and most successful reach a stage at which they stop expanding.

If history is any indication, many of today’s economic heavyweights will ultimately decline as new businesses take their place. Research by the Kaufman Foundation shows that only about half of the 1995 Fortune 500 firms remained on the list in 2010.

That’s the funny thing about those large companies:  they all have birthdays, either as start-ups themselves or as spin-offs from other companies (who were once start-ups).  Many of them are born during very bad times – as long as the entrepreneurial incentives, and entrepreneurial optimism, remain intact.

Over half the companies on the Fortune 500 were started during a recession or bear market.  The patents for the Television, Jukebox, and Nylon were granted during the greatest period of job destruction in our history:  The Great Depression.  (Although we can’t confirm any patent information on the chocolate chip cookie, it too was invented at the same time.)  This is precisely the creative destruction that makes our economy an engine of innovation and wealth creation.

That $1 trillion in forfeited economic output demonstrates that a growing economy, with plenty of opportunity, and no shortage of entrepreneurial activity (at start-ups and within firms) should not be taken for granted.


Related stories:

How private entrepreneurs won WWII

Freedoms ForgeIn case you missed it late Friday (June 6) online at the WSJ:  How private entrepreneurs won WWII.

We appreciate the author’s (Freedom’s Forge) point that it was the entrepreneurial spirit of both the Titans of Industry and their smaller counterparts who made the Arsenal of Democracy possible.  “Big and small firms – all – stepped up.”

Easy to forget that in 1940 we had only the 18th largest military in the world, behind Argentina.

Appreciating the rich for how they got there, Part II

We once wrote that the hard-earned success of entrepreneurs is what gives them the inclination and the wherewithal to help support the next generation of high-growth companies.  The wealth created “yesterday” is not stuffed under plump mattresses, it’s used “today” to fund the businesses and innovations that enhance and enrich all our lives.  Most of those savings come from a relatively small fraction of individuals in the top income tax bracket, and to disparage them is to bite the hand that feeds long-run economic growth.

Intel's 4004: the first microprocessor

Intel’s 4004: the first microprocessor

John Steele Gordon, author of “An Empire of Wealth: The Epic History of American Economic Power,” advances the argument in the 6/4/14 Wall Street Journalextreme leaps in innovation, like the microprocessor, bring with them staggering fortunes – but also enrich and enhance all our lives.

(N)o one is poorer because Bill Gates, Larry Ellison, et al., are so much richer. These new fortunes came into existence only because the public wanted the products and services—and lower prices—that the microprocessor made possible. Anyone who has found his way home thanks to a GPS device or has contacted a child thanks to a cellphone appreciates the awesome power of the microprocessor. All of our lives have been enhanced and enriched by the technology.

This sort of social transformation has happened many times before. Whenever a new technology comes along that greatly reduces the cost of a fundamental input to the economy, or makes possible what had previously been impossible, there has always been a flowering of great new fortunes—often far larger than those that came before. The technology opens up many new economic niches, and entrepreneurs rush to take advantage of the new opportunities.

The full-rigged ship that Europeans developed in the 15th century, for instance, was capable of reaching the far corners of the globe. Soon gold and silver were pouring into Europe from the New World, and a brisk trade with India and the East Indies sprang up. The Dutch exploited the new trade so successfully that the historian Simon Schama entitled his 1987 book on this period of Dutch history “The Embarrassment of Riches.”

Steele mentions a few other notable examples:

  • James Watt’s rotary steam engine sparked the Industrial Revolution, causing growth – and thus wealth and job creation – to sharply accelerate.
  • Railroads made transportation cheap and created national markets.  Railroad owners and retailers made fortunes while everyone benefited from easier access to cheaper goods.
  • Edwin Drake’s drilling technique made oil abundant, the Bessemer converter made steel cheap, and both taken together made the automobile possible;  this in turn had spillover effects (and fortunes) in other industries (rubber, glass, road building, etc.)

The Little Miracle Spurring Inequality today is cheap computing power.  Software, hardware, the Internet, and precise inventory control have transformed the world and created huge new fortunes in the process.

To see how fundamental the microprocessor—a dirt-cheap computer on a chip—is, do a thought experiment. Imagine it’s 1970 and someone pushes a button causing every computer in the world to stop working. The average man on the street won’t have noticed anything amiss until his bank statement failed to come in at the end of the month. Push that button today and civilization collapses in seconds. Cars don’t run, phones don’t work, the lights go out, planes can’t land or take off. That is all because the microprocessor is now found in nearly everything more complex than a pencil.

Just as before, that wealth will not be stuffed into mattresses, it will go to work:

Any attempt to tax away new fortunes in the name of preventing inequality is certain to have adverse effects on further technology creation and niche exploitation by entrepreneurs—and harm job creation as a result. The reason is one of the laws of economics: Potential reward must equal the risk or the risk won’t be taken.

And the risks in any new technology are very real in the highly competitive game that is capitalism. In 1903, 57 automobile companies opened for business in this country, hoping to exploit the new technology. Only the Ford Motor Co. survived the Darwinian struggle to succeed. As Henry Ford’s fortune grew to dazzling levels, some might have decried it, but they also should have rejoiced as he made the automobile affordable for everyman.

Our column in the Business Journal

On April 7 a syndicated column entitled “Why your company should avoid venture capital” ran in several City Business Journals.  The piece struck us as a bit uncharitable and off point, so we asked our hometown Tampa Bay Business Journal for the chance to reply, to which they graciously agreed.  Our column ran today and can be found here.  (Or if you prefer a .pdf, here.)

Early stage investors don’t always fit neatly into categories and take varied approaches to working with entrepreneurs, so one must be careful not to paint with too broad a brush when criticizing or praising.  However the industry as a whole is indisputably critical to the nation’s wealth and well-being.

20% of U.S. gross national product is created by companies that were formed through venture backing. Everybody knows Google and Facebook, and before them Apple and Intel, but there are countless lesser known venture-backed companies throughout the country who have contributed to economic growth and created high quality jobs.  Venture capital is the one asset class that consistently creates the next generation of great companies and jobs and it doesn’t ask for (or need) bail-out.

Four new additions to our libraries

In The Spirit of the Laws Montesquieu posited that the invention of The Letter of Exchange was politically transforming because capital could now travel.  In his view it has always been true that:

Commerce is sometimes destroyed by conquerors, sometimes cramped by monarchs; it traverses the earth, flies from the places where it is oppressed, and stays where it has liberty to breathe.

The latest addition to The Library in St. Pete offers excruciatingly detailed data (and interactive map) in support of Montesquieu’s notion, applied to the migration of economic clout within the United States.  Author Travis H. Brown uses data mapping of IRS taxpayer records over the past two decades to show the movement of millions of Americans and over $2 trillion in adjusted gross income among the states.  Or, as he puts it, “Money walks because opportunity talks.”

Our regular readers will not be surprised to learn that the migration of working wealth is primarily to the Southeastern growth corridors; nor will they be surprised to learn the money is walking to states with the best climate for entrepreneurs.  While this migration has been more subtle than the California Gold Rush or Irish Potato Famine, Mr. Brown argues it is just as significant:

If you are losing your working wealth to other states, you are losing your most precious cargo.  These are your earners, your workers, your entrepreneurs; this is your tax base.  This great movement of working wealth into and out of states is staggering and has serious economic ramifications.

Kevin D. Williamson agrees with that assessment, and in Suicide Pact takes a look at Brown’s data and devises five easy steps to “cripple” your state:

1. Make work expensive.
2. Attack lifetime savings.
3. Run up your state’s long-term liabilities.
4. Tax fanciful things.
5. Don’t just be crazy — be California crazy.

Williamson thinks the trends will only get worse for those states surviving on legacy industries:

There was a time — and it really wasn’t that long ago — when if you were a  financial firm, you had to have an office in Lower Manhattan, when film studios  had to have offices in Los Angeles, and high-tech firms really needed to be in  Silicon Valley.  If Travis Brown’s big data set shows us anything it is that  those days are done.  You can build very fine automobiles in the United States,  but if you aren’t already in Detroit, you’d be a fool to set up shop there.

 ~ ~ ~

A second recently-added book makes essentially the same point in a global/historical context.  Our popular 4-part series based on Professor Geoffrey Jones’s book concluded that since 1850 those countries with the most friendly environments for entrepreneurs have innovated and prospered.

Why, after the Industrial Revolution began in the West, did the Rest struggle to catch up?  Entrepreneurs are the missing gap in the analysis of what creates a prosperous modern economy.  Institutions and human capital are treated as the first order causes of economic growth. The assumption is that if a society evolves or adopts the right institutions, or else has good human capital investment, firms and entrepreneurs will more or less appear spontaneously and create economic growth. The business history literature suggests that this is a considerable over-simplification… To have entrepreneurship, there must be entrepreneurial opportunities.

~ ~ ~

In conjunction with these additions to The Library in St. Pete, we’ve updated the library of resources for entrepreneurs at our website as well.  “Worry less about the idea, more about the execution” explains why investors are often reluctant to sign NDAs, and “Growth Equity is All Grown Up” describes how growth equity has matured as an asset class and incorporates the best characteristics of both venture capital and private equity.

We hope you will find these four additions interesting and enjoyable.

The dignity of innovation

It’s been said that Shakespeare’s audiences had only marginally better lives than Sophocles’.  That changed around 1800 when prosperity and development climbed sharply and suddenly, first in the North Sea region and then diffusing throughout “the West.”

Last Fall we ran a 4-part series (I, II, III, IV) based on this book which skipped the question of Why the Industrial Revolution happened and focused on How and Where it spread:  those countries with the most friendly environments for entrepreneurs innovated and prospered.  On that score “the West” did better than “the Rest.”

bourge-dignityIn Bourgeois Dignity: Why Economics Can’t Explain the Modern World, Deirdre McCloskey tries to answer the Why.  While scientific, political, and economic advances laid the groundwork, it was the idea that entrepreneurship had dignity that made the difference.

(O)ne doesn’t see a change in the psychology of businesspeople… What changed was the sociology. That is, what changed was the attitude of the rest of the society toward businesspeople, and with that new attitude came a change in government policy. It was suddenly all right to get rich and to innovate.

From Amazon’s description:

During this time, talk of private property, commerce, and even the bourgeoisie itself radically altered, becoming far more approving and flying in the face of prejudices several millennia old. The wealth of nations, then, didn’t grow so dramatically because of economic factors: it grew because rhetoric about markets and free enterprise finally became enthusiastic and encouraging of their inherent dignity.

In subsequent interviews she has said that “It was not inevitable [but] by 1900 everyone not blinded by some millennial fantasy, Left or Right, could feel it.”

It is neither inevitable nor consistently applied, so it’s good to be reminded, as Jonah Goldberg does in Innovation vs. Regulation:

Despite a century of anti-corporate rhetoric about the power of corporations, they actually come and go with amazing rapidity (only 13 percent of firms on the Fortune 500 list in 1955 were there in 2011).

But government is forever. The state has the unique ability to protect existing “stakeholders” from the threats posed by innovation and competition, whether those stakeholders are businesses or unions, fat cats or philanthropies. That’s where the votes are and where the checks come from.

But progress — material, medical, economic — comes from innovation. Economist Deirdre McCloskey notes that until the 19th century, innovation was a negative word because innovators upset the established order and the powers that be…  (F)or all of human history, humans lived on about $3 a day, using today’s dollars. For 200,000 years, the line was essentially flat, until around 1800, when a culture that valued innovation spread from England to Europe and the New World. Since then, wealth has skyrocketed, all thanks to a culture willing to let innovators pull up the stakes of the existing stakeholders.

In Silicon Valley, where government’s touch is light, we can see the rapidity of innovation at work. In health care, education, and other areas where the government’s hand is heavy, we see stakeholders holding on for dear life.

It seems paradoxical, but failure is what makes us rich.  Well over half of the companies on the 2009 Fortune 500 list began during a recession or bear market.  The patents for the Television, Jukebox, and Nylon were granted during The Great Depression.  Also born at that time:  the chocolate chip cookie, Scrabble and Fender Guitars (kinda).  The decline of U.S. Steel was bad for the company’s shareholders and its employees, but it was good for people who use steel — meaning everybody else in the world.  Without the pressure and opportunity created by the possibility of failure the entire U.S. economy would be (at best) stuck in the early 19th century.

National prosperity is generated by the start-ups who innovate and challenge entrenched incumbents.  Anyone who’s worked for a large corporation – especially in an R&D department – would not rely primarily on that model for innovation.  Anyone who’s worked for a large corporation – especially in a dying industry – would not rely primarily on that model for job growth.  Yes, start-ups lack the economies of scale and R&D budgets of larger firms; but that’s the support venture capital provides.  Those start-ups that do gain traction are able to raise capital, and, with hard work and a little luck, become large companies…  and then face the next generation of innovators.

Warren Buffett and after-tax returns, redux

return-on-investmentWriting in The New York Times, a professor of economics at Boston University claims to have built a sophisticated computer model that shows if we were to abolish the corporate income tax we’d significantly raise investment, output and real wages.  He’d replace the lost tax revenue with higher personal income tax rates.

Abolish corporate income taxes and, yes, there would be more investment by and in those corporations.

However the secret to national prosperity is found more in entrepreneurs and the investors who back them – both of whom often pay taxes at the higher personal income tax rates.  Raise their taxes and there will be less investment by and in those sources of growth and prosperity.

Academic explanations that depend on hypothetical models are fine as far as they go, but a simpler micro-economic proof is available:  investors put up money (only) in expectation of an after-tax return, and it is simply a fact that more projects – startups or expansions of existing businesses, large or small – are viable when taxes are 0% than when they are 40%.  There are a lot more projects that can expect to earn 10% pre-tax than the 17% you need if you are going to pay 40% in taxes.

We’re not privy to all the factors accounted for in the model, but we’d be reluctant to raise taxes in any way that punishes saving and investing.

The professor is not the first op-ed writer at the NYT to overlook this point.  From November 28th, 2012, Warren Buffett and after-tax returns:

In an op-ed this week in The New York Times, Warren Buffett writes that investors ought to assess investment ideas without regard to their personal tax rates.  He opens by suggesting no reasonable person declines a good investment opportunity based on the after tax return.  Quoting a hypothetical investor response, Mr. Buffett writes:

“Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 percent.” Only in Grover Norquist’s imagination does such a response exist.

He later closes the op-ed in similar fashion, with a tongue-in-cheek challenge:

In the meantime, maybe you’ll run into someone with a terrific investment idea, who won’t go forward with it because of the tax he would owe when it succeeds. Send him my way. Let me unburden him.

To be clear, we are big fans of Mr. Buffett’s investment style and more than impressed with his long term returns.  He is one of the greatest investors of modern times.  But many  of us who invest in early-stage, high-growth companies – the companies responsible for all net job growth in the economy – disagree with the idea that individual tax rates don’t matter when it comes to investment decisions.  Investors will always seek the best risk-adjusted return on their money, whatever the external constraints.  If taxes and other risks go up, they will expect higher returns to compensate for the greater risk; when those returns aren’t available or attractive they will sit on their money.

Reasonable people will disagree on what tax rates should be.  But can we at least agree that there are some forms of investment activity which promote economic growth, and that those forms ought to be encouraged, perhaps with favorable tax treatment?  Our investors’ capital is tied up for years, resulting in reward only if our portfolio companies grow (and hire).  That is not the same activity as trading securities or Treasury bonds, which Mr. Buffett has done with amazing success, and for which he practices his own tax-avoidance strategies.  Mr. Buffett’s minimum tax on “millionaires” is essentially a tax on capital gains, which is a tax on economic growth and job creation.

We’d like to take issue with something else Mr. Buffet seems to suggest.  In his op-ed he seems to treat investments as being either “worth doing” or “not worth doing.” However one of his well-known nostrums is that obviously “terrific” investment opportunities are rare, and that value is more likely to be found or created via attention to the more mundane operating or competitive considerations at the margins.  And at the margins, changing the tax rate clearly affects the viability of additional projects.  As a friend of mine recently said, this is true for established companies as well as start-ups:  for Costco (one example) to build a new store, a 40% tax rate on the income will require much higher sales expectations for the store than if taxes were 30%, or 20%, or 0%.  It’s the same analysis regardless of who is making the investment decision: rich angel investor, venture capitalist, Fortune 500 CFO.  When taxes are higher, fewer stores get built and fewer companies get started.

There’s a heroic assumption embedded in the op-ed’s analysis:  that there will always be a nicely growing economy, with plenty of opportunity, and no shortage of entrepreneurs.  We believe it is not safe to assume that entrepreneurs will continue to risk their wealth and careers, expend the energy, and make the enormous sacrifices required to build a business no matter how big a bite the taxman takes out of their eventual reward.  It’s fine to say investors will look for the best opportunity regardless, but if there are fewer entrepreneurs there will be fewer opportunities, and the economic pie will start to shrink.

Mr. Buffett is no doubt correct that “terrific” ideas will still find willing investors, but what about all the not-obviously-terrific-but-still-really-good ideas?  For every Facebook there are hundreds of other early-stage companies who receive financial backing and grow nicely and thousands of new stores opened by established companies; those investments are approved only if the after-tax returns are sufficient.  The economy is not built on a series of towering home runs that clear the fence no matter how strong the wind is blowing into the park.  Winning takes singles, doubles, walks, anything that advances runners and scores runs.  Raising taxes on investment is like building a pitcher-friendly park and keeping the infield grass long:  you better plan on low-scoring games.

Will voters split The Golden State into Six Californias?

A prominent Silicon Valley venture capitalist, frustrated by his state’s broken institutions, has launched a ballot initiative to split California into 6 states.  (Named Jefferson, North California, Silicon Valley, Central California, West California, and South California.  Fwiw.)

These pages have often extolled the virtues of doing business in the Southeast and Texas, the best climate for entrepreneurs and where we have focused our investment efforts for over twenty years.  Along the way we may have poked gentle fun at our friends in California whenever the state’s business environment fared poorly in surveys or did something like retroactively tax entrepreneurs.

So we can try to imagine the frustration engendered when a large and diverse geographic area strains under distant and schlerotic governing institutions – and we love the idea of having a state named after our 3rd president.  Hard to see how this becomes a political reality though.

But Cali ballot initiatives can get gnarly so perhaps it bears watching…

From the 12/23/13 San Jose Mercury News:

Lots of folks believe California is ungovernable. Venture capitalist Tim Draper has a solution: Six Californias, including one called Silicon Valley…

Veteran political observers were quick and unanimous in assessing the plan’s odds of success at zero. At the same time, they said Draper’s modest proposal could spark discussion about how to fix the state’s manifold problems, such as bursting prisons and jockeying over water rights.

The sheer size of California raises questions about representation and accountability. A single state Senate district has more people than all of South Dakota,” said John J. Pitney, a political science professor at Claremont McKenna College, east of Los Angeles…

(Draper) argued that the status quo in Sacramento, which regularly features budget gridlock and statehouse gamesmanship, “is not cutting it for our schools, our businesses, our infrastructure or our people.”

Asked by this newspaper how much of his own fortune he plans to sink into his latest political crusade, Draper deadpanned: “As little as possible.” Then he added, “I’ll make sure it gets on the ballot, so that Californians have a chance to make the decision.”




Thanksgiving: the forgotten entrepreneurial tale

Every child in America learns of the hardships endured by the Pilgrims as they established Plymouth Colony.  Some lucky ones even learn how the Pilgrims found salvation via private property, division of labor, and capitalism.  The luckiest ones of all learn about capital preservation when a venture capital investment fails.


Mayflower with shallop – William Halsall, 1882

When a group of Puritans known as “Separatists” fled England they first settled in the Netherlands, where they took menial jobs and over time grew to miss their native culture.  They lacked the resources for a passage to North America, so they sent two entrepreneurs from their congregation to London to seek financial backing – a successful merchant named John Carver and Robert Cushman, a “wool comber of some means.”  While those two were in London, an ironmonger (a dealer in metal utensils, hardware, locks, etc.) from that city named Thomas Weston was visiting one of Carver’s in-laws in the Netherlands and learned of the Pilgrims’ need for funds.

Whether we call that serendipity or opportunistic networking, it resulted in Weston putting together an investor group to back the voyage.  Weston and his London Merchant Adventurers put up 7000 pounds and also recruited experts to assist with the enterprise:  roughly 50 additional settlers with the vocational skills to help build a colony in the new world.  These “non-Separatists” crammed aboard the Mayflower with the Separatists and together became known as the Pilgrims.

What happened to that £7000 investment, you ask?  Here is the story as told at

Weston and his fellow investors were dismayed when the Mayflower returned to England in April 1621 without cargo. The malnourished Pilgrims had been subjected to “the Great Sickness” after the arrival at Plymouth, and the survivors had had little time for anything other than burying their dead and ensuring their own survival. Weston sold his London Merchant Adventurer shares in December, although he did send a ship, the Sparrow, in 1622 as his own private business venture.

The Pilgrims attempted to make their first payment by loading the Fortune, which had brought 35 additional settlers in November 1621, with beaver and otter skins and timber estimated to be worth 500 pounds. The ship was captured by French privateers and stripped of its cargo, leaving investors empty-handed again.

A second attempt, in 1624 or 1625, to ship goods to England failed when the Little James got caught in a gale in the English Channel and was seized by Barbary Coast pirates. Again the London Adventurers received nothing for their investment. Relations, always tempestuous between the colonists and their backers, faltered.

Facing a huge debt, the Pilgrims dispatched Isaac Allerton to England in 1626 to negotiate a settlement. The Adventurers, deciding their investment might never pay off, sold their shares to the Pilgrims for 1,800 pounds. Captain Smith, of the failed Jamestown venture, felt the London Merchant Adventurers had settled favorably, pointing out that the Virginia Company had invested 200,000 pounds in Jamestown and never received a shilling for their investment.

By our back-of-the-envelope calculation, the investors got back 26% of their invested capital.  If only they’d kept their long-term perspective…

On a more serious note, that outcome fits into the first category of entrepreneurial failure listed in Fail the Right Way and reflects well on those involved:

1. Liquidate all assets, investors lose most/all money: 30-40%
2. Not realizing the projected return:  70-80%
3. Falling short of initial projections: 90-95%

With “failure” this common, he urges executives to distinguish between business failure and personal failure.  It’s vital to not let the former, which can be a valuable learning experience, pressure you into the latter, which can become a career-damning ethical lapse:

Although the original backers did not get the return for which they’d hoped, the endeavor ultimately succeeded thanks to the intrepid settlers who displayed many of the noble traits found in entrepreneurs:  flexibility (they had to settle further north than intended), persistence (through brutal hardships), the value of good partners (Squanto and the Wampanoag tribe), and the courage and optimism necessary to accomplish the impossible and stupid.

All great and honorable actions are accompanied with great difficulties, and both must be enterprised and overcome with answerable courage.

– William Bradford, 2nd, 5th, 7th, 9th & 11th Governor of Plymouth Colony

Our business – like every business – has its ups and down, but we have much to be thankful for.  Much.   So we’d like to take this opportunity, here at NVSE, to give thanks for the trust and patience of our Limited Partners, the initiative and dedication of our entrepreneurs, the support provided to them by the many friends in our network, and the nation that offers the freedom to pursue happiness.  We love our work, have been blessed with terrific successes and honorable failures, and get to do it all with great people in beautiful weather.   God Bless you and your families – we hope you have a wonderful Thanksgiving.

Entrepreneurs and global wealth since 1850 – Part IV

Why, after the Industrial Revolution began in the West, did the Rest struggle to catch up?  Professor Geoffrey Jones argues that entrepreneurs are the missing gap in the analysis of what creates a prosperous modern economy.  Since 1850 those countries with the most friendly environments for entrepreneurs have innovated and prospered.

In this final installment we excerpt the author’s thinking on three more factors at the national level that affect entrepreneurship:  human capital, geography, and infrastructure.  We then close below the jump with his conclusion (verbatim) from the working paper that led to the book. 

(Here are links to Part IPart II, and Part III of this series.)

A popular explanation for wealth and poverty is egalitarian mass provision of secular education.  We agree that investing in human capital is important in its own right, but also agree with the author that it does not guarantee the spontaneous emergence of entrepreneurship.  Other vital pieces have to be in place as well:

Knowing that political and legal institutions or human capital matter is important – but a further set of critical questions relate to how firms and entrepreneurs interact with these aspects of an economy. It is firms and entrepreneurs which create wealth and innovation, rather than governmental institutions or schools. Here the economics literature is less well-developed. Institutions and human capital are treated as the first order causes of economic growth. The assumption is that if a society evolves or adopts the right institutions, or else has good human capital investment, firms and entrepreneurs will more or less appear spontaneously and create economic growth. The business history literature suggests that this is a considerable over-simplification… This brief survey of the historical evidence suggests that neither institutions nor human capital are fully discrete, and that historical case studies provide different answers to the question about what matters most. There are likely to have been other factors at work also. To have entrepreneurship, there must be entrepreneurial opportunities.

Regarding the role of geography and infrastructure, Professor Jones appears to ascribe the emergence of large integrated firms in the U.S. to the “Chandlerian” model and offers keen observations about two other interesting cases:

The growth and size of the American market provides a key component of the Chandlerian explanation for the emergence of large integrated firms in the United States.  It seems plausible that both in the case of Britain, the first industrializer, and Japan, the first successful non-Western catch-up, identification of entrepreneurial opportunities, and the building of managerial structures which permitted their exploitation, was facilitated by geographically compact domestic markets and unusually large capital cities.  The market opportunities for firms and entrepreneurs in most of Asia, Latin America and Africa were more constrained. They often faced great difficulties if they wanted to sell beyond their local markets because of poor transport and communications infrastructure. In India, market conditions have been identified as one explanation why India’s powerful and rich merchants in the seventeenth and eighteenth centuries left manufacturing in the hands of small artisans, pointing to fragmented markets, inadequate transport infrastructure, lawlessness and disregard for property rights.  These constraints were relaxed as the British colonial regime imposed political stability and promoted transport infrastructure, but a well-established argument in the literature on nineteenth century India has maintained that the small scale of the domestic market retarded the growth of a modern machinery industry…

The role of the state in catching up economic backwardness has been debated since the writings of Gershenkron decades ago.  However, the ways in which governments facilitated entrepreneurial perception and exploitation of opportunities has not been the primary emphasis of this research. Yet it is difficult to account for the rapid economic growth of the United States in the nineteenth century without mentioning government policy. The Federal government purchased, or annexed, much of the territory of the present day country, and then largely gave it away. State governments were active promoters of infrastructure investment. High levels of tariff protection widened the market opportunities for entrepreneurs and firms by shutting out cheaper imports from Europe.

Please find the summary/conclusion from Professor Jones’s white paper below:


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