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The weak economy has sent our elected officials scrambling for solutions to boost economic growth and create jobs. The White House has latched onto increasing the number of American entrepreneurs as the answer. The increase should raise gross domestic product (GDP) and lower unemployment, the argument goes.
While this sounds logical, trying to stimulate the economy by encouraging more people to go into business for themselves doesn’t appear to work. That’s because entrepreneurial talent can’t be quickly built by giving people a short class in writing a business plan or using QuickBooks. If we can influence entrepreneurial talent at all—an open question—it takes long-term investments in education. Despite the plethora of government programs designed to increase our stock of entrepreneurs, there is a limited supply of people capable of creating and running businesses that generate a lot of jobs and produce wealth.
The levers policymakers can influence in the short term—giving entrepreneurs more access to credit or training people in business startup skills—also do little because these factors are only a small part of what limits the supply of entrepreneurial talent. Efforts to train unemployed people to start businesses are a case in point. Research shows these policies have no long-term effect on the amount of GDP growth and job creation that comes from entrepreneurship.
The reason is simple. If few people have the skills or good ideas for new, high-potential businesses—those that demonstrate a way to meet a market need that can be protected by sustainable competitive advantage—making it easier to start any business does little to help the economy. All that happens is more people lacking the necessary talent to sustain businesses start businesses. They end up failing without having produced many lasting jobs or having contributed much to economic growth.
New York University economist Will Baumol suggests a better approach: Instead of trying to increase the amount of entrepreneurial talent in the economy, policymakers should provide incentives to reallocate that talent from unproductive or destructive forms of entrepreneurship to more productive forms.
To Baumol, entrepreneurship takes three forms: productive, unproductive, and destructive. Productive entrepreneurship is the kind we all want. When an entrepreneur figures out how to allow people to access information faster on the Internet or to eradicate a disease, we are all better off.
Unproductive entrepreneurs don’t make us better off; they simply gain personally at someone else’s expense. The private equity guys who exploit differences in tax rates on carried interest and ordinary income, or tort lawyers who successfully sue companies that make money, don’t create wealth. They merely shift it from one party to another.
Destructive entrepreneurs make us worse off. For example, Columbia University sociologist Sudhir Venkatesh explains that while running a drug cartel or a criminal gang demands a lot of entrepreneurial talent, the money these entrepreneurs make comes at the cost of a lot of death and destruction.
Baumol’s argument is that the supply of talented entrepreneurs is limited, and that policymakers know little about how to increase it, particularly in the short run. As a result, they will get more bang for the policy buck if they concentrate instead on encouraging those who have entrepreneurial talent to use it for productive purposes.
It might be tough to shift people out of destructive entrepreneurship into the productive kind. After all, few people choose between becoming drug kingpins and biotech company founders. But offering an incentive for people to engage in productive entrepreneurship instead of the unproductive version has promise.
We could tax earnings from business activities that merely shift wealth from one party to another at a higher rate than money made from productive entrepreneurship. We could forgive student loans of productive entrepreneurs, but not the unproductive ones. We could even make credit cheaper for productive entrepreneurs than for the wealth-shifting types.
How we do this would require much more analysis than can be provided in a short column, and policymakers would have to carefully analyze the incentives they create to make sure people could not easily game the system. But based on the lack of results from current efforts to increase entrepreneurial talent, trying to reallocate it to Baumol’s productive form of entrepreneurship is well worth undertaking.