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Tax breaks, bailouts, and stimulus packages for big business are the most commonly prescribed remedies for economic growth. Policymakers believe that such companies as General Motors (GM), Citibank (C), and Intel (INTC) form the backbone of the U.S. economy. Creating policies to support them, they think, will develop jobs and boost gross domestic product.
These behemoth-centric policies are misguided. Because new small businesses create the most jobs, a handful of innovative startups that become billion-dollar businesses will most drive GDP growth.
Companies old and new are continuously and simultaneously destroying and creating jobs. When you look at the big picture, as the Kauffman Foundation did in a report it released this summer, you find that established companies are job destroyers. From 1977 to 2005, they erased 1 million net jobs per year. At the same time, new businesses in their first year added an average of 3 million (net) jobs annually; they were the job creators. Young companies also create jobs fastest: On average, one-year-old enterprises create nearly 1 million jobs, while 10-year-olds generate 300,000 per year, according to the report. Startups drive job growth, and they should be the focus of job-creation policies—not the larger, established employers.
Even if policymakers were to do everything right in nurturing startups and putting the economy back on track, the U.S. would merely regain the 3 percent GDP growth rates that have been the norm. How do we get the economy to grow at 4 percent, doubling GDP in 18 years, vs. 24 years? This would have the effect of lifting millions out of hard times while creating jobs aplenty.
To answer this question, the Kauffman Foundation's Robert Litan just published Inventive Billion Dollar Firms: A Faster Way to Grow. It's a succinct argument that suggests helping a few really innovative startups become big businesses. How many? Maybe less than 60. (Note: Kauffman has supported my research on globalization, immigration, and entrepreneurship.)
Litan bases his analysis on the work of Yale economist William Nordhaus, who estimated that inventors capture just 4 percent of the financial value of the gains to society from their innovations. According to Litan's computations, in order for society to benefit from an additional $150 billion in output (amounting to 1 percent of GDP), inventors/entrepreneurs must develop new products, services, and processes that collectively earn $6 billion a year in profits ($150 billion multiplied by 0.04). That works out to 60 new "inventive" or innovative firms whose revenues reach an average of $1 billion per year, assuming a 10 percent profit margin.
The most innovative companies usually earn more than 10 percent profit, so Nordhaus' 4 percent estimate may be too conservative. The number of companies needed to hit home runs may be much smaller—maybe as few as 30. And companies such as these provide benefit to other companies around them by making the economic pie bigger.
Since I am not an economist, I don't know how accurate Litan's analysis is. I do know that he is right when he cites examples whereby General Electric (GE) opens up new horizons for all humanity with its lighting technologies; Ford (F) and GM revolutionize the transportation industry; Google (GOOG), Apple (AAPL), and Facebook help the entire technology sector with their Internet, mobile, and social media platforms; and new pharmaceuticals, medical devices, and treatments lengthen and improve quality of life.
I also know that when companies get big, they usually stop innovating. Other than Apple, which seems to release one game-changing technology after another, you would be hard-pressed to name another large company that innovates in any industry. Google is one of the biggest names in tech, but it is not an innovator. Following its original search engine and ad platform, what has Google developed that is earth shattering? Yes, Google did develop a nice e-mail system and some mapping software, but these were incremental innovations. For that matter, what earth-shattering products have IBM (IBM), Hewlett-Packard (HPQ), Microsoft (MSFT), Oracle (ORCL), or Cisco (CSCO) produced in recent times? Like Google, these companies constantly acquire startups and take advantage of their own size and distribution channels to scale up the innovations they have purchased.
So I agree with Litan that it's urgent to nurture innovative startups and help develop them into billion-dollar businesses. That's why I support a further Kauffman initiative called Kauffman Labs for Enterprise Creation, which targets specific industry sectors such as biotech, energy, and education. Through aggressive nationwide campaigns, it is searching for big-idea people who might not otherwise start big companies. It teaches these individuals the basics of starting and growing a business. Then it provides financial support and mentoring and facilitates entrepreneurial networking.
Last year the Kauffman Labs team combed the ranks of young scientists who might have business-worthy findings (but who usually pursue academic careers) and homed in on 13 who were eager to start companies. Members of that charter class have already launched nine new companies, mostly in biomedical fields. This year, Kauffman put out a call for proto-entrepreneurs with big ideas in the field of education—startups that produce new kinds of learning tools or promote new learning models at any level, from kindergarten through graduate school. Some of the companies Kauffman is helping to spawn may become billion-dollar businesses.
Kauffman Labs is exactly the type of initiative that we need at the national level to get our economy back on track. With the burgeoning deficit and record unemployment, our resources are limited. Instead of providing more handouts to stodgy old businesses, we should invest in creating hundreds of innovative, game-changing startups.