The Entrepreneurship Myth an interview with Scott Shane about his book The Illusions of Entrepreneurship.

Some things that aren’t surprising.

Describe the typical startup that you found.
The median startup is a business that’s capitalized with about $25,000. The financing of that business comes from the entrepreneur’s savings. The business is a retail or personal service business, a hair salon or a clothing store, that kind of thing. The founder doesn’t have expectations of a very high growth business, in fact [the entrepreneur is] probably thinking a goal of $100,000 a year of revenue is a good goal.

And it’s most likely to be organized as a sole proprietorship and to have no employees besides the owner—is that correct?

That’s right. And in fact we’re getting close to half, very close to the median would even be home-based.
Why do you think the myth of entrepreneurship, the image that you’re debunking, is so popular?
Part of it is we have a belief that entrepreneurship is good because it’s associated with things that we like to believe about Americans: being independent, doing your own thing, going your own way. The other part of it is that paradoxically, there is one really, really good thing about entrepreneurship that people don’t talk about, which is dominant and we have lots of evidence to support: People who run their own businesses have greater job satisfaction than people who don’t. I think part of it is that we’re trying to make sense of this paradox—that we really like it, but financially it isn’t so great. So we create a myth that says because we like it and it makes us happy, it must also make financial sense, because otherwise there’s a kind of conflict we can’t resolve.

Some things that are surprising are the conclusion the author makes. Rather inappropriately from my perspective. I think the government’s track record of picking winners and losers is pretty poor. The best strategy is always one that lowers costs for everyone, rather than favoring one group over another.

You write that “encouraging startups is lousy public policy,” based on the data you’ve examined. What would you propose as policy alternatives?
The part that’s lousy public policy is the idea that entrepreneurs, regardless of what kind, are good, and if we just have more of them, it’s better. But what’s a good public policy is if we picked certain kinds of startups, and we emphasized the increase in those. But the way the policies are set up, they don’t encourage the specific high-potential startups. Most of the policies are: More entrepreneurs—just let’s get volume. It’s a very volume-oriented strategy. That’s bad public policy.
You collect a lot of data in your book and come to some counterintuitive conclusions about entrepreneurship. What would you say is the biggest illusion?
I think the biggest myth entrepreneurs have is that the growth and performance of their startups depends more on their entrepreneurial talent than on the businesses they choose. I hate to deflate egos, but on the other hand I want people to have a realistic understanding of things. The industry a person picks to start a business has a huge effect on the odds that it will grow. If you go back 20 years or so, about 4% of all the startups in the computer and office equipment industry made the Inc. 500, 0.005% of startups in the hotel and motel industries made that list, and 0.007% of startups in eating and drinking establishments. So that means the odds that you make the Inc. 500 are 840 times higher if you start a computer company than if you start a hotel or motel.

Marginalrevolution has a post on firm size and liability.

So small entrepreneurs appear to be in some part an answer to our often litigious society.

Two different views on how entrepreneurs are made.

Tyler Cowen:

A Brazilian entrepreneur, that is. First and foremost, entrepreneurship is predicted by family characteristics, most of all having other entrepreneurs in the family and coming from a large family. What predicts finding a successful entrepreneur?: “the individual’s smartness and higher education in the family.” Entrepreneurs are not more self-confident than non-entrepreneurs and overconfidence is a big danger. Social networks predict who becomes an entrepreneur but not who becomes a successful entrepreneur. Entrepreneurs in Brazil exhibit more trust but this result does not seem to generalize across countries.

Here is the paper, from the World Bank. I thank Russ Roberts for the pointer.

Chris Dillow:

In other words, what makes an entrepreneur is access to capital – the sort of access that comes from having a wealthy background. This is consistent with two other papers. David Blanchflower suggests here that lack of access to credit explains African-Americans low rate of entrepreneurship, whilst he and Andrew Oswald say here (pdf) that:
…..
Now, why do I stress this whilst Tyler picks out “family characteristics”? The difference between us, I suspect, reflects a widespread difference between supporters and critics of capitalism. Whereas supporters of capitalism look for personality-based explanations of differences in people’s behaviour, critics look instead for more impersonal, structural factors – though of course these influence (determine?) personality.

And funnily enough, we can both easily find what we’re looking for.

Wisconsin Entrepreneurs:

Roughly half the people in Wisconsin are thinking about starting a business or have started a business, according to a new study of the state’s entrepreneurial climate. The study, “A Medium for Growth: The State of Entrepreneurship in Wisconsin,” (Download the complete report – 5 meg PDF) reported the strikingly high figures after surveying 1,144 randomly selected households across the state last year.

The Governor of Wisconsin is encouraging Entrepreneurs. Here are the details:

The mission of the Governor’s Business Plan Contest is to encourage entrepreneurs in the creation, start-up and early-growth stages of high-tech businesses in Wisconsin. Participants have the chance to win seed capital, valuable services that will help them launch their businesses and a Grand Prize worth $50,000. Since its inception in 2004, more than 1,000 entries have been received and nearly $650,000 in cash and in-kind prizes has been awarded. In 2007, 12 finalists won cash prizes.

Produced by the Wisconsin Technology Council and a growing list of partners, the Governor’s Business Plan Contest engages contestants in a six-month process that includes mentoring and comments from judges on selected plans. It will also lead to valuable public and media exposure for the best business plans submitted by contestants and spur economic growth in Wisconsin. In addition, past finalists have raised a reported $11 million in private equity, such as angel and venture capital.

The statewide contest is an opportunity to compete for cash and in-kind prizes, but it’s also a chance to get constructive feedback on your business plan and to help move it from a virtual business to a reality. In 2008, contestants will once again have the opportunity to win upwards of $200,000 in cash and services!

NPR has a show on entrepreneurs called From Scratch. I caught the episode on Bear Naked while listening on satellite radio, and I’m left wondering a few things:

1. How many similar stories of business start ups do we not hear about because they end in failure?

2. If there are important differences between failures and successes, what are they?

3. Why don’t they have a show dedicated to failed start ups?

William Baumol is one of the leading economists who has done research on entrepreneurship. Here is a google scholar list of his work ion the area.

His article/book titled: Education for Innovation: Entrepreneurial Breakthroughs vs. Corporate Incremental Improvements captures an important empirical fact:

This paper explores the following hypotheses on the appropriate education for innovating entrepreneurship: a) breakthrough inventions are contributed disproportionately by independent inventors and entrepreneurs, while large firms focus on cumulative, incremental (and often invaluable) improvements; b) education for mastery of scientific knowledge and methods is enormously valuable for innovation and growth, but can impede heterodox thinking and imagination; c) large-firm R&D requires personnel who are highly educated in extant information and analytic methods, while successful independent entrepreneurs and inventors often lack such preparation; d) while procedures for teaching current knowledge and methods in science and engineering are effective, we know little about training for the critical task of breakthrough innovation.

According to this article in the Economist entrepreneurs in Japan have had a hard time.

Japan scores poorly on almost every measure of entrepreneurship. It has the second-lowest level in the OECD of venture-capital investment as a share of GDP, and what little venture capital is available goes disproportionately into existing firms rather than start-ups. Venture-capital investment in Japan amounts to some $2 billion a year, around a tenth of the figure in America. Start-ups account for 4% of all firms, compared with 10% in Europe and 14% in America. Japan also came last in the International Institute for Management Development’s rankings on entrepreneurship and second-last in the Global Entrepreneurship Monitor’s ranking of early-stage entrepreneurial activity (defined as the proportion of people of working age who are involved in such activity). Why?

Cultural factors are a big part of the explanation. As a hoary old Japanese saying has it, “the nail that sticks out is hammered down.” Conformity is valued over individualism. “Students work hard at school, but they learn how to take tests, not how to think,” laments Sakie Fukushima of Korn/Ferry. And unlike American culture, which venerates the maverick self-made millionaire and is tolerant of failure, Japan frowns upon public displays of wealth and stigmatises business failure.

Although innovation doesn’t just happen in start ups. If the culture, incentives, and environment are right, it can be just as likely to occur in large corporations. Look at Google for a good example. They allow their staff to commit 20% of their time to any project of their choosing.

Given the innovative prowess of Japan’s industrial giants, does it matter if start-ups have a hard time? The Economist Intelligence Unit, a sister company of this newspaper, ranked Japan first in a recent study of innovation, based on the number of patents awarded per million people. Japan generates 51% more patents than America in absolute terms, which works out at around 3.5 times as many patents per person. It also has more scientific researchers per million people (5,900 compared with 4,200 for America) and a higher research and development (R&D) intensity, at 3.4% of GDP compared with 2.8% for America.

But things may not be as rosy as these numbers suggest. Patents are an imperfect proxy for innovation; Japan’s armies of researchers spend more time than their foreign counterparts on non-research activities such as administration, which reduces their effectiveness; and a report by the Cabinet Office found that the effectiveness of Japan’s private-sector R&D—the ratio of operating profits to R&D expenditure—declined throughout the 1990s (see chart 7).

Akira Takeishi of the Institute of Innovation Research at Hitotsubashi University has investigated why Japanese firms are highly competitive in some industries (carmaking, electronics, imaging products, video games) and less so in others (personal computers, software). He concluded that Japanese firms did best in manufacturing industries with closed product designs that do not require collaboration with the rest of the industry, and worst in fields based on open standards and modular architectures. So if the nature of innovation has changed, and it now depends on collaboration with other firms around the world, Japan could be in trouble. Japanese patents with foreign co-inventors accounted for less than 3% of the total, compared with 12% in America.

If government is going to try to steer the process it is extremely important to create a level playing field for ALL industries and not favor one over another. After all 10 years ago who would have predicted the composition of products we’ll see this Christmas?

Another concern is that too much government effort to encourage start-ups and promote innovation is concentrated on manufacturing and technology rather than services, which is arguably where change is most needed. To keep the momentum going, the OECD recommends reductions in capital-gains tax to encourage venture capital; more portable pensions and performance-based pay for researchers to encourage mobility between academia and industry; a broader educational curriculum; and the promotion of cross-border trade and investment, since good ideas often come from abroad. Changing Japanese attitudes to entrepreneurship will take time and further reforms, but at least the wheels have started turning.

The next Economic Indicators Breakfast meeting will be April 2nd and we’ll be discussing entrepreneurship. In preparation, I’ll be linking to a lot of the research I come across on the topic. Here is a paper which is part of a larger publication coauthored by Dean Karlan from Yale.