Federal and state governments are spending billions to boost entrepreneurial activity to help drive the country out of recession. But those efforts may not bring the kind of job growth and economic benefit that many expect, according to economics professor Scott Shane, who has dug into years of data to try to get a clearer picture of entrepreneurship and its effects.
Most start-ups and existing small businesses are modest ventures that don’t generate a lot of new jobs or sales, said Shane, a professor of entrepreneurial studies at Case Western Reserve University in Cleveland.
“Only a very small share -- a couple of percentage points -- of firms ever grows, adding employees or increasing sales, over the businesses’ lifetimes,” he said. “As a result, a small portion of start-ups accounts for most of the growth new businesses are responsible for.”
Shane tried to pop the bubbles of many commonly assumed ideas about entrepreneurship in his book “The Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors and Policy Makers Live By,” published last year.
Shane said he’s not against encouraging entrepreneurship but wants policymakers to be clear about their goals and realistic about outcomes.
Entrepreneurship, as his research has found, may provide a safety net for someone who is unemployed or it may provide a happier, if not more lucrative, alternative to working for someone else.
But start-ups with the best potential to create significant jobs, sales and wealth for the founders are rare and most often match the type of high-growth, high-risk businesses that venture capitalists target, he said.
About 3,200 businesses received venture capital backing in 2007, according to the National Venture Capital Assn. About one-half to two-thirds were new venture capital recipients, Shane said.
That small segment adds jobs at a faster clip than the total private sector.
From 2003 through 2005, venture-capital-backed companies posted compounded annual job growth of 4.1%, compared with 1.5% for all firms, according to a 2007 study by IHS Global Insight for the venture capital group. Venture-capital-backed firms accounted for about 10% of all nongovernment jobs and 17% of the U.S. gross domestic product, according to the study.
Recent comments by Treasury Secretary Timothy F. Geithner about possible new regulations for the venture capital industry sparked fears among such investors that their efforts to help launch those high-potential, high-risk businesses could suffer.
“There is a paradox in the way academics and policymakers and, frankly, the public at large thinks about entrepreneurship,” Shane said. Here are excerpts from our conversations last week:
The idea that small businesses are the engines of economic growth is popular. Is it correct?
Some numbers help clarify it. There are approximately 25 million businesses in existence in the U.S. at any given time. Approximately three-quarters of them are non-employer businesses -- they don’t employ anybody. The sales of businesses that are employer businesses are 97% of total sales. So 75% of the firms, the non-employer firms, are accounting for 3% of the sales. That says that 97% of sales come from 25% of the firms.
Do start-up businesses add significant numbers of jobs as they get older?
A lot of new businesses die out. Only about 3% of employer businesses have any kind of sustained, true job growth over time.
Are current efforts to stimulate entrepreneurship misguided?
If the idea is to try to stimulate job growth by stimulating entrepreneurship, then yes, I think they are misguided. I think that policy to try to help encourage entrepreneurship in general -- all kinds of entrepreneurship just generally starting businesses, writ large, as a way to generate job growth doesn’t make sense. Policies to stimulate job growth have to be really targeted in terms of the kinds of business creation activities they are designed to support.
How should policymakers target the creation of high-potential businesses?
To say “We know that a small proportion of entrepreneurships generate most of the jobs and most of the wealth. We need to encourage those kind of entrepreneurships. Let’s look at what those look like. Let’s assess characteristics associated with them so we can invest in ones with the highest probability of success.” To me, it’s not rocket science because it’s looking at the same kinds of things you look at as a venture capitalist.
Now, you wouldn’t want policymakers to look at only the kind of businesses venture capitalists look at because there are other kinds of high-growth businesses that also are good.
Should government support for run-of-the-mill start-ups be eliminated then?
No, because it goes back to that we might want to have policies to support entrepreneurs for other reasons. A lot of people who start businesses do it because it makes them happier. And we probably want to have policies that make Americans happier.
It’s not that policymakers should discourage typical businesses from being formed. It’s that we should be honest about what typical businesses do and not say we want to create typical businesses to create a lot of economic wealth and job creation.