Economist: Fish out of water

Schumpeter

Fish out of water
Oct 29th 2009
From The Economist print edition


Policymakers are turning their minds to the tricky subject of promoting
entrepreneurship



UNEMPLOYMENT is creeping ever higher. In the United States it will soon
exceed 10%. In parts of Europe it is closer to 20%. Around the world young
people are finding it all but impossible to get a job.


So far policymakers have focused on rescuing the economy from free fall,
boosting demand, however indiscriminately, and rescuing failing companies,
however expensively (AIG received $180 billion-worth of government
support). But policymakers are beginning to turn their minds to the
potentially more rewarding question of creating tomorrow's jobs, rather
than trying to save yesterday's. The buzzwords in government circles are
entrepreneurship, innovation and venture capital.


This makes perfect sense, in theory. Innovative start-ups are efficient
engines of job creation and long-term economic growth. In America start-ups
have accounted for almost all the net job creation in the past couple of
decades. In the developing world, new technologies are helping to break the
cycle of poverty. An extra ten mobile phones per 100 people in a typical
developing country boosts GDP growth by 0.8 percentage points, according to
the World Bank, by helping small entrepreneurs flourish.


Governments have also played an important role in igniting
entrepreneurship. As well as creating some of the vital infrastructure of
innovation by investing in higher education, they have also had a direct
hand in driving entrepreneurship itself. Governments helped bring into
being the venture-capital industry: witness the work of American Research
and Development (ARD) after the second world war or the Yozma Fund in
Israel in the 1990s. They have also supercharged high-tech clusters:
Silicon Valley was created as much by the Pentagon's demand for new kit as
by freewheeling entrepreneurs. Most of the world's other great
entrepreneurial hubs, from Bangalore to Guangdong, bear the stamp of
government intervention.


But replicating these successes is difficult. The road to the
entrepreneurial future is littered with failed government schemes.
Malaysia's massive BioValley complex, which opened in 2005 at a cost of
$150m, is now known as the "Valley of the BioGhosts". Dubai's
entrepreneurial hub is awash in a sea of red ink. Australia has little to
show for its ambitious BITS (Building on Information Technology Strengths)
programme. The European Union's European Investment Fund, which was started
in 2001 with an endowment of more than €2 billion ($1.8 billion at the
time), has failed in its mission to burnish the sorry record of the
European venture-capital industry.


How can governments do a better job? Two well-timed new books provide some
clues: "Boulevard of Broken Dreams: Why Public Efforts to Boost
Entrepreneurship and Venture Capital Have Failed—and What to Do About it",
by Josh Lerner, and "Start-Up Nation: The Story of Israel's Economic
Miracle", by Dan Senor and Saul Singer.


Mr Lerner, a professor at Harvard Business School, outlines some common
failures. Too many countries are seized by ambitions that bear no relation
to their particular comparative advantages. Although Malaysia had few
skilled biologists, its politicians decided to build BioValley on the ruins
of Entertainment Village, an attempt to create a Malaysian Hollywood that
failed for lack of media nous.


Too many politicians treat entrepreneurship as yet another gravy train.
Norway squandered much of its oil wealth investing in new businesses that
were founded by the relatives of politicians and bureaucrats. Policymakers
are also lax when it comes to designing venture funds. They try to insulate
them from risk or allow public investments to crowd out private ones. The
Canadian government's experiment with venture capital failed because the
Canadian Labor Fund Program had so much money that it frightened off
private venture capitalists, while earning mediocre returns itself. New
Zealand's government, in contrast, did much better because it invested
public money in private funds.


Mr Lerner points out that two foolish tendencies are particularly hard to
resist when politicians are struggling with high unemployment. The first is
the temptation to spread the wealth around to every region and interest
group. France's attempt to transform Brittany from one of its more backward
regions into a hive of high-tech activity failed dismally for an obvious
reason: entrepreneurial firms cluster in particular places. The second is a
suspicion of foreign investors. The Japanese government lavished money on
start-ups in the 1990s but was reluctant to embrace foreign venture
capitalists. Japan now has one of the rich world's weakest venture-capital
markets.



Levantine wiles


The country that has led the world in promoting entrepreneurship has also
done the most to plug itself into global markets. The Israeli government's
venture-capital fund, which was founded in 1992 with $100m of public money,
was designed to attract foreign venture capital and, just as importantly,
expertise. The government let foreigners decide what to invest in, and then
stumped up a hefty share of the money required. Foreign venture capital
poured into the country, high-tech companies boomed, domestic venture
capitalists learned from their foreign counterparts and the government felt
able to sell off the fund after just five years.


Last year Israel, a country of just over 7m people, attracted as much
venture capital as France and Germany combined. Israel has more start-ups
per head than any other country (a total of 3,850, or one for every 1,844
Israelis), and more companies listed on the NASDAQ exchange, a hub for
fledgling technology firms, than China and India combined. It may not have
the same comforting ring as "the Swedish model" or "the polder model", but
when it comes to promoting entrepreneurship, "the Israeli model" is the one
to emulate.