The appropriate size and scope of the government’s “safety net” is an enduring debate in American politics, but an under-appreciated aspect of the issue is the intersection between the safety net and innovation. The Atlantic‘s Derek Thompson had a piece Friday on that subject that’s well worth a read.
The broadest debate in Washington, and on the primary trail, is about whether government needs to step up to create jobs or step back to allow the market to work by itself. But what if we need both: A stronger safety net to lessen risk for wannabe-startups and purer free market approach for established corporations?
It’s good advice. As he points out, we can encourage entrepreneurship by lowering the risks associated with starting a new venture. We do this already with things like bankruptcy law. And while there will always be serious risk associated with starting a business – as there should be – we can make changes like decoupling health insurance from employment so potential entrepreneurs aren’t held back by fear of losing coverage. (Parts of the recent healthcare reform legislation take steps in this direction.)
We can all agree with Thompson that “startups shouldn’t just be for rich kids who can afford to take a chance on a big idea.”
But if the point of all this is jobs and economic growth, as Thompson says, it’s worth noting that the benefits of innovation are highly concentrated in a small subset of entrepreneurs and firms. In other words, creating jobs via startups is an elite activity.
Harvard Business School professor Josh Lerner draws this distinction in his book Boulevard of Broken Dreams, delineating between “subsistence businesses” and “high-potential new ventures,” or what the Kauffman Foundation calls “gazelles.”
A 2010 paper by Kauffman researchers makes this point nicely:
The data generally show that:
• In any given year, the top-performing 1 percent of firms generate roughly 40 percent of new job creation.
• Fast-growing young firms, comprising less than 1 percent of all companies, generate roughly 10 percent of new jobs in any given year.
Of course, for every high-growth gazelle there are plenty of businesses that were promising enough to attract venture capital but ended in failure. But even taking into account the failures, the pool of companies that investors see as potential gazelles is still quite small.
Acknowledging as much may impact how we think about the safety net as a tool to promote innovation. Thompson notes that we could expand the safety net in targeted ways, focused on startups, or do it more broadly. From the perspective of innovation, the former may be more wise.
One final factoid to underscore the importance of focusing on high potential startups concerns the question among innovation researchers on how to accurately measure entrepreneurship. It turns out that self-employment fails to capture what we think of when we talk about innovation and entrepreneurship, as Silicon Valley has one of the lowest self-employment rates in the world. And the highest? That honor goes to West Palm Beach and its concentration of “self-employed” retirees.