Innovation and the entrepreneurial business culture revisited

A recent post, Lessons for Rhode Island from Silicon Valley: An historical reflection on an actual innovation economy, discussed what made Silicon Valley's entrepreneurial culture so unique and what some of its economic growth policy lessons are for Rhode Island.

In the latest edition of The Weekly Standard, Thomas Hazlett has written about the book, Overcoming Barriers to Entrepreneurship in the United States, in a review entitled Mastering the Game: The business of America is small business - and entrepreneurship.

Hazlett has these words to say about the entrepreneurial culture of Silicon Valley:

...The entrepreneurs who stir the pot in brash and productive new ways are a mysterious force, difficult to chart with PowerPoint bullets. There is no doubt that innovation and risk-taking--the contributions of these master chefs of the economic stew--drive progress. But they are elusive, and will not hold still for measurements.

This sleek, nifty volume of essays seeks to pursue the beast--and if not to capture it, then, at least, to triangulate its position. Edited by labor economist Diana Furchtgott-Roth, it teaches us why venture capitalists cluster in places like Silicon Valley...

...the book is, caveat emptor, not a cheerleading manual: Neither Henry Ford nor Sam Walton nor Bill Gates is mentioned. The authors are social scientists at prominent institutions who probe substrata economic formations looking for clues as to what factors drive the self-employed to leave their wage jobs behind, and how public policies impact this migration.

For instance, the chapter on Silicon Valley's venture capital hub offers a fascinating window into the sociology of entrepreneurial nurturing. Venture capital investments in Silicon Valley appear to be made differently than elsewhere: They come earlier to start-ups, and lavish more capital on firms. Either due to this, or the other way around, start-ups there outperform those elsewhere, on average.

Why is this? The answer seems to lie in the commercial culture. Unlike investment bankers doling out high-risk, early-money investments on the East Coast, Northern California financial sources are run by technical experts possessing business experience--entrepreneurs funding entrepreneurs. These capitalists operate like bankers, but they know more. Which may account for the more frequent huge payoffs in Silicon Valley and a higher wipeout rate. No irony here: Risk is hardwired into the entrepreneurial economy, and ugly failures are inputs into spectacular successes.

Economist Junfu Zhang, the author of the VC chapter, concludes that the mission launched by many local or state governments--to replicate the Silicon Valley experience--is a fool's errand. The social networks that form are key; capital chases smart people connected to other smart people. Wealth is created when those dollars and networks combust. The best strategy is to eliminate the underbrush of tax and regulatory disincentives that inhibit productive economic activity generally. Or somewhat more ambitiously, create a Stanford University and let the graduate students figure out the rest.

After 17 years in Silicon Valley, I have worked as an interim executive in numerous cities east of the Mississippi River over the last decade. One of the most striking observations from these experiences is how many people tried to replicate Silicon Valley without understanding or paying attention to any of the fundamentals which made the Valley successful. The social network out West (or in the Cambridge/Boston area) did not spring up overnight and the operating companies and the services infrastructure which support them are now firmly rooted in an entrepreneurial culture where explicit and tacit knowledge flows freely.

On a broader policy level, Hazlett writes:

...In the essay on tax policy, written by Donald Bruce and Tami Gurley-Calvez, an interesting body of research is presented. It shows that the vast majority of business owners in the United States pay taxes as individuals, not corporations. This means that rate increases for high-income taxpayers reduce pay-offs for the start-up entrepreneur. And tax hikes on capital reduce the pool of risky funds that these new ventures seek to tap.

Soaking the rich sinks this ship. Entrepreneurship is all about creating new wealth while tax redistribution is premised on the assumption that resources are static and the collateral damage from tax hikes is no more than the cost of ear plugs to block out the whining at the country club...

Therefore, given the tax filing nature of small businesses and entrepreneurs described above, the Left's negative description of the recent reduction in RI income tax rates for higher earning individuals as only tax cuts for the wealthy and their desire to roll back the reductions has a clear economic impact: Restoring higher taxes is likely to take away cash flow from many of the very small businesses which could otherwise invest the higher profits in expanding their operations and providing more jobs.

Rhode Island's economic engine will only begin to heal itself when the lessons articulated above and in the earlier post are heeded.