How to help entrepreneurs? Get government out of the way
Entrepreneurs need freedom to prosper
Peter Klein is an associate professor in MU's Division of Applied Social Sciences and Director of the McQuinn Center for Entrepreneurial Leadership. This article is based on his paper "Entrepreneurship and Creative Destruction," in Brendan Miniter, ed., The 4% Solution: How to Unleash the Economic Boom America Needs in the Twenty-First Century.
Discussion of entrepreneurship policy has virtually exploded in recent years. Policymakers talk about entrepreneurship as a way of improving economic conditions the way they used to talk about roads, dams, bridges and other infrastructure projects. But what exactly is entrepreneurship? Is it simply self-employment or new-venture formation — a set of outcomes that can be measured, analyzed and perhaps stimulated using the usual sorts of economic policy instruments — or a way of thinking or acting?
Unfortunately, economists have not, by and large, figured out how to incorporate entrepreneurial judgment into their models. Economies grow through capital accumulation and technological innovation, but these are too often treated either as unexplainable, automatic trends or as variables controlled by government planners as they "fine-tune" the economy. But entrepreneurship just isn't subject to government control. Instead, entrepreneurship is a fundamental aspect of human behavior and the central part of a dynamic, vibrant, successful market economy.
How should we think about entrepreneurship? As former Defense Secretary Donald Rumsfeld famously put it, "The truth is there are things we know, and we know we know them — the known knowns. There are things we know that we don't know — the known unknowns. And there are unknown unknowns: the things we do not yet know that we do not know." The entrepreneur's primary role in society is to deal with the unknown unknowns. An entrepreneur has a vision of a business opportunity but cannot encapsulate the details of this imagined opportunity in formulas, cash flow predictions, reliable charts and figures, and other techniques for dealing with known unknowns. To exploit this imagined opportunity, the entrepreneur must acquire productive resources and put them at risk of profit or loss — putting skin in the game.
The entrepreneur's critical function, in this perspective, is ownership. Entrepreneurs prosper as they put these resources to their highest-valued uses. Private property and the profit-and-loss system give entrepreneurs incentives to experiment and to learn from their mistakes as they seek to make the best use of resources and to expand the capital under their control in the face of an unknown future. Profits and losses are the entrepreneur's primary decision-making tools in deciding how best to satisfy consumer wants and needs. To do this, entrepreneurs must be able to weigh costs and benefits that reflect actual economic conditions — hence the importance of free markets for inputs and outputs. Without private ownership of resources and the market-price system, entrepreneurs have no way to calculate the most effective ways of producing and innovating.
Government actors, on the other hand, lack key characteristics critical to true entrepreneurship. They don't ultimately bear the gains and losses they create, and no mechanism exists for rewarding success and punishing failure akin to the market's competitive selection process among entrepreneurs. They try to replace entrepreneurial initiative with bureaucratic control, but in the real world of uncertainty, such control can never be effective. It is only entrepreneurs — who bear the gains and losses from their own attempts to deal with an uncertain future — who can make an economy grow.
What, then, should government do to foster entrepreneurship? Government cannot create entrepreneurs or tell entrepreneurs what to do. Government needs to get out of the way. Consider a few examples of what government should avoid:
- Don't create and exacerbate business cycles
Government policy should not interfere with entrepreneurial planning, forecasting and investing through bad monetary policy: creating asset bubbles by aggressive monetary expansion, trying to keep prices and wages artificially high through macroeconomic stimulus programs and creating uncertainty that discourages investment through ever-changing monetary and fiscal policy. Entrepreneurs rely on market prices to form judgments. Activist policy that manipulates prices sabotages entrepreneurs in serving their critical function.
- Don't bail out failing enterprises
Economic progress takes place as entrepreneurs experiment with different combinations of inputs and outputs, trying to find those that make the best use of the economy's scarce resources. For this, market feedback is essential. If a business cannot produce goods and services that consumers want to buy, it should be liquidated and its assets made available to other entrepreneurs to try again. For this reason, bailouts, subsidies and "too-big-to-fail" guarantees hinder the market process of directing productive resources to their highest-valued uses, instead rewarding lobbying and other forms of influence-seeking and discouraging entry by nascent entrepreneurs who lack political connections.
- Don't try to plan clusters of entrepreneurship and innovation
The remarkable success of America's information technology industry has tempted policymakers to think they can engineer the next Silicon Valley through targeted subsidies, tax breaks and other instruments. But technology clusters emerge from the bottom up, not the top down. Clusters often rely on powerful "anchor entities" such as universities, incumbent firms, research institutions and the like, but these anchors cannot be planted for the specific purpose of creating a cluster. We don't know where the next cluster will emerge, what products it will produce, what new industries and markets will result — which is part of the beauty of capitalism — and neither can government planners.
What government can do is support institutions — sound money, protection for private property, respect for the rule of law — that encourage capital formation, reward entrepreneurial initiative and allow market competition to sort resources among actual and potential entrepreneurs. Figuring out how to best use our resources and grow our economy is not a job for Washington bureaucrats. In fact, it's a job bureaucrats cannot perform precisely because they are insulated from the price signals and incentives of the marketplace. Only if we allow the entrepreneurial function to flourish can we be confident the U.S. economy will thrive and grow in ways we cannot today imagine.