Improvement in societal standard of living comes from advances in economies.  Most advances in economies derive from technological innovation creating new products and services or enhancing productivity, at least in today’s environment.  And technological innovation is either incremental, building on prior technology or fundamental, building on scientific discovery.

 

Scientific discovery often comes from research universities, funded both by the government  (in wartime for defense, in peacetime mostly for health) and by private industry.  Most incremental innovation is funded by industry and by private investors.  Regardless of the source of funding, designing, developing, and producing the product that consumers or business want to purchase requires one or more entrepreneurs.

 

Who are these entrepreneurs, either independent or corporate employees (sometimes called “intrapreneurs”)?  They are people who obviously believe in the idea or concept, but also are motivated by the lure of potential rewards despite the inherent risks

 

What are the risks?  They may involve loss of money, loss of other opportunities to make money, loss of reputation, fear of failure, waste of a substantial portion of one’s productive years.  For a corporate employee, it may risk his career and potential pension, perhaps his current employer.

 

As an interesting aside, entrepreneurship in Europe has lagged that in the U.S. significantly.  One of the cultural reasons, I believe, is that Europeans are far harsher and more judgmental of failures.  Someone who starts a company in Germany (or elsewhere) that fails, will be referred to, often for the rest of his life, as “Frederick, the one who started the software company that went bankrupt”.

 

What are the kinds of rewards being sought?  They include:  making a lot of money, being one’s own boss, favorable reputation, earned respect, satisfaction of accomplishment, economic and organizational independence.  For most entrepreneurs, the chance to make a lot of money looms large, although it is certainly not the only motivating factor.

 

One of the enabling factors that has fueled the growth of innovation has been the availability of risk capital, or venture capital.  Although reputation and bragging rights motivate the venture capitalist, his overwhelming motivating potential reward is monetary.

 

Consideration of the history of venture capital in the U.S. is very interesting.  Prior to World War II, wealthy families backed occasional ventures, but there was no formal and professional organization.  After the war, four VC firms came into existence:  J H Whitney & Co, Rockefeller Brothers (later changed to VenRock), American Research and Development, and Bessemer Securities.  By the mid 1970’s, there were a handful more.  Then, in 1978, President Jimmy Carter tried to eliminate any difference in taxation rates between ordinary income and capital gains.  Congress rebelled, and passed the Steiger Amendment, which enshrined a 50% reduction in tax rate for gains on investment held longer than 12 months. The outpouring of money into new and existing venture capital investment firms since that date has been nothing short of incredible.  And, with all that money available now, entrepreneurs started emerging from the woodwork, and we have had the boom in new companies and new products that has changed the way we live.  Motivation matters.

 

So what, if anything, can the government do to encourage entrepreneurship?  I believe there are four areas:  protection of intellectual property, funding of basic research, licensing requirements, and taxation policy.

 

Our patent laws are good.  Our young and still small companies are vulnerable to foreign nations and companies stealing their intellectual property.  The government could take a stronger position with foreign governments, most notably China, to put end to the practice, perhaps even by joining the U.S. startup company as a joint plaintiff.

 

It is difficult for our corporations to fund basic research, when they are under pressure from investors to produce quarterly earnings gains.  The downstream benefits of basic research are long in coming, and risky to begin with.  We should have a national policy of funding the great research universities and qualified researchers, through the ups and downs of the economy, but of carefully and fairly vetting the various proposals.  We should encourage universities to develop well-thought out technology transfer templates and agreements.

 

Licensing for many small businesses, especially service-based ones, is done mainly by the states, rather than by the federal government.  There are many cases of restrictive licensing, lobbied for by existing competitors that make entrepreneurship in smaller sized businesses far more difficult than it should be.  State governments should set up commissions to review all licensing regulations, with an eye toward fostering new business formation and competition with entrenched firms.

 

We should encourage the long-term investment nature of venture capital with tax policy.  Without changing tax policy for investment in public companies, we could tax investment gains in private companies (private at the date of investment) on a sliding scale, favoring length of ownership.  For example, an investment in a startup held at least two years could receive a tax break of 20% off the public shares capital gains rate, one held three years 40% off, etc., down to 90% off from 5 years and on.  This would definitely incentivize both entrepreneurs and investors in startups to take a long range view.

 

I think we get reasonably good marks in the arena of encouraging innovation.  The suggestions above will help strengthen our position, but the most important thing we can do is to avoid doing damage to what we have today.  Any prospective law or regulation should be strangled in its cradle, if it makes it more difficult to start a business, if it fails to protect intellectual property, if it reduces funding for scientific discovery or if it makes financial gain  less appealing for high risk investments in startups.

2 thoughts on “More Economics –Risks and Rewards

  1. As usual, a great post, and one particularly near and dear to my heart. A few thoughts:

    – First, the patent situation needs a lot of work in this country. Patent reform is still sorely needed around both process and method patents (which should be worthless) and trolls and litigation problems. The courts have done a little work on this, and another big case is pending at the moment, but Congress actually has to take some action here

    – Immigration also needs to be on your list. Many startups have relied on skilled workers on H1B visas to fill gaps in local and national talent pools, and the current administration seems to dislike legal immigration, without a plan to skill-up domestic talent to meet demand

    – Decreased regulation of businesses in general, but of smaller companies in particular, should be on your list

    – Improving tax treatment, something you discussed, is great, and there are a couple adds to what you came up with. One is that there are some parts of the tax code that give very favorable treatment to long-term holds on private investments. Read Fred’s post on QSBS exemptions from a few years back here: http://avc.com/2013/07/qualified-small-business-stock/

    – Similarly, tax policy could also step in and reward even longer-term holds on on public securities. It’s possible Ries and Andreessen’s LTSE initiative will lead to a market correction on the short-term problem, but if not, tax policy can step in

    – Government also needs to continue looking for all opportunities to create level playing fields. Net neutrality is a great example of a policy that has served entrepreneurship incredibly well that the current administration is about to dismantle

    Liked by 1 person

  2. Yes, while our patent laws may be “good,” many people, myself included, believe that the amount of intellectual property protection provided to inventors and entrepreneurs here in the U.S.A. has been considerably weakened over the past few years, making it far more difficult for independent inventors and small companies to prevent large companies and foreign entities from easily pirating their ideas and inventions without any fear of adverse consequences. In particular, the efficacy of, and the amount of protection afforded by, our patent system here in the United States was perhaps most seriously damaged with the recent introduction of the Inter Partes Review (I.P.R) procedure for challenging the validity of any United States Patent, a procedure which has been used thus far by a large number of alleged infringers to invalidate the great majority of the (previously valid) patents that have been put through the procedure. This has allowed some large United States corporations like Apple and Google to completely avoid having to pay royalties or any other form of compensation to many small inventors, or at the very least, has resulted in significant delays in those inventors getting any substantial compensation, not to mention the significant costs involved. In addition, recent SCOTUS decisions such as Alice Corp. vs. CLS Bank International have made it increasingly difficult for inventors and entrepreneurs to obtain patents for their ideas and inventions. Finally, interestingly enough, while our patent laws and procedures here in the United States have recently weakened the amount of intellectual property protection available to small businesses and inventors in general, the patent laws in many other countries, and China in particular, are being greatly strengthened as companies such as Huawei, Samsung, and HTC have become innovators, rather than copiers and pirates. This has resulted in a very curious turn of events: more and more patent holders based in the USA are litigating and trying to enforce their intellectual property rights in countries like China, Germany, Korea and Japan, and not even bothering to do so here at home.

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