Issue #21, Summer 2011

Progressive Entrepreneurship: A Work in Progress

To read the other essays in the “From the Ground Up: Fostering Entrepreneurship” symposium, click here.

A few years ago, the noted economist Benjamin Friedman laid out the moral case for a progressive commitment to robust economic growth. Growth, he argued, increases opportunity and mobility, makes fairness more likely, and strengthens support for tolerance and democracy. At the same time, he offered two caveats. First, to achieve these results, growth must be widely shared. If those at the top commandeer its fruits, opportunity and mobility will stagnate, and social tensions will rise. Second, if the right kind of growth is valuable in part because it provides public goods, then a basic tenet of public-choice theory holds that the market by itself will undersupply those goods. The right kind of collective action can improve on pure market outcomes.

Friedman might well have added a third caveat: Growth in output loses much of its luster if it doesn’t increase the supply of good jobs. Between its pre-recession peak in 2000 and the next cyclical peak in 2007, for example, real manufacturing value-added increased by more than 20 percent—while manufacturing employment declined by 19 percent, from 17.3 million to 13.9 million. Standard economic theory tells us that as productivity gains reduce the demand for labor in established sectors, new opportunities will emerge to absorb the excess. That is what happened during our transition from an agricultural to an industrial economy, as sustained gains in agricultural productivity freed up labor for mass production. But as we have learned during our latest great transformation—still ongoing—to an information-based economy, the process can be painfully slow and unfair. What is a displaced 55-year-old factory worker in Michigan supposed to do?

After World War II, when the U.S. economy bestrode the world like a colossus, American businesses could absorb or pass on increased production costs. Consumers’ real incomes were rising robustly, and American steel, auto, and textile manufacturers faced little pressure from lower-priced imports. Today, global competition makes that all but impossible. So sectors of our economy that seek to export or are challenged by imports have no alternative; they must relentlessly increase productivity. That can be good for consumers: Compared to a generation ago, cars from the (shrunken) Big Three are of significantly higher quality and are made far more efficiently. The flip side is that it takes fewer workers to produce each car. A compelling case can be made that the twenty-first century U.S. economy needs a robust, globally competitive manufacturing sector. It’s much harder to make the case that this sector will ever again generate the number of jobs we need.

If we care about opportunity and mobility for all, then we must do what we can to accelerate the emergence of new sectors. Progressives must bet on innovation. Research by the Kauffman Foundation has uncovered a startling fact: During the past generation, the lion’s share of net new job generation occurred in firms less than five years old. In 2007, the last year before the Great Recession, these firms provided fully two-thirds of net new jobs. So pro-growth progressives should be disposed to favor measures that facilitate the formation of new firms and increase their odds of succeeding. And because the research also suggests that periods of recession and high unemployment provide opportunities for new business formation, we should do what we can to wring advantages out of today’s less-than-robust economy.

Far from being spontaneously self-organizing, markets are structures of laws and rules that create incentives and disincentives for different kinds of behavior. Markets are human creations subject to reflective revision based on the outcomes they generate. That is what the proponents of the innovation agenda argue, and that is also what progressives believe. There is thus a solid basis for evidence-based analysis and dialogue.

And there is a shared point of departure as well: the centrality of information and the importance of maximum feasible transparency. For example, we all saw what happened when firms were allowed to keep derivatives and “special purpose entities” off their regular balance sheets. Progressives should find it easy to support proposals requiring companies to report all assets and liabilities on their balance sheets fully and intelligibly so that investors and regulators can assess their real financial condition. In the same vein, it makes good sense to maximize public access to all government-supported research. After all, these grants and contracts are funded by public tax dollars in furtherance of public purposes. And all other things being equal, innovation is likely to accelerate if those who can push the research further or move toward its commercial application have access to it.

There are other promising points of convergence. Most people who have spent substantial time in university settings agree that the three-decade-old Bayh-Dole Act, which established the framework for the commercialization of university-based research, has had some unanticipated consequences and needs revision. It serves no one’s interest if university bureaucracies impede the pace of technological innovation, and the Commerce Department has the power to issue new rules that would break the logjam. Progressives will cheerfully agree that developers should bear the costs of their activities that would otherwise be off-loaded onto taxpayers. (The principle that agents should internalize the externalities for which they are causally responsible is attractive in many spheres.) Using the Internet to speed new firm formation is just common sense, and it’s hard to imagine anyone objecting to its sensible implementation. The Obama Administration has repeatedly endorsed expanding the research-and-development tax credit and making it permanent. And it is intriguing that some pro-innovation scholars even have a good word for “private enforcement” (aka tort lawyers) as an adjunct to public regulators whose efforts are often misdirected and ineffectual.

A Long-Running Debate

So far, so good. But there are some obstacles to a full-throated progressive embrace of the innovation agenda. Some are obvious. For example, innovators tend to start with small ventures, and typical progressive approaches to taxation and regulation tend to hit smaller firms harder than larger ones. Our tax code doesn’t make it easy to distinguish between the legitimate concerns of entrepreneurs and the efforts of highly compensated lawyers and financiers to lower their effective rate of taxation. Progressives need to think harder about ways of drawing that line so that new ventures aren’t hobbled at the starting gate. Much the same goes for mandates: New and small firms have a much harder time internalizing the costs of compliance, and progressives have not always supported strategies that could reduce this burden. Here again, progressives should be willing to rethink the obsolete assumption that what works for larger, older firms should apply to startups. And the reverses of recent decades have tended to make progressives more conscious of threats to stability and security than to innovation and growth. It has taken many aging progressives too long to realize that the manufacturing economy of their youth cannot be restored.

Progressives must face an inescapable truth: We can’t rebuild a full-employment economy whose gains are widely shared unless new firms create tens of millions of new jobs during the next generation in sectors we can hardly imagine today. Accelerating the pace of innovation—and its effective commercialization—is the essential precondition for renewing progress toward a better society. We don’t have the luxury of proliferating pilot projects or indefinitely subsidizing our preferred modes of transportation and energy. Only the private sector can bring change to scale, and it can do that only with innovations that pass the market test. We need to put growth first, and with it, the laws and rules that promote it.

That said, there is a tension between economic growth and other things progressives care about. It is unlikely that progressives will throw their support behind an innovation agenda unless there is reason to believe that average Americans—not just the favored few—will benefit. Nor should we. Growth in economic aggregates is not good enough. There is a potentially powerful coalition in favor of a pro-innovation agenda linked to concrete measures to ensure that its fruits are widely shared. But this coalition can become real only if those who focus on innovation accept the need for reciprocity. It is not good enough to repeat the mantra of “creative destruction” if the gains from destruction accrue principally to the creators while the costs are borne by those whose way of life is destroyed.

One example of the tension can be found in tort law. The legal scholar George Priest distinguishes between the “deontological” and “instrumental” approaches to tort law. Deontological approaches are concerned with issues such as “corrective justice”—in plain English, compelling individuals who have harmed others through actions such as property violations and breach of contract to compensate the victims for their losses. Progressives typically favor this approach: If you’re responsible for fouling the environment or injuring your workers, you’re equally responsible for cleaning up the mess or compensating the injured. Priest criticizes such approaches on the grounds that they impede innovation and growth, recommending instead instrumental strategies that take these economic goods as maximands and pursue redress through private insurance and mandatory investments in cost-effective prevention measures.

Philosophers have long known that the consequences of unconstrained utilitarianism map poorly onto settled beliefs about decency and justice, a thesis that applies as much to tort law as to any other field of policy. While growth matters a lot, it is not the only thing that matters. For example, it may well be the case that the vigorous pursuit of mine safety reduces the productivity of many mines and increases the price of coal. There’s little doubt that the former CEO of Massey Energy believes just that. But the cost of safety standards is hardly a knockdown argument against enforcing them. Conversely, there comes a point at which additional increments of safety, environmental cleanliness, or species preservation become disproportionately expensive, a proposition that progressives are often reluctant to acknowledge—for example, when it’s ten times more expensive to abate 98 percent of an environmental nuisance than to stop at 95 percent. We don’t have to embrace cost-benefit analysis to believe that at some point additional increments of a social good come at too high a price. But the broader point is this: A society that is unwilling to make reckless employers pay for breaches of workplace safety has lost its moral bearings. Maximizing growth at the cost of easily avoidable injury and death is simply wrong. To enjoy legitimacy, law must comport with our sense of what’s right.

Nor are progressives comfortable with innovators’ confidence that competition always improves outcomes. For example, while competition among jurisdictions has some positive features, it also has negative consequences. When states compete for businesses by offering ever-larger tax breaks and other concessions, the costs often exceed the benefits. The problem is that the benefits are typically upfront, not the least for the politicians who land new plants and corporate headquarters, while the costs show up when it’s too late to do anything about them. If competitive incentives are skewed, the results are usually perverse. The “race to the bottom” isn’t just a figment of the imagination; witness the collapse of underwriting standards for mortgages and collaterization in the frenzied quest for market share and year-end bonuses.

In addition, innovation scholars have thought a lot harder about the policies they prefer than about the politics of getting them adopted. Take immigration. Many groups (including a bipartisan commission I helped organize) favor a more accommodating stance toward high-skilled immigrants for the simple reason that our current policy is patently self-defeating. Speaking only for myself, I would be willing to support high-skilled immigration reform as a freestanding measure. But for most progressives, high-skilled immigration is part of a much larger picture, and they fear that moving on a single proposal, however attractive, might further weaken support for comprehensive reform. Perhaps action on highly skilled immigrants should not be “held hostage” to other immigration issues. But in the real world it is and probably will continue to be. The pro-innovation community, which heretofore has emphasized loosening restrictions on foreign students and others with valuable training and skills, could build trust and help break the stalemate by looking at the issue more broadly and endorsing some version of comprehensive reform.

Growth and Fairness

The issues raised here are not new. For the past three decades, there has been a tension among progressives between “neoliberals” who are comfortable with growth-oriented economics and the use of market mechanisms in social policy and more traditional liberals who continue to embrace the regulatory and economic security strategies that became canonical during the New Deal. The former group emphasizes the pro-growth consequences of open-trading regimes; the latter, their disruptive effects on established firms and communities. The former believes that the structure of the tax code affects economic growth and that how we raise funds for essential public purposes matters as much as how much we raise; the latter focuses almost exclusively on the consequences of taxation for aggregate demand. The former is willing to consider structural challenges in entitlement programs, while the latter views such changes as an abrogation of the social compact. The former believes that continuing on our current fiscal course would be more damaging than are the steps needed to get off it; the latter fears that the cure could prove worse than the disease, which may not be life-threatening after all. I could go on, but you get the point.

In short, while “progressive entrepreneurship” is far from an oxymoron, it is at best a promising possibility. Turning it into an achieved reality will take some work on both sides. Progressives must embrace growth as a high priority, and they must therefore endorse its preconditions. Innovation and entrepreneurship must be to the twenty-first century what industrialization and mass production were to the twentieth. For their part, innovation advocates must recognize that not all reservations against growth and competition are the product of ideology or ignorance. Justice matters, and so do public goods that markets cannot provide. There’s no reason in principle why these disparate concerns can’t be fused into a practical agenda with broad-based political support. But actually doing so will take the kind of open-minded, good-faith discussions that are all too rare in today’s polarized politics.

 

 

Issue #21, Summer 2011
 
Post a Comment

PBrandt:

Anti-trust efforts to bust up oligopolies and monopolies in almost every sector of our economy, and removing subsidies and tariffs in sugar, corn, oil, energy, etc. would do more to spur entrepreneurship and small firm formation than any of the remedies discussed in this essay. Only a few sectors of our economy actually live with competition. Most of the big ones, energy, pharma, health insurance, food, agribusiness, telecommunications live in weak competition, many of which on FICA tax "entitlement" money (just who is entitled here?) and bought politics which stops innovation and new firm formation. The AT&T case is the best example. It started a 20 year economic expansion, yet busting up market concentration never appears once in this essay as a remedy!

Jun 15, 2011, 11:54 AM
Tino:

Mr. Galston,
Thank you for this illuminating essay. This is the first comprehensive articulation of personal beliefs I could not summarize as elegantly as you have. I hope that the principled pragmatism you advocate will be more widely adopted here in Washington.

Jun 17, 2011, 11:39 AM
Cato The Eldest:

This essay is like a drink of cool water on a hot day. I had to read it twice, the second time slowly, to take it in. Were I president, the civic horror of that idea aside, I would ask Galston to lead my council of econ advisors. And btw, PBrandt's comments are dead-on. The innovative explosion that came after WW1 was anchored in Roosevelt's trust-busting, opening up room for thousands of new ideas and firms.

Jun 25, 2011, 4:54 PM
Jeremy:

Fantastic article, I was reading something very similar the other day over at Entrepreneurial America. But the country so polarized, how do you get a balanced, centrist message across? The new media really rewards and encourages extreme stances on issues. How do you encourage common ground on growth and entrepreneurship when states like Wisconsin are tearing themselves apart over labor issues?

Jun 30, 2011, 11:26 AM
Marvin H. Gladstone:

The debate is ongoing: whether (1) capitalism can be reformed to salvage its historic entrepreneurial innovative attributes while minimizing those which are socially-destructive; or (2) socialism can be reformed to minimize its curtailment of civil liberties and its apparatchism, while promoting its egalitarianism. The Galston commentary advances the discussion.

Jul 6, 2011, 1:50 PM
SeanMMasters:

PBrandt is spot on, here. The biggest blockade for many new, innovative business is often the high cost-barrier(s) to entry, not whatever regulatory environs that business may operate in. Consider the capital required to launch an automotive company or a telecommunications firm, for example. Innovation isn't being halted by regulation, but by the enormous capital costs required to entry (let alone the astronomical costs required to compete).

Jul 11, 2011, 10:27 AM
izzie:

I did business with three venerable independent companies scattered across the US (a welding machine manufacturer, a spray gun manufacturer, and a producer of automotive chemicals) in the late 1980s and by the mid-90s they had all been gobbled up by the same conglomerate. I just checked their annual report and they say they have "approximately 840 decentralized business units." They can't even say precisely because the number changes from day to day as they deal companies like poker chips. All three independents were better companies, from a customer service standpoint, than they were under combined ownership. And think of the hundreds, maybe a thousand, of families disrupted by their new reality of lower paychecks, suddenly no guarantee the factory would remain in the hometown of the founder, you get the picture. This business paradigm which creates great wealth for a new financial/administrative tier that didn't exist two generations ago now sucks up all that income that once sustained the middle class. And the middle class paid taxes, too, without the benefit of those tax avoidance attorneys who are employed to minimize tax liabilities for the new super-rich. Anybody who owns a small business and has kept their eyes open has seen many examples of this culture-wrecking activity over the past generation.

Sep 19, 2011, 5:19 PM

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