It's the economy, stupid

It is a truth universally acknowledged that an economy short of jobs must be in need of entrepreneurs to start new businesses. But what if this assumption is just plain wrong?

What if small businesses are not, as every politician, government official and corporate spin jockey has proclaimed in the past decade, ‘the engine of the economy”?

A number of government programmes and a large amount of lip service will have to change if the views of an American entrepreneurship researcher aired on a recent trip to South Africa are to hold water.

Among the provocative ideas of Scott A Shane, professor of entrepreneurial studies at the Case Western Reserve University, is the possibility that higher economic growth rates lead to increases in the numbers of business start-ups, and not, as is widely assumed, that increased business start-ups drive economic growth.

It is probably the hype created by a growing economy that spurs increasing numbers of people to start working for themselves, argues Shane, the author of Illusions of Entrepreneurship, who was the keynote speaker at a recent conference on entrepreneurial development in Johannesburg.

In fact, he postulates that a high number of business start-ups probably has a slightly negative effect on the growth rate of an economy, because research shows that the productivity of existing businesses is higher than that of start-ups.

If the entrepreneurs spent their energy working for existing firms rather than starting up their own, the growth rate of the economy would be even higher.

The figures
When it comes to job creation, Shane quotes statistics that show no fewer than 43 people in the United States attempt starting up in business for every permanent job created.

That is, a job that still exists 10 years later. Fewer than 1% of Americans are employed by new businesses and research shows start-ups offer lower pay and few or no employee benefits.

An argument in favour of high start-up rates in an economy is that they fill niches that are ignored by existing businesses.

But Shane has evidence showing that the average entrepreneur starts a business in an over-traded industry and does so by poaching the clients of his former employer.

To those who have grown up with the axiom that new business formation is good for the economy, Shane may sound like an eccentric professor.

But his research is often cited. He writes a column for the New York Times on entrepreneurship and recently received a Global Award for Entrepreneurship Research, a Swedish prize for empirical research into entrepreneurship.

Shane paints a rather grim picture of the typical US entrepreneur—more than 70% of all start-ups fail within the first 10 years.

This is not very different from the often cited warning in South Africa that ‘80% of all businesses fail’‘, but the really depressing statistics concern those businesses that do survive.

On average entrepreneurs make less money than they would have had they worked for someone else and that includes the income they earn from selling their businesses one day.

To earn their meagre keep, they work much harder than those who work for others—and not because they love what they do.

Research shows that they are unhappy about the long hours they put in. But there is one redeeming feature of the life of a typical US entrepreneur—there is evidence to show that they are generally happier than those working for others.

Shane argues that this is why the majority of entrepreneurs choose to start their own businesses—they don’t want to work for others and are perhaps willing to pay a premium, in the form of lower income, for the privilege of being self-employed.

He points to research that shows the average entrepreneur is overoptimistic about his chances of success and tends to make some dreadful choices when starting up, the worst of which is to choose an overtraded industry, such as construction or the restaurant trade.

But these industries inevitably get chosen for their low barriers to entry and because entrepreneurs tend to start up in industries where they’ve worked and gained experience before.

Shane says studies show only 10% of new businesses grow larger than their start-up size and only 3% grow to 100 employees or more.

The end of start-ups?
But Shane doesn’t argue that startups should be eliminated. Supergrowth firms—such as Google—looked pretty much like the average start-up not so long ago.

But he argues against indiscriminate government encouragement for start-ups through tax breaks and subsidies. These are given under the misconception that it will lead to job and wealth creation.

If that is what a government is after, it should imitate the venture capital industry, which is highly selective of the industries and the individual entrepreneurs it invests in, says Shane. That industry is highly successful.

In 2003 US companies backed by venture capital employed 10-million people. This was despite the fact that since 1970 venture capital has invested only in an average of 820 businesses a year—out of a pool of two million start-ups annually.

How relevant Shane’s US-focused conclusions are to South Africa is a difficult question because of the lack of research on South African entrepreneurship, says Kerrin Myres, director of the centre for entrepreneurship at the Wits Business School.

‘I think we need a large-scale, multi-partnership study of entrepreneurial behaviour in South Africa.’‘

In an interview with the Mail & Guardian Shane declined to comment on South Africa’s attempts to encourage small businesses and entrepreneurship because he hadn’t studied it.

But in response to a general question about the likely success of a policy to encourage the unemployed to become self-employed—a central thrust of the South African small-business project—he said: ‘If the goal is to generate jobs and wealth, it’s unproductive because one of the things that we know is that those very businesses have extraordinarily high failure rates, they generate very few jobs and very little wealth, so when you stop the subsidy, you have relatively little to show for it.’’

But if the aim is to ameliorate the effects of the ‘horrible’’ and ‘psychologically damaging’’ state of permanent unemployment by giving people something to do, ‘then it makes perfect sense to take a bunch of people who’ve never been employed and turn them into entrepreneurs.

Now they will be happier because you’ve given them something to do and you’ve channelled their attention to something productive.’’

Misguided impact
Myres agrees that ‘we should not expect what is essentially a social development programme to have an economic impact.

It has huge ramifications. It changes, for example, the way we look at funding. If it is a social development programme, then we shouldn’t be using standardised methods of access to finance.

Maybe we need some funds to have much more of a grant-oriented basis—tiny grants that could really help people to buy that extra sewing machine they need to start a business.’’

Myres says Shane’s point about supporting high-growth entrepreneurs is valuable. It is too difficult to identify highpotential candidates among the thousands of start-ups.

Rather, high-growth industries must be identified and industry-specific institutions set up to support existing entrepreneurs.

‘I don’t think you need physical incubators (centres that house and nurture new businesses). I think you can do it virtually,’’ says Myres. But she points to one important difference between the US and South Africa.

‘In the US entrepreneurs naturally emerge. They’re in a very munificent environment. So, if you’re a natural entrepreneur, there’s lots of support and encouragement and role models and
education.

That’s not true at all in South Africa. So we also have a developmental task. We can’t just sit back and wait for people to pop up that are high potential [entrepreneurs]. We have to engage in creating them.’’