The Entrepeneurship Deficit

I want to back up Matt Yglesias’s response to Chris Edwards’s post at the Cato blog provocatively called “The Death of Private Investment”. In the original post Chris points to alarming statistics from the Bureau of Economic Analysis. He declaims:

Business investment continues to be in a deep recession. Companies are simply not building factories or buying new machines and equipment.

Why not? I suspect that many firms are scared to death of higher taxes, inflation, health care mandates, increased labor regulation, and other profit-killers coming down the road from Washington. That is speculation, but I haven’t heard a better explanation of the death of private investment in America.

to which Matt responds:

Note that though the steepest cliff-diving happened in 2008 Q4 and 2009 Q1, the decline actually began way back in 2006, so it’s hard to say how fear of Barack Obama could have caused it. As for a better explanation, how about the problems in the financial system that were accumulating during this period and then reached a true crisis point in the fall of 2008? Surely we haven’t forgotten about that already, have we? And since the collapse, we’ve been facing a problem of low aggregate demand and deflationary expectations, both of which discourage investment, combined with massive overcapacity in real estate.

I’m forced to point out that the steps that the Obama Administration has taken over the last ten months to bolster the economy have, unfortunately, served to incentivize additional capacity in areas in which we already have “massive overcapacity”. Cash for Clunkers hasn’t just enabled auto companies to work off inventories. It’s caused them to re-open production lines and boost production.

However, Matt is right. I’m no graph-drawer so you’ll need to forgive the clumsiness of the next two charts, both taken from the BEA’s numbers linked above. Here’s the gross private domestic investment in real 2005 dollars from 1946 to date:

As you can see it’s been showing robust growth for more than 50 years. There was a sharp dip during the recession in the first part of this century and another dip now. But if you look more closely at the data there’s more cause for concern. The following chart illustrates real gross private domestic investment less residential investment 1995, the first year for which data is available, to date:

To my eye this chart illustrates domestic investment that has been pretty flat for more than a decade. I wish I had the ability to segregate investment in the medical sector from the rest of the data. Because of the heavy government subsidies in the sector, investment in the medical sector, particularly things like palatial offices for doctors and Taj Mahal hospitals, are attracting a considerable amount of private investment. They are seen as having reduced risk.

I think what we’ve seen over the last decade is a genuine deficit in entrepeneurship, i.e. risk-taking. Consequently, I believe that while Matt is correct in observing that the lack of investment didn’t start with Obama, Chris is right in that it’s a genuine problem.

I can offer all sorts of explanations for the decline. The large proportion of foreign capital (sometimes referred to as the “global savings glut”) is risk averse. So are big companies. So are the wealthy. Big companies and wealthy individuals tend to go to substantial lengths to avoid or mitigate risks rather than embracing them.

However, I honestly don’t see how the economy can recover, particularly how it can create new jobs, by returning to the status quo ante. We should not go back to the over-leveraged past. We should allow resources to flow to the industries of the future rather than propping up the industries of the past. That’s the direction that policy in any administration should be taking.

Unfortunately, existing industries and established institutions have political influence and are willing to exert it to support its position while the industries of the future have none.

6 comments… add one
  • But what are the industries of the future? What technological breakthrough is straining at the leash waiting for a cash infusion? I wonder if the problem is that we don’t have any great ideas at the moment. It feels as if we’re in an age of technological refinement rather than some great leap forward. It’s all about improving performance and efficiency for existing mature technologies.

  • One of the ways you subsidize the industries of the future is by restraining the power of the established industries so that they can be allowed to emerge.

  • steve Link

    While small and medium businesses are our strength, the part of the market where Verdon’s ideas actually work, we continue to support big business with tax breaks and regulations that favor them, put on the books at their request. Big business is anti-competitive. Look at all the states dominated by one or two health insurance companies.

    Tangentially, it is my belief, and I concede I do not have the data to back this up, that health care costs are a major factor here also. I think that there must be a lot of people who are afraid to go out and start a new business because of fears about lack of insurance. Much safer to stay employed. I certainly see this kind of effect at my group. People have passed up opportunities to leave or to retire because they worry about health care costs. If you are self-employed and get sick, you risk losing your insurance and going broke. If you already have some illness, even just hypertension, the costs may be exorbitant or you may not be able to buy any at all. That means new businesses are pretty much limited to the wealthy and the very poor or very high risk takers. (nice use of Taj Mahal)


  • Intriguing. I’m not sure that the statistics bear out an entrepreneurship deficit when it comes to new business creation (which you may not be saying), but I agree that there may be too strong an investor preference for established players. The venture capital sector has significantly bought into the system as it currently exists, and so places a large proportion of its bets in a relatively small proportion of industries (namely those where very strong IP is a factor).

    There’s nothing wrong with that given the limitations of the system, but it does mean that outside high-tech, there may be too much stasis wrt winners and losers. I’m less sure about the investment patterns in private equity in this regard – maybe some of your commenters who work in that field can chime in. In any case I fully agree that the federal government could do a _lot_ more to spur entrepreneurship, and should.

    I do agree with the left that effective health care reform could be a boon to entrepreneurship. I know that I personally chose not to become an entrepreneur out of grad school mainly because I could not choose to forego decent health insurance for that long. But I also don’t think any of the likely bills to come out of Congress this year will really improve on that situation.

  • ” things like palatial offices for doctors and Taj Mahal hospitals”

    I guess I just can’t afford to go to those docs with the palatial offices…I sure haven’t seen any of them.

    Perhaps they are the ones doing discretionary, uninsured, stuff. Well, I can’t afford that stuff either…

    Perhaps you can point out some examples.

  • Steve:

    I can show you some orthodontist’s offices . . .

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