Entrepreneurship
is a big part of what made America great. As we know, the whole world
is currently in an economic rut. Being that I'm an American, I look
at the issue from the perspective of a Yankee. Going forward, the
success of America will largely depend on the success of the
entrepreneur.
This
post will mostly be based on the work of economist William Baumol. I
know economics has been called the dismal science. But, I think
Baumol has something interesting to say about entrepreneurs. However,
before I get to Baumol I want to mention something from Peter
Drucker.
Drucker
suggested that we might be in the age of the entrepreneur. He wrote,
“A hundred years ago the worldwide panic of 1873 terminated the
century of laissez-faire that had begun with the publication of Adam
Smith's Wealth of Nations in
1776. In the panic of 1873 the modern welfare state was born. A
hundred years later it has run its course, almost everyone now knows.
It may survive despite the demographic challenges of an aging
population and a shrinking birthrate. But it will survive only if the
entrepreneurial economy succeeds in greatly raising productivites.”
That's
what really matters. The increasing of productivity. But,
productivity might not mean what you think. Productivity doesn't just
mean getting more things done in less time. While that is one element
of productivity, it is not the only piece. The entire economy is
about the allocation of resources. If you can't increase the quantity
of a resource, increasing productivity means you have to increase its
yield. To sum it up, increasing productivity means getting more out
of our resources be they time, money, land, energy, or whatever.
Now
to Baumol. Baumol holds professorships at both NYU and Princeton. The
focus of his research is on entrepreneurship and innovation. Let me
ask you this. What is an entrepreneur? It's a pretty good question.
And, it's kind of difficult to answer.
Professor
Baumol writes, “If entrepreneurs are defined, simply, to be persons
who are ingenious and creative in finding ways that add to their own
wealth, power, and prestige, then it is to be expected that not all
of them will be overly concerned with whether an activity that
achieves these goals adds much or little to the social product or,
for that matter, even whether it is an actual impediment to
production.”
Building
off of this definition Baumol suggests that there are three types of
entrepreneurial activity: productive, unproductive, and destructive.
Productive entrepreneurship is about innovation. Unproductive
entrepreneurship has to do with something called “rent-seeking.”
And, destructive entrepreneurship is things like organized crime.
I
think we all have an idea what organized crime is. It has do to with
things like those guys with pinky rings. It's a destructive form of
entrepreneurial activity and I won't spend any time on it. Let's talk
about innovation, a productive form of entrepreneurship.
Stated
simply, innovation is about the creation of new value and new wealth.
It's not invention or scientific discovery. It's not creativity.
Rather, it is the commercialization of creativity. It's about taking
new and creative ideas and putting them in a form that consumers find
valuable and are willing to pay for.
Let's
run through a couple of examples. These days it seems like all eyes
are focused on the Silicon Valley. I was going to use Apple computers
as an example but, instead, let's talk about the namesake. The
Silicon Valley is the home of the personal computing industry. As you
probably know, it got its name from the fact that silicon is the
material used to create microprocessors. But, silicon is nothing more
than a chemical element that we find in the ground. Here's a picture
of silicon:
Nobody
wants that crap! The innovation, at play, was taking silicon and
turning it into the parts of a computer. That is what people value. That
is what people want. It took people like Bob Noyce, and Jack Kilby,
to take silicon and make an integrated circuit. What they did was
increase the yield of a resource. That black silicon doesn't do
anything. But, a computer does a helluva lot!
As
it turns out, most innovation is not high-tech. I'll just do one
example. I'm certain you have heard of Sam Walton. And, unless you're
one of those snobs that won't go below Target, chances are you have
been to a Walmart. Walmart is the largest retail operation in the
world. What Walmart did, to become so successful, is the very
definition of low-tech.
The
innovation that made Walmart so huge is ridiculously simple. The
company was build on the premise of low margins and high volume. What
the discount retailers, like Walton, discovered was that by selling
more goods at a lower price they could make more money than if they
sold fewer goods at a higher price. Today we take this for granted.
But, at the time, it was pure innovation. The customer wins and the
company wins. Walmart is a big-time, productivity increasing
innovation. And, it's based on an extremely low-tech idea.
Innovation
is a productive entrepreneurial activity. Now let's talk about
unproductive entrepreneurship. The example that Baumol gives is
something called rent-seeking. There's a good chance you aren't
familiar with that term. Please let me explain, because it's very
important. If innovation is about adding new pieces to the puzzle,
rent-seeking is about shuffling the existing pieces around. To put it
differently, rent-seeking is about getting a bigger piece of the pie
for yourself. Innovation is about making the pie larger for everyone.
Let's
do some examples. One example of rent-seeking, which relates directly
to the name, is landholding. As we know, the 19th Century
was an era of westward expansion in America. People migrated towards
the Pacific Ocean as quickly as they could. Settlers laid claim to
the land they occupied. If you wanted to use “their land” you
would have to pay a fee. You would have to pay rent. These
land-grabbers were entrepreneurs but they were unproductive. They
didn't contribute anything to society. It was an “I got mine!”
mentality.
Another
example is usury. The dictionary defines usury as, “The practice of
lending money and requiring the borrower to pay a high amount of
interest.” If you've been following this article, you know that
usury is a form of rent-seeking. An example of usury are payday
lenders. People who start a payday lending business are
entrepreneurs. But, their entrepreneurial activity is unproductive in
that it contributes nothing to society. Actually, usury is also used
by organized crime.
I
know, I know the proprietors of these establishments would argue they
are providing a valuable service. But, the fact of the matter is they
are taking advantage of people's ignorance. Allow me to demonstrate.
Without looking below, tell me the mathematical formula for
compounded interest. I doubt you'll be able to, very few people can.
I too had to look it up. (I have included the formula at the bottom
of this post.)
A
third example of rent-seeking would be "greenmail." As you might know,
greenmail has to do with hostile corporate takeovers. This is where a
person (or company) buys shares of a targeted company's stock. The
buyer then threatens to take to the company over. If the target
company doesn't want to be taken over they have to buy back the
shares at a substantial premium. Greenmail results in a profit but it
certainly is not productive.
All
in all, I am not trying to place judgment on people. What I am saying
is that the future of America resides with the entrepreneur. But, not
any entrepreneur. The key is that our entrepreneurial activities be
productive. Rent-seeking isn't necessarily illegal. But it isn't
productive either. If we are going to get America back on track we
need to increase productivity. We need to innovate.
This is the equation for compounded interest:
Not so easy!
