HBS professor Josh Lerner in his new book studies where public efforts to spur entrepreneurial activity have gone right and wrong offering policy prescriptions to guide government actions in the future.
Silicon Valley is the poster child for capitalism, the synergistic geography where smart private money supports cool ideas, creates jobs, boosts national productivity, and provides a handsome return for investors.
Less well understood about the area's development was the role played by the U.S. government in making it a success. "Particularly during the early years, the government played a critical role in shaping Silicon Valley," especially spending and funding from the U.S. Department of Defense, writes HBS professor Josh Lerner in his new book, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed—and What to Do about It.
Government has played similar catalytic roles in creating hubs of innovation is places such as Tel Aviv and Singapore. Such success stories often get lost against the common perception that government just bungles things when it wades into the private sector.
Lerner's book studies where public efforts to spur entrepreneurial activity have gone right and wrong—there are many more of the latter, the author acknowledges—and offers policy prescriptions to guide government actions in the future.
Sean Silverthorne: Why is this book right for the times?
Josh Lerner: There are two sets of events that make this book particularly timely.
Q: You devote a chapter to sovereign wealth funds, which I know are a research interest of yours. Are these a promising source of public support for entrepreneurial efforts?
A: In the book I consider a special, but highly visible, manifestation of the government as entrepreneur: the sovereign wealth fund. A sovereign fund can be defined as a state-owned fund that invests in various financial assets. These institutions have been experiencing remarkable growth, and an even greater increase in scrutiny from business and political leaders worldwide.
Sovereign funds can spur entrepreneurial activity due to their abundant capital resources and long-term outlook. To be sure, this is not easy: Many of the challenges facing sovereign wealth funds are similar to those encountered in the other public venture capital and entrepreneurial promotion schemes that I've summarized above. But these organizations must struggle as well with added issues, which make the effective leadership of sovereign funds especially challenging.
First, these organizations face political scrutiny, particularly in Europe and the United States. One might assume that sovereign funds, which have been part of the economic landscape for more than half a century, are too familiar to cause worry. But the rapid growth of these funds in recent years and their role in a few high-profile transactions have called attention to them and inflamed public anxieties.
Careful scrutiny suggests that many of the criticisms of sovereign funds have been misleading, but even these problematic perceptions can make performing their roles difficult.
The second major challenge relates to the need to generate good returns on investments. Groups, particularly the larger ones, must struggle with the cruel mathematics of size. Strategies that may be attractive for a small capital pool become much more difficult to implement with more capital under management. This problem is most acute when investing in entrepreneurial projects and private equity, on which many sovereign funds have increasingly focused.
Q: Let's put you on the spot. How is the Obama administration doing in boosting entrepreneurship?
A: The administration appears to have a keen understanding of the importance of research and innovation. To the extent that it follows through on the promise to create a more favorable environment for entrepreneurship—by using steps such as increased public funding for basic research, eased restrictions on immigration by high-skilled scientists and engineers, and a streamlined patent system—it is likely to translate into a better environment for high-potential entrepreneurs.
In other respects, the track record is not so good. As we've discussed, one of the most common fates of programs to stimulate high-technology ventures is capture. Funds end up getting distributed in ways that have little to do with the needs of high-potential ventures or society more generally, but rather by the whims of the powerful and well-connected. From the empty BioValley complex in Malaysia to the repeated U.S. Small Business Innovation Research grants to Beltway "mills" that produce few real innovations, this pattern is depressingly familiar.
Successful programs, by way of contrast, have clear, well-defined investment processes. They limit the danger of political influence by establishing independent bodies to oversee the programs. In many cases, they have further reduced capture problems by passing the funds onto intermediaries such as venture capital funds that make the real investment decisions. By keeping individual awards relatively modest, they limit efforts to misdirect these funds.
Unfortunately, the funding of clean tech innovation under the stimulus program has been characterized by a lack of clarity and consistency. In this uncertain environment, it is not surprising that entrepreneurs have responded in the old-fashioned Washington way: by hiring lobbyists. The big winner of the Department of Energy's battery funding orgy, A123 Systems (with $249 million in awards), spent about $1 million on Washington representatives between 2007 and early 2009. A partner at leading venture capitalist New Enterprise Associates suggests that at least half of the 25 clean tech firms in its portfolio have hired lobbyists. This does not seem like the ideal way to boost entrepreneurial innovation.
Q: Is there more research to be done in this area?
A: Sadly, the academic literature in this area is comparatively sparse. Economists have turned only recently to the question of how to boost entrepreneurship. In contrast to other government interventions designed to boost economic growth, such as privatization, programs to promote entrepreneurship have received little scrutiny by economists. Not only are the theoretical foundations much less well developed, but empirical studies are much fewer in number and generally less sophisticated. While related issues—such as the impact of research and development subsidies—have attracted more attention, definitive answers are scarce even among these better-researched topics.
Thus there is a substantial opportunity for further research into these questions that work over the next few years will hopefully begin to address. At the same time, these problems are complex and unlikely to yield easy answers. Policymakers face the challenge of having to consider many different options. It is often unclear how proposed changes will interact with each other. Furthermore, there is no clear "instruction manual" that explains which changes will have the desired effects, and academic research is unlikely to quickly develop one.
Q: What are you working on now?
A: I am working on a variety of related questions. First, venture capital's "big brother"—private equity or buyout funds—are attracting increasing scrutiny as regulators seek to prevent another potential economic meltdown. We are trying to understand the extent to which private equity contributes to the economic volatility, or "systemic risk," in the economy.
Another project is looking at the very smallest of investors in young firms: angels or individual investors. These investors are frequently hailed as a crucial component of the innovation system, but the choices behind and consequences of angel investments are poorly understood.
This article was provided with permission from Harvard Business School Working Knowledge.