Monday, March 26, 2012

Select for the entrepreneur

What would it mean for our entire culture to be entrepreneurial? In our December 2011?Lab with the Academy for Entrepreneurial Leadership at the University of Illinois, participants quickly agreed that it?s more subtle than asking every undergraduate to take a business course.

But the room was intrigued by a series of proposals from Pablo Montagnes, a professor of Managerial Economics and Strategy at the University of Chicago. The underlying thread was that the best thing to do to encourage entrepreneurship may be to create settings that include greater concentrations of people with entrepreneurial characteristics.

We spoke with Montagnes after the session to explore his ideas further. His conversation with Labs Content Director Andrew Benedict-Nelson follows.

Andrew Benedict-Nelson: What do you think was the most significant idea that emered from this Lab?

Pablo Montagnes: I guess the most significant idea from my perspective was that if we want to encourage entrepreneurship, then it?s helpful if we can create a culture of entrepreneurship. So as opposed to a direct subsidy to entrepreneurs, or strengthening patent laws, or all sorts of other possible ideas, it seems like what the group seemed to agree on, was the best way to encourage entrepreneurship was to create an entrepreneurial culture.

ABN: That makes sense to me. That idea manifested in the Lab in several different ways. So, since you?re an expert in public policy, I thought I?d investigate that a bit more with you. So let?s say we have a scale from 0-100, zero being a country where entrepreneurialism is not possible at all, and 100 being the most entrepreneurial society possible. Where would you say the United States ranks?

PM: So, the United States as a whole, I think very high. In terms of the culture overall, in terms of entrepreneurship in arts, entrepreneurship in business, I think we?re very, very entrepreneurial- more than the rest of the world. But in terms of government policy, I guess I?d think of Latin America as actually being more entrepreneurial in terms of government policy. And maybe even China, so I would say that the U.S. is maybe in the upper half, but not right at the top.

ABN: Those seem like two really interesting examples to investigate. In what specific ways would you say that public policy in Latin American countries and China is entrepreneurial?

PM: So Latin America has, in general, two ways I would describe their public policy environment as entrepreneurial. One is they actually experiment more. They?ll do things like give certain cities more money to accomplish something. And they actually run experiments, which is in my mind a very entrepreneurial thing.

The other way is it has a lot of local autonomy in terms of how things get done. So, the money all comes from the federal government, but the way that it?s spent is determined at the state and urban level much more in Brazil. The degree to which there is centralization of the government policy, I would say that?s anti-entrepreneurial because it doesn?t allow you to experiment.

ABN: Hmm, that?s interesting, because I think many Americans would make that argument about federalism and the relationship between the states and the federal government. But I?m not sure that it?s true in practice, because the states aren?t viewed as constituent elements of a whole in the same way that, say, the provinces of Canada are. Even with the legitimacy of a representative legislature, it would not feel legitimate here to separate them out and try out different kinds of policies in different states or regions.

PM: Right, each state itself can innovate an experiment, but it?s hard to do systematic from the federal government experimentation. There are some examples of projects where the federal government will do things like target five different metro areas, each of which represent a different kind of environment. But I?d say there are fewer experiments of that type than there are in some other countries.

ABN: What about China?

PM: China is entrepreneurial in a different way. China has completely different legal systems applied in different regions of the country. They have Hong Kong and Macau, which for historical reasons are very different. Then you have the coastal southern region, which have much more freedom in terms of economic rule, but at the same time there?s northern and rural central China where nothing has really changed.?

The number of successful businesses that are started by immigrants in America is enormous.

So they?re able to run something like five or six Chinas in terms of which rules apply. They?re experimenting in that sense and trying new things in different ways. That?s different from Brazil, where the same law of the land still applies everywhere. They change the policy, but they don?t change the law. It?s not the case that owning property is legal in some parts of Brazil, but not in others. But that is true in China.

ABN: Right. So I get that the different legal regimes in different parts of China would sort of naturally lead to a kind of policy experimentation. But I don?t quite follow that it?s necessarily entrepreneurial. I mean, I don?t disagree that it could be, but could you explain to me the next step?

PM: Yes. I think what they?re doing there is that when they created these economic zone, they weren?t sure how they were going to go, so they treated it like a start-up process. To me, experimentation and entrepreneurship are linked. You don?t know how things are going to turn out. You have a hypothesis, but if it was deterministic, if it was a sure thing, then the opportunities wouldn?t exist. They didn?t know how it was going to turn out in terms of the economic side of it, but also in terms of whether they going to be able to maintain political power, was this going to lead to dissent from the central government, stuff like that. There were a whole bunch of variables, and they weren?t sure how these were going to work; that?s why they tried it in a small area first.

ABN: I?m going to push on this a little more. Because even though I see where you?re coming from, I think a lot of people would say, ?Well wouldn?t it be even more entrepreneurial to have a single set of policies across a country that encourages people to do their own experiments??

PM: That?s a good question. I would say that that?s true, it?s a definition of entrepreneurial policy is what?s most friendly to entrepreneurs. If the definition is being entrepreneurial with policy itself, then it?s not true.

ABN: I mean, I hear where you?re coming from, because it seems very difficult to me to get that kind of experimental mindset in government, perhaps more difficult in democratic countries. I don?t think we have much of it in the United States. I?m not sure how we would get it.

PM: There?s an informal version of it happening in the sense that you have some states innovate on internal policy and then some other state adopts it. But actively getting people to have an entrepreneurial government is very difficult, especially because with the type of people the government attracts at the bureaucratic level, who are typically less entrepreneurial. The stereotype of a government job is that it is much more stable and much less creative than a job in the private sector. It?s difficult to change the culture in organizations like government where there is very little turnover. It?s so big that it?s a difficult animal to change.

ABN: So about two-thirds of the way through the Lab, after we had reached this idea of a culture entrepreneurship, Jeff Leitner turned to you and asked what single piece of public policy you thought could be changed to most encourage such a culture. And the first thing you mentioned was a change in immigration policy. Why did you say that?

PM: The thought was that if you want to change the culture, you need some sort of selection device for this hard-to-measure quality called entrepreneurship. You could imagine some sort of personality test, but it?s pretty hard to come up with an objective measure of someone?s entrepreneurialism right off the bat. If there were some sort of test, you might learn to cheat on it. And it?s not clear that there would be any legal way to do any of this anyway.

But something that correlates very strongly with entrepreneurialism is the desire to move to an area with more freedom. If you?re choosing between bureaucratic India and market-driven America, and you prefer America, then you?ve kind of revealed that you?re an entrepreneur and that you have strong complements to the free market system. And so one way to get more entrepreneurialism into the country is to select entrepreneurs. And one way to do that is to allow more in than there ?should? be.

If there were some other measure ? if we knew that left-handed people were more entrepreneurial ? then I would say that we should hire more left-handed people or let more left-handed people into the country. But we don?t have a measure like that. The measure we do have is a desire to take a risk and move to the United States for a particular reason. Immigration policy is a way that at the macro level, we can select for people who have had a more difficult route, the people who are taking the most risk to move to a more free environment. That can work at a national level but it can also work in an organizational level.

ABN: I think it?s a total game-changer to think about immigration policy this way. I think if you ask the average person on the street, ?What is the immigration debate in the United States really about?? you?d hear many things. ?Obeying the law,? ?Being the hope of the world,? ?Preserving our national character,? ?Racism,? ?English,? and so on. But very few people would say, ?It?s about how entrepreneurial we want to be as a nation.? I?d really like to see what the debate would look like if everyone understood that to be the goal. How do you think that could reshape the discussion?

PM: I think it?s actually something that both sides would tend to agree on. So there?s lots of evidence that you could cite. The number of successful businesses that are started by either first- or second-generation immigrants in America is enormous. Steve Jobs?s dad was Lebanese. One of the Google founder?s parents is Russian.

That?s not to mention all the small businesses that are started on the fringes. Immigrants are much better off sometimes by necessity because they?re forced to start their own businesses because of discrimination. The Chinese started laundries not because they thought that was a great initiative but it was the only initiative they could go into. In medieval times, the Jews went into banking not because they wanted to per se, but because there was a religious ?niche? there.

The U.S. is best at creating these kinds of opportunities for people. If people want these kinds of opportunities, we should be the ones who let them take advantage of them. Often the immigration debate is about illegals stealing jobs from Americans. But entrepreneurship is about creating new jobs and new things that would not exist otherwise.?

Patents can create great incentives for innovation, but they can also hinder it.

ABN: So the argument goes that if entrepreneurialism and immigration were completely in sync, it would be ridiculous to say, ?We have to stop those immigrants from stealing our jobs.? It would only make sense to say that in terms of critiquing the immigration policy as insufficiently entrepreneurial.

PM: That?s what we have right now. There?s a lottery for green cards and there?s also a system for investors to get their green cards. And the lottery system is larger than the investor system. So more people get in through the lottery every year than get in through the closest thing we have to an entrepreneurship green card.

ABN: There?s an argument that says that every person who completes an advanced degree in this country should just get a green card, no questions asked. The idea is that if our institutions helped these people develop ideas for new research or new products, they might as well develop them here.

PM: I totally agree with that.

ABN: That?s kind of like your left-handed argument. If someone is capable of earning an advanced degree, there?s a reasonable chance that they?re more likely to be able to start a company than any random person. But do you think there are other observable characteristics that would indicate entrepreneurship and we could also design an immigration policy around?

PM: Well, I think that the ability to speak English is probably a correlate. If you?ve taken the opportunity to learn English in your home country, I think that in itself shows an entrepreneurial drive.

ABN: That?s fascinating to me. Because if a random person came up to me on the street? and said, ?Our immigration policy should only be to let in people who already speak English,? I would immediately reject that. But if they justified it in terms of those people being more entrepreneurial, I?d have to give it a second look.

PM: I wouldn?t make it a requirement. I would make it more like Canada?s system, where you get points for various characteristics. A four-year degree is worth so-and-so and a five-year degree is worth so-and-so. You could have English worth a few points, and you could also factor in things like age.

The other entrepreneurial characteristic I think of is country of origin. Nigeria comes to mind ? Nigerians seem to be very entrepreneurial. Lebanese too. The common factor seems to be if they came from a country with difficult circumstances. So Canadian immigrants I think of as less likely to be entrepreneurial. But it?s hard to say ? I can?t actually articulate what the relationship to the policy would be.

ABN: I don?t really know anything about immigration; my default position seems to be, ?Let?s just do whatever is best for the economy,? and I tend to assume that means letting most people in. This would seem to give us a more sophisticated way of answering that question.

PM: Well, it?s what?s best for the economy, but also what?s best for what segment of the economy. Most economists would agree that letting in a lot of unskilled labor is actually still good for the economy. But it?s not true that it?s good for everybody, in particular high school drop-outs and African American men with no college degrees, who seem to suffer from illegal immigration. Whenever we talk about a policy as it effects the economy, we want to talk about things that increase GDP, but we also want to keep worrying about things that increase inequality. And illegal immigration is one of these things that increases GDP but definitely increases inequalities.

ABN: So in a way, even though this is very interesting, it doesn?t really solve what people take to be the core of the immigration debate, which is the illegal immigration across the U.S.-Mexico border.

PM: Yeah, exactly. The other thing is, I?m really talking about the lowest 20th percentile of people that are disadvantaged by illegal immigration. The people like the Minute Men are not disadvantaged. You don?t see a lot of African-American drop-outs fixating on the immigration issue. You know, the people who are actually complaining about it the most are people who are probably benefitting from it.

ABN: It?s just another weird day in the American political system.

So your first answer for how we could tweak public policy was about immigration. What might two through four be?

PM: I think public policy should seek to substitute for market values so that when the market can?t provide something, that?s an opportunity for the government. I think a clear, unambiguous, uncontroversial area is increased support for basic science. The U.S. has been an enormous spender in that area. I think that continues to be a major thing the government can do.

I think there has to be some sort of intellectual property reform so entrepreneurs are protected when they have new ideas. Patents can create great incentives for innovation, but they can also hinder it. So I think there has to be a wholesale re-thinking of how patents to work on an entrepreneurial basis.

If an area is ripe for reform, it is probably ripe for experimentation.

I?m also a particular fan of prizes as an effective mechanism in the economy. So as opposed to granting patents after the fact, you could suggest a problem and then give the person who develops the solution a prize. But then the solution itself would become either the property of the government or it would go into the public domain. You could imagine all sorts of areas to apply that to.

ABN: To me, this goes back to the issue of experimentation. I think we can all agree that the concept of intellectual property itself was a great idea. But in the early modern era they never expected to have to deal with millions of patents and patent trolls and all the drags we have on the system. It seems like we?re at a point where we should say, ?Well, let?s experiment with some changes in order to make this system more entrepreneurial.?

PM: Yeah. It?s an area that?s ripe for reform, and if an area is ripe for reform, it?s probably ripe for experimentation.

ABN: So you would agree that in this area it?s not just a matter of entrepreneurs getting together and demanding a specific reform? That we have to actually be entrepreneurial in figuring out what the most entrepreneurial policy is?

PM: Clearly, yes.

ABN: So we have immigration. We have basic research. We have intellectual property. What other changes would make for more entrepreneurial public policy?

PM: I like the idea of allowing the government to compete with the private sector and allowing the private sector to compete with the government.

An example that?s kind of hot on my mind right now is the U.S. Postal Service. I think there?s a lot of opportunity with the USPS, but they?re limited right now by regulation as to how they can compete with the private sector. But I would love to see them freed up from those constraints and see how they can innovate and compete at the local level.

I think it?s good that garbage collection has been privatized in many places, but we should also let the local Department of Sanitation compete for that. Charter schools are another area where you could foster competition ? not unbridled competition, but competition ? for certain types of services.

This type of competition is particularly good for areas where there isn?t a clear market failure. There?s no natural reason why the private sector shouldn?t get your garbage. You just need a law that says that you can?t let garbage pile up in your backyard, and then a private system of garbage collection develops. But you can?t do that with, say, fire protection. If my house catches on fire, and then I don?t put it out, it?s not just that I?ve broken the law ? my neighbor?s house will also catch on fire.

So there are some areas where government intervention is natural and some where it isn?t. There are a lot of government service areas where there isn?t a natural fit; it?s just so ingrained in us that we think there is, but there?s no reason that it has to be.

ABN: To me, the example that comes to mind in this area is the new health care exchanges. I was recently reading that in California, there are some county health care insurance programs that were developed for public workers, but were also opened to the general public. Now they?re considering whether those programs will be able to compete on the statewide exchange.

PM: So Los Angeles County could compete for clients in San Francisco?

ABN: And they?d also be competing with Blue Cross Blue Shield or Cigna.

PM: That?s cool, I love that.

ABN: So let?s say this is a manifestation of what you?re talking about, a kind of creative competition between the public and private sectors. There are many people who would look at this and say that these counties are performing functions that could be taken care of more efficiently by new companies. They might argue that the government service is preventing a new company from coming into existence. So why would you argue that this private-public competition is in fact more entrepreneurial?

PM: That?s a good question. I kind of reject the premise that more competition just in the private sector is always good. In the area of health care, for example, you have non-profit entities like Kaiser Permanente. Well, does the fact that they are a non-profit mean that there is more competition, or less? How exactly is that different from the government competing? We?re so used to the rhetoric that supposes that government involvement means less competition. But in the setting you just described, it means more competition. That, to me, means more entrepreneurship. The government is going to take a somewhat different approach than a private company. We want to get many different approaches, not fewer.

ABN: You could also argue that in order for the exchanges to be perceived as fair, the government entities that offer health care through it should not be the same as the ones running it.?

Bankruptcy law is focused on people who lived beyond their means rather than people who invested beyond their means.

PM: Yeah I like that, that?s a good point. The regulator and the competitor can be different.

ABN: So I have a few more questions about what happens when we make entrepreneurship a design principle for public policy. The way I was thinking about this in the Lab was that we could have almost a sort of ?First Amendment? of entrepreneurship. You could imagine a situation where if a law hurt entrepreneurship in some significant way, it would be automatically rejected.

PM: You wouldn?t want any law that would be so abrupt, or dichotomous. You want entrepreneurship to be part of a discussion of the balance of cost and benefits. let?s say one of the things that hinders entrepreneurship is testing drugs. Clearly there?s a whole host of FDA policy. But they?re there for a reason. They?re not there just to hinder entrepreneurship. But you could imagine a court interpreting a constitutional amendment to protect entrepreneurship in order to strike down the whole FDA.

There?s general policy areas that we can tweak the tax code, immigration, and patents, that would encourage entrepreneurship. But I can?t think of any particular laws off the top of my head that are clear losers.

ABN: So I?d like to shift our focus from the government to other institutions. Our partner in this Lab was the Academy of Entrepreneurial Leadership at the University of Illinois. What did you take away from the session about how we can create an entrepreneurial culture at universities?

PM: I believe that there are two things that universities do. First, they serve as an intellectual mechanism that gets people of a certain type together. Those people learn from each other and they also get all the signals to the world of who they are. So you?re a very different person, from the marketplace perspective, if you went to MIT or if you went to St. John?s in Santa Fe. Very different schools, but very different labels on what your strengths and abilities are. The second thing universities provide is the input, the coursework.

I think the first factor ? selection ? is where you can have the most effective impact on an entrepreneurial culture. With the second, you can impart knowledge and skills, but you can?t change the culture of a university. The culture is defined by history of the university and the people coming through. I think a feasible way to make a university more entrepreneurial is to admit more entrepreneurial people.

ABN: So let?s say the University of Chicago comes to you tomorrow and says, ?Okay professor, we now want entrepreneurialism to be the number one selection criteria for admittance to the University of Chicago.? How do you change the admissions process?

PM: It?s similar to what I suggested for immigration ? you would want people who had taken the most entrepreneurial path to get there. So newer Americans, people from poor backgrounds ? holding all those equal, you would want to select someone whose parents had a lower educational level. You?d want to select someone whose household income is less, who comes from the worst neighborhood, holding all those equal. You?d want to select the person who has come through the hardest channel to get there.

And then clearly you want to not hold all those equal ? you would want to give some people an advantage as marginal candidates. Let?s say you have a white guy who went to prep school and then a second-generation Somali refugee who grew up in Flint. If their grades and everything else was equal, you would want to go with the Somali because they have demonstrated entrepreneurial risk-taking.

ABN: There are some people who would read this interview and say, ?That just sounds like race-based affirmative action by another name.?

PM: Well, you?re not bringing race into it, though. Race would correlate with some of these things. But we would be using this as a criteria of something we value. We wouldn?t value blackness in and of itself. We wouldn?t have a preference for dark-skinned people. We would have a preference for providing opportunities for people who society has conspired against because they would be more entrepreneurial.

ABN: It seems a little easier to understand in terms of creating a certain type of culture at a specific university, rather than proposing it as some sort of absolute change to all university admissions processes.

I?m trying to think what else you could do. Maybe reward people who started a business in high school, something like that.

PM: The problem is that there?s the effect and then there?s the magnitude of the effect. I don?t think that there?s going to be a huge magnitude effect for a big school like U of I. It might be that at a smaller school it could have a greater effect.

ABN: I think I see what you?re saying. I started out in journalism school at Northwestern, and on the first day of class, the professor asked everyone in the lecture hall to raise their hands if they had been the editor of their high school newspaper or yearbook. I?d say upwards of 80 percent of the folks raised their hands. It immediately established something about the school?s culture.

PM: That?s cool. Being an editor-in-chief signals something. The question is if there is some similar measure of how entrepreneurial someone is.

I think of the most entrepreneurial guy I know. When he was in high school, he ran a little website that was a forum for high school wrestling coaches in Massachusetts. It was a completely non-school-related thing. They probably didn?t even take it into consideration when he was applying for college, but it was a very entrepreneurial thing. And he has now started four very successful companies.

So how do you get to that? I wish there was some immediate data point. It?s possible that if you had some measure of who went on to become entrepreneurs after college, you could run some sort of regression to see if anything pops up. It?s plausible.

ABN: So it might turn out that when we crunch the data, the most important thing was having been an Eagle Scout or something.

PM: Or it could be some combination of factors, like having played football and flute ? unlikely converging activities. It may be a series of characteristics that you can independently put together and find something.

I believe in a strong social net, but not to protect people taking risks in their lives.

ABN: So another idea that emerged while we were talking about building a culture of entrepreneurship is that the work and the struggle itself of starting a new venture is undervalued.? What do you think of that?

PM: I think that it is. But is it a good thing that it is? Do you want potential entrepreneurs to be scared off? I just bought a house, and there was an enormous learning curve dealing with all the bureaucratic crap. But next time I?ll be better prepared. The same thing applies to entrepreneurs, who have to learn an enormous amount of nitty-gritty to start a company. What do we want to emphasize that?

ABN: But still, on a gut level don?t you feel like this is a big part of the story that?s missing? Isn?t there something we should do about that?

PM: People are making a cost-benefit analysis. If all you do is emphasize the cost, you won?t get too many people wanting to do the thing, unless they?re masochists. I would say it?s more important that when someone is actually in the process struggling, you help them recognize that it?s supposed to be hard. You don?t want people to go into it thinking it?s easy, because then when the first few obstacles come up, they may think the idea is wrong or they?re not suited for it.

ABN: So pretend for a moment that it is in fact an unambiguously good goal for society to recognize the struggle it takes to be an entrepreneur. How do you enshrine that in public policy?

PM: Bankruptcy reform would be one area. Bankruptcy laws have to balance risk-taking versus abuse. You want people to have some protection asset so that if they fail, they don?t fail completely ? they?re not wiped out. You can imagine the extreme version. The worst bankruptcy law in the world would be one where anytime you go bankrupt, they shoot your family.

ABN: They shoot your family?!

PM: That?s the most extreme bankruptcy law you can imagine. No one would go bankrupt, but no one would take risks.

The weakest one you could imagine is one where anyone can declare bankruptcy at any moment. Then people would be taking all sorts of crazy risks. There would also be fraud.

So you?d want some sort of happy medium between those two things. The problem is that there?s a variety of instruments that you can change in bankruptcy law: how long, what assets are protected, how much you have to pay back, over what period, are houses protected, are life insurance policies protected, and so on. The question is how you would organize that law optimally for entrepreneurs.

I would say we haven?t done that yet. At the individual level, it?s mostly focused on various kinds of consumer debt. It?s focused on people who lived beyond their means rather than people who invested beyond their means. It seems like right now bankruptcy law is designed around people who bought too many cars. We would want a bankruptcy law that somehow recognizes the difference between people who consumed beyond their means and those who invested beyond their means.

ABN: Because the person in the investment scenario may have been creating all sorts of value for the economy, employing people, giving them skills, testing out potentially valuable concepts so other people don?t have to.

PM: Yeah ? we?re working under the premise that we want to encourage people to take more risks and innovation. I think that?s a true premise, because when an entrepreneur succeeds, the benefits are dispersed widely throughout society. When an entrepreneur fails, the costs and the loss are concentrated on the entrepreneur. So Google is a great success for us all and the entrepreneur are rewarded. But if there was something just as awesome as Google that we didn?t get, those guys lost $150,000 and probably the rights to whatever they created. They bear all the costs. So you might want to find some way that allows people to make one mistake, because these future benefits have a concentrated cost.

ABN: I?d be curious to see the effects that this type of bankruptcy law would have on the culture. Let?s make it very simple ? let?s say that there was a Bankruptcy A for people who bought an extra Porsche and Bankruptcy B for people who had certain types of failed entrepreneurial ventures. You could imagine that people who had been through Bankruptcy B would be perceived differently in terms of credit-worthiness, the job market, etc.

PM: Yeah, that?s right. There would be a different stigma attached to it.

ABN: So when I was talking about this with John Clarke from the Academy of Entrepreneurial Leadership, we discussed the idea that you may need a strong social safety net in order to have a society where it?s safe to be an entrepreneur. How does that look to you as a person who works on public policy?

PM: I believe in a strong social net, but not to protect people taking risks in their lives. To me the social safety net is there for things you?ve got no control over. So no, I don?t think that a strong social safety net is a necessary condition for entrepreneurship. I don?t think it even has a huge effect on it. I don?t think a lot of entrepreneurs are thinking, oh, the government will take care of me in terms of basic provisions if I fail. It probably has some benefit at the margin, but I don?t think it?s a driver.

ABN: See, I have this conflict too. I fundamentally believe in a social safety net because I don?t think people should die in a gutter. I don?t think it?s some sort of instrument to create entrepreneurs. And I definitely don?t buy the argument that taking it away makes people more entrepreneurial.

PM: Oh no, I don?t mean that. I don?t think that at all. It could actually be the opposite, it could actually encourage more entrepreneurship. I just don?t think it?s a dominant effect.


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