Sunday, 1 July 2012

Book Review: The Illusions of Entrepreneurship by Scott A. Shane, Yale University Press, 2008

(this book review was first published in the SBE's Business Economist, 17 July 2008)

Scott Shane’s book is an enjoyably-written contrarian view of entrepreneurship. His purposes in debunking the myths about entrepreneur-ship are to help aspiring entrepreneurs become more successful, to provide a more accurate picture of what they’re really like and their impact the economy, and to encourage policy makers to examine the real costs and benefits associated with the promotion of start-ups.

Many of the myths have sprung from the celebrated few who’ve made it big; therefore the term is quite emotive. One might not necessarily think of the average self-employed as entrepreneurs, but these people are who this book is about; what they do isn’t as innovative, lucrative or beneficial as we think. To see how much you think you know about entrepreneurship, you can take the online quiz.

Professor Shane says that believing the myths will prevent aspiring entrepreneurs from doing the things they should do to succeed or else focus their attention on the wrong things. “Doing what most entre-preneurs do is a mistake; the majority of entrepreneurs are wrong about how to run a new company.”

Here are some of his more surprising findings:

Entrepreneurship is largely a very common, often low-tech vocation, such as construction, retail trade or accounting. Only around 7% of new companies in the US are started in high-tech and only 3% of business founders consider their new business to be technologically sophisticated. The typical start-up isn’t innovative at all, has no plans to grow, has one employee and generates less than $100,000 a year in revenue.

Entrepreneurs tend to choose industries in which they are most likely to fail. They tend to start business in industries in which they’ve worked before and understand, and these tend to be highly competitive and employ the most people.

The US isn’t becoming more entrepreneurial and it isn’t one of the most entrepreneurial countries in the world, appearing at the bottom of the self-employment league table compared with other OECD countries. Number one is Turkey. Developing countries have a much higher rate of new business creation than developed ones; start-ups are more than twice as likely in Peru, Uganda, Ecuador and Venezuela than in America.

The typical American entrepreneur comes up with no innovative idea nor possesses an extraordinary dream. People don’t start businesses to make a lot of money, become famous, better their communities, seek adventure or improve the world. They just don’t like working for someone else. Those most likely to go into business for themselves are the unemployed, those who work part-time or have changed jobs often. Experiences often associated with being an entrepreneur, like migrating, dropping out of school and networking don’t increase the odds of starting a business, whereas going to college, getting a professional degree and having some experience managing others in a business setting do.

The typical start-up in the US requires around $25,000, usually coming from the founder’s savings, though many borrow personally as well. Venture capitalists matter very little to the majority of entrepreneurs, and 92% of all venture capital goes into the IT and health-care sectors.

Just a few entrepreneurs are very successful; the wealthiest 10% of business owners have almost three-quarters of all business wealth, 38% of all personal assets and 39% of all personal wealth.

The book is primarily about entrepreneurship in America, and though there is some discussion of where America ranks in the GEM league tables, I couldn’t help wondering about other countries. Even if entrepreneurship – self-employment – is no engine for growth inAmerica, does it not provide an important means of poverty-alleviation in developing countries? I’m thinking here about micro-credit in places like Bangladesh or small businesses based on mobile phone transactions in parts of Africa and Asia.

Professor Shane devotes just four paragraphs to one non-financial benefit of entrepreneurship, that is, founder satisfaction. Apparently entrepre-neurship makes people happier. For women this satisfaction comes from the flexibility to work and care for children. Data show that as companies get bigger, job satisfaction of people who work in them declines. Self-employment can provide people with autonomy, flexibility and greater control over their lives. It’s difficult to value this personal satisfaction and the impact a happy person has on his or her family, but as benefits go, it seems like a pretty important one.

The tenth chapter of the book was the most fascinating; it looks at the impact of entrepreneurship on the economy. Seen as a panacea for many of society’s ills, elected officials often view assisting start-ups as a fundamental goal of public policy. They say that start ups encourage innovations, create jobs and make markets more competitive. Not true, according to Professor Shane; start-ups don't generate much employment nor do they substantially enhance productivity. There isn’t any evidence that new firm formation causes economic growth; rather economic growth causes people to start businesses. In fact his own regression analysis found that the rate of new firm formation in a particular year has a negative effect on a country’s real per capita GDP in the following year. Since existing businesses are more productive than start-ups, he claims that we would get more economic growth for each dollar or hour invested in the expansion of existing business then having more start-ups. He ends by criticizing policy markers’ attempts to convince voters they have encouraged economic growth by actively promoting the establishment of new enterprises.

The conclusion is somewhat dismal: entrepreneurship is “a story of poor outcomes for individuals, cities, states and countries.” It causes financial hardship for many and hinders wider economic well-being. Almost all the economic value of entrepreneurship comes from a small handful of stars. His recommendation to investors, the entrepreneurs themselves and policy-makers is to do a better job in identifying the few new businesses that are more productive than existing companies and invest in them. He also recommends the elimination of policies that encourage people to start businesses like transfer payments, subsidies, loans, regulatory exemptions and tax benefits. This is a thorough reality check on entrepreneurship, and hopefully the beginning of a serious debate on its role in our economies.

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