Does America Really Need More Entrepreneurship?

My recent A&Q on entrepreneurship in the U.S. questioned several common ideas for increasing the number of startups, such as cutting taxes, building a safety net to reduce the risk of leaving a company to start one’s own business, and investing in regional clusters. The following reader proposes another solution, followed by my reply:

ANSWER

Most startups fail. The success rate for venture capital funded companies is about 10 percent. And those are the ones that got funded. For each of those, there are about 100 proposals. For more ordinary businesses, the typical lifespan of a new restaurant is under three years. So it's not clear that more startups help much.

QUESTION

Why do we need startups if most startups fail? Well, suppose this were a question about species and longevity. Why must species adapt if most of them go extinct? The answer is that evolution serves an excellent purpose for later generations of life, because the surviving species tend to be stronger, healthier, and more resilient than their ancestors.

You might shudder at a comparison of a free market economy to survival-of-the-fittest Darwinism. But many economists have welcomed the analogy. A healthy start-up rate—“business dynamism,” they call it—is “critical to long-run economic growth,” according to Ian Hathaway and Robert E. Litan in a 2014 Brookings paper. They continued:

Research has established that this process of “creative destruction” is essential to productivity gains by which more productive firms drive out less productive ones, new entrants disrupt incumbents, and workers are better matched with firms. In other words, a dynamic economy constantly forces labor and capital to be put to better uses.

The reason to care about a healthy startup environment is that large old companies became very good at sustaining their business models; but without competition, they don’t have much incentive to improve their product or service for customers. (The cable industry, one of the country’s most famous oligopolistic industries, is also one of the most hated.) Competition is ugly; ask any restauranteur. But imagine a world in which every restaurant knew for certain no other chef would ever do business on his street. It would be a good reason to raise prices and spend less on fresh food. That world would be a lot less delicious.