Kill All the Lawyers Entrepreneurs

By / 4.30.2010

On the heels of a severe recession, with stubbornly high unemployment and a still-sputtering recovery, economists and policy-makers are casting around for something — anything — that might jump-start economic growth and rapid job creation. One place we might expect them to look for ideas is our own economic history: Where have new jobs come from in the past? What is the pattern of recent economic recoveries?

As it turns out, job creation in the American economy comes disproportionately from new and young companies. Sluggish economic times, moreover, can be the cradle of entrepreneurship: Over half of the companies on the Fortune 500 were founded during a recession or bear market. Entrepreneurs are also responsible for introducing a large share of innovations that improve our standard of living.

One would think, then, that the conditions for job creation would be obvious: Avoid steps that would discourage new companies from starting and that would make it as difficult as possible for them to grow. But alas, one would be wrong. In recent weeks, we have seen signs that policy-makers and legislators still have no clue how to solve the jobs dilemma.

An Assault on Startups?

First, Bloomberg BusinessWeek reported last week that the Internal Revenue Service (IRS) is targeting the use of freelancers and “perma-temps” by many firms. At issue is the classification as freelancers of workers who remain on a company’s payroll months and even years, a violation of the tax code. Because such workers offer flexibility and help reduce costs, many companies that use them are young and small. As Nick Schulz pointed out, this “assault” on voluntary work arrangements might not be the best idea when we’re interested in encouraging job creation.

Data from the Census Bureau and Bureau of Labor Statistics indicate that the average size of new firms has been shrinking by about one or two employees for several years. On one hand, that’s a potentially worrisome trend as it suggests a Red Queen effect whereby we need to start more and more new companies just to generate a steady level of jobs. On the other hand, as the BusinessWeek story pointed out, this trend also indicates that more new and young companies are using flexible employment — freelancers, independent contractors, temporary workers — as a way to help boost their chances of survival and growth.

Just last week the CEO of a young firm explained to me how he and his co-founder opened up their office space some time ago to anyone who wanted to come in and write software for them on a temporary basis. Some of those who did became full-time employees, while others ended up starting their own companies in the same office. It’s difficult to predict what effect the IRS action will have on new and young companies, but it seems safe to say that it won’t be the job creation elixir for which policy-makers are searching.

Another recent, admittedly less worrisome development was the appearance in the financial reform bill of some provisions that likely would have suppressed startup activity. One provision required startups that raised funding to register with the Securities and Exchange Commission and then wait four months for review. Another hiked the monetary thresholds for “angel investors” — wealthy individuals who play an increasingly important role in financing new companies — which could have worked to prohibit much startup financing.

The anti-startup and anti-angel provisions have since been watered down, but remain testaments to how easily and quietly we might kill the golden goose in this country. Who sits down and asks, How can I depress entrepreneurship today?

Entrepreneurship Essential to Any Recovery

These recent episodes take place against a backdrop of an apparently anti-startup zeitgeist taking shape. An impressionistic gaze at the landscape reveals an increasing tendency for policy-makers to focus on things large and well-established, even as our economy and society are driven more and more by the new and small.

One indication of this is well-known: The rush to bail out some of the biggest and oldest companies in the economy sent the wrong message to potential entrepreneurs. There was a compelling rationale to the actions to save General Motors and Chrysler, just as there was one to pour money into banks and other financial institutions. But the composite signal was perverse: bigger and older are better. The largest banks in the country now have a bigger market share than they did prior to the recession, and these aren’t necessarily the primary sources of financing for new and young businesses. The zeitgeist was expressed quite succinctly in the BusinessWeek story: “It’s easier and quicker to audit smaller businesses.” So there you go — ease trumps dynamism.

New companies and the jobs and innovations they generate are not silver-bullet solutions. Yet economic recovery surely won’t happen, or be as strong, without them. Entrepreneurship in the U.S. has been remarkably resilient for about 30 years, with a surprisingly steady level and rate of firm formation. While encouraging the formation and growth of more startups is clearly something that would boost economic growth, it’s not entirely clear how we might go about doing that. What is crystal clear, however, is that we could very well succeed in killing entrepreneurship if we don’t pay attention to what goes on in Washington.