Scott Shane's bathtub metaphor for self-employment data
W: Are there myths about small business that you find yourself debunking repeatedly?
SS: My book Illusions of Entrepreneurship is all about that, and so are some of the columns I write. But here’s just one. The growth of a start-up depends less on a person’s entrepreneurial talent than on the type of business they choose to start.
Sorry to deflate some egos here, but the industry in which you choose to start your company has a huge effect on the odds that it will grow. Over the past 20 years or so, about 4.2 percent of all start-ups in the computer and office equipment industry made the Inc 500 list of the fastest growing private companies in the U.S. Just 0.005 percent of start-ups in the hotel and motel industry and 0.007 percent of start-up eating and drinking establishments made the Inc 500.
That means the odds that you will make the Inc 500 are 840 times higher if you start a computer company than if you start a hotel or motel. There is nothing anyone has discovered about the effects of entrepreneurial talent that has a similar magnitude effect on the growth of new businesses.
W: You are a visiting scholar at the Cleveland Fed. What do you do there?
SS: I wish I could tell you that I get to print money, but unfortunately, that’s not part of the arrangement. I work with the Cleveland Fed on a lot of small business finance and entrepreneurship issues. The Fed isn’t just a research unit, it also makes policy, and a lot of the writings I do with them are for practitioners.
We ask questions like: How many small businesses actually have employees? Who really creates jobs among small and new businesses? What percentage of businesses actually fail? Do more people actually start a business, or fewer, in a recession?
W: So does a recession prompt more entrepreneurs to start businesses?
SS: In a bad economy, the number of businesses both starting and failing goes up. The net effect is negative, because the economy’s effect on exit from business is worse than its effect on entry into business. Some people have claimed that entrepreneurship hit record highs during the Great Recession, but that’s because people only measured transition into self-employment. Actually, the total number of business owners went down.
I often use what I call the bathtub analogy: People entering into entrepreneurship are like water coming out of a faucet; failure is like water going down the drain. If we measure the level of water in the tub and it has gone down, we know the number of people working for themselves has gone down. Maybe the number of people becoming self-employed has gone up, but the number who have failed has gone up even more.
The work I did with the Fed on the Great Recession showed that its effect on entrepreneurs was not good.
W: What are some other surprising or counterintuitive results of your research with the Fed?
SS: Mark Schweitzer, senior vice president and director of research at the Fed, and I wrote a short public policy article about the connection between home equity and entrepreneurial activity. When people run businesses, they often mix personal and business finances. In the loose credit markets leading up to the housing bubble, it was easy for people to borrow against their homes. Some business owners said, “It’s a pain to get a business loan—I’ll just borrow against my house.”
This isn’t that surprising. But people often underestimate how much small business credit comes from banks against personal assets. And that’s how people miss things like the effect of the housing crisis on small businesses. If policy makers can’t fix the housing problem, they will not fix the small business credit problem.
W: So these crises that seem to be unrelated are actually tied together.
SS: And different policies are ill-thought-out because they can be based on a myth or have unintended consequences—I want x, so I do y, and I won’t think about how y will affect everything else.
Another example of this is the idea that more start-ups equate with higher growth. If you look at places with high start-up rates, they’re not necessarily the same places with high growth—in other words, the places where businesses are hiring a lot. Part of reason the reason for that is the basic economic principle of opportunity cost.
W: What is opportunity cost, exactly?
SS: Say Google is hiring, and Google gives you free sushi in the cafeteria and picks up your dry cleaning. People are going to want to work at Google. If you live in Addison, Alabama, where most of the employers have gone away, and you need a job, then maybe you start your own business. In Silicon Valley, where Google is located, the opportunity cost for entrepreneurs is greater, because they’re giving up a lot to start a business. In Addison, the alternative is unemployment, so it’s not a great opportunity cost.
Policy makers sometimes try to design policy to “get more entrepreneurship.” They think if we increase the volume, it’ll change the culture. No. You don’t get a lot of high-growth tech companies because a lot of other people are opening lawn care businesses. These things have different distributions—the places where you have the high growth are not necessarily the places where you have volume. I write a lot about stuff like that.
W: You’re a columnist for three different publications at the moment, and you write guest articles and op-eds frequently, too.
SS: I write columns every other week for Entrepreneur and Businessweek, and I blog for Small Business Trends.
I also write books. One of my themes that gets huge attention is my work on genetics. People find genetics inherently fascinating. I did this book, Born Leaders, Born Entrepreneurs, that looks at business and biology broadly.
W: What made you decide to explore biology?
SS: Honestly, everything I have ever studied seems to have come about by accident. Imperial College in London had invited me to come and do some work on entrepreneurship, and one day, one of my colleagues, a Cypriot scholar named Nicos Nicolaou, said to me, “Have you ever thought about the genetic component to entrepreneurial activity?” Nicos is a brilliant idea man. I started to work with him on a piece and got very interested in the topic. We had to do a lot of ground work to get where we wanted to go.
W: How so?
SS: Well, the thing about unusual and controversial topics—which this is—is that people don’t believe you. We started with a conceptual, theoretical piece and sent it to journals. They came back to us with: “No way is that true.” So we did our first twin study. It was very straightforward: Identical twins should be more likely to do the same thing than fraternal twins if there is a genetic component to that activity, because identical twins share 100% of their DNA, while fraternal twins share only 50%. So we did the twin study to show that there was a genetic piece to entrepreneurship.
W: What did you have in mind beyond the twin study?
SS: What we really wanted to do was molecular genetic stuff, which is more expensive. But funders wanted to know, “Why should we give you money when no one has proved any genetic basis to entrepreneurship?” So we did the twin study to establish a genetic basis and continued by getting money from the European Union to do molecular genetics studies.
We found an association between a couple of genes with some aspects of entrepreneurship; it’s a very painstaking and long process, because the reality is that the relationships are going to be very complex.
People have been looking for individual genes and their association with intelligence for a long time, for example. DNA makes about 80% of the difference in IQ, but to date, individual genes have been found to explain only about 2% of the difference in intelligence. For entrepreneurship, it could be 50 to 100 genes or 500 or 1000 with different stimuli and interactions with one another.
W: What other aspects of biology do you think affect business?
SS: I edited a special issue of Organizational Behavior and Human Decision Processes on the biological basis of business. There are three avenues to approach this: genetics, brain function and hormones.
W: How do hormones come into play?
SS: People have found that things like how people trade commodities and stocks is affected by cortisol levels. Base testosterone is associated with all kinds of things like risk taking, starting businesses and so on. So now I’m starting to branch out to these other two approaches. Weatherhead is a great place for doing that. Richard Boyatzis knows all about brain function and has done numerous studies of leadership using fMRIs.
The basic principle is that people’s biological makeup affects their behavior—and business is only human behavior in a particular setting. Humans’ genetic makeup, brain function, and hormones have not changed that much since prehistoric times. Running a hunting group is different from running a company...or maybe it’s not! Maybe hunting antelope is not all that different from figuring out how to pursue a business opportunity. I think there’s a really basic set of human behavior behaviors underlying business.
W: Where do you start to gather evidence for this?
SS: We’re starting some fMRI studies in Cypress, trying to find out which parts of the brain are activated when people are exploring business ideas.
One thing that Richard and I have been discussing with folks in cognitive science here at CWRU is the idea of a center for the study of the biological basis of business. There is a lot of expertise here at Weatherhead and at CWRU generally in this stuff. The center would do interdisciplinary research into different avenues of brain function, genetics—doing both molecular and twin studies—and then also hormones.
The reason why having a center matters is that the sciences are expensive. Most things in business are cheap to study from the perspective of universities. So when you’re talking about organizational behavior, or finance, or whatever, you’re talking about buying a person a computer. It’s virtually free for them to do their work. When you get into this biological stuff, you’re talking about science costs, not social science costs. The dean of an engineering school gives new hires a start-up package of several hundred thousand dollars. The dean of a business school is like, “The seed money can’t have more than three zeroes.”
W: What’s it like to write for popular news outlets?
SS: There’s a difference between writing a column and writing a blog. My columns for Entrepreneur and Businessweek are arguing a position, not just describing, and second, they are edited. The headline and deck are almost always written by a copyeditor, and they always push the envelope on what the column says.
So for example, I’ve written columns about women entrepreneurs. People tend to argue that women are becoming more likely to become entrepreneurs. Actually, it’s stagnant. The numbers aren’t changing. So my point is that if you want more women entrepreneurs, you have to ask, what’s the obstacle for them? But the copyeditor wants the headline to be, “Professor says women don’t want to be entrepreneurs.” And then people want to thrown rotten tomatoes at me!
The problem is, online it is a desperate escalation of screaming. You’re competing with stuff like articles on the runner-up for Miss Paraguay, who is an Olympic javelin thrower. She didn’t do very well at the Olympics, but she’s beautiful, and she’s gotten enormous media attention. That’s what we’re competing with on Yahoo. So the editors are like, “We have to shout.”
W: Do you have time to read others’ columns and blogs?
SS: I do so all the time. I’ve actually stopped using paper—I use a Kindle and read all my journals online. I read the other columnists for Small Business Trends, Bloomberg.com, and Entrepreneur, because I want to make sure I don’t say the same thing as someone else, and that I take a consistent approach.
I subscribe to a newsletter called Innovation Daily, and every morning I scroll through what’s up, where. There are also a few people I really want to follow because I’m interested in everything they say—some world-class economists, like Paul Krugman and Greg Mankiw. I read Krugman because I usually think he’s wrong and Mankiw because I usually think he’s right.
Otherwise, it’s more efficient to follow topics, and that’s what the internet is great at. Who wrote what on which topic? Innovation Daily finds people who wrote in sometimes obscure outlets I have never heard of, and I click through to find out what they have to say.
Scott Shane, PhD, is A. Malachi Mixon III Professor in Economics
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