Why innovation is still capitalism’s star

08/20/2013 5:19 PM

08/20/2013 5:19 PM

Capitalism is culture. To sustain it, laws and institutions are important, but the more fundamental role is played by the basic human spirit of independence and initiative.

The decisive role of the “spirit of capitalism” is an old idea, going back at least to Max Weber, but it needs refreshing today with new evidence and new thinking. Edmund S. Phelps, a professor of economics at Columbia University and a Nobel laureate, has written an interesting new book on the subject, “Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and Change” (Princeton University Press). It contains a complex new analysis of the importance of an entrepreneurial culture.

Phelps discerns a troubling trend in many countries, however, even the United States. He is worried about corporatism, a political philosophy in which economic activity is controlled by large interest groups or the government. Once corporatism takes hold in a society, he says, people don’t adequately appreciate the contributions and the travails of individuals who create and innovate. An economy with a corporatist culture can copy and even outgrow others for a while, he says, but in the end it will always be left behind. Only an entrepreneurial culture can lead.

Is the United States really becoming corporatist? I don’t entirely agree with such a notion. Even so, President Barack Obama has been talking a lot about innovation as a job creator this year, and while some of his intentions may be good, I’m afraid that some of his proposals look a little corporatist and might suppress individual initiative.

In his State of the Union address in January, for example, the president proposed that the government should create 15 “innovation institutes,” modeled on a public-private partnership that he helped start in Youngstown, Ohio, that is devoted to developing 3-D printers. There was more in this vein in his administration’s 2014 budget, offered in April. And in a speech on July 30 in Chattanooga, Tenn., Obama suggested extending the number of innovation institutes to 45, or almost one for every state. The institutes, he said, would be “getting businesses, universities, communities all to work together to develop centers of high-tech industries all throughout the United States.”

Will such measures work? Should the government really be trying to start a 3-D printer center? And why in Youngstown? It is easy to be skeptical of such a plan, especially when it was started in a swing state just before the presidential election. Websites of the two senators and two representatives introducing bills this month supporting the president’s latest proposals are suggesting, in not-too-subtle terms, that the legislation would bring jobs to their own states.

Successful companies usually aren’t started this way. Phelps, citing a McKinsey & Co. study, suggests that in free-market capitalism, “from 10,000 business ideas, 1,000 firms are founded, 100 receive venture capital, 20 go on to raise capital in an initial public offering, and two become market leaders.” It is easy to doubt, as Phelps does, that the odds are favorable for a Youngstown 3-D printer center.

How you view the innovation institutes, and the topic of capitalism and culture, may depend on your own experience. Many people have never seen the hatching of a successful business idea. That makes it hard to judge the subtle changes that may be occurring in the nation’s culture and in its potential for innovation.

My own business experience has certainly helped shape my thinking. Yale, like many other universities, sensibly allows its professors to spend limited time in business, providing the opportunity for faculty members to gain valuable experience outside the ivory tower and to offer their technical skill to the business world.

In 1991, I started a business with Karl Case, an economics professor at Wellesley College, and Allan Weiss, a former student of mine at Yale. We called it Case Shiller Weiss, Inc., and it was devoted to an innovation we dreamed up. The idea was a new “repeat sale” home price index, which would track the changes in the value of the same houses over time.

At the time, this was an entirely new line of business. And, at first, that posed a problem: We were spectacularly unsuccessful in raising money. We talked to venture capitalists and their committees, to no avail. They just didn’t seem to get our business plan. We must have appeared odd to them — overly academic, perhaps. One remarked that we’d do better proposing a new shopping center.

But we went ahead with our idea anyway. At first, Allan worked without pay. A friend of Case, Chuck Longfield, contributed some money. And in 1995, I took out a home equity line of credit on my house in New Haven so I could personally lend more money to help keep our business afloat. The experience was stressful, especially when adding it to the burdens of my main job, as a professor. I thank my wife, Virginia, for her tolerance of my overwork and my worrying, and for allowing me to put our family savings at risk.

In the end, our business was successful, and I think a big part of it was that we relied on our own ideas and energy and, to a large extent, our own money. In 2002, we sold the business to Fiserv Inc. and then licensed Standard & Poor’s to create what are now known as the S&P/Case-Shiller Home Price Indices. In 2006, the Chicago Mercantile Exchange began trading futures on 11 of our indexes. Fiserv sold the index business to CoreLogic early this year.

In short, our business made its mark without any help from the government.

This little real-life experiment convinces me that committees of experts, even at smart venture capital firms, will often not recognize real innovation. I think that America’s business success through the decades has occurred because we have so many people with specialized knowledge who are willing to put their money, time and resources on the line for ideas that can’t be proved to a committee.

That experience may also help explain why I think the new crowdfunding initiative, started by the Jobs Act that the president signed last year, is an exciting step forward. It’s all about finding and mobilizing people who really understand specific, hard-to-prove ideas for important investments.

At the same time, other of my experiences incline me to think that government-appointed committees of experts can help set the stage for an entrepreneurial culture, under certain limited circumstances.

Long before I started any commercial ventures of my own, I received some federal government support in the form of National Science Foundation research grants, awarded to me decades ago as a young professor. They allowed me to do research, and though it was not directly related to my later business endeavors, the process developed my expertise and reinforced a sense of entrepreneurial opportunity.

These grants were awarded competitively, based on the quality of the proposals, and gave me experience with a system focused on creating opportunities for those who try hard. Later, from 1983 to 1985, I evaluated others’ proposals when I served on the foundation’s panel for economics. Observing the process from the government side convinced me that the foundation really works. Maybe it’s because the panelists are chosen from successful scientists, who serve anonymously out of public spirit.

In any case, as Phelps has argued, direct government involvement in capitalism is a delicate thing. The system’s success depends on subtle cultural factors — and these require careful nurturing.

Videos

Join the discussion

is pleased to provide this opportunity to share information, experiences and observations about what's in the news. Some of the comments may be reprinted elsewhere in the site or in the newspaper. We encourage lively, open debate on the issues of the day, and ask that you refrain from profanity, hate speech, personal comments and remarks that are off point. Thank you for taking the time to offer your thoughts.

Commenting FAQs | Terms of Service