By | June 16, 2017

Entrepreneurs are universally celebrated, but what if modern day entrepreneurship is creating ventures that do more harm than good?

A piece this week in Harvard Business Review by Robert E. Litan and Ian Hathaway reminds us of this point by citing the work of William Baumol, who passed away last month.

Baumol’s overarching theory is fantastically compelling. It suggests the number of entrepreneurs in an economy is essentially fixed and what influences a nation’s entrepreneurial output is how those entrepreneurs are incentivised.

 Image result for On,the,rise,of,unproductive,entrepreneurs,like,Travis,Kalanick

As per our own longstanding argument that innovation should not be treated as a universally positive phenomenon — since innovation comes in both good and bad forms — the view here is that the underlying incentive structure of the economy in which an entrepreneur operates dictates whether ventures are productive or unproductive.

As the Baumol paper noted:

…entrepreneurs are always with us and always play some substantial role. But there are a variety of roles among which the entrepreneur’s efforts can be reallocated, and some of those roles do not follow the constructive and innovative script that is conventionally attributed to that person. Indeed, at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy. How the entrepreneur acts at a given time and place depends heavily on the rules of the game—the reward structure in the economy—that happen to prevail.

Baumol’s paper references Rome as a historic example of these poor incentives structures in play.

…the Roman reward system, although it offered wealth to those who engaged in commerce and industry, offset this gain through the attendant loss in prestige. Economic effort “was neither the way to wealth nor its purpose. Cato’s gods showed him a number of ways to get more; but they were all political and parasitical, the ways of conquest and booty and usury; labour was not one of them, not even the labour of the entrepreneur.”

As a result technologies which were fully available in Roman times languished even though they would spread like wildfire during the high middle ages.

What this implies is that innovation and output doesn’t necessarily languish because of a lack of entrepreneurs willing to take risk. It languishes because entrepreneurs are incentivised to direct their efforts to parasitical ventures based on rent-seeking, monopoly formation or unproductive vanities — that potentially includes everything from fintech and the digital app industry to the re-emergence of luxury artisanal or service-oriented craft ventures.

In short, entrepreneurs stop focusing on growing the pie and start focusing on stealing other people’s bit of the pie for themselves, or launching ICOs in get rich quick schemes.

Alternatively, they dedicate themselves towards developing sectors that would never be cost effective were it not for state subsidy sponsorship. Think of it as another incarnation of Gosplan 2.0.

As HBR’s Litan concludes:

If the U.S. is going to tackle its many problems, we are going to have to find ways to encourage would-be entrepreneurs to start innovative, productive businesses, rather than dedicating their efforts to co-opting government in order to secure economic advantage.

It should be noted that no company exemplifies this unproductive practice more than Uber.

Hence it’s worrying that amidst all the focus on Uber’s horrible corporate culture, very little attention is still being paid to the underlying non-viability of the business model, which is mostly based on undercutting the competition via free giveaways, exploiting drivers and/or adjusting the rules of the regulatory framework to suit the company’s own monopolistic agenda.

Thank goodness then for Hubert Horan, who’s bucking the trend with another scathing analysis of what’s really the issue with Uber.

As he notes in Naked Capitalism on Thursday:

Uber’s strategy was always to skip the hard “create real economic value” parts of this process, and focus strictly on the pursuit of artificial market power that global dominance would provide. As noted, Uber’s $13 billion investment base was used to fund the predatory competition needed to drive more efficient competitors out of business. This was 1600 times the investment funding Amazon needed prior to its IPO because Amazon could fund its growth out of positive cash flow. By contrast, Uber’s carefully crafted “narrative” allowed it to pursue predatory competition for seven years without serious scrutiny of its financial results or whether its anticipated dominance would improve industry efficiency or consumer welfare.

And if that doesn’t persuade you perhaps the following will (our emphasis):

Kalanick’s management culture, while repulsive on many levels, was actually brilliantly aligned with its business strategy and its investors’ objectives. Companies that can make money in competitive markets by creating real economic value do not have to create ruthless, hyper-competitive cultures where there are no constraints on management behavior as long as they are totally loyal to the CEO’s vision and can rapidly capture share from more efficient competitors. None of Uber’s bad behavior was aberrant—it was a completely integral part of its business strategy. Without this culture, Uber would have never grown as rapidly as it has, and would have never had any hope of industry dominance.

Hopefully, that makes the point.