How Can the U.S. Create More Start-Ups?

A&Q is a special series that inverts the classic Q&A, taking some of the most frequently posed solutions to pressing matters of policy and exploring their complexity.

The U.S. likes to think of itself as the world capital of start-ups. But America doesn't lead the world in actually starting new businesses. By various measures, it's behind Canada, Denmark, and Norway.

Rather, it is the global leader in venture capital: Nineteen of the top 20 world cities in per-capita venture capital investment are in the United States. There are a lot of countries with higher entrepreneurship rates, but American companies have an especially good chance to grow from small fry to global behemoth.

By definition, entrepreneurs are abnormal. Normal is applying for a job. Normal is interviewing with a company. Normal is accepting a salary that comes prepackaged with amenities, like health care and a little bit of paid time off. Normal is leaving home, commuting to the office, sitting in your employer’s line-of-sight, and clocking out at the end of the day.

Starting your own company means rejecting the normal grooves of adulthood, the easy patterns of working life, and doing the hardest thing: something else. The decision is often private and personal, but some people think they can encourage more people to be entrepreneurial with national and local policies. Can they?

ANSWER

QUESTION

Can America tax-cut its way to innovation?

Entrepreneurship is always a risk, and one approach to encouraging more start-ups is to make it less expensive to jump from employee to entrepreneur. You could, for example, set aside tax cuts for companies under a certain size, or encourage more deregulation in certain industries that new firms are trying to enter.

But tax cuts and deregulation come with their own set of concerns. And beware the unintended consequences of gutting taxes and regulation for any constituency, even when it’s a treasured category like “small business."

If the government structures the tax code to dramatically benefit small companies, then start-ups might have less incentive to grow beyond certain sizes. For example, a tax credit for companies with fewer with 10 employees also acts as a huge marginal tax rate on each of those companies’ 11th employees. Too much deregulation might also have negative consequences. If you relax the regulations on domestic mobile money apps to attract more competition, you might also allow more fraud. In sum, the case for warping taxes and regulation to benefit small companies and start-ups means creating new laws and loopholes that might not always have great outcomes.

What’s more, the countries with the most small businesses often have high taxes.

ANSWER

QUESTION

Would realistic approaches to strengthening that safety net spur entrepreneurship? Providing universal health care and instituting a stronger welfare policy, or even a universal basic income, might reduce the risk of striking out on one’s own. But on its own, this does little to grow the supply of good ideas.

Several Scandinavian and northern European countries have higher rates of entrepreneurship than the United States. Maybe that’s not a coincidence. It’s possible that stronger safety nets could be a boon to entrepreneurs by mitigating the risk of going it alone.

Indeed, starting and sustaining a start-up carries risk, and one reason many would-be entrepreneurs resist doing their own thing is that, if they fail, they lose more than a job: They lose subsidized health-care coverage, too. Several studies have found evidence of "entrepreneurship lock," where workers are “locked” into their jobs, because they would pay much more for insurance as one-person companies.

But a comprehensive policy for innovation needs more than universal health care to lay out a safety net for America’s daring thinkers. It requires ideas for improving the quality of American thinking.

ANSWER

QUESTION

Couldn’t abandoning liberal arts education make the workforce more technically competent, but less creative?

In the last five years, one of the most popular reform suggestions has been to shift the U.S. education system toward a focus on STEM—Science, Technology, Engineering, and Math. Software innovation continues to be huge in the U.S., so why shouldn't more young people develop skills that would let them write code? And many of the significant problems we face as a species—whether internal, like cancer, or external, like global warming—are problems of medical innovation and technology. So let’s train more medical innovators and technologists, right?

The short answer is: Sure, it would be great to have more medical innovation and extraordinary technology. But the appropriate follow-up is: Why is it necessary to denigrate the liberal arts to achieve that result? As Fareed Zakaria, the author of In Defense of a Liberal Education, writes:

The typical successful entrepreneur isn’t somebody in their early 20s; it’s somebody in their late 30s. The best education for starting a company comes in starting a few things, failing a few times, and figuring out how to do better.

ANSWER

QUESTION

It might create more entrepreneurship. But will it also give companies an excuse to pay their workers less money?

On its face, the case for accepting more educated foreign-born people seems unobjectionable. Immigrants are twice as likely to start a business than native-born Americans. Thousands of foreign-born teens and twentysomethings come to the United States to attend college and then have to leave, which essentially means that the U.S. is offshoring the benefits of its education system.

Are there any good reasons not to expand high-skilled immigration, for example by increasing the number of H-1B visas for foreign professionals?

Some economists say yes. One paper by the economists Kirk Doran, Alexander Gelber, and Adam Isen found that additional H-1B visas didn’t make companies any more innovative (as measured by patenting and use of the research and experimentation tax credit). Instead, it just allowed companies to reap higher profits by pushing workers’ wages down. “Additional H-1Bs lead to lower average employee earnings and higher firm profits,” they found, and “additional H-1Bs cause at most a moderate increase in firms’ overall employment."

The government might not be able to help start-ups just by opening its doors a little wider. It might actually have to help companies get off the ground.

ANSWER

QUESTION

Is this just a fancy form of favoritism?

In the last decade, the U.S. government has invested in several “clusters”—a group of interconnected companies in the same geographical area. For example, the U.S. Small Business Administration put several hundred thousand dollars into northeast Ohio's FlexMatters, a group of manufacturing companies near Cleveland that print electronic parts on flexible plastic.

Economists argue that companies often benefit when they’re surrounded by similar suppliers, manufacturers, and retailers. But the most successful clusters—whether Oregon’s wine industry or San Jose’s software contingent—are hard to predict before they emerge. And once they’re thriving, they don’t need so much government help to keep going. Allowing the government to pick winners and losers invites favoritism. Industrial policy isn’t evil: Silicon Valley is the beneficiary of decades of defense spending in the Bay Area. But too often, the preferences of policymakers weigh more than the economic viability of the companies.

ANSWER

QUESTION

What if neither the families nor the new neighbors want to be in denser cities?

Giving families vouchers to move to more productive cities with greater income mobility could be a boon for young people in slower-growing cities and suburbs who want to move to larger more expensive cities but can’t afford to. Indeed, most of the cities with the greatest concentration of college graduates—or the greatest increase in college graduates—also have record-high home prices.

As I’ve written, this is a great achievement, because cities that assemble the most smart people tend to have the greatest long-term growth. Enrico Moretti, an economist, has estimated that for each college graduate added to a new industry in a city, the metro area eventually creates five additional jobs.

But a massive voucher system to relocate hundreds of thousands of people could have some downsides: It could accelerate the decline of poorer cities and create crowding in richer cities that can’t keep up with construction. And who would qualify?

Looking ahead, there are more big questions about whether entrepreneurship is something the U.S. government can nudge forward—and, if it can, what it exactly that should entail.

Is it wise to construct a public policy regime dedicated to maximizing start-ups, or is that merely an ugly stepchild of failed industrial policy?

Several measures of entrepreneurship are declining in the U.S., even as our standing as the global Mecca of billion-dollar start-ups (“unicorns”) has grown. What’s behind this seemingly contradictory story? Why are we simultaneously becoming both less and more entrepreneurial?

As the rest of the world catches up to the United States in venture capital and computer-science skills, relatively similar ideas and companies will be coming from all corners of the world, and the key differentiator might not be the quality of engineering, but rather marketing and distribution. Should business schools reflect this future by focusing more on global marketing?

Maybe there’s an answer we haven’t considered yet. Drop your thoughts into an email to letters@theatlantic.com.