Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity

Monday, May 7, 2007

AMITY SHLAES: Good afternoon. Welcome to today's Council on Foreign Relations meeting. At the council, we always start with two questions of business. Could you please turn off your Blackberrys, cell phones, electronic devices. And if you turn them off, check to be sure they are off. This meeting is on the record.

You'll notice my scarf. Most of us here today are talking about the election in France. One thing that is clear about that election, looking at it last night, this morning, was that it was about economic growth. The French voter, formerly mocked in places including this room for his disinterest or aversion to -- disinterest, aversion towards the growth topic, turned to it. Instead of voting for Segolene, the French voter voted for someone who wanted to engage on the economy.

That's a change, since generally sort of Western growth complacency in all these countries, we tend to look at growth as something that happens, rather like the weather, and that the business cycle theory, which says recessions come and go, exacerbates that trend and excuses it. We tend even now very often to believe that economic growth is decided by four important men and maybe one woman at a business table in a national capital. Politicians say big companies, executives, lobbies, they mysteriously set the rate and then it happens and the rest of the economy goes along with that.

But nowadays there's also a spreading realization that growth doesn't just happen, and that when we talked about the actors at the table, we forgot the most important person, the person who is not at the table, often, and that person has a French name; he's the entrepreneur. In fact, in his debate last week, Sarkozy said: I want France to be a people of entrepreneurs, to have the ideas that yield the labor productivity, that increase the salaries, that improves the growth.

Some of the credit for that, I think it's not exaggerated to say, goes to the two gentlemen beside me. The first of these is Carl Schramm, president/chief executive of the Kauffman Foundation. Carl comes originally out of the industry where innovation could yield the most benefit, health care, arguably. (Laughter.) I think I first encountered him as a reader in the early '80s. When asked about prices in the hospital industry, a crazy industry, he said there is no burden on hospitals to control costs, thereby proving himself a sort of Cassandra of his industry because indeed there was a giant health care inflation that followed. Carl is both an economist and originally a lawyer.

Our second guest is his co-author, Robert Litan, also of Kauffman. Many of us first encountered Bob in the banking sector during the S&L crisis in the early '90s. Bob's famous prophecy, his Cassandra quote he uttered in 1990 about S&LS, he said the industry is a dinosaur; the only real question is when, not if, it's going to be folded into banking. And that too turned out to be more or less right. He's worked with the Treasury, as an official at OMB, at the Justice Department supervising the Microsoft investigation, he tried to pull what Bob did together.

I think of him as someone who's interested in quantifying -- (audio break). (In progress following audio break) -- back to the table. So they pull in students at their headquarters in Kansas city to learn about enterprise. They fund studies of entrepreneurship all across the country, including here at the council. They recently hosted Entrepreneurship Week, which spotlighted all kinds of entrepreneurs. They are in the process of making Kansas City the world capital of robotics entrepreneurship.

And now they have given us this book, "Good Capitalism, Bad Capitalism." When I read that, I was very impressed. It really is the missing -- text for the missing person, the one about entrepreneurial functions, the one that goes next to Samuelson and Mankiw and the other books that graduate students and undergrads should have before them. So we'd like to talk to them about that today.

And I suppose I'll start with a very basic question for you, Carl. What is an entrepreneur and what isn't?

CARL J. SCHRAMM: Can I say at the beginning, Yale's talking to seven different countries -- or seven different people who are interested in translations of the book. And I think the French cover was going to be that yesterday -- (laughter) -- but now it's going to be this today. (Laughter.)

But anyway, an entrepreneur -- and you know, there's been a great resurgence of interest in Schumpeter, and part of it's been brought forward by Ed Phelps, our distinguished colleague here today. It's the person who essentially delivers the new, who births the new. (Short audio break) -- in our phrase, they teach us about human needs we don't know we have. That is the discontinuity in history that entrepreneurs make.

And to your implicit question, Amity, certain environments, certain social environments, certain economic environments in fact engender this, this messy economy that produces the mess that entrepreneurs are famous for.

The second thing they do is they create jobs. Over half the jobs in the United States are in firms that are less than five years old, the new jobs that are created every year. (Audio break) -- of our economy.

The third thing, of course, is they are the engine of wealth production. Much of what we see as this enormous resurgence of the American economy -- after those of us who lived through the '80s, economists who thought that we ought to have central planning a la Galbraith, this economy was not supposed to happen. It was over. (Audio break) -- in the last four, five or six recessions. It's people who are displaced from engineering jobs and elsewise who actually go out and make a new business and have created much of our new economy.

SHLAES: In the book you start with four kinds of capitalism. Maybe, Bob, you can tell us what they are.

ROBERT E. LITAN: I'll tick them off. Actually, this is a book about growth. I mean, we have capitalism on the title, and there are a lot of economic books about growth. It's become a hot topic after probably, oh, a 30- or 40-year hiatus. Much of economics that I'm grew up with, I'm sure if any of you took economics, it was all about macro stability, making sure that the economy was close to potential, you know, interest rates, fiscal policy, all that stuff, right, and you probably had very little about what determines the long run growth rate.

Well, in the last, oh, probably 10 years or so economics has changed largely because of the availability of data. It was a joint effort between the University of Pennsylvania and the World Bank that produced a bunch of data that compared GDP and a bunch of other variables around the world. And economists -- (audio break) -- and the availability of data led to just an explosion of econometric work trying to explain GDP growth in different countries. And so we've got a whole industry called cross-country regression, and the journals are full of them. And actually, Jeff Sachs' latest book, for example, is a compilation of some of his cross-country regressions, and most books about economic growth today are about cross-country regressions.

You won't see any regressions in our book, and you won't see any math. There are a few graphs. (Laughter.) But basically, we have a totally different way of looking at economic growth. We think of basically four different kinds of capitalism, and the reason why it's capitalism is the whole world today is capitalists, except for North Korea and Cuba, to some degree or another. And we point out how, after the Berlin Wall fell in 1989, there was this jubilation that, you know, capitalism won. Francis Fukuyama wrote actually, I think, in Foreign Affairs, the famous article, "The End of History," and the whole -- wasn't it? Wasn't it --

MR. : (Off mike) --

LITAN: Oh, was it in the National Interest? Okay. Well, I learned something today. I'm sure that won't be the only time.

So anyway, he wrote the famous article, all right. The famous article basically said the commies lost, and the capitalists won. And then in 1998, Dan Yergin and Joseph Stanislaw wrote this book that got on TV, big deal, "Commanding Heights;" same thesis, except they interviewed about 300 or 400 people around the world who would all celebrate that capitalism won and the commies lost.

And implicit in that notion that capitalism had won is that capitalism was monolithic, that, you know, it's all the same. And in fact, we point out -- the whole thesis of our book is that it's not monolithic; that the only thing that these capitalists countries share in common to some degree or another is they protect private property. But beyond that, you've got 190 countries in the world, and they certainly don't look alike. And so we attempt to try to bring some ordered chaos and put them in four buckets.

Oligarchic capitalism, which pretty much means what it says -- all the wealth and power is concentrated in the few. And a gross exaggeration, basically, Africa, Latin America, Russia and the Middle East -- Arab Middle East are oligarchic. And what characterizes oligarchic is that growth is not the central objective of those economies. The central objective there is to pocket money for the people who are running it.

The second category is state-value capitalism. Again, what it -- basically means what it says. It's where you still own private property, but the state guides resources, whether through the banking system or through a variety of other means; basically Southeast Asia, Japan to some degree, certainly China, India to some degree. And by the way, footnote, not every economy is pure; there are mixes of the types at any point in time, but basically, one -- economies tend to be one or the other or predominant one or the other.

Third category -- and by the way, state-guided capitalism can work and it has worked, because if you're far behind and you have somebody to catch up to, namely the United States or Western Europe, you can basically borrow technology, apply a bunch of cheap labor to it, and you can pick winners because the winners have already been designated by the market. And you can pick off one by one, and so you can grow very rapidly. But we point out you eventually run out of gas and you can't survive doing state-guided forever.

The third category is bureaucratic capitalism or big firms. It's basically Japan today and it's Western Europe. It's where big firms dominate the economy. Big firms are good. You need them in order to sort of refine inventions, to mass produce a lot of innovations. But big firms, as we know, can be stultifying, and they can run out of gas. And grossly speaking, Europe, which was getting close to the United States, Japan was getting close in the `80s, when we had all these books, "Japan is Number One" and a book by Lester Thurow, "Head to Head," saying the Europeans were going to overtake us -- both of those economies ran out of gas, and they fell behind us in relative terms. And we argue that's largely a function of the fact that they're big firm capitalists, because not only are they bureaucratic firms, but they also have big labor, they have labor protection, labor rules, labor ossification that maybe the new French president will overturn.

And then, finally, the fourth category is entrepreneurial capitalism, and to that we give a credit to my co-author Carl. When I started working for the foundation about four years ago, I never heard of the word or the phrase. And Carl has done more than anybody, I think, in the world to breathe life into this concept, where an economy that an entrepreneurial capitalist is basically drawing its main energy from new firms that are coming up with radical innovations, the transformative innovations that have huge externalities to the rest of the economy. And you can obviously tell that we love entrepreneurial capitalists.

SHLAES: Speaking of running out of gas, I wondered -- I noticed in your book, "An Ambivalence About Natural Resources," the question of whether they're a blessing or a curse for an economy. Could you talk a bit about that and what you found?

SCHRAMM: You know, I worked with Bob for now more than four years and wrote this book. And this is the first time, I thought, we actually had a chance at running a hedge fund together. (Laughter.) I didn't know we could predict this, right? So we borrow technology and the market tells us who's going to win. Yeah, we'll see you guys later. (Laughter.) I think -- we think that if you wake up one day with too much oil in the ground or other commodities, it actually in the long haul will prove a curse.

LITAN: Right, and it can stultify entrepreneurship. Basically, you know, you get lazy. Economists have a version of it called the Dutch Disease, where basically you end up with an overvalued currency and you're uncompetitive in everything else. But we have another criticism of it, that we basically think it's sapping entrepreneurial energy.

Now there are a couple states in the Arab world now that are trying to use all this wealth. And maybe, you know, they'll change the facts. You know, Dubai and the UAE and, you know, are now building a new world out there. And in fact they've come to us and asked us, you know, what's the magic sauce for entrepreneurship? I don't know if they'll be able to pull it off. Because you know, they've grown up under one system, and it's sort of hard to switch gears.

SHLAES: I was struck by one sentence in your book. You wrote, "The failure of democratically elected regimes around the world to advance growth should give pause to policymakers who have sought to make the promotion of democracy the most important foreign policy objective in the nation." You're criticizing the policy of the Bush administration, implicitly or explicitly. (Laughs.)

Can you talk a bit about that? What's wrong with democracy? Or maybe democracy isn't enough, or maybe it shouldn't come first.

SCHRAMM: Well, my own hunch is that -- this book doesn't instigate it, but it's part of a number of treatises that are going to start a discussion, if it's not already underway, about not just the moment with us and the Arab states but the larger question of, what's the future of democracy? But let me go back to your question, and that is, I think, we are implicitly critical. And the way, I think, at least I see it -- I think Bob shares this view -- is, you know, to march -- and I'm being a little hesitant here because of the audience.

But to march into the world of foreign policy thinkers is to see sort of three children in a family. Two have grown healthy and they're big, and one is a dwarf, and that's economics. The other are a military thesis and the political thesis. And those are the guys who basically have been superordinate in their power in the family.

And the march of democracy is good. That shouldn't be our question. The question should be, how do you fertilize, grow, spawn and propagate democracy? And I think the point we're making here is, it's just not clear you just go march it out. You know, many columnists say, you know, we can't plant democracy, you know, with guns. But then the great pause in all those columns is, so what would you do?

And to go back to your question, Amity, you know, it's very interesting. Bob has mentioned how many people call us. And I think, and I've just recently written this in a report to the -- about the foundation last year. You know, increasingly the United States is seen by foreign interests. No one can avoid the fact that we are in an accelerating period of productivity that even baffles us and our best economists. We can't explain it, but here it is. Many things are dysfunctional in this society, but look at this market continue.

And I think from abroad, from what we can tell from our perch, people are increasingly coming to a view that somehow this phrase "entrepreneurship" in the United States is somehow part of this mojo, that it's not well-understood. And that's how it is that we get to this vision, that, you know, if this -- and I think we write about it pretty clearly -- you know, if you could push this to the point that it is in fact a jobs generator, it could go some distance to peace and -- behind peace -- maybe be one could effect to establish the political systems that undergird progressively better kinds of economies. Bob, in outlining this, essentially is making a value judgment about each of these economic models relative to what it means in terms ultimately of individual freedom and creativity, the potential for creativity.

SHLAES: Yeah. But right now in the debate, trade tends to come last -- well, it's stalled, but foreign policy, war comes first. You're saying put the runt, the smallest one, trade, up front and feed it.

SCHRAMM: Give it a diet, all right.

SHLAES: Whatever.

SCHRAMM: Send it to school.

SHLAES: Send it to school.

SCHRAMM: Dress it up. Buy it some tickets.

SHLAES: Because trade can -- (laughter) --


SHLAES: -- because trade can trump war. War doesn't always trump trade; trade can trump war. It can work the other way, as well.

SCHRAMM: Yeah, but, Amity, it's not just trade. It's the idea or the notion of entrepreneurship. I mean, if there's one -- one thing -- I think it may -- we may fine it easier to export without engendering all kind of malice and also electing -- you know, one of the dangers -- I don't have to tell this crowd -- is that -- one of the dangers of democracy, you get the wrong guys, all right? And we're learning that in Spain, all right?

LITAN: (Chuckles.)

SCHRAMM: And the one thing -- I don't think you have that danger if we spawned a bunch of entrepreneurs, all right?

LITAN: Yeah.

SCHRAMM: Now, we may get some people that will, you know, eat our lunch. But even that is still, in the interest of the world -- you know, we're all for competition.

SHLAES: And we're winning, yes --

SCHRAMM: And -- but you're not going to have -- entrepreneurs are going to -- we're going to basically destroy countries and destroy world peace through democratically, you know, elected processes. And we have too many examples throughout history of having bad guys come through -- you know, come to power through democracy.

Now, that doesn't say that we celebrate dictatorship, which we don't. We just simply say you probably would have put the cart before he horse, and the cart here is probably exporting our entrepreneurial values, which I think can be universally admired.

SHLAES: Well, one of the things they have at Kauffman is these reverse Rhodes Scholarships -- I don't know if that's what you call them -- but all the young people I saw who were studying about economics and enterprise at Kauffman for a short period --

SCHRAMM: Right. This is Gordon Brown's phrase, "the reverse Rhodes scholarship." We have these Treasury fellows, which we call Global Scholars at Kauffman -- that's the invention of the British. I was sitting in my office in Kansas City and the phone rings, and it's Gordon Brown saying, can I put money in the budget message to sponsor people? Our best graduates go into Kauffman, you teach them about entrepreneurship.

Now, you know, there is a perfect example of one country saying, there's something that we have to understand there. And Gordon Brown is, in my experience, the most articulate political leader in the world. I can't imagine -- I can't name an American politician of equal interest and sympathy and understanding, knowledge about the economics of entrepreneurship as Gordon Brown. So -- but Brown, in establishing this, in a sense touched off a huge wave of interest in exactly this phenomenon.

LITAN: Let me just add one thing here. There is a huge difference between entrepreneurship and small business, and that's another distinction we make in the book. If you were to look at almost any American politician, they all celebrate entrepreneurship, all right?


LITAN: They all give, you know, credit to the word, but what they really mean is small business and money for the SBA, all right? That's what it comes down to.

But the thing that we're talking about -- and it's consistent with really the meaning of the French origins of the word -- entrepreneurs are those people, as Carl said, who bring something new, either a new product, a new service or a new way of doing things, and they're probably a small fraction of all businesses. But those are the people that we want to celebrate. And if you look in the literature, those are the people that Schumpeter celebrates, that Peter Drucker does, that Will Baumol, our third author does, and that's where you get the externalities. That's where you get the growth.

And we point out in our book -- we take this from Will's work -- that if you look at some of the major innovations in the last hundred years, take the car, the airplane, air conditioning, the PC, Internet search engine -- the list goes on -- they all were developed not out of some AT&T/Bell Labs -- I mean, Bell Labs did do the transistor; I give them credit for that -- but these other radical innovations, which basically transform society, were developed by entrepreneurs.

And if you want transformative change, that's where you want to put your money.

SCHRAMM: You know, this vocabulary issue's very important. As Peter Drucker once said, your best weapon in transformative administration is precise vocabulary. And if you sit in our jobs, and you talk entrepreneurship, you can see Americans register. You can see it right -- go across their face. You're talking about the SBA, or you're talking about venture capital. That's what you see. Okay.

If you go to Europe, people say, "Oh, that's SME" -- small and medium-sized enterprise. That's the EU phrase.

That's not what we're talking about at all. And one of the tragedies is, you know, when people come from other countries and they get under the wing of the State Department -- they're going to teach about entrepreneurship -- they all go home after two weeks and say, "All we need to do is have an indigenous venture capital fund in Herzegovina. That's it, and then we're America." Right? And Jeff Sachs has already told them that they need a small SEC and a federal reserve bank, and then it's America. Right?

And the whole essence of what this phenomena is, is missed every day of the week.

SHLAES: I'm going to open it up to questions in one minute, but I'd like to take the liberty to ask you one last question, since we're in New York, about the relative competitiveness of the U.S. and specifically capital markets here, and Sarbanes-Oxley. What is your view on that and --

LITAN: Well, I'll start. Actually, we may have some difference of views, because --

SHLAES: Different views, yes.

LITAN: We'll see how restrained Carl is here in a minute. (Laughter.)

I actually was one of the people that was -- I was part of one of the commissions that worked on the capital market study. The House got Glenn Hubbard, John Thornton exercised. There were a whole bunch of academics that worked on it.

And so we had a team that worked on just the litigation and the regulatory environment. And so we covered SOX.

My own view is the obsession -- I can understand why everybody in New York is obsessed with capital -- you know, the competitiveness of the IPOs and all that. But I actually -- even though I worked on the team, I have a different view. I think we should look at SOX and shareholder litigation and all these other things that are in the report not from a perspective of whether foreigners are going to come and issue an IPO in New York or in London or Frankfurt. That's not the issue. The issue is, what's it doing to the U.S. economy? All right. Are the benefits greater than the costs? That's the issue.

The New York issue is a parochial issue. It's a much larger issue.

I think one open question, for example, is, is the cumulative weight of all the stuff that's imposed on public enterprises and then driving them to -- is it driving them to private equity? And is that good or bad? I don't know the answer to that, honestly. I don't. I can give -- I can make both sides of the argument. But it clearly, in my view, is one contributing factor.

And so I think we should approach Sarbanes-Oxley from that perspective. I think Sarbanes-Oxley needs to be tweaked, and it is being tweaked by the SEC.

In retrospect, it's not clear we ever needed Sarbanes-Oxley, because we threw the bad guys in jail. And you know, when reporters called me about five years ago or six years ago, when I was full-time at Brookings, and they asked me, you know, "Are the Enron guys going to go to jail, and MCI and all those other guys," my instinct was no, the juries will never understand the cases. It's too complicated, and the guys will get off scot-free.

And the main motivation for Sarbanes-Oxley, I think, was there was no faith that the Justice Department was going to put the guys in jail, because we need this whole elaborate regulatory apparatus instead of deterrents.

Well, as it turns out, with a few exceptions, we did put them in jail. And the Justice Department, to my surprise, prosecuted these cases incredibly wisely. They didn't do all this complicated financial stuff. They just found a lower-level guy to basically switch, and then he said, "My boss made me cook the books." End of case. And they've done it in every single trial. And so in retrospect, now that they bad guys have gone to jail and other CEOs know that they could go to jail, do we really -- did we ever really need Sarbanes-Oxley? That's the big question.

SCHRAMM: To Bob's point, all of those convictions were done with the full statutory weight of the Securities Acts as they stood before Sarbanes-Oxley. And Bob and I don't differ at all. I mean, I think, in fact, it's an issue about whether or not we watch the capitalization of companies switch from public to private and whatnot. The markets will do what they will do.

I actually in a previous book have actually been, at some cost to domestic peace at home -- (laughter) -- actually celebrated what Michael Milken did. My wife happens to be a securities lawyer and once was a securities regulator. (Laughter.) So markets do what they do. You can never look back.

I don't think you can look back -- or a recent person can't look back at that period and see that the innovations in markets were phenomenally important to a further surge of growth. I think the issue I have with it is, just as Bob says, I think in retrospect it wasn't needed. And I think it's an interesting moment. I think contemporaneously, many people knew it wasn't needed. We had very many smart lawyers who were doing autopsies of the draft bills and so forth.

The net is that I think in a society which altogether defaults to quickly to seeing businesspeople as unethical, you didn't need further weight. And I think the continuing weight of it is, we're developing a different jurisprudence and worse, a different culture of business. And that is, if it's not statutorily specifically prohibited, okay, if it's not "male prohibita" then it's okay. There is no "male" per se, and I think that's a wicked outcome. And all the business ethics professors in America lined up nose-to-nose will be a line of irrelevant sleeping people. They won't change it.

SHLAES: At this time I would like to open it up to questions from our audience. Please wait for the microphone and speak directly into it -- this lady back here -- and please stand and state your name and affiliation.

QUESTIONER: Hi, thank you, I'm -- (name inaudible).

My question is this: What kinds of government policies really are targeted to entrepreneurship? Where do we see that in the U.S. framework, and that does not exist in Europe? And aren't most -- this is really one question. Aren't most small businesses -- don't they think they're entrepreneurs? Aren't they just sort of not as successful as the ones that you're highlighting?

LITAN: Okay, on the second issue, probably most small businesses are what we would call lifestyle entrepreneurs. They're there to make a living. They own a restaurant; they own a dry cleaner. And they don't have any pretensions to become Google. And a lot of them like it that way, and there's nothing wrong with it.

In fact, there's a great book that is out. John Koten here is from Inc., and one of your writers, Bo Burlingham, has got this book out.

QUESTIONER: Small Giants.

LITAN: Small Giants, yes, it's about these firms that are now bigger than your mom-and-pops, but they may be 25, 50, $100 million companies. They're fantastic companies, but they don't want to get any bigger. And so most entrepreneurs, I mean, most small businesses are like that, all right?

Now what policies, make a long story short, we say basically, if you want to have an entrepreneurial society, you have to do four things. Low barriers to entry -- it's going to be easy to form a business. The World Bank now ranks everybody around the world to do that.

Second, there has to be rewards once you start a business for making it big. That means a relatively low tax environment. It also means things like labor market approachability. You've got to be able to grow. And that's -- the knock on Europe is, there's no incentive to grow in Europe. Because you've got -- the huge weight of labor regulation comes down on you if you have over 15 people in a firm, all right?

Third thing is, you have to discourage unproductive entrepreneurship, rent-seeking. Litigation, to a large degree, is rent-seeking. And unfortunately that's one of our Achilles' heels in the United States, and I don't have to tell you about that. So we have some recommendations on that score.

And the fourth category is, there have to be incentives to keep the winners on their toes. So the guys who win, the Microsofts and the Googles or whatever, there has to be enough competition in the system to keep it going. And that means low barriers to entry again, open trade so that people can't get lazy.

So those are your four recipes, and we have lots of details in the book underneath those.

SCHRAMM: But just in case lurking in your question is, should government do proactive policy? I think our position is basically no, we're doing just fine, thanks. You can just imagine an executive Department of Promoting Entrepreneurship. (Laughter.)

SHLAES: Isn't that what the Department of Commerce thinks it's doing?

SCHRAMM: Like so many executive departments, who am I to tell you what they think they're doing. (Laughter.)

SHLAES: Are there bad secretaries of Commerce and better secretaries? Do you think different secretaries of Commerce perceive their jobs differently?

SCHRAMM: Oh, hugely. Bob and I were talking about that the other day. Yeah, hugely differently, they do. (Laughter.)

SHLAES: (Off mike) -- maybe we shouldn't have had it on the record.

QUESTIONER: I certainly agree -- Harold Evans -- the remarks about democracy which requires more than elections. It requires a judiciary, transparency and a culture which we often forget.

My question, really, is this: Wouldn't it be helpful to make a distinction between entrepreneurship and innovation? I can be an entrepreneur and open a garage next to my neighbor, and I'm an entrepreneur, I've risked capital. But I'm not innovating unless I think of something new like selling cars on the Web. And this is very important because innovation is hampered in this country partly by law, patent law, for instance, endless litigation, and I think we should focus on innovation and use that term precisely because we need to encourage that.

And as Carl has written in his book, anybody can get capital, it's global now, okay. The technology's global. What has America got? Innovative potential.

SCHRAMM: Yeah, that's exactly the point I was saying before -- that we equate the true definition of entrepreneur equals innovation, and it's different from the dry cleaner or the restaurateur. And so you're expositor of Made in America, of all the famous innovators; not them were entrepreneurs, by the way, all right. Some of them were, but we're celebrating the entrepreneur who actually either does the innovation themselves or brings it to market, commercializing it.

LITAN: Right. And just to steal a little phrase that we've been using -- because we're trying to filter that question out, Harry. We're working very hard at Kauffman, because I think it actually is a predicate to probably a whole new line of grant making, but -- I have that sense. The phrase I'd steal is from Isaiah Berlin, and that is, you know, foxes and hedgehogs; foxes know many things, hedgehogs know about one. And in this sense, it seems to me, that innovators are often fox-like, and hedgehogs are like entrepreneurs -- they settle down and make the business happen.

Now our society needs both, but I think they're very different people and completely different functions; but they are tremendously related, and we don't know much about how that works. That's part of the tangle of this bollixed problem inside universities over controlling intellectual property and getting it out, okay. They are confusing the fact that they run a cage of foxes with the view that what they really ought to do is own a cage of hedgehogs. (Laughter.)

SHLAES: But in your book, you make much of this legislation by Dole. Can you just explain very briefly how that changed the environment?

LITAN: Well, it was altogether good when it happened in 19 -- well, it happened in 26 years ago. And like so many things that happened in Congress, there was a specific point, but the unintended consequence was much, much larger. And the issue was there was confusion as to whether or not -- if you were an NIH researcher, for example, and you developed a new breakthrough in medicine, whether you owned it or the government owned it, and there was a vigorous discussion. And unfortunately, there's a resurgence of this discussion about how to settle the federal deficit. We suddenly go back to universities and the federal government will monetize the intellectual property that we paid for.

You know, I often think, you know, when auditors become entrepreneurial, Enron happens, okay -- (laughter) -- and when the federal government becomes an entrepreneur, nothing happens. (Laughter.) So -- but Bayh-Dole basically clarified that, and suddenly, we had an explosion of intellectual property and more creativity coming out of universities. Now universities with their lightning ability to analyze things 25 years later had figured out that somehow there's money in them thar hills, and at the moment we are basically watching the suspension of the 13th Amendment in many of our great research universities, as professors are virtually enslaved to a technology transfer officer, who says: You know, your great innovation, it's terrific, but Merck is going to pay us through the nose, and who cares if it takes four or five or six years for our outside counsel to bargain every last drop of this value out for, you know, alma mater. And it's a very kludgy, stupid outcome, but it was a great act on the part of the Congress to clarify this.

SHLAES: This gentleman, please.

QUESTIONER: Merritt Fox, Columbia University. There's a point of view --

SCHRAMM: Are you the technology transfer officer up there?

QUESTIONER: No, no. (Laughter.)

There's a point of view that venture capital is extremely important to the kind of innovative entrepreneurship that you're talking about, and that vital equity markets are very important to have a vibrant venture capital industry. I'm wondering what your take on that is in terms of innovative entrepreneurship in other countries and if you think vital equity markets are important, what kinds of public policies would promote them.

LITAN: You want to take that?

SCHRAMM: Well, I mean, Merritt and I actually were on a panel just, what, 10 days ago? -- I can't remember anymore -- talking about Sarbanes-Oxley and other things.

Well, of course equity markets are essential for venture capital. And it's not clear that every country needs its own equity market; as we're learning in a globalized world, people can go anywhere to issue stock. But we certainly agree with your premise.

But I think what's going on now is a topic that we do not address in the book. I mean, I don't have to tell you here in New York -- we're in the midst of a major economic revolution going on right now, and there are people that are going to write about this, and that is we are depublicizing companies at an unbelievable rate. And so -- and, by the way, some of those private equity firms, as you know, have a venture capital onto them. And so -- now, we know that eventually they got to go public, because that's the only way they're going to have an exit. So that's why I don't worry that our public markets are going to disappear, because otherwise these guys aren't going to make money; but on the other hand, in the interim, the world's changing incredibly rapidly with a lot of implications, and maybe one of the areas where we may do some philanthropy, actually -- what it's doing to the entrepreneurial culture, we don't know.

One of the fears that we have in our book, by the way, related to this is that since the NASDAQ bubble being burst, what's happened, as you know, is that the preferred form of exit of new companies is to sell out and don't go IPO. And we are implicitly worried about that, if not explicitly worried about it, because you get swallowed by Microsoft, and the entrepreneurial impulse is gone, and -- by the way, and so are the people, all right, and you get squashed. And so this is not a good outcome, at least in our view.

LITAN: No. And we're stuck -- and the innovation is gone, you know. By the way, the venture capital industry is an industry that thinks it's in very, very, very, very serious trouble, as you may know. They think they're a broken industry. And the marvel of, you know, capitalism is it seems to keep self-healing, and one of the things that's happened obviously is for smaller companies -- we had an incredibly vibrant, very private market of angel capital investors, which the Kauffman Foundation has recently stitched together, created the Angel Capital Network -- or the Angel Capital --

SCHRAMM: Alliance.

LITAN: -- Alliance, yeah. And the Angel Capital Foundation to support it. So, you know, a very fluid move to increase information. Cheap information flows are what's critical to making efficient markets, and I think we'll see stratified -- all kinds of venture capital approaches emergent.

SHLAES: Back of the room -- Phil Revzin.

QUESTIONER: Hi. I'm Phil Revzin from St. Martin's Press. I just wondered in your four classifications or castes or classes of capitalism, is there any room for movement among them? And if so, who are the chief candidates up or down, and how is that going to happen, under what timeframe?

SCHRAMM: Oh, you asked a great question.

The whole second half of the book is devoted to, what do you do move from one category to another? And we just go by -- you know, by topic. We're obviously most pessimistic about oligarchies, because really, when you come down to it, you need a revolution -- and hopefully, it's peaceful.

We had the equivalent of a peaceful revolution when the Berlin Wall fell. All right. And it wasn't capitalism changing, but it was a system that was transforming.

But there's not probably a lot that we can do about it, which is to say not much we can do a lot about Africa, Latin America and Russia. It's going to have to come internally.

State-guided economies -- the best story I have there is, the best way they can change is through benign neglect. Leave things alone. So China's basically leaving a lot of entrepreneurs alone and just looking the other way. The whole IT sector in India -- this wasn't our thought; we drew this from T.N. Srinivasan at Yale -- the whole IT sector in Bangalore all grew up because India ignored it completely, didn't write any rules for it, didn't require investment and all that. If it did, it would have never developed.

So that's the best way state-guided economies can do something, is not deliberately; just ignore it.

The hardest thing is -- and a really hard thing is for bureaucratic societies to go entrepreneurial. And you know, I wasn't kidding about France. Maybe they will. But we are somewhat -- not pessimistic but cautious on bureaucratic economies, because if you've got big firm, big labor, big politics, everybody is sort of vested in that system, it's hard to move. And we think the linchpin of it is labor immobility.

And so we recommend, rather than a big bang for Europe -- by the way, Sarkozy may be able to pull off a big bang where he just eliminates all labor rules. I doubt it. I think the French will shut down the country before that happens.

But -- so we recommend incremental Chinese-like reform. So for example, in Europe, what you could say is, you could adopt rules and say new firms are not subject to that labor regime.

The way it is now, only if you're a certain size do you become subject. So if you're small, you're not subject, but if you grow larger, then you've got the oppressive weight of the whole labor regime on you. That gives you no incentive to grow.

But instead what we say is, why don't you just simply say new firms are exempt? And then you'll gradually change.

In effect, that's what China did. China, instead of privatizing its whole economy and giving it away to the oligarchs, which is what the Russians did -- they did not follow Jeff Sachs' advice, all right -- and they decided to do stuff at the margin, incremental. And it's clear, in retrospect, which has worked.

So incremental reform is possible in these societies. It's going to be very difficult, because the other final problem both Europe and Japan have is, they're aging incredibly rapidly. And one thing we know from entrepreneurship studies: it's young people where you basically get your most innovation. And so they've got a real challenge.

QUESTIONER: My name is Joseph Cari. Just as a follow-up, could you go into a little more depth in your answer about how you can see if it's possible for the Middle East to develop this entrepreneurship and -- how do you see that? Because that's critical to any kind of long-term solution.

LITAN: You're absolutely right. You know -- and I don't want to monopolize this. Carl, I'm sure, will jump in here on this.

You know, the Middle East is just awash in cash, all right, and there are some enlightened people that we have met -- when I say "we," the enlightened network -- I mean, the whole network of Kauffman -- we travel all over the world. And in fact, one of our vice presidents, Lisa Mitchell, went to a big conference in Oman recently. There were over a thousand people there. A lot of them were women, all right, and they want to be entrepreneurs. They want to use their husbands' money and go into business with us. And there is a tremendous untapped pool of capital. All they need is skill.

And so they have come to us saying, "How do we get the skill? How do we learn sort of how to be entrepreneurial?"

And so, you know, I'm not kind of joking. I think one thing you can do is that if a Middle East country comes to us and basically says, "Why don't you run a reverse Fulbright, and we'll send our best and brightest to be trained by you, to basically learn how to do entrepreneurship; we got the money, but we don't have the skills," maybe that's one way of doing it.

And then you create new role models. And the new role model in the Middle East is not the sheikh who gets a billion dollars because they're related. The new role model becomes the next, you know, Bill Gates, you know, or the next -- you know, the next person who founds Al- -- you know, the equivalent of Al-Jazeera, but makes a bunch of money. We have to change the ethos.

And I think that over time -- maybe I'm being Pollyannish -- I think if you had five or 10 years of sort of people coming to the United States to learn how to do things and then send them back, you'd have a lot of joint ventures between the United States and those operations. They would by definition be friendly to the United States. And you could, I think, move the oil tanker to become more entrepreneurial. But ultimately it's the country leaders who are going to have to let that happen. They're going to have to be willing to let an entrepreneurial class grow and let other people become rich other than just the royal family. That's the big key. That's why they're oligarchs.

SHLAES: Gary Rosen?

QUESTIONER: I'm Gary Rosen from Commentary magazine. I'm not a French socialist, but if I were, licking my wounds this morning, I would say, "Well, we have our bureaucratic capitalism and we have 35-hour work weeks. We have all these lovely little cafes that, when you get rid of the rule about a small firm being 15 people or fewer, will be replaced by Starbucks. I have a generous pension. Why is it that I want your entrepreneurial capitalism? Why is my form of capitalism bad capitalism?

LITAN: You want to take that? Because you love the French. (Laughter.)

SCHRAMM: Well, I was just there. And they were really nice to my children, and the food was great.

I think the answer is, you know, that is a cultural issue. That what you have described is a situation of satisfying. We're satisfied. But the externalities of what you pay for that are pretty extraordinary. Unemployment at 10 percent. That means people do live on the government. And if you see disparate incomes and different wealth status as important, you're not going to change your situation in that way.

I think the other thing that's of great consequence, I think, culturally is individual creativity and the contribution of it. And, you know, there are many explanations for why that wall fell down, but certainly the constant exporting of a vision of what America is (in gross ?) is what people say. Right? But, you know, the conditions that we represent, as people articulate this to us all the time, they talk about essentially a version of individual creativity and the ability to contribute.

And there are French kids, just like there are American kids, who understand who it is who makes these extraordinary discontinuous breakthroughs. I often say, you know, when I graduated from high school, the word "entrepreneur" was not on the SAT, and if it had been, anybody would have said "inventor." And if you said "inventor" when I graduated from high school, the average American kid -- in fact, I would bet universally -- would name all dead people: George Westinghouse, Thomas Edison, the Wright brothers, et cetera, Andrew Carnegie. We knew their stories backward and forward.

I have a 17-year-old in a very fine private school, which means, of course, she doesn't know any of those names. (Laughter.) As my daughter says, "You know, Dad, I go to a commie school." (Laughter.) Anyway, but, "commie school" be damned, she knows, as every 17-year-old knows, who did Facebook, who did YouTube, who did Google. These are people who are actually just a few years older.

The statistics are amazing. You know, when I graduated from college, when Bob graduated from college, the Labor Department suggested that before we retired at 65, we'd have four employers. (Sounds like ?) France, right? I've got a son coming out of college next year. Between 22 and 30, he will have four employers, and most likely one of the four will be himself or somebody he knows right now. And that talks to a level of dynamism that is extraordinary. That is, I think, prima facie evidence of kids in search of creative outlets.

Now, to a French ear, four jobs in eight years is, you know, apostasy. It's extraordinary. And the conundrum of all this is -- and it is a huge political conundrum -- we have this enormous velocity in our labor force that we did not once know, but we should all be worried because we're very insecure -- except we have the lowest level of unemployment. So square those two things up. Okay?

And I think what it begins to tell us is, sort of where I began, it begins to tell us something about what we expect of democracy. And among other things, one of the ways we would articulate that is it calls into America -- or into question here in a smaller scale exactly what it's calling into question in France, and that is, what is the social contract?

How much -- in this case we can now in 2007 maybe say the question differently: How much security is the state going to provide you to prevent you from becoming creative?

LITAN: I would add just two quick things.

Talking to your hypothetical socialist inside you, which I'm sure it isn't, all right? There's no socialist inside you.

But two points: One is, everybody who goes to France and who meets somebody our age and talks to them and to ask, you know, what are your kids doing, all right? I'm sure you've had this conversation, all right? And they'll say, you know, my son went to the ecole de blah blah blah and this and that and so forth. They graduated with great honors, and now they're working in Ireland or the U.K., all right, or they're not employed in France, all right? And you can't sustain a society like that, all right? And they know that.

And the second thing I'd tell them is, they've got their proverbial heads in the sand for those people, because they are retiring in droves. They're aging much faster than we are. And due to the miracle of French medicine, they're going to live a long time, all right? And when they're 75 or 80 years old, and they're now 55 but when they're 75 or 80 -- things continue the way they are now, there ain't going to be money to pay for them, either their social security or their health care, unless we have some new burst of energy. Because the money ain't going to be there.

SCHRAMM: Sounds a lot like Upstate New York. (Laughter.)

SHLAES: Carroll Brown.

QUESTIONER: Carroll Brown.

Picking up on this mention of statistics, some of us who may have studied Economics 101 a hundred years ago, using Paul Samuelson, learned that seven out of 10 small businesses go bust within five or six years. And again, going to your distinction between small business and entrepreneurship, and I haven't read your book, but do you have any numbers that reveal how many of these entrepreneurs manage to last more than 10 years?

SCHRAMM: Well, John Koten is probably our expert statistician there, because they do polling on this.



QUESTIONER: (Off mike.) The ones that are successful last a while, and the others disappear. Failure rates are still pretty high, but the cumulative good that comes out of the companies that succeed far outweighs the cost of the constant turnover. And most entrepreneurs are serial entrepreneurs, so they -- you know, one business that they start fails. It doesn't mean they get out of entrepreneurship or they're not doing anything productive after that. They'll start other businesses and keep going.

LITAN: I was about to say, we financed a bunch of studies on this, and the numbers are all over the map. But I think -- one of the studies that we did -- I think, four years out, still 65 percent are in business, all right? Now 10 years out, you're right, probably 30 percent.

Although one correction -- I would say that, I mean, I took economics from Samuelson, and I don't think the word "entrepreneur was in Samuelson's version. In fact, one of the things we did is, we did a word search on all economics textbooks that are now in Economics 101, and we looked for the word "entrepreneur." And I think, if you add them all, the entire market, which is like, several million books, all right, and there must be like 10 books or so, the word entrepreneur collectively in all the books is mentioned like 10 times, in all the books, all right? So I mean, it isn't yet infused itself into the profession.

SCHRAMM: Ned Phelps in his Nobel Lecture mentioned the word "entrepreneur" more times than all the previous Nobel winners did "sigma," total. (Laughter.)

SHLAES: We've got one last question -- this gentleman right here.

QUESTIONER: Thanks. Rich Lyons, Goldman Sachs.

The word "corporate entrepreneurship," on one view, is obviously oxymoron. But another view, and this is sort of a financial industry view: There has been no radical transformation of our industry. But if you put an investment banker or an FX trader to sleep 10 years ago, they wouldn't know what to do today, and it's about the hundreds of small push-aheads that occur every single day. Isn't that also very, very important to the process?

SCHRAMM: Well, it's hugely important. And I think if there's one thing we learned together on this journey, I think I learned it probably more than Bob did, because he was my tutor on this. But I think it is perhaps one of the most valuable insights in the book. It is this observation about the importance of big firm, small firm, a mixed economy that is our economy.

Now when you talk about large firms, there's absolutely just positive evidence that they are becoming hugely more efficient and, I think, more entrepreneurial. There's a lot of evidence of it. If nothing else, you look at their productivity rates. You know, they account for more of the GDP than they did 25 years ago. That's 65 percent of the head count, extraordinary increase.

And I for one am ready to credit a lot of that as entrepreneurial behavior, with the caveat that the companies that couldn't do it have basically been merged into companies that could brutally beat them into doing it, okay? So you either get with the program or you get out of business. And but that is important to understand what's going on there as a signal to a much larger phenomena that business is teaching the rest of us.

And again it goes to the question, I think fundamentally a democracy -- I was in Brussels a couple of weeks ago, or just a weekend ago. And I was on a panel with the former prime minister of Slovakia, who out of no place said, you know, the most stabilizing force in world politics in the United States corporation. And I think a lot of things can be learned out of the United States corporation, and at the moment, one of the things that can be learned is in fact what war on bureaucracy looks like. And, you know, to point to those productivity numbers is to suggest somebody has figured out how to beat back bureaucracy, and, as we've written elsewhere, bureaucracy is the antithesis of entrepreneurship. They cannot coexist. So what you're commenting on, I think, is quite a profound cultural shift in a number of our largest companies that are going in this direction.

By the way, they go against great odds, theoretical odds and tutored odds, to come out of business schools, because I think business schools have yet to catch the profundity of this. And a lot of it springs from names, business professors who are clever about strategy and so forth who actually learned from professors like Samuelson and Galbraith, who each, by the way, didn't just not mention the work, okay; each declares -- Galbraith stronger than Samuelson -- that there is no utility to entrepreneurs anymore. Galbraith writes that in the '80s, okay, and he says that all innovation will come out of big, industrial laboratories, that the age of the entrepreneur is over, explicitly declares these things. And to examine a lot of what goes on in business schools now continues as if this revolution had not happened.

LITAN: And two footnotes to that.

Schumpeter, too, in a book, you know, "Capitalism, Socialism and Freedom" -- he was very pessimistic about the future of entrepreneurship. He thought the same thing -- big bureaucracy is going to take it over.

And finally, on the corporate labs -- there was an article in The Economist just about a month ago that was talking about the death of the corporate lab. If you think about corporate R&D today, the biggest corporate R&D is in Microsoft, all right? You've got it in GE -- although it's decentralized, and that's the way they defeat bureaucracy is they decentralize the company -- but basically R&D has been totally diffused. And in our economy now, R&D is small firms, as I said, then selling out to big firms, and hopefully that will change for the reasons I articulate later. But just to re-emphasize, yes, you need both. And we're not saying that you can have a whole economy full of entrepreneurs. It's impossible.

SHLAES: Well, we want to thank Carl and we want thank Bob for coming today. (Applause.)








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