THE COST OF BAD ENTREPRENEURSHIP

Entrepreneurs are lionized by influencers and politicians as job creators and innovators. Without high-quality entrepreneurship the world would be less dynamic. But should entrepreneurship be advocated with caution? Jeff Bezos, Warren Buffett, and Larry Ellison are familiar faces because they built multi-billion dollars empires? However, the typical entrepreneur is less successful than the faces gracing the cover of Forbes Magazines. Sixty-five percent of new American businesses fizzled out after ten years, 75% fail after fifteen and venture-backed start-ups deliver less than stellar returns, since 75 percent do not return investors’ capital.

Beneath the glitz and glamour, entrepreneurship is a laborious task requiring years of hard work and sacrifice. Yet even with immense effort entrepreneurs can still fail depending on market conditions and resource availability.  Usually, entrepreneurs reap the fruits of their labor after spending years honing useful skills, so this is why the average age of a successful start-up founder is 45. Tech billionaires like Sergey Brin and Larry Page are outliers. The trend is for older start-up founders to be more successful in business.

Statistically, gaining professional expertise is a better route to entrepreneurial success than starting a business in your twenties without the relevant experience. People who become exceptionally successful entrepreneurs in their twenties should be commended for their talent. However, such people are not the norm, and their failure highlights the wealth destroying effects of entrepreneurship. Although entrepreneurship is painted as an instrument of wealth generation, low quality entrepreneurship results in waste. Establishing a business due to need or the desire to be one’s boss could lead a productive employee to misuse resources by channeling energy to inefficient ventures.

For instance, quitting your job as an advertising executive to start a rival firm is more likely to result in failure than success because statistically most businesses fail. Further, being a good manager does not always indicate that one will succeed as an entrepreneur. Therefore, in this scenario entrepreneurship entails a deadweight cost because the advertising executive would have created more value by working for somebody rather than operating his own business. So, instead of maximizing value, entrepreneurship becomes a wealth depleting tool.

Funds that could have been diverted to saving, investing, or expended on leisure enhancing goods were wasted because one individual miscalculated by thinking that he was fit for entrepreneurship. The crowding-out effect also occurs when banks offer loans to unsuccessful entrepreneurs with the right packaging that could have served more efficient ventures. However, many prominent entrepreneurs have encountered years of failure, so failing is not an excuse to evade entrepreneurship. But policymakers should embrace the reality that some people are better poised for entrepreneurship than others. The incessant promotion of entrepreneurship is doing more harm than good because low-quality entrepreneurship misallocates talent and drains resources.

Furthermore, research shows that miscalculated entrepreneurship reduces earnings over time. Typically, entrepreneurs earn 4% to 15% less annually than their salaried peers, work more hours, and experience greater income insecurity. Additionally, their earnings rise slower over time and only a small fraction make more money as business owners than they did as employees. Most people would be better off in a stable job than as an entrepreneur. Though successful entrepreneurs are plastered in the media, Magnus Henrekson and Tino Sanandaji in a 2014 paper,  point out that most small business activities do not measure high growth entrepreneurship. On average, small businesses rarely scale or enhance value-creation. Another important conclusion of this paper is that self-employment is not an appropriate measure of entrepreneurship because most self-employed people do not launch innovative and hyper-successful businesses.

According to a study from Europe, self-employment is only financially beneficially if self-employed people manage to expand their operations, but when they remain solo-entrepreneurs they do not earn more than salaried employees. Obviously, entrepreneurship is not a terrible thing, however most people are not oriented to become entrepreneurs. Therefore, entrepreneurship should be marketed with caution or miscalculated entrepreneurship will continue to waste resources and destroy capital stock.