Entrepreneurship and Innovation in and out of the Credit Crunch
Imagine you are an entrepreneur. Maybe you have already built up a business, sold it off and are looking for something new. Maybe your business is ticking over but you don't have any real sense of the future. With the current rate of business closures and a seeming avalanche of redundancies, you might be forgiven for thinking the very last time to set up a new venture is in the teeth of the worst recession since the 1930s. Understandable, but wrong! In fact rates of new firm formation (the closest proxy indicator we have for entrepreneurship) rose in both of the last two recessions, in the early 1990s and early 1980s. An while we don't have data for earlier periods, the wealth of case studies available confirms that there certainly was plenty of entrepreneurship and innovation in Britain in previous recessions in the late 1940s, the early 1930s, and, indeed, the early 1920s and even further back.
What kind of logic is it that can claim that entrepreneurship rises during a recession? How can such a counter-intuitive argument hold? Well it has to be accepted that it is not straight forward. Most economists thought that the large increases in self-employment in the 1980s were more about the newly redundant avoiding the strictures of unemployment rather than evidence of a new wave of technological innovation, for example. But recessions have in the past provided new opportunities that were less available during years of growth.
The rationale is one highlighted by Joseph Schumpeter in the 1930s, when he wrote about 'creative destruction'. It is because recessions can be terrible for vulnerable incumbents, that they may provide opportunities for new entrants. In good times even weak incumbents may be strong enough to restrict new entrants. A really revealing indicator here is how the numbers of successful ethnic entrepreneurs has jumped in each of the major recessions in the twentieth century in Britain. Precisely those groups most easily excluded from full participation in society - immigrants and their children - find barriers have fallen compared with the good times.
2009 - the right time?
What does this mean for now? Well, no one is forecasting that lots of fortunes are there to be made in 2009, at least not outside debt collecting. Rather that opportunities are likely to abound for entrepreneurs to get established now. Those desperate to make their fortune may just have to be patient awhile yet.
And the opportunities are probably in fairly obvious places. So first spot where they are not. Recessions are overwhelmingly characterised by some substantial economic restructuring. There was not much point focusing entrepreneurial endeavours on coal mining in the 1980s, or cotton in the 1930s, as those activities were facing declining demand. Equally it is a foregone conclusion that the financial sector of 2010 onwards will have to be substantially smaller share of the economy than in 2007, for example.
Judging where the opportunities are requires a little more imagination, but once again there are some fairly obvious indicators. First there has been no diminution in the rate of technological innovation. A recent PhD dissertation at the Henley Business School found that in 1980 a medium sized computer cost the equivalent of employing 210 people for a year. By 2000 that had fallen to the annual cost of just two workers. By 2006 that same computer power now cost just two minutes of work for the average US white collar employee.[1] With such a collapse in the cost of information processing having taken place so very recently, we don't need to look too far to see where the greatest potential for innovation lies.
Second, the markets likely to grow most are also by and large fairly predictable. Some understanding of global and macro economic trends is helpful here. Semi skilled worker wages remain a fraction of European, so while transport costs remain low, China will continue to act as the world's factory. Entrepreneurs interested in manufacturing will continue to produce off-shore. More pertinent for UK-based entrepreneurs is, however, the relative cost of advanced engineering knowledge in India and China. Even with a bigger depreciation in sterling than in 1931 and 1948, with the vast increase in the supply of technically skilled graduates in Asia, British engineers will be priced out of doing ever more advanced level design and construction of complex technologies. The value added for UK-based entrepreneurs will therefore increasingly be in commercial applications and market making, rather than design (and it has long since disappeared in all but some very specialised manufacturing).
Third, while past recessions do provide some sort of guide to the current, we need to be ware of how the credit crunch will affect the likely shape of economic activity over the next few years. The 1930s Depression was exacerbated by beggar-thy-neighbour trade restraints. So firms then with business models based on export-growth struggled. While no one can know the future, the economic imbalances of recent years in Anglo Saxon economies will have to wind down. Consumer demand as a share of the economy will have to decline in Britain and America, to be replaced with exports. The opposite needs to happen in Germany, Japan and China. So whereas past recessions in Britain have seen the industrial sector contract and consumer demand increase, 2009 and 2010 are likely to see the opposite. Successful entrepreneurs will want to focus their business models on areas of growth, which may mean increasingly supplying goods and services to UK firms targeting overseas markets, even targeting export markets directly.
The importance of politics
Finally, politics matters. Indeed, in this particular cycle, with the massive increase in the state's share of economic activity, politics really matters. This has important implications for entrepreneurs, as political outcomes are even less predictable than economic. It means that flexibility in the business model will be even more important than before. Consider two obvious scenarios. First, the fiscal boost means that any growth in demand comes initially from the public not private sector in 2009 and 2010. But as this is likely to be followed by such very considerable fiscal retrenchment, such demand is likely to evaporate shortly after. So, by all means seek public sector contracts, but don't get locked in. Second, while any new venture will be forced to insure against deflation (by virtue of banks being unwilling to lend), in fact the growing risk of curing deflation is of a really big inflationary spike occurring sometime in 2010-2011. All firms will need to hedge against such policy-induced outcomes, but new ventures may be particularly exposed.
[1] Peter Cook, 'Transaction Space', unpublished Ph.D. dissertation, University of Reading, 2009, p. 2.2 & A-4.
