“If you’ve got a business—you didn’t build that. Somebody else made that happen,” declared President Barack Obama at a campaign stop last week in Virginia. Evidently, the president believes that economic growth and job creation are largely the result of actions taken by benevolent government agencies. But while it is certainly the case that good governance is essential, entrepreneurs engaging in voluntary cooperation coordinated through competition in free markets is what actually creates wealth and jobs.
In the Virginia speech, the president also observed, “Somebody helped to create this unbelievable American system that we have that allowed you to thrive.” As parts of “this unbelievable American system” that “allowed” businesses to “thrive,” the president cited “a great teacher” and that “somebody invested in roads and bridges.” With regard to building a business, the nebulous “somebody” who “made that happen” is, of course, government.
So what are the real background conditions for enabling economic growth and the production of increasing wealth? Intuitively most people think of wealth as chiefly consisting of material items, e.g., factories, farms, forests, mines, houses, ports, telecommunications networks, and yes, roads and bridges. However, research at the World Bank has found that once all of a country’s natural and produced capital is added up, they together generally constitute less than 20 percent of its actual wealth; the remaining 80 percent is intangible. What is intangible wealth? The World Bank study, The Changing Wealth of Nations, defines it as “human capital, social, and institutional capital, which includes factors such as the rule of law and governance that contribute to an efficient economy.”
Human capital is the set of skills and knowledge people living in a country have acquired. This is roughly measured by the average years of schooling per capita and a country’s average healthy life expectancy. So yes, great teachers certainly do contribute to the development of human capital. But it’s worth noting that the U.S. spends the most per pupil in the world, rising in constant dollars from $4,500 per student in 1970 to $10,500 in 2008. In the meantime that 17-year-old students in 1973 scored 285 points on the National Assessment of Educational Progress tests. In 2008, they scored one point higher—286 points. The math scores were 304 and 306 respectively. Our public school teachers may be great and better paid, but the data don’t show they’ve gotten better results.
Nevertheless, with regard to human capital, the United States is doing pretty well compared to other developed countries. The U.S. has the highest percentage of high school graduates of any country and only Canada, Japan, and Israel edge out the U.S. on percent of population with college degrees.
Social and institutional capital is measured by the World Bank’s rule of law index. This index takes into account the extent to which citizens have confidence in and abide by the rules of society. In particular, it measures the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence.
Adding up all of the natural and produced capital and dividing it by our population, the World Bank calculated in 2005 that our natural capital amounted to about $14,000 per person, and produced capital was about $100,000 per capita. Intangible capital was a whopping $627,000 per person. In other words, about 85 percent of American wealth consists of institutional and social capital, such as strong property rights, the rule of law, an honest bureaucracy, and an educated populace, that enable the process of entrepreneurial innovation and job creation in free markets.
Good governance underpins these things, but not all governance is good. Just as government can enable the voluntary creation of wealth, it can also impede and even destroy it. Consider the case of Venezuela where Hugo Chavez’s Bolivarian revolution has so impeded that country’s economic growth that increased total per capita wealth has fallen from $80,000 to $70,000 per person between 1995 and 2005. Zimbabwe under Robert Mugabe has even much worse record; total per capital wealth has dropped from $6,500 to $5,000 per person.
The United States is not Venezuela or Zimbabwe, but recent research suggests that the social and institutional background conditions that encourage and enable voluntary cooperation in markets to produce wealth and new jobs are being eroded. A bellwether for this erosion is the falling rate of new business startups.
The Kauffman Foundation, which has been tracking the rate of business startups since 1980, reports they have hit an all time low. Its new study, "Where Have All the Young Firms Gone?" finds that “Building on a long-term trend, the nation's business startup rate fell below 8 percent for the first time in 2010, marking the lowest point on record for new firm births.” The study adds, “New firms as a percentage of all firms continued a steady downward trend in 2010—going from a high of 13 percent (as a percentage of all firms) in the 1980s to just under 11 percent in 2006 before making a steep decline to the 8 percent in 2010.”
This decline is critical to job creation. A July 2010 study, "The Importance of Startups in Job Creation and Job Destruction," by Kauffman senior fellow Tim Kane found that since the 1980s, new startups “create an average of 3 million new jobs annually. All other ages of firms, including companies in their first full years of existence up to firms established two centuries ago, are net job destroyers, losing 1 million jobs net combined per year.” Kane came to the astonishing conclusion, “Startups aren’t everything when it comes to job growth. They are the only thing.”
The 2012 study found that while new business startups created 2.3 million jobs between March 2009 and March 2010, the net job creation from all U.S. private sector firms was minus 1.8 million jobs. The U.S. unemployment rate was then 9.7 percent. The number of business startups has dropped from 554,109 in 1987 to 394,632 in 2010. The 2012 Kaufmann report notes that the share of job creation from young firms has fallen from more than 40 percent in the 1980s to 30 percent now. While acknowledging that the severity of the Great Recession no doubt contributes to this decline in entrepreneurial activity, it is important to note that startups were a major factor in lifting the U.S. economy out of previous economic downturns. Why is new firm creation lagging now? Perhaps it has something to do with the Obama administration’s idea of governance.
First, numerous studies find that higher tax and regulatory burdens impede entrepreneurial activity which in turn slow economic growth and job creation. For example, a 2010 study, "The Economic Effects of the Regulatory Burden," done for the Swedish Agency for Growth Policy Analysis (of all places), found that while some rules are necessary for entrepreneurs and markets to function “that countries with a light regulatory burden show more rapid economic growth in GDP per capita.” A 2008 study, "Government Size, Composition, Volatility, and Economic Growth," done for the European Central Bank examined the effect of government size and fiscal volatility on economic growth for developed countries between 1970 and 2004. The study finds that the bigger government and the slower the growth rate. Every percentage point increase in the share of total revenue going to government decreases overall economic output by more than a tenth of a percent. The report further noted, “Public capital formation may indeed turn out to be less productive if devoted to inefficient projects, or if it crowds out private investment.” Other words, despite the impression that Obama gives, not every government expenditure on infrastructure or a business subsidy is an “investment.”
Focusing more directly on the effects of regulation on economic growth, a study done for the Canadian government in 2006, "Regulatory Expenditures and Compliance Costs," confirmed, “Between 1977 and 2000, each dollar in US federal government regulatory expenditure was found to contribute about $21 in compliance cost burdens for business and state and local governments.” That study shows that regulatory compliance costs fell during the Reagan administration from $650 billion annually to $550 billion, but rose $700 billion by the end of the Clinton administration. A March 2012 study, "Red Tape Rising," by the conservative Heritage Foundation claimed the Obama administration in its first three years had imposed 106 new major regulations (those costing more $100 million in compliance) that boosted regulatory costs by more than $46 billion annually, which is five times greater than the costs imposed by the Bush Administration during its first three years. Another crude measure of the size of regulatory burden is the number of pages published each year in the Federal Register. In 1980, under President Jimmy Carter, that number reached more than 87,000 pages, dropping to around 47,500 pages in 1986 in the Reagan administration. Last year the Federal Register published nearly 82,500 pages.
A new study for the Weidenbaum Center at Washington University in St. Louis reports that in constant dollars federal regulatory agency spending has increased from $15 billion in 1980 to $50 billion today. If every dollar of federal regulatory spending multiplies by $21 in compliance costs, that implies more than $1 trillion annually in regulatory costs to businesses and individuals. The IRS expects to collect $1.4 trillion in income taxes this year. Regulations can act as substantial barriers to entry for the startups that have historically been the source of job creation in the U.S. economy.
In his speech last week in Virginia, the president declared, “The point is, is that when we succeed, we succeed because of our individual initiative, but also because we do things together.” But all of his examples of the things we "do together" were government projects, e.g., building roads, the Golden Gate Bridge, the Hoover dam, fighting fires, public schools, and inventing the Internet. We can argue over whether or not these are services that can only be provided only by government. The crucial point that the president misses is that “this unbelievable American system” thrives chiefly on private enterprise, and that a lot of the government intervention that he favors is hindering rather than helping businesses and entrepreneurs create new jobs and more wealth.
Science Correspondent Ronald Bailey is the author of Liberation Biology (Prometheus).