Washington: Competing Visions
The National Competitiveness Act would make Uncle Sam a venture capitalist.
Sen. Ernest "Fritz" Hollings (D-S.D.) is a gruff, sometimes crude populist prone to using personal invective and ethnic slurs to make his points. On the floor of the Senate he once referred to Sen. Howard Metzenbaum (D-Ohio), who is Jewish, as "the distinguished senator from B'nai B'rith." In 1993, he suggested, presumably in jest, that we launch a nuclear attack against Tokyo to show the Japanese the power of American-made goods. And, to barely a peep of public outcry, he recently mocked African diplomats as cannibals.
Hollings may be a buffoon and a bigot, but he is a powerful man in Congress. As chairman of the Senate Commerce Committee, he has ambitions that stretch beyond Capitol Hill to the labs, factories, and offices of America's high-tech companies. His National Competitiveness Act, a bill that combines high-tech pork and industrial policy with a dash of political correctness, passed the Senate in mid-March and is now in conference committee. A final bill is supposed to emerge in June or July.
The competitiveness bill would further extend the political process into the rough and tumble of entrepreneurship. As Hollings expressed its underlying philosophy in a floor speech, "We [elected officials] legislate the [nation's] fine standard of living." After all, he noted (as his Southern Democrat ancestors spun in their graves), "We built this industrial empire with protectionism."
The bill pitted two of the Senate's most disparate personalities against one another: Hollings and Republican Jack Danforth, the patrician Episcopalian minister from Missouri. Even though the bill passed by a 59-40 vote, Danforth and most Republicans were able to filibuster and to delay the final vote by three days. The debate became so nasty that Sen. Arlen Specter (R-Pa.) threatened to cite Hollings with a rules violation for insulting Danforth on the floor.
Anticipating a new source of federal funding, such industry heavyweights as Motorola, Intel, AT&T, and Honeywell backed the bill. Opposing it were academic economists and the National Venture Capital Association, a small trade group whose industry is threatened by the bill's subsidies.
Indeed, the most controversial and most troubling provision of the competitiveness bill got the least funding: a two-year, $100-million "pilot" program that makes Uncle Sam a venture capitalist. The venture-capital program authorizes the Commerce Department's under-secretary of technology to grant licenses to "civilian technology companies"—existing or newly formed venture-capital firms that invest in businesses developing either "critical" or "advanced" technologies as defined by law.
Venture capitalists invest in new businesses that are too risky to get funding from banks or other financial institutions. Instead of loaning money and requiring the fledgling entrepreneur to start repaying the loan immediately, venture capitalists trade up-front cash for part ownership in new companies; venture firms make their money if and when the embryonic businesses go public or sell out to larger companies. Although they have backed pizza-delivery chains and retailers such as Staples, venture capitalists are best known for supporting high-technology companies with high growth potential.
And venture capitalists worry that the government money will distort their high-risk, high-return business by pulling scarce private dollars out of promising start-ups and well-run venture-capital funds and into less-commercial companies and subsidized but less expert venture-capital funds. They also fear that the regulation that comes with subsidies will spill over into their whole industry. Says Mark Heesen, director of legislative and entrepreneurial affairs at the National Venture Capital Association, "Venture capital, by its very entrepreneurial essence, is an industry which requires freedom from regulation in order to maintain its creative, risk-taking spirit."
Despite their odd designation as "technology companies," the federal licensees won't be manufacturers but financiers, using government money or loan guarantees to invest in businesses developing high-tech products. The bill authorizes $100 million in grants and up to $600 million in low-interest loans to the licensed venture capitalists.
To get a license, venture capitalists may face tough regulations and social engineering. The House version of the bill instructs the Commerce Department to target funding to "economically depressed areas" and businesses owned by "socially or economically disadvantaged individuals." The undersecretary can also limit "the aggregate amount of shares in any [venture-capital] licensee which may be owned by any stockholder." This provision, says Heesen, "lets political appointees [in the Commerce Department] and their bosses regulate financial markets."
The program's fans argue that entry-level, high-tech entrepreneurs—the next generation of Bill Gateses—can't find money to bring their innovations to market. "The venture-capital market has dried up in the last several years," argues Sen. Jay Rockefeller (D-W.Va.), a principal supporter of the bill. "If Thomas Edison wanted to invent a light bulb these days, he would have to bring in Shea Stadium in his arms with all the lights on to convince venture capital that the light bulb is an idea which might be useful."
Rockefeller is wrong. The formal venture-capital market hasn't "dried up." New investments in funds went from $1.4 billion in 1991 to $2.6 billion in 1992. As the recession ended, reports Harvard Business School professor William Sahlman, "a significant increase in early-stage investing has taken place." And venture capitalists have also been willing to back long shots—witness their support for biotechnology companies with nothing more solid than a good idea.
Changes in taxes and regulations, trends in the greater economy, and the inherent riskiness of the types of firms venture capitalists back lead to dramatic fluctuations in venture-capital funding. New investments by formal venture-capital funds varied from $1.4 billion in 1982 to $3.4 billion in 1983; from $3.3 billion in 1986 to $4.2 billion in 1987 to $2.9 billion in 1988.
But formal venture-capital funds actually provide a tiny percentage of financing for new firms. In Financing Entrepreneurs, a 1993 book she edited, American Enterprise Institute technology policy analyst Cynthia Beltz reports that institutional venture capitalists finance only about 2,000 of the approximately 700,000 businesses that are incorporated each year. Carnegie Mellon University management professor Richard Florida says formal venture funds assist around 10 percent of high-tech start-ups.
New businesses get money from lots of informal sources—family members, second mortgages, business "angels" (such outside investors as Ross Perot or Lotus's Mitch Kapor), other companies. A Harvard Business School study shows that 75 of the 100 fastest-growing companies between 1982 and 1989 were self-financed from savings, credit cards, or other forms of personal debt.
In Financing Entrepreneurs, Harvard's Sahlman and Carnegie Mellon's Florida assert that there is no shortage of money available for new businesses. Industrial-policy critic T.J. Rodgers, CEO of Cypress Semiconductor, says, "I could leave Cypress, write up a business plan, and raise $10 million in a week. No good idea goes unfunded."
Even if venture capital were short, the federal government should stand clear of such inherently risky investments. The market research firm Venture Economics reports that between 1969 and 1985 one-third of the investments made by 13 venture-capital firms resulted in partial or total losses. Venture capitalists make money by striking it rich on a few investments, knowing that many others will turn sour.
But the whole point of the competitiveness bill is to funnel money to areas the marketplace might find too risky to support. Indeed, the bill appears to guarantee that it will predominantly finance losers. Before a civilian technology company can get a license from the Commerce Department, the company must show that it will make investments "in critical technology projects for which eligible technology firms cannot obtain necessary financing solely through commercial capital markets."
"I think this means that if you have an idea which cannot hack it, come to uncle," said Danforth, the bill's chief Senate opponent, during the floor debate. "We like bad ideas. If you have got a bad idea out there, we will fund it. In fact, if it is a good idea we will not fund it."
From the supersonic transport to the Synthetic Fuels Corporation to the Sematech consortium, the feds have a lousy record of supporting commercial technologies. The National Venture Capital Association's Heesen worries that the existence of federal venture-capital funding might lure private investors into throwing good money after bad.
And unlike venture capitalists, who have a financial incentive to cut their losses and let failing companies go under, the government has every incentive to keep pouring money into losers: Lawmakers' constituents demand it. Writing last year in The Wall Street Journal about the competitiveness bill, Carnegie Mellon economist Allan Meltzer noted that governments often confuse wealth creation with job creation. With government as a venture capitalist, politicians and the people who work in money-losing businesses will be able to demand subsidies to keep firms open and, as Meltzer says, to provide "hope for a better future."
When the bill reached the Senate, the Democrats appeared genuinely surprised at the intensity of Republican opposition. Majority Leader George Mitchell expressed the exasperation of his party when, two days before the final vote, he complained that "we have [spent] nearly five full days [debating] a bill that is very similar to a bill passed in less than five minutes two years ago." In fact, just before Congress ended its 1992 legislative year, the Senate had easily passed a competitiveness bill; but the 1992 version authorized only $208 million in spending and didn't contain the venture-capital program. (That bill died without a House vote.)
Danforth, Kansas's Nancy Kassebaum, Georgia's Paul Coverdell, Colorado's Hank Brown, and other Republicans added amendments to the 1994 bill to, among other things, prohibit the Postal Service from penalizing businesses that use Federal Express and other private couriers, reform civil liability for piston-engine aircraft manufacturers, and make the cost of proposed federal regulations more visible. Hollings thundered that these amendments were not "germane" and were merely attempts to derail the bill.
That was indeed partly the point, though only partly. Republicans had hoped to get these amendments through Congress by attaching them to other bills likely to pass. And these amendments would certainly have enhanced "competitiveness" more than Hollings's bill.
The debate eventually got personal. Danforth, who had backed Sematech and the Chrysler Corporation bailout, appeared an unlikely opponent of the bill. But more recently, the Missourian has moved away from overt industrial policy and toward capital-gains tax reductions, tax credits for basic research, and less-targeted supports for businesses. Yet when Hollings correctly pointed out Danforth's past votes, he accused the Republican of engaging in "monkeyshines, which is a polite expression, maybe, for hypocrisy."
While Danforth didn't respond directly to Hollings's harangue, Specter defended his Republican colleague. He asked Hollings to apologize and tone down his rhetoric; unflattering personal comments directed from one senator to another violate Senate rules. After a heated exchange, Mitchell called "no harm, no foul," and returned the debate to the bill.
Outnumbered Republicans faced an almost-unified Democratic Senate (only New Jersey's Bill Bradley opposed the bill) and shaky support from liberals in their own party. Danforth was able to continue his filibuster only because Kassebaum insisted that her amendment to reform aircraft-manufacture liability remain attached to the bill. She was the swing vote, and after six days of debate, Mitchell made a deal: Kassebaum's aircraft amendment would be introduced as a separate bill and voted on immediately after the competitiveness act. Danforth could propose a separate amendment that removed the venture-capital program from the bill.
Danforth agreed. His amendment failed, 55-44. The entire bill passed by a 59-40 vote, and Kassebaum's bill passed, 91-8. The House and Senate will work out their differences in a conference this summer. As of early May, the House leaders had not appointed their conferees. With all the amendments attached to the Senate bill, one congressional staffer predicts a dozen committees may be involved in reconciling the two versions of the bill. "This conference is going to be a mess," he says.
Congress is clumsily responding to legitimate concerns about the health of American businesses. Cypress CEO Rodgers admits it can be difficult for mid-size companies to grow into big companies. Start-ups can get venture capital from a number of sources; large firms with healthy bond ratings can issue debt relatively cheaply and often have better access to the stock market. But mid-size companies face fewer, and less attractive, choices: borrowing heavily from commercial banks, issuing debt at junk-bond rates or stock at an equivalent discount. If Congress repealed the Glass-Steagall Act of 1933, banks could purchase securities from the same companies to which they loan money, giving medium-size companies a new source of equity capital.
Using the idiom of Democratic consultant James Carville, Rodgers suggests another change in policy that would help companies of any size: "Cut the capital-gains rate, stupid." When Congress reduced rates on capital-gains and other income taxes in 1981, new commitments to venture-capital funds doubled to $1.3 billion the first year. Lower capital-gains rates would also entice individuals and companies to make investments in established but growing companies.
Susan Eckerly, deputy director of economic policy studies at the Heritage Foundation, suggests other reforms: Make the business tax credit for research and development permanent; deregulate telecommunications; reform product-liability laws; reduce government mandates on employers—many of the sorts of amendments Republicans wanted to add to the competitiveness bill. Eckerly says she favors "anything that lets businesses keep more of their money and not send it to Washington."
Unfortunately, repeated government failures won't dissuade politicians from passing out the pork and claiming credit for the successes they may stumble across. Too few elected officials agree with Bill Bradley. "Government bureaucrats reading business plans and interviewing would-be Bill Gateses will not stimulate or expand the flow of private capital," he said. "Given a choice, I will stake my faith in markets and not in bureaucrats."
Rick Henderson is Washington editor of REASON.