Why innovation is still capitalism’s star?

Capitalism is culture. To sustain it, laws and institutions are important, but the more
fundamental role is played by the basic human spirit of independence and initiative.

INNOVAticias.com / Red / Agencias, 01/10/2014

The decisive role of the “spirit of capitalism” is an old concept, going back at least to Max Weber, but it
needs refreshing today with new evidence and new thinking. Edmund S. Phelps, a professor of
economics at Columbia University and a Nobel laureate, has written an interesting new book on the
subject. It’s called “Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and
Change” (Princeton University Press), and it contains a complex new analysis of the importance of an
entrepreneurial culture.

Professor Phelps discerns a troubling trend in many countries, however, even the United States. He is
worried about corporatism, a political philosophy in which economic activity is controlled by large
interest groups or the government. Once corporatism takes hold in a society, he says, people don’t
adequately appreciate the contributions and the travails of individuals who create and innovate. An
economy with a corporatist culture can copy and even outgrow others for a while, he says, but, in the
end, it will always be left behind. Only an entrepreneurial culture can lead.

Is the United States really becoming corporatist? I don’t entirely agree with such a notion. Even so,
President Obama has been talking a lot about innovation as a job creator this year, and while some of
his intentions may be good, I’m afraid that some of his proposals look a little corporatist, and might
suppress individual initiative.

In his State of the Union address in January, for example, the president proposed that the government
should create 15 new “innovation institutes,” modeled on a public-private partnership that he helped
start in Youngstown, Ohio, that is devoted to developing 3-D printers. There was more in this vein in
his administration’s 2014 budget, offered in April. And in a speech on July 30 in Chattanooga, Tenn.,
Mr. Obama suggested extending the number of innovation institutes to 45, or almost one for every
state. The institutes, he said, would be “getting businesses, universities, communities all to work
together to develop centers of high-tech industries all throughout the United States.”

Will such measures work? Should the government really be trying to start a 3-D printer center? And
why in Youngstown? It is easy to be skeptical of such a plan, especially when it was started in a swing
state just before the presidential election. Web sites of the two senators and two representatives
introducing bills this month supporting the president’s latest proposals are suggesting, in not-too-
subtle terms, that the legislation would bring jobs to their own states.

Successful companies aren’t usually started this way. Professor Phelps, citing a McKinsey study,
suggests that in free-market capitalism, “from 10,000 business ideas, 1,000 firms are founded, 100
receive venture capital, 20 go on to raise capital in an initial public offering, and two become market
leaders.” It is easy to doubt, as Professor Phelps does, that the odds are favorable for a Youngstown
3-D printer center.

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How you view the innovation institutes, and the topic of capitalism and culture, may depend on your
own experience. Many people have never seen the hatching of a successful business idea. That
makes it hard to judge the subtle changes that may be occurring in the nation’s culture and in its
potential for innovation.

My own business experience has certainly helped shape my thinking. Yale, like many other
universities, sensibly allows its professors to spend limited time in business, providing the opportunity
for faculty members to gain valuable experience outside of the ivory tower and to offer their technical
skill to the business world.

In 1991, I started a business with Karl Case, an economics professor at Wellesley College, and Allan
Weiss, a former student of mine at Yale. We called it Case Shiller Weiss, Inc., and it was devoted to
an innovation we dreamed up. The idea was a new “repeat sale” home price index — which would
track the changes in the value of the same houses over time.

At the time, this was an entirely new line of business. And, at first, that posed a problem: we were
spectacularly unsuccessful in raising money. We talked to venture capitalists and their committees, to
no avail. They just didn’t seem to get our business plan. We must have appeared odd to them —
overly academic, perhaps. One remarked that we’d do better proposing a new shopping center.

But we went ahead with our idea anyway. At first, Allan worked without pay. A friend of Professor
Case, Chuck Longfield, contributed some money. And in 1995, I took out a home equity line of credit
on my house in New Haven so I could personally lend more money to help keep our business afloat.
The experience was stressful, especially when adding it to the burdens of my main job, as a professor.
I have much to thank my wife, Virginia, for her tolerance of my overwork and my worrying, and for
allowing me to put our family savings at risk.

In the end, our business was successful, and I think a big part of it was that we relied on our own
ideas and energy and, to a large extent, our own money. In 2002, we sold the business to Fiserv Inc.,
then licensed Standard & Poor’s to create what are now known as the S&P/Case-Shiller Home Price
Indices. In 2006, the Chicago Mercantile Exchange began trading futures on 11 of our indexes. Fiserv
sold the index business to CoreLogic early this year.

In short, our business made its mark without any help from the government.

This little real-life experiment convinces me that committees of experts, even at smart venture capital
firms, will often not recognize real innovation. I think that America’s business success through the
decades has occurred because we have so many people with specialized knowledge who are willing
to put their money, time and resources on the line for ideas that can’t be proved to a committee.

THAT experience may also help explain why I think the new crowdfunding initiative, started by the
Jobs Act that the president signed last year, is an exciting step forward. It’s all about finding and
mobilizing people who really understand specific, hard-to-prove ideas for important investments.

At the same time, other of my experiences incline me to think that government-appointed committees
of experts can help set the stage for an entrepreneurial culture, under certain limited circumstances.

Long before I started any commercial ventures of my own, I received some federal government
support — in the form of National Science Foundation research grants, awarded to me decades ago
as a young professor. They allowed me to do research, and though it was not directly related to my

Arturo Soria 245. Edifico, EUDE. 28033 Madrid. T. (+34) 91 593 15 45

CIF: B82969106. Inscrita en el Registro Mercantil de Madrid, Tomo 39517, Folio142, Hoja B 348700, Inscripción: 1ª
later business endeavors, the process developed my expertise and reinforced a sense of
entrepreneurial opportunity.

These grants were awarded competitively, based on the quality of the proposals, and gave me
experience with a system focused on creating opportunities for those who try hard. Later, from 1983 to
1985, I evaluated others’ proposals when I served on the foundation’s panel for economics. Observing
the process from the government side convinced me that the foundation really works. Maybe it’s
because the panelists are chosen from successful scientists, who serve anonymously out of public
spirit.

In any case, as Professor Phelps has argued, direct government involvement in capitalism is a
delicate thing. The system’s success depends on subtle cultural factors — and these require careful
nurturing.

Arturo Soria 245. Edifico, EUDE. 28033 Madrid. T. (+34) 91 593 15 45

CIF: B82969106. Inscrita en el Registro Mercantil de Madrid, Tomo 39517, Folio142, Hoja B 348700, Inscripción: 1ª