Discussions and Research papers

11

Nothing has been more important since the beginning of my reign than increasing the prosperity of my people. The introduction of certain new manufacturing industries … enables thousands of my people to gain their bread honorably, the raw material stays in the country … and my subjects can easily pay their taxes. While previously money left the country, it now stays within, making the country richer and more populated. Leopold I, Emperor of Austria (1640–1705)1

We quote Emperor Leopold here because his touching concern for his

subjects’ welfare (and their ability to pay their taxes) communicates

a clear message: the government needs to play a big role in expanding

his country’s economy. Instead of issuing a proclamation encour-

aging local entrepreneurs to innovate, he instituted an active policy,

backed by state funds, to create important new industries. The idea

of depending solely on local entrepreneurs to build such industries

would not have entered his head.

Leopold was neither the first nor, certainly, the last head of

state to hold such views. Rulers of his era were well aware that build-

ing a country’s economic prosperity had the desirable side-effect

of increasing its power in international affairs, and many acted

on that realization. In the late 1600s Sir Walter Raleigh observed,

“Whosoever commands the sea, commands the trade, whosoever

commands the trade of the world commands the riches of the world

and consequently the world itself.”2 As a result, the competitive race

1 Government: Boss, financial partner, regulator – Entrepreneurs in mixed economies

1 J. Berenger, Histoire de l’empire des Habsbourg 1273 –1918 (Paris: Librairie Arthème Fayard, 1990), p. 331.

2 A. Herman, To rule the waves (New York: HarperCollins, 2004), p. 150.

C o p y r i g h t 2 0 1 2 . C a m b r i d g e U n i v e r s i t y P r e s s .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

EBSCO Publishing : eBook Academic Collection (EBSCOhost) - printed on 1/26/2020 1:10 PM via UNIVERSITY OF THE CUMBERLANDS AN: 465765 ; Kressel, Henry, Lento, Thomas V..; Entrepreneurship in the Global Economy : Engine for Economic Growth Account: s8501869.main.eds_new

Gover nment: Boss, fina ncia l pa rtner, r egulator12

to industrialize and sustain national trade advantages was a con-

stant source of international friction, sometimes leading to war.

Statesmen have been involving themselves in their countries’

economies for centuries. They know that building and maintaining

a healthy industrial base is the key to growing national wealth and

sustaining prosperity. They are not about to leave the outcome of

this high-stakes game to chance. Naturally, the economic purists

who advocate totally free markets are perpetually distressed by this

state of affairs.

But these purists ignore the lessons of history. Free enterprise

cannot prosper without the infrastructure, investments, and rule of

law that government provides. Likewise, governments sabotage eco-

nomic growth – and their global influence in the bargain – when

they try to impose too many controls on business, or establish rigid

plans for its direction.

In other words, government and entrepreneurs need each other.

This does not imply that Emperor Leopold’s command-and-control

mode of economic planning is a model for our times. Economies

have evolved toward more open, mixed systems with complex inter-

play between the public and private sectors. Entrepreneurs may

exploit opportunities to build new companies or industries, but gov-

ernments still play a major role in charting the overall course of an

economy and supporting its growth. The only “pure” systems are

failed systems. Plenty of evidence is available to back this up.

Historical antecedents

National economic development programs have historically relied

on several stratagems:

investments in education and infrastructure;• subsidies for exporters;• state funding to help or even create new companies;• erection of trade barriers to limit imports;• establishment of local monopolies or cartels to reduce domestic • competition and increase the ability to export.

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Histor ica l a ntecedents 13

This is as true for free-market countries as for nations with con-

trolled economies. A nation’s official commitment to free enterprise

has never stood in the way of a little cheating to help its preferred

industries.

For entrepreneurs, such government involvement – or “med-

dling,” as the purists would have it – is a decidedly mixed blessing.

Government influence over the economy can have a decisive impact

on the success of individual ventures, and decisions made at the

highest levels can foster or stifle entrepreneurial efforts.

Problems usually start for entrepreneurs when political leaders

are looking to jump-start their country’s industrialization process.

Politicians typically believe that national programs to promote rapid

industrial development (and exports) work faster than independ-

ent entrepreneurial enterprises acting in their own perceived best

interests.

It follows that the establishment of state-owned corporations

to address critical industrial needs has been a recurring theme in

countries that are seeking to accelerate their industrialization.

Clearly, the heads of these state-owned enterprises are bureaucrats,

not entrepreneurs, in the context of our discussion.

But real entrepreneurs who build new industries with direct or

indirect state help have also emerged in most industrializing coun-

tries. Entrepreneurs have learned to live with whatever hand the

government deals them and find ways to prosper, which is part of

the definition of being an entrepreneur.

For example, during Leopold’s reign Austria began producing

textiles and arms in privately owned factories. At the start of the

process, the country lacked the knowledge and expertise to build

and operate these industries. So it set about attracting the talent it

needed.

Its appeal was simple. The government promised to grant local

monopolies, place import restrictions on competitive products, and

give business people access to some state capital to establish their

industries. These incentives lured experienced entrepreneurs and

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Gover nment: Boss, fina ncia l pa rtner, r egulator14

skilled technicians from elsewhere to set up shop in Austria. If you

were an entrepreneur, seventeenth-century Austria was a good place

to be, not in spite of government meddling, but because of it.

England, the birthplace of the Industrial Revolution, may have led

the way in the race to industrialize in the seventeenth and eighteenth

centuries, but over the next 200 years its increasing prosperity encour-

aged others to follow its example. France, the US, Germany, Russia,

Japan, and other countries industrialized in turn, each at its own pace,

and with varying degrees of government oversight and support.

Since the 1960s it has been the turn of Asian countries to join

the ranks of industrialized nations, and they have done so with a

high level of government involvement. These newcomers have

learned from history, and have no hesitation in using aggressive

national economic strategies to hasten their growth. China, India,

South Korea, and Taiwan have all emerged as industrial powers,

with exports that compete successfully with the most sophisticated

products of the developed world. Their emergence has revolutionized

the world economy and trade patterns.

China has been the most closely watched of all the Asian suc-

cess stories, because of both its size and its extraordinary industrial

progress. It launched its industrial program in earnest only in the

late 1970s, but by 2010 it moved from the back bench to second place

in the world economy, displacing Japan. It now has prospects of sur-

passing even the US.

China’s industrialization process has been a forced march, con-

trolled by an omnipotent Communist Party. Individual entrepreneur-

ship has played a minor role. The term “state capitalism” has been

applied to the current Chinese model because of its combination of

state and private capital. But this policy is actually a modern form of

an old system called mercantilism. It should be seen in that context.

Early mercantilism

Mercantilism has a long history. The term is commonly applied to

national economic policies that encourage exports and discourage

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Histor ica l a ntecedents 15

imports. The ultimate goal is to produce a trade surplus. Such pol-

icies were roundly condemned as long ago as 1776 by Adam Smith in

The Wealth of Nations.

Smith advocated free trade of complementary products among

nations. But as we have already noted, very few statesmen are will-

ing to leave economic development hostage to the vagaries of the free

market when vital national interests are at stake.

Mercantilism as a policy was widely practiced from the seven-

teenth to the nineteenth century, particularly as countries with

agrarian economies sought to industrialize. It protected fledgling

domestic industries from being crushed by outside competition.

Governments would provide state support to build locally important

industries where the market risk was very low and the technology

well established. Once these industries had succeeded in replacing

imported products, the state could then promote exports and hope-

fully generate a trade surplus.

Does this sound familiar? It should. Classic mercantilism

bears a striking resemblance to policies being pursued by developing

countries to this day, including China.

Colbert launches modern French industry

Mercantilist policy was first deployed on a large scale by Jean-Baptiste

Colbert (1619–1683), finance minister of France for twenty-two years

under Louis XIV.

Leopold I expressed pride in the growing prosperity of his

Austrian subjects. Whether Colbert worried much about the wel-

fare of his fellow Frenchmen is highly debatable. What is certain is

that Colbert’s big problem was financing the aggressive wars of his

king.3

Four years after Louis XIV personally took over the reins of

government in 1661, he chose Colbert to rescue France from near

3 For a summary of Colbert’s career and influence, see I. Murat, Colbert (Paris: Librairie Arthème Fayard, 1980), pp. 225–263.

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Gover nment: Boss, fina ncia l pa rtner, r egulator16

bankruptcy, mostly brought on by previous military adventures. But

this did not stop the “Sun King” from enmeshing France in conflicts

of his own making. In the succeeding fifty years of his reign France

was involved in three major and two minor wars, creating a nearly

constant need for cash.

During this era soldiers and foreign allies had to be paid in

gold and silver. Since France lacked mines for precious metals, the

only way to accumulate bullion was by building a trade surplus, and

the structure of the economy made that impossible. French industry

was underdeveloped and backward, in the hands of small craft enter-

prises that simply could not compete in international markets.

Colbert decided to fix the problem by building industries such

as glass and textile manufacturing. His plan was to restrict com-

petitive imports and promote exports of exceptionally fine products.

In this way he could generate a trade surplus that would bring a net

inflow of foreign gold and silver into France.

Ruthless, determined, able, and in full control of the finances of

France, he poached craftsmen and entrepreneurs from various coun-

tries by offering highly attractive incentives to set up shop in France.

Many of the resulting businesses were granted “Royal Privilege,”

which meant that they received state funding, paid no taxes, and

were guaranteed government orders for their products.

Colbert expected that such new businesses would become inde-

pendent of state support as their products became commercially suc-

cessful. But this was a slow process. He was known to complain of

continuing demands by entrepreneurs for new funds to cover operat-

ing losses. If you were a favored entrepreneur in Colbert’s France, you

did very well. Why not hold onto your perks as long as you could?

The new companies built large factories with over 1,000 work-

ers – something new in France at the time. Their workers lived in

dormitories and were paid minimal wages. The working day was

between fourteen and sixteen hours, and the only days off were reli-

gious holidays. Colbert complained to the Roman Catholic author-

ities that there were simply too many of those.

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Histor ica l a ntecedents 17

Labor was cheap because France was blessed, if that is the

word, with a large population and significant unemployment in its

rural economy. Colbert had enough foresight to ensure a continued

supply of cheap labor by encouraging early marriages – women were

expected to marry before the age of twenty.

Having pirated technical expertise from other countries,

Colbert worried about losing what our era calls “intellectual prop-

erty” by the same means. He took draconian steps to prevent it. Once

in France, skilled craftsmen could not leave the country. Severe pun-

ishments awaited those caught fleeing – from a sentence of rowing

in one of the King’s galleys to the death penalty.

For Colbert’s program to succeed, French products had to win

international customers. To ensure that the new industries produced

the highest quality goods, Colbert established a corps of state-funded

industrial inspectors who were tasked with checking the quality of

products. Delinquent producers were penalized and publicly pun-

ished for repeated lapses in quality.

At the same time he made sure that the industries he was build-

ing were protected from outside competition until they were ready

to compete in the international market. For example, the importing

of Venetian glass was forbidden in 1672. And woe to the entrepreneur

who attempted to evade his trade and quality controls. His techno-

crats were said to have had over 15,000 small entrepreneurs executed

for the crime of importing or manufacturing cotton cloth in viola-

tion of French law.

Colbert did not limit his attention to manufacturing. He was

also anxious to compete with the Dutch in international trade,

which they dominated. To that end Colbert promoted the construc-

tion of a merchant navy, and gave preference to its ships for French

trade. To discourage competitive transport, high fees were placed on

foreign vessels visiting French ports.

By most measures Jean-Baptiste Colbert was a thoroughly

nasty man, widely hated within and outside France. But he launched

the country on the path of large-scale industrialization. Under his

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Gover nment: Boss, fina ncia l pa rtner, r egulator18

compulsion French industry became renowned for its quality, par-

ticularly in such luxury products as silk fabrics, tapestries, and fine

glass. In these areas French products came to surpass any goods pre-

viously available on the international market.

Many famous company names in France date from this era,

including the tapestry maker Gobelin and the glass maker Saint-

Gobain. In 1688 a Venetian ambassador wrote that “such is the qual-

ity of the French products that they are the best in the world and

attract orders from all countries.” Colbert’s policies were successful

in at least sustaining the finances of France in spite of the country’s

being in an almost continuous state of warfare.

Colbert’s basic approach held sway in France for some time after

his death. In the eighteenth century French industry benefited from

government attempts to attract English technicians and entrepre-

neurs. France sent agents on undercover missions to England to recruit

people and collect commercial secrets, particularly those dealing with

production machinery and metallurgical processes. For example, the

first English steam engines were secretly imported into France.

In 1779 the ice between France and England thawed consider-

ably as the two countries signed agreements allowing the French to

import steam engines openly. Bilateral agreements covering other

products were also negotiated, but true free trade was far in the

future. Entrepreneurs who followed the rules had done well under

tight government control, but free trade was something better to

look forward to.4

In fact, it was in 1846 that England led the way to a national

free-trade policy by removing the restrictive Corn Laws and easing

its control of the export of advanced technology. By the 1860s prac-

tically all restrictions on imports were gone. At that time England

4 This presentation draws on the wealth of historical information found in J.-C. Asselain, Histoire économique de la France du XVIII siècle à nos jours (Paris: Éditions du Seuil, 1985), pp. 77–105; A. Malet and J. Isaac, XVII and XVIII Siècle (Paris: Librairie Hachette, 1923), pp. 190–194; and Murat, Colbert, pp. 249–261.

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Moder n merca ntilism 19

had such a huge industrial lead on other countries that it could afford

to be generous and open its market. It did not anticipate that imports

would ever threaten domestic industry. Other countries trying to

catch up continued to play by more restrictive trading rules – and

are doing so still.

Modern mercantilism

You might ask why we are spending so much time on mercantil-

ism and its history in a book on the modern global entrepreneur.

The simple answer is that today’s entrepreneurs operate in a world

where governments increasingly control economies, a defining fea-

ture of mercantilism over the centuries and one that will not dis-

appear quickly.

This reality shapes the economic decisions made by business

people and entrepreneurs as they seek markets and business partners

in countries with diverse economic agendas. To fully understand its

implications, it is necessary to see it in a historical perspective.

For the same reason we must also take some time to discuss

China, by far the most prominent of modern countries with controlled

economies. China has the second largest – and fastest growing – econ-

omy in the world. What happens there, in consumer or industrial mar-

kets, has a huge impact on the direction of all global business.

Industrializing Asia

We are witnessing an economic revolution in Asia, affecting billions

of people. Countries in that region are striving to industrialize as

quickly as possible. Given the pressure to make rapid progress and

the top-down structure of many of their economies, it is not surpris-

ing that Asian countries would adopt mercantilist methods.

Indeed, we are living in the golden age of broadly defined mer-

cantilism. It is currently being practiced in a highly developed form,

on a scale unprecedented in history, by China. The world’s most

populous country has embarked on a path to industrialization that

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Gover nment: Boss, fina ncia l pa rtner, r egulator20

in some ways mirrors the journey of France under Colbert, using

some of the same strategies. Its astonishing success has prompted

other countries to learn from its example and shape their trade pol-

icies accordingly.

Long relegated to the ranks of a “third-world” country with a

primarily agrarian economy, China has vaulted into a position of eco-

nomic leadership in just forty years. The ruling Communist Party

still controls the land, much of the economy, the military, foreign

policy, and whatever else is of major importance to the country. But

the highly pragmatic Party has abandoned some communist prac-

tices and embraced a number of capitalist methods without relin-

quishing political control.

Perhaps the biggest difference between China and the devel-

oped West is that the state owns all of the country’s banks, either in

part or in whole. It also controls their activities, and can therefore

channel capital to meet its industrial objectives.5 China’s reluctance

to allow banks to operate outside of government control is as much a

matter of history as it is of ideology. The country suffered through a

long period of weakness and foreign intervention, and its government

is determined to keep it free of foreign economic domination.6

Within China the most obvious sign of the success of these pol-

icies is plain to see. Visitors are frequently amazed at the quality and

quantity of public facilities that have been built in the past couple of

decades. Indeed, the development of a modern infrastructure is a key

element of comprehensive state plans for industrial development.

Of course the government of China had some powerful advan-

tages in its rapid construction of the infrastructure to support a

modern economy. In addition to absolute control of the country’s

5 For an excellent review of the Party’s role, see D. Shambaugh, China’s Communist Party: Atrophy and adaptation (San Francisco, CA: University of California Press, 2010). Also, R. McGregor, The Party: The secret world of China’s Communist rulers (New York: HarperCollins, 2010).

6 H. Jones, Chinamerica: Why the future of America is China (New York: McGraw-Hill, 2010) contains a good overview of Chinese economic practices and policies.

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Moder n merca ntilism 21

finances, the government owns all the land. Hence it can develop

roads, airports, railways, and public structures without the legal

restrictions found in countries where land is in private hands. It can

also set arbitrarily low lease rates for land to stimulate the build-

ing of factories and other facilities wherever and by whomever it

chooses.

China’s emergence as an economic power is not accidental. It

is based on long-term development plans drawn up by government

authorities in order to

preserve Chinese control over key domestic industries and the economy;• promote exports and create a trade surplus;• acquire modern technology; and• build a domestic industrial base capable of innovation.•

Developing nations are watching China’s amazing progress very

closely. As more countries adopt various aspects of its approach,

entrepreneurs in the global marketplace will have to make adjust-

ments to economic systems in which mercantilism is flying high

and the government is in the pilot’s seat. It is worth looking more

closely at what they face in China, and may encounter in the other

countries that it influences.

Mixed ownership, tight control

China’s economic policy permits a mix of ownership models: pri-

vately owned businesses, joint ventures with foreign investors and

corporations, and businesses that are fully government owned and

funded. Regardless of ownership, foreign trade by all of these busi-

nesses is controlled by the government. Needless to say in a country

where the currency is tightly regulated, access to foreign exchange

is also strictly controlled.

Some businesses in non-strategic consumer industries,

such as textiles, services, and retail, may be fully owned by for-

eign investors, but restrictions exist on investment and cap-

ital repatriation. Large companies in industries deemed critical,

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Gover nment: Boss, fina ncia l pa rtner, r egulator22

including telecommunications services and banking, are either fully

government-owned or have majority government ownership. Even

when these vital companies are publicly traded, the government

maintains significant ownership and ultimate control.

Fifty-four state-owned enterprises, including China Mobile,

Petro China, Sinopec, and China Electronics Corporation (CEC), are

considered “backbone” companies. To get an idea of the scale and

scope of these enterprises, consider the fact that CEC, which was

established only in 1989, today has 70,000 employees.

While control remains with the parent company, CEC owns

fourteen subsidiaries that are publicly listed and have some degree of

public ownership. These businesses cover software, computers and

computer components, and consumer electronics products. Some of

these companies rank among the world leaders in their product cat-

egories. They include joint ventures with foreign companies such

as HP, IBM, and Philips who contribute their technology. With rev-

enues in excess of $10 billion annually, CEC is a big technology con-

glomerate with the resources to address new business areas.

As would be expected in such an economy, exporting for the

purpose of acquiring foreign exchange is a key objective of state plan-

ners. In this they have been markedly successful. Much to the chag-

rin of its trading partners, China runs a large trade surplus. A major

reason for this success is the number of foreign companies that have

moved their production to China. The products from these trans-

planted factories are exported under their original brand names.

Like Colbert’s France, China’s government offers significant

incentives to attract foreign manufacturing: a modern infrastruc-

ture, a disciplined low-cost labor force, and significant financial

inducements for companies that locate factories in areas of the coun-

try designated for development. It is enough to convince many com-

panies that previously manufactured in Europe, Japan, or the US to

move their equipment into Chinese plants.

China benefits from its new status as the world’s factory in

three ways.

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Moder n merca ntilism 23

Transplanted manufacturing plants churn out products for which there • is already worldwide demand, building exports at minimum risk.

These plants provide employment for many millions of Chinese workers.• Last but not least, they bring the latest technology into China, helping • it acquire the skills and knowledge to compete on its own in the

international market.

By some estimates as much as 70 percent of the exported products

from China are from such transplanted manufacturing plants.

To take one prominent example, most Apple® products are

assembled in China, using imported and locally manufactured com-

ponents. In some cases the factories where they are produced are joint

ventures with local companies; in other cases the manufacturing is

done by contractors such as Foxconn. Either way, it is estimated that

over 100,000 workers are employed in manufacturing Apple prod-

ucts alone. These wildly popular products are sold worldwide under

the Apple brand, helping boost China’s burgeoning trade surplus.

Foxconn, a huge company ($80 billion of annual revenues in

2009) of Taiwanese origin, exemplifies the importance of transplants

to the development of China’s economy and its workforce. Foxconn

is a contract manufacturer of electronic products not only for Apple,

but for HP and other major international brands.

The company has built virtual dormitory cities for its Chinese

workers. One such location, in Shenzhen, houses over 300,000 work-

ers in a sprawling compound. Since factories draw their low-wage

workers from rural areas, owners have to provide the workers with

access to affordable housing near the plants.

Building domestic industries

Infrastructure, employment, exports: all are prerequisites for a mod-

ern industrial economy. But other bricks are needed to build a stable

industrial base. While transplants contribute to growth, they are no

substitute for home-grown industry.

China’s leaders, anxious to make sure that foreigners do not

control key industries, made the development of domestic industry

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Gover nment: Boss, fina ncia l pa rtner, r egulator24

a state policy, as one analyst has noted. “In the late 1990s increas-

ing dependence on foreign companies led Beijing to build strong

national industries in the protected shell of the domestic market.

But then excess capacity and reliance on foreign consumer markets

impelled Beijing to strive to make its national champions truly glo-

bal and to back them with an assertive trade policy.”7

Its success in turning these companies into effective global

competitors was and is helped by the use of foreign-developed tech-

nology from foreign firms seeking access to the potentially large

Chinese market. Since many are restricted from doing business on

their own in industries deemed critical to the state, foreign com-

panies have to participate in joint ventures within China, which

involves a sharing of their expertise.

It works like this. As noted above, China may allow minor-

ity foreign ownership in a China-based company. There is a better

chance of this happening if the local company can acquire state-

of-the-art technology as part of the deal. In this scenario foreigners

benefit economically from the domestic market, but without hav-

ing total control of the venture or of their intellectual property.

For example, GE has made minority investments in local com-

panies that produce wind turbines for power generation – an indus-

try that Chinese authorities deem critical as they seek to build world

leadership in this new technology. GE is expected to contribute its

own technology to the joint venture.8

Chinese authorities have also targeted electric automobiles

as a crucial product for the country’s industrial future. Here, too,

they are looking to foreign firms for technology that could give

them a leadership position. “China’s government is considering

plans that could force foreign auto makers to hand over cutting-edge

electronic-vehicle technology to Chinese companies in exchange for

7 J. Holsiag, “China’s flexing of its muscles is a sign of weakness,” Financial Times, September 28, 2010, p. 13.

8 See P. Glader, “GE in China wind-power venture,” The Wall Street Journal, September 28, 2010, p. B3.

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Moder n merca ntilism 25

access to the nation’s huge market, international auto executives

say.”9

But the imported technology does not generate products

strictly for domestic consumption. For example, Japanese and

European companies that pioneered high-speed train technology

and shared it with Chinese companies are now facing competition

from the Chinese products in international markets.10

Overseas companies find access to China’s immense and

increasingly affluent market a powerful argument for sharing their

expertise, but the country needs to develop its own technology if it

is to build a competitive industrial sector. To that end, government

planners are working to generate domestic innovation by funding

research institutes and universities.

In addition, the authorities are pushing local companies to

invest in research and development. This investment rose from 0.5

percent in 2004 to 1.8 percent in 2009. When a new industrial activ-

ity needs to be developed to meet a market need, state funds are

available and every effort is made to build plants for mass produc-

tion. This ensures that new technologies are not neglected.11 China

now ranks among the top four largest generators of patents after the

US, Japan, and Germany.12

The effort is paying off. Some newly created corporations in

technology sectors have already become world leaders. For example,

Huawei Technologies, established in 1988, is now one of the lead-

ing manufacturers of advanced telecommunications and networking

equipment, with over $30 billion in annual sales in 2011. Huawei

successfully competes globally against established vendors such as

Alcatel-Lucent and Ericsson.

9 N. Shirouzu, “China spooks auto makers,” The Wall Street Journal, September 17, 2010, p. A1.

10 N. Shirouzu, “Train makers rail against China’s high-speed designs”, The Wall Street Journal, November 18, 2010, p. A1.

11 J. Dean, A. Browne, and S. Oster, “China’s state capitalism sparks a global back- lash,” The Wall Street Journal, November 16, 2010, p. A1.

12 IEEE Spectrum, July 2011, p. 68.

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Gover nment: Boss, fina ncia l pa rtner, r egulator26

Follow the leader

You can debate whether a top-down, controlled economy can con-

tinue to prosper into the indefinite future. It is easy enough to point

to basic weaknesses including a neglect of environmental condi-

tions and overbuilding of certain industries. We can point to plenty

of examples in other countries where bureaucratic incompetence

sooner or later impedes progress.

However, the emergence of China has changed global trade

patterns. It is hard to think of an industry that is not affected by

competitors from China or by the promise of sales of its products to

China. Hence the importance of China to entrepreneurs with ambi-

tions to become global players.

China’s success also encourages other industrializing coun-

tries such as Malaysia, India, Brazil, Thailand, and Vietnam to step

up their own national initiatives to woo manufacturing sites from

the developed countries with subsidies and other incentives.

Vietnam’s case is especially interesting. It too is a country con-

trolled by a monolithic Communist Party but open to foreign capital

and technology importation. Foreigners are investing in the country,

setting up factories that once upon a time would have gone to China.

Two-thirds of the economy is now in private hands (but with state

supervision); the remaining third consists of state-owned corpora-

tions in industries deemed vital by the authorities. In general terms

Vietnam is closely emulating the Chinese model.

However, the government is dealing with the same problem that

has bedeviled other mercantilist countries, starting with Colbert’s

France: state-owned companies can easily become unprofitable, for-

cing taxpayers to cover their losses. This has been the case with the

Vietnam Shipbuilding Industries Group, which ran up multi-billion

dollar debts while its operating losses ballooned.13

13 J. Hookway and P. Barta, “A troubled state flagship makes waves in Vietnam,” The Wall Street Journal, September 22, 2010, p. C1.

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Moder n merca ntilism 27

In spite of this risk, the model of combined state and private

ownership is spreading. For example, Brazil is funding the construc-

tion of dams to generate power through such companies. A dam built

to generate 11,200 megawatts, begun in 2010, is 49 percent owned by

the government-controlled Eletrobras. Its total cost will be BRL 20

billion. The rest of the funds came from non-direct state sources and

private investors. The demand for power is stimulating the interest

of investors, with the government coming in when such generating

capacity or transmission needs are not met by private capital.14

Heavy-handed government doctoring of the economy, admin-

istered with an (un)healthy dose of good old-fashioned mercantilism,

can act as a quick tonic for an underdeveloped industrial sector. It

is not only developing countries that are tempted to self-medicate

in this way. In developed countries where jobs are disappearing, dis-

gruntled citizens are alarmed, and political pressure is building to “do

something,” politicians are equally susceptible to the lure of more

government intervention. We return to this subject in Chapter 10.

Among the public, a commitment to free trade is usually the

first victim of the malaise. The call for tariffs to deter low-cost

imports has become ever louder in countries that, like the US, have

suffered a loss of industry. A recent survey shows a marked deterior-

ation in US public opinion regarding free trade agreements, accord-

ing to The Wall Street Journal. In 1999, only about 30 percent of the

people polled believed that free-trade agreements hurt the US econ-

omy, while in 2010 over 50 percent thought such agreements hurt

the country. Even more significant is that only about 15 percent of

the people believed that such agreements were helpful.15

Given this level of disapproval on the part of the public, we

should not wonder if politicians engage in ever louder saber-rattling

over tariffs and trade deficits in the coming years.

14 P. Winterstein, “Brazil power will still see state pressure under Roussseff,” Dow Jones Newswires, September 2010.

15 S. Murray and D. Belkin, “Americans sour on trade: Majority say free trade pacts have hurt the US” The Wall Street Journal, October 4, 2010, p. A1.

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Gover nment: Boss, fina ncia l pa rtner, r egulator28

Implications for entrepreneurship

The changing world economic order has enormous implications for

entrepreneurs everywhere. The greater the degree of government

control and willingness to finance and protect industries, the harder

the task is for independent entrepreneurs reliant on private funding.

Such policies affect access to markets and capital. And, most trouble-

some, government-protected competitors can behave irrationally, as

they are not subject to normal market forces.

We live in a world where the fastest-growing economy is the

one where the government has the most control. This has encour-

aged other governments to become more involved in their economies

in the hope of encouraging competitive new industries and defend-

ing established ones. Ours is also a time when trade barriers are

likely to grow.

How do entrepreneurs feel about building their businesses in

this environment? It depends on where they are, and where the best

market for their products is located. We look first of all at the effects

on a Chinese entrepreneur.

While China’s planners are not dependent on domestic entre-

preneurs to build the country’s economic muscle, there is ample

opportunity for entrepreneurship in industrial sectors that don’t

compete head-on with state enterprises. There is even a growing

venture capital industry there to finance such new businesses. Some

of this activity is financed by foreign capital looking for high returns

in a fast-growing economy.

Indeed there are investment opportunities available. A growing

number of independent entrepreneurs, as opposed to state-appointed

managers, are now creating big businesses. For example, the largest

group of Chinese electronics retail stores, Gome, was started by a

private entrepreneur. He was reputed to be the richest man in China

after the company had a public offering of its securities in the Hong

Kong exchange. We will discuss three other Chinese startups in

Chapter 8.

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Implications for entr epr eneurship 29

As an independent entrepreneur in China, you would welcome

the government’s financial help. In fact, a survey of entrepreneurs

in China suggests that many count on some kind of government

support for their success.16 But you would have to learn to deal with

state planning policies.

For example, 2010 was the last year of a national Five Year Plan

that called for a 20 percent reduction in energy use per unit of GDP

to reduce pollution. As a result, if you are an entrepreneur running

an energy-intensive manufacturing business, you might find that

the power available to your factory has been reduced or even shut

down by the local power utility. Such cutbacks actually occurred in

2010, reducing the production of materials such as polysilicon used

to manufacture solar cells.

Your only alternative would be to buy diesel-powered electrical

generators. Of course, their exhausts will add to air pollution – dir-

ectly negating the intent of the Five Year Plan. But that is not your

problem.

Now, let us imagine that you are an entrepreneur in the US.

You are likely to wish for freedom from all government interference.

Here is a classic statement of this position from two US entrepre-

neurs, published as a letter to the editor in The Wall Street Journal:

“In our experience [as entrepreneurs] the very last group we would

appeal to for help with a new venture would be a federal bureaucrat.

We thus feel the best way to revive the US economy and revitalize

the past ability to innovate would be to cut government spending,

regulation, and taxation.”17

While such total independence is praiseworthy in principle,

it simply isn’t practical in the real world. Entrepreneurs aiming to

build major enterprises have no choice but to have a global strat-

egy and they cannot do it just on the merits of their products. This

16 R. Steeter, “Asian entrepreneurs are bullish on the future,” The Wall Street Journal, August 6, 2010, p. A13.

17 Letter to the editor by R. Gamblin and K. Borgh, The Wall Street Journal, September 18, 2010, p. A14.

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Gover nment: Boss, fina ncia l pa rtner, r egulator30

means they may have to accept from the US government such “help”

as tax rebates, licenses, access to loans, or financial assistance with

exports if they are to succeed.

For example, if you want to sell your products in a country

where government restrictions limit imports, you will certainly

welcome US government help in opening such markets. You will

also be happy to accept its help in protecting your intellectual prop-

erty. And you will also welcome new business opportunities created

by government mandates.

Here is an interesting example of how a US government man-

date helped launch a new business. Telnet was arguably the first

commercial packet switching network service provider. In the mid-

1970s, it started offering dial-up modem access to central packet

switches that provided email and, later, file transfer services.

Telnet subscribers accessed these services through local wire-

line telephone networks, which created a problem. In some states the

telephone rates are flat or fixed, while in other states they are priced

on usage. There were long holding times for data sessions, amount-

ing to tens of minutes or even hours, and customers who paid by

usage complained about their charges. Telnet lobbied for relief with

the Federal Communications Commission (FCC).

Eventually the FCC created what it called Special Access,

which mandates that third-party service providers can pay the local

telephone carrier to provide space in the telephone end office for their

equipment (modems, multiplexers, routers, and management equip-

ment). In return they got local phone numbers at that end office and

a flat rate for these services. AOL was arguably the most successful

of all Internet service providers in exploiting special access, mailing

tens of millions of CDs to potential customers, and signing up mil-

lions of subscribers.

Special access is now offered in over fifty countries around the

globe, with other countries adopting what was arguably a great suc-

cess in the US in stimulating novel data communication services.

Today it is being used increasingly for voice communications via

packet switching, a development unforeseen in the 1970s.

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Implications for entr epr eneurship 31

All of the companies that benefit from this cost structure

owe a debt of gratitude to a government agency for creating it. It is

an excellent example of how, instead of crying about government

“interference,” smart entrepreneurs learn to take advantage of such

actions. They adapt in ways that allow them to profit from all oppor-

tunities, including government assistance, which support innova-

tive business models and help pay for new technologies. That is what

they have done throughout history. (We will return to these issues

later in the book.)

Working with the system

Just because countries have restrictive industrial policies does not

mean that there is no market in those countries for innovative prod-

ucts from abroad.

For example, advanced semiconductor devices essential for the

manufacture of electronic products are freely imported into China

and other countries that lack internal competitive resources. This

policy enables new companies from other countries to build their

sales at attractive prices. We will discuss one such entrepreneur-

ial company, RMI (Chapter 5), which became a leading exporter to

China of advanced chips for its communications industry. We will

also discuss Aicent (Chapter 9), a Silicon Valley-based company,

which sells telecommunications services in China.

It is always satisfying to declaim about freedom from govern-

ment intrusion, but it should not be forgotten that, even in the US,

government programs have generated opportunities that spurred

the creation of major new industries. US government policies have

enabled huge investment opportunities in telecommunications, the

Internet, and alternative energy production, to name only the most

important recent examples.18

18 For a fuller discussion of this topic see H. Kressel and T.V. Lento, Investing in dynamic markets: Venture capital in the digital age (Cambridge: Cambridge University Press, 2010), especially chs. 1, 4, and 6.

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Gover nment: Boss, fina ncia l pa rtner, r egulator32

In telecommunications, for example, the deregulation of

the US industry in 1996 and the opening to newcomers of what

was once a monopoly field enabled the formation of entrepreneur-

ial companies that eventually grew to be worth many billions of

dollars. Similar deregulatory steps in other countries also led to

the growth of extremely valuable businesses in services and in

advanced hardware and software products. Following deregulation,

the US government played a key role in allocating wireless spec-

trum to companies and regulating its use. This in turn impacted

the development of technology to use this spectrum in wireless

communications.

The growth of the Internet is, if anything, a more striking

instance of beneficial government support. Originally developed

with government funding, its implementation, coupled with

nearly universal access to broadband communications by con-

sumers, enabled an almost infinite number of new businesses

offering products and services on the Web. The opportunities

ranged from commerce (Amazon.com, for example), to auction

sites (eBay), software on demand (Salesforce.com), and social net-

works (Facebook.com).

Our third example of a government initiative in the US (and

many other countries) that holds promise for entrepreneurs is the

fostering of energy generation that uses non-fossil fuels. Hundreds of

new companies have been formed to develop and manufacture solar

energy sources, wind-driven generators, and biomass sources. They

depend on subsidies created by government policies to insure the

commercial viability of these alternative energy sources. Without

government “meddling” many of these new businesses would not

exist. Whether these investment opportunities are good ones depends

on many factors, and we return to this subject in Chapter 10.

Of course government involvement in the economy has a

downside as well as an upside. The bounty of opportunities opened

through government initiative is accompanied by legal challenges

with the potential to kill new businesses.

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Summing up 33

Nowhere is this more apparent than in the case of the Internet,

where enormous business potential exists side by side with obstacles

for entrepreneurs to overcome.

To name one such challenge, the issue of Internet privacy pits

new businesses against government regulations. One of the com-

mercial services enabled by the Internet, now being widely exploited

by new entrepreneurial companies, is the ability to track the online

behavior of individual consumers for the purpose of improving the

ability to sell them products.

Its use is being challenged as an intrusion of privacy: “Since

July 2010 at least six suits have been filed in the US District Court

for the Central District of California against websites and compa-

nies that create advertising technology accusing them of installing

online tracking tools that are so surreptitious that they essentially

hack into users’ machines without their knowledge.”19

Summing up

The world order is being fundamentally changed and entrepreneur-

ship must adjust accordingly.

Here is a comment by one observer regarding our new

situation.

Two-thirds of the world’s people live in countries that are

growing fast. Unfortunately, the one-third of the world’s

population living in [relative] stagnation includes the US, Japan,

and Western Europe, which contribute disproportionately to

world GDP – for the time being. The source of the growth is the

great migration from rural poverty to urban prosperity, perhaps

the greatest engine of economic expansion in history. But

this sort of growth implies great disruptions in the economic

life of many countries; it arises from a shift in the world

19 J. Valentines-DeVries and E. Steel, “Cookies cause bitter backlash: Spate of lawsuits shows user discomfort with latest innovations to online tracking tech- nology,” The Wall Street Journal, September 20, 2010, p. B1.

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Gover nment: Boss, fina ncia l pa rtner, r egulator34

economic structure, not incremental expansion of the existing

structure.20

Under such conditions, entrepreneurs need to learn to suc-

ceed in international markets, where each government has its own

set of rules. And, rules there will be, as countries intensely com-

pete to defend their industries and nurture new ones on the basis of

innovation.

National industrial policies have historically been condemned

by many people as infringing on their liberties within countries

founded on the principles of “free enterprise,” such as the US. Yet

today political pressure in these same countries is intensifying to

build import barriers, promote exports, and find new ways for gov-

ernments to promote the creation of new, innovative industries to

replace the mature ones that have migrated to countries with lower

labor and capital costs.

This is precisely the situation in which, more than ever, we

need entrepreneurs to stimulate economic growth. Calling for more

entrepreneurship in an era of big government may seem counter-

intuitive, but it is actually the most desirable way to generate eco-

nomic growth in the developed countries of the world.

In short, we need both private entrepreneurial and public ini-

tiatives to advance economic goals. In the next chapter we discuss

the role of entrepreneurship in achieving that objective.

20 D. P. Goldman, The Macro Strategist, from [email protected] – September 19, 2011.

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