Entrepreneurship: Inequality Solution?

By Robert VerBruggen

James Pethokoukis writes, in a post titled "The solution to income inequality and immobility? It’s been right in front of us all along":

In Average is Over, economist Tyler Cowen depicts a future where the tech-savvy 15% get fabulously wealthy, while the rest of us make do with flat wages and free online games. ...

Ex-banker and current entrepreneur Ashwin Parameswaran offers this alternative to redistribution, which he succinctly and brilliantly summarizes thusly: “Instead we should empower the low and medium wage earners of today to become the capitalists of tomorrow whilst protecting them with a safety net that protects them as individuals rather than protecting the firms and unions that they are members of.”

In short, capitalism for the masses.

Parameswaran points out that it’s never been so easy to start a business, and it’s only going to get easier. First, the explosion and success of crowdfunding and peer-to-peer lending, he explains, “shows us that speculative equity ventures and business loanss can and are being funded by the man on the street.” Second, technology has also made turning a concept into a business simpler than ever — and not just social networking. Whether its using manufacturers in Asia or 3-D printers here at home, even the little guys can move from their bright idea from thought to physical product.

In regards to mobility, I have an optimistic point and a pessimistic point to make about this. Both will involve charts from this Brookings Institution report, and they will lead, unfortunately, to a rather pessimistic conclusion. I'm pretty skeptical in regards to inequality, too.

Here's the first chart, which I've posted on this blog before:

Basically, what this shows is that cognitive skills (measured through the AFQT, which is similar to an IQ test) don't fully overcome the effects of having rich or poor parents. Highly skilled poor kids struggle a lot more than highly skilled rich kids do. Greater opportunities to start or invest in businesses could help these children climb, aiding the cause of mobility.

Unfortunately, there's something that this chart doesn't show: how many poor kids even have decent cognitive skills, which are rather helpful when it comes to making money in the business world, whether by starting a business or by picking good businesses to invest in. It turns out that by their late teens about 60 percent of poor kids score in the lowest third of cognitive ability, while fewer than 15 percent of them score in the top third:

So, the opportunity here is rather limited: Easier business creation could help the subset of poor children who have the skills to benefit from it and yet don't manage to escape poverty in the current system. Those kids matter, but helping them is not the same as solving immobility. You can respond to this with "But we're going to fix education, so everyone can start businesses!" -- and, well, good luck with that. About 25 percent of Americans still don't graduate high school, and I've presented evidence that a sizable proportion of high schoolers find basic algebra highly difficult.

And what about the broader picture of inequality -- ignoring the link between parents and their children, how will this affect the distribution of income within society? Again, a large proportion of the lowest-income people won't really have access to these opportunities because they lack the skills needed to start businesses or pick investments that earn money on net. And it's worth reiterating the argument of Average Is Over in this context, to rule out a trickle-down effect: There will be no reason for businesses, including the businesses started through these new methods, to hire low-skilled people instead of buying robots.

I'm not sure how the rest of society will fare inequality-wise, either, because these ventures have a winner-take-all element to them -- both for the people starting the businesses and for the people putting up the money. There's a reason that smart investors, especially those of limited means, go with index funds rather than choosing a bunch of specific businesses to invest in.

A great majority of businesses fail within the first few years, some scrape by with small profit margins, and only a few become phenomenally successful; this is not exactly a recipe for reducing inequality. I suppose if rich people put up the money while talented poor and middle-class people take salaries for a few years before the businesses fail, that could be a good thing in itself. But it's hard to predict how all that will shake out, and the article Pethokoukis links to stresses that non-rich people's risky investments are key to this vision of "capitalism for the masses."

It's also very possible these businesses will merely amplify existing inequalities: The smartest people with the richest parents might be best positioned to make money through these new channels, too, while other people tend to stay out -- or to lose money, sometimes large sums of it. It's a lot easier to take some time off for a risky venture if Mom and Dad will pay your rent while you get situated, and it's easier to put together a high-risk investment portfolio with extra trust-fund money than with small, hard-earned paychecks.

It's terrific that it will become easier to start businesses. It might even help some talented poor kids improve themselves. But if Tyler Cowen is right that average will soon be over, we should be worrying about the people who are not talented -- and we can't forget that starting a business comes with as much risk as it does reward.

Robert VerBruggen is editor of RealClearPolicy. Twitter: @RAVerBruggen

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