May 2, 2008 | posted by Michael Baxter in IABN |

The world’s largest economy got off to an awful start.      The first-ever English colony in North America, Roanoke Colony on Roanoke Island failed in the most spectacular fashion.  It was founded in 1587 by 100 men and women in a venture fronted by Sir Walter Raleigh.  A few years later the colony was gone – no one knows why, or what happened to the intrepid explorers and extraordinary risk takers who gave their lives to the mission.  The country we know today as the United States of America was built upon this failure.    But in a way, things have not changed.  According to Paul Ormerod in his book, Why Most Things Fail, “more than 10 per cent of all economically active firms in the US go extinct within a year.” 

Risk taking is endemic to the US – maybe it is what makes the country the success it is, but on the other hand, maybe risk taking has become far too great.

As was told here yesterday, it appears there is just a chance that the credit crunch has passed the halfway mark.  Now is perhaps the time to contemplate our navels, and reason what really caused it and how a similar crisis can be avoided in the future?

Yesterday, the National Institute of Economic and Social Research claimed that one factor that may have helped create the finance crisis was a too relaxed attitude to failure.

As was told here on Tuesday, the high profile buy-to-let investment seminar group Inside Track went into administration this week.  Well, apparently, one of its founders ran a pyramid selling company which went bust in the 1980s – and NIESR seems to think this is significant, and yesterday drew attention to the 2002 Enterprises Act which was introduced to remove the stigma from honest failure and facilitate serial entrepreneurship.     

But many have argued this act has backfired, and has made the penalties for bankruptcy too lax – a factor, some say, that lies behind the recent surge in insolvency levels.

NIESR then turned its attention to the US, where bankruptcy laws are, or so it says, extremely lax.  US bankrupts can keep a minimum $125,000 housing equity – for example.

Maybe the fast and loose approach the US took to failure was a big factor behind the credit crunch.  NIESR says, for example, “International co-ordination of bankruptcy law is needed and laws need to be changed in countries like the US with poor practices which encourage excessive risk.”

NIESR is run by some extremely clever economists. Its Director Martin Weale is deservedly one of the most respected economists in the land, and there is no doubt that laws relating to entrepreneurism are important.   But are the laws really too lax?

In the US, entrepreneurs are often hailed as heroes – and those first settlers from Roanoke Colony were the first.

And now, follow Raleigh and the later colonists on board the Mayflower, mentally travel the Atlantic and consider this argument put forward by Newsweek economics editor Stefan Theil. 

“Just as schools teach a historical narrative, they also pass on “truths” about capitalism, the welfare state, and other economic principles that a society considers self-evident. In both France and Germany, for instance, schools have helped ingrain a serious aversion to capitalism. In one 2005 poll, just 36 per cent of French citizens said they supported the free-enterprise system, the only one of 22 countries polled that showed minority support for this cornerstone of global commerce. In Germany, meanwhile, support for socialist ideals is running at all-time highs—47 per cent in 2007 versus 36 per cent in 1991.”

Mr Theil was contrasting US with European attitudes to entrepreneurism.  He has argued that the likes of Brin and Page –that’s the Google boys, and Bill Gates are held up as heroes in the US.     Steve Jobs walks on water, and Warren Buffett has a halo that shines so bright you would need very dark glasses if you should ever visit Omaha.

And here is a question for you to ponder.  Who was the greatest economist of the 20th century? Well that is an easy one – Keynes of course.   Well, maybe, but some would argue that actually that epitaph should belong to someone else, an Austrian, seldom talked about in the UK, but revered by many in the US - Joseph Schumpeter

Joseph Schumpeter was a colourful character.  He once said he had three goals in life, to become the greatest lover in Vienna, the greatest horseman in Europe and the greatest economist in the world.  Modesty, it appears, was not his strong suit – but many believe that his third ambition at least was realised.

And what was the idea that made him famous – or at least famous in some quarters?

Schumpeter coined the phrase “gales of creative destruction”.   For him, entrepreneurs were the heroes, and failure an essential ingredient.

What is interesting about Schumpeter is that while his name is often splattered over economics books written by Americans, Alan Greenspan for example waxed lyrical about him in his book The Age of Turbulence, his name is not mentioned much in the UK – probably not much in Europe either – with the possible exception, presumably, of Austria.

There is also something inevitable about failure.  At the beginning of the last century, the economist Alfred Marshall drew up a list of the top 100 companies.     Mr Marshall was no mean economist, he wrote perhaps the first-ever textbook on the subject that was commonly quoted, and he counted among his pupils John Maynard Keynes.

So large and powerful were the companies on Marshall’s list, he argued that they would probably survive  indefinitely.    He referred to them as the Californian Redwoods – trees that can live for so long that to us humans, with our short life-span, they practically appear immortal.  Redwoods have in fact been known to live for over 2,000 years.

But in 1999, the economist L Hannah revisited the Marshall list, and discovered that of the 100 largest firms in 1912, 29 had, by the time of the study, gone bankrupt, 48 had disappeared, and just 19 of them were still in the US top 100.

Failure then is both inevitable and essential.

It is something we all understand intuitively.  Robert W Johnson, founder of Johnson and Johnson once said, “Failure is our most important product,” meaning the company had to experiment and take risk in order to move forward.

Sometimes large companies can internalise failure – in the way that Robert Johnson described.    Other times, companies behave like venture capital firms, and sit on the wings letting others innovate, and then just swooping and buying the successes – for example the giant drug companies, and now, increasingly, media companies like Microsoft, Google and News Corp. 

But innovation is not certain.  We just don’t know in advance what will work, and what will fail.

Economists might think of business leaders as being like a ship’s captain, standing on the bridge, hands on the ship’s wheel,  staring ahead looking for icebergs.    But as professor Donald Sull, an expert of business strategy, once said, it would be more appropriate to draw an analogy with a racing driver – making split second decisions.

The truth is that for entrepreneurs, the life-blood of future growth – failure is an ever present risk.

This is not understood.    The likes of Gordon Brown try to reform the tax system in order to encourage entrepreneurism, but miss the point.

Entrepreneurs are not put off starting their own ventures because they worry that they may have to pay too much capital gains tax, or because corporation tax is too high.    They are far more concerned about how they will survive, and their big fear is failure.

If you have two individuals who over a ten-year period earn exactly the same amount of money, but one has a steady job, and the other is an entrepreneur who has built up a business from scratch – who do you think pays the most tax?

The answer, almost certainly the entrepreneur, because his or her wage fluctuates each year.  Some years, hardly anything will be earned and the entrepreneur may not even use up all the personal allowances.  Maybe on another occasion, almost 50 per cent of all the money earned over those ten years is earned in one year – nearly all income in that year will prompt income tax at 40 per cent.

In the UK,  attitudes to entrepreneurism are too critical.  Bankruptcy carries massive social stigma costs, leaving many just too scared to contemplate entrepreneurship.

There is a danger that the backlash against banks and their excessive risk taking will hit entrepreneurs.  That is surely the single biggest danger to emerge  from the credit crunch.

The true reason for the credit crisis was that the US caught an English disease – the belief that house prices only ever go up; this is what caused excessive risk taking.  In Britain, would-be entrepreneurs opted instead for the safe route of buy-to-let investing.  We gave the US the fool’s faith in bricks and mortar – the US has far more to offer us – belief in the individual’s ability to innovate, and encouragement. If only the stigma of failure could be removed.