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Editor's Note: The following guest post comes to us from Thomas Vass of The Private Capital Market, a subscription-based crowdfunding website. Vass writes in to discuss the nexus of financial and political interests between crowdfunders and regional economic development professionals, using the concept of innovation economics. In this first half of the article, Vass explains the concept of innovation economics, and how it has evolved. For previous articles from Vass, click here.
Much of the public commentary about crowdfunding has focused on how it can help entrepreneurial startups obtain capital, which Title III of the JOBS Act of 2012 addresses. Often, proponents of Title III cite an easy-going, unexamined assumption that crowdfunding for entrepreneurial startup companies will magically lead to more job creation and regional economic development.
For example, in their review of the North Carolina initiative to implement an intrastate crowdfunding law, Mark Easley and Steve Reaser state that, “Start-up companies and small businesses play a critical role in creating new jobs and growing the economy. Crowdfunding legislation is one part of Representative Murry’s commitment to North Carolina small business and entrepreneurs.”
The unchallenged assumption about job creation forms the preamble of the crowdfunding legislative initiative in the State of Washington, which states:
BE IT ENACTED BY THE LEGISLATURE OF THE STATE OF WASHINGTON:
NEW SECTION. Sec. 1. The legislature finds that start-up companies play a critical role in creating new jobs and revenues. Crowdfunding, or raising money through small contributions from a large number of investors, allows smaller enterprises in Washington to have access to the capital they need to get new businesses off the ground.
The assumption about job growth needs to be challenged, and the concept of crowdfunding, as a component of regional economic development strategy, needs to be placed in a bigger conceptual framework so that the benefits of crowdfunding can more easily be obtained by regional agencies and economic developers who intuitively know that this tool is important, but do not have the right policy framework in mind on how crowdfunding promotes sustained economic development.
Crowdfunding does not magically create jobs and economic growth, as securities officials in Kansas note about their two-year-old intrastate crowdfunding initiative. In Kansas, only six companies have claimed the intrastate crowdfunding exemption in more than two years, according to Lynn Hammes, director of finance and administration at the Kansas Office of the Securities Commissioner.
The unexamined assumption about crowdfunding and job creation is just like an earlier fascination in the economic developer community about “industrial clusters,” whose promotion, it was assumed, would automatically lead to more jobs and increased regional income.
Back then, every state and regional economic partnership hurried to implement some form of an industrial cluster strategy, leading one European observer to note that the main outcome of the cluster strategy seemed to be a large number of government meetings where economic development professionals gathered to talk about industrial clusters.
He called this phenomenon “clusters of clusterers.”
Both concepts, crowdfunding and industrial cluster strategies, are important concepts and work in tandem to create jobs, but both concepts need to be placed within a new intellectual framework of innovation economics in order to understand how they fit into a much more comprehensive and complicated economic policy framework.
Just like roads and sewer lines formed the infrastructure resource base of the older industrial recruitment strategy, crowdfunding requires its own type of regional capital market infrastructure in order to become a viable economic development policy tool.
Innovation economics has the right theoretical framework to guide the build-out of that bigger capital market infrastructure because it covers the entire capital market process involved with technological innovation.
Part of the change in thinking about crowdfunding is a deeper appreciation of the financial interests at the state and regional level who benefit from crowdfunding, and more importantly, those financial interests who do not. Some of those compatible interests are located in the professional economic development community, but some of those in that community are not so supportive of the outcomes of crowdfunding.
Understanding the nexus of financial interests between crowdfunders and economic developers means clearly identifying the alliances and allies between the two financial interests, and promoting those alliances, while minimizing the disruptive effects of those interests who do not benefit from crowdfunding initiatives.
The crowdfunding policies need political advocates and business allies who promote the entire range of capital market innovation economic activities. Without this activism, crowdfunding will not become a successful economic development policy tool.
The old innovation economics did not do a very good job at making those shared financial interests apparent, or promoting the alliances that would have supported the industrial cluster strategy. Consequently, the industrial cluster strategy never attained its hoped-for regional economic promise. The forces of the status quo were able to subvert the concept of industrial clusters and co-opt it to promote the status quo.
And, without a more transparent identification of those opponents to crowdfunding, and special interest activism to support it, neither will crowdfunding.
Way back in 2008, when it seemed that everything was possible, the topic innovation economics endured a brief flurry of notoriety in an academic debate over the proper role of the Federal government in directing the affairs of economic development. 1
On one side of the debate, Robert Atkinson teamed up with the Brookings Institute to describe how innovation economics requires a strong Federal government role to oversee improvements in private sector productivity so that America can be “competitive in the new global economy.” 2
For Atkinson, innovation economics was primarily about productivity improvements of large corporations domiciled in the U. S. He proposed to create an entirely new federal agency called the National Innovation Foundation, to direct the affairs of innovation in each state.
Atkinson’s advocacy of a strong central government role in directing the activities of state innovation economic development was open to attack that it would lead to a form of centralized elite-driven European-style slow economic growth in America.
The other side of the debate advocated a very limited role for the federal government and described innovation economics based upon the concept of technological innovation, and product commercialization. According to this perspective, the initial factor endowments that made America different than Europe was its culture of individualism, which created a comparative national advantage in technology innovation.
Vass warned that, “Once the Federal government gets both its regulatory nose, and its bureaucratic hiney, in the innovation tent, a series of irrevocable events will take place that foreclose future innovation economic growth. There is a basic logical inconsistency between increased government intervention and innovation economics that Atkinson’s exploits for political advantage.”
Both sides of the debate wrongly assumed that President Obama would embrace the concept of innovation economics. 3
In the innovation economics as productivity improvement camp, Atkinson identified the main financial beneficiaries as very large corporations, whose operations were amenable to federal government policy. One of his main institutional partners for large corporations in stimulating innovation were university tech transfer offices. According to Atkinson, those offices would spin out innovation, and place it directly in the hands of the large corporations, and earn a handsome return on royalties from the university intellectual property.
His idea about tech transfer would have had an economically perverse effect on innovation in America.
Atkinson identified parochial interests that were opposed to globalism as the financial interests that would resist his concept of innovation economics.
In the innovation economics as technological innovation, Vass identified the main allies of innovation economics as professional trade associations whose members would benefit from doing more deals, and middle market technology firms with over $1 million in top line sales revenues.
The financial interests in the economic development community, according to Vass, that would oppose innovation economics were the status quo industrial recruitment interests, local chambers of commerce, globalist organizations, like the Brookings Institute and, interestingly, the status quo members of the angel and venture capital community, who enjoyed a monopsony over directing private capital to their handpicked selection of entrepreneurial companies.
The improvement of adding innovation economics to crowdfunding and economic development in this second conception of economic policy is providing a logical chronology of steps that economic developers could take to implement the crowdfunding component to create jobs.
Innovation economics is about explaining the economic and financial processes that occur in product innovation and commercialization, from idea formation all the way through to product sales and marketing. For economic developers, mirroring this process of product commercialization with supportive economic policy would be a big improvement over existing practice.
Capital market transactions for private companies also follows a similar chronology to the innovation sequence of events that is related to the growth stages of a company, and economic development policy would follow this same logical chronology of events.
For crowdfunding, applying this chronology of events to economic development would place crowdfunding within a coherent economic framework for its role in creating jobs. New startup companies need capital, then they need growth capital, then they need private securities exchanges to transact exchanges of private securities, then they need investment bankers to do M&A deals, and finally, they need access to the public stock exchanges.
Crowdfunding plays an important job creation role in the front end and middle of the capital market funding processes. But, crowdfunding, by itself, without all the other capital market members supporting it, would be an ineffective tool to promote job creation. Crowdfunding, to be successful, requires ongoing political advocacy from all capital market financial interests, not just the crowdfunding interests, and it must be integrated into the entire sequence of capital market transactions that support technological innovation.
The industrial cluster strategy, as a stand-alone tool used by industrial recruitment agencies, has proven to be useless as a job creation tool because industrial cluster strategy never developed a political advocacy support team. The special financial interests who would benefit from the industrial cluster strategy never developed the group self-awareness to compete with the forces that desired to maintain the status quo.
In order for advocates of crowdfunding to team up with advocates of regional economic development to create jobs, the main shift in perspective is from seeing crowdfunding as a way to help a company raise capital, via crowdfunding, to doing more capital market deals in a regional economy.
The value of crowdfunding for regional economic development is that it tends to increase the rate of deal flow within the geographical boundaries of a metro region.
In other words, financial interests who benefit from crowdfunding, being the business professionals who assist companies in issuing securities, the companies who use crowdfunding to raise capital, and the potential investors who may invest in a company, need to shift their public relations advocacy focus from promoting the idea that crowdfunding helps an amorphous small company raise capital, ala the Washington State preamble to their legislation, to a public relations message that crowdfunding increases the rate of deal flow within a regional economy.
The crowdfunding proponents need to make it clear to all the other capital market partners how crowdfunding serves the entire capital market, because everyone benefits when more deals get done. Whereas, not many downstream capital market partners benefit financially, if one or two deals (or, as in the case of Kansas, only six crowdfunding deals) get done in two years.
Increasing the rate of deal flow has the potential to increase jobs and regional incomes, about 5 years into the future after a crowdfunding event. It will take hundreds and hundreds of crowdfunding events every year in a metro region to increase the rate of job creation. And, backing up the time line of innovation, it will take hundreds and hundreds of new product ideas, every year, to generate new firms that need funding.
Likewise, the financial interests within the economic development community who benefit from an increased rate of economic growth, namely business and securities attorneys, CPAs, business consultants and internet resource companies, need to begin viewing crowdfunding as a tool for increasing the rate of regional deal flow. That type of political advocacy for crowdfunding will cause them to confront their adversaries in the economic development community who favor the status quo.
Increasing the rate of deal flow is seen as a part of innovation economic development strategy that follows the chronology of events in technology product commercialization. Successful product commercialization creates new future demand markets and new regional inter-industrial clusters, which finally, will create new jobs.
This same economic development strategy has been called “local economic gardening” by Chris Gibbons, of Littleton, Colorado. Instead of approaching economic development like many other cities and towns, attracting large companies with tax and land incentives, Littleton uses a form of innovation economics to develop its economy from within.
Littleton focuses on retaining and assisting second stage companies, while creating a friendly environment for local entrepreneurs. According to Gibbons, the advantage of an economic gardening strategy versus an incentive-based strategy are that the cost per job created is much lower, the investment stays local and it is a long-term strategy as opposed to a short-term.
He tends to omit the part that it takes hundreds and hundreds of capital market events, and that those events may create jobs about five years into the future. Plus, he tends to overlook the part about risk in private equity investments.
1. Commentary: What is Innovation Economics? Thomas E. Vass and Dan Loague, Innovation Economics Alliance, LLC, Global Corporate Xpansion, November 2008.
2. Boosting Productivity, Innovation and Growth Through A National Innovation Foundation, Robert Atkinson and Howard Wial, Metropolitan Policy Program, Brookings Institute, April 2008.
3. Innovative Opportunities: Obama's Entrepreneurial Moment, Business Xpansion Journal, January 2009.
Thomas Vass is the owner and manager of The Private Capital Market, Inc., a fee-based subscription crowdfunding website. He is the author of Predicting Technology (2007), which explains his theory of technology evolution, and is the holder of a patent on how to select technology stocks for inclusion into an investment account.