The Nasdaq rode a roller coaster this past week, but is still the star of the stock market boom. People are pouring money into new dot-com businesses and other high-tech firms that have yet to show any profit.
Anyone with any knowledge of economic history knows that a lot of these investors are going to get burned. That is wonderful, and it is something for which all Americans should be grateful.
No, I am not being cynical. The economic phase that we are going through will almost certainly result in some households losing their financial jackets, if not their shirts, when the shaky firms in which they have invested go belly up. But this whole process of prolific innovation paired with eager investment is tremendously good for society as a whole even if some households end up taking financial hits.
Someone once said, “It is better to have loved and lost than never to have loved at all.” Economic growth is analogous. It is better to have innovated and invested and lost than never to have innovated and invested at all.
Innovation is the key to economic growth, to making more efficient use of resources to meet people’s needs and wants. Societies that provide incentives for innovation grow faster than those that do not.
Some innovation takes place because of intellectual curiosity—a person conceives of a new device or a new way to do things. Such innovation is common in the pure research carried on at universities. But most innovation takes place because someone thinks they can make money by doing so. The old adage about building a better mousetrap implied that the world would “beat a path to your door” to buy your product, not just congratulate you on your ingenuity.
But getting many of today’s innovations to market involves a lot of time and substantial investment of capital. Most bright inventors and innovators don’t have that crucial resource. But here in the United States, we have financial institutions to bridge that gap. There is a large, well-developed venture capital market with people who have experience in identifying ideas with potential payoffs and shepherding their new clients to market.
Many investment banks are eager to manage initial public offerings, and plenty of equity exchanges, including local over-the-counter markets and Nasdaq, are eager to take on new firms. An increasingly large segment of individual and institutional investors is willing to put at least some of a portfolio into promising new ventures.
This institutional ability to marry bright ideas with capital is one of the United States’ greatest strengths and the source of much of its economic dynamism. It is unappreciated by the general public and by Congress.
While frustrated individual inventors may complain about the difficulties they themselves had in securing financing for a bright idea, it is clear that this is far easier to accomplish in the United States than in any other country of the world. England, France, Japan and Germany are light years behind the U.S. in their ability to motivate and nourish startups.
Culture is an important factor. In the United States, failing in a business or filing for bankruptcy does not have the stigma that it does in these other countries. Many of the most successful U.S. entrepreneurs have gone bust at least once. U.S. investors are willing to take risks in a way that is largely unknown in stodgier Europe.
Joseph Schumpeter, a great Austrian-born economist of the first half of the 20th century, described capitalism as a process of “creative destruction.” New enterprises rise up, challenge and supplant the old. Marxists mistakenly saw this process as a wasteful aspect of market economies, arguing that central planning would use resources more rationally.
But history now clearly shows that decentralized economic systems that afford opportunity for individual creativeness are far more productive and more efficient in use of resources than any centrally planned society.
Inevitably in this process, some ideas turn out to be bad ones, and some new enterprises end up being badly managed. Many fail, and those who invested in these ventures take a loss. But on the whole, even with these failures and losses, an innovative society is far ahead of one in which innovation is stifled by the lack of necessary institutions.
So don’t worry if many dot-com enterprises bite the dust, the Nasdaq drops a thousand points, or your 401(k) plan has a bad quarter on occasion. These are all signs of an economy that, while occasionally messy, is efficient, thriving and growing.
© 2000 Edward Lotterman
Chanarambie Consulting, Inc.