The new German government initiative “Gründerland Deutschland” (startup nation Germany) aims to increase the number of business startups and looks to the US Silicon Valley for inspiration. This is a good beginning; however, it should go even further, for it is not the number of startups that is crucial but their innovative strength and ability to succeed in the marketplace, according to Deutsche Bank economist Thomas Meyer.

The federal government has set up the startup initiative “Gründerland Deutschland” to encourage more Germans to start a business or engage in other entrepreneurial activity. A large catalogue of measures ranging from PR campaigns to prolonging a public-private venture-capital fund shall boost entrepreneurial spirit. In a related development, last month  a report delivered to Chancellor Angela Merkel claimed Germany's legendary innovation engine is faltering, but could - - with a major tune-up - - help propel the economy from crisis to sustainable growth. Forward-looking recommendations, such as how to move more effectively toward electric cars and the smart grid, rest on sobering assessments of government programs, trends in technology transfer, and conditions for entrepreneurs and investors. This package of analysis and advice came from the federally chartered Expert Commission on Research and Innovation, also known by the acronym EFI. The Bundestag, the German Parliament, is expected to discuss these issues in May and debate what actions to take.

The independent commission led by researchers at the Center for Entrepreneurial and Financial Studies at TUM, the Technische Universitaet Muenchen, spanned disciplines from engineering to economics. "Innovation is not only about having good ideas and good developments," Professor Ann-Kristin Achleitner said, "but it's very important to bring these developments to the market."

Deutsche Bank economist Thomas Meyer, says the US is revered as one of the most entrepreneurial regions in the world by many observers. There are two main reasons for this: firstly, the US has the highest share of startups of any industrialised country. Especially in the most interesting high-tech sectors, the US managed to expand its startup activity in the last few years, while the trend was negative in Germany (see chart). Secondly, many young companies in the US have made it to the top. The rise of Google - -  from a Silicon Valley startup to a globally used search engine - -  is arguably the best example.

A DB study published last December looked at startup activity in the US. What can Germany learn from the US experience?

Meyer says government incentives have only limited importance. In the US, the government contributes only roughly 1.5% of the total initial capital injections. Banks and credit-card companies contribute - -  in contrast to widely held beliefs - -  the bulk, i.e. 39%, of startup money. Furthermore, cooperation with public-sector research institutions plays a smaller role for innovative US startups than, say, cooperation with universities and other companies.

What is more, investors and lenders perform an important quality check: startups that pass that check have a much lower probability of default henceforth. After all, each investment is screened very closely. Thus, market mechanisms are required to separate good business ideas from bad, and must not be distorted by government intervention. 

Nevertheless, business startups remain very risky. In the US, less than 30% of startups survive more than 10 years. Failure is thus the rule, not the exception. For this reason it is important to mitigate the process of insolvency, i.e. the financial and social hardships for those affected. The “Gründerland Deutschland” initiative embraces this idea but focuses too much on the founder of the company (eg, by the idea to halve the period until the exemption of residual debt). In fact, the efficiency of the entire insolvency process needs to be improved. In the US, creditors benefit as well: if a company goes bankrupt, they get back roughly ¾ of their claims; in Germany, by contrast, only ½ of claims are salvaged.

Thomas Meyer says Germany also needs to reduce regulations and bureaucracy hampering startups. In Germany, startup costs are much higher than, for example, in the US and many other countries. Here, the government initiative should be even bolder.

A considerable difference between business startups in the US and Germany lies in motivation. While the wish to earn more money drives many nascent entrepreneurs in the US, Germans founders often seek personal fulfillment. Ideally, entrepreneurs should be able to achieve both but this is not always possible. In some cases, there are trade-offs, e.g. when it comes to the question of whether to accept venture-capital funding. Typically, such a move enhances the growth outlook and economic success of the startup but curbs the decision-making power of the founder.

The government initiative “Gründerland Deutschland” aims to increase the number of business startups. The economist says this is a good beginning. But it should take even bolder steps, for example with regard to cutting red tape and the reform of the insolvency process. Furthermore, commercial success should play a larger role. Business startups are not ends in themselves: they only have a positive effect if they are able to prevail in the marketplace. Thus, the chief task is to foster a modern, competitive and dynamic economy where it is easier for innovative startups to grow and make profits. What is more, successful startups are the best advertising for a dynamic, entrepreneurial culture: genuine role models are more convincing than any PR.

SEE also, today's Finfacts report: US report says governments can have bigger impact on job creation rather than focusing on new technologies such as clean tech