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News : Innovation Last Updated: Dec 13, 2010 - 4:21 AM

How many new billion dollar firms would it take to permanently increase the US GDP by 1%?
By Finfacts Team
Dec 10, 2010 - 4:14 AM

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How many new billion dollar firms would it take to permanently increase the US GDP (gross domestic product) by 1%? According to the Kauffman Foundation, the answer is most likely between 30 and 60. Collectively, the impact from high-growth firms that are able to realize $1bn in revenue could significantly accelerate the US economic recovery, and over time greatly increase income and wealth of the average American household.

If, for example, the US economy grew at 4% annually rather than 3%, GDP would double six years faster (eighteen years versus twenty-four years). Given the magic of compounding, this extra one per cent would cumulate over a century to produce roughly three times the level of GDP than would otherwise exist.

Since World War II, the American economy has averaged 3.3% growth per year, but fell to a negative growth rate during the height of the recession in 2009. Even as the economy recovers, the Kauffman Foundation says it is widely believed that the long-run sustainable growth rate has fallen to less than 3%.

In an article last January, Finfacts reported on what is termed the 'New Normal' - - the view that once the current phase of deleveraging, de-globalisation and re-regulation is over, investors and policymakers will “find themselves in a landscape that only partially resembles that which dominated the 2003-2007 period.”

Real US GDP rose an average of 3.4% per year from 1960 through 2007, according to economists at ratings agency Standard & Poor's. Last January, S&P said growth would average only 2.6% over the coming decade.

Mohamed El-Erian, CEO of PIMCO (Pacific Investment Management Co.), which manages the world’s biggest bond fund, told Bloomberg this week that US policy makers are reacting to the 'New Normal' by pursuing “increasingly unconventional” strategies to aid the economy.

“The 'New Normal' is still here,” El-Erian said. “What the policy makers are doing is kicking the can down the road in response to the symptoms of the 'New Normal,' but they’re not yet changing the medium-term dynamics.”

“What is a danger is that we stay stuck in a new normal where unemployment rates stay high,” President Obama said on CBS’s “60 Minutes” program last month.
“People who have jobs see their incomes go up. Businesses make big profits. But they’ve learned to do more with less, and so they don’t hire.”

Finfacts reported on Thursday that male unemployment among US workers who haven't a university degree, has fallen from 1960s highs in each of the subsequent decades.

Finfacts reported last May that the US jobs market underperformed the Eurozone and other economies in the decade before the Great Recession

Looking over a long stretch of history, despite occasional recessionary periods, the US job market has steadily increased employment to accommodate a growing population until the 2000s. During the 1990s (specifically, from December 1989 through December 1999), the economy gained 21.7m payroll jobs. By contrast, from December 1999 through December 2009, the economy lost 944,000 jobs. Job gains in the 2000s were weak even if the losses that occurred during the recession are excluded.

The Kauffman Foundation, which is the leading organisation in the US for research on entrepreneurship, asks is there any way that long-run growth rate can be boosted by a full percentage point? In a new study,Inventive billion Dollar Firms: A Faster Way to Grow?, the Foundation’s vice president for research and policy and author of the study, Robert Litan, suggests one possible way.

“If innovative, high-growth firms historically have been the drivers of economic growth in both output and jobs, then cultivating the creation of more such firms will increase growth of the economy in the long run,” Litan said. “Our challenge is to create environments that foster the growth of these new successful companies that generate large social benefits.”

The Kauffman paper uses $1bn in sales as a proxy for highly innovative firms. Using some plausible assumptions about key parameters, Litan estimates that 30-60 more such companies launched every year would achieve the permanent percentage point increase in economy-wide GDP. This estimate rests on the findings of Yale economist William Nordhaus that highly inventive companies, like individual inventors, generate gains to society that vastly exceed the profits earned by the companies or inventors themselves.  

With US GDP currently nearing $15trn, one per cent extra growth would require an additional $150bn in output annually. Robert Litan says economists typically would say that the way to generate that additional growth is for society to somehow increase its "productivity" growth  - - higher ratio of output to inputs over time. He says it however doesn't translate into how many additional firms and of what kinds it would take to achieve such an outcome.

The 4% figure implies that, in order for society to benefit from an additional $150bn in output, inventors (read: entrepreneurs) must develop new products, services, and processes that collectively earn for themselves only $6bn a year ($150bn multiplied by 0.04) after taxes. If, as seems reasonable, the average inventive firm returns 10% on its sales, it would take $60bn in sales to generate $6bn in profits. "If this $60bn were spread evenly across all billion dollar firms, we have our answer! The economy needs sixty inventive companies to be formed each year whose revenues eventually mature to an average of $1bn (because the figure is an "average" some new companies' sales can exceed $1bn, while other successful enterprises with large social benefits can fall short of this benchmark)," the report says.

Robert Litan says the challenge is to get more billion dollar companies above the numbers that would normally be generated - - that is, producing the necessary incremental improvements in the numbers of successful companies launched - - is to find, help launch, and nurture individuals and teams who would not otherwise be or choose to be successful entrepreneurs. He says: "In other words, we need to find ways of changing the career paths of individuals with great ideas capable of producing social gains well in excess of private rewards and turn them into company founders or co-founders. How can the United States do that?"

“Whatever the ‘magic number’ of highly successful firms may be,” adds Carl Schramm, president and CEO of the Kauffman Foundation, “the bigger question is: How do we ensure the creation of those firms here in America?”

One answer, the Foundation believes, is in the creation of “entrepreneurial ecosystems.” Currently, research universities across the country are creating mentoring programs for faculty, alumni and student entrepreneurs. These commercial, private-sector “accelerators” use a competitive selection process to nurture new potential breakthrough companies in markets including medical devices and web-based businesses.

Kauffman Laboratories for Enterprise Creation, launched last year, aims to recruit highly motivated individuals with commercial ideas that have the potential to produce billion-dollar-plus companies. Kauffman Labs surrounds the successful candidates, chosen in a highly competitive process, with entrepreneurial instruction and mentoring from some of the nation’s leading experts in the same industry or “vertical.” The first Labs program consisted of outstanding postdoctoral scientists who have developed promising technologies. The next program, which starts in early 2011, consists of potential entrepreneurs with innovative commercial ideas in the educational field. Future Labs programs will be centered on other verticals ripe for high-growth, innovative startups.

How America can regain its competitive footing, with Michael Porter, Harvard Business School professor:

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