In a recent article entitled Where's The Beef? Can Venture Capital Save California?, Gino DiCaro, Vice President of Communications for the California Manufacturers & Technology Association, points out that California’s high share of venture capital has not led to a lot of growth in manufacturing. He reports that California accounts for over 40 percent of all U.S. venture capital activity, but only “1.3 percent of the new or expanded manufacturing facilities in the last five years.”
DiCaro’s article raises an interesting question: Does it matter that California’s dominant position in venture capital fails to translate into growth in manufacturing in the state?
I think not for several reasons.
First, increasing manufacturing isn’t a path to faster economic growth. A study of the differences in state economic growth going back to the 1930s showed that manufacturing’s share of a state’s industrial structure actually reduces per capita income. So states like California are better off economically if they reduce their reliance on manufacturing.
Second, places with more venture capital have higher economic growth. Studies show that venture capital-backed companies are more innovative and have higher employment and sales growth than comparable companies not financed by venture capital. Therefore, California benefits from its large share of the U.S. venture capital industry.
A quick glance at California companies shows that new venture capital backed start-ups can enhance economic growth even if they don’t create any new manufacturing businesses. For instance, Google and Facebook don’t make anything, but are hiring workers and generating wealth at a rapid pace. If a state can create companies like these, does it matter if venture capitalists don’t back a lot of manufacturing businesses?
Third, recent research conducted by Larry Plummer of the University of Oklahoma indicates that efforts to increase start-up activity in manufacturing might hinder efforts to create more high tech companies. Plummer’s study shows that places with more high tech new businesses tend not to have more manufacturing start-ups and vice versa. Because venture capital is designed to enhance the growth of high tech companies, not manufacturing ones, there’s no reason to expect the size of a state’s venture capital industry to be related to manufacturing’s share of state economic activity.
In fact, Plummer’s study shows that the same factors that increase the rate at which manufacturing firms are created actually reduce the level of new business creation in high tech. For example, places with faster growing populations and a lesser share of the population that graduated from college have more manufacturing startups, but fewer high-tech ones. Although Plummer didn’t look at the effect of venture capital, it’s possible that places with high levels of venture capital have more high tech start-ups and fewer manufacturing ones.
In short, DiCaro’s article is an example of argument-by-spurious-association. He says that something is wrong in California because the state has high rates of venture capital activity but low rates of manufacturing firm growth. However, if manufacturing firm growth isn’t an objective of policy makers, this pattern doesn’t matter. Venture capital encourages the formation of high growth, high tech companies, which generate wealth and create jobs. As long as venture capital does this, we should be happy.
Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.