Entrepreneurs give much more than they take

Several years ago, I was having dinner with a good friend — an intelligent, mild-mannered, generally well-informed person who works for a major Canadian company. Politically, in Canadian terms, he could be described as a centrist. At some point, the topic of the wealth of Jeff Bezos came up and my friend scoffed and said, “This is totally unreasonable. I mean, how many filet mignons can one man eat?!”

This comment, coming from someone who is part of the mainstream Canadian corporate world, is quite representative of how most people feel about “extreme” wealth and the “uber rich.” It also encapsulates several common, and profound, misunderstandings regarding entrepreneurship, wealth creation and wealth in general.

First, extremely successful and therefore usually extremely rich entrepreneurs typically use the vast majority of their wealth, not for personal consumption, but as working capital to expand the reach and strength of the businesses they are involved with. I do not suggest for a moment that Jeff Bezos and his like do not enjoy extremely lavish lifestyles. They often do. I am merely saying that even if you add up their personal consumption and personal assets (private jets, mansions, art collections, etc.), these typically account for far less than what they have invested in their various companies.

Generally, those investments are not risk-free. Jeff Bezos having a net worth of, say, US$241 billion (a recent estimate by Forbes of his real-time net worth) does not mean he has a safe somewhere — a very large safe! — with US$241billion in cash in it. This number is, rather, the current market value of his Amazon stock. If he tried to sell his holdings all at once, their value would almost certainly plummet. So, his US$241 billion is a paper value that is, up to a point, quite theorical.

But my third and final point is much more important and consequential than the first two: the vast majority of the economic benefit created by innovative entrepreneurs — well above 90 per cent of it — is distributed to consumers and the general public, not appropriated by the entrepreneurs and initial wealth creators themselves. This economic benefit includes, not just financial wealth, but also things like new and improved products, whose value is not as easily quantified.

This crucial economic fact has been established by several academics, including William Nordhaus, Nobel Prize–winning professor of economics at Yale. In a 2004 research paper, Nordhaus compared productivity gains in the greater American economy with firms’ retained profits in order to approximate how innovation generates both private benefits for inventors and entrepreneurs as well as value for society as a whole. The private value is the total of innovation-driven profits retained by the entrepreneurs, while the social value is the heightened efficiency of labour, capital and other inputs fostered by entrepreneurs.

It turns out the social benefit dwarfs the private gain. Nordhaus found that innovators capture about seven per cent of the immediate benefits as profits. In the long run, however, because of competition and other factors, they retain only about 2.2 per cent of the overall social value generated. Over time, consumers and others receive almost 98 per cent of the total surplus generated by the entrepreneurs’ innovation, whether technological, managerial, financial, or some mix of the three.

Nordhaus’ results are consistent with the “creative destruction” theories of 20th-century economist Joseph Schumpeter, who argued that individuals’ self-interested entrepreneurship ultimately creates second-hand but very big spillover benefits that spread throughout the economy, and when aggregated, are almost always far greater than the profits earned by these “first movers,” as Ayn Rand called them.

Innovation and entrepreneurship are absolutely crucial to the long-term economic growth and overall prosperity of our societies. Successful entrepreneurs end up giving far more to all of us than they keep for themselves — whether or not this was their initial intent. Afterwards, if they decide to “give back to society” — give back again, that is — through philanthropy, so much the better. But we should realize that they have already given far more than any of their donations through their initial actions as successful entrepreneurs.

Financial Post

Michel Kelly-Gagnon is founding president of MEI, a public policy think tank with offices in Montreal, Ottawa and Calgary. He thanks Sam Bonnett for discussion.