Entrepreneurship Can Be Unproductive or Destructive

Frank Pasquale –

rifles-to-be-burned-in-kenya-2016

Entrepreneurship in the international arms trade leaves everyone (except the entrepreneur) worse off.

In contemporary American law, few figures are as lionized as the “entrepreneur.” Lobbyists evoke entrepreneurship as a cornucopia of better goods and services at lower prices. Even ostensibly academic business law courses tend to offer a narrative of wise incremental development of legal doctrine toward enabling disruption, easy entry into markets, and ultra-flexible corporate forms. The lawyer is ideally, in this view, a fixer capable of profit-maximizing distributions of responsibility and liability. Some even dream of automating this role via smart contracts, to ensure even more rapid entrepreneurial activity.

Professional Responsibility courses also tend to adopt a similarly reverential attitude toward the business client, instilling an ethic of “zealous advocacy” in generations of students. Few question whether the near-evacuation of ethical self-reflection from advocacy roles systematically advantages dubious (or worse) business propositions.

This emphasis on the disruptive and new is jarring in law, because legal systems’ internal values so often prize stability, regularity, precedent, and tradition. Pressed to justify it, partisans of disruptive innovation often turn to economics—a discipline all too happy to oblige with just-so stories of creative destruction. As William Baumol has observed, where economic growth has slowed, it is often “implied that a decline in entrepreneurship was partly to blame (perhaps because the culture’s ‘need for achievement’ has atrophied). At another time and place, it is said, the flowering of entrepreneurship accounts for unprecedented expansion.” Both policymakers and mainstream legal scholars tiptoe through the tulips of entrepreneurship, wary of disrupting the business plans of the disruptive innovators they admire.

However, as Baumol went on to wisely observe, there is no obvious connection between entrepreneurship and genuine productivity. Productivity, defined from a properly politico-economic perspective, reflects society’s ability to meet real needs, create capabilities, and to promote human flourishing. Some entrepreneurs contribute to it, but others do not. As Baumol observes, there are unproductive entrepreneurial activities, and at “times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy.”  Baumol also argues that the relative balance of productive, unproductive, and destructive entrepreneurs is not dictated by technology or culture. “Changes in the rules and other attendant circumstances can, of course, modify the composition of the class of entrepreneurs,” he reminds us, insisting on the intertwining of political and economic reality.

Law students tend to hear little to nothing about Baumol’s distinctions here, despite his status as one of the greatest economists of the 20th century. That is because the epistemological appeal of many dominant law and economics approaches is grounded in an ostensibly value-free and scientific assessment of the costs and benefits of different sets of legal rules. Describing certain economic activity as useless or parasitical is a value judgment. Better instead, in the eyes of the old law and economics, to stick to more quantitative assessments of value, or abstract descriptions of optimal legal rules that “neutrally” apply trans-substantively, without respect to the nature of the business they are affecting.

The problems with such an approach are readily apparent. First, there are obvious instances of entrepreneurship that leaves everyone (except the entrepreneur) worse off.  In later work, Baumol described the international arms trade as one clear example: rapidly cheapening implements of destruction, and making them more readily available, is not a form of efficiency to be celebrated unproblematically. There may be cases where this arms trade enables a scrappy band of rebels to overcome an oppressive tyranny. But far more common are other dynamics: consolidation of power by tyrannical regimes; arms races among factions within a nation, and nations themselves; out-of-control armaments easily snapped up by terrorist forces.

Similarly, in banking, all too often legislators and regulators rush to promote “financial innovation” without fully understanding its consequences. For example, at present, the Office of the Comptroller of the Currency (via its proposed “fintech charters”) and the Consumer Financial Protection Bureau (via its Project Catalyst) are promoting financial technology (fintech) firms. Fintech may promote competition and create new options for consumers. But we should ensure that it is fair competition, and that these options don’t have hidden pitfalls. In my research on the finance and internet sectors, I have explored patterns of regulatory arbitrage and opaque business practices that sparked the mortgage crisis of 2008. I see similar themes emerging today.

In the run-up to the crisis, federal authorities preempted state law meant to protect consumer borrowers. Their stated aim was to ensure financial inclusion and innovation, but the unintended consequences were disastrous. Federal authorities were not adequately staffed to monitor, let alone deter or punish, widespread fraudulent practices. They also flattened diverse state policies into a one-size-fits-all, cookie-cutter approach. We all know the results. Millions of families lost their homes to foreclosure, and the economy suffered a permanent output gap that undermines our nation’s strength to this day.

In short: entrepreneurship and innovation are not good in themselves. The toxic assets at the core of the financial crisis were innovative in many ways, but ultimately posed unacceptable risks. Entrepreneurial arms dealers could easily provide massively destructive weapons to terrorists. Many less troubling products and services have shadow sides that outweigh their ostensible benefits. Until law and economics places such concerns at the core of its inquiry—rather than relegating them to backwater arenas of externality correction and transfers—it will fail to account for core economic dynamics. Law and political economy addresses these issues directly, as an intersecting realm of monetary value and social values.

Frank Pasquale is a Professor of Law at University of Maryland Francis King Carey School of Law.

Note: Some of this post was based on my recent testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs Committee, available here.

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