Sen. Sherrod Brown (D., Ohio) recently introduced the Business Incubator Promotion Act, which would provide federal grants for the formation and expansion of business incubators in areas with higher-than-average unemployment. But Congress should reject the bill because incubator supporters have failed to make a case for such funding. No one has identified a failure of private markets that could justify such grants to incubators, and no studies show that incubators create jobs.
Government intervention is needed when free markets fail to operate properly. Take, for example, basic research. Because many businesses cannot capture a large enough financial return from basic science, they do not invest enough to produce necessary technological advances. To remedy this problem, the government runs research laboratories and provides grants to academic researchers. Such research provides the basis for many useful technologies -- the Internet being a case in point -- that wouldn’t have been developed without government funding.
Before policymakers intervene in the incubator market, they need to ask what the “market failure” is that requires government support. The National Association of Business Incubators defines “business incubation [as] a business support process that accelerates the successful development of start-up and fledgling companies by providing entrepreneurs with an array of targeted resources and services."
So, Congress should demand evidence that the private sector fails to provide such support before committing taxpayer dollars to business incubators. But economic theory and common sense hold that private-sector investors should provide this support as long as the assistance accelerates the development of new companies. And if the private sector readily provides these services, then there is no market failure necessitating government intervention.
Advocates of business incubators argue that they create a lot of jobs. The NBIA, for instance, cites a study conducted for the Commerce Department’s Economic Development Administration by consulting firm Grant Thornton, which showed that for “every $10,000 in EDA funds invested in business incubation programs, an estimated 47 to 69 local jobs are generated.”
While these numbers sound good, they are fundamentally flawed. No study has ever shown that business incubators cause startups to create more jobs than they otherwise would have. To determine the job impact, researchers would have to conduct experiments, randomly placing some companies in incubators. If the companies in incubators employed more people than the other businesses, then the only difference between them -- being in the incubator -- must be the reason for the extra jobs.
Instead, studies in support of business incubation estimate the total number of jobs created by multiplying incubator company employment by a standard multiplier that accounts for jobs created indirectly, as well. The flaw here lies in assuming that the incubator should get credit for producing new jobs. If advocates can’t show that being in the incubator causes companies to add employees, then they shouldn’t credit it for the job creation.
What about the incubator advocates’ argument that incubator companies have lower failure rates and higher employment than other companies? That would be true even if incubators do nothing to help entrepreneurs. Being a good entrepreneur means figuring out how to save money, and incubators save business owners money by providing rent and services at below-market prices. If talented entrepreneurs know how to stretch a dollar, then the better performance of incubator companies can be entirely explained by the more talented entrepreneurs (whose companies would be more likely to survive and hire anyway) entering incubators to take advantage of government largesse, with the incubator experience accounting for none of the difference.
Before Congress spends money on business incubators, it should first ask for convincing evidence that a market failure exist -- that the private sector fails to provide incubation services -- and for evidence that incubators cause companies to create jobs. Otherwise, there’s no justification for Sen. Brown’s bill.
The author is an Entrepreneur contributor. The opinions expressed are those of the writer.
Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).