Are Crappy Startups Wall Street’s Fault?

Is Wall Street blocking the next Google (s goog) from even getting off the ground? Yes, according to a new report from the Kauffman Foundation, which says high-paying jobs in the financial sector have bled the prospective pool of startup founders and employees until it’s pretty shallow. In a report called Financialization and its Entrepreneurial Consequences, the authors (Paul Kedrosky and Dane Stangler) explain that because jobs in the finance sector pay so well, they take talent away from startups and may even be responsible for the “potentially weaker” startups being funded. From the report:

As the data on MIT graduates and the sectoral share of science and engineering employment suggest, it is conceivable that some degree of talent allocation between entrepreneurship and employment was affected by the rise of finance. Recall Figure 3 [shown below]: If we presuppose that some fraction of those scientists and engineers working in the financial sector would otherwise have started companies, we can imagine perhaps a slight effect of financialization on potential entrepreneurship. This also points to a question of the quality of companies being started, which we discuss below. It is difficult, again, to make firm statements as to causation, but the historical data seem to suggest that a two-way feedback effect exists.

Financialization could have a suppressive effect on potential entrepreneurship by draining away human capital. Conversely, an underlying decrease (or, at least, not an increase) in entrepreneurship creates a shortage of new financing opportunities for the financial sector, meaning the sector must find other outlets in which to be innovative and make money from money—causing the sector to expand.

The report acknowledges its drawbacks; for example, it draws causation from a variety of factors hugely affected by outside variables, from the overall economy to generational shifts in views about entrepreneurship. It also relies heavily on data from 2006 or earlier, which omits the impact of the latest bursting of the financial bubble as some of that innovation in finance resulted in the mortgage crisis. The study also looks at the rate that science, engineering and math (STEM) graduates have moved into the financial sector as opposed to starting companies.

The report’s primary argument is that Wall Street pay is so monumental startups don’t really have a chance to recruit the best and brightest of the so-called STEM graduates. This can make it difficult for startups to find more employees, which affects the overall quality of the startups.

Here’s where I think the survey breaks down a bit: It equates STEM graduates with the pool of founders. Many startups today are created not only by those in the so-called STEM fields but also by liberal arts, business and other graduates . I’ve written before how simple it can be to create a “startup” with little code and access to someone’s cloud platform. I don’t think these startups are out to create a business necessarily, so I don’t think they are the audience that the Kauffman report is talking about, but it’s also true that some of those startups will become a business.

Plus, even for those that start out in a STEM degree program, history is littered with college dropouts who go on to build huge companies. Yes, the debate between dropping out to start a business or stay and graduate continues to rage, but I think the survey misses a crucial point about entrepreneurs: For most, starting a business isn’t a career choice; it’s a calling. Thanks to an idea, a passion, a strong desire to never work for anyone else, most people start companies because they can’t do anything else. Typically, those founders create the strongest companies. If they fail, they’re still likely to go back and try again.

So while I can buy into the argument that there are a missing generation of scientists, mathematicians and entrepreneurs ready to join startups because they were lured by Wall Street’s high-pay, I can’t buy that there are many entrepreneurs among that crowd that have forsworn building their own business for the sake of a gilded paycheck. So yes, Wall Street may be taking away prospective employees, but perhaps a wider base of engineering and science talent would help solve the problem? Maybe our immigration programs should be revamped, or perhaps a greater emphasis on science and math will pay out in more children choosing to go through those degree programs.

The report concludes by imagining what would happen as the financial sector becomes a smaller proportion of the gross domestic product. Its authors conclude that not only could entrepreneurship rise, but the quality of companies will improve and then through the growth of those new companies, financial services will be available to meet their needs as opposed to creating bizarre financial instruments that seem to be the equivalent of shell games. It’s likely that we’ll soon be able to test that conclusion.

Picture courtesy of Flickr user epicharmus.