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I try to avoid business people. They tend to be crass, abrasive, materialistic and above all productive: always finding ways to provide goods and services to society. It's very unpleasant. But today I held my nose and attended a talk by a prominent entrepreneur from the high tech industry discussing how to foster innovation. The solution, I heard stated very clearly, was protectionism.

Not blatant protectionism, mind you. He was not interested so much in protecting mom & pops from the Walmarts of the world or insulating giant industrial conglomerates from competitive pressures. Given his background in a rapidly-changing, capital-intensive industry, his focus was primarily on creating "incentives" and "enablers" and "tweaks in the system" to encourage small, domestic companies to get a leg up. Examples included government funding, creating a venture capital-friendly environment, tax credits for investments in small firms, and providing incentives for the commercialization of university research.

Another example included creating a "bias" in government procurement procedures towards small domestic firms. His argument was that of a high schooler: everybody else is doing it. Despite WTO commitments, all the biggest players in the game have this bias, so your country should be no different. The game is rigged, so there's no point following the rules to the letter.

Of course, this flies in the face of everything one learns in international economics courses. It also breaks the traditional mold of business people as anti-government and free-marketeers. But it is not really all that surprising: from the point of view of a rationally-thinking entrepreneur, you want to make starting up a business as easy as possible. If you face an unfair competitive advantage in foreign markets, then you should pressure your domestic government to respond in kind.

And from my own point of view, it was quite entertaining to see a highly-successful businessman getting quite animated about how we used to be "protected" by tariffs, or how we should force domestic pension funds to invest a percentage in the domestic market. A couple of points:

1. I am obliged to drag out the ECON101 notion of what is seen vs. what is not seen. There are always trade-offs when you provide government support for a particular industry. The benefits are clear to the industries on the receiving end. But you always need to consider the unseen costs - what are the alternative uses of those funds? who is getting snubbed? and so on. That was not part of this entrepreneur's thinking process.

2. While our intrepid entrepreneur was busily pointing out the value-added of having small, innovative firms grow into global competitors, he failed to mention the value-added of having your market open to innovative foreign firms. Domestic firms are not the only source of wealth creation. For instance, he tells the story of how he recently bought a pair of scissors for 23 cents (made in China). He used it as a cautionary example of how we faced competitive disadvantages from foreign firms. What he failed to mention was the wealth-creating effects that 23-cent scissors and their equivalents have for consumers.

3. While I am in general agreement that most countries continue to give domestic firms an unfair advantage, it's worth remembering that things used to be worse. The entrepreneur, for instance, was able to set up his companies abroad and raise capital for his firms in a dozen foreign markets . That would have been very difficult if not impossible 30-40 years ago. If we take his advice, writ-large, we may not see any further improvement over the next 30-40 years.

Still, I'm not rejecting his argument entirely. Since all governments provide support to their domestic firms in some form, the question becomes how to get the most "bang for buck" from subsidies while minimizing distortions. At what point does the benefit from stimulating domestic innovation outweigh the costs of subsidies? This is not an easy question to answer, but it's naive to reject the question out of hand.

UPDATE: John Robertson asks: "do small firms account for most net job creation?" Not really, but:

"Research... suggests that, at any point in time, a relative handful of high-performing companies account for a large share of job creation and innovation. This conclusion suggests that a key to long-term economic growth may lie in ensuring that the economic environment is conducive to the ongoing creation of these types of high-growth performers."

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