NVCA: Strengthen Education To Address Offshoring –

On March 11, 2004, Robert Grady, managing partner of Carlyle Venture Partners in San Francisco, testified on behalf of the National Venture Capital Association before the U.S. House of Representatives Committee on Education and the Workforce. The following is an edited excerpt from Grady’s written testimony, which focused on the key drivers of job creation.

Recently, there has been a great concern expressed regarding the so-called outsourcing of certain job functions to other nations. Politicians and others have been grappling with how to respond to the changing nature of our economy so that the United States may continue to hold the position of global economic leader. Our economy has always been extremely dynamic – that is one of its greatest strengths. We have continuously reinvented ourselves in cycle after cycle through innovation, while simultaneously raising the standard of living of Americans and improving the quality of our lives. In the short term, America is not in economic crisis. Our unemployment rate is 5.6%, inflation and interest rates are low, and economic growth has been strong. But over the long term, there is cause for concern – and we must take the steps today that will allow us to innovate and compete in the knowledge economy of the future.

So what have been the keys to America’s economic out-performance? And what are the keys to being able to compete in the knowledge economy of the future? In our view, several imperatives stand out: (1) ensuring the continued availability of risk capital; (2) maintaining transparent, liquid, trusted capital markets; (3) strengthening our educational system; (4) constantly seeking to maintain the world’s best system of higher education; (5) investing in basic R&D to keep America at the forefront of innovation; (6) maintaining flexible labor markets; and (7) expanding world trade.

America’s culture of risk capital has allowed a wide range of startups to flourish. Data from the Census Bureau show that since 1988, almost 10 million jobs have been created by companies with less than 500 employees. Two years ago, Decision Resources Inc. and Wharton Econometrics conducted a study of the impact of venture capital investing on the U.S. economy. The results of the study were staggering: It found that in the year 2000, venture-backed companies accounted for $1.1 trillion in sales – or about 11% of U.S. Gross Domestic Product. Further, the study found that venture-backed firms directly employed over 12.5 million people, and directly or indirectly supported over 27 million people. In addition, the study found far higher than average levels of R&D spending as a percentage of sales and patents generated per employee. Finally, it found that these benefits were widely spread across the United States, with venture-backed companies employing people in 49 of the 50 states. The point that the study made clear is that the leverage on venture capital investing, in terms of job creation and innovation, is substantial – everywhere in America. Incentives for capital formation and risk-taking, such as long-term capital gains reduction, should remain in place.

Our public capital markets are widely acknowledged as the deepest and most transparent in the world. Congress and the financial system should do everything possible to keep them that way. Yet, we should not adopt measures in the name of corporate reform that will have the effect of making financial statements less reliable and will choke off the innovation that is so critical to American success. In that regard, it is not prudent to require companies – especially small private companies with no public stock price history – to expense against income the awarding of incentive stock options to employees. As a matter of accounting transparency and reliability, a requirement to expense options would make income statements less reliable, as there is no agreed-upon method for valuing options, and several of the types of methods proposed rely on estimating the volatility of the stocks of companies with no trading history. Lastly, expensing options would punish the most successful companies – by valuing most highly the options of those companies with the best growth prospects. Expensing would be economically damaging to the country by changing the ability of the most innovative and high-growth companies to allow people to work for ownership instead of cash compensation.

Thirdly, if we are to compete successfully, our people have to be trained to do so. The health of our schools is essential to the health of our country. In this regard, legislation that ensures that our schools are performing, our kids can read, and parents of children in failing schools have more rights to do something about it is critical. Fortunately, there is a bipartisan consensus to invest more in education at the federal, state, and local level. The trick now is to make sure that the resources that this consensus can provide are used to maximum effect – attracting the most talented people to the classrooms to teach, allowing the use of both technology and better infrastructure in the classrooms, and addressing critical problems. In particular, we would urge support of programs to increase the number of students pursuing mathematics, science, and engineering education in the United States. This is one area in which America is falling behind.

Re-Engineer Education

Related to this point is, of course, the condition of our system of higher education – long acknowledged as the best in the world. Here, too, we need to increase the proportion of science, math, and engineering graduates if we are to remain competitive in a knowledge-based economy. We should be aware that our competitors are making this investment. The Chinese government, for example, has set a goal to increase the proportion of those in the 18- to 22-year old age group who attend four-year colleges. It plans to increase that level from 4% at present to 20% within twenty years, according to Think Equity Research. Think Equity reports that this will require the building of 10,000 universities the size of the University of Indiana. Americans must ensure that access to education continues – from K-12 all the way through the community college and university system. Just as “no child should be left behind” so, too, should “no adult in need of retraining be left behind.”

A key feature of America’s preeminent university system has been the funding of individual investigators at our research universities through the research agencies of the federal government – the National Institutes of Health, the National Science Foundation, the Department of Energy, the Department of Defense, and so on. The investments made by this and previous Congresses in the basic R&D enterprise in the United States have been critical to spawning innovation and ensuring our economic leadership. The advances this research has promoted in materials science, high performance computing, high energy physics, biomedical research – in a wide array of areas – has laid the groundwork for American leadership and American competitiveness in a large number of related industries.

We must work to ensure this and future Congresses will continue this investment in innovation. This year’s budget contains a record amount for federal R&D, but there are budgetary constraints facing the Congress going forward, particularly in non-defense discretionary spending. In this regard, venture capitalists -particularly among the many constituents – are focused on the future. Yet many of the investments most critical to that future – in education, in universities, in transportation infrastructure, in education – are in this category of discretionary spending. Venture capitalists, in particular, therefore recognize that without entitlement reform, investments in the future will be under-funded.

One oft-cited point of comparison with the European economies is that of labor market flexibility. In several European economies, employees who work for a certain relatively short time cannot be terminated, for up to two years. This has not had the effect of creating more jobs, but rather of discouraging employees from being hired in the first place. Similarly, lengthening plant closing notification requirements – as some are proposing we do in response to the wave of news reports on outsourcing – may simply discourage the opening of facilities in the first place. Reducing labor market flexibility in the United States will not create more jobs, and we would urge the Committee to consider that the more flexible system extant in the United States today has attracted rather than destroyed jobs.

Finally, part of our faith in an innovation-led, knowledge-based economy is the conviction that American ideas and products can compete anywhere in the world. More open markets will yield more growth, more jobs, better and more affordable products and services, and higher standards of living for Americans. According to the U.S. Trade Representative’s office, over the past decade exports accounted for 25% of America’s economic growth and have supported over 12 million jobs. A level playing field that opens international markets to American innovation and the products and services it has yielded will contribute the most growth to the American economy, while allowing our innovators to secure the highest quality components and services at the best price from wherever they may exist in the world.

No Quick Fix

It is easy to look at the rapidly changing nature of the economy and react with fear. In the late 1920s, concerns about America’s ability to compete against lower cost producers led President Hoover to recommend and Congress to enact the Smoot-Hawley tariffs. Growth and employment shrunk by a staggering 25% in the years that followed. In the 1970s, there were concerns about the ability of U.S. automakers to compete against Japanese producers, but a new cycle of innovation and product quality later led to market share gains. In the 1980s, Congress and others were concerned about our ability to compete in semiconductors – yet the biggest growth in value and in job creation in semiconductors in the 1990s was right here in the United States.

As a country that has been built on the pioneering of new markets and industries, the United States will always be faced with the challenge and the question of whether to continue to pioneer, or to turn inward in some attempt to consolidate our gains. Yet it is the combination of innovation and entrepreneurship that will continue to improve the lives of Americans, maximize the creation of new jobs to help offset the job erosion that has always been part of our economic landscape, and provide Americans with an exciting set of new opportunities for growth