Apparently founding a start up is the worst possible decision you can make

By Tim Worstall , written on April 29, 2014

From The News Desk

If Felix Salmon is to be believed, founding a startup is sheer lunacy.  Or at least the message he takes from Gideon Lewis-Kraus's "No Exit."

The deeply irrational decision to found a company – one which statistics tell us  is almost certain to fail – is akin to throwing away a large chunk of your precious youth. Meanwhile, the Silicon Valley ecosystem as a whole will happily eat you up, consuming your desperate and massively underpaid labor, and converting it into a few obscenely large paychecks for a handful of extraordinarily lucky individuals.

On its face, the winners, here, are the people with the big successful exits. But after reading No Exit, a different conclusion presents itself. The real winners are the happy and well-paid engineers, enjoying their lives and their youth while working for great companies like Google and Facebook. In the world of startups, the only winning move, it seems, is not to play.

This isn't quite and wholly true. As Salmon points out in his piece, founding a start up is an expensive lottery ticket. The expense is the money that could be earned elsewhere, while the lottery is of course being able to cash out into the billionaires' lifestyle. It's the odds between those two that determine whether the bet makes sense and Salmon is calculating that, with nine out of 10 startups failing, it's not worth it. Go get the paycheck and the free food and enjoy life instead, he recommends.

However, there's a few small problems with this thought. For one, appetite for risk is personal. We know very well that male appetite for risk is higher than female and that's one reason why there are more male entrepreneurs (add however much extra for gender discrimination that you feel appropriate).

Those gender differences in risk tolerance are paltry compared to the variation over the whole population of course. I've spent my entire working life in startups of one kind or another and I wouldn't have had it any other way. Going to work for The Man was simply never going to be an option. There are other people for whom the lack of a structured career progression is akin to torture. As long as people are accurately estimating their own risk profile what would indeed be a bad bet for some to many can still be a good one for a few.

But the other thing being missed is who really benefits from all of this activity. As Salmon says, the overall returns to the capital being invested seem to be negative. That's OK, we're well used to the idea of speculative investment bubbles, from canals through railroads to the fondly remembered dot-com boom of the 1990s. And there's certainly a coterie of economists who think that such over- or mal-investment is necessary to actually get new technologies over the hump and into general usage.

Even if we accept that Salmon is correct that founding a start up is not the most economically rational decision, and we also observe that the capitalists as a whole aren't doing all that well out of it either, is it possible to the whole thing to still be a good idea on net?

Yes, certainly it is: for the real measure of whether an economic model or adventure works is, what do the consumers get out of it? Not what profit can be gouged out of them, not the returns to investors nor the lifestyles of the workers, but what's that consumer surplus that the users of a product get? And here our answer can be unequivocal. We can just look at the amount of time that people are spending using all of these wonders that the Valley is producing, note the general value of peoples' time (according to Joe Stiglitz, when working for President Sarkozy, we should probably measure this at minimum wage) and multiply the two together. Thus the consumer benefit of Facebook is the hours spent on it times the minimum wage: a number that is vastly larger than the profits, revenues or even stock market valuation that Facebook has been able to capture.

We normally measure whether something is economically rational by whether we can make back the cost of the resources we've used to do it. But this is really rather restrictive, and simply answers whether it's a profitable thing to do. That profit depends upon being able to capture the value being created, not on the amount of value being so created.

When we relax this assumption and look at that consumer surplus being created then it is, as above, obvious that the system as a whole is economically rational. For it's increasing the consumer surplus and that's the whole point of our economic game: to maximize consumption opportunities, nothing else.

[Image adapted from wikimedia by Brad Jonas for Pando]