By Simon Johnson.

This post draws on points discussed in class #7 of Entrepreneurship without Borders, a course at MIT Sloan. More details on the course are here.

With the US government in partial shutdown (including suspending a significant amount of research and development activity) and the very real threat of a default on US government debt looming, now is a good time to ask – can the US maintain its edge in technology-based entrepreneurship? What would it take to squander the advantages we currently have? Can other countries catch up or surpass us on this important dimension that matters a great deal for technological innovation, productivity improvement, and job growth?

Consider, for example, Germany, which has a strong small and medium-scale business sector, but traditionally not the kind of “home run” entrepreneurs seen in Silicon Valley.

In part this may be due to culture. In particular, Silicon Valley and perhaps the US in general are relatively tolerant of failure – failing with a start-up is often regarded as valuable experience. In contrast, in Germany there is stigma attached to business failure. In comparing across countries, ask questions about where top engineering talent wants to go to work – in Germany the preference seems to be large companies.

But there is also an important difference in capital markets – it is much easier to go public with a relatively young company in the US compared with Germany. The lack of an initial public offering (IPO) exit may limit the appeal to venture capitalists. The Neuer Markt, introduced for tech startups in the 1990s, was not a success – damaged by the Internet bubble bursting and some fraud. The recent US JOBS Act lowers disclosure requirements for some companies and makes it easier to engage in “crowd sourcing” of capital. Does this help or hurt entrepreneurial start-ups? The answer presumably depends on whether investors get treated well or badly by companies and by the investment banks that represent them.

German venture capital (VC) funds are more dependent on wealthy families; pension funds and endowments in have been prominent limited partners (LPs) in the United States. German funds tend to be smaller – investing less and willing to exit for lower amounts. As a result, there is less inclination to look for and bet on potential “home runs”. Some US venture capital funds derive most of their returns from the small number of investments that return 10 times the original outside investment (or more).

This is really helpful if you want to attract the best and the brightest potential entrepreneurs from around the world. People who want to hit business home runs would like to be funded by VC funds that are willing to place big bets. In this case, it makes sense not to see failure as a negative – perhaps actually making it easier to get backing for the next venture; in part, culture can be an outcome of economic incentives. (This point is made clearly and with math by Ramana Nanda and Matthew Rhodes-Kropf in their paper, “Innovation and the Financial Guillotine“.)

All of these long-standing advantages would be wiped out if the US defaults on its federal government debt. That would be the end of the world’s safest asset. Our value as a safe haven would disappear. And forget about taking your company public any time soon.

Most likely venture capital and most other sources of funding for business would dry up completely.

Playing games with the debt ceiling is a very bad idea – threatening to blow up innovation along with the rest of the US economy.