August 2011

A crisis is an opportunity riding the dangerous wind.
– Chinese Proverb

In late May/early June  I led a group of ISU faculty, students, and ag industry folks on a trip exploring entrepreneurial supply chains in China. The trip was provided funding the the USDA International Science and Education (ISE) Competitive Grants Program.

This was only my second trip to China, though I did some work in the 1990s on a team that developed Pioneer Hi-Bred’s entry into China.  As a side note, we visited the head office of Pioneer-China, and they now have 600 employees in-country.  It was an interesting way for me to close a loop on some work I did sixteen years ago!

There is tremendous discussion in agriculture today about opportunities, whether trade, investment, or business partnerships.

I was struck by the scale and speed of economic change.  China is able to absorb technology and business innovation decades in the making in a very short period of time.  In an environment of almost unlimited capital, this makes for rapid change.  For those traveling in Chinese cities, you just need to look up.  The number of cranes is unbelievable.  The eastern part of China is a massive construction zone.

Chinese Skyline: Cranes and Hazy Smog

The size of the country and its population magnifies the change.  At 1.4 billion people, China’s rounding number is more people than in the United States in total.

The implications of this rapid change for agriculture are the new demands placed on agriculture and the food industry for a more wealthy Chinese population.  While per capita income in China is moving up rapidly, it still is just around $7,000.  However, even a portion of 1.4 billion people moving up to middle class incomes involves an upgrade in diet and subsequent impacts on agricultural demand.

The chart below is dated, but depicts the general idea of dietary upgrade as per capita income changes.  The proportion of calories consumers derive from animal proteins (eggs, dairy, meat) grows as income moves higher increases.  Cheaper calories from starches (rice in China) give way to more expensive calories from eggs, milk, cheese, and meat products.  You will notice China is on the far left side of the chart (2002 data).

China faces significant constraints in its agricultural production capacity even as its population demands more, however.  China has approximately 300 million acres of arable land, covering 13 percent of its territory. This amounts to 0.67 acres per capita, less than 40 percent of the world per capita average, one-eighth the U.S. level, and one-half the Indian level.   China comprises 22 percent of the world total population, but has only 7 percent of all arable land.

China will apply resources to increase its agricultural productivity; certainly price incentives/high prices will motivate it.  The constraint in land resources, however, is fundamental and limits the agricultural production capacity of the country.

Another significant challenge is the structure of land holdings in China.  The average farmer in China is very small, with only about one third an acre per farmer.  This makes the application of large scale cropping technology very problematic.  One can’t farm gardens/smallholder plots with 200+ horsepower tractors equipped with the latest in precision farming technology.

The limits of production capacity of agriculture in China create a frontier of opportunity for U.S. agriculture.  Untapped agricultural production capacity in the U.S., from more abundant natural resources as well as acumen in agricultural technology, can and will play a significant role in meeting the demands of Chinese consumers.

The U.S. already ships bulk commodities to China, soybeans being the biggest export.  About half our soybeans from Iowa end up in China, for example.  China is importing a little U.S. corn, which will also likely increase.  Imports of higher value food and agricultural items are also likely to increase, along with technologies related to improved agricultural productivity.

Chinese cultural and political currents heavily favor self-sufficiency in agriculture and food.  However, resource constraints and comparative advantage favor trade flows with manufactured products flowing out of China and agricultural products flowing in.  It will be interesting to see how this dynamic evolves in the next decade.

America is a land of taxation that was founded to avoid taxation.
– Laurence J. Peter

In the previous post I wrote about a survey that found that Iowa State University alumni entrepreneurs disproportionately started their companies in places other than Iowa.  While there are a number of reason for this, it seems likely that the business climate in Iowa, or lack thereof, must play some role.

But how do we measure business climate?  How do we gauge how friendly or unfriendly the environment in one state is for starting and operating a business versus another?  One method is to look at taxes.

My colleague Peter Orazem and former graduate student Joe McPhail have worked on a very interesting means of sizing up the business climates of states, and are in the process of updating their data.

This paper analyzes tax policies across states, with particular emphasis on marginal tax rates, or the tax rate that applies to the last dollar of the tax base (taxable income or spending).  Marginal tax rate is a term often applied to the change in one’s tax obligation as income rises.

The paper finds that there are persistent differences in distortionary tax policies across states which have caused persistent differences in capital investment across states.  There is evidence that there are low levels of labor productivity in states with the most distortionary policies compared to states with more favorable tax policies.  Iowa’s taxation ranks most negative among the 48 states, dead last,  in the analysis for its impact on labor productivity, and thus its impact on income, employment, and investment.

Taxes on property, corporate profits and consumption are the most damaging to labor productivity. Jointly administered income and capital gains taxes have smaller but still significant effects. Corporate taxes are particularly inefficient because they generate relatively little tax revenue per unit of lost productivity.

The overall effect of marginal tax rates on output per worker are substantial, reducing state labor productivity an average of 19.4%. They are responsible for substantial differences in the level of labor productivity across states: from a minimum negative impact of 11.8% in Nevada to a maximum of 27.6% in Iowa. States that rely more heavily on distortionary tax levies discourage capital investment, leading to lower levels of labor productivity and wages.

There are large and persistent differences in state tax policies as state taxes simply don’t change much over time.   The authors show that in theory, taxes on capital income, capital ownership, and sales will all lower labor productivity by distorting prices and returns to investment.  As implemented by the states, property taxes are responsible for 35% of the lost labor productivity while corporate taxes and sales and excise taxes are each responsible for 25% of the adverse effect. Income taxes and capital gains taxes have smaller negative effects, but as they are imposed together, their joint effects are also statistically significant and economically relevant.

The joint effects of tax policies are substantial, lowering labor productivity by an average of nearly 20% over the period 1977-2004. Tax policies have become more damaging to labor productivity over time, from -13.7% in 1977 to -24.5% in 2004.

Driving the negative effect is the reliance on rising marginal tax rates, apparently because of their greater distortionary effects on prices and returns compared to flatter tax rate structures. Tax policies can lead to substantial differences in equilibrium labor productivities across states, creating a gap of nearly 16 percentage points in output per worker between the least distortionary tax mix (Nevada: -11.8%) and the most distortionary (Iowa: -27.6%). Even though taxes differ in their relative efficiencies in generating revenue, with corporate taxes being the most costly and sales taxes the least costly in lost labor productivity per proportional increase in revenue, it is the highest marginal tax rate and not the type of tax that proves the most important for lost state labor productivity.

From an Iowa perspective, there are several observations:

  • While Iowa taxes don’t appear uncompetitive versus other states looking at individual rates, the net effect of their impact is significant because of their marginal effect, or impact on the last dollar of taxable income or consumption.  In effect, Iowa has the nation’s highest marginal impact on success (income, investment) which negatively affects wages, investment, and employment.
  • The impact of Iowa’s many tax credits and exemptions is to increase marginal tax rates.  A simplified tax regime with a broader tax base decreases this marginal impact and distortionary incentives to realize income, invest capital, and create jobs in other states.
  • State tax policy is relatively stable over the course of time.  One implication is that significant changes in state tax policies are apparently difficult to make.  The other is that if a state like Iowa can improve its competitive tax impact relative to other states, the improvement will likely persist over time.

Taxes are necessary to fund government services, but the structure of those taxes makes a significant difference in terms of the climate for investment and production.  Taxes matter.

Our real objective is not just jobs but productive jobs–jobs that will mean more goods and services to consume.
— Milton Friedman (Free to Choose: A Personal Statement)

In the previous post, I cited the results of a survey of 1982 to 2006 graduates of Iowa State University.  The 15.8 percent of Iowa State University graduates between 1982 and 2006 who had created at least one for-profit business, resulted in the creation of 222,569 jobs.  These companies had 2007 revenues of approximately $64 billion.  For an indication of magnitude, note that Iowa gross domestic product was $135.7 billion in 2008.

An interesting result of the survey was that 84 percent of these over 200,000 jobs were created outside the state of Iowa.  Only 35,242 of the jobs created at firms started by ISU alumni entrepreneurs were created in the state of Iowa, 15.8 percent of the total.  A higher proportion of total companies founded by alumni were located in Iowa (35 percent), but those businesses located outside Iowa had more jobs created per enterprise.  Large metropolitan areas both in the Midwest (Minneapolis, Chicago, and St. Louis, Kansas City) and outside the Midwest (Phoenix, Los Angeles, Dallas, Seattle, San Francisco) recorded multiple alumni starting businesses.

If ISU alumni entrepreneurs had started their firms in Iowa and all the jobs created at those firms were also in the state, then theoretically Iowa’s economy would be about 40 percent bigger than it is today.  Can you imagine an Iowa with that many more firms, jobs, and people?

So what’s going on?  Undergraduate enrollment at Iowa State is comprised historically of greater than 70 percent Iowa residents.  It seems reasonable to expect some propensity for an entrepreneur to locate their business in their state of residency and undergraduate attendance.  However, that expectation isn’t met by the data from the survey.

It’s not that I believe that ISU alumni have a particular requirement to start their firms in Iowa, even if they grew up in the state.  We just need to trade some of our native entrepreneurs for those from other states.  I immigrated all the way from Nebraska and have started two companies in Iowa, but apparently this is rare behavior.

Part of the story is the overall environment for entrepreneurs in Iowa.  Iowa’s report card for entrepreneurship is not stellar, with the state consistently ranking between fortieth and fiftieth in most measures of entrepreneurial activity such as venture capital investment, manufacturing investment, employment growth, and new business creation.  This fact makes the entrepreneurial activity of Iowa State University alumni appear all the more impressive.  It may also explain the disproportionate amount of entrepreneurial activity of alumni outside the state of Iowa.

There were some important indicators from the survey on firm location.  The top response for business location in the survey was ‘where I lived’ (82 percent ranking it as very important) indicating that alumni had already moved away from Iowa to pursue their careers when they started their entrepreneurial ventures.  Rather than move back to their native state of Iowa, they located their business where they lived currently and had built their post-undergraduate career and lives.  The first business start for alumni was on average ten years after graduation.

The founding of entrepreneurial ventures by ISU alumni, over 70 percent of whom are Iowa natives, outside the state of Iowa likely signifies problems in the business climate in the state.  A more dynamic business climate would lead to a higher proportion of undergraduates pursuing careers in their native state because of more numerous and better quality job opportunities.  This, in and of itself, would increase the likelihood of alumni ventures being started in Iowa.

The consequences of what is commonly referred to as ‘brain drain’ are profound from an entrepreneurial as well as an economic perspective.  Policies that have focused on keeping students in state to attend college miss the point that if they do not find a commensurate way to make a living in the state upon graduating they will leave (Artz, Georgeanne M. and Li Yu, 2009).

A more dynamic entrepreneurial ecosystem in the state would encourage more alumni to either start their ventures in Iowa sooner after graduation or to move back from another state after having pursued employment with another company for a time.  It would also attract more entrepreneurs who are non-Iowa natives.

The ISU alumni survey reveals the economic impact of alumni entrepreneurs and the positive role that higher education plays in spurring entrepreneurship.  Entrepreneurs tend to have higher incomes, their ventures create jobs for others, and they are more active in their local communities.   This activity does not occur in a vacuum, however, and the business and entrepreneurial climate in the state plays an important role in the form and location of alumni’s entrepreneurial ventures.

Research- and technology-intensive universities like Iowa State can have a dramatic impact on the economy via the entrepreneurial activities of its alumni.  The economic activity this entrepreneurship can spur is part of a larger entrepreneurial ecosystem, however, that necessarily requires a vibrant economic environment to fully extend its potential impact.

In the next post, I’ll dive deeper into issues regarding Iowa’s business climate, as well as that of other states.

Artz, Georgeanne M. and Li Yu.  How ya gonna keep ‘em down on the farm: Which Land Grant graduates live in rural areas? Working Paper No. 09016. Iowa State University Economics Department. July 2009.

The critical ingredient is getting off your butt and doing something. It’s as simple as that. A lot of people have ideas, but there are few who decide to do something about them now. Not tomorrow. Not next week. But today. The true entrepreneur is a doer, not a dreamer.
     – Nolan Bushnell, founder of Atari and Chuck E. Cheese’s

My colleagues Bob Jolly and Peter Orazem conducted a survey of Iowa State University Alumni a few years ago to gather data on the entrepreneurial activity of that group.  Do graduates of a public university exhibit entrepreneurial behaviors over the course of their careers that are at all different from the population at large?  What sort of businesses do they start?  When do they start them?  Do entrepreneur alum’s incomes differ from their non-entrepreneur counterparts?

You can view an extensive summary of the results of this survey of 1982 to 2006 ISU graduates here, but the results showed that the education and experience received at Iowa State University had an impact on the entrepreneurship activity of graduates.  While formal classes and programs on entrepreneurship were not offered at Iowa State University until the latter 1990s, it appears that something in the university experience and the subsequent career path of graduates leads to relatively high rates of entrepreneurship.  It also appears to lead to higher rates of firm survival for alumni entrepreneurs than for entrepreneurs generally.

While the state of Iowa has consistently lagged other states in various measures of entrepreneurial activity, Iowa State University graduates exhibit a higher rate of entrepreneurship compared to the population as a whole.  Various studies show an entrepreneurship rate for Iowa’s population of around 5 to 6 percent.  This compares to 15.8 percent found among 1982 to 2006 graduates in this survey.  The implication is an entrepreneurship rate among Iowa State University graduates about twice that of the general population of the state.  Entrepreneurship rates varied by college of graduation, with the highest rates among those who received a bachelors degree from the College of Agriculture and Life Sciences or the College of Design.

Iowa State University graduates also appear to exhibit higher entrepreneurship rates than other college graduates.  One study (Farlie) found that U.S. college graduates had an average annual entrepreneurship rate between 1996 and 2008 of 0.296 percent, implying a 7.4 percent entrepreneurship rate over a twenty-five year period as with the alumni survey.  Interestingly, Fairlie found U.S. college graduates to have a slightly lower annual entrepreneurship rate than the population as a whole, which had an average annual entrepreneurship rate of 0.305 percent over the 1996 to 2008 time period.

Iowa State University graduates may have more comparable entrepreneurship rates with respect to other institutions of higher learning with a scientific and technical core, though there is not extensive data available on this topic.  In one example, The Massachusetts Institute of Technology (MIT) surveyed all of its living alumni and found an entrepreneurship rate of 23.5 percent.  Keep in mind that MIT has a very rich history of significant technology entrepreneurship, with alumni having created companies such as Hewlett Packard, Intel, and Digital Computer.  Given that the entrepreneurship rate among the earliest cohorts in this survey was about 25 percent, we suspect that the rate for Iowa State University would have approached the MIT level if graduates pre-dating 1982 had been included as they were in the MIT study.

In the next post, I’ll discuss the results of this survey related to job creation by ISU alumni entrepreneurs.

Fairlie, Robert W.  2009.  Kauffman Index of Entrepreneurial Activity.  Kauffman Foundation.  Available at:

Roberts, Edward B. and Charles Eesley. Entrepreneurial Impact: The Role of MIT.  February 2009.  MIT Sloan School of Management.

To succeed, jump as quickly at opportunities as you do at conclusions.
– Benjamin Franklin

Marking some of the progress we’ve made at the Agricultural Entrepreneurship Initiative are the Iowa State University students who are working on their own startup companies.  It is interesting to watch them go through the same ups and downs familiar to any entrepreneur, with only occasional flashbacks to past midnight sweats.

One example that has made great progress is recent months is Scout Pro.  In a nutshell, Scout Pro’s software assists farmers, crop scouts, and agronomists in identification of pests using software on a tablet device like an iPad. The concept for the business was developed in a class I teach, the group won the Pappajohn statewide business plan competition this spring, with a more formal launch for their product occurring later this month at the Farm Progress show.

Michael Koenig, founder of the company, has done a great job pushing the concept forward.  His partner students, Stuart McCulloh and Holden Nyhus, have also worked to make their vision a reality.  The video they’ve posted on their website is really good stuff.

The first part of the entrepreneurial process I talk about with students is opportunity recognition, the ability to look at the world through an entrepreneurial lens and recognize economic opportunities.  The Scout Pro team has learned that there is indeed opportunity in the marketplace.  However, they are now learning that executing on that opportunity involves a lot of hard work.  Leveraging resources, team building, and outright execution have very quickly become the primary focus of their efforts.

There have been a spate of articles recently about the decline in entrepreneurship rates in general (Wall Street Journal example).  I will withhold discussion of that topic for another day, but congratulate one company on the progress they have made in creating a startup success.