Venture Capital: Manufacturing Is Not the Path to Stimulate Economic Growth

California has a high share of venture capital. But in a recent article, Where’s The Beef? Can Venture Capital Save California?, Gino DiCaro, Vice President of Communications for the California Manufacturers & Technology Association, makes an interesting point: point: All of California’s venture capital hasn’t created much growth in manufacturing. While California accounts for over 40 percent of all U.S. venture capital activity, DiCaro says, it is home to only “1.3 percent of the new or expanded manufacturing facilities in the last five years.”

DiCaro’s article raises an interesting question: Does it matter that California’s dominant position in venture capital fails to translate into growth in manufacturing in the state?

Venture Capital: Manufacturing Isn't the Path to Stimulate Economic Growth

I think not for several reasons.

First, increasing manufacturing isn’t a path to faster economic growth. A study of the differences in state economic growth going back to the 1930s showed that manufacturing’s share of a state’s industrial structure actually reduces per capita income. So states like California are better off economically if they reduce their reliance on manufacturing.

Second, places with more venture capital have higher economic growth. Studies show that venture capital-backed companies are more innovative and have higher employment and sales growth than comparable companies not financed by venture capital.  Therefore, California benefits from its large share of the U.S. venture capital industry.

A quick glance at California companies shows that new venture capital backed start-ups can enhance economic growth even if they don’t create any new manufacturing businesses.  For instance, Google and Facebook don’t make anything, but are hiring workers and generating wealth at a rapid pace.  If a state can create companies like these, does it matter if venture capitalists don’t back a lot of manufacturing businesses?

Third, recent research conducted by Larry Plummer of the University of Oklahoma indicates that efforts to increase start-up activity in manufacturing might hinder efforts to create more high tech companies.  Plummer’s study shows that places with more high tech new businesses tend not to have more manufacturing start-ups and vice versa. Because venture capital is designed to enhance the growth of high tech companies, not manufacturing ones, there’s no reason to expect the size of a state’s venture capital industry to be related to manufacturing’s share of state economic activity.

In fact, Plummer’s study shows that the same factors that increase the rate at which manufacturing firms are created actually reduce the level of new business creation in high tech.  For example, places with faster growing populations and a lesser share of the population that graduated from college have more manufacturing startups, but fewer high-tech ones.  Although Plummer didn’t look at the effect of venture capital, it’s possible that places with high levels of venture capital have more high tech start-ups and fewer manufacturing ones.

In short, DiCaro’s article is an example of argument-by-spurious-association.  He says that something is wrong in California because the state has high rates of venture capital activity but low rates of manufacturing firm growth.  However, if manufacturing firm growth isn’t an objective of policy makers, this pattern doesn’t matter.  Venture capital encourages the formation of high growth, high tech companies, which generate wealth and create jobs.  As long as venture capital does this, we should be happy.

Editor’s Note: This article was previously published at under the title: “Venture Capital Doesn’t Need to Encourage Manufacturing to Stimulate Economic Growth.” It is republished here with permission.


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

6 Reactions
  1. Scott – do you remember the “Massachusetts Miracle”? Mass managed to build part of their economy pretty brilliantly but.. forgot to work on the rest of it and… OOPS! (In that case, they boosted high tech and the expense of low tech.. including the support industries for high tech.)

    Larry has some great insights on all this — if we really believe it’s an ecosystem, then growing one sector at the expense of others is counterproductive.

    Glad to see Larry’s work get visibility – and glad to see you keepin ‘ on!

  2. What specific types of regulations are the most costly? Compliance with environmental regulations costs almost four times as much in small businesses than in large businesses. The cost of tax compliance is more than twice as high in small firms than those larger. The fact that small businesses are bearing an over sized burden is not a new phenomenon. Many new environmental regulations destroy small businesses but do little to help the environment.
    Small businesses battle against multinationals in means to resist globalization. It is therefore in the benefit of those with power to destroy and obliterate them. This may explain why so many small businesses are not surviving, and why governments choose to make it difficult for them. Redundant government regulations are destroying small businesses by taking avoidable time, and causing unreasonable expenses.Small businesses have a drawback over larger firms due in part because they can’t afford satisfactory funds for competence, such as equipment and staff. Also they don’t benefit from the discounts of bulk buying as much as big businesses, which buy in larger quantities. They are also burdened with unnecessary paperwork and taxation. Today, we already comply with a crushing load of government-mandated requirements from variety of federal agencies. The total cost of compliance of these federal regulations is a stunning $1.75 trillion.

  3. Scott,

    It’s no big secret that the cost of living and the tax structure in California are undesirable to the creation of many new businesses when compared to other states. However, I’m curious if this is especially true for traditional manufacturing companies that rely on employees to build their products. It would seem that these companies would automatically have higher operational costs due to the higher salaries and taxes required to operate in CA. This, in turn, would negatively impact their profit margin assuming the prices for their products are comparable to those of their competitors (competitors that are based in states or countries that enable lower operating costs). So, I

  4. Despite high productivity from American workers the United States struggles to compete against overseas manufacturing because of their labor cost advantages. While I think that the U.S. does need manufacturing capabilities, we won’t ever return to the prominence we enjoyed during the 20th century.

  5. Robert: Have you read American Steel by Richard Preston?

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