Bold investment in innovation can help us battle the economic crisis

It is not often you hear a suggestion or comments from a Chancellor that make you want to yell out in praise, and shout: "YES!" But George Osborne elicited precisely that response from me earlier this week. Actually, it was a reluctant yell. I don't consider myself a fan of Mr Osborne, but if the plan is good, regardless of whose idea it is, it's a good plan.

Mr Osborne's proposal is for the Government to buy bonds in small and medium-sized enterprises. Adam Posen, member of the Bank of England Monetary Policy Committee, presented a very similar approach a few weeks earlier.

Yet the critics line up. They say it's not up to authorities to fund entrepreneurs; it is up to the markets. Please! Has the lesson still not been learnt? Sometimes, markets can be downright masochistic, and if the greater good is best served by more money being ploughed into new businesses, you can be sure the markets will promote the opposite approach. And entrepreneurial spirit can transform an economy. Give a thug the opportunity to create wealth, and knives are replaced by PowerPoint as the tool of the trade.

Over the last 10 years or more we have been turning our backs on entrepreneurs. Markets led the way. As for banks, most criticism misses the point. The problem with banks was not that they took too many risks; rather it was the complete opposite.

It all began when dotcoms crashed. The West turned away from risk. Instead, we opted for safer assets, such as property. The housing market boomed because it was seen as safer than equities. Consumer spending was funded by debt, but it was not irresponsible debt, or so they said. After all, in most cases, people's borrowing was covered by the net equity in their property. And property is as safe as... well, as safe as houses. More recently, when house prices stuttered, investors looked for alternative safe assets, such as gold and government bonds.

The problem is that risk-free investing may seem appealing, but if everyone adopts that approach, innovation in the real economy is killed, growth stutters and so-called safe assets look dodgy.

During the boom, topping up your mortgage was easy, so was obtaining a loan to fund a holiday in the Maldives. But getting a loan to kick-start a new business was hard. Unless you lied, and said you needed the money to speculate in the property market.

The lesson of the dotcom crash was that investing in entrepreneurial business was risky. The lesson was wrong. The FTSE 100's highest ever closing score was posted on 30 December 1999. That was when risk-taking peaked.

The IMF got caught up. It congratulated banks on the invention of mortgage securitisation. That's when mortgages are chopped up and sold on in pieces, so no bank had full exposure to the lending decisions they made. In 2006, the IMF, that august institution that is currently trying to lead the world out of crisis, said that the chances of a banking crisis had been greatly reduced, thanks to mortgage securitisation.

Can you believe that? In future all IMF communiqués should carry a statement saying: "Warning by international governments, complying with IMF recommendations can seriously damage the economy's health".

Sure, we had financial innovation, but very little real innovation promoted entrepreneurs.

The truth is that occasional busts are good. Not every new business succeeds – far from it; most fail. Yet, research carried out by the European Commission's Flash Eurobarometer found that 43 per cent of Britons agreed with the statement that a business should not be formed if there is a risk it will fail. Our cousins in Europe are even more risk averse, while the survey found that just 19 per cent of Americans shared the same belief.

The US's success was built on failure. Walt Disney, Henry Ford and Abraham Lincoln all flirted with some form of bankruptcy. Today's crisis can be solved by bold entrepreneurs backed by bold investors. But first the Government needs to take initiative. Instead, corporates hoard their massive cash mountains, while government bonds and gold soar in price. Markets flee from risk and, in the process, take the risk that the global economy will stagnate for years.

Only something far reaching can change the mind-set.

For all that, there remains a flaw. More lending to inherently risky entrepreneurs is not enough. Investment in exchange for profit share, or equity, which can make up for the inevitable losses that will occur on some loans, provides the answer. I don't think either Mr Osborne or Mr Posen is there yet, but they are getting closer.

Michael Baxter is the author of The Blindfolded Masochist: Creation Versus Destruction: The Power of Economic Networks, which was recently published by HotHive and is available at book shops, or online from www.thehothive.com. You can read his daily musings at http://blog.share.com

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