Nothing Ventured

by Nick Serpe

Silicon Valley wants to revitalize the Rust Belt with venture capital. The story of venture suggests we shouldn’t hold our breath.

An advertisement published by the National Venture Capital Association to promote a reduction in the capital gains tax.

Congressman Ro Khanna, a first-term Democrat representing a large chunk of Silicon Valley, has a lot of friends in high places in the tech sector. But when he ran a campaign in 2014 emphasizing their support and celebrating the Valley’s accomplishments, he lost.

So in 2016, Khanna tried something different and won. This time, he promised to represent not only the interests of companies like Apple and Intel (both headquartered in his district), but also “folks who had been left out” of the “profound transition from an industrial to a digital age.” Since taking office, he has committed himself to channeling the technical expertise and enormous wealth of Silicon Valley to the economically depressed American interior.

In March 2018, Khanna and Congressman Tim Ryan, Democrat from Ohio, helped bring a particularly (though not exclusively) Californian institution—the venture capitalist fund—to the Midwest on the “Comeback Cities Tour.” They took a delegation of venture funders, including hillbilly whisperer J.D. Vance, through cities in Ohio, Michigan, and Indiana—all states that backed Trump in 2016.

The tour only generated a couple hundred thousand dollars for Midwestern businesses, a fraction of the billions of dollars that venture capitalists invest in the Democratic strongholds of California, New York, and Massachusetts each year. Yet it served as an advertisement for venture capital’s much-vaunted function: risking resources on startups with the potential to grow rapidly, develop innovative products, and create high-paying jobs.

Elite segments of the tech sector sense that the political fissures exposed by Trump’s victory are entwined with plutocratic entrenchment and diminished opportunities for the working class. So they are eager to prove that they can ease economic malaise by bringing growth to regions with very little of it. And the instrument of that growth, they believe, is venture capital.

The Comeback Cities Tour belongs to a long tradition. Venture capital represents a very small part of US GDP, but it plays an important ideological role. In times of crisis, when financiers have felt the need to justify their activities to the broader public, they have held up venture capital as a force for good—as an engine of technological development and economic growth that benefits everyone. Venture capitalists risk their own money to build companies that contribute to a dynamic economy. The reality, however, is that the benefits of venture, like those of the financial sector as a whole, flow primarily to rich investors. Throughout its history, venture capital has been successfully deployed to conceal this reality, soothing popular hatred of the bankers while advancing their agenda.

An Angel Gets Its Wings

American business leaders feared for the future of capitalism in the 1930s and 1940s. A massive financial collapse contributed to the rise of socialist and fascist threats to the economic and political order—which were only beaten back in the US through legislation that increased the state’s role in economic activity. During World War II, the federal government took an even stronger hand in regulating industry. Businessmen regained some public trust for their contributions to the war mobilization, but Wall Street worried that a command economy might become more attractive.

So bankers launched a counterattack. According to the historian Martha Louise Reiner, the financial sector used venture capital as a “rallying cry” to stave off the threat of central planning. The Investment Bankers Association felt compelled to “prove that free enterprise—and its accumulated wealth—met society’s needs.” The activities of venture capital—more theoretical than real in 1946—fit the bill perfectly.

Yet if bankers felt apprehensive about the wartime economy, they also greatly benefited from it. It was the war, in fact, that taught them how to be venture capitalists. The grandfather of modern venture capital, Georges Doriot, founded his firm American Research & Development (ARD) in 1946 after earning his chops procuring goods for the US Army during the war. In the coming decades, the young venture sector continued to take advantage of government support, most notably through a Small Business Administration program that provided state funding to match private venture capital. Meanwhile, the state proved to be the “Biggest ‘Angel’ of them all,” according to historian Stuart Leslie, through contracts for the advanced technology needed to power the American war machine during the Cold War.

Venture capital was a tiny industry, and remained so through most of the 1970s. At the end of that decade, however, venture investment pools grew by leaps and bounds, as did the number of funds. This inflection point coincided with the broader financialization of the economy, following a crisis in corporate profitability that had begun at the tail-end of the booming 1960s. In the face of this crisis, the US government undertook measures to expand access to credit, in order to compensate for the decline in real economic growth. The strategy prevented the crisis from deepening, but it has come at great cost: growing inequality, increased public and private indebtedness, and repeated speculative manias resulting from money chasing money in asset bubbles when no avenues for productive and profitable investment are available.

The sharp growth of venture capital in the late 1970s also reflected major changes in public policy. Two moves in particular opened the floodgates: a reduction in the capital gains tax in 1978, and a revision to federal rules on institutional investment pools that allowed them to put some money into riskier venture funds in 1979. The latter change was ultimately more vital to the venture explosion: within a few years the majority of venture funding was raised from sources like pension funds, foundations, and university endowments—and all of that money was nontaxable.

But the venture sector cut its teeth politically on the capital gains tax. The 1978 fight proved to be a watershed moment in the transition from the Keynesian postwar consensus to the conservative economic ideas that have dominated both major US political parties ever since, and venture played a critical role. Venture lobbyists were some of the first to push the supply-side argument that lower tax rates would increase tax revenue by stimulating economic growth over the long term. They drew on a tradition reaching as far back as World War II, when investment bankers had demanded a lower capital gains tax using the justification that it would spur venture investing—which would help the economy grow. History suggests these promises haven’t panned out. Cuts to the capital gains tax are a great way to make the rich richer, but we can’t count on them to put that money to productive use.

Bubble Boys

Thanks to the policy overhaul of the late 1970s, venture funds were flush with institutional investor cash in the early 1980s. They poured that money into technology start-ups whose products featured components that often owed their existence to long-term federal investments. By 1983, there were over a hundred venture firms, compared to the fewer than twenty in existence through most of the 1970s. There were 173 tech company initial public offerings (IPOs) that year, over five times as many as three years earlier.

All this investment didn’t produce a flourishing, diverse ecosystem of new technology firms. Instead, it led to overinvestment and speculation. The disk drive business became an especially hot market. In 1982, the New York Times reported that thirty new disk drive companies were founded over a single year. By the end of 1983, there were over seventy companies in the market.

Then came the crash: by the end of 1984, the industry’s valuation had collapsed, and incomes sector-wide fell a staggering 98 percent. Some of the smaller venture capital firms still tied up in non-public companies went bust; many others managed to cash out in public offerings and acquisitions. By the end of the 1980s, many VC firms that had publicly prided themselves on making equity commitments to young and innovative companies had turned to safer, lower-yield investments in retail outlets, and others turned to the dark side of private equity: leveraged buyouts (LBOs) financed through the purchase of junk bonds.

All it took to go from investing in the industries of the future to embracing overhyped markets and LBOs was a simple calculation about where there was money to be made. The venture capitalist Tom Perkins couldn’t make the point any clearer than he did in an interview after the 2008 financial crisis: “I love bubbles. We made a lot of money in bubbles….You don’t get rich by betting against the market.”

If venture capitalists can’t resist bubbles, they also tend to chase fads. Venture firms are mocked for pursuing the mania of the moment—nanotech, VR, AI, cryptocurrency, cleantech—and for investing in rackets like Juicero and Theranos. But they always made their most celebrated investments in companies that capitalized on technological breakthroughs funded with public money. With the public sector in retreat and the private sector pushed by a multitude of forces to aim for short-term profitability, the current behavior of venture capital is inevitable.

The worldwide decline in corporate profitability in the last half century has led investors to chase easy sources of profit. Sometimes that leads to investment in high-growth technology firms—many of which turn out to be duds or scams, or simply elaborate schemes to lower labor costs in existing industries. But the consistent result, as Robert Brenner has argued, is “a world economy in which the continuation of capital accumulation has come literally to depend upon historic waves of speculation, carefully nurtured and rationalized by state policy makers.” Venture capitalists help propel the waves of speculation upon which our current regime of capital accumulation depends.

In the last few years, early funding for new companies has dropped dramatically, as have the number of IPOs of venture-funded companies. In fact, there are about half the number of public companies in the United States as there were twenty years ago. Venture funds are pouring money into late-stage funding of companies with fast-growing but unprofitable businesses, dumping their pre-public shares in failing companies at a discount in secondary markets, or getting their startups acquired by tech giants like Google.

In an opinion piece on the Comeback Cities Tour, Tim Ryan and a couple of the venture firm partners who traveled with him through Akron and Youngstown and Flint and Detroit claimed the interstate highway as their model for bringing new opportunities to the Midwest. “The interstate of the future,” they wrote, “will connect talent, ideas, and capital as much as the road system of the past connected physical commerce.” It should go without saying that the interstate highway system was a massive public project—one that, incidentally, provided a major subsidy to the automotive and fossil fuel industries.

The paltry funds pledged by investors following the tour indicates how seriously people in regions decimated by decades of capital flight and austerity should take the comparison. We can blame venture capitalists for not taking risks, but recent history has made it clear that the system is designed so that risk falls onto the public, and the rewards go to the people who already have everything. Maybe we should stop outsourcing our dreams to people whose imaginations are bounded by the bottom line.

Nick Serpe is the co-editor of Dollars & Sense and an editor at large at Dissent.


This piece appears in Logic's fifth issue, "Failure." To order the issue, head on over to our store. To receive future issues, subscribe.


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