Foreword

Venture Capital in the Macro-Economic Context.

Professor Josh Lerner, The Jacob H. Schiff Professor of Investment Banking at Harvard Business School 

“Innovation is the central issue in economic prosperity.” 
– Michael Porter

Economists, policymakers, and practitioners across industries generally agree on the need for greater innovation. This consensus, among groups with often disparate goals, stems from the fact that innovation drives economic growth. As early as the 1950s, academics such as Abramowitz and Solow (who would go on to win the Nobel Prize in Economics for his work on this topic) determined that technological progress catalyzes economic progress by improving the effectiveness of labor and capital. Policymakers prioritize innovation given the potential for economic growth to reduce poverty and enhance living standards.  

However, lagging productivity growth across many Western countries has prompted broad concerns about innovation. Research efficiency is falling across fields as ideas appear to be getting harder to find. Large firms are investing less in R&D, with the decline concentrated in research expenditures. Regardless of the causes, the consequences will likely be substantial given innovation’s role in economic prosperity. 

Against this troubling backdrop, the venture capital (VC) industry has remained one bright spot. VC has financed startups at early stages that have ultimately grown into some of the largest and most well-known companies around the world. However, VC investment has been concentrated in a narrow slice of technological innovation despite the significant increase in capital deployed by VC investors and the growing number of startups receiving funding. VCs have increasingly gravitated towards startups with business models that optimize existing products and services for convenience, cost, or other similar dimensions instead of more “radical” forms of innovation.  

This highlights that VC in its current form is not a cure-all to stagnating innovation. There may exist promising startups poised to tackle society’s biggest challenges; but because their businesses face greater regulatory, technology, or market risks, they may receive relatively less— or no —attention from VCs relative to “safer” startups that provide incremental innovation only. As a result, much-needed technological progress in key areas of the economy may be stymied. 

Thus, the inflection point at which VC currently finds itself — combined with the proliferation of potentially paradigm-shifting technologies leveraging Artificial Intelligence — undoubtedly presents both challenges and opportunities. For investors willing to take the sorts of calculated risks that characterized the early VC industry, some of the most difficult problems facing society today may also present some of the greatest investment opportunities. Adopting new approaches for thinking about VC investment — for instance, by recognizing that outsized financial returns can be produced while solving big issues at scale  — could be integral to the next wave of innovation.