Paul Romer is the STANCO 25 Professor of Economics in the Graduate School of Business at Stanford University and the man who added the t (for technology progress) to the l (for labour) and k (for capital) for the function for economic growth. New Growth Theory shows that economic growth doesn’t arise just from adding more labor to more capital, but from new and better ideas expressed as technological progress. In a recent article by Paul Romer, he says that Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. In this article he goes on to say “Economic growth occurs whenever people take resources and rearrange them inways that are more valuable. A useful metaphor for production in an economy comesfrom the kitchen. To create valuable final products, we mix inexpensive ingredientstogether according to a recipe. The cooking one can do is limited by the supply ofingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer fromunacceptable levels of pollution and nuisance. Human history teaches us, however,that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic
value per unit of raw material.”
Have we found a new recipe that makes a cluster vibrant? Is it crucial that clusters facilitate the formation of teams of people who would otherwise not form a new enterprise – lots of slices in the founding team? We know that technology companies in clusters are formed by teams and not by one person. Then by adding the ingredient of funds in many slices from investors (angels and VCs) to each mix in a number of rounds, do we make the formation of new ventures possible? For angels, the cost of capital is lowered from an investment to “fun” money so they are prepared to risk more in aggregate and also justify higher valuations which leads to lower dilutions to the founding team. Also the option pool (originally just for managers) is now split many times and is open to all.
The cluster takes a large number of separate ingredients and provides the environment to bake together. Informal groups of angels in which each angel accepts their own risk work very differently from funds of angels run by a manager. The manager has raised the fund by combining many slices and has a much lower appetite for risk. VCs in high technology companies always invest in slices even if they could fund the deal themselves. The other benefit is that lots of small slices brings lots of small expertise to the baking with the sum being greater than the parts. This aggregate expertise is lost to managers of funds.
Hat tip: Richard
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