Arnold Kling  

Start a Business, Young Person

An Infinite Contradiction... Framing Effects and Memory...

Paul Graham says,

Most organizations who hire people right out of college are only aware of the average value of 22 year olds, which is not that high...

The most productive young people will always be undervalued by large organizations, because the young have no performance to measure yet, and any error in guessing their ability will tend toward the mean.

His point is that if you are exceptional and young, you should start your own business. That way, you will get more than an average reward.

Graham and I think alike on many issues. Several of the ideas in his talk mirror those in my book on starting a business, Under the Radar. Graham also did a great deal to promote Bayesian spam filters, something that I advocated also. I use a Graham-inspired filter called Popfile.

One of Graham's points is that young people need experience in figuring out what customers want. In my book, I call this "learning by selling."

Learning comes from taking on challenges. Entrepreneurship is a constant, in-your-face challenge. Relative to that, college is a stroll in the park.

As Graham points out, the cost of starting a business is plummeting. Given that college expenses are going the other way, the learning-to-cost ratio has shifted in favor of entrepreneurship over college.

Thanks to Michael Mandel for the pointer.

For Discussion. As a parent, could you convince yourself that investing $15,000 in helping your 18-year-old start a business is a reasonable "tuition" payment?

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CATEGORIES: Business Economics

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The author at Acton Institute PowerBlog in a related article titled Book Smarts vs. Street Smarts writes:
    The Donald chose book smarts over street smarts this season.Many may know that the season finale of The Apprentice was brodcast last night, with the conclusion being a victory for the “Book Smarts” team (college educated or higher) over the &# [Tracked on May 20, 2005 8:19 AM]
The author at Half Sigma in a related article titled Are young workers undervalued? writes:
    A post at EconLog quotes a line from a Paul Graham article: The most productive young people will always be undervalued by large organizations, because the young have no performance to measure yet, and any error in guessing their [Tracked on May 20, 2005 10:05 AM]
COMMENTS (34 to date)
Bernard Yomtov writes:

Graham takes a rather silly one-dimensional view of people. Sure, some 18-year olds might make fine entrepreneurs. But most won't, and I fail to see the justification for:

a. Defining life objectives solely in terms of "productivity."

b. Limiting "productivity" to what one can accomplish running a business.

People can be "young and exceptional" in lots of ways, and the notion that the best way to use one's talents must be to start a business is ludicrous.

captain mike writes:

However difficult it is to go through college, I don't think that educational institutions focus enough on so called "learning by selling." there really is only so much you can learn in an insulated classroom.

a focus on learning by selling would make a tuition payment a much more valuable investment.

Matthew Peppe writes:

I can only see this making sense in minority cases where a person has the skills needed to start a business. I'd think it would be safer to go to college and get credentials rather than risking it all as an entrepreneur. If the business fails, even though you may have gained valuable experience, future employment would be much easier to get with a diploma. What are the success rates for new businesses?

Mark Horn writes:
People can be "young and exceptional" in lots of ways, and the notion that the best way to use one's talents must be to start a business is ludicrous.
I don't think that the article was directed at those people who wish to be "young and exceptional" in "lots of ways". I think it was directed at people who are trying to get a job in a company, and suggesting an alternative. The cost of that alternative used to be exceptionally high, such that it wasn't really much of an alternative. But the cost is coming down, and some who might otherwise pursue a career with a company might want to consider the alternative.

Ironically, I think that there are lots of examples where this happens already. It's not just this guy's line of work: technology. Take film making. I recently saw a film and got to chat with the director. This guy produced the entire film with a hand held camera and his macintosh notebook computer. Not long ago, he would have had to come up with investors or been hired by a large movie studio. Not anymore. Now he can do it entirely on his own.

Artists have been doing this for a long time. I recall several art majors in college who, not able to get their work in an expensive showing at a gallery, simply put up a sign and sell it on a corner, or at a flea market. Now they can reach a wider audience selling it on the Internet.

It is a very good thing that it's easier to make money doing the thing that you're passionate about. I don't think the article is about trying to pidgeon hole someone's talents. I think it's about enabling more people to use their passions as their occupation.

Brad Hutchings writes:

Young people should be encouraged to get their degrees and, if they have the right entrepreneurial drive, get a business started while in college or grad school. The biggest challenge for someone without a degree is leading people who have them. In life, there is definitely an education pecking order. Listen to Jim Rome's (sports talk) schtick about Cal State vs. University of California and it's all you need to know. Except that the Cal State degree is worth more than not finishing at UC (or Yale for that matter). If you need any further convincing, compare Tana to Kendra on The Apprentice. Insecure white trash versus confidence and class. Tana is, without a doubt, the new poster child for "stay in school". Need more convincing? Kobe vs. Shaq. Nuff said.

aaron writes:

How about both? Take a lighter course load and take a little longer in school. 5.5 yrs shouldn't decrease your marketability much if your venture doesn't work out, and the experience should make good resume fluff.

Mark Horn writes:

As someone in the technology field, I have hired in the past, and will hire in the future, people who have never even sniffed college. And the reason is that they've demonstrated a talent level that I'm looking for. I don't really care about what diploma they have or don't have. I care about what they're doing or capable of doing.

Of course, occasionally, one of the people that I hire is just not fit for the job. But that mistake seems to not be limited to people without a degree. Maybe it's the field that I'm in. But degrees just don't matter to me. What matters to me is what they've done.

Of course, where the rubber meets the road, is when answering Arnold's question. Would I take my children's education money and give it to them to start a business? I don't know, but at this point I lean towards no. Of course, I've got 11 years before the first one gets in that position, so I've got time to re-evaluate.

spencer writes:

The question is not the age of the person starting the business. The question is what is the business. Is the product in demand and does the business have something that will give him an advantage over the competition.

Remember, most start-ups fail. Assume the business will fail. Then look at it as an alternative to a year at school. Will the kid
learn more from a business failure then a year in school? That is a much harder question but my
presumption is that it will be the exception when you can answer that question to the affirmative.

In the 1990s we had a massive new shift into a new high tech field where credentials had not yet been established. In that environment a dropout who had learned to program on a Trash-80
was a valuable resources. But that is no longer true. So a year of that type of experience was more valuable in the 1990s then it would be today.
so your coment on the value of a year of experience versus a year of school probably was at a peak in the 1990s and is falling now.

But isn't everything in this comment ignoring the basic question of what is his marginal product?
If this question is applied to a minimum wage analysis shouldn't it be used here?

Brent writes:

First here’s a list of successful business people who have dropped out of college (or high school):

Bill Gates
Paul Allen
Michael Dell
Richard Branson
Ted Turner
Steve Jobs
Lawrence Ellison

And there’s many more, especially in the entertainment industry. College doesn’t count for as much as it used to, and if you need proof look in the newspaper for professional job openings. You will find in a large portion of the listings the words “experience required”. This is because colleges are not doing a good enough job preparing students for the real world. I would hate to be a young graduate without having had a summer internship (in your field) every summer while at college. Do I think that a kid coming up through education system needs to go to college? Probably. Does he need to finish? It depends very much on the circumstances, but I think there is less of a need today, then there has been in the past.

dsquared writes:

It is not possible to start up "a business" in the pure generic term, so it is impossible to answer Arnold's question. You would have to make a decision about a specific business proposition that your hypothetical 18 year old might have come up with.

And this is the big advantage of education over entrepreneurship for the young person; although it is not possible to start a generic business (or even to pick one at random from a menu), it is possible to start on a generic or randomly-chosen degree course and get most of the benefits of having done so. Starting a business to which you are only partly committed and have no real knowledge of what it entails is a disater; starting a degree course with no real commitment is pretty much what is expected and you get your "entry ticket to the middle class" just the same as long as you can remember to show up every now and then.

cb writes:

There are many aspects to a business - Marketing, Accounting, Finance, Sales, HR, IT, etc. An 18 year old starting a biz would be learning the mechanics of operating a biz on the fly, with only friends/contacts and books as a resource. Personally, I find biz books useless. I would think the chances of success are higher for people with experience, in particular small biz experience, preferably with several different firms, perhaps in different industries, unless he/she know what industry they wanted to start a biz in. I wouldn't give money to an 18 year old. No telling how much capital would be blown before they knew what they were doing.

Lancelot Finn writes:

I'm convinced that mass college education, as practiced today, is hugely inefficient. I doubt your average 18-year-old entrepreneur would make much money, but they'd learn a lot more about life than they do in the artificial and insulated environment of college. People would get much more value out of college if they did it a bit later, and were more self-consciously interested in learning as oppposed to career development. Most people in college don't know why they're there and never figure it out.

Rather than giving an 18-year-old $15,000 of startup capital, I'd rather start up a business myself and be the part-time manager of it, then employ my kid in it, at first to raise college tuition, but later letting him take it over if he wanted to.

One problem is that there's a taboo in our society against nepotism. Maybe if you're an independent businessman you can hire whoever you want, but if you're working for the government or a private corporation, this would be considered culpable. Of course I realize there are reasons to oppose nepotism, first because it could lead to suboptimal staffing at the shareholder's or taxpayer's expense, second because it creates network effects which prevent those who are born without high-powered connections, especially racial minorities, from getting ahead.

But it has huge disadvantages, because parents can't pass on skills to, or create work for, their kids, and instead are forced to outsource this responsibility to universities which do it expensively and inefficiently.

I wouldn't be able to tell my 18-year-old he couldn't go to college. He'll want it too bad, because everybody else is going. He might be happy to hang out in his home town for a couple more years, get his own apartment, work for me, spent time with friends, start a band, whatever, and then see how he feels... but not if that leaves him with the feeling that life is leaving him behind. There's a coordination problem.

Mass college education was a social revolution. We should partially reverse that social revolution, but it will be very very hard.

Duane Gran writes:

I also like Graham's writing, but he overlooks an obvious third way: start a business while in college. I did this, and although it nearly tanked my college career, it has directed the trajectory of my professional life in interesting and satisfying ways. This strategy has the added benefit of resolving the "what am I going to do after a graduate" malaise that afflicts many.

Lawrance George Lux writes:

My niece and her husband started a Freight Dispatch business before the last Recession. She knew the business from previous employment, and they got the line of Credit because of her husband's current employment. They now have three Employees plus an Accountant, and the husband complains he has to work two Jobs. They have increased their Profits every year--even through the recession. Neither has a complete College education. I have seen success. lgl

catfish writes:

I work in a program that helps adults go back and get their college degrees and am continually amazed at what people have been able to accomplish without college degees. There is a catch, however. Many of our students have a couple of decades of experience with a company and have risen high in the ranks. When they are laid off, however, they are unable to get a comparable job at another company. As more people go to college, the need for a degree increases because without one, you are simply ineligible for many jobs. The need for a degree is so important that many companies pay for their employees to get degrees so that they will be eligible for promotion. My program is an interdisciplinary one, so it is not like this degree is going to be directly related to work.

In short, an entreprenurial 18 might want to delay college a few years in favor of running a small business, but should go ahead and go to school eventually.

Patinator writes:

I have had this conversation many times with my parents. I take the stance that a college degree is good because it shows persistence, but that for the ***right individual***, it is not needed. Degrees are most useful for those who do not want/cannot take the risks of starting their own business and are OK with being one of the masses in the workplace. This, of course, is fingernails on the chalkboard to them because for their generation, a college degree was the transgenerational inheretance that justified immigration.

I would be OK with giving my kid some money to start a business in lieu of college, but they would have to be extremely intelligent and motivated, had to have demonstrated some kind of entrepreneurial flair before then or have potential money making hobbies.

At least important is learning the absolute necessity of networking. If you know how to network, you will never need to use monster.

Brad H: I have to question anyone who uses Jim Rome as a basis for economic arguments. Kobe vs. Shaq? So, if I stay in school, I will be a better basketball player?

Brad Hutchings writes:

Pat: The Rome reference was about perception, not an economic analysis. If you're going to start at the top and always be at the top (Jobs, Ellison, Gates, etc.) then you're beyond the pecking order. There are just a handful of such people. If at some point in your career, through a merger or acquisition, you have to climb the ladder, the degree and the reputation of the school are really important. It's just how it is. Did you see Trump ask Kendra why she stayed in school? No. Did Trump force Tana to make an excuse for not finishing? Yes, twice. As for Kobe/Shaq, look how much less trouble Shaq has gotten himself into. Going away to college (like marriage) tends to be a civilizing experience as well, and that shouldn't be discounted.

dr writes:

Blanket statements that everyone should start a company annoy me. Just because it's easy to start a software company does not mean that all industries are like software. Even if you accept that the barriers to entry in software are dropping (pretty arguable, given that MIPS per dollar was never the major barrier), this doesn't mean that barriers to entry in other fields are changing. Suppose you want to make cars, drill for oil, or discover drugs? You're going to need more than a laptop and a business license.

Ben writes:

I would like to point out for those that did not read his essay that Graham is not suggesting that people start businesses instead of going to college. What he does suggest is that instead of working for a company after graduation, starting a company instead.

Michael Tinkler writes:

"Going away to college (like marriage) tends to be a civilizing experience as well, and that shouldn't be discounted."

The divorce rate and the drop out rate may both speak the above comment.

As someone whose institution is expected to civilize the savages, I wish they'd start businesses and learn from their turnover rate what horrific people they are rather than wait for me to get it throught to them.

james writes:
But isn't everything in this comment ignoring the basic question of what is his marginal product? If this question is applied to a minimum wage analysis shouldn't it be used here?


If a young entrepreneur doesn't generate a marginal product greater than what he pays himself, "economic theory" says he'll soon be unemployed. But the folks who treat this theory as some kind of inviolable economic law are refusing to look at the empirical data.

I just ran a regression that shows entrepreneurship is *negatively* related to unemployment. Not that facts should get in the way of theory, mind you.

Ray writes:

The fact that so many businesses simply require a college degree, regardless of the major, only reinforces the old notion that it's just a piece of paper. But a piece of paper that you must have if entrepreneurship isn't your bag.

The reasoning from on high for the mandatory degree, regardless of discipline, is that attending college instills both certain professional attitudes and practices and the "best and the brightest" are more likely to go to college.

But that would also be a good reason to hire the "some college" guy who worked up to mid management without a degree. Yet the places I'm thinking of won't touch the "some college" guy, regardless of experience.

Obviously I'm not talking about very specific disciplines such as economics or law, but I worked as a financial advisor for one of the "big" firms, and they'll take a 4 year degree in Estonian Medieval Feminist Literature but you have to have the degree.

Matt writes:

I really try hard not to hold college degrees against people. In some fields it's literally impossible to proceed without one. But for any person who actually had a choice, I have to wonder how a truly exceptional individual could STAND to put themselves on hold for four years sitting around in classrooms, going ever-deeper into debt, and watching their domain knowledge fall out of date. I'd much rather see business experience (even -- perhaps ESPECIALLY -- business failures) on a resume than a degree and a few summer internships. And when business ventures have gone south, I've found plenty of "day job" employers with the exact same attitude.

And when I think of what the money I wasted on college could have done for me if I'd had it available in business, it's literally hard not to break down in tears. Hell, just 5% of it would have gotten me over the short term cashflow crisis that killed my last venture.

College may indeed be better for average people. But average people aren't the subject of the discussion. Average people, frankly, probably shouldn't be starting their own businesses.

David Thomson writes:

“Obviously I'm not talking about very specific disciplines such as economics or law, but I worked as a financial advisor for one of the "big" firms, and they'll take a 4 year degree in Estonian Medieval Feminist Literature but you have to have the degree.”

Affirmative action lawsuits have a lot to do with this nonsense. Companies began to be fearful promoting a white guy with only a high school diploma over a black fellow possessing a college degree. It’s strange that few people are aware of this harsh reality. Is it suppose to be some sort of secret?

spencer writes:

When I was an undergraduate I had an uncle that recruited and hired engineers tell me that all the engineering degree meant was that the kid had the intelligence and the self discipline to learn to do the job.

I think that is very true -- even in a field like engineering. Degrees are part of the sorting process. The next step is on the job training and success in a company environment.

Not getting a degree puts you outside the established pattern and puts one on a very different course. A very, very few can suceed that way-- but it is a very few. So again, when can you honestly say that this is the best path for a young person and that they will learn or advance themselves more starting a company then being in school.

POPFile was not inspired by Paul Graham. It uses a different mathematical implementation and was coded prior to his article. POPFile certainly benefitted, however, from the hoopla surrounding his article.

Bob Knaus writes:

Your dad is always supposed to give you good advice, right? When I was a teenager, my dad told me "There aren't enough hours in the week for you to get ahead working for somebody else. You need to have other people working for you."

That was true for a farmer (later baker) with an 8th grade education. He only succeeded with hired help. But it's not true if you go to work in management or a highly skilled profession.

It took me a long time to figure that out. When I was 19, I left the farm and started my own business programming computers. (Spence's comment about a high-school dropout programming a Trash-80 nails me right on the head!) 13 years later, I had gone through a trajectory of business expansion and failure, and had learned a helluva lot about computers and business. I finally found success as a management consultant, working for somebody else.

To my dad's credit, he did ask me if I needed to go to college when I was 19. I told him NO! At that point, all the computer science courses had you feeding punch cards into a mainframe. I had no use for that... what interested me was the PC revolution that was brewing.

Addressing a couple of other points raised in the discussion... it has been my personal experience that my lack of education has been no barrier to managing those with lots of it, and has never been an issue with inspiring trust in clients. Either you have leadership, or you don't. And no, this is not the way to go for an "average" (I'm guessing 80th percentile) kid. If you're good but not great, college is the place for you.

Excellent post Arnold!

Capt. Bob Knaus

Bernard Yomtov writes:

I just ran a regression that shows entrepreneurship is *negatively* related to unemployment.

Perhaps you could describe this regression in more detail. I'm having a hard time figuring out what it might look like.

Brad Hutchings writes:

Bob, I certainly understand your point. Perhaps I was a bit absolutist in stating the existence of the pecking order. Let's try it another way... If you have a degree, nobody will ever question why you don't have the degree. If you have it, there will be people who question your qualifications and/or disqualify you right off the bat, regardless of intelligence, track record, or skill. Even Microsoft, founded by a college dropout, hires its engineers from the best schools and has lots of Masters and PhDs in its employ!

It's funny, I was sure that Bill Gates dropped out of college, not grad school, but I wanted to check, so I googled for "bill gates drop out" and found this article, where Scott McNealy slaps Bill Gates for not finishing his degree. Our business world still places a lot of value on that piece of paper.

Brad Hutchings writes:

I screwed that analogy up... If you HAVE the degree, nobody will question. If you DON'T HAVE. someone will.

Conchis writes:

"The most productive young people will always be undervalued by large organizations, because the young have no performance to measure yet, and any error in guessing their ability will tend toward the mean."

The immediate question this suggests to me is why the whole market doesn't start to unwind. If exceptionals all start businesses, taking themselves out of the pool, they reduce the average productivity of the remainder, creating a new round of exceptionals for whom it's a better prosepct to start business, and so on ad nauseam: voila, instant lemons problem.

Because we don't tend to see the entire market unravelling like this, there must be something else going on. I'm sure there are more possibilities than this, but here are a few, mostly motivated by the fact that (at least some) companies have pretty strong incentives to get around the lemons problem.

(1) You may not be able to predict people's performance precisely, but you can do a lot better than the using the population average. There's an entire HR industry built around this sort of signalling/screening thing. (Obvious.)

(2) Firms that are still forced to undercompensate early in careers can make up for this through wage structures that overcompensate later for proven performance.

(3) The analysis assumes people's marginal value within an organisation is the same as their marginal value starting a business on their own. That's unlikely, for two reasons: (a) even for exceptionals, there will often be exceptional firms where, because of the calibre of your co-workers, you're going to be better off accepting compensation below your in-firm marginal product than your out-of-firm marginal product; (b) as many people have noted already, your marginal product outside the firm is probably pretty low - chances are, your firm will fail, and the major value from starting it is likely to be learning from that failure.

(3) Given this, firms wanting to attract exceptionals can do so by offering them better learning experiences (I think this is exactly what we see with top consultancies). In fact, given that failing in business is costly, they could probably get away with slightly worse learning experiences, coupled with a little more security. The other advantage of this is that it's a form of compensation that is more valuable to exceptionals that to mediocres, thereby offsetting part of the initial screening problem.

(4) Same theme: firms may be able to further offset the screening problem by structuring jobs in a way that appeals to exceptionals, but not mediocres. Given that we generally don't want to do stuff that we're crap at, this probably isn't that tough.

I should clarify that I'm obviously not suggesting that no-one should ever just go out and start their own business: as with anything, it will be appropriate in some cases and not in others. But I think the cases in which it's appropriate are fewer than the sort of analysis outlined above might suggest, and they probably depend at least as much on individuals' levels of risk aversion, as their exceptional productivity.

Liberty Lover writes:

Paul Graham does not discuss the economic costs of Sarbanes/Oxley. I am dealing with it now and it is really burdensome to change a lot of computer systems. As a result, sales support and other growth initiatives are put on hold.

Maybe if/when SOX can be integrated as a turnkey system or some other way to lower costs then it will not be such a burden.

Matt writes:

I don't know about others. But every business failure (and I've had a few of them already) has taught me far more than I ever learned in college. Each failure leaves me better prepared to face the next challenge.

And I'm not sure where this "failing in business is costly" idea comes from, especially considering that we're comparing it to college. I could start and run 20 companies and watch them all go bankrupt for less money than college cost me, and each one of them would be more intellectually valuable in and of itself than four years in college. (Although if, after...say, 10 failures, I didn't have some improved clue about how to make money, then perhaps I didn't belong in the "exceptional" category to which this discussion implies.)

Putting money into a new business is a kind of gamble. Maybe you'll lose all the money you put in, or maybe the business will succeed and you'll earn profits. But college is not a are completely certain to lose 100% of the money you intend to pay for it, and probably at least half again as much in hidden costs. The worst that can happen with a new business is that it fails and the founder has nothing. With college, you typically walk out the door with _considerably less_ than assets to speak of, but crippling loads of debt.

Now those who say "few people will question why you got your degree, but many will question why you didn't" are correct as to the facts. But I don't draw the same implication from those facts.

If you are the kind of person who can most effectively learn the lessons that entrepreneurship teach, then you _do not want_ to work for or with people who value a piece of paper over demonstrated knowledge and experience. Working with such people will be a _profoundly_ demoralizing experience for you. When such people look down their noses at you because you chose to learn instead of jumping through hoops, you'd be well-advised to regard it as them selecting themselves out of your consideration. They're just saving you from the pain of a match that wouldn't have worked well anyway.

The rest of us will be glad to know you.

Mike writes:

The idea that people when there 18 years old go to college and come away with a degree in 4 years is completley untrue in reality. In reality, 40 percent of people never complete there degree and those that do usually take 6+ years. Many people just go to college because its whats expected and end up wasting both there time and everyone elses.

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