By Richard Kasmin, NJEDA Chief Economist

Differential access to capital has impacted inequality throughout history. This issue of the Economist’s Corner examines how access to capital has affected people of color in New Jersey in the past and what we can do to address persistent inequalities moving forward. 

Capital

In economics, capital refers to assets that can generate economic benefits. Generally, the first thing that comes to mind is physical capital, or fixed assets such as machines, computers, and structures such as offices and manufacturing plants. But not all capital is tangible. There are intangible assets, such as the knowledge and skills people build up through education and experience. These assets are otherwise known as human capital.
 
Economists dating back to the father of economics, Adam Smith, have conceptualized and sought to understand the impact of human capital. In his famous publication known as The Wealth of Nations, Smith wrote, “The acquisition of … talents during … education, study, or apprenticeship, costs a real expense, which is capital in [a] person. Those talents [are] part of his fortune [and] likewise that of society.” Smith here is making the case that education and experience constitutes capital as it requires costly investment and has clear economic value to a society.

So, how can we assess the value of human capital? Many economists have tried to understand the economic value of education. Work by eminent economists(1) has sought to produce estimates of wage and salary income as a function of years and quality of education, age, and experience. Such studies consistently show significant positive returns to years of education. In short, more education equals more income.

But that more education equals more income does not mean all education is of the same value or that “equal” education creates equal value. Rather, the formal education system is but one institution that develops the mind of the individual. This was made clear over 50 years ago in James Coleman’s landmark Equality of Educational Opportunity study, which was commissioned as part of 1964 Civil Rights Act. The Coleman study showed wide disparities in test scores along racial lines, which was of no surprise at the time. What was surprising was Coleman’s conclusion as to the cause. As stated in the report, “One implication stands out above all: That schools bring little influence to bear on a child’s achievement that is independent of his background and general social context; and that this very lack of an independent effect means that the inequalities imposed on children by their home, neighborhood, and peer environment are carried along to become the inequalities with which they confront adult life at the end of school.” In other words, education matters, but so do many other factors, including a person’s support system, opportunities available outside the classroom, and the neighborhood they grow up in. 

Deficit or Debt?

Coleman’s finding does not refute the idea that more education increases human capital, but it does suggest formal education alone cannot overcome prior built-up deficits in human capital. If you consider the racial education achievement gap as more a function of past human capital investment deficits than a function of current education production, you are faced with a startling thought – you can’t properly address the achievement gap without considering the accumulation past generations’ deficits. And the accumulation of past deficits is commonly referred to in economics as a debt. This existence of an education debt was conceptualized by Dr. Gloria Ladson-Billings in her American Education Research Association 2006 Presidential Address(2). Ladson-Billings’ contention is, if the existence of this education debt generates current human capital deficits, you cannot possibly fix the deficit without fixing the debt. At a minimum, Ladson-Billings’ contention is we must take a holistic approach to address the achievement gap.

NJ Labor Market Outcomes by Race/Ethnicity 

Keeping this framework in mind, we can turn our attention to the economic data in New Jersey, what inequalities persist, and what policies the State has in place to tackle them.

First, let’s look at some of the recent data and trends by race and ethnicity related to the labor market and income. Clearly there are significant disparities in labor market outcomes by race. Employment rates as of 2018 were rising for white, black, and Hispanic New Jerseyans, yet employment rates for minorities continued to lag that of white people. Real incomes were rising across the board as the economic expansion continued to mature. Yet for black people, as of 2018, the level of real income remained below where it was prior to the recession. And large disparities in real income by race and ethnicity persisted.

    
Source: American Community Survey data

As the following chart shows, as of 2018, sharp disparities in educational achievement persisted by race and ethnicity. Given the evidence that more educational attainment yields more income, these educational achievement disparities probably explain a significant portion of disparities in labor market outcomes.

However, there is good news. Educational achievement rates for minorities are rising. Since the end of the recession through 2018, the share of the population aged 25+ with a college degree or more is up significantly among all major racial and ethnic groups. 

  
Source: American Community Survey

NJ Entrepreneurship by Race/Ethnicity

Studies show education level is positively correlated with entrepreneurship and entrepreneurial success(3).  Thus, lower levels of education among racial and ethnic minorities may be a barrier to entrepreneurship(4).  Certainly in New Jersey, disparities in labor market outcomes and educational attainment are reflected in business ownership data. 

According to the most recent publicly available data, non-Hispanic white people owned approximately 69 percent of New Jersey businesses while accounting for approximately 54 percent of the working-age population. This contrasts with non-Hispanic black people, who owned approximately 7 percent of businesses but accounted for approximately 14 percent of the working-age population. Hence, the data indicates disparities in business ownership along racial lines.

  
Source: Survey of Business Owners, 2012

The disparities are even larger once you consider the share of businesses with employees, as distinct from sole proprietorships. As of 2012, only 5 percent of black-owned businesses and 11 percent of Hispanic-owned businesses had employees. By contrast, 25 percent non-Hispanic white-owned businesses and 32 percent of Asian-owned businesses had employees. When you aggregate the data, for companies with employees: 77 percent are owned by non-Hispanic white people, 2 percent by black people, 15 percent by Asians, and 6 percent by Hispanics. For companies without employees: 67 percent are owned by non-Hispanic white people, 9 percent by black people, 9 percent by Asians, 14 percent by Hispanics.

  
Source: ​Survey of Business Owners, 2012

The positive news on this front is the most recent data on firms with employees shows solid growth in black-, Hispanic-, and Asian-owned firms.

Source: ​Annual Survey of Entrepreneurs, 2016; Survey of Business Owners, 2012

New Jersey’s Holistic Approach

In this piece, we’ve discussed the significance of human capital for economic value creation, presented views on the causes and significance of racial and ethnic achievement gaps, and provided evidence on how underinvestment in human capital is evident in economic data. To address the issue of an education or general human capital debt calls for a holistic approach. 

Governor Murphy’s Economic Plan for a stronger, fairer New Jersey takes a holistic approach to addressing this challenge by making high quality education from Pre-K through college more affordable and taking on other barriers to success with criminal justice reform and direct investments in underserved communities. Governor Murphy’s recently-released talent-based economic development strategy – “Jobs NJ: Developing Talent to Grow Business in the Garden State” – builds on these efforts to expand opportunities for career-seekers to gain skills and for employers to fill their talent needs. The plan lays out a collaborative, whole-of-government approach to enhance equity in the Garden State by ensuring all career-seeking New Jerseyans have the education and training necessary to access high-quality employment and that businesses and employers offering high-quality employment can quickly and efficiently fill their talent needs.

Part of addressing the problem is also realizing how long it takes for investments in human capital to reap benefits, so although investments in human capital are incredibly important, they may not sufficiently help people currently active in the labor or entrepreneurial market. On this front, we must appreciate how human capital is linked to access to financial capital. The evidence shows access to financial capital is lower for minority owners. For instance, one study found minority-owned businesses often rely more on personal and family wealth than external debt or equity for business financing(5).  Another study showed that among businesses with annual gross receipts of $500,000, 17 percent of minority-owned businesses received loans, compared to 23 percent for nonminority-owned businesses(6).  And access itself is not the only issue. Studies have shown minority owners, even when they need funding, are less likely to seek loans from banks for fear of rejection(7). 

There are multiple NJEDA administered programs that focus on the problems of minority access to financial capital. The recently-expanded Angel Investor Tax Credit includes a 5 percent credit for investments made in firms located in Opportunity Zones and minority- or women-owned firms, and the new NJ Accelerate program matches loan funding up to $250,000 for start-up businesses, with an additional 5 percent loan for minority- and women-owned business enterprises. Furthermore, the NJEDA recently released a request for information to inform the potential creation of a diversity seed fund that would focus on driving capital to Black- and Latinx-owned enterprises. These programs, together with Governor Murphy’s other investments in a more holistic approach to addressing the human capital debt, should help move us toward a stronger, fairer New Jersey.

For more information on the Economist’s Corner, or to view the archive of Economist’s Corner postings, please visit www.njeda.gov/economistcorner.

Sources:
1  Jacob Mincer, Gary Becker, and James Heckman, to name a few
2 Ladson-Billings, G. (2006). From the achievement gap to the education debt: Understanding achievement in      US schools. Educational researcher, 35(7), 3-12.
3 Fairlie, Robert, and Alicia Robb. 2010. “Disparities in Capital Access between Minority and Non-Minority-Owned Businesses: The Troubling Reality of Capital Limitations Faced by MBEs.” Minority Business Development Agency, U.S. Department of Commerce, Washington, DC.
4. Barr, M. S. (2015). Minority and women entrepreneurs: Building capital, networks, and skills. Hamilton
Project Discussion Paper 2015-03. Washington, D.C.: Brookings Institution.
5 Robb, Alicia. 2013. “Access to Capital among Young Firms, Minority-Owned Firms, Women-Owned Firms, and High-Tech Firms.” Office of Advocacy, U.S. Small Business Administration, Washington, DC.
6 Fairlie and Robb, 2010.
7 Bates, Timothy, and Alicia Robb. 2013. “Small-Business Viability in America’s Urban Minority Communities.” Urban Studies. http://usj.sagepub.com/content/51/13/2844.full.pdf+html.

  By Richard Kasmin, NJEDA Chief Economist
 

Innovation is an essential ingredient for economic growth. But what exactly do we mean when we speak of innovation? At its core, it’s economic evolution – the process of taking what has been discovered and applying those discoveries to create improved ways of using finite resources to get things done. 

Innovation can be in the form of a process or a product. For example, learning ways to use available technologies to produce things more quickly, or cheaper, or with less energy consumption are types of innovation. 

The creation of something as seemingly simple as a pencil was the product of uncountable innovations over hundreds of years. Think of what it takes to produce a pencil: the raw materials, the ability to arrange for those resources to come together, and the labor and machinery required to make a pencil. And that’s to say nothing of getting the pencil to the market, where the value of the product is finally realized.

The big differences between the pencil and what we consider more modern examples of innovation can be measured on two dimensions: time and value. In terms of time, we’re talking about past and present. It’s difficult, in the year 2020, to consider a pencil the product of innovation. DNA engineering, by contrast, is happening now, and it seems almost magical in terms of potential economic impact. In terms of value, different innovations have different economic impacts. The pencil certainly created economic value, but when compared to the potential benefits of DNA engineering in terms of health care, the economic benefits of a pencil seem small.

Many state policy makers understand the value of innovation in terms of economic growth and increasing standards of living, and they are implementing various policies to encourage innovation. No matter what the innovation, there is one thing they all have in common – risk. Innovators and the people who invest in innovators take risks. Thus, this is where policy makers generally focus their attention – how to mitigate the cost of taking risk to encourage innovation investment.

The Angel Tax Credit

One such policy we have in New Jersey to encourage investment in innovation is the Angel Tax Credit. As the name suggests, The Angel Tax Credit provides tax credits to so-called angel investors against qualified investments in New Jersey technology and life sciences businesses. It is meant to boost access to funding for early-stage businesses engaged in technology and life sciences. Moreover, assuming the tax credit does encourage investments that would not have otherwise occurred, it increases the size of the innovation economy and helps to build a robust angel investment community.

Angel investors are a special breed of investors. More than just funds, angel investors also tend to invest their time and expertise into the firms they support. They fund early-stage entrepreneurs and often serve as mentors or outside directors of startups.

Research indicates angel investors have significant positive effects on the firms in which they invest. As evidence, a study conducted by the National Bureau of Economic Research showed firms with high angel investor interest were more likely to succeed than firms with low angel interest (Fig 1). The researchers concluded, “Firms that attracted a high level of interest among angel investors were more likely to grow, issue patents, win new rounds of funding, and have a successful exit from the startup phase.”

Figure 1 – The Positive Impact of Angel Investing

Source: National Bureau of Economic Research

In 2020, the size of the tax credit will rise from 10% to 20% of qualified investments. Moreover, there will be an additional 5% credit for investments made in firms located in Opportunity Zones and minority- or women-owned firms.

Increasing the size of the tax credit makes sense. To understand the right size of the incentive, one must consider the motive to invest in the first place. Angel investment are high risk investments – the investor is making an investment in a firm at its earliest stages of existence. Firms during this time are more likely to be engaged in research and development and are likely to have little-to-no revenue. Thus, these firms have no clear market value – you can’t really assess economic value without generating some revenue. Thus, the value of these firms is based more on a bet for what it will be worth once their products hit the market. And a lot must go right for all that to happen. 

Thus, these tend to be very high-risk investments where investors are making a bet to hopefully generate multiples of their original investment. As such, a larger incentive is likely necessary to alter investment decisions, which is what incentives like the Angel Tax Credit are meant to do.

Angel Tax Credit History

Since the program’s inception in 2013 through 2019, the NJEDA has approved around 1,400 Angel Tax Credit applications for almost $600 million in investments in around 90 New Jersey-based businesses.  Looking at the sector destinations of those investments, 45% went to life sciences companies and 55% went to technology companies (of which, 14% went to clean technology companies).

The two charts below show flows of approved applications and investments broken down into three sector destinations — clean technology, life science, and other technology. Figure 2 depicts applications by year for the life of the Angel Tax Credit program. Figure 3 depicts the investment flows for which those tax credits were applied. Focusing on the last four years, approved applications have averaged around 240 per year for an average of around $120 million in investments per year. 

Figure 2 – The Number of Applications Per Year

Figure 3 – Investments Supported by Angel Tax Credits

The Geography of Venture Capital and Angel Tax Credits

One question we might ask is, where do we see venture capital flows in New Jersey, and how representative of geographic coverage in the state are Angel Tax Credits? To answer the first part of that question, we mapped data from Crunchbase, a web-based platform that provides data on the locations of headquarters who received venture capital funding (2011 to present). As the map below shows (Figure 4), there is evidence of what looks like a Start-Up Corridor, with hot spots around Jersey City and Princeton. There are some concentrations of firms along the shore and near Camden. When we look at the locations of headquarters for firms that benefitted from angel tax credit investors (Figure 5), we see some similar hot spots in and around Jersey City, Newark, New Brunswick, and Princeton. Most all activity is in the northern portion of the state, north of 195. It may be worthwhile to consider whether more can be done to expand the geographic coverage of the Angel Tax Credit outside some of the current hotbeds to attempt to expand the venture capital ecosystem.

Fig. 4 – VC in New Jersey

Fig. 5 – Angel Tax Credit HQs

Underrepresented Communities

As noted earlier, the new iteration of the Angel Investor Tax Credit will provide bonuses for investments made in opportunity zones or firms that are minority- or female-owned. That begs the question, what evidence do we have firms in such categories require more attention? 

According to a recent survey by DiversityVC and RateMyInvestor, nationwide only one percent of venture-backed founders are black and less than two percent are Latinx. Clearly, black and Latinx populations lack access to venture capital. 

Female-owned firms – companies that are both solely owned or owned in partnership with male owners – do not fare much better. In the eleven years of data released by Pitchbook (2008-2019), female-owned firms in New Jersey generated 176 deals capturing $769 million in venture capital flows. The flow during this period accounted for approximately 13 percent of deals and 9 percent of capital flows. Clearly females are underrepresented in this corner of the economy. 

Yet, as depicted in Figure 6, the data shows female-owned firms in New Jersey are seeing a growing share of flows. Looking at the linear trend (depicted in the dotted lines), since 2008, the share of deals and flows in New Jersey going to female-owned firms has increased approximately one percentage point per year. In 2008, female-owned firms accounted for approximately 7 percent of deals and just 4 percent of capital in New Jersey. In 2019, those shares rose to approximately 23 percent and 14 percent, respectively. 

Figure 6 – The Share of Venture Capital Flows Going to Female-Owned Firms
 

In conclusion, policymakers are focused on supporting the growth of innovation ecosystems for good reason – innovation is instrumental for economic growth and increased standards of living. Given the risk commensurate with angel investing, increasing the size of tax credit should incentivize increased investment and encourage growth of New Jersey’s innovation ecosystem. Furthermore, the evidence shows women- and minority-run firms have historically faced challenges in accessing capital, and the focus of the Angel Investor Tax Credit on these populations should lend needed support.

For more information on the Economist’s Corner, or to view the archive of Economist’s Corner postings, please visit www.njeda.gov/economistcorner.