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A Diverse Economy

Does Hawaii need one? How should we get it?

(page 2 of 4)

David Watamull, CEO of Cardax Pharmaceuticals,
says Hawaii's lack of venture capital
prevents local start-ups from growing or forces them to move.

Bill Spencer, CEO of Hawaii Oceanic Technology and president of the Hawaii Venture Capital Association, notes, “Right now, we have an economy that depends on tourism to survive. Yet, here we are – we don’t even have enough revenue to keep our beach bathrooms clean.” Like Gibson, Spencer believes the solution lies in building a broader base for the economy. “We’re missing one leg of the stool. We need a third leg, some way to balance the economy – because right now, if anything hurts tourism, tourism goes down and we’re in the dump.”

But to Brewbaker, diversification isn’t about jobs – or even revenues, exactly – though he does agree with the analogy of the economy as an investment portfolio. “In classic portfolio theory,” he says, “one seeks diversification as a way of maximizing risk-adjusted returns.” The idea is to reduce risk by carrying a mix of assets. That way, when one class of investments is depressed (stocks and bonds for the individual investor, say, or tourism and construction for the larger economy), the effect is moderated by others in your portfolio (real estate and commodities for the individual, or high tech and film for the state). Economists call this effect “negative cross-correlation.” The problem, according to Brewbaker, is that the government usually approaches economic diversification blindly.

“Nobody,” he says, “actually does any analysis as to whether, by diversifying into a particular industry, the negative cross-correlation of its performance with respect to existing industries’ performances is risk-reducing. The state doesn’t even know what that last sentence means; and yet, it is the actual reason for diversifying a portfolio!”

A Capital Idea

Still, the march toward diversification stumbles on. Broadly speaking, there are two camps in the debate on how to get there. (True skeptics, like Brewbaker, rarely get to make their case.) One camp believes that the main impediment to growing a vibrant tech sector is a shortage of investment capital for promising companies. The other camp, while acknowledging the dearth of capital, believes that the cure is much more complicated and includes better education, workforce development and improved infrastructure. Their debates resemble the old “chicken or the egg” dilemma.

David Watumull, president and CEO of Cardax Pharmaceuticals, believes the problem is capital. He points out that Hawaii is fairly efficient at supporting early-stage companies, helping them with proof of concept. Angel investors and a series of tax credits play a vital role at this level. “(Act) 221 was certainly part of that,” Watumull says. “It did an excellent job of getting startups going.” The difficulty, he points out, is funding the growth stages that produce viable, profitable companies. “That’s traditionally been funded by venture capital,” he says, “and Hawaii’s traditionally venture poor.”

This gap creates a kind of valley of death for Hawaii tech firms. Some stagnate and fail. Others find funding elsewhere and have to move. Watumull intones a short list of Hawaii success stories that left the Islands: Verifone, Digital Island, Pihana. He points out, “Each one probably raised a couple of million dollars and went from 10, 20, 30 people, to hundreds, maybe thousands of employees. If we want that type of growth here in Hawaii – which I believe we do – then we have to find a way to attract capital.”

To illustrate the primacy of capital in the diversification equation, Watumull likes to contrast three cities that have worked hard to create biosciences sectors: San Francisco, San Diego and Baltimore. While the first two cities have been successful, Baltimore’s efforts have been anemic, despite several advantages. Watumull notes, “They have an excellent research institution, Johns Hopkins University; they’re right near D.C.; and they have the largest number of NIH grants. But they still have very little biotech – nowhere near Boston or San Francisco or San Diego.” The reason, he says, is that those cities have capital.

Some of that, Watumull believes, is simply chance. “Each of those places started with just one or two successes,” he says, “people who by hook or by crook got their company to where they could sell it.” These successes, however accidental, provided the capital for further growth in the region. But, while that model could work here in Hawaii, it’s not a good bet. As Watumull puts it, “Here we are in the middle of the ocean, geographically isolated. We’re going to have to be proactive.” He gives several examples of regions with successful diversification strategies: Singapore, which invested its enormous sovereign funds to essentially buy a biotech industry; Arizona, which has used a carefully calibrated set of tax breaks and grants to encourage investment; and especially, Utah, which, with the bold use of a tool called a fund of funds, has managed to both create a homegrown tech industry and lure several major corporations to the state. (See sidebar on page 110.) “There are definitely ways that we could attract some significant amounts of capital,” Watumull says, “enough to have a substantial impact on Hawaii.”

All of these strategies rely on tax credits and similar tools. But Brewbaker remains skeptical about the use of tax credits, particular one-to-one credits like Act 221. “If you’re a high net-worth individual with millions of dollars in income and a $100,000 tax liability with the state, you can simply invest in a qualifying high-technology business (the definition of which is arbitrary, if loosely sensible) and claim a tax credit for the entire amount. In effect, the state has given you back the $100,000 you owed.”

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