Public Policy, Economics and Entrepreneurship: March 2009 Archives

Mark Kuyper sent along a column from Fortune by Glenn Hutchins that makes the following observation about setting the policy agenda to ensure the entrepreneurship leads us out of this recession as it did out of the recession of the 1970s:

The public policy agenda, when it pivots from the immediate crisis to fundamental questions of how to foster growth, must focus like a laser on promoting capital formation and innovation. We should recognize that being for good jobs but being against wealth creation is akin to being for families but against procreation. One flows naturally from the other. Policies that increase the after-tax cost of capital or discourage the best and the brightest from working in the investment industries would be every bit as disastrous as letting Lehman fail. Portraying business leaders as culprits - while letting consumers, homeowners and public officials off scot free - risks moving us from a culture of aspiration to one of blame. Buttressed by policies that reflect an understanding of both shared responsibility and opportunity, investors and entrepreneurs can create the future.

I had the distinct honor and pleasure of teaching an MBA seminar this semester that explored these issues in great depth.  We explored all of the policy issues that shape entrepreneurial economies. We even took this further and examined how entrepreneurial economic development also helps to strengthen our society and shape our culture.

The final assignment was the following:

You have just been named "Entrepreneurship Czar."  Your charge is to develop a plan to help foster entrepreneurial economic growth.  While this paper should draw upon materials covered in the class do not just repeat points we have made throughout the term.  Be bold.  Be creative.  Be visionary.

1. What would be the key pillars of your plan?  Why have you chosen each of these pillars? 
2. What would be the steps that you would recommend be taken to implement your plan?  Be specific and clear. 
3. What are the anticipated outcomes from your plan?  Be specific and clear. 

They presented their plans the last night of class this past Tuesday.

There was unanimous agreement that a fundamental change in tax policy and the tax code was needed.  However, their recommendations were quite varied.

• Several wanted to replace income tax with a national consumption/sales tax
• Others wanted to keep the income tax, but throw away the current code and make it a very simple income tax with no deductions allowed -- some wanted a flat tax, but other favored two brackets (slightly higher for higher incomes).  Several were concerned that a sales tax would inhibit consumption, which tends to drive our economy.
• One student wanted to base income tax rates on entrepreneurs based on their years in business -- no tax for first year and slowing increasing rates with each year.

There was also consensus that education needs to be addressed.  Here were some of their proposals: 

• Add economics education to the "Three R's" -- reading, writing, arithmatic, and economics for students of all ages.
• Make education more competitive, with elite Magnet Schools and Internships that expose high achieving students to innovation and entrepreneurship
• Create a youth entrepreneurship incubator system to offer experiential learning

Property rights was the other most common theme.  Many in the class had no knowledge of the Kelo Decision that expanded the eminent domain powers of government when we first began looking into this topic.  I had them read both the decision and Justice O'Conner's dissent.  All in the class seemed very concerned about how Kelo -- and several more recent actions by the Federal government -- erode property rights.  After all, property rights are the foundation of entrepreneurship in any economy.

Other proposals from my students touched on immigration policies that encourage entrepreneurs to come to America, forcing balanced budgets at the Federal level, global free trade, tort reform, voting rights reform (this was a controversial proposal from one student that tied voting rights to property), simplifying the patent laws to empower small businesses to innovate, and creating universal access to high speed Internet across the US.

Thanks to all of my students in this class who made this one of the best experiences I have had as a college professor!

I wrote a post last week about a potential small business bubble in the economy if we look to a massive infusion of debt backed by the SBA to jump start entrepreneurial activity in our economy.  From that post:

The part of the plan that worries me the most is holding banks accountable for how much small business lending they do each month.  The last time the government pushed bad debt on us we ended up with a real estate bubble pumped up in large part by the subprime lending that banks issued due to intense government pressures.

Now add increased fraud and abuse to my worries about this plan from President Obama.

The House Small Business Committee held a hearing yesterday with representatives from the SBA and the Government Accountability Office (GAO) to review the SBA's Historically Underutilized Business Zone or HUBZone program. 

The HUBZone program began in 1997 to allow the SBA to issue contracts to small businesses in areas of high-unemployment.  The purpose of the program was to increase employment opportunities, economic development in underprivileged areas, and spur investment in areas that have been neglected by economic growth. Sound familiar?  This was another attempt to use SBA lending to meet a political objective.  I know this sounds like a program just full of good intentions, but in reality these things never seem to work the way that they were supposed to work.

According to the SBA, about $8 billion in contracts were awarded to HUBZone firms in FY 2007.  However, the SBA let applicants self-certification for eligibility into the HUBZone program.  So guess what happened -- abuses of the program occurred. 

In a report released today by the GAO, nineteen firms were wrongly awarded nearly $30 million in federal contracts though the HUBZone program.  The firms were misidentified and should have gone to small businesses in low-income neighborhoods.

Congressman Graves from Missouri, Ranking Member of the committee, said after the hearing, "This is the exact same hearing we had last year, how many more times do we need to hold this hearing before the SBA fixes this?  This is a prime example of wasting taxpayers' money.   If the SBA won't fix this, then the Congress will."

Although I am glad Rep. Graves is letting the light of day shine on this abuse, imagine the mischief that will occur when we turn on a fire hose of SBA loans into the economy as the President has proposed.  More fraud, more abuse, more bureaucracy to ride herd over the growing mass of loans, and more Congressional hearings to try and sort it all out.

I have a better plan.  Get government out of the way and let entrepreneurs do what they do -- start business that may or may not succeed.  And, let's get bankers back to doing what they were supposed to do all along -- only give loans to lower risk businesses that can repay their credit through the cash flow of their businesses.

The March 14, 2009 issue of the Economist has a special report on the role of entrepreneurship around the globe.  I had to chuckle about their seemingly new-found "discovery" of entrepreneurship. And while some of the information is rather dated, especially in their background pieces, there are some interesting articles. 

"Lands of Opportunity" looks at the emergence of entrepreneurship in Israel, Singapore and Denmark:

...[T]he governments of all three countries remain enthusiastic supporters of the entrepreneurial idea. The Danes and the Singaporeans regard it as their ticket to success in a global economy and the Israelis as a matter of survival. All three are also helping to spread the creed in their regions. Arab countries are beginning to realise that the best way to deal with Israel is to copy its vibrant economy. Denmark serves as a model to European leaders such as France's Nicolas Sarkozy who want to combine dynamism with social protection. The Chinese regard Singapore as a useful laboratory for reform. In the 1980s China asked Goh Keng Swee, Singapore's former finance minister, to advise on the development of its special economic zones; today it is keeping a watchful eye on the city-state's model of state-sponsored entrepreneurship.

"Magic Formula" seeks to uncover the ideal government policy to encourage entrepreneurial growth.  Interestingly, education and immigration were cited as the keys to high growth ventures:

The first is a vibrant higher education system. Business is increasingly dependent upon knowledge, particularly technical knowledge. Some 85% of all the high-growth businesses created in America in the past 20 years were launched by college graduates. University research departments have helped to drive innovation in everything from design to entertainment.

The second is openness to outsiders. Emigrés have always been more entrepreneurial than their stay-at-home cousins: the three most entrepreneurial spaces in modern history have been the ones inhabited by the Jewish, Chinese and Indian diasporas. In today's knowledge economy educated émigrés are at the cutting edge of innovation. They create more firms than regular folk; they circulate ideas, money and skills; they fill skills gaps; and they mix and match knowledge from different parts of the world.

"Saving the World" recognizes the growing trend of entrepreneurship being used to address social issues.  Interestingly, the author in the end acknowledges that the most significant impact entrepreneurship can have is as an engine of job and economic growth. 

In the long run, however, the best thing that entrepreneurs can do for the poor may be simply to see them as workers and customers. A rising number of Western companies are pursuing what C.K. Prahalad, a management professor at the Ross School of Business at the University of Michigan, calls "the fortune at the bottom of the pyramid". Businesspeople have realised that billions of pennies can add up to a lot of money. Cemex, an innovative Mexican cement firm, employs thousands of poor Mexicans. Casas Bahia, a Brazilian retailer, specialises in serving poor customers. India's ICICI Bank uses technology and customer service to reach poor rural Indians.

But, my favorite article in this special report is the final one, "The Entrepreneurial Society," which concludes that entrepreneurial economies work better than managed economies. 

"Every generation needs a new revolution," Thomas Jefferson wrote towards the end of his illustrious life. The revolution for the current generation is the entrepreneurial one. This has spread around the world, from America and Britain to other countries and from the private sector to the public one. It is bringing a great deal of disruption in its wake that is being exaggerated by the current downturn. But it is doing something remarkable: applying more brainpower, in more countries and in more creative ways, to raising productivity and solving social problems. The "gale" that Schumpeter celebrated is blowing us, a little roughly, into a better place.

Unfortunately, Washington seems to be full of counter-revolutionaries who wish to move us toward a managed, socialized economy.  As I have argued often, "socialized entrepreneurship" never works over the long-term -- It is the ultimate oxymoron.

The National Federation of Independent Business released important research today that tested various legislative approaches for healthcare reform and measured how each approach would affect different constituencies.

One of the first-ever applications of experimental economics to healthcare policy, the modeling tested reform proposals currently being discussed and considered by Congress. Researchers Stephen Rassenti (Chapman University) and Carl Johnston (George Mason University) built an insurance market in a laboratory and measured the outcomes on small businesses, large businesses and employees. The findings suggested that there is no panacea for health reform and that a "one-size-fits-all" solution will not work for our nation's employees and employers - small or large.

"As we tested possible approaches to healthcare reform it became clear that small business is particularly vulnerable to certain reforms. We must ensure that healthcare reform addresses small businesses' concerns around cost but we also need the system to be accessible for them and their employees," said William "Denny" Dennis, senior fellow, NFIB Research Foundation.

Subjects acted as employers for 360 "months." Each produced two goods, using virtual employees they could hire and lay off. Employers paid virtual salaries to the workers. To attract employees, firms chose which insurance policies to offer and how much to contribute toward the premiums. Employers could finish with profits or losses. Some employers were large (more than 12 employees in this experiment), and others small. Employers could grow or shrink depending on their success. Some employers had thick profit margins; others had thin margins. Employees had different skill sets, commanding different salaries.

The research tested eight legislative approaches, many being discussed by policymakers. Examples include: mandating employers to provide coverage, including a test with a minimum contribution level; mandating individuals to purchase coverage; and combining employer and individual mandates (also testing a minimum contribution level).

Key Findings

• Mandates- Employer and individual healthcare mandates, separately or combined, don't improve outcomes for all stakeholders. Some reform scenarios actually come close to making everyone worse off.
• Profit margins - Large companies with low profit margins tend to exhibit behavior similar to small companies, even though they have many employees and otherwise act 'large.'
• Small businesses are especially vulnerable - Small employers and their employees would be especially vulnerable to policy errors, which is why it is important to consider the negative impact of policy decisions on this group.
• Bankruptcy - The greatest likelihood of bankruptcy for employers occurs in the two scenarios where employers are mandated to provide insurance and pay at least 50 percent of the premium.
• Choosing an insurance plan - Employers are not better equipped to select plans for their employees, as is often alleged. Individuals (employer or employee) are better able to pick insurance plans for themselves than for others.  This suggests that an employer role in plan selection may not yield additional benefits.

"This is a path-breaking, sophisticated study of healthcare reform proposals in a controlled setting," said Vernon L. Smith, co-recipient, 2002 Nobel Memorial Prize in Economic Sciences in a foreword to the study. "Of particular interest to me were the findings that no scenario of treatments makes all stakeholders better off, while some plans come precariously close to making all stakeholders worse off. Hence, we see the importance of this study in trying to identify plans with unintended consequences to be avoided, and some of the more promising alternatives that pose inevitable tradeoffs for the participants."

President Obama unveiled his plan to help small business yesterday.  From the New York Times:

"Today, too many entrepreneurs can't access the capital to start, operate, or grow their business," Mr. Obama said. "Too many dreams are being deferred or denied by a form letter canceling a line of credit."...

The administration's plan included provisions increasing loan guarantees for small business to 90 percent of the loan value to encourage banks and other lenders to extend credit, and waiving the Small Business Administration's loan fees and requiring banks that received federal bailout money to report each month how much small-business lending they did.

When my students use phrases like "not enough" or "too many" without any supporting facts, they learn quickly that I will go right at these unsubstantiated assertions.

Recent surveys of small business owners don't seem to support Mr. Obama's "too many's".

A recent American Express OPEN survey I blogged about last month found that the number of small business owners saying that they have been affected by the tightening of credit has dropped significantly since October.  A recent study by the NFIB Research Foundation found that access to credit was a distant third in its importance as an immediate problem from the current financial situation.  43% said slowing sales was their biggest worry, followed by unpredictability of business conditions at 23%.  Only 9% cited inability to obtain credit.

Most small business owners have already figured out how to make it through the recession.  They are cutting costs, getting back to bootstrapping, building up cash when possible, and cutting back on their debt.

The part of the plan that worries me the most is holding banks accountable for how much small business lending they do each month.  The last time the government pushed bad debt on us we ended up with a real estate bubble pumped up in large part by the subprime lending that banks issued due to intense government pressures.

In spite of what we are being told, capitalism is not the cause of the current financial mess -- it is government meddling in the free market system to serve its own agenda. 

Let's not let government meddling create a small business bubble by forcing too much debt into the system that is too easy for small businesses to obtain.

The so-called Employee Free Choice Act, also known as "Card Check", is on the agenda again in Washington.  The Heritage Foundation has a clear and concise summary of this bill and its implications which you can read here.

Susan Eckerly, senior vice president, public policy for the National Federation of Independent Business, said this about the bill: 

"For small business owners, it's a nightmare to see this bill resurrected from the grave in which the last Congress rightly laid it to rest.
 
"The Employee Free Choice Act will not only subvert a long-standing democratic process, it's an attempt to overturn more than 60 years of established labor law. The last thing small business owners need is a government official stepping to dictate the wages and benefits they offer their employees.
 
"It's also difficult to understand the union claim that this law is needed to 'level the playing field,' when unions have won an average of nearly 60 percent of the union elections held since 2000.
 
"This can only be interpreted as an attack on our country's principal job creators and therefore, the economy as a whole. This was a bad bill in 2007 and the ensuing years haven't made it any more palatable. NFIB and its members will do everything in our power to defeat it again."

Rep. Sam Graves of the House Small Business Committee responded to the introduction of the legislation by saying:

"Card Check throws the secret ballot and privacy rights out the door for workers." said Graves.  "I agree with Warren Buffett that the secret ballot is a fundamental American principle.  Washington should be focused on creating and preserving jobs, not passing legislation that will cost more workers their jobs."

"Card Check" would allow labor unions to be created after a simple majority of workers have publicly signed authorization cards, and possibly without business owners having been notified.   Without the secret ballot, workers could face coercion to vote in a particular way.  For small businesses "Card Check" threatens their ability to create jobs.  Further, the "Card Check" legislation would allow government bureaucrats to set working conditions and kill the entrepreneurial spirit.

"I continue to be amazed by the further attacks on job creation and small business at a time when our economy is in a tailspin.  I will not support legislation that kills jobs for Americans, and threatens small business owners.  Many small businesses are already operating on razor-thin profit margins, the "Card Check" legislation would have a devastating impact on employers that are already struggling to make ends meet."

The attacks on the free market system are making our heads spin.  I hope that we don't all succumb to battle fatigue.

A new Fortune Small Business/Zogby Poll has found that a little less than half of small business owners say that they have been affected by the recession.  What is really remarkable to me about these results is that if you listen to the media, every business in the US is on the brink of disaster. 

The fact that 57% have not been damaged gives us hope that the entrepreneurial engine we need to pull us out of the recession is ready to grow when the time is right.  This fits with what I am hearing from entrepreneurs. 

Here is a summary of this poll:

• 43% of small business owners say their businesses have been damaged by the recession
• 22% say they have cut the price of products or services
• 17% say they have downsized through layoffs or attrition
• 14% say they have cut salaries
• 27% say their businesses lost money in 2008; 22% say they broke even
• 45% say they would still choose to start a company if they were entering the workforce during the recession

In a speech at Columbia University yesterday Czech President Vaclav Klaus offered advice to US policy makers.  From Rueters:

"I am therefore convinced that fighting for freedom and free markets, something we always appreciated here in this country (the United States), remains the task of the day," Klaus said....

"The best thing to do right now would be to temporarily weaken, if not repeal," business regulations on labor, the environment, social issues and health, he said.

One of the bloggers I spent some time with at the Kauffman bloggers forum was Sramana Mitra, who writes for Forbes.

She adds her voice to the growing chorus of those who have concerns with the Obama administration's agenda for the economy.  She is worried that advice they are getting about entrepreneurship is too narrow, relying only on a handful of venture capitalists:

A growing concern is the current lack of policy to support entrepreneurship from this administration, especially bootstrapped entrepreneurship. As the government tries to assess what might stimulate entrepreneurship, I don't see many "practitioners" of true entrepreneurship represented on President Obama's advisory council. Who represents the voice of the bootstrapped entrepreneur in the government? Who understands the extreme cash-strapped conditions under which entrepreneurs operate? Without understanding, how can they design an effective system?

William C. Dunkelberg, chief economist for the National Federation of Independent Business issued the following statement on February job numbers based on NFIB's monthly economic survey that will be released on Tuesday, March 10.

"There was a decline in average employment per firm of 1.0 workers reported for the past three months by small business owners in February, the largest decline in survey history.

"However, 11 percent reported unfilled job openings, unchanged from February and a positive sign going forward. Job openings are a significant predictor of the unemployment rate. Over the next three months, 13 percent plan to create new jobs (up four points), and 10 percent plan workforce reductions (down four points), yielding a seasonally adjusted net-negative 3 percent of owners planning to create new jobs, three points better than January but still historically very low. 

"Not seasonally adjusted, job-creation plans were positive in all industry groups except manufacturing. It looks like the service sector may be finding its legs. Of the nine census regions, job-creation plans turned positive in all census regions except the East South Central and South Atlantic states.

"By year end, growth should be positive again, perhaps as strong as a 4 percent annual rate. Large pools of pent-up demand are forming and will soon begin to be transformed into actual spending."

Let's hope he's right!

Reid Hoffman, founder of LinkedIn, offers an interesting proposal to help use start-ups to revive the economy in an op-ed piece in the Washington Post. 

His proposal has three components:

First, encourage small business with loans. Apply to the United States the micro-lending model that has proved successful in developing countries, extending credit lines of up to $50,000.

I like this idea as long as it is done privately.  We need more groups like Kiva, the social enterprise that does micro lending around the world.

Second, welcome foreign innovators. Harvard research fellow Vivek Wadhwa reports that immigrants have founded more than half of all Silicon Valley start-ups in the past decade. These immigrant-led, American tech companies employed more than 450,000 workers and grossed $52 billion in 2005.

Amen to this idea.  I have been arguing this for some time.  Our immigration policy is stuck in the mid-1900s.

Finally, match funds for venture capital and angel investments. Venture firms and investors need financial incentives to invest in companies that create U.S. jobs. What if firms with credible histories could receive as much as $100 million in federal matching funds if their investments create jobs in the United States? Investors could keep their normal return plus 50 percent of the returns on the matching funds, while the other half goes back to the government to revitalize further investment.

Well, two out of three ain't bad.  We don't need a government bureaucracy meddling in venture capital and making decisions about winners and losers.  Trust me -- they would not just enact a neutral, across the board matching program.  Those eager little lobbyists on K Street would make sure to create all kinds of special incentives for their clients.  Remember how political the SBA programs have gotten over the years.  We could achieve the same ends with a large tax cut.  It would have the same affect without creating another power base in DC.

What I like best in his essay is a call for creative debate on what should be done.

This is the time for President Obama to take a page from his campaign playbook. Why stop at tapping the grass roots to debate the stimulus? He should seek to fund innovation at the grass-roots level. Obama is familiar with using YouTube and social networks -- products of start-ups and tools of the people.

Problem is, those in charge in Washington have their agenda set that is driving their policy.  Free enterprise, market-based economic growth, and property rights are not part of their play book.

(Thanks to Bruce Schierstedt for passing this along).

According to today's ADP Small Business Report, small businesses lost 262,000 jobs in February.

This marks the fourth consecutive month of decline in the small-size business sector.  February's number shows greater job losses than January demonstrating the recession's continued impact on small businesses.  Since small businesses are the backbone of the economy and our primary source of new jobs (80% of new jobs over the past 20 years), today's report gives an indication of the long road to recovery.

"Where is our bailout?"

This is the consistent cry we have been hearing from small business owners on Main Streets across the US over the past few months.  Be careful what you wish for.

With word that SBA backed loans are failing at a rate of almost 12%, the Obama administration has added a big bucket of cash from their "We are All Socialists Now" Act of 2009 to beef up the SBA's coffers.

This is the worst thing we could possibly do to help small businesses at this time.

A major contributor to the troubles that many small businesses are facing is excessive debt.  Although debt may have seemed to help out in short run, it only tightens cash flow over the long-run.

Debt payments become yet another fixed cost that pushes breakeven up even further.

Let's look at an example -- say, an entrepreneur named Angel makes hand-made guitars.  Assume she makes $100 on each of the 50 guitars she sells each month.  Angel is able to take out an SBA loan to upgrade some equipment and to pay for a new website.  This loan will obligates her to a monthly payment of $1,000.  To maintain current profits, Angel must now sell 10 additional guitars each month just to cover her loan payment.

When times are good we might be able to justify her loan as an investment in growth.  But this is not a time of growth for most small businesses -- it is a time to survive.

Now assume that instead of making more credit available for small businesses we cut the income tax rate by 5%.  Since virtually every small business in the US is a pass through entity, all profits pass through the entity and becomes part of the owners' personal income. 

Now Angel will be able to keep a little more of the $100 profit she makes on each guitar.  If her sales drop due to the recession, she will not need to sell as many guitars to keep afloat.  And if she can keep her sales steady, she will have a little more money available each month that she can spend, thus helping the other small businesses she buys stuff from.

I know what all you Keynesians and born-again Keynesians out there are saying right about now. "Wait a minute Professor Cornwall.  Angel's spending is not enough to help us right now.  Uncle Sam is the only one who can spend us out of this recession."

But, history shows us that you are wrong.  Keynesian policies never worked as advertised.  I agree with Mitt Romney's comments from an interview with James Pethokoukis of US News & World Report:

First of all, the economy is too big for the government to think it can pull a string and the economy will jump. It is a global economy and what is happening here will be affected by what is happening around the world. ... So the best thing our government can do is encourage the conditions that allow new business to grow and old businesses to expand. And that means reduce burdens on them, provide incentives for them, encourage Americans to invest in them, build the pool of risk capital again, each of these things helps the private economy grow and that's how you create jobs and that's how you get us out of the doldrums we're in.

And that means cut Angel's taxes so she can grow her business, make more money, add some jobs, and invest her profits to start to re-build her retirement portfolio.