Wednesday, October 31, 2012

Sandy: More Broken Windows

And now we see the Broken Windows Fallacy taken to an extreme — on CNBC of all websites.

Damage From Sandy? What About Potential Economic Boost? - Asia Business News - CNBC
The positive multiplier effect of reconstruction after Sandy could be as much as five times, according to Frank Holmes, CEO and CIO of money manager U.S. Global Investors. If the cost of the damages comes up to $20 billion, the economic boost in terms of spending and activity could be $100 billion, he said.
Hurricane Sandy might appear to create economic activity, but such activity is not going to have the multiplier effect some theorize. At least, not based on the experiences of previous disasters. By this twisted logic, the horrible events of Sept. 11, 2001, should have been an economic boost: buildings and transit lines had to be rebuilt. Instead, the economic effects linger for many families and businesses.

Sandy is just one more thing New York and New Jersey didn't need.

There are many, many problems with viewing a natural disaster as an economic boost. These issues are both ethical and economic, and we should consider these equally in the instance of a disaster.

1. People were lost, and that's not a positive psychologically.

Psychology matters in economics. Suffering families might not spend as much, for a number of reasons. Plus, these families lost wage earners. We might have lost productive workers, creative artists, and entrepreneurs. You never know the value of lost people and shouldn't rely solely on numbers. One of the problems I have with analyses of World War II is that economics views the loss of working-age men as an "opportunity" for others. While true, shouldn't we also ask what was potentially lost?

People are an economic engine. That's why countries with immigrants are more likely to thrive, while nations with declining populations are in economic decline. Look to some European nations for an example of the population:growth correlation. As I ask later, what if the survivors leave the damaged area? That did happen to New Orleans.

2. Resources were wasted.

This is both an economic and ethical issue. The cars, computers, furniture, and other materials lost were manufactured in processes that consumed natural resources. That's a lot of wasted energy (hydrocarbons) that will be expended again to recreate the lost items. It is also a lot of wasted materials, only some of which can be recycled. That's not an economic benefit.

3. Replacement "pulls forward" demand, not always creating new demand.

Yes, the taxis and subway cars will need to be replaced. But, these "durable goods" wear out anyway. In some states and cities, taxis and transit vehicles are retired after a set number of years. The idea is that such scheduled retirements improve safety and energy efficiency. Replacing durable goods early merely shifts the schedule — so instead of replacing a taxi or train car in three years, it will be replaced in 2013.

The "Cash for Clunkers" program shifted demand. The pulling forward not only shifted demand cycles, but also created a spike in used car prices. I'm expecting a similar spike because many of the vehicles lost would have entered the regional used car market. Other replacement cycles will be interrupted and distorted, too.

4. Residents and businesses with means relocate.

Some people cannot imagine leaving New York or New Jersey, but there is a good chance that some people will relocate — taking their economic activities with them. If you can afford a beachside property, you likely won't have a problem buying another house somewhere else.

Most businesses cannot wait to rebuild, so they will relocate if possible. With the current glut of retail and industrial properties, it isn't unthinkable that companies will be able to relocate quickly and return to business. That's a good thing for the nation, yet a bad thing for the region that loses a business.

5. Holiday tourism and shopping will decline.

New York and much of the Mid-Atlantic enjoy brisk tourism and retailing during the winter months. From the holiday parades and displays to the peak of the Broadway season, New York is going to be dealing with a decline in visitors. Fewer visitors translates into lower fourth-quarter transactions and lower tax revenues.

It isn't merely tourists that will be cutting back in the Mid-Atlantic. Residents having lost property, including entire households, are not going to be spending on toys and luxuries for the holidays. These residents are going to be rebuilding whatever they can rebuild. That's going to affect discretionary spending.

6. Rebuilding costs opportunities.

The businesses and people not relocating will need to rebuild. Some of the funds will come from insurance, but other funds will come from savings and current income. Those expenses take money from new ideas, new products, and basic daily needs. Opportunity costs are the basic reason the Broken Windows Fallacy is a fallacy: spending to rebuild means you aren't investing in the future.

There will be growth… sort of.

There will be rebuilding, which should include improvements to infrastructure and some businesses. These are investments that should have been made anyway, but were often delayed by political choices. Hopefully, there will be investments that have long-term economic benefits. Still, I expect only a minor, short-term bump to GDP and regional economies.

Sometimes, after a serious disaster a place doesn't recover. I don't fear that New York and New Jersey won't recover, but the recovery will be slow and painful. It will be unlikely to help our economy "bounce" from its current doldrums.

Monday, October 22, 2012

Entrepreneurs Do Create… and Create Jobs

I am a "serial entrepreneur" by nature. As early as junior high, I was trying to sell my services as a computer tech and programmer. I also knew I wanted to sell my creative writing. Business fascinated me — I tracked the stock market, the precious metals, and the general commodities when I was in the fifth grade.

Not everyone is an entrepreneur; I understand that. Unfortunately, many people don't seem to understand what motivates entrepreneurs and how we help economies and society overall. On an older blog post, the following comment was recently posted:
So instead of viewing him [the entrepreneur] as a 'job creator', he's just another consumer. He may consume other peoples' labor (time/skill/effort) in creating a corporation to earn him profits, but he's not a job creator. The market demand creates jobs. Not entrepreneurs. Entrepreneurs just chase demand and buy labor in order to earn even more revenue and make profit. Entrepreneurs do not create jobs unless the demand permits them to profit. They are not responsible for job creation. It's a side effect of profit-seeking.
— Tom on
This reaction, incredibly misguided as it is, is typical of what I hear among my colleagues at the university. As I sit in the cafeteria or lounge, they decry "business people" and "entrepreneurs" with no appreciation for how most business people and innovators think. Yes, there are greedy, manipulative, and purely profit-driven business people. But, that's not how the majority of entrepreneurs approach business.

Let's address the misunderstandings in order.

Myth 1. The entrepreneur is just another consumer.

No, most entrepreneurs have ideas that they want to share with others. From recipes for better cookies to ways to better analyze data, entrepreneurs believe they have better ideas. Those ideas might be new creations, new methodologies, or innovations to existing ideas. In some cases, the entrepreneur simply imagines a better service or a better price, based on innovations to distributions and customer service. Most entrepreneurs, however, are small business people — so they focus on products and services, not distribution networks.

When I offered computer training or service, what exactly was I consuming? When I develop software, what am I consuming? I need to buy a computer, development tools, and books, but I'm not generally using anyone else.

Myth 2. Employees are "consumed" by entrepreneurs.

Most small businesses fail. Entrepreneurs tend to fail several times along their journeys towards some success. During those early struggles, and often well into moderate success, small businesses pay employees even when the business is not profitable. Remember, small expanding businesses create jobs in the United States. Most of these expansions are risky. The owners, the entrepreneurs, pay employees and invest in equipment in the hopes of a future profit. That profit might never arrive, though.

A good tech company creates a lot of millionaires, as an example. Doesn't sound like exploitation, since the employees know they will work miserable hours for a potential payout. In skilled professions, the employee can be a co-owner. Entrepreneurialism is seldom large factories with poor working conditions in today's economy. In the past, entrepreneurs tended to have the "better" factories; times were different, though, and a "good" factory job seems an oxymoron to me.

My wife and I paid employees when we were earning nothing at all. Most small entrepreneurs have to do the same thing. When times are tough, most small businesses do all they can to keep employees with special skills. You borrow money and you do without, so you can take care of your employees. That doesn't sound like unfair consumption of labor to me.

Might I need employees again someday? I don't know. If I do, I will once again do all I can to keep the best and brightest.

Myth 3. The market demand creates jobs. Not entrepreneurs.

The demand doesn't exist when most entrepreneurs create a new product, service, or innovation. Yes, after someone opens a business it can seem obvious, but it wasn't obvious enough or everyone with the resources would already be in the business. Who knew there would be any demand for the first video game? Who wanted a personal computer? Was anyone demanding the single-serve K-Cup coffee machine? Restaurant concepts can be disruptive and new. I remember when California Pizza Kitchen was "weird" and "funky" but it seems to have been a good idea.

Entrepreneurs, especially the creators and innovators, have an idea and see a potential market before the public knows they will want the product or service being imagined. We do not chase demand — we seek to create a product so good people will demand it. That is a huge difference, a distinction that too many people don't seem to grasp.

When my wife and I had a computer store with a dial-up Internet service, nobody knew they "needed" the Internet. We thought people would come to see the benefits of online service and demand Internet access. Yes, we hoped to make money, but we were not chasing public demand. We were hoping to create demand and to explain the benefits of this new virtual world to potential customers.

Myth 4. Entrepreneurs just chase demand and buy labor in order to earn even more revenue and make profit.

As the previous myths demonstrate, the reality is far more complex than chasing demand (we seek to create products and services people will demand) and buying labor (we often invest in workers while unprofitable). The entrepreneurs I know are not chasing money, they are chasing particular passions they want to share. Yes, entrepreneurs want to profit — but you misunderstand entrepreneurs if you believe profit is everything. It's not.

When I create something, I do want it to be the best possible whatever-it-is on the market. The way we measure "best" is market demand or critical reception. And the market I want to please and serve might not be the market others seek. I'd be happy making less money if my products or services reached particular audiences.

Do some entrepreneurs follow demand? Certainly. We see that in how many products are merely derivatives. However, it isn't that common for a pale confederate to dominate a market. Something must be better, cheaper, or in some other way be superior if it is going to "win" in the marketplace. What is superior to the market might be the "good enough" product that's significantly more affordable. That is still innovation, since it requires some thought to make a good product for less money.

It is about the ideas.

Entrepreneurs create jobs because we create products, ideas, and services nobody else imagines. We do this without knowing what the demand will be or what the financial rewards will be. We take risks. I'm unable to stop thinking about new ideas for businesses. Most of the ideas are bad ideas, and I dismiss them after brief consideration. Other ideas… they need to be tried. And the ideas that are tried? Most of those will also fail! Yet, it is always about having an original idea, something nobody else is trying to do in quite the same way.

What many of my colleagues don't appreciate is that being in business, to me and many of the entrepreneurs I know personally, is about having those new, exciting ideas. Profit is merely the result, but we are driven to create and to innovate. Yes, we are also competitive. Often that competitiveness leads us to "keep score" in various ways, including profits or market position. When I wake up, I'm thinking about new ideas that might appeal to a market. I am always looking around, wondering what might be the next "big thing" in my community or nationally. It is a compulsion to wonder about business cycles and innovation.

If I made a lot of money, I'd likely be giving a fair amount of it away. My wife can attest to my long list of ideas for charities, ranging from cat rescue havens to improved libraries in rural areas. If I have any success in life, I want to share that success with others.

I'm not certain what my next destination is in life, but it is likely to be entrepreneurial again. I want to pursue my ideas, my personal vision for new products and services. That's not about money — it is a form of self-expression.

Once a business is beyond the "start-up" stage, things do change. Most entrepreneurs are not interesting in running a stable, boring company. An entrepreneur thrives on innovation and disruption. Once the innovation ceases, companies start to focus on cost controls and bottom lines in a way that doesn't align with the entrepreneurial impulse. We're not bean counters: we're dreamers. Maybe entrepreneurs are adrenaline junkies.

Yet, this post won't persuade anyone convinced entrepreneurs are all about the profits. To the non-entrepreneur, the compulsion to take risks must be about the potential material rewards. Yes, financial rewards are nice, but seeing any idea do well is an emotional rush.