Small businesses are dead capital

Often, when I’m reading a Forbes article and I think to myself, “This is a darned fine article,” I look at the byline to find it is another good article by Daniel Fisher.

That happened recently while reading, How the Government is Helping Hedge Funds Make Billions off IPOs.  This paragraph caused me to glance at the byline:

Hedge fund managers can thank Congress and the SEC for the opportunity [to buy early stakes in companies before they go public]. Some call it “regulatory arbitrage”: well-meaning but inherently flawed laws such as Sarbanes-Oxley that were designed to protect small investors from the next Enron have imposed such heavy costs on public companies that many private ones are delaying their initial public offerings. Venture capitalists, employees and early investors who want to sell out have little choice but to sell their shares to lightly regulated funds, which can buy stock in the next IPO at a steep discount to what retail investors ultimately will pay.

Innovation has a lot of headwinds these days. Most of it caused by (to borrow Fisher’s words) ‘well-meaning but inherently flawed’ ideas.

But I find the well-meaning and inherently flawed ideas around investing in small businesses especially annoying.

In this country you can easily sign up for an online brokerage account and buy and sell slivers of ownership in thousands of publicly traded companies on the various stock exchanges for as little as $4 per trade, with some assurance that the presence of the Securities and Exchange Commission has lowered your chances of being defrauded.

You can just as easily make personal loans to people who need cash now using Prosper.com.

You can donate money to loan to small businesses and create jobs (and make money). Well, at least you get a bracelet with that one.  Or you can lend money to entrepreneurs all over the world. You can also donate to individuals who need help funding the creative projects like a large tortoise that looks like a trading post.

But, if you want to invest with entrepreneurs here at home, it’s not so easy. You need to know somebody who wants to start a business. Or know someone who knows someone. Or you need to know a venture capitalist. Start-up investing is an opaque network of angel investors and venture capitalists.

This, folks will tell you, is for our own protection because there will be too many con men out to get you to invest in their bogus company.

But, I’d rather make it easier for everyone to invest in start-ups and let the market develop solutions to help people from being defrauded. The SEC currently makes trading equity in unregistered companies very difficult. This basically makes small businesses dead capital.

Prosper.com and Kiva.org use simple approaches to limit your risk.  First, you lend in small amounts to individual borrowers — for example, $25 — and you can diversify across many borrowers. So, if you lend to one deadbeat who doesn’t repay you, you’re not out your life savings.

Second, these sites act as an SEC and rating agency of sorts by qualifying borrowers and setting appropriate interest rates based on credit risk. Kiva.org works with organizations that administer the loans with the entrepreneurs with full disclosure on that organization’s track record.

We could use the Prosper/Kiva/Kickstarter models bring start-up and small business capital alive. A similar service could act as registration agent of sorts and market maker to connect investors and business owners and allow users to invest as little as $5 directly with entrepreneurs.

Why not? I’d rather invest directly in an entrepreneur with a chance, even if it is ever so slight, of getting a return on that investment than donate it with the assurance that I won’t.

A refreshing look at jobs

I much prefer Phil’s take (HT: Arnold Kling) on jobs to Megan McArdle’s.

From Phil:

The same technology that is eliminating jobs also connects us and empowers us in ways unimaginable just a few years ago. Maybe what’s becoming obsolete is not jobs per se, but the idea that they are something that you simply find.

Increasingly, perhaps, a job is something that we each have to create. We can’t count on someone else to create one for us. That model is disappearing. We have to carve something out for ourselves, something that the machines won’t immediately grab.

That sounds difficult, maybe even a little dangerous. We’re all comfortable with the idea of “finding” a job. We search for them; we hunt them; we land them. All of these images assume the job already exists.

But to create something new…what does that even mean? Do we all become entrepreneurs? (I think the answer to that question is yes, although many of us will have to learn to be entrepreneurs within existing organizations.) Ultimately, it means we have to find something useful to do, something so useful that others are willing to pay for it.

In other words, as my grandparents use to say, go out make yourself useful to somebody.

“Like” buttons

Speedmaster, at the Pretense of Knowledge, points out Bill Clinton’s support for an agency to “do something about misinformation” floating about on the web.  In other words, he wants a centralized and corruptible version of the Like button.

I’m willing to bet that Clinton couldn’t understand how Like buttons could be more effective (though not absolutely perfect) than such an agency.  I can imagine that he would argue that such an agency would be able to assemble experts that would do better than the everyman Like.

Genius

I know I’m way behind the times, but I recently outsourced my music listening selections to an open source solution, Apple’s Genius. I never could quite find the time to build playlists and shuffle was getting to haphazard.

So far, so good.  It’s been mixing music I don’t listen to much or at all that happens to have found its way onto my iPod with the stuff I listen to more often and I like.

That’s yet another way Apple adds value to its product at no monetary cost for its users.   And, yet another way an open-source solution makes our lives incrementally better.

Now, I think it would be nice if iTunes suggested podcasts in similar fashion.  “Those who like this podcast also like these…”  Perhaps it does already and I just haven’t figured it out.

Macro economics is like magic? Close to it.

F.A. Hayek regarding the ‘Austrian School’ of economics, from The Fatal Conceit (p. 98):

By its stress on what it called the ‘subjective’ nature of economic values it produced a new paradigm for explaining structures arising without design from human interaction.

By “subjective” Hayek means that the value of the things we trade — the morning newspaper, a Coke, a haircut — is determined subjectively by each of us.

By “structure”, I believe Hayek means a system of prices by which a potato’s price becomes relative to how much time it takes you to earn enough to buy it.

All of the prices reflect the subjective values we all place on these items and these prices are discovered through the experience of human interaction and trading these things, not by anyone setting the price.

I’m reminded of an example in Russ Roberts’ The Price of Everything, when the econ professor Ruth asked who set the price of a home she plans to sell.  The seller, answered her students.  Ruth responds, so if I have a house that’s in a neighborhood where like houses normally sell for $800,000, I can set the price for $1.2 million and expect to get that price?  Who really sets the price?  Nobody.

Hayek continues:

Yet, during the last forty years, its [the Austrian school] contributions have been obscured by the rise of ‘macro-economics’, which seeks causal connections between hypothetically measurable entities or statistical aggregates.  These may sometimes, I concede, indicate some vague probabilities, but they certainly do not explain the processes involved in generating them.

Here’s the good part (emphasis added):

But because of the delusion that macro-economics is both viable and useful (a delusion encouraged by its extensive use of mathematics which must always impress politicians lacking any mathematics education, and which is really the nearest thing to the practice of magic that occurs among professional economists) many opinions ruling contemporary government and politics are still based on naive explanations of such economic phenomena as value and prices, explanations that vainly endeavour to account for them as ‘objective’ occurrences independent of human knowledge and aims.  Such explanations cannot interpret the function or appreciate the indispensability of trading and markets for coordinating the productive efforts of large numbers of people.

In other words, macro-economics is really the use of math to relate things that may not really exist.  This is a hard one for people to accept.  After all, GDP is GDP isn’t it?  It’s real?  Those statisticians and economists know what they’re doing, don’t they?

What’s real are the trades between you and others.  What’s real is the thought processes that went your mind that led you to make those trades, as well as the thought processes that went through the minds of your trading partners.

GDP is not real.  The thought processes exist somewhere — in our minds.  GDP is a number printed on a page.  What that number means doesn’t exist anywhere.

Why should any student have to settle for an awful school?

Joel Klein, outgoing superintendent of New York’s public schools, writes in this weekend’s Wall Street Journal Opinion about the challenges and successes of education in a piece called Joel Klein: What I Learned at the Education Barricades.

I enjoyed this piece and highly recommend it.  One part I found outstanding, some parts I found interesting and unsurprisingly, there was some I disagreed with.  But, overall, I think Klein is getting very close to the right track.

First, here’s what I thought was outstanding.  Klein asks:

…why should any student have to settle for a neighborhood school if it’s awful?

I appreciate it when someone can boil down a long, emotional, difficult and complex debate to one simple question.  Why should any student have to settle for a neighborhood school if it’s awful?

I’m looking forward to using that in future discussions on education.  I think the reflexive response will be something like, if the other choices are worse, then it doesn’t matter.   To which a good response may be, I’d rather give the parents more power to make that decision rather than less.

Klein, then goes on to write:

The debate shouldn’t be about whether a school is a traditional or charter public school. It should be about whether it’s high-performing, period.

Okay.  Now, here’s where Klein starts to lose me.  These two sentences sound very good, no doubt.  Who would argue with those?

I agree that debating whether a school is high-performing is better than letting it continue to rot.  But, the problem I see here is that there are numerous ways to measure performance.  Many in the education field disagree on which is best.  I happen to think only one measure is valid and very few people agree with me.

The only valid measure of performance is how many parents would choose to enroll their kids in the school if they had full control over the decision.

I offer this revision to Klein’s statement:

The debate shouldn’t be about whether a school is a traditional or charter public school. It should be about whether parents are choosing to send their kids there and why or why not.

Klein ends with this:

To prevail, the public and, most importantly, parents must insist on a single standard: Every school has to be one to which we’d send our own kids. We are not remotely close to that today.

I disagree.

I’ll give Klein credit for being far better on this than most.  He almost has it. He has the correct accountable party: parents.

But, I think Klein misses on the desire to have every school be one we’d send our own kids to.

To me, that’s like saying every restaurant must be one I’d choose to eat at myself or every pair of shoes must be shoes I’d wear. With restaurants and shoes it’s easy to see that we have a wide range of preferences and needs and that’s okay. That’s evidenced by the abundance of shoe companies and styles.

It wouldn’t make any sense to issue Klein’s single standard on these or any other good or service that comes in a wide range of choices.

But, it is easy to imagine what would happen if we did.  It would be impossible to come up with a restaurant or shoes that would suit everyone.  We’d join political factions to make sure that the restaurants and shoes we preferred were available by pushing our agendas on everyone else and fights would break out.

Sound familiar?  It should.  That’s exactly what we have with public education now.  We’ve unnecessarily pushed education into the political arena and that’s caused most of the problems.

Do you want to fund education through taxes to ensure everyone has access?  Great.  But, why do we need government to run schools?  Why do we not want to give parents of school age children more power to choose where they send their kids to school?

I recommend the following revision to Klein’s standard:

Every school should be primarily accountable to one group: the parents who decide to send their kids to that school.

At most, our local education departments should function similarly to our local health departments.  They should help make sure the schools are safe, clean and have effective procedures in place for emergencies and keeping track of children.  Though, I could be convinced that service could be provided privately as well.

Really, we shouldn’t have to debate whether a school is high performing or not.  The parents should decide.  When a school doesn’t perform well enough, the parents will leave it and it will close.

We have to reset our expectations for education.  We have to trust parents to make the right choices for their kids.  Most will do a good job and markets will emerge to help parents with that just as markets have emerged to help us make better choices elsewhere as consumers.

We won’t always agree with the choices other parents make.  But, that’s okay.  We don’t always agree with the shoes they wear or how they live their lives, but we typically butt out and leave them to make those decisions on their own just as we expect them to butt out of our personal affairs.

The Answers Are All Around Us

Today’s EconTalk podcast was Knowledge, Power and Unchecked and Unbalanced with guest Arnold Kling.  Like occasional EconTalk guest Mike Munger and the host Russ Roberts, Kling has a knack for discussing economic principles in common language and looking at real world examples to illustrate these principles in things that are so common that we generally take them for granted.

The entire podcast is worth a listen.  I found a few things especially blog worthy.

First, we often talk about bigger and smaller government.  Kling makes an interesting point (near 14:36 mark).  As we have grown government spending the number of governmental units, or decision-makers, has stayed the same.  We have one Congress, 50 states, 435 members of Congress, 100 Senators.  Yet, more is spent per capita than ever before and the number of people making the Continue reading

Five Excellent Paragraphs from Thomas Sowell

The following paragraphs are from pages 60 through 61 of Thomas Sowell’s Intellectuals and Society.

For several years, I’ve theorized that any problem can be sourced to a problem with a feedback loop.  Supernanny knows this.  Kids aren’t bad.  The feedback the parents provide their kids is usually to blame.  Overweight people choose to ignore the feedback the scale or BMI provides.   Moral hazard is a feedback problem.  Car accidents are usually a result of a feedback problem, whether it be with a driver or with the vehicle system.

In these paragraphs, Sowell eloquently writes about feedback problems, markets and goverment.  He uses the term consequential feedback.  I wish I would have thought of that.

Continue reading

Do Your Preferences Agree With Your Local Policitians’?

The market for health care was once organized to meet the needs and preferences for people using the service.  For a long time, this market has been becoming more organized to meet the preferences of politicians.  This week’s legislation makes it more so.

Unfortunately, few understand what these words mean.  That’s too bad.

An example might help.  Consider the market for food, which is more essential to living than health care.  This market is still very much organized to meet the needs and preferences of people who buy food.

There are many different ways to assess the success of this market.  Some measures might include food availability, options for people at all income levels or size of waist lines.  The problem with such measures is that they reduce a rich environment filled with many variables down to a few metrics.  These measures can’t capture things like the delight caused by enjoying a favorite snack or that little bit of extra value enjoyed by a few based on a slightly different version of a product (Michelob Ultra vs. Michelob).

Now consider what might happen if the food market was overtaken by government.  The politicians in charge might decide that a single factor was most important.  Maybe high food availability.  For  many people this sounds reasonable.  Who’d be against  high food availability?

What these people miss is that reorganizing the food market to deliver on this goal has trade-offs.  A trade-off may be that a politician decides we need to dedicate less shelf space to beer to have more shelf space for wholesome foods like apples.  Again, to many this sounds good.  The politician will likely cite the destructive results of alcohol abuse and remind us that an apple a day keeps the doctor away.  Few people would likely disagree with this reallocation of shelf space.

To free up the shelf space, politicians must decide to eliminate a version of Michelob.  They decide to keep Michelob because it sells more than Michelob Ultra.  Very smart people those politicians.  The people who preferred Mich Ultra are out of luck.

What’s missed by many people in this seemingly justifiable reorganization of the food market is that the previous allocations of products and shelf space were a result of consumers expressing their preferences through their actual purchasing patterns.  In other words, this is what customers wanted – even if they didn’t know that explicitly.

While a politician may be able to sell us (even those who prefer Mich Ultra) with fancy talk about how more shelf space need be dedicated to apples and less to beer, that doesn’t change the fact that customers valued the space higher with Mich Ultra.

This reallocation will result in surplus in apples and beer shortages.  Stores will have a difficult time giving away the extra apples and beer lovers will be disappointed because they will have a hard time find beer to buy.

Instead of recognizing that food availability worked better before when consumers expressing their preferences through prices and buying patterns with grocery stores and food makers responding accordingly, some do-good politicians will convince us that his new version of shelf space allocation will solve the problem.  He’s a smart dude.  He went to an esteemed college (though nobody will ask him which class he learned to be better at choosing for others what they are capable of choosing for themselves).  He just needs more of your money to implement the change.  We all nod our heads in agreement.

The cycle will start all over again to generate new shortages and surpluses causing less food availability with fewer of our needs and preferences met, but because change was made, the politician will be able to spin victory and several years later a new politician will come along with his plan to fix things with more of your tax dollars.

His plan may be to use a different metric to measure success.  We’ve done nothing but that make food less available, so let’s switch to measuring options available at all income levels and the cycle begins again.

While politicians continue to use taxpayer dollars to tinker, very few people will understand that everything worked just find before politicians started meddling.

Doe this market sound familiar?  This meddling has been happening to K-12 education and the results aren’t great.  After decades there’s no agreement on how to measure success and few people realize that the truest measure of a school’s success is whether their student enrollment is growing or shrinking.

While we meet to politician’s desire to deliver on a single variable – make education available to to everyone – in many cases what’s available is a school that is so bad that only those with the least ability to make a choice send their kids there.

And, we all miss out on all the variations, quality, availability and a rich assortment of educational opportunities that the education market could produce if only it were allowed to serve the needs and preferences of the people sending their kids to school rather than the politicians who are trying to put a feather in their caps.