Growthology

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Here is an essay just published in the wonderful journal innovations, one of the editors of which is the brilliant Phil Auerswald.

Download Creative Discovery Innovations June 2009

Also, a great post the other day by Jeff Cornwall at The Entrepreneurial Mind.

Private Schools for the Poor?

The cause of much of the developing world's problems is a lack of human capital. Aid agencies and international groups therefore call for more spending on public schools, without wondering if this cash infusion actually achieves any meaningful change. Is there a better way? 

Last week on City Journal's website, Liam Julian reviewed James Tooley's The Beautiful Tree: A Personal Journey Into How the World's Poorest People Are Educating Themselves. The book discusses the millions of poor people around the world who prefer to send their children to private schools, as opposed to government schools were teachers are often truant. Julian writes, 

Do pupils in private schools for the poor actually learn more than those in public schools? To find out, Tooley assembled and trained research teams that eventually tested 24,000 fourth-graders from impoverished areas who attended a range of schools—private schools recognized by the local government, private schools not so recognized, and public schools—in India, Nigeria, Ghana, and China. His findings are stunning: 

The results from Delhi were typical. In mathematics, mean scores of children in government schools were 24.5 percent, whereas they were 42.1 percent in private unrecognized schools and 43.9 percent in private recognized. That is, children in unrecognized private schools scored nearly 18 percentage points more in math than children in government schools (a 72 percent advantage!), while children in recognized private schools scored over 19 percentage points more than children in government schools (a 79 percent advantage).

As goes Delhi, so apparently go Hyderabad, Ghana, Nigeria, and China: private-school students drastically outperformed their public-school peers in every location.

Where good ideas go to die

Why has Washington, DC increasingly become the place where good ideas go to die?

On May 12, the Senate Finance Committee held a hearing on health care reform. There was a long table of 13 experts, and a vast majority agreed that ending the tax exemption on employer-provided health benefits should be part of a reform package.

They gave the reasons that experts — on right or left — always give for supporting this idea. The exemption is a giant subsidy to the affluent. It drives up health care costs by encouraging luxurious plans and by separating people from the consequences of their decisions. Furthermore, repealing the exemption could raise hundreds of billions of dollars, which could be used to expand coverage to the uninsured.

Democratic Senator Ron Wyden piped up and noted that he and Republican Senator Robert Bennett have a plan that repeals the exemption and provides universal coverage. The Wyden-Bennett bill has 14 bipartisan co-sponsors and the Congressional Budget Office has found that it would be revenue-neutral.

The Finance Committee’s chairman, Senator Max Baucus, looked exasperated. With that haughty and peremptory manner that they teach in Committee Chairman School, he told Wyden and the world that this idea was not going to happen.

In the World’s Greatest Deliberative Body, senators don’t run things. Chairmen and their staffs run things.

That is David Brooks; read the whole thing here.

Lessons:

1. The big battle over health care is now dead. The vast machinery of politics and media will trudge on for months, but essentially this is over. History will look back at the $1.6 Trillion CBO score and recognize it as the turning point. Why did it happen?

2. President Obama made the same vague mistake that President Bush made. Rather than specify a solid framework for legislation (on immigration, on Social Security, take your pick), the new way to kill your own agenda is to talk up general principles and leave Congress to craft actual legislation. Without clear leadership (and not just behind the scenes), the modern result is acrimony. Inside the beltway, the Clinton health care experience remains a searing lesson in the "wrong way" -- overly strong presidential specificity. But the lesson has been overlearned. What the Clintons did wrong was to hijack the legislative process with a massive semi-secret commission. That wasn't leadership. Somewhere between being a control freak and a mere rhetorician is the golden mean of presidential leadership.

3. It's not too late. Despite lesson #1 above, Obama and key Senators could skip the whole kabuki dance of failure. Announce the old approach dead. Admit you lost, and explain why. And then restart by working with a new coalition, a truly bipartisan one this time (hint Wyden-Bennett). It's been done before. Tax reform in 1986 died and was reborn many times, as recounted in The Showdown at Gucci Gulch.

The Facts of Growth (Not a Mystery)

Stanford economists Charles Jones and Paul Romer have an ungated working paper with a title that will probably be confusing to lay readers, but may be one of the most important summary paper I've ever see (it probably is; I have yet to digest it). It is titled, The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital

Here is a summary of our new list of stylized facts, to be discussed in more detail below:

1. Increases in the extent of the market. Increased flows of goods, ideas, finance, and people — via globalization as well as urbanization — have increased the extent of the market for all workers and consumers.

2. Accelerating growth. For thousands of years, growth in both population and per capita GDP has accelerated, rising from virtually zero to the relatively rapid rates observed in the last century.

3. Variation in modern growth rates. The variation in the rate of growth of per capita GDP increases with the distance from the technology frontier.

4. Large income and TFP differences. Differences in measured inputs explain less than half of the enormous cross country differences in per capita GDP.

5. Increases in human capital per worker. Human capital per worker is rising dramatically throughout the world.

6. Long-run stability of relative wages. The rising quantity of human capital relative to unskilled labor has not been matched by a sustained decline in its relative price.

Nicolas Kaldor's original article in 1961 also laid out six facts. They predominantly described the behavior and ratio of inputs and outputs: measured capital, labor, GDP, interest rate, and so forth. These new facts, as the authors discuss, define the agenda of study among growth scholars and show how much progress has been made in the field. I for one am impressed at how decisively we have moved beyond explaining growth in terms of ingredients, and have moved on to recipes.

So why is that so many popular discussion of growth emphasize how totally mysterious it is? William Easterly's book, "The Elusive Quest for Growth" is a case in point, but I think that kind of soundbite epitomizes the policy conversation. Growth is described ad nauseum as a "mystery" in reverent tones. And, not to make a pun, it really makes me sick. (This is no knock on Easterly -- his point is that experts tried to force correlations into causations, and failed. They were stuck on Kaldor 1.0)

How about this: growth isn't a mystery. By and large, we know what works and what doesn't. Corruption doesn't work well, property rights do. Globalization is working everywhere it is allowed. Protectionism is a disaster, in the long term and usually before. Democracy, unfortunately, seems insignificant in promoting growth, but free markets are essential. And, as every young American RTS playing teen knows, technology wins. And as almost every great innovator attests, entrepreneurship equals technology.

There remain unanswered questions, sure. But because scientists have yet to control fusion hardly means they can't design an engine that harnesses energy for locomotion. Because philosophers have yet to agree on the meaning of life surely does not imply they have no sense of morality. Bottom line: we know everything we need to know about growth to end poverty on Earth in this century. Will humanity be successful in growing universal prosperity? My suggestion: stop with the mystery mumbo-jumbo, and start reading this paper.

Hassett challenges Obama on Creative Destruction

Obama and his team seem sharply opposed to the view that creative destruction is a valuable economic force. They seem happy with what might be called destructive destruction -- the obliteration of value and wealth without any resulting positive change.

Kevin lists banks, automakers, taxes, and cardcheck. He hits pretty hard, but is it unfair?

Most valuable, I think, is his dispensing with the claim that Obama is a socialist. There is no threat of socialism, any more than there is a failure of capitalism, and I think the sooner people move past that provocotaive language, the better. The 21st century is all about cometing forms of capitalism. State-dominated capitalism is the dangerous temptation we face.

Understanding the Depression Index

A week ago, I presented a new index - what I call the Depression Index - in an article at RealClearMarkets. This post explains the index in more detail.

I developed the measure to help get a grip on how bad the macroeconomic situation in the U.S. actually is, having made this same point among colleagues: "This recession is fundamentally worse and different than anything since the Great Depression for one reason (and maybe more). The only comparable spikes in unemployment in modern history happened when the central bank caused interest rates to rise, episodes in 1974 and 1980-82. This time, the Fed is pushing rates in the opposite extreme, with the same outcome." I decide to quantify my argument, but extended the logic to consider the other policy tool, counter-cyclical fiscal policy (deficit spending and lower taxes). It is also often used to fight recessions, but this tool has also been stretched to the extreme as well.

The Depression Index compares three broad measures of capacity: The Fed Funds rate, the annual budget deficit rate (annual deficits as a percentage of Gross Domestic Product), and the basic monthly unemployment rate. This first chart shows each series independently:

 

We can see that the FFO and URATE were quite stable and closely related around the 2-7 point range during 1990s and in the 5-10 point range in the mid to late 80s. They have diverged sharply now, as has the deficit rate. If anyone is interested, here is the spreadhseet with all the data and source links.

When you combine the three series, you get the depression index:
Depression Index = Fed Funds - Budget Deficit (Surplus) / GDP - Unemployment Rate

 

The current index is negative 23.1, twice as low bad as any time on record (Note: FFO data extend back to 1954). What does this mean? Well, it is easy to mock the index and suggest that the central bank just raise the FFO to 23.1 and all will be well. That works for me, as long as you are happy with the consequence of nuking the American economy. Not the point. What the index tells me, at least, is simply that policy capacity is overstretched. I tend to be dismissive of actual "depression" talk, but this index honestly makes me recognize that the macro economy is in an extraordinarily abnormal situation, and normal analytical tools, models, forecasts may not be worth very much. It also suggests the macro economy is fragile enough that any additional shocks will not be cushioned and instead cut into economy capacity severely.

Two objections to the index occur to me. One, fiscal policy is meant to be counter-cyclical but has a lag, as does monetary policy. Timing is a fair point, but difficult to resolve. A remedy would also obscure the present situation. A second criticism is that the deficit is less salient as a measure of policy capacity than budgetary debt. I am tempted to consider that, but again, it feels like there is some boundary to the amount of deficit financing that can be executed in a single year, making it a fair measure of immediate capacity.

In any case, we can consider a 2-component depression index that leaves aside fiscal policy. Consider this next chart:

Here again, we see an unprecedented policy-economy overstretch. The unemployment rate has rarely exceeded the fed funds rate by more than 4 points, touching beyond 6 just once in the summer of 1958. But now the gap is just over 9 points. In other words, our present situation defines what economists call being "out of ammo."

Unfortunately, the most recent labor data established two ominous milestones. First, the May numbers  mark the 17th recessionary month, which makes this the longest NBER declared recession (two prior "longest" recession were 16 months in duration). There's always the possibility that the NBER says a year from now that the economy started to recover in May or June, but I would not bet my job on it. Second, the unemployment rate net change of 4.5 points is the biggest in modern history. And both of these milestones are probably not endpoints.

Stimulating Fewer Jobs

In another strike against government effort to create jobs, the NYTimes excellent "You're The Boss" blog (which we should have on our blog roll) observes how the extension and modification of unemployment insurance is undercutting small businesses. This is an old saw, but research backs it up: legislation that tries to protect workers will chill hiring instead. When will they ever learn?

It gets even worse when the employee files for unemployment. A lot of people — including a lot of business owners — don’t understand how this works. Because the government cuts the unemployment check, it is widely assumed that it’s the government that pays the unemployment benefits. In reality, those benefits are funded by employer taxes. And here’s the killer: The more unemployment benefits your former employees collect, the higher your taxes go.

It works like insurance. If the government pays a claim, your rates go up. In fact, if your former employee collects $10,000 in unemployment payments, you can expect to pay close to twice that in increased premiums. At least that’s how it works in my state, Illinois.

Thus, this becomes another cost of doing business that smart owners attempt to control. How do you control it? By making as few hires as possible, by making sure that those hires you do make are as strong as possible, and by combining documented rules with good management.

And now, thanks to the stimulus package, unemployment insurance has been extended as much as an additional 20 weeks. If you’ve had to lay off 10 people, this could easily result in additional taxes of $10,000, $50,000, or even $100,000. It’s a time bomb that won’t go off until after employers get their contribution-rate increase in November, but it will go off.

And therein lies the final irony: Even after the economy improves, I’m going to think long and hard before I hire anyone. Thanks to the stimulus package — the stimulus package — the costs, paperwork, and legal exposure associated with hiring employees is on the rise. I’m not saying the package is all bad, but it does make it less appealing for small businesses to hire more people, or even to offer health insurance, for that matter.

The Twitter Revolution In Iran

What we are witnessing in Iran is the first ever geek-led revolution. You've heard of the Orange Revolution, the Cedar Revolution, and the Rose Revolution. Upon further reflection, Iran is just the place for a Twitter Revolution. It boasts the world's highest per capita number of bloggers.

The Iranian regime is complaining that the U.S. government is behind the Twitterfest, but they couldn't be more wrong. The government has had little to do with it. (Aside from a few tepid remarks by Obama and the State Department requesting not to shutdown Twitter for scheduled site maintenance.)

Rather, the people of America - not the government - are helping the Iranian people who are bravely slugging it out in the streets after their election. 

Take the example of Austin Heap, a S.F. computer programmer. He is helping everyday Iranians get around the censors through the use of proxy servers. (A proxy server helps its users conceal their identity.) 

His blog, which lists proxy servers and now password protects them, has grown from a few dozen hits a day to over 100,000 in less than twenty-four hours. People are emailing in to him saying where there are more proxy servers and thanking him for helping them reconnect with loved ones. Even though he's receiving death threats from people within Iran, he knows that he has to continue helping out the Twitter revolution going on there. Unfortunately, he was detected, according to The San Francisco Chronicle. 

By mid-Tuesday, Iran appeared to be blocking all non-encrypted Internet traffic, making the 1,600 new proxy-server addresses now in his in-box temporarily useless. But Heap was working with other professionals and companies seeking new ways to reconnect.
"I haven't been in the middle of an outpouring like this, ever. And it makes me incredibly proud of the IT community," he said.
While it's not clear how much impact Heap's efforts are having, history may look back on his tweets about proxy servers as a profound moment in political evolution, said Stanford's Milani [a professor specializing in Iranian politics]

One growthology's favorite books is Clay Shirky's Here Comes Everybody: The Power of Organizing with Organizations. If you want to understand the Iranian Twittering Revolution, go out right now and buy the book. Or sit at home and order it.  

Shirky describes how for a time, a teenage girl was the Western world's only access point for the coup that ousted the Thai prime minister. Her blog posts on the topic went viral. 

Here's how he described what is going on in Iran right now during a Q&A with TED. Shirky gave a great TED Talk in 2008 and with full disclosure in mind, the Kauffman Foundation, is a TED sponsor.

I'm always a little reticent to draw lessons from things still unfolding, but it seems pretty clear that ... this is it. The big one. This is the first revolution that has been catapulted onto a global stage and transformed by social media. I've been thinking a lot about the Chicago demonstrations of 1968 where they chanted "the whole world is watching." Really, that wasn't true then. But this time it's true ... and people throughout the world are not only listening but responding. They're engaging with individual participants, they're passing on their messages to their friends, and they're even providing detailed instructions to enable web proxies allowing Internet access that the authorities can't immediately censor. That kind of participation is reallly extraordinary.

. . . 

So how does this play out?
It's complex. The Ahmadinejad supporters are going to use the fact of English-speaking and American participation to try to damn the dissidents. But whatever happens from here, the dissidents have seen that large numbers of American people, supposedly part of "the great Satan," are actually supporters. Someone tweeted from Tehran today that "the American media may not care, but the American people do." That's a sea-change.

Venture Capital and Systemic Risk

The White House released its draft paper on proposed changes to U.S. financial regulation yesterday. Included on this list were many hopes and dreams -- it is the most wide-ranging proposed update to U.S. financial rule-making since the Depression -- but among among them was a change that could be unhappy for the beleaguered venture capital industry.

Here is the relevant section:

All advisers to hedge funds (and other private pools of capital, including private equity funds and venture capital funds) whose assets under management exceed some modest threshold should be required to register with the SEC under the Investment Advisers Act. The advisers should be required to report information on the funds they manage that is sufficient to assess whether any fund poses a threat to financial stability. [Emphasis added]

This is potentially worrisome. Depending on what is meant by "modest threshold" in the preceding, many or even most venture capital partnerships could be forced to register under the Investment Advisers Act. After all, average assets under management is not dissimilar to average assets at a typical private equity firm, so a new threshold that captured most private equity firms would, by definition, capture most venture firms as well.

The cost of complying with the Investment Advisers Act is usually advertised as trivial. Recent experience in the hedge fund industry has demonstrated that is not the case, however, with firms sometimes hiring full-time compliance officers and incurring other costs taking the total to $200,000 a year, and more. Even if costs are more typically half of that for venture firms, it is material.

This would be ill-timed and inappropriate. First, the industry seems wrongly targeted. It is not a source of systemic risk in the sense that other large financial firms can be, with no use of leverage, no off-balance sheet exposure, and a relatively small amount of assets under management. Granted, fund strategies can drift, and I would not want venture capital status to be an easy out for funds wishing to escape regulatory oversight, but the systemic risk from venture capital pales in comparison to that of other financial entities.

Second, the industry is currently, as I have argued elsewhere, in the process of shrinking to a size where it can once again deliver the kinds of returns it did a decade ago, and earlier. The future of the venture industry is likely one with many $70m to $120m funds, but very few mega-funds with hundreds of millions of dollars. While the performance incentive comes from successful investing, day-to-day viability of such small funds comes from management fees that typically start at 2% of assets and decline after four years. With salaries, overhead, travel, audit, rent and the many other costs in running a small business, a new compliance line item could make smaller venture funds uneconomic precisely when such funds are most needed.

We should scrutinize the financial industry carefully for new and emerging sources of systemic risk. In doing so, however, regulators must minimize costs while choosing the right targets and focusing on the causes of risk, like unmonitored leverage, which is nonexistent in venture capital. I would hate to see the trajectories of future entrepreneurs altered by an over-eager and indelicate registration process that made uneconomic the kinds of small, risk-taking venture funds our economy needs right now.

Protests = Democracy?

Events in Iran this week have been pretty riveting, true, but let's keep things in perspective: protests are neither equivalent to democracy nor do they automatically lead a country to democracy.

The American media has been breathless in reporting on the newfound power of the people in Tehran, and apostles of the new "social" media see this as sort of the tech version of the Rapture. On NPR this morning, one of the Americans who is commendably allowing Iranians to use his computer as a proxy server to send messages on Twitter averred that this is a turning point in the history of technology and democracy.

It is?

First, on a superficial note, the fact that allegedly doctored photos zip around the Internet doesn't herald a new era of media. Did we really need social media to tell us that Iran is a repressive country?

Second, on a deeper level, this raises that irritating academic debate about what, really, is democracy. As Fareed Zakaria and others have pointed out, there is a major difference between democracy as popular sovereignty, and democracy as constitutional limitations on the scope of government. The latter, "liberal" democracy, is what by and large characterizes the West. The former, "illiberal" democracy, too often gets mistaken for complete democracy. 

The election protesters in Tehran are rightly being hailed for their courage: Iran's illustrious history has been tarnished by repression. But what is it we in the West expect to come out of the protests? Popular sovereignty expressed through mass assembly can often be the enemy of liberal democracy (see Revolution, French or Africa, twentieth century). Let's say, in the end, Moussavi ends up assuming office: do we really believe this will cease all friction between Iran and the West? The Iranian public, if polls can be trusted, largely supports the nuclear program as an expression of prideful nationalism. And it's far from clear how the balance of power among the clerics, military, and "other" politicians stands, or how it is shifting.

There is little doubt that Ahmadinejad has been disastrous for the Iranian economy: per capita income is around $12,000, but this largely reflects oil and gas revenue, and most observers agree that it is unsustainable and unaccompanied by actual economic development. (The separate debate about the relationship between level of income and democracy sort of falters in cases like this.) But it's not clear that the necessary economic reforms will inexorably follow from the fissures of freedom now appearing.

In any case, we should cheer any challenge to oppressive authority. But let's not assume, or pretend, that this represents any sort of triumph (yet) of social media, of democracy, or economic development.

Uncompetitive Ohio?

A fundamental part of any period of rapid growth or decline is movement. Creative destruction plus a large, open, continental economy yields massive shifts in population. Rural moves to cities. Old cities give way to new. I like to say that a downturn is more of a restructuring than a recession. It's not as if when the economy grows back, all the saggy parts will inflate again.

Michigan, California, we know about those states. But did you know Ohio is on the downswing as well? The Dayton Daily News reports:

NCR will move its corporate headquarters from Dayton to Duluth, Ga., taking with it more than one thousand jobs from here. ... In the memo sent to employees, Nuti wrote, “The decision to consolidate functions in Georgia and build a corporate headquarters campus focused on innovation is in line with our business strategy to drive growth, improve our innovation output, increase productivity and continually upgrade our focus on the customer. In addition, we will decrease time-to-market for innovative solutions, improve our internal collaboration, deliver next generation employee education programs and lower our current operating costs.”

Somewhere in that lies the truth. Or part of it. The full article digs deeper and identifies the direct international flights that go direct to and fro Atlanta. From Dayton, it's 60-90 minutes just to get to one of the regional hubs in Columbus or Cincy. But I wonder. 

The article makes no mention of taxes, so I turned to the handy-dandy Tax Foundation's 2009 State Business Tax Climate Index. So guess which state is ranked 47th out of 50?  And guess which state is ranked 27th? Nothing to see here, folks. Move along.

The Stimulus Sun God

Six weeks ago, Michael Cembalest, CIO of J.P. Morgan Global Wealth Management, sent out his regular "Eye on the Market" newsletter, which included a stunning chart. Comparing the current economic "rescue mission" with past recessions (as of April 22), Cembalest displayed monetary and fiscal stimuli, with the Sun deities representing the present policy response:

All you can really say about this is, wow.

Cembalest began the newsletter by recalling that "ancient sun worshippers were mostly unaware of the astronomical forces at work guaranteeing that the sun would rise every day, whether they offered a sacrifice or not." This could probably apply to most economic policymakers, who often seem to think that, but for their efforts at managing and steering the economy, all growth and activity and innovation would come to a halt and we would all pitch into poverty.

Health Care & Growthology Mantra for Summer '09

Our friend and economist-blogger-in-arms, Arnold Kling, has an interesting take on how to fix health care in The American, the online magazine of AEI. He writes that,

One illusion about healthcare reform is that the only problem we have to tackle is the uninsured. The larger problem is that those of us with insurance have too much coverage, so that neither patients nor doctors have to pay attention to costs when making decisions. That is going to have to change. 

Such an injection of cost into the market would serve as a signal to would be innovators who can drive down costs. (For more see Paul Howard's "Health Care's New Entrepreneurs," in City Journal.)

You might remember that Kling was a participant in this February's Economics Bloggers Forum. (Kling blogs at EconLog, a popular economics blog.) During one of the panel discussions, Kling was skeptical that one of the barriers to entrepreneurship is lack of health care. He and Bob Litan argued about it, so it comes as some surprise that one of the problems with employer-provided health insurance is "job lock," something of a hobbyhorse of the Kauffman Foundation. Kling writes,

Workers who are concerned about the availability of health insurance may suffer from “job lock.” They might wish to leave their job for self-employment, pursuit of formal education, an opportunity with a smaller firm, or early retirement, but the potential loss of health insurance is a deterrent.

I haven't had the chance to talk with Bob about this, or Carl Schramm -- point being that both know more about health care policy than my doctor and I combined -- but I am torn about the upcoming battle over healthcare reform. Whatever the bill pays for, I am likely to distrust its impact on market incentives, but how it pays may turn me into a full-throated Obamaite (Obamacon?  What are they called?). The WaPo has a great article today about Dem infighting over the revenue plan for healthcare. Growthology mantra for the summer: Taxing employer-provided health insurance is not just a way to pay for reform, it is health care reform. Every entrepreneur knows this is the key to levelling the playing field. Let's hope it happens.

The Mark Thoma / Kauffman Blogger Forum Interview

 

Mark Thoma, Professor, University of Oregon and author of the blog Economist's View

Depression Index

Our very own Tim Kane has a nice empirical piece up at Real Clear Markets today. Tim makes crystal clear just how stark things are right now in the economy.

Nice work, Tim!

China and the World

Menzie Chinn's graphs of China's GDP growth is quite good.  Since 1980, China's GDP has grown from 0.3 Trillion interntational dollars to a projected 10T in 2010. The U.S. GDP grew from 3T to 14T over the same time.

So, while it's good news that China seems to be rebounding in terms of growth, due in part to the implementation of a substantial stimulus package, one has to keep in mind how big the Chinese economy is (in USD, 8.8% of world GDP, compared to 12.4% in International dollars).

One can't help but notice that the Euro area was roughly equal to the U.S. in terms of overall GDP when it was created (Menzie marks it as 1991), but now is 15-30 percent below, entirely due to slower growth.

The Future Happened Yesterday and Today

Not to self-aggrandize, but this report, authored by me, was released the other day. I started with a question posed by our Kauffman colleague Keith Mays: how many companies on the Fortune 500 list were founded during a recession? It turns out that well over half of the companies on the 2009 list started during a recession or bear market. 

This, in and of itself, is remarkable. But it also turns out that the Fortune figure, when broken down by decade and when looked at in the context of recent Census papers that Kauffman has helped fund, fits neatly into a narrative of the American economy moving from the bureaucratic capitalism of Galbraith's New Industrial State to the entrepreneurial capitalism of the past two or three decades (and the entrepreneurial capitalism of a prior era). The composition of the companies on the Fortune list is rather dynamic (surprisingly, I think), but even more importantly, startups have been enormously important in terms of job creation. Without startups, we would have had only a handful of years in which overall net job creation in the economy was positive.

In fact, startups are much less sensitive to recessions than the overall economy, which seems to run counter to conventional wisdom. In any case, the research paper tries to tell a story: we would appreciate any and all feedback.

Kedrosky: Cut Venture Capital in Half

Paul K, a colleague at Kauffman and relentless blogger, published a brilliant short paper on the venture industry today -- RIGHT-SIZING THE U.S. VENTURE CAPITAL INDUSTRY. It's must reading for the charts alone. A snippet:

External capital is sometimes required by some private companies in their early stages, and it is good that there is a class of professional investors with enough financial resources to provide that assistance when it is needed. However, venture capital and entrepreneurship are separate phenomena, even among growth companies, and conflating the two, let alone implying that the former causes the latter, is untrue and unhelpful.

My frustration with the VC mytique is the persistent belief that it is the foundation of entrepreneurship (hey, that's a good tag line ...). Most of the folks I know in this world acknowledge that the trend is to invest in later stage companies. I hear the word profitable a lot. A profitable startup is not a startup. You can have profitable companies or startup companies. Not both. 

Paul's paper focuses much more on the hard numbers at stake in contrast with the low returns. I agree, but still wonder if Sarbox isn't killing the startup scene (including VCs).

Unemployment vs. Jobs

The view that the latest employment news is good rests on the observation that the rate of decline in payroll jobs has slowed. I would not put much confidence in this data.

 

Consider the following counterpoints:

1. Payroll numbers are notroiously unreliable until final revisions are completed (monthly revisions occur for 2 months after the initial report, and an annual revision is done that corrects data stretching back multiple years).

2. The payroll data includes an unknown number of "phantom jobs" due to double-counting workers who change jobs during the month (my research here; BLS confirmation here). Since the rate of turnover tends to slow during the early phase of a downturn, and rise again during a recovery, it seems likely that the highest declines in January and February were exaggerations.

3. Aggregate Hours data show no deceleration, as noted by Jeff Frankel (HT Paul Krugman).

4. The Unemployment rate data show no deceleration. This is especially relevant because these data are almost never revised (I think we can call it "tweaked"). Consider the chart above, which contrast the change rate in unemployment compared to the the payroll jobs (in percent terms).

The chart above shows way too many upticks in the unemployment rate for me to start looking for green shoots. The monthly correlation between these two series is -0.57 which would probably be higher if not for the constant U rate fluctuation between -0.1 and 0.0 in growth periods. The 6-month moving averages of the series have a correlation of -0.87. So in the chart above, knowing only one series gets revised and the other does not, what should we expect? It's too early for me to say conclusively, but my guess is that the payroll numbers are likely to be revised downward and/or continue in deep negative territory.

One other depressing observation: There have been 39 instances since January 1948 when the change in the unemployment rate was 0.4 or more. How many have occurred in this recent recession?  Nine. That includes six of the last six months.

Unsticky Wages? Not so fast.

Over at BusinessWeek, there's a discussion of whether a company should cut pay or lay off workers in a time of distress, with management tending to always prefer laying off workers to cutting the sacrosanct base salary.

There may be a skill effect going on here. In an era/economy dominated by low-skill jobs, a firm could more easily boost productivity by threatening to lay off or actually laying off workers. But in a knowledge economy, many of the workers feel a part of the team and eliminating part of the team can lead to diminishing returns. Just imagine if the Beatles had cut Paul McCartney (or even George Harrison.)

 

BW cites Dan Ariely, the go-to guy for behavioral economics after he wrote the magnificent book, Predictably Irrational, which is also the title of his pretty informative blog. 

Dan Ariely, a behavioral economics professor at Duke University who sees value in cutting pay vs. jobs, notes that salary is what economists call a "positional good," meaning people care more about how much they make relative to their peers than the absolute level of what they take home. That's why Wall Street bankers get angry if their bonuses don't match what rivals are pocketing a few blocks away, and why distressed U.S. autoworkers who have given up years of hard-won benefits take some solace in the knowledge that they still many more than many other industrial workers.

A skills shift? Just maybe there's a clue in this article about Professor Ariely in Haaretz. (Professor Ariely is Israeli.)  

Ariely and his colleagues ran several experiments, among everyday people in India and among American students, in which participants were given a cognitive challenge - such as a memory game or a puzzle - as well as technical tasks requiring little thought, such as fast-paced typing. The researchers promised participants bonuses of varying sizes for good performance. They discovered that when it came to the cognitive tasks, which demanded mental effort, participants who were offered the largest bonuses performed less well than those in the two other groups, which were promised smaller ones. When the task was a purely mechanical one, however, the financial incentive did prove effective. [Emphasis mine.]

This is all interesting stuff.  But Let's not be so fast to say job losses are less frequent in the new (more altruistic?) economy when the facts say the fastest rising rate of unemployment in the U.S. since the 1930s is happening right now.

Sticky Facts

Then again, the facts don't seem to back up the flexible pay argument. The best measure of compensation, according to a friend at the BLS, is the ECI (employment cost index).

Total compensation costs for civilian workers increased 0.3 percent from December 2008 to
March 2009, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  This follows a 0.6 percent increase for the September to December 2008 period. In March 2009, wages and salaries also rose 0.3 percent, while benefits rose 0.5 percent.

The ECI is a really useful fact-based piece of reality to keep in mind as you are assaulted by news and opinion that Americans are suffering from lifestyle declines.  It is awfully hard to square that with the ECI's report of compensation growing at 2/3 a percent every quarter! Maybe the ECI is a slightly lagging indiciator, but there's no denying a deceleration down to just 1/3 a percentage point last quarter.

Who wants to bet the ECI goes negative?  I'll wager $10 to anyone (or up to 50 anyones) that ECI growth remains positive during 2009.