Growthology

Commen Sense Policies for Jobs, UI edition (again)

Robert Barro rides my hobby horse in this WSJ op-ed about the flawed incentive of the unemployment insurance system. 

The peak unemployment rate of 10.1% in October 2009 corresponded to a mean duration of unemployment of 27.2 weeks and a share of long-term unemployment of 36%. The duration of unemployment peaked (thus far) at 35.2 weeks in June 2010, when the share of long-term unemployment in the total reached a remarkable 46.2%. These numbers are way above the ceilings of 21 weeks and 25% share applicable to previous post-World War II recessions. The dramatic expansion of unemployment-insurance eligibility to 99 weeks is almost surely the culprit.

... [S]uppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred ... the unemployment rate would have been 6.8% rather than 9.5%.

What Banks Can Learn from VCs

I often give venture capital firms a hard time. It's partly because with their crummy performance that they deserve it, partly because with their humorlessness and hubris that they need it, and partly because I know more VCs than bankers -- and it's always more fun to fight with people you know than with people you don't.

But there is a flip side to this.  Financial services industry is in upheaval like at no other time since the previous depression. From banks to brokers to, yes, VCs, financial services is seeing major changes in how and whether it makes money.

So, which part of the industry is changing fastest? Venture capital. More venture firms, as a percentage of the total extant, will have failed over the current period than is the case with banks in the U.S., but with no need for a government-led bailout. We can have widespread VC financial failures without societal consequences.

At the same time, the nature of the VC industry is changing rapidly, with new entrants (micro-VCs and super-angels, but also larger funds), new partners and new brands, and even a change in sectoral & stage emphasis. The industry a couple of years out will look very different from what it did a few years ago, let alone what it looked like a decade ago.  This change is not being driven by regulators, but by the individual actions of new entrants and competitors, trying to respond to changes in the funding market, as well as to changes in their customers -- entrepreneurs.

The result: Radical change in a sector of the otherwise wasted financial services industry. New people, new companies, new markets, new providers of capital, all in the space of a few years. Will it produce higher returns? I hope so, but if it doesn't, rest assured more VC firms will fail, and there will be no talk of a safety net, or a bailout.

Why is venture different? Why is this rapid failure/speciation/innovation sequence not playing out in banking? In part, and not to get all deregulatory about it, because we don't let it. The most important difference between venture and other parts of the financial services system, especially banking, is that the former isn't regulated (okay, regulated very, very lightly), while the latter is highly regulated. That regulation, while well-intended, has the effect of straightjacketing the industry, meanwhile preventing usurpers and change and innovation, and making banks that are already too big to fail, too bigger to fail.

It is wrong and simplistic to say that if we just deregulated banks that all would be well. But it is also true that the path to having half of the banking industry (in assets and firms) shrink away, with no societal consequences (as is happening in venture), could be at least informed by what is happening right now in U.S. venture capital. [-]

Too Many Tourist VCs, or Too Many Apex Predators?

Provocative statistics from Diana Frazier of FLAG Capital this morning in PE Hub. She says the following about venture investing in the period 2001-2009:

• # of VC-backed companies started: 24,100
• # of VC-backed companies with exits over $100m: 750 (3%)
• # of VC firms: ~850

As she archly points out, there were fewer notable VC-backed exits in the period than there were active venture capital firms. Ouch.

Now, what are we to do with this? She approvingly quotes Mike Moritz of Sequoia, who says that "Tourists go home" in venture capital. In other words, it is a tough business, and efforts to make it more democratic have failed. There are simply too many firms and too much capital. I'm on side with that, of course, having argued repeatedly and wearyingly that the industry needs to shrink to health.

It's worth pointing out, however, that this was a woeful exit period. Further, most of the current crop of super-angel and micro-VC firms don't need $100m exits to move the needle on their teensy funds. They can happily exit at half that amount and still seeing solid cash-on-cash multiples.

What this speaks to, I think, it is the essential brokenness of the traditional venture business. There are simply too many apex predators for this market, and there aren't enough large fish. The venture industry needs to shrink, in other words, but most of the shrinkage needs to happen at the top of the food chain. [-]

Where does the Laffer curve peak?*

Ezra Klein asks "Where does the Laffer Curve bend?" but he's really asking where it peaks.  It bends at the origin, of course, a tax rate of 0.1  percent. 

Many experts think the Laffer Curve peaks around 60-70 percent, but I'm confident none of them would recommend this as the target rate.  Maximizing government revenue is a hideous goal, fit for the likes of Kim Il Sung.  The goal, one would hope, is to maximize human welfare.  This starts with considerations of private wealth generation, should include deference to liberty and personal property, and end with careful appreciation of long-term growth.  All of those point to an optimal lower rate which would be lower relative to the preferences of the respondents.  My guess is that even the most ardent social planners would opt for a rate no higher than 50 percent. But it would be pretty easy to argue for a top rate of 15 percent.

It's a shame that very little empirical evidence is known on this question.  I've been working on some experiments, but need to finish up those working papers with the results.  At minimum, this seems like ripe material for the next blogger's survey, no?

Sustainable or Green, but not both

Virginia Postrel suggested this fascinating question for the Q3 economics bloggers survey.  So much for green jobs, it seems.

Which taxes will rise?

The great tax debate is likely to dominate fall politics, says CNNMoney's Allan Chernoff:

Tax cuts Congress enacted in 2001 and 2003 are scheduled to expire at the end of this year, which for some Americans would push up federal income tax rates. Also at stake are taxes on dividends and capital gains, as well as tax credits and deductions.

Back in May, the Tax Foundation published a handy summary list of the tax cuts set to expire. 

Jeff Miller (A Dash of Insight) suggested that I ask our panel of econ bloggers about this in the Q3 survey.  Great idea, and the results show more pessimism than either of us expected. See chart below, and Jeff's assessment here.

Politico.com has a nice summary of a debate this week in which Secretary Tim Geithner focused on the tax rate affecting the "top 2 percent" of income earners, which is only one of the components in play.  Since that bracket is often debated in terms of its effect on entrepreneurs, the Secretary was blunt in dismissing that concern, calling it “a political argument masquerading as substance.”

Only 3 percent of small business owners would be affected by the tax policy changes, he added, leaving 97 percent who “would not pay a penny more.”

While that's a true statement, I wonder if it captures the effect of higher tax rates on incentives.  For those 97 percent of business who aren't profitable enough to be affected this time around, we can all agree they want to be more profitable, and envision their firms being so. The question then, is whether higher tax rates affect their payoffs for making the entrepreneurial commitment? I'd say a failure to extend the current low rates on cap gains and dividends would be central to entrepreneurial concerns. In essence, a successful startup is 100 percent capital gain for the founders.

Coming full cirlce, Chernoff's story offers an excellent inside look at the hot button "uncertainty" issue:

As the tax rate deadline ticks, professional tax planners are growing impatient. "They're dysfunctional," complained Evan Snapper, financial advisor with Anchin Block & Anchin. "It's terrible. It's a political game that's hurting the country." Usually accountants advise clients to defer income and investment gains until the following year -- why owe taxes now when you can put them off? But the possibility of higher tax rates in 2011 calls that logic into question.

"It's tax planning turned on its head," said Doug Flynn, a certified financial planner at Flynn Zito Capital Management. Because of the uncertainty, planners can't yet advise clients whether to sell real estate, stocks and bonds or to convert traditional Individual Retirement Accounts into Roth IRAs, which requires payment of taxes on investment gains.

Odds of a Double-dip Recession = 44%

Although most of the 68 economics bloggers who participated in our Q3 Survey think the odds of a double-dip recession are low, the average response is 44 percent.   And notice the number who think there is no chance of a double-dip are negligible.  Thanks to James Hamilton for the question. 

So, should we ask this again next quarter?   

The pessimism behind the pessimsm

In my last post, I presented the summary economic outlook from the Q3 Kauffman survey of top economics bloggers.  Behind the pessimism, the next question is really troubling.  It says that not only is the economic news grim, but things are worse than the news.  Just five percent of bloggers think the economy is doing better than official figures show, while 47 percent think it is doing worse. That's shocking. 

Let's remind ourselves what the official data are.  The latest unemployment rate is 9.5 percent.  Payroll employment declined by 125,000 in June.  GDP growth was estimated to be 3.7 percent in Q1, and 2.4 percent in Q2 (though this was reported after the survey was taken), much lower than expected & hoped.  Maybe the survey reveals some knowledge that GDP growth in Q2 would be disappointing, but I think this response represents something deeper.

Everyone knows that the unemployment number is lower than what it would be if all the discouraged workers were counted in the labor force.  But that's an official statistic itself: the so-called unemployment rate of 16.5 percent (official the U-6 rate) which is reported on table A-15 of the Employment Situation Report.  So that story isn't driving blogger pessimism.  Another ghastly official state is the weekly report of jobless claims, which has been over 400,000 for years now, and just today climbed uncomfortably close to 500,000.  Think about that.  Nearly half a million Americans filed for jobless benefits in one week.  And that's been the pace for years now.

But according to econ bloggers, even that isn't bad enough to reflect reality.  What could explain their pessimism?

One possible explanation: uncertainty. Look, this was by far the most common adjective used in bloggers' descriptions of the current state of the U.S. economy.  It seems convenient for some pundits to claim unertainty is a cheap explanation. It surprises me that they take themselves seriously.  The notion that economics was clockwork was discredited by none other than JM Keynes, right? Isn't the great insight of 21st century econ that rationality has been oversold and that uncertainty matters?  And in a year when nobody seems to know something as simple as whether the economy will recess or grow in 2011, what tax rates will be in 2011, whether the reform of 1/7th of the economy is Constitutional, one at least has to admit that uncertainty has rarely been so high as it is now. 

The other explanation: certainty.  In other words, the wrong policies are in place, and bloggers are certain that they're wrong.  This shows up in the following survey response:

The third explanation, and the one that animates my fears is the realization that yes, Virginia, the Fed is out of ammo.  It's not that the Fed couldn't manufacture inflation if it wanted to. I have no doubt about that.  Rather, I think the economy is finally coming to grips with a genuine constraint. We can't just reinflate this bubble by pushing back the debt to the next generation with lower and lower interest rates keeping the bubble economy inflated. The gig is up.  

 

Econ Bloggers' Consensus is Grim

Sometimes a picture really is worth a thousand words. But why stop with one picture? The Kauffman Foundation’s Q3 of economics bloggers was just released, and uncertainty rules the mood, literally.  Here some of the best charts. 

First, I composed this word cloud based on "five adjectives" that each blogger used to describe the current state of the U.S. economy.  It speaks for itself (and the fine print is truly worth examination).

 

The biggest surprise in blogger attitudes is revealed by the simplest questions.  Below, for instance, is the overall assessment when confined to five choices.  Looking at the chart for the first time, I would be shocked that this was the assessment of an economy in recovery. Some 68 percent of respondents described the economy as “mixed” – a word that seems today’s modern day equivalent of the 1970s “malaise.” But I'm not looking at this for the first time.  The charts from the previous quarter showed negative attitudes, but not this negative. Literally nobody thnk the economy is strong and growing now.

 

While 52 percent say that the U.S. economy is doing roughly the same as official stats would indicate, regrettably, some 47 percent of respondents think that the U.S. economy is doing worse. And when asked about prospects for growth of numerous different variables over the next 3 years, well, the outlook is grim.  Budget deficits and interest rates in the U.S. are expected to grow more strongly than just about anything else.  I'm afraid all this confirms my expectation for a 5-year recovery. 

After Inception: Durability of Startup Jobs

Now that we've settled the argument whether startup firms create the most jobs in the economy (Yes, 100%), a common counter-argument needs some attention.  Do startup jobs last?  Critics say no.  But what does the data say?

Along comes doctoral candidate and Kauffman research analyst Michael Horrell and colleague Robert Litan with this new report, After Inception. Highlighted points here:

• Cohorts of firms started each year retain, on average, 80 percent of their initial total employment to age five.
• Older cohorts of firms exhibit increasingly higher employment retention rates over five years, but these rates are not substantially higher than those of new startup cohorts.
• Cohorts that start during a recession hire fewer people in the first few years following their birth, but they catch back up to the same levels of employment at age five.
• Prolonged recessions, on the other hand, appear to lower employment among cohorts. Cohorts at age five that had survived through portions of three recession years had roughly 10 percent less employment (as compared to their startup years) than cohorts of firms that encountered no recessions in their first five years.