Starting a new Business - A Flight into the Unknown

Where I live - Joseph, Oregon - there's a group of people who want to start a new art school.  They're starting a new non-profit group, working to bring in people from other places to teach, want to buy two older buildings, and want to do all of this at the same time with virtually no money.  This is a good example of how to start a new business with an immense amount of risk.

Are all these ideas worthy?  Sure.  Why not?  Yet, that's not the question.  One good question is what are the priorities?  What do you really want to do?  What do you really want to accomplish?  What is your primary purpose?

Start-ups need cash reserves.  Start-ups don't have a track record which significantly complicates budgeting.   Under such conditions, budgeting is a shot in the dark.  Because of the great many unknowns a start-up faces, there's a need to build in a lot of ability to flex with circumstances you really have very little idea about.

Not only are costs challenging to scope, they are probably easier to scope than revenues.  This is especially true when there is little hard data that can be used to firm up the revenue forecasts.  Now, people will say "oh, that's not really that much of a problem.  There's other places that hold art classes and we can just use their experience."  There's a host of reasons why that view is dangerous.

Extrapolating from the experience of other's - which is what that argument amounts to - is problematic.  There's a good deal of statistical discussion on this issue - extrapolating beyond your data.  By it's very nature, extrapolation is a journey into the unknown.  It might be the best you've got.   Here's the thing though, you need to look at the broader circumstances of the experience of others and compare those circumstances to your own to come to some sense of how relevant their experience is to your new enterprise.

I'm not saying it's a wrong path to travel down.  Rather, that you need to be cautious as you travel down that path.  I've seen people who are really just grasping for confirmation grab onto whatever data they can get their hands on as justification for what they want to be true.  Whether it's actually true or not is another story, and people who question such approaches are sometimes treated as inconvenient pessimists.    

De-Regulation and Economic Implosion

There's been some interesting news the last few days.

1. Evan Byah retiring.

For some odd reason, he's being portrayed as a centrist democrat.  I think Bill Mahar is right on labeling him a corporatist.

2. Frontline Program on Derivatives Regulation
They ran a great overview of the political and personal dynamics that underlies how the fierce opposition to regulating derivatives led to the financial implosion.  They did a good job of showing how Brooksley Born was demolished in her attempt to promulgate regulating derivatives.  Those who have followed this story have known about her efforts for over a decade.  This show first aired in October '09.

Frontline on derivatives.

3. De-regulation under Clinton and U.S. Employment

I hope - but sadly doubt - that this story helps to re-write the role of Bill Clinton in de-regulating so much of the economy and thereby help set up the massive financial implosion and job exodus from the U.S. to China.  Frontline did a story some time ago titled "Is Wall-Mart Good for America?"  That program lays out the domestic economic impacts of the Clinton's trade policy with China that opened the door to massive job exodus to China, largely to the benefit not of consumers but of Wall-Mart stock holders.

Employment Much Worse in this Recession

Below are three charts comparing unemployment and labor force growth in this recession compared to other post WWII recessions. NOTE: Click on a chart to open it larger in a separate window.

Before we get into the charts, these charts certainly underscore the critical need to do much more for job growth than worrying about debt.  The Obama Administration and Congress really need to place a much greater emphasis on jobs.  This is both a Main Street issue and is also a key piece of shoring up the housing sector.

Looking at Chart 1, it's sobering to see how much higher unemployment has risen, and how fast it's risen in this recession, compared to other recessions.  Keep in mind that the vertical axis is percent so the fact that the labor force itself is larger is not a factor in these results.  The unemployment rate is a ratio determined by dividing total unemployment by the total labor force.  Chart 1 shows that jobs have been shed at a much greater rate than in previous recessions.  I suspect that's due to (a) fewer restrictions on an employer's ability to reduce their workforce, and (b) employer's perception of the likely depth and length of the recession.

What I find even more shocking is Chart 2, the percentage change in the civilian employment by month across post WWII recessions (Charts 1 and 2 aren't directly comparable).  Chart 2 is just the monthly percent change in civilian employment and it's a dramatic drop.

Chart 3 shows the percentage change by month of the civilian labor force.  The civilian labor force is defined as people 16 years old or older who are not in the military, prison, institution, school and are employed or looking for work.  Chart 3 shows that the civilian labor force kept growing, but at a slowing rate, up until about this past October.  Then, the civilian labor force actually began to shrink.

A drop in civilian labor force can be due to a variety of reasons though a significant reason right now is it likely reflects people dropping out of the labor force as they stop looking for work.  Another factor may be immigrants, legal and otherwise, returning to their prior home since labor force includes U.S. citizens as well as legal and illegal aliens.  One aspect of the labor force decline that concerns me is I suspect there's a good deal of older folks (over 40) in this pool whose jobs are not likely to return.  This type of unemployment problem is called structural unemployment.  It's the most difficult type of unemployment to solve.  Another concern with a declining labor force is that it also reduces what the economy can produce, absent an offsetting productivity gain.

For a bit of good news, Chart 6 illustrates that the official unemployment rate is nowhere near the official rate of the Great Depression.  By official unemployment rate I mean to suggest that the actual unemployment rate is greater.  The official rate does not count people who would like a job but have stopped looking for work.  These people are referred to as discouraged, despite whatever they might be called on FOX News!

Bankers, Economics, and when will Obama REALLY Work for Main Street?

Joseph Stiglitz spoke today at the Davos World Economic Forum.  In a wide-ranging talk, Bloomberg reports that he chastised bankers for creating 'negative value' for society.  Reuters reports that banks are doubling-down on risk.

No doubt there are those that argue that bankers are just being rational when using government bail out money to make money for the bank's shareholders.  These folks argue that it's not the banks fault.  Rather, it's government's fault for not instituting the 'correct' rules.  Yes, let's blame the rape victim for the rape.  What me?  I did nothing wrong.  I was presented with such an opportunity that any hot blooded male would have done the same thing.  Right.

I, for one, supported the bank bailouts.  I still do.  There was a problem with not putting stringent lending strings and so forth on those bailouts.  That's why Tim Geitner and others need to be replaced.  They never should have been part of the Obama Administration.  Though, law is conservative, and Obama has certainly been conservative in his economic support for the middle class.

The Administration's recently announced measures aimed at the middle class are like feeding crumbs to the people of Haiti.  Sure, they'll take those crumbs.  What would you do?  I would.  That doesn't absolve Obama of his insane economic policies, the latest one being a spending freeze.  Recall that during the campaign, McCain proposed such a policy and candidate Obama ridiculed it saying it was like using a hatchet when what you need is a scalpel.  He's just handed the opposition a gift.  As Krugman rightly points out, it's a stupid, cynical, wrong-headed political stunt.  In an earlier post, I addressed the need for more stimulus spending rather than addressing the debt.  Professor of Economics James Galbraith characterized the spending freeze proposal as like tossing red meat to the sharks in hopes that the sharks won't go after the people.  Ouch.  He's right, in my view. 

Robert Reich hit the nail on the head in saying "...Obama’s package of middle class benefits is small potatoes. They’re worthwhile but they pale relative to the size and scale of the challenge America’s middle class is now facing. Obama can no longer afford to come up with lists of nice things to do. At the least, he’s got to do two very big and important things: (1) Enact a second stimulus. It should mainly focus on bailing out state and local governments that are now cutting services and raising taxes, and squeezing the middle class. This would be the best way to reinvigorate the economy quickly. (2) Help distressed homeowners by allowing them to include their mortgage debt in personal bankruptcy — which will give them far more bargaining leverage with morgage lenders. (Wall Street hates this.)"

Rachel Maddow had a great segment last evening in which she showed a series of bar charts on GDP and job losses by quarter for the last two years of the Bush Administration and the results during the Obama Administration.  The results are striking, GDP growth and the reduced job loss numbers are a good start at turning the economy around.  The economy has begun to recover, and the banking sector's not on it's death bed.  This is the beginning of a recovery.  Yet, what's your view of how the Obama Administration has done?  They have both houses of Congress, 59 seats in the Senate (more than the R's had at the end of the Bush years) and what does Obama propose?  A spending freeze.  As Ms. Maddow put it "there he is on the one yard line and what does he decide to do?  He decides to punt from the one yard line rather than driving it in for the score."  

The 'Chicago School' and the Real World of Human Beings - Minimum Wage

Recently, some people have argued that the minimum wage should be reduced to employ more people.  Krugman has posted several responses to this proposal.  Since I've linked them, you may read his analysis of this proposal.

We do know that from the view of an individual employer, he/she will likely argue that if they paid their employees less, they'd be able to hire people for more hours.  Whether this leads to more income overall is questionable.  Though that is a question.  From Econ 201 (literally), minimum wage lies above the equilibrium wage in the labor market, by definition otherwise you don't need minimum wage.  This then leads to a quantity supplied of labor greater than the quantity demanded by employers.  This is usually as far as the analysis is taken.  What about the view from the economy as a whole?

Recall that a 'factor of demand' that is, one of the 'things' that affect demand for goods in the economy is income.  Now income and a wage are two different things, but let's just say that a cut in wages is a cut in income and vice versa (this is the assumption that minimum wage critics use).  Higher minimum wage leads to more income and then leads to more goods being demanded.  In turn, since the demand for labor is what's called a 'derived demand,' the higher demand for goods by workers leads to higher demand for labor by employers.  In this way, a higher minimum wage can lead to more people being employed than before the minimum wage was increased.

People will counter with:
1. Higher minimum wage will lead to lower profits for the employer.
Perhaps.  Not clear though given the higher sales from people having more income.  Let's say it does lead to lower profit.  Yes, the employer will buy less stuff.  Though, I suspect the minimum wage employee will spent a greater percentage of his/her income than will the employer, though there will certainly likely be cases where this is not so.

What strikes me about this entire argument is how self-serving it is.

The July 18, 2009 issue of the Capitol Times notes the following:
""The source of wealth has changed over the past 30 years; corporations have become the engine of inequality in the U.S.," says Sam Pizzigati, associate fellow at the Institute for Policy Studies in Washington D.C. "In the past, wealth came from ownership: Today it comes increasingly from income."

The highest incomes come from executive pay at top corporations. In 2007, the ratio of CEO pay to the average paycheck was 344 to 1, lower than the record 525 to 1 ratio set in 2001, but substantial.

This year's ratio is estimated to decrease to 317 to 1. In the '60s, '70s and '80s, the average ratio fluctuated between 30 and 40 to 1.

Over 40 percent of GNP comes from Fortune 500 companies. According to the World Institute for Development Economics Research, the 500 largest conglomerates in the U.S. "control over two-thirds of the business resources, employ two-thirds of the industrial workers, account for 60 percent of the sales, and collect over 70 percent of the profits."

Corporations systematically created a wealth gap over the last 30 years. In 1955, IRS records indicated the 400 richest people in the country were worth an average $12.6 million, adjusted for inflation.

In 2006, the 400 richest increased their average to $263 million, representing an epochal shift of wealth upward in the U.S.
In 1955, the richest tier paid an average 51.2 percent of their income in taxes under a progressive federal income tax that included loopholes. By 2006, the richest paid only 17.2 percent of their income in taxes. In 1955, the proportion of federal income from corporate taxes was 33 percent; by 2003, it decreased to 7.4 percent. Today, the top taxpayers pay the same percentage of their incomes in taxes as those making $50,000 to $75,000, although they doubled their share of total U.S. income.

"Over the past 30 years, the income of the top 1 percent, adjusted for inflation, doubled: the top one-tenth of 1 percent tripled, and the top one-one-hundredth quadrupled," says Pizzigati. "Meanwhile, the average income of the bottom 90 percent has gone down slightly. This is a stunning transformation."

Meanwhile, wages for most Americans didn't improve from 1979 to 1998, and the median male wage in 2000 was below the 1979 level, despite productivity increases of 44.5 percent. Between 2002 and 2004, inflation-adjusted median household income declined $1,669 a year. To make up for lost income, credit card debt soared 315 percent between 1989 and 2006, representing 138 percent of disposable income in 2007. "

Structure-Conduct-Performace

One way I've found that's helpful in organizing information for doing policy analysis is using this Structure-Conduct-Performance (SCP) framework.  One thing I like about it is I'm able to use economic principles and purge out all the material like dead weight loss, inefficiency of government 'intervention' and so forth.  There's a great deal of micro principles that are useful in helping evaluate possible impacts of a policy.  For example, we can still use all the price analysis, elasticity concepts, the crucial concept of opportunity cost, and the notions of inter-dependence between markets as well as using these tools to predict who might win and who might lose.

The Structure pertains to the rules, laws, prices, and so forth that are relevant to the policy you are examining.  What gets included under Structure is quite flexible.  Generally, think of it as whatever you understand as important to the evaluation you are conducting that is presently in existence and considered critical to describing the problem you're hoping to solve.

The Conduct pertains to the choices that various players make in response to the Structure as it currently exists.  For example, by choice we could be referring to how much electricity a customer uses given the prices, technology, income, and other traits that are known to affect consumption.

The Performance pertains to what are the value of key outcomes you are concerned with.  For example, the amount of electricity used at a given time of day, or month of the year and so forth.

Note that there's some flexibility between what you consider Conduct and what you consider Performance.  One way to think about this distinction is the Performance are the dependent variables that you would like to impact and the Conduct are the independent variables that pertain to actions by one or more parties.  In my example, it would be the consumer's use of electricity.  Note also that there may be other variables, and virtually always will be other variables, that influence the dependent variable(s).  If they are not associated with choices by some party, then they describe aspects of the Structure that are considered important.  I use this equation structure loosely as a way to give you a sense of how to organize the SCP concepts.

Then, we can use analysis, information, theory and so forth to test various hypotheses.  For example, let's say we want to reduce electric use overall.  If we have information from some studies on electric use and prices, we might be able to propose how to change the current Structure in order to affect consumer Conduct sufficient to after Performance by reducing electric use by the desired amount.

As you can see, the SCP is a shell that has great flexibility.  What I like about it is it's provides a systematic way to gather and organize information.  It doesn't tell you what to do or what not to do.  That's one of it's benefits over the partial equilibrium comparative statics model (PECS) from micro economics, although we still need to rely on the analysis tools of the  PECS model that helps us predict impacts.  Another aspect of the SCP framework that I like is it allows for all sorts of information to be combined.  This might include assessment of the how receptive consumers might be to the proposed prices change.  Or, what consumers might support it and what consumers might oppose it.  It also allows for consideration of the chance of confronting a legal challenge on procedural and/or substantive grounds, for example.

I've seen decision-makers discuss and reach decisions, often in a convoluted way.  This SCP framework can also be helpful to the analyst responsible for organizing information for both analysis and presentation.

Economics and Policy

Economists, or many of us, LOVE to tell decision-makers what they ought to do.  Though, far too many of those in the profession also want to cling to the illusion that they are also being 'objective.'  Oh, yes, don't you know that economics is a 'positive' science?  Positive as in 'objective' and 'value neutral.'

One might reasonably ask how a profession that deals to such a degree with money, and writes so extensively about what does and does not constitute value, can possibly think of itself as being value neutral.  Thankfully, there are esteemed practitioners of the craft who know otherwise.  Of course, they are seen as being a minority of crack pots.  Or worse, they are labeled as journalists or sociologists.  But whose complaining?

Sadly for those who continue to swallow the cool aid, such eminent economists as Joan Robinson are among the ranks of economists who understood how economics can better serve society.  Stiglitz has written cogently about development after his stint as the chief economist of the World Bank and it's senior vice president.  Baumol wrote years ago that economics is more like biology than physics even though physics type models were more the type employed in the profession.

What has worked for me is to borrow the structure-conduct-performance framework from Industrial Organization and apply it to policy.  I'll describe how I use this approach in a subsequent post.