Thursday, 26 July 2012

Separating the Wheat from the Chaff in the City of London

Last night St Paul’s Institute and JustShare hosted a debate on the social usefulness of the City at St. Mary-le-Bow Church in Cheapside, a beautiful if ironic place to discuss the activities of what the Economist has termed the “banksters.”

Speaking on behalf of the City was Raquel Hughes who, despite predicting an increased emphasis on ethics and deterrents to future scandalous behaviour in the City, did not own up to the structural or cultural problems embedded in London’s financial sector. She admitted that much needs to be done to regain the trust of the sector’s customers and the UK citizenry, but was vague on identifying the source of the problems. She was of the view that higher capital requirements and a Leadership programme for young City workers would be sufficient address any issues related to immoral behaviour. She also warned us not to bash a sector which sustains  such a large number of jobs and generates tax receipts. (No need to mention the thousands of jobs lost over the course of the past few years due to the crisis the instability of the sector produced.)

Tony Greenham, head of finance and business at new economics foundation gave an impassioned speech, explaining how an enormous proportion of activities in the city are wasteful, corrupt and wealth extracting and that - crucially - it has not been fully acknowledged just how deep reforms in the City need to go. He stressed that years into this crisis, there still hasn’t been a proper identification of which activities in the City are essential and which are corrupt. He said that it’s rather a deception to conflate the banking and insurance activities of the entire UK financial industry with the investment banking activities of the City. It’s not enough to separate retail from investment banking; there are still activities in investment banking which allow bankers to gamble dangerously with other peoples’ money. He believes that those activities should take place in partnerships so that the risks of asocial financial activity are borne by the gamblers.

When asked what two changes to the City the speakers would recommend, Mr. Greenham cited the closure of tax havens, including the return of stolen money to its countries of origin and the proper taxation of the remaining funds. Secondly, he reiterated the need for the breakup of the investment banks so that casino activity is segregated into partnerships – a practice which was more common before the Big Bang of the '80s.

I asked whether shareholders have any role to play in changing the financial system in order to address the systemic problems of short-termism and instability. Ms. Hughes responded that shareholder activism was welcomed by the boards of financial institutions but I think that activism so far has been rather limited due to shareholder heterogeneity with some short-termist investors adding to the problem. The Kay Report recommends that financial intermediaries be legally required to act in the best interests of investors, subjecting them to much stricter controls on conflicts of interest. Strengthening investors’ responsibilities represents a major challenge to the status quo; those profiting from finance even as savers’ returns slump are bound to lobby vigorously. The ultimate owners of the capital may be a key source of change in the City of London.

Wednesday, 25 July 2012

Grassroots Governance through the Quantified Community

In her book, The Economics of Enough, economist Diane Coyle has several recommendations for making the economy and society more sustainable and fair. One of the principles upon which she bases those suggestions is decentralisation, particularly with regard to government decision-making. Significantly cheaper information costs and greater availability of information and data “make it highly unlikely that top-down decisions by governments will be the optimal way for solutions to the challenges of Enough to emerge.”[1] Whereas the private sector has embraced technology to innovate, re-engineer, outsource and globalise their operations (in terms of both trade and FDI) over the course of the past 40 years, the public sector has largely remained stuck in outdated, inefficient governance systems because, unlike the private sector, the public doesn’t face the same competitive discipline.

It is hoped – and expected – that widespread access to broadband and social networking communications will provide the impetus for changes in governance frameworks.  Diane Coyle says, “It is easy to overhype the scope for online technologies to change government.  There is obviously some potential but much more thought will need to be given to how to use the technologies to improve engagement and accountability."[2]  Because governments rarely engage their citizens in informed debate in order to take difficult decisions, it’s likely citizens will begin to work around governments.  “We’re likely to see much experimentation – including using the online technologies – in creating new processes or institutions to tackle collective problems.  Some of this will eventually change the way governments operate.”[3] 

I recently found a piece by Esther Dyson, a digital technology entrepreneur and analyst of technology’s impact on business, privacy, security, creativity and politics.  She writes about the Quantified Self movement, defining this as individuals equipped with the tools needed to measure their own health and behaviour, through monitoring devices and software.  A growing movement, this monitoring allows individuals to improve their health “and live more productively.”  She is also actively trying to foster the emergence of a Quantified Community movement, with communities measuring the state, health and activities of their people and institutions. She says, “Just consider: each town has its own schools, library, police, roads and bridges, businesses, and, of course, people. All of them potentially generate a lot of data, most of it uncollected and unanalysed. That is about to change.”

She cites the fact that there are many independent data-analysis software tools available as well as websites which provide data that can be sifted for local information and presented visually.  She gives the example of SeeClickFix, a user-generated data tool that allows people to collect information on infrastructure problems such as potholes, broken streetlights and such to monitor the repairs.  Contests such as New York City’s BigApps competition encourage developers to create mobile apps which use city data about a variety of subjects, from restaurant inspection results to school performance records.   The possibilities of these tools are very exciting.  Dyson explains:

As people and communities use such tools, more and better ones will be created, and developers will start mashing data together, enabling us to see, for example, the relationship between people’s exercise habits and local health statistics.  Employers and insurers can also contribute anonymised data.  The goal is to create competition – among communities and among developers of the tools – and thus to foster even better tools and more liveable, productive communities. 

I was surprised to read that Moscow has a quantified movement as well – antropolis – which provides a map of community development projects with associated data on management, budgets and suppliers. 

A key driver of the Quantified Community that Dyson recommends could be local newspapers as many are searching for new business models and unique content: “they have the connections, the resources and the respect to play a key role….Despite the pending demise of print journalism, local papers still generally reach more local citizens than any other single institution.  They need a way to remain relevant; this could be it.” The possibilities for local data analysis and benchmarking are enormous, especially in the areas of health, education and employment. This movement is in its infancy, but provides early stage models which could provide serious benefits to communities “that could benefits from more self-awareness and the spur of scrutiny and competition….With luck, as some communities lead the way, others will learn from them. Someday, citizens will not just complain about local problems; they will have the data to prove their case – and to figure out how to fix those problems.”

I think that Esther Dyson is helping to move the debate about what we call the Big Society here in the UK from discussion about ideology and austerity to solid, implementable models which already have case studies on the ground.

[1] Diane Coyle, The Economics of Enough, Princeton University Press, 2011.
[2] Ibid., p. 288.
[3] Ibid., p. 289.

Tuesday, 24 July 2012

Changing the Incentive Structure of Anglo-American Corporations

There is a clarion call to reform aspects of capitalism in order to address the problem of financial instability - an economic externality which has resulted partly from short-term financial behaviour and overleveraged institutions and sectors.  Professor of Law at Case Western University, Lawrence E. Mitchell, says in a recent piece that a significant cause of the financial crisis has been the disappearance of corporate equity funding and its replacement with debt over the course of the 20th century, debt which has more recently been off the balance sheet. Furthermore, he explains, sources of capital gains have shifted from profits reaped through retained earnings to future profits in the form of velocity-induced trading gains. Professor Mitchell asserts that the very sustainability of American industry and the future wealth of America are at risk when shareholders or mangers on their behalf gamble with debtholders’ money, spending today the future profits of American industry.

Since about 1962, common shareholders in the US have actually withdrawn more money from corporations than they have invested – this is apparent from the disappearance of retained earnings from corporate balance sheets and trends in net issuance of common stock. By 2002, retained earnings had dropped on average to 3% (from 50 to 60% from the beginning of the 20th century until the early 1960s), returning to 11% by 2007. Retained earnings which had represented permanent stockholders’ equity were replaced by debt, much of this off-balance sheet financing.

Shareholder capitalism is based upon laws, which in turn were based on principles of economic utilitarianism, which place ultimate control or a corporation in the hands of shareholders who elect the board of directors; it’s the stockholders as the residual claimants of corporate wealth who are meant to bear the greatest risk. Professor Mitchell says that trends in the debt/equity ratio have actually resulted in investment in corporate America which is almost nil and that the real riskholders are the creditors.

Thus we have the dangerous anomaly of boards and managers managing for shareholders (with shareholder interests in stock price maximisation and shareholder taste for risk) with creditors’ money.  This ability to use other people’s money for shareholder profit creates powerful managerial incentives to short-change the long-term health of the corporation for short-term gain, putting the American productive sector at risk…pre-crash (2006), over 30% of the profits of American corporations classified as ‘industrial’ came from financial transactions rather than the production of goods and provision of services.  And financial assets constituted almost 48% of the total assets of non-farm, non-financial corporations.[1]

In order to protect the sustainability of American industry and its ability to create permanent and transferable wealth, Professor Mitchell recommends that incentives are created for investors to reap the rewards of their investments through industrial profits rather than market speculation.  His specific suggestions include the following:

  • building long-term investing into the initial investment decision by developing a sliding scale capital gains tax
  • returning to largely insider boards
  • making appropriate accounting changes to rely more heavily on cash flow than income statement accounting.

Professor Mitchell, along with Professors Lynn Stout, Martin Lipton and Margaret Blair are the most well-known of the ‘board primacists’ – a group which advocates against greater ‘shareholder democracy’ in favour of increased board discretion. They argue that shareholders need to delegate their authority in order to allow the board to manage the enterprise free of short-term pressure. They believe that facilitating shareholder democracy and shareholder power would create greater costs than possible benefits. Board primacy theorises that because shareholders are a heterogeneous group, their objectives are not uniform; therefore they believe corporate law requires re-theorising in light of this new reality.

On the other hand, there has also been a groundswell of support for greater shareholder education, communication and involvement among some corporate governance academics who base their thinking on the claim that the board primacists conflate two aspects of the processes by which group decision are taken; these two are the responsiveness of the governance system and the composition of the shareholder electorate. Professor Grant Hayden of Hofstra University and Professor Matthew Bodie of Saint Louis University are two who say that because of this association, board primacists are arguing for governance structures that put greater distance between the shareholder electorate and the board which could have serious negative consequences.

Hayden and Bodie believe that by restricting the decision-making franchise,” board primacists have detached their governance structures from the underlying desires of their constituents without substituting anything in their place.”  They argue that “the breakdown of this particular distinction between shareholders and constituents could mean that we should investigate treating other constituents [variously defined but typically include shareholders, employees, suppliers, customers and creditors, sometimes expanded to include neighbours, towns or society ]more like shareholders, rather than the other way around.” [2]

Andrew Clearfield of Investment Initiative corporate governance consultancy is also a voice on the side of responsible shareholder involvement, being himself a former portfolio manager.  He believes that because shareholders are widely dispersed, management can behave as if they were the principals of a company rather than its agent.  Professor Stout says that when managers behave in such way, it’s difficult to bring them to heel; hence her preference for insider boards.  Mr. Clearfield says, “and unfortunately, history is replete with examples where exactly this has happened, to the detriment of shareholders (and often almost everyone else as well).”[3]   

He describes the fact that there are both short-termist, high-turnover shareholders who dislike the idea of shareholder activism in governance but that there are also shareholders who take significant positions and actively work to foster change from inside a company, remaining involved for many years:

There are governance-oriented investors who engage actively with their holdings not because they are planning to flip them, but on the contrary, because they expect to be involved for the long haul.  There are short-term investors who are essentially arbitrageurs, and who try to hide behind a mask of concern for governance, when all they really want is to stimulate an event or transaction which will enable them to exit at a profit.  And there are all sorts of shades in between.[4]

Mr. Clearfield challenges the assumption which board primacists make of director and senior management benevolence; he says that an emphasis on options incentives – which were not implemented on the insistence of shareholders – have often become detached from reasonable performance criteria and that managers have found various ways to game the release of favourable results and pricing of their share options.  The homogeneity of boards is another red flag Clearfield and many others cite as a problem for corporate governance: “Directors constitute a sort of club united not only by social ties but also by mutual economic interests.  They sit on each other’s boards and do not make waves….they become followers rather than leaders.  That should not be their function.”[5]   He cites boardroom duplicity for the failures of GM, Kodak, Hewlett-Packard, BP and Enron. 

Like many corporate governance reformers, Mr. Clearfield advocates shifting corporate focus  to the long-term by changing terms of executive incentives (to vest over longer periods with clawback provisions for illusory results), ceasing to give analysts earnings guidance and abolishing quarterly earnings statements (as John Kay recommends here in the UK).  “Make the market cool its heels and wait for longer term results, and it will have to take a longer-term perspective.”

The board primacists are concerned about short-termist investors or the few hyper activists who desire to micro-manage a company.  For Mr. Clearfield, the danger isn’t that the majority of shareholders will take their lead from the few prominent activists, but rather that they won’t pay enough attention to corporate governance to even bother to vote out a board which manages disastrously.  This is the scenario that has been more of a concern to those with a more macro view of public outrage over corporate fraud, corporate governance reformers like Lord Myners and the government.   Though the system has been prone to abuse by the short-term interests of the opportunists, “incumbent boards and managers who have large positions in the equity themselves are guilty of this at least as often as dispersed shareholders.”[6]

The board primacist professors, Stephen Bainbridge, Margaret Blair and Lynn Stout argue that if boards were able to take decisions free from shareholder pressure, they would make better choices about how the firm should be run.  Professors Hayden and Bodie refer to these commentators as ‘wise ruler’ theorists because they attribute the board with great acumen and invest them with great power; critical to board performance, they claim, is their independence and insulation.   Hayden and Bodie have a different take; they say that the goal of the corporation is not just shareholder wealth maximisation but that the directors owe a duty to the constituents of the corporation, which consist of all stakeholders including shareholders, employees, creditors and the local community.  According to this model, stakeholders contribute their resources to the enterprise with the implicit bargain that the company itself will fairly apportion responsibilities and rewards. [7]  The board is hired by the stakeholders to serve as the apportioning body; it is an agent, but has authority over stakeholders in order to carry out its function.  So in actual fact, the role of the board is more of a trustee than an agent.

Two board primacists, known as the “long-term interests” theorists include Professors Lawrence Mitchell and Martin Lipton who are critical of the short-term perspective of shareholders but their concern is more to do with the long-term efficiency of the corporation.  Professor Mitchel proposes self-perpetuating boards with complete freedom from shareholder oversight which he believes would enable them to manage responsibly and for the long term.[8]  In this model, shareholders have a limited role but election time would become a time for a more meaningful vote on the company’s future. 

If shareholders are left with even less power in corporate governance than they already have today, the corporate good may become more detached from the actual preferences of the firm’s constituents.    Hayden and Bodie argue for a radical change: they say that with respect to their preference profiles, shareholders are more like other corporate constituents than once thought:

Instead of focusing on the fact that shareholders are now as ‘bad’ as other constituents for the purposes of corporate governance, we could view this as evidence that the other constituents are just as ‘good’ as shareholders, a least in this respect.  That is, the breakdown of this particular distinction between shareholders and other constituents could mean that we should treat the other constituents more like shareholders rather than the other way around.

They therefore suggest expanding voting systems to include other constituents besides shareholders.  And though they recognise that there may be difficulty in arriving at an accurate and manageable way of identifying specific members of a constituency, like customers, for an election, ‘the breakdown of the fundamental distinction between shareholders and other constituents should at least force a re-examination of the scope of the corporate franchise.“[9] 

These suggestions would be a major step in the transforming (or returning) the current Anglo-American shareholder corporate structure into stakeholder capitalism.  There’s a powerful argument that such a change could usher in a more stable, efficient, sustainable and responsive corporate system with better informed, engaged and responsible investors.

[1] Professor Lawrence E. Mitchell, “Whose Capital; What Gains?” Governance Studies at Brookings, July 2012.
[2] Grant Hayden and Matthew Bodie, ‘Shareholder Democracy and the Curious Turn Toward Board Primacy,’ William and Mary Law Review, April 2010.
[3] Andrew Clearfield, “Short-termism and Corporate governance: Prof. Stout creates a straw man,” Investment initiatives, 12 July 2012.
[4] Ibid.
[5] Ibid.
[6] Ibid.
[7] Hayden and Bodie, 2010.
[8] Ibid.
[9] Ibid.

Tuesday, 3 July 2012

This would not go down well with Oprah

On the fundamental nature of ultimate reality, I do not see eye to eye with Andrew Cohen, one of evolutionary spritualiaty’s leading proponents. However, I was surprised to discover that I agree with some of what he says in his blog today. And I think his thoughts are in direct conflict with some other new age authors, speakers and advocates such as Marianne Williamson, Deepak Chopra and the whole happiness brigade. Cohen asks:

"Why, for the luckiest people who have ever been born, should happiness be a birthright?  And in light of our good fortune, why should our spiritual aspirations be so focused on the pursuit of inner peace?  Do we really think God created the universe so that you and I, at the beginning of the 21st century, could be happy?  Is that really the ultimate purpose of this fourteen-billion-year process?”

He goes on to conclude, "I don’t believe the purpose of life is just to be happy…It’s my conviction that we are here for a reason, that there is a grand and great purpose to our presence in this universe, and that none of us are going to truly find what we are looking for unless we get over our misguided pursuit of personal happiness and connect with that greater sense of purpose – that ultimate reason for being.”

This sounds much like my own blogpost of the 19th of April on the summum bonum. 

Cohen and the other evolutionary/integral worldview champions say that their form of spirituality is the most evolved of all faiths or truth claims on earth.  I find it therefore ironic that Andrew Cohen has just discovered the idea that happiness is not the highest good, as over 2000 years ago God made it clear to us that our holiness is more important to Him than our happiness.  This is because happiness is conditional on endowments and conditions and can change like the weather.  True joy is something far deeper and more sustainable; it comes about through a personal relationship with and commitment to follow his Son.  True joy can withstand the difficult process of transformation  - called sanctification - that is needed to make us complete and mature, not lacking anything. 

Sunday, 1 July 2012

Book Review: Lifecycle Investing by Ian Ayres and Barry Nalebuff, Tanto Media Inc., 2010

(this book review was first published in the SBE's Business Economist, 14 Sept 2010)

The authors of Lifecycle Investing, Professors Ayres and Nalebuff of Yale University, believe that one of the greatest risks we all face is that of living too long and not being able to afford it. The subtitle of this book is ‘A new, safe and audacious way to improve the performance of your retirement portfolio,’ but they could also have called it ‘Time is your retirement money.’ From both historical data and Monte-Carlo simulations of their lifecycle investment model, the authors conclude that in addition to diversifying one’s retirement portfolio among assets, investors should also spread their market exposure throughout their working lives. They show empirically that people generally invest too little in the market when they’re young in comparison to when they’re older, finding that the typical investor is twenty or even fifty times more invested in equities in his or her early sixties in comparison with their late twenties (even after accounting for inflation).

The key message of the book is to use leverage to buy equities when one is young. They argue that investors have not traditionally appreciated the potential value of temporal diversification and that this is even more important than the gains from diversifying across assets as the returns in different years are less correlated than the returns in different stocks. “This book seeks to foster a second diversification revolution. Better diversification across time leads to reduced risk. And reduced risk allows for increased market exposure and higher returns."

The diversification benefits of leverage are possible whenever a person knows that he or she is going to have a substantial amount of savings in the future; for many people their total wealth is tied up in their human capital. The strategy comes down to two important figures: the present value of one’s lifetime savings (cash value of current savings plus the present value of future savings contributions) and what they call a person’s individual ‘Samuelson share’. Paul Samuelson showed that for a plausible type of risk preference, individuals would want to allocate a constant proportion in the stock market year after year, regardless of what happened to the value of stock. Ayles and Nalebuff come up with the following investment rule: every year of your working life your investment target is the product of your Samuelson share multiplied by the present value of your lifetime savings. The target allocation will be different for every person and is based on the return and risk associated with equities and how this compares to bond returns. The higher the return on equities and the lower the risk, the more one would want to allocate to stocks. The second component is one’s attitude toward risk; the more risk-averse one is, the less one would want to invest in stocks whatever their predicted return.

The authors compare their strategy – investing all liquid savings in equities with 2:1 leverage to achieve a Samuelson share of 83% early in working life, ramping down leverage until retirement – with two common strategies in use today:

• the target-date strategy: invest 90% of liquid savings in stocks at age 21 and reduce this proportion linearly to 50% by age 65;

• and a constant proportion invested in stocks strategy.

They perform simulations using stock market data back to 1871. In every case, no matter when one retires (even if right after the crashes of 1929 or 2008), their lifecycle strategy fared better. Much of the book is devoted to the mechanics of the investment strategy, simulations and results. They also compare lifecycle investing to buying a home, which is also a form of temporal diversification with borrowed money, the leverage declining as the loan is repaid. Thus with home ownership, one keeps a relatively constant exposure throughout the course of one’s life. The added advantage of lifecycle investing, they say, is that it allows diversification across time and across assets. Ideally young investors should borrow money to invest in a broad market basket of international stocks (probably through low cost mutual fund indexes and ETFs).

There is an entire chapter on contra-indications, warning that lifecycle investing is not appropriate in the following situations: if one has student or credit card debts, if one has less than $4,000 to invest, if one’s employer matches contributions to a retirement plan, if one needs the money to pay for children’s college education, if one’s salary is correlated with the market or if one would worry too much about losing money.

Perhaps the most compelling chapter is the last, ‘What if everyone did it,’ and here the authors take a tour of the history of investment strategies, subsequent legal rulings and changes in instruments. They say that under a modern view, an investment objective of preserving capital is not inconsistent with a disciplined, ramping-down approach of buying equities on margin when the client is investing for the long run. The authors appear to be totally committed to their approach; in fact they plan to be ‘in there pitching’ to the US Department of Labor for a regulation signalling that strategy is not per se imprudent or unsuitable. However, they also acknowledge that it may take some time to convince regulators.The authors provide a website for those with questions or who would like to input their own data for simulations. And though perhaps their promise of helping people see the world from a different vantage point in order to help them be ‘happier and wealthier’ is a bit much, the apparent hate mail that they received when they first presented their ideas might have been unfairly reactionary. Time will tell.

Book Review: The Illusions of Entrepreneurship by Scott A. Shane, Yale University Press, 2008

(this book review was first published in the SBE's Business Economist, 17 July 2008)

Scott Shane’s book is an enjoyably-written contrarian view of entrepreneurship. His purposes in debunking the myths about entrepreneur-ship are to help aspiring entrepreneurs become more successful, to provide a more accurate picture of what they’re really like and their impact the economy, and to encourage policy makers to examine the real costs and benefits associated with the promotion of start-ups.

Many of the myths have sprung from the celebrated few who’ve made it big; therefore the term is quite emotive. One might not necessarily think of the average self-employed as entrepreneurs, but these people are who this book is about; what they do isn’t as innovative, lucrative or beneficial as we think. To see how much you think you know about entrepreneurship, you can take the online quiz.

Professor Shane says that believing the myths will prevent aspiring entrepreneurs from doing the things they should do to succeed or else focus their attention on the wrong things. “Doing what most entre-preneurs do is a mistake; the majority of entrepreneurs are wrong about how to run a new company.”

Here are some of his more surprising findings:

Entrepreneurship is largely a very common, often low-tech vocation, such as construction, retail trade or accounting. Only around 7% of new companies in the US are started in high-tech and only 3% of business founders consider their new business to be technologically sophisticated. The typical start-up isn’t innovative at all, has no plans to grow, has one employee and generates less than $100,000 a year in revenue.

Entrepreneurs tend to choose industries in which they are most likely to fail. They tend to start business in industries in which they’ve worked before and understand, and these tend to be highly competitive and employ the most people.

The US isn’t becoming more entrepreneurial and it isn’t one of the most entrepreneurial countries in the world, appearing at the bottom of the self-employment league table compared with other OECD countries. Number one is Turkey. Developing countries have a much higher rate of new business creation than developed ones; start-ups are more than twice as likely in Peru, Uganda, Ecuador and Venezuela than in America.

The typical American entrepreneur comes up with no innovative idea nor possesses an extraordinary dream. People don’t start businesses to make a lot of money, become famous, better their communities, seek adventure or improve the world. They just don’t like working for someone else. Those most likely to go into business for themselves are the unemployed, those who work part-time or have changed jobs often. Experiences often associated with being an entrepreneur, like migrating, dropping out of school and networking don’t increase the odds of starting a business, whereas going to college, getting a professional degree and having some experience managing others in a business setting do.

The typical start-up in the US requires around $25,000, usually coming from the founder’s savings, though many borrow personally as well. Venture capitalists matter very little to the majority of entrepreneurs, and 92% of all venture capital goes into the IT and health-care sectors.

Just a few entrepreneurs are very successful; the wealthiest 10% of business owners have almost three-quarters of all business wealth, 38% of all personal assets and 39% of all personal wealth.

The book is primarily about entrepreneurship in America, and though there is some discussion of where America ranks in the GEM league tables, I couldn’t help wondering about other countries. Even if entrepreneurship – self-employment – is no engine for growth inAmerica, does it not provide an important means of poverty-alleviation in developing countries? I’m thinking here about micro-credit in places like Bangladesh or small businesses based on mobile phone transactions in parts of Africa and Asia.

Professor Shane devotes just four paragraphs to one non-financial benefit of entrepreneurship, that is, founder satisfaction. Apparently entrepre-neurship makes people happier. For women this satisfaction comes from the flexibility to work and care for children. Data show that as companies get bigger, job satisfaction of people who work in them declines. Self-employment can provide people with autonomy, flexibility and greater control over their lives. It’s difficult to value this personal satisfaction and the impact a happy person has on his or her family, but as benefits go, it seems like a pretty important one.

The tenth chapter of the book was the most fascinating; it looks at the impact of entrepreneurship on the economy. Seen as a panacea for many of society’s ills, elected officials often view assisting start-ups as a fundamental goal of public policy. They say that start ups encourage innovations, create jobs and make markets more competitive. Not true, according to Professor Shane; start-ups don't generate much employment nor do they substantially enhance productivity. There isn’t any evidence that new firm formation causes economic growth; rather economic growth causes people to start businesses. In fact his own regression analysis found that the rate of new firm formation in a particular year has a negative effect on a country’s real per capita GDP in the following year. Since existing businesses are more productive than start-ups, he claims that we would get more economic growth for each dollar or hour invested in the expansion of existing business then having more start-ups. He ends by criticizing policy markers’ attempts to convince voters they have encouraged economic growth by actively promoting the establishment of new enterprises.

The conclusion is somewhat dismal: entrepreneurship is “a story of poor outcomes for individuals, cities, states and countries.” It causes financial hardship for many and hinders wider economic well-being. Almost all the economic value of entrepreneurship comes from a small handful of stars. His recommendation to investors, the entrepreneurs themselves and policy-makers is to do a better job in identifying the few new businesses that are more productive than existing companies and invest in them. He also recommends the elimination of policies that encourage people to start businesses like transfer payments, subsidies, loans, regulatory exemptions and tax benefits. This is a thorough reality check on entrepreneurship, and hopefully the beginning of a serious debate on its role in our economies.

Book Review: The Natural Survival of Work by Pierre Cahuc and Andre Zylberberg, MIT Press, 2006

(this book review was originally published in the SBE's Business Economist, 7 Jan 2008)

The primary messages of this engaging book are that economic growth necessitates job creation and destruction, and that the efficacy of many labour-market policies can now be assessed. Economists know more about best practices in creating jobs and fighting unemployment over the long term than ever before. The authors address some emotive issues surrounding unemployment and dispel some myths. They are critical of labour-market policies based on politics rather than economics, particularly in France. They cite the fact that 90,000 jobs are created every day in the US and a roughly equal number are destroyed. They assert that the process of globalisation is not the primary reason for these dynamics; but rather the very process of wealth creation – characterised by the permanent flux of technological innovations and changes in preferences, causing labour reallocations: “A market economy is a seething ebullition of trials and errors, successes and setbacks, creations and destructions.”

Empirical evidence is cited to counter the belief that reducing the amount of time spent at work creates more jobs, based on the mistaken ‘lump of labour’ idea that there exists a finite quantity of jobs or hours of work in an economy. This notion also underlies the belief that immigrants take jobs away from residents. Jobs, the authors say, are fragile: “They can bloom and wither very quickly and in very large numbers.” But if an economy is sufficiently adaptive (in its means of production and infrastructure), then variations in the size of the population have no more than a small impact on unemployment and wages, no matter how sudden or large. In Europe, especially, the higher the cost of redundancies and barriers to entry into goods and services markets, the greater the negative impact of immigration on employment. They demonstrate these points with examples of immigration to parts of the US and Europe and the shortened work-week in France.

The authors’ ‘15% rule’ states that at the national level, around 15% of jobs disappear every year and 15% are created, though job layoffs tend to make the headlines far more, with the accompanying human distress they bring. Job creation, however, is mostly diffused. Just as layoffs don’t occur only in declining sectors, jobs aren’t only created in expanding ones. Creations and destructions occur simultaneously within the same sectors. A larger discussion of the impact of globalisation[1] would have been helpful, though, looking at the migration of not just manufacturing jobs, but increasingly higher value-added service ones to developing countries. There is no discussion about offshoring, business process outsourcing or the transfer of higher value-added activities by multi­national corporations (such as R&D and logistics) to China and India.

The authors challenge the notion that an increase in minimum wage reduces employment, as this theory only holds in a world of perfect competition. The key to the impact of the minimum wage on employment is the conditions of an economy at the outset. If the minimum wage is low, an increase attracts new workers to those firms with an interest in hiring. If it is too high, every increase makes firms want to let go of those employees whose productivity has been overtaken by the new minimum wage. Examples of the former situation come from the US and of the latter from France.

The rest of the book looks at incentives and disincentives to work, the utility of unemployment, employment protection, the efficacy of education and training programmes and the tools available for evaluating public policies on employment. Their conclusions offer new ways of thinking about these issues. For example, they say that the process of looking for work is an economically useful activity, in fact one of the most profitable for society as a whole. In some European countries, however, an unemployed person is regarded more as someone “afflicted with a serious illness than a person who is still a participant in economic life.” Interestingly a very short job search (whereby benefits are curtailed too early) is not necessarily a sign of greater efficiency because the quality of the resulting matches may be low, as is reported to have occurred in the US in the 1990s.

Politicians tend to recite the mantra that the key to economic competitiveness lies in education. Evidence, though, suggests that most efficient use of public support for both education and training should be targeted primarily at young people and should be deployed, in part, outside the school system. Surprisingly, it is the least-skilled individuals who derive the smallest advantage from training programs. Coupled with the fact that these programs are usually costly, their net payoff is often negative. Furthermore, research has also shown that certain situations in a family setting, like having children of the same sex share a bedroom, can determine the developmental capacities of children and adolescents. This in turn can exert a significant influence on their success at school and their future.

The authors also evaluate public policies on employment by looking at the experiences of the US, Sweden, France, the UK and Switzerland. One forceful conclusion reached is that employment aid is more efficient the closer the job being aided is to a regular job and least efficient when it is for a temporary job in the public sector. In addition, neither generous nor stingy benefits for unemployed persons automatically guarantee a quick rehire. Other key findings are that the retirement of the baby boomers threatens to aggravate underemployment; that massive public-sector job creation does not soak up unemployment; and that taking a training course for several months does not significantly improve one’s occupational outlook. Employment should be protected through fiscal measures that give firms an incentive to assign more weight to the social value of jobs. And lastly, unemployment insurance should be grounded in a mutual commitment between the employment services and the unemployed person.

This book is short, non-technical and creatively written for the economist, but also accessible to the general reader, demonstrating a more evidence-based long-term approach to the subject of employment.

[1] See the IMF’s ‘The Globalization of Labor’, World Economic Outlook.