Improving Business Climate?

Recently, in The Wall Street Journal, a group of business people were asked what could be done to improve the business climate in the United States. Most of the comments involved corporate good citizenship initiatives and reinvesting in local production. The problem here is that this seems to miss the point of business, to maximize profits, and how you improve the general welfare of society through the economy. Whether or not these commentators have a point is open to debate. Here is the article: http://online.wsj.com/news/articles/SB10001424052702304017204579224072622277830?mod=hp_jrmodule

First thing to establish is that the point of a business is to make money and that in itself can be a benefit to society. In its most abstract, a business is a legal fiction, a false legal entity, in which a group of people get together to collectively produce a good or service. Back in the days of yore, most business arrangements were partnerships. People came together to collectively produce something for profit. Unfortunately, when businesses failed, the individuals were personally liable for the debts of the partnership. That meant when a business folded, often the members of that business were left destitute by the debts of the business. Go back far enough in time and that would end with debtors' prison for the founders and homelessness for their dependents. This created a large disincentive for individuals to take on a lot of debt, which also acted as a large impediment to business growth. This is why modern corporate legal codes create a variety of means for principals (people founding a business) to limit their liability through legal arrangements. This allows people the freedom to start businesses without the fear of utter ruination if they fail. The theory being that business growth, job creation and profits are in themselves a social good that society is willing to bear some risk to foster. Or, in other words, having a thriving business community that is growing and creating jobs generally works for the good of society and that justifies the added risk to lenders in not allowing them to raid the assets of the businesses' founders should the businesses fail.

Secondly, business founders who make a lot of money often use their largess to fund socially responsible endeavors. And even when they don't, the money and jobs their businesses create furthers the growth of the global economy, creating more wealth for society. One needs look no further than Bill Gates' creation of The Gates Foundation, or Warren Buffet pledging to donate the bulk of his fortune to charity, to see this in action. http://www.forbes.com/sites/alexmorrell/2013/07/08/buffett-donates-2-6-billion-in-berkshire-hathaway-shares-to-gates-foundation-other-charities/ . But even when the titans of industry are not as generous as Bill Gates or Warren Buffet, it is not like their fortunes turn to dust or are wasted. Society's wealth is held in banks, and through banks it is loaned to local businesses and the local community to further create more wealth. And if it is not put in banks, it is invested directly into the stocks and bonds of other businesses which funds those businesses' expansion which also creates more wealth. Money is never stationary, unless it is buried in the back yard and not spent, and the more it moves, the better off we are as a society.

So, with this understanding, why is it that so many business owners are concerned with corporate good citizenship and investing in the local community? Presumably, if these actions were profit maximizing in the first place, modern businesses would already be doing them to become more profitable and we would all be better off as a result. The reason is that, as the economy creates wealth, it does not do so equitably. What I mean here is that the economy creates winners and losers; some make huge amounts of money, and others do not. And while profit maximization improves aggregate well being, it does not do so for all individuals. These individuals who do not profit tend to resent the profits of others and feel cheated by the global economy.

In the USA there has been growing resentment of big business. As a result of outsourcing, and accelerated by the recent recession, many people have seen their livelihoods disappear and their nest eggs shrink. It is hard for the individual who is downsized when their jobs are outsourced to see the bigger picture. More over, it is harder still for that person to make a living and continue to contribute to the economy with no job. So while aggregate wealth is improved, local economies suffer. It is in these economies that the commenters in the above Wall Street Journal Article are urging businesses invest. The hope is that in investing in underutilized communities, it will create enough wealth and new jobs to make up for the lost profits caused by not outsourcing the jobs to cheaper international markets. Only time will tell if this burgeoning insourcing movement actually creates wealth. But it is clear that the commentators in the above article think this will be the case.

The Death of Small Business Investment

There once was a time, long, long ago when small business was the driver of the US economy and where big business did not dominate our economic policies and concerns. While it is true that small businesses still employ a huge proportion of the working people in the USA, it is also true that this proportion has been shrinking and that small business has been suffering in the post recession economy while big businesses have been hording cash and recording record profits. http://www.forbes.com/sites/scottshane/2012/04/21/small-businesss-share-of-employment-is-shrinking/

This has become an area of concern both for economists and politicians alike as stagnant job growth has plagued our economy and economic policies of late. Currently, worries about the Fed tapering their monetary easing programs has a greater effect on the stock markets than good fundamentals reported by the companies themselves. This is a sign that our current tepid growth is capital driven instead of driven by company fundamentals. http://www.usatoday.com/story/money/markets/2013/06/19/stocks-wednesday/2437101/

One of the major things that separates big business and small businesses is access to capital. A large business with an established balance sheet and a long track record of profits is a much more credit worthy entity than a small start up with few employees that is in the process of developing marketable products and services. This is true, by the way, even if the large business is not public and does not have access to public stock and bond issuances to fund expansion. Its track record allows it to borrow money at a much lower cost from investment banks at rates that the small business would envy. In a post recession world where banks are increasingly reluctant to lend to business at all, this advantage is only compounding. Where a large business today can use a large chunk of restricted stock (essentially a large stake in the firm itself) and other company assets to secure a business loan, a small business owner usually has to mortgage both his business and his house to secure similar funding. And even then they borrow at much higher interest rates than the big business. A lot of this is driven by the perceived relative risk in investing in both companies.

But...

Complicating this factor has been the slow erosion of a post Great Depressions set of laws called Glass Steagall. Glass Steagall was a set of regulations that separated investment banking from consumer banking. The idea behind this was that, if the government is going to give you access to the Fed borrowing window, and access to deposit insurance, that it wanted you investing that money in the local economy to promote small business and home ownership. With the erosion of these laws, banks were free to invest in complex securities and derivatives instead of their communities. This sort of investment is what helped inflate the economic bubble that popped in 2008/2009. While arguments go both ways for whether repeal actually caused the Great Recession, not enough analysis has been done into how the repeal has affected small business borrowing and liquidity. What we do know is that small businesses have had a harder and harder time competing with big business in the years since repeal, and the extra competition from the securities markets now available to banks could not have helped. What I mean is that instead of competing with other small businesses and real estate for loans, now small businesses compete with investments in the securities markets as well.

At some point, we as a nation are going to have to revisit this change in regulatory scheme. Because the end result has been that while our banks and large businesses are investing in international capital markets, using international operations to avoid domestic tax liability and outsourcing jobs around the world, small business is suffering. Small business, the former driver of our economy, does not have the capital it needs to expand an flourish. And when small business can't expand, it can't hire, and thus our unemployment rate stays stubbornly high, tax revenues stay low, and our economy flounders.