Risky Business (Part 2/6)

[Read Part 1: Risk | Part 2: Risky Business | Part 3: Risk & Reality | Part 4: Risk & Politics | Risk, Reality, & Bullsh-t ]

You knew I was going to open with that headline.

Everyone thinks that the success of the American economic model is built on success; on our ability to produce winning enterprises. We focus on looking back at the history of the winning enterprises…profiled in Forbes or Business Week…and try and see what lessons we can learn.

We’re doing it wrong.

The success of the American economic model is built largely on failure.

It is built on our willingness as a people to try things and to risk failing; built on the fact that we accept failure as part of the price of ultimate success; and ultimately on our willingness to accept displacement and change as a natural part of our social and economic lives. From the Wall Street Journal:

The early years of the U.S. railroad industry were crowded with hundreds of start-ups. “In the 1840s and 1850s, it seemed like everybody and his brother was chartering a railroad,” says Anne Calhoun, reference librarian at the B&O Railroad Museum in Baltimore. “It was the new thing to do, like the Internet is now.”

In February 1827, the Baltimore & Ohio Railroad became the first common-carrier railroad in the U.S., meaning the first rail transportation system to carry freight and passengers for revenue. (The “common-carrier” concept was later applied to telecommunications.) By 1935, B&O had absorbed more than 100 other lines, “some of which existed only on paper,” Ms. Calhoun notes. Similar consolidations happened all over the U.S., as other railroad companies acquired weaker rivals.

The history of the auto industry repeats this pattern. Records indicate that as many as 2,600 vehicle-making companies have been started in the U.S. since 1896, when brothers J. Frank Duryea and Charles Duryea launched Duryea Motor Wagon Co. in Springfield, Mass. “Some never really got off the ground, or made only one car,” says Mark Patrick, curator of the National Automotive History Collection at the Detroit Public Library.

Most of these companies were formed before 1929; the Great Depression wiped out scores of them. Others were bought out by larger competitors or couldn’t compete with mass producers such as Ford Motor Co. and General Motors Corp. — the last remaining major U.S. car companies. Many just couldn’t muster the resources to survive. “They were undercapitalized,” Mr. Patrick says, “just like a lot of small companies today.”

What does this mean for the economy?
Stephen Jay Gould wrote a great book, Wonderful Life, talks about the Burgess Shale, and the wild proliferation of invertebrates it contains. He suggests that the fossil record supports a history in which at a point in time, a wild diversity of creatures suddenly appeared.

Most of them died out.

But the ones that survived were far better equipped to thrive.

The history of the American economy (and to a lesser extent, the European economy) has been driven by a number of things…a relatively benign climate, but one not so benign that survival is guaranteed, a geography that both encourages trade and requires that traders cover large distances to succeed (I’m making the ‘Guns, Germs, and Steel’ argument here) and the strength of the enterprises that managed to be created and flourish where logically they shouldn’t have.

This involves failure; the fact that we can’t predict winners means that we have to tolerate a number of losers in order to get the few that succeed. Losing is painful (just ask me…) and expensive (ditto), not only for the entrepreneur but for the employees of the startup that fails, or worse, of the established business that it displaces.

Politically, that is a bitter pill to swallow.

And those who are harmed use everything in their power to survive…including turning to the government and using their electoral and financial power to protect themselves.

Joseph Schumpeter laid it all out in his classic, if not-so-easy-to-read book, Capitalism, Socialism, and Democracy.

He argues that democracy is a prerequisite for a true capitalist system, but that it is also it’s downfall as the losers in the economic footrace begin to use the political system to protect themselves. The legitimacy of the political system is challenged, and ultimately a rational-bureaucratic state emerges. (I’m skimming a rich and deep argument into two sentences here; you really ought to go read the book, it’s far better than I’m making it out to be)

We’re seeing that here every day, as businesses work to use the government and its power to regulate to shield them from risk, or to force risk onto a competitor, and as unions try and use the power of government to buy benefits for their members. From the L.A. Times:

Legislators and the governor approved a contract for the state’s 23,000 guards last January that, in addition to a 34% pay increase over four years, has created a spiral of sick leave and overtime. Overtime hours have risen by 25% over the last two years, costing taxpayers $200 million in time-and-a-half pay, even as California faces a $34-billion budget shortfall.

That’s how 110 correctional officers earned more than $100,000 last year. Two guards made more than the director of the Department of Corrections and one, at $145,000, pulled in more than California’s attorney general. They racked up this overtime bonanza as state prison wardens worked to curb overtime by filling long-standing vacancies with 2,100 newly hired guards.

But with the ballooning state deficit triggering teacher layoffs and hospital closures, why on Earth did lawmakers agree to rules that force them to hand over wads of cash to correctional officers?

Part of the answer surely lies in the union’s political generosity, the $251,000 it gave to Davis’ reelection campaign and the $1 million it lavished on legislators and their causes last year. And the union isn’t shy about playing its soft-on-crime card against lawmakers who dare to defy it. But defy it they must. Anything else is one more slap in taxpayers’ faces.

When we legislate high-paying jobs, or when we regulate profits to corporations, we risk losing the flexibility and dynamism that lets our economy ‘learn’ the best way to do things.

Lest you start believing that I’m suddenly at risk of becoming a libertarian contributor to Samizdata, understand that in my world, a dynamic and failure-prone business world is not a bad thing. The specifics of what should be made and how are things which shouldn’t be ‘planned’ on a macro level.

But there is a crucial role for government in two areas: first, in mitigating the risk of business failure on households. Dickens’ London or the New York City of ‘Gangs of New York’ don’t represent the kinds of cities where many of us would want to live; second, in ‘fertilizing’ sectors of the economy … small or startup business through credit and regulation. The government should try and stay out of which business, or even which type of business succeeds, but the existence of a fertile breeding ground for future large businesses is, I believe a Good Thing for a variety of reasons.

By encouraging individuals and small businesses to take risk…both as a society and within our companies and organizations…we grow, and thereby minimize the overall risk to all of us.

It’s all about managing the risk.

This is Part I
Part II is here
This is Part III
Parts IV > VI aren’t written yet.

2 thoughts on “Risky Business (Part 2/6)”

  1. This is very interesting, A.L. Keep it up.

    re: Joe’s comment, it is a common misconception that the Japanese aren’t entrepreneurial. There are many stories like Honda’s.

    BUT, they are mostly found in the post-war period. Our bombers wiped out many businesses, and there was lots of space for new ones to grow. The guys who started Sony were almost literally sitting in the rubble dreaming up business plans.

    Now weak business are kept alive by the Japanese government, and the smart people all have lifetime jobs.

    The most precious resource an economy can have is people who have nothing to lose, and are eager to try something new.

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