Tuesday, December 15, 2009

Growth Conspiracy

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
Frédéric Bastiat 1848
I was talking to a friend the other day about how we were coping with the recession in our respective businesses. (Or conspiring to expropriate more surplus value from the proletariat, depending on your point of view of course.) He has fifty employees - twice my own number. But we have faced some of the same challenges: reducing supply to meet demand (including, unfortunately, staff levels), and reducing prices to secure sales. In terms of staff numbers and prices, both our businesses are back to about 2004 we reckon. Broadly in line with the economy I suspect.

Neither of us are content to stay in 2004. Like tens of thousands of businesses throughout Ireland who have made it this far, we are juggling the the dual concerns of surviving the remainder of the recession and positioning ourselves for recovery when it comes. Neither outcome is guaranteed of course. To that extent, growth-oriented businessmen are like Bastiat's 'good economist': dealing with the seen and the unseen, including an uncertain future that must be foreseen.

Oddly enough, economics itself has little useful to say about the nature of business, and especially the firm. Nor would it appear that the economic theory of the firm has improved much over these past twenty years - according to Paul Walker. But perhaps it doesn't matter. Most business people work in and run small firms with fifty or fewer employees: the quintessential entrepreneurs. Perhaps understanding the nature of entrepreneurship itself is enough in the absence of any fuller theory of the firm? I like Art Carden's perspective on the topic in an insightful essay entitled A Note on Profit, Loss and Social Responsibility. Here is his take:
The profitable entrepreneur does well by society in that he takes resources and converts them into something more valuable. The unprofitable entrepreneur does poorly by society by wasting resources; nonetheless, even entrepreneurial losses provide valuable information about market conditions and the range of employments of labor and capital that are (or are not) profitable. Profitable entrepreneurs show us what to try. Unprofitable entrepreneurs show us what not to try.

With apologies to Adam Smith, the entrepreneur brings about a socially beneficial outcome which was no part of his intention by seeking his own self-interest. Profitable entrepreneurs are rewarded for creating value, while unprofitable entrepreneurs, though punished for wasting resources, nonetheless confer benefits on society because their unprofitable ventures reveal information about production plans that do not create value. The prospect of profit means that the plan will be tried; the reality of loss means that revealed information will be trustworthy.
I also like Carden's idea that entrepreneurship - and business for that matter - is fundamentally about risk management:
Entrepreneurship is an exercise in risk transfer and risk reduction, and those who become entrepreneurs are those with a comparative advantage in bearing risk. We can say that this is ethically laudable: entrepreneurs (and, in particular, capitalist entrepreneurs) have a comparative advantage in reducing risk and in smoothing out future consumption patterns. It is the job of the capitalist-entrepreneur to advance income to current factors of production (labor and capital) in anticipation of being able to sell output at a future date for more than the costs of production.
This has important implications for Ireland's recovery. Just as there are good economists and bad, so also there are good unintended consequences as well as (the better know) bad ones. In fact, economic growth (and the affluence that it brings to billions) is an 'unintended consequence' of the decisions of millions of individual businessmen. Think of William Nordhaus' calculation that only 2.2% of the value of innovations accrues to the innovators: the other 97.8% goes to the users of the innovations. A very positive unintended consequence indeed.

Cambridge economist Sir Partha Dasgupta reminds us in the 2009 Royal Economic Society public lecture that there are a number of vital elements necessary to sustain growth (reported in the FT). These include physical capital, human capital and technological capital. Here in Ireland we have a quantitatively and qualitatively better supply of these 'capitals' as we end the decade than we had at the start of the decade. We also have considerably more social capital - including effective public institutions - than ten years ago. It is the combination of these capitals that Dasgupta sees as providing the basis to launch and sustain growth to the benefit of society as a whole.

My friend and I - any many other Irish people in businesses - can use these capitals to grow our businesses. Ireland's future economic success - both job and wealth creation - will be achieved one business plan at a time; even knowing that many plans will fail (risk again). Whether it is launching new businesses (I've been following the extraordinary story of Demand Media lately, ht MediaFuturist) or re-launching existing ones, it is unintended consequences that will secure a better future for all Ireland's people.

The 'foreseen unseen' - Bastiat would approve.


  1. ''Entrepreneurship is an exercise in risk transfer and risk reduction, and those who become entrepreneurs are those with a comparative advantage in bearing risk''When I read this reminding me a film documentary about young entrepreneurs 'The YES Movie''
    www.TheYESmovie.comby Louis Lautman

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