Understanding Risk Really Matters


risk

This is an excellent topic to mull over. Risk-taking is the foundation of all innovation and wealth creation. From the WSJ, comments below…

Risk-Averse Culture Infects U.S. Workers, Entrepreneurs

 By BEN CASSELMAN

Americans have long taken pride in their willingness to bet it all on a dream. But that risk-taking spirit appears to be fading.

Fewer Americans are changing jobs. Companies are hoarding more cash. And the proportion of new businesses has fallen. The result? A less dynamic economy.

Three long-running trends suggest the U.S. economy has turned soft on risk: Companies add jobs more slowly, even in good times. Investors put less money into new ventures. And, more broadly, Americans start fewer businesses and are less inclined to change jobs or move for new opportunities.

The revival of the housing market has been all over the news in the past weeks but as MarketWatch’s Jim Jelter explains, there are three other areas of the economy that are doing better than you think.

The changes reflect broader, more permanent shifts, including an aging population and the new dominance of large corporations in many industries. They also may help explain the increasingly sluggish economic recoveries after the past three recessions, experts said.

“The U.S. has succeeded in part because of its dynamism, its high pace of job creation and destruction, and its high pace of churning of workers,” said John Haltiwanger, a University of Maryland economist who has studied the decline in American entrepreneurship. “The pessimistic view is we’ve lost our mojo.”

Companies that gamble on new ideas are more likely to fail, but also more likely to hit it big. Entrepreneurs face long odds, but those that achieve success create jobs for many others.

As important, say economists, are small acts of risk-taking: workers who quit their jobs to find better ones, companies that expand payrolls and families that move from sluggish economic regions to ones with low unemployment rates.

Multiplied across the U.S. economy, these acts of faith and ambition help speed money, talent and resources to where they are needed.

Of course, too much risk-taking can be dangerous, as the financial crisis showed. And with the stock market soaring, some types of risk are displaying signs of a strong pos-tcrisis rebound. Indeed, the Federal Reserve said it was watching for signs that easy-money policies are leading investors to take excessive risks.

Playing It Safe

But a broad cross section of U.S. economists, from a range of academic disciplines and political persuasions, agree that a specific and necessary kind of risk-taking is on the decline. Historically, risk-taking that supports high rates of churn—lots of hiring and firing, company formation and destruction—gives economies more flexibility to adapt to changing markets.

Maxim Schillebeeckx is the kind of ambitious young American who has long propelled the U.S. economy. A 28-year-old doctoral student in genetics at Washington University in St. Louis, Mr. Schillebeeckx also has a graduate degree in economics. He helped create a student-led consulting firm to provide scientific advice to local startups.

But despite his enthusiasm for entrepreneurship and his experience in startups, Mr. Schillebeeckx said he planned to look for the safety of work in consulting or private equity, rather than launch his own company or work for a new venture.

“I’m pretty risk averse, personally,” Mr. Schillebeeckx said. “On the entrepreneurial side, you have to be willing to jump off the deep end.”

Mr. Haltiwanger and other economists said this decline in risk-taking—both by companies and individuals—has coincided with a broader slowing of the U.S. economy, particularly for new jobs.

In the eight recessions from the end of World War II through the end of the 1980s, it took the U.S. a little more than 20 months, on average, for employment to return to its pre-recession peak. But after the relatively shallow recession of the early 1990s, it took 32 months for payrolls to rebound fully.

After the even milder recession of 2001, it took four years. Today, nearly four years after the end of the last recession, employment has yet to reach its pre-crisis peak.

Economists have proposed various explanations for the series of slower rebounds, including the rise of outsourcing and automation that have allowed companies to produce more with fewer workers.

Pockets of the U.S. economy still burn with a risk-taking spirit. Google, Apple and Facebook reshaped the technology sector, creating new categories of products and services. Energy companies and their investors bet billions of dollars on new drilling techniques that have unlocked new reserves of domestic oil and natural gas. Such coastal cities as San Francisco and Boston, and college towns like Boulder, Colo., and Austin, Texas, boast vibrant communities of entrepreneurs and investors.

But risk-taking seems more concentrated than years past, by industry and by region, said Dane Stangler, director of research and policy at the Ewing Marion Kauffman Foundation, a Kansas City, Mo., nonprofit that studies entrepreneurship.

“We absolutely see geographic divergence,” he said. “We’ve got these hotbeds of startups, but you just don’t see the same level of activity in other areas of the country.”

That is a problem for regions left behind. Cities with high levels of entrepreneurial activity had significantly better job growth than those that relied more heavily on existing businesses, according to findings by Harvard economist Edward Glaeser and two colleagues that were published last year.

Entrepreneurship is a numbers game that draws a handful of winners from a crowd of participants, Mr. Haltiwanger said. He and other researchers have found that a relatively small number of fast-growing companies create a disproportionate number of new jobs. But such companies are almost impossible to identify ahead of time.

Little about Sam Walton’s Bentonville, Ark., five-and-dime store suggested Wal-Mart would one day become the world’s leading retail chain. Little about Jeff Bezos’s online bookstore suggested Amazon’s future as the Web’s biggest commercial hub.

The problem with fewer Americans starting businesses is that there are fewer chances for the next Amazon or Wal-Mart—or even the successful small- or medium-size business.

“It just means that there are fewer new companies that are creating jobs, fewer new companies that are competing for workers,” said Lina Khan, an economist who has studied the decline in entrepreneurship for the New America Foundation, a Washington think tank. “Traditionally being able to start your own business has been a path to upward mobility.”

Fewer Americans are choosing that path. In 1982, new companies—those in business less than five years—made up roughly half of all U.S. businesses, according to census data. By 2011, they accounted for just over a third. Over the same period, the share of the labor force working at new companies fell to 11% from more than 20%.

Both trends predate the recession and have continued in the recovery.

Investors, meanwhile, appear to be losing enthusiasm for startups. Total venture capital invested in the U.S. fell nearly 10% last year and has yet to return to its pre-recession peak, said PricewaterhouseCoopers.

The share of capital going to new business ventures has fallen even faster, PricewaterhouseCoopers data show, and is more concentrated: Silicon Valley took 40% of venture funding in 2012, up from about 30% in the late 1990s.

The decline in risk-taking is reflected in U.S. migration: Americans move less often, with rates of interstate migration falling for at least 20 years, according to census data. They also have less workplace wanderlust: 53% of adults last year held the same job for at least five years, up from 46% in 1996, according to the Labor Department. The share of workers who voluntarily left their jobs in a given year plummeted to 16.1% in 2009 from 25.2% in 2006 and remains well below prerecession levels, Labor Department data show.

Economists at the Federal Reserve Board of Governors found the falling rate of interstate migration over the long-term correlated strongly with the decline in job changes. In other words, Fed researchers said, people are moving less because they are changing jobs less.

Recent declines in moving may be tied to the collapse of the housing market, which left millions of homeowners owing more than their homes were worth, making it harder to relocate. But the longer trend predated the latest housing bust. Researchers have proposed such explanations as changing demographics and two-income households, which could make it harder for families to move.

Companies, too, are taking fewer risks. Rather than expanding payrolls, for example, they are keeping more cash on hand—5.7% of their assets at the end of 2012, up from under 3% three decades earlier, said the Federal Reserve, a rise that accelerated after the recession. Workers are hired more slowly, particularly at newer companies, Labor Department data show.

Andy Gugar opened Mercado’s restaurant in Tyler, Texas, in 1987, with a second location a year later. By the early 2000s, the chain, known as Posados Café, had a dozen locations in Texas and Louisiana.

Since then, expansion has slowed. The chain now has 16 locations and brings in about $38 million per year in sales. Scott Nordon, Posados’s chief operating officer, said the chain might one day reach 20 or 25 restaurants but was in no rush.

“We don’t want to have 100 stores,” he said. “There’s no pressure for us to grow. If we see an opportunity, guess what, we’re going to take advantage of it. But if it doesn’t, we’re content.”

The conservative strategy predates the recession, Mr. Nordon said, but the financial crisis and the current weak economy have reinforced the view. The company plans to pay off debts over the next four years and will fund any expansion with cash. “Longevity is the name of the game,” he said.

Economists aren’t sure what is behind the decline in risk-taking. Among the possible explanations are the rising cost of health care, which makes it riskier to quit a job and more expensive to hire more employees; increased state and local licensing requirements that serve as barriers to newcomers—one recent study found that roughly 29% of U.S. employees required a government license or certificate in 2008, up from less than 5% in the 1950s; and immigration rules that deter would-be entrepreneurs from other countries.

An aging population is also cited. Young people are more prone to start companies or move for jobs. But the slowdown in risk-taking began before the baby boom generation began to retire. [Blogger Note: But we would expect a demographic slowdown in risk-taking to start long before retirement when the median age of baby boomers passed through the middle aged productivity years. In other words, long before 2008] And even younger workers change jobs less often.

One barrier for prospective entrepreneurs may be the growing dominance of large corporations in nearly every industry, which make it tough for new ventures to gain a foothold. A small bookstore no longer needs just a better selection or a friendlier staff than the crosstown competition—it also has to compete with national chains and, increasingly, such Internet retailers as Amazon. [This is winner-take-all consolidation.]

For the first time since such records have been kept, the Census found in 2008 that more Americans worked for big businesses—those with at least 500 workers—than small ones. The trend has continued since.

The work of running family businesses has also scared off younger generations, said Henry Hutcheson, president of Family Business USA, which advises these businesses.

“The lure and ease of joining a blue chip firm, where you get a good job and a decent salary, just seems to be overwhelming,” he said. “People are saying, ‘I can go take over my dad’s garden center and I can go run this thing and work seven days a week and be there from dawn until dusk, or I can go manage a Home Depot and they’re going to pay me $150,000 and I’ll get weekends and vacation.’ ”

Tony Raney faced that choice. Until a year ago, Mr. Raney worked for the small chain of appliance stores his family operates in Wilkesboro, N.C. After watching his stepfather work nights and weekends, Mr. Raney had second thoughts, especially since national chains offered lower prices. “It’s a lot riskier to be an independent business owner,” he said. “Big business is out to get you.”

A year ago, Mr. Raney left the family business for a data-entry job at a national appraisal firm. “I feel safer,” he said. “I have no desire to show up and be the head of the corporation. I just want to show up and do the job.”

———–

This analysis ignores some of the direct policy causes that adversely affect risk-taking behavior. Such policies include:

  1. Greater uncertainty over government tax, regulatory, and monetary policies;
  2. Increased capital taxes, lowering risk-adjusted hurdle rates of return and decreasing capital accumulation;
  3. Low interest rates that distort prices across the economy, enable excessive borrowing and asset speculation, but decrease savings accumulation and seed capital;
  4. A government subsidized housing bubble that has hampered labor mobility;
  5. Increased employer healthcare costs;
  6. Higher corporate taxes in a competitive world market;
  7. Political failure to address entitlement reform.

The list is not exhausted. Combined with demographic changes, globalized labor supplies, political cronyism, and excessive public sector spending, is it any wonder that people have tamped down on their animal spirits? As this blog has documented extensively, misguided central bank policy has turned investment risk-taking into casino gambling on asset speculation. Things won’t really improve until we normalize our market economy and policymakers are taking us farther afield.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s