Relevant and even prescient commentary on news, politics and the economy.

Obama Bucket Shop act

Yves Smith  points us to information on our notions of new business and venture capital:

Amar Bhide, who has written the classic, The Origin and Evolution of New Businesses, has decisively debunked the idea underlying the Obama Bucket Shop act, which is that public stock offering are an important source of funding for new businesses.

The problem is, as Bhide explained, is that academics focus on the easy to study but relatively inconsequential venture capital funded companies which look to IPOs as an exit. Bhide found that only 1% of new and young businesses were funded by venture capital. Similarly, his multi-year study of Inc 500 companies found that a comparatively small portion had VC backing, and even then, many got VCs in at a late stage, not because they needed the money but having the “right” VCs would lead to a much bigger premium when they went public.

Bhide found that most new businesses are based on an insight about an business opportunity that the founders discovered as employees (ie, they saw a market niche that incumbents were ignoring).
These ventures were funded by savings, friends and family, and credit cards.

Similarly, the idea of venture capital or stock promoter funding as some sort of boon for entrepreneurs is wildly overstated.  The value added of venture capital is questionable. It produces stock-market type returns with more volatility. A colleague who founded a successful venture capital firm left when it went to do a second round of funding (the junior partners stayed on). He gave a long form, compelling analysis as to why: when you actually went through the numbers, the returns to the entire asset class depended on the returns of a very few firms, and even at them, of a very very few deals

Cleveland = The New India?

My Economics Professor in MBA School, Peter Klein, lectured fondly of the Indian (as in subcontinent, not AmerInd) “entrepreneurs” who risked life and limb going through rubbish heaps looking for scrap metal and other items that could be sold. Despite the risk—I’m not writing metaphorically when I say “risked life and limb”—it was the best opportunity they had of making a better life for themselves.

Apparently, that Indian entrepreneurial spirit (or, as Newt Gingrich might call it, “work ethic”) is being mirrored these days in Cleveland. But now a former county treasurer wants to put a stop to it:

[Former Cuyahoga County Treasurer] Jim Rokakis: We’re looking at a neighborhood that has almost as many vacant houses awaiting demolition as there are houses with people living in them. We have one here. One here. One here. One there.

[Narration?] Rokakis is leading the effort to tear down thousands of abandoned homes because they’re rotting their neighborhoods from the inside out. It often starts, he told us, when a vacant house becomes an open house to thieves.

[TV Correspondent] Scott Pelley: It’s a nice house from the roof to about here. And then down here it’s been ripped to pieces. What’s goin’ on?

Rokakis: Well this is typical because this is as high as they could reach without using ladders. They ripped off the aluminum siding, which you’ll see on most of these houses. The aluminum and the vinyl siding comes off. It’s getting’ about a buck a pound.

Pelley: Essentially foreclosure scavengers have been through here?

Rokakis: The thieves have gone high tech. They know when evictions are occurring ’cause they’re posted online. And they will follow the sheriff. They’re usually there that afternoon or that evening.

Rokakis: So, in here, what you’re gonna see, well. I guess they took everything including the proverbial kitchen sink, right? The sink is gone. The plumbing is gone in this house. All the copper. Anything metal that had value is gone. The furnace is gone.

Pelley: The light fixture–

Rokakis: Light fixture came out–

Pelley: Is gone. How often is this happening in Cleveland?

Rokakis: This happens every day. And the foreclosure crisis creates this spiral, because as a result of this people are now more likely to leave neighborhoods like this. And as they leave, the scavengers come in and do the same thing to the house next door or across the street.

Apparently, Mr. Rokakis objects that houses are starting to look like Bruce Willis’s after the opening scenes of RED. Maybe someone will set the former treasurer straight that the employment of “reuse, reduce, and recycle” techniques in the service of entrepreneurial activities is an Economic Virtue.

(Though, speaking strictly for me, I’m glad that my wife and eldest daughter are willing to delay their hoped-for move to Cleveland for at least the next few years.)

Economists:Entrepreneurs::Blind Men:Interior Decorators

As part of my continuing series of Analogies that Should Be on the SAT, this is what Famous Entrepreneurs do (h/t Brad DeLong):

In the IBM PC era, Steve drove innovation forward with the Macintosh. This, like the Apple II, was squarely aimed at expanding the use of PCs to everyone, the “computer for the rest of us.” Everyone now knows that this was innovating too fast, and that cheaper, duller IBM machines running Microsoft’s dull clone of an earlier operating system would become the standard. But do you know how Steve changed when he realized that “the rest of us” were not going to buy the Mac? He learned that the most important early customers for Macs were corporate marketing departments (those graphics!) and worked hard to create, as he told me not long after, “the best computer company for those corporate marketers we can.”

This is what Nobel Prize-winning economists do (h/t Noah):

As Thomas J. Sargent, one of the leading proponents of the Rational Expectations Hypothesis recounted, “after about five years of doing [standard statistical tests] on rational expectations models, I recall Bob Lucas and Ed Prescott both telling me that those tests were rejecting too many good models.

“Real entrepreneurs don’t wallow in vision, they sell product.” “Real” economists, otoh…

What Will We Tell the Doctors?

“The practice of medicine was accepted to be a chancy way to make a living, and nobody expected a doctor to get rich, least of all the doctors themselves.”  – Lewis Thomas, The Youngest Science, p. 4 (Penguin, 1995 edition, quote via Google Books)

Lost in the discussion of Paul Ryan’s “plan” is the group of entrepreneurs that will be most harmed economically by enacting it: doctors—most especially general practitioners.

I was speaking with David Warsh last week at Kauffman, and pointed out what “everyone knows” but no one will say: U.S. doctors net about twice as much money as doctors in the rest of the civilized world. (As a ballpark, $200K in the U.S. and $100K elsewhere.)  And until you can solve some of that, you won’t really make much of a dent in the High Cost of Medicine.  David noted that solving that “isn’t going to happen.”

Paul Ryan’s plan is a large step toward making it happen—just not in the way David (or I) would have expected it to happen.

Let’s sidebar the usually Capitation v. Fee-for-Service discussion, which will only have an effect at the margin.  Assume that doctors net, say, $25 per patient (net of paying for office staff, supplies, waste disposal, etc.).[1]  If they schedule four patients per hour ($100)[2] for eight hours a day ($800) five days a week ($4,000) for a fifty-week year ($200,000), they make their salary.

Note the assumptions I made: the per-patient return is certainly variable (standard MC/MR curve), so the real return is based on volume and where that volume falls on the MC curve.  So long as a doctor can schedule to see 160 people a week—8,000 visits a year—they are continually busy and receive optimal returns.

But the market is not perfect.  I am of an age where a few visits a year is strongly suggested.  Tom or Rebecca, by contrast, go in once (if at all) and otherwise when they are unhealthy.[3]  It seems intuitive that, given search costs (think labor markets), a doctor’s practice is marginally more profitable with more repeat patients. Customer retention is therefore of enhanced value in the current equilibrium.[4]

But shifting the burden of payment while not capping insurance margins is also an easy first-order solution: fewer insured people, certainly; higher margins, probably (positive, maybe not significant), shifting of funds toward the sector that reduce overall consumption, and—inevitably—fewer doctor visits for the older and most likely to need care.

Note [4] above becomes relevant on the supply side; the relationship is weaker if still positive.  But the discretionary spending is reduced; Fee-for-Service fades except in the “concierge” segment of the market.  Capitation becomes the rule, and the model that has become prevalent—insurance companies guaranteeing doctors a salary—become the rule.

But visits to the doctor have declined, due to those most in need having the least ability to pay and therefore dropping off the insurance rolls.

So the insurance company doesn’t expect the doctor to make 8,000 separate treatments a year.  Or they do, but find at the end of the year that they were mistaken. The next year they offer to pay based not on 32 patients a day, but rather 30. And, given the frictions in the market, the majority of doctors agree, preferring the certainty of $187,500 a year to the risk of treating the uninsured, who are now a much riskier group.

And then the multiplier effect comes in.  Recall that there are fixed costs as well; doctors’s returns mirror the standard MC/MR curve.  So the actual loss begins gradually, but becomes steeper as the years go by—convexity effects appear.

Eventually, doctors have to right-size their practice. The current trend toward Vertical Integration may mitigate effects in the short term. But eventually—probably within 15 years, though it may take 20—doctors will find that their salaries (“net capitation fees”) are significantly closer to those of their European and Canadian peers.

Coincident to its effect on the poor and the elderly, Paul Ryan’s plan will speed the convergence of doctors’s salaries in the world.  The aspiring doctor in the Harvard Class of 2037 may well look at Lewis Thomas’s thoughts of one hundred years previous and say, “Nothing ever changes.”

The question that remains today is “What will we tell the doctors?”

[1]When I looked a few years ago, my doctor was paid $41 for my $125 office visit from insurance, and I had a $15 copay.  If you can’t figure out how $56 gross can become $25 net, go into a heavy-service industry, such as restaurants or doctoring, and look at their cash flows.

[2]Note that there is no inherent need to conform to the schedule, assuming the patients are not time-constrained.  That is, one can spend longer with patients—more than eight hours in a day—and maintain quality of care at the expense of leisure time.  This is a fairly simple equation and is left for when this isn’t a blog post.

[3]Again, the equation to show when the marginally-unhealthy choose to visit the doctor is left as an exercise. All we need for blog post purposes is to know that the choice is dependent on several factors, including disposable income and out-of-pocket cost.

[4]This is in no small part, at the margin, due to the support of the current Medicare/Medicaid system.

[5]Contracts still require both parties to consent, and the 6.6% decline is the net result—one might assume that some insurance companies will reduce their margins to pay doctors more.  One might also assume a pony with a pointy thing sticking out of its forehead with equal likelihood. There may well be a chimera of hope—though the scenario only extends the timeframe instead of ending the process—but it will not be sustainable, though it may be iterative (which would further attenuate the process).

Infrastructure and Human Capital Interlude

Busy week, so just a couple of things of note.

  1. Via Dr. Black, my old neighborhood gets a chance to build a better future:

    “It’s a great partnership among a number of researchers from academia, the private sector and national laboratories. It’s a great collaboration for a solid project that will help the environment,” said Penn State spokeswoman Annemarie Mountz.

    Foley said the project “will spur real innovation and job growth for Philadelphia, the region and the nation. We have a world class team of universities, corporations, and economic development entities that made this proposal come to life. There is no better place to do this work than in the Philadelphia Navy Yard.”

    My mother would have agreed, but she stopped working there (coincidentally) around the time Tom was born. Indeed, the renovation of the Navy Yard has been an American Success Story (driven by a Norwegian shipbuilding firm and a clothing retailer), and we can almost pretend that the area has “recovered.”

  2. Similarly, the results of the Race to the Top came in a couple of days ago. You may have heard that our Superstar Governor was cruelly betrayed by Washington bureaucrats and/or the evil NEA.

    Well, until the actual video was released, after which point yet another Republican decided to prove that people collecting unemployment are Just Lazy (though he does claim not to have lied to Superstar Governor, leaving the question of where the story from the Governor should be sourced).

So the old area is gaining because of Federal government management, and the current area is suffering because of State government mismanagement. It’s almost enough to make me think that there’s a difference when people want to accomplish something.

Opower…this is your profile

The Washington Post reports on an interesting development. If people aren’t able to “see” how they personally fit in to the ‘economy’ or ‘carbon footprint’ in a real way, they often ignore the ‘problem’ or keep it so abstract it does not touch them.

Three years ago, Dan Yates and Alex Laskey, the co-founders of Arlington-based Opower, came to a conclusion: People cared about their carbon footprint, for the most part, but needed a blueprint for reducing it. The longtime friends recognized an opportunity to create that path by providing people with an analysis of their electricity consumption.

Since then, Opower has blossomed into one of the rising stars of the energy industry, on track to post a $35 million profit this year, roughly eight times its revenue in 2008, according to the privately held company.

“We’re starting to see stronger adoption of Opower’s product by a lot of operators,” said Teresa Mastrangelo, an analyst with researcher Smart Grid Trends. “It’s a very simple way to start educating consumers on how they use energy.”

Opower essentially takes raw data, obtained from a utility company that contracts its services, and creates detailed reports on how customers’ consumption compares with their neighbors. The report also provides customized tips for each customer to address wasteful behavior. What’s more, the Opower team, made up of 105 employees, redesigns utility Web sites, offering e-mails and text alerts to update customers on usage…

Conclusion to my Kauffman Institute Presentation

Note: This is “what I believe I said,” not“what I would have said” and is presented here solely to document the confluences that were, perhaps, clearer in my head than they were in the presentation itself.  As such, several references here are echoes of earlier pieces of the presentation. (Links to same will be updated as soon as possible.)

To review, there are three standard methods of reducing a fiscal debt: default, inflate, and taxation and/or budget cutting.  I believe it is clear that default is not desirable; the historic examples of 1917 Russia and the State of Louisiana are clear indicators that issues persist long after the act itself, and the recent suffering of the Argentineans in 2002 and 2003 clearly shows that, even at the time, default is at best a problematic solution, more an amputation than a lancing.

The second, moderate inflation, has the collateral issue that some of the assumed benefits of an inflationary policy—especially an inflationary policy in an environment with a relatively low savings rate—do not accrue to the country whose currency is the dominant one in the world.  As I noted earlier, David Beckworth is doing some research in this area, and I look forward to seeing the results.It seems safe to assume that the benefits of inflation will not accrue in the way a model might predict, and therefore “solving” the problem with inflation will require a suboptimal level to achieve optimal policy.  The chance of having to repeat “the Volcker experiment” would not be small, while the likelihood of success would not be so large.

Budget cutting is an abiding idea. While I’m perfectly willing to stipulate that one might be able to cut around 1% of GDP from the US defense budget, and that some direct consumption—though much of this is a State and Local issue more than a Federal one—might be reducible, this appears unlikely to have more than a marginal effect. While we like—indeed, make a living from identifying—marginal effects, the magnitude of the issue at hand requires more.  Since we generally can stipulate that transfer payments are at worst neutral (or, by Jim Baker’s “supply-side/conspicuous consumption” theory presented earlier, likely beneficial to both the velocity of money and overall tax revenues), gains from there will, at best, not help the team.



This leaves taxation, and it is perfectly reasonable to assume that taxation can be increased. Except that, as you can see from the graphic I have left on the screen, we have a large deadweight loss in health care spending. We spend approximately 6% more, on a percent-of-GDP basis, than the next country, with no noticeable economic value-added.  Having that deadweight loss hanging over the economy limits options—possibly as much or more than being the dominant currency.  And since the basic premise of this panel appears to be that we would prefer that the US Dollar remain the dominant world currency—that is, becoming the 21st century equivalent of 20th century Britain not being a desired outcome—we are left to the reality that we cannot solve the budget crisis without reducing or eliminating much of the deadweight loss in the health-care system.

Were we to solve only half of the difference and transfer that amount to tax revenues, we would solve the budget deficit without adding any drag to the economy, effectively substituting tax revenues for cost overruns. We would, in short, have produced a better team: a better engine for growth and a greater potential for entrepreneurial opportunity, even if a groundskeeper becomes underutilized in the process.

The most viable alternative to addressing the deficit by addressing the deadweight loss in the health-care system appears to be to yield our place as the world’s Reserve currency of choice. There does not appear to be much of an appetite for that, even if there were a clear mechanism to do so.

As economists we look for the suboptimal.  In this case, we can identify the areas where the returns are low—defense spending—the areas where spending growth might be moderated—Government Direct Consumption, although that is a very nominal portion of the Federal budget—and areas where there are clear deadweight losses—health care spending.  Only the latter shows much promise as a direct, not just a marginal, way to address the problem.

Where are the Household Entrepreneurs?

Glancing through the CBO survey that only checked one side of the ledger, and therefore made Greg Mankiw happy, I came across the data on Corporate Taxes paid, by Quintile of Income.

Now, there has been a groundswell of declarations that people aren’t “leaving the job market”; instead, they are supposedly being “entrepreneurs,” starting their own businesses voluntarily (as opposed to because firms won’t contract with an individual), and reaping the benefits of the ownership society. This was the alleged basis for preferring the smaller, more subject to “population control” changes household survey to the payroll survey when measuring unemployment. (See here for a sample discussion.)

As noted in the sample discussion, the household survey doesn’t jibe with Social Security payments. So we are left with the possibility that the income of those entrepreneurs is being maintained at their corporate level, for some reason.*

Which should mean that Corporate Tax payments, as a percentage of all corporate tax payments, would have also risen among the “new entrepreneurs.”

Source: CBO, Table 1B. As usual, select the graphic to enlarge it.

It doesn’t look that way. I can’t find a single level of earnings that isn’t down at least 25% over the past ten years—and that’s the lowest quintile of earnings, not exactly the type of people you hear about being “success stories.”

So if you really think there are a lot of new S-corps out there, it appears that they’re either (1) in the group averaging more than $231,300 a year in income (see Table 1A), or (2) so poor that their tax bills are falling behind those paid by everyone else, and they’re clearly being irrational having a corporation in the first place.

Unless I’m missing something. If so, what?

*Since the highest marginal tax rate for individuals equals the corporate tax rate, that reason (especially for them levels, most of whom would not pay a marginal rate of 35%) is unlikely to be tax-related, except possibly as a matter of timing payments, which would not significantly alter a long-term trend.