U.S. businesses are being destroyed faster than they’re being created
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When the banking crisis happened in 2008, there was some talk and pressure from consumer groups and governments (at least in the U.S.) to make capital available to individual consumers. However, this was a short-lived sentiment, or at least one that never had any teeth to it. Banks stopped lending to consumers as readily as they had before the crisis while the Federal reserve kept interest rates and especially interest rates they give to banks extremely low.
This meant that if you already had capital(large businesses, wealthy individuals) it was easy to get nearly free money. whereas if you didn't it was nearly impossible. This led to consolidation as big businesses could buy up many small ones .
I predict this will continue happening as long as the combination of low interest rates and inaccessible consumer loans continues.
[1]: http://www.npr.org/blogs/money/2014/01/31/268350791/episode-...
Monopolies have more pricing power and scale, so all else being equal they are lower credit risks than smaller companies. Since they enjoy an advantage on cost of capital, they have an intrinsic synergy when buying out a smaller competitor since they can increase their ROIC simply by lowering their capital costs (and in practice almost always have operational overlap).
It makes sense for the banks, it makes sense for the large companies, and it makes sense for the small companies being acquired. The only one being harmed is the consumer.
Not that I don't understand you point on a moral basis, it's just that is not the framework used to make these decisions.
Generally speaking, access to credit is treated more importantly than possession of capital, due to the leverage credit provides. For individuals however, it is treated negatively (the more credit you have registered with the credit-reporting agencies the less future credit will be extended to you) while for businesses, because they generate income, it can be treated positively. This is generally because credit-granting institutions often do not perform a deep enough analysis to determine if credit utilization in a business is leading to organic or artificial growth; it's a difficult task to perform, and the difficulty is compounded by the long time scales it can sometimes take before the determination of organic-vs-artificial can be pronounced. Simply possessing sufficient credit to take control of assets until someone else pays more for the assets induces all sorts of "fake-it-til-you-make-it" games.
Throw into this cauldron of unintended consequences the official and quasi-governmental support (which boils down to more credit extended for these activities) for real estate development, medical care, and education, and it is small wonder we see the kinds of unbalanced stresses we observe in banking, housing, medical and education sectors.
An especially egregious example of this in action in the US are the "limits" on number of financed properties secured through government mortgage assistance programs. The layperson could be excused for believing that the mortgage assistance programs are meant for "the little guy", and the limit would be one financed property per household, owner-occupied. The taxpayer foots the bill, so it should only be for families and individuals who need the government-stabilized mortgages for the house they live in, right? What actually happens is there are a complex set of rules between Freddie Mac, Fannie Mae, FHA and VA programs that delivers government support for taxpayers to subsidize hundreds of thousands of "investors" to get taxpayers to supply the mortgage assistance for up to about 10 properties, only one of which needs to be owner-occupied, up to a $2M aggregate loan value.
In HN-terms, it is as if there was a taxpayer subsidy that let you put up 10% of a $2M loan for your startup idea, dis-chargeable in bankruptcy, at credit rates you could not touch in the private markets. The scrutiny hurdle to clear to secure this financing is much lower than for YC; it's mostly taxpayer money that's at risk and the agency problem runs rampant here. This is an outright gift to the banks that originate the loans and service them for the origination and servicing fees but don't underwrite the risk, as well. You should have heard the cries of doom and gloom when the government agencies a few years ago mulled dropping the number of investment properties that could be carried. Most of these "professional investors" are oblivious to how real businesses obtain credit, and the real cost of credit in the private markets.
There are no easy answers here, unfortunately. Credit is a legitimate feature of the modern economic landscape, and a bona fide tool in an honest business' toolbox.
Low interest rates make consumer loans more accessible. It's much easier to service a 5% loan than a 10% loan.
Here's the National Federation of Independent Business survey about what are the primary concerns of business. Interest rates/financing is last ... pretty much at an all time low.
http://www.nfib.com/surveys/small-business-economic-trends/
I'm pretty sure that if I dug up the Federal Reserve report it'd also show that banks have excess reserve (i.e. money that they'd love to lend at a reasonable interest rate rather than earning 0%).
When a loan officer decides whether to approve a loan, they look at the collateral and whether the borrower can service the loan payments. A lower interest payment absolutely makes it easier for borrower to service the payments, and hence for a bank to justify a loan. Ergo, lower interest rates makes loans more accessible.
Also your claim is contradicted by the survey I posted. For the last few years the NFIB survey has consistently returned the same results: access to financing is not a big problem for businesses.
The evidence doesn't support the claim that the problem is the banks.
BTW, this is true not only for the US, but for other economies as well. The exact same thing happened in Japan in the 1990's.
If there are other ways for a bank to use their cheap money
I haven't looked recently, but the last time I did banks had excess reserves and the Fed was debating whether to charge banks for depositing money at the Fed. Again, basically the opposite of what you're claiming.
SWAG. You believe in Austrian economics?
However, what I generally understand is happening, or rather is not happening, is called "pushing on a string". No matter how low the rates or availability of loans (not so sure that was true in Japan in the '90s), nothing can get a business to borrow money if they don't think they'll be able to pay it back.
I'd also suspect that's somewhere in the priority list of central banks below preventing widespread bank failures (note what happened after it was decided to throw Lehman Brothers to the dogs, albeit we'd better be past that point in the US), and very possibly making it very cheap for the government to borrow money. "Trillion dollar deficits as far as the eye can see" don't hurt so much when interest rates are so low....
However, what I generally understand is happening, or rather is not happening, is called "pushing on a string". No matter how low the rates or availability of loans (not so sure that was true in Japan in the '90s), nothing can get a business to borrow money if they don't think they'll be able to pay it back.
That's exactly right. And that's where a lot of economic theories break down ... because its assumed that firms always maximize profit. If you assume that, firms will always borrow money if money is free (i.e. 0% interest rate), and put the money to use earning >0%.
I think we've seen that's not a great assumption though because firms are not always maximizing profits.
Going from first principles, the application of "macroeconomics based on aggregate demand" to the microeconomics of specific firms is always going to be iffy.
Zillions of factors, e.g. local demand, regulatory regimes, uncertainty of about the latter and tax regimes, current and future ... heck, I gather the Austrians don't entirely dismiss Keynes's animal spirits concept, they just have some explanations for it, which get harder to apply the more you move away from purely financial considerations.
E.g. if Main Street, these small and medium size businesses, conclude they've been declared Enemies of the People, the animal spirits of the people in them are going to be affected. Not to Godwinize this discussion, but I gather those of the school who survived did so by getting the hell out of Dodge (https://en.wikipedia.org/wiki/Richard_Ritter_von_Strigl#Late...) and that also critically disrupted the school. You can imagine how scholars felt when they discovered von Mises' archives in Moscow after the Cold War....
So why are there fewer new businesses if it is not financing?
Let me address this first. The initial claim that I replied to was that 'low interest were causing loans to be inaccessible'. That claim just doesn't make sense. I'm comfortable my claim that low interest rates makes loans more accessible is correct.
Beyond that narrow claim I'm not nearly as certain.
So why are there fewer new businesses if it is not financing?
Now this is an interesting question and one I don't know the answer to (and I haven't seen an answer too). That might make a good Phd thesis. A SWAG would be that its got to do with suppressed aggregate demand. I don't know if the data exists for Japan in the 1990's but would give you one data point. It kinda of makes sense that new business formation would slow during stagnant growth ... but the opposite could be true. People could be forced to start businesses because the conventional career path is less attractive. Anyway, I have to put this in the 'I don't know' category for me.
The Mortgage Credit Availability Index[1] is at around 115. If it had been tracked in 2007 it would have been at 800.
The chart you posted in a previous comment doesn't really address the availability of credit. It just says that businesses are not as concerned about financing and interest rates as other issues. In that same link it reports that 24% of small businesses were planning capital outlays and that 48% explicitly were not looking for a loan. I don't know what to make of that except that, it's not really addressing my point one way or another.
1. Technology has disintermediated many of the barriers in bringing your service directly to customers, and so more people are becoming freelancers rather than working for an organization. I would love to see this chart compared to rates of self-employment, Kickstarter campaigns, and people who make their living off EBay.
2. We're in a cyclical depression in new business formation. The economy is still pretty sluggish; few people feel they can gamble on striking out alone under these conditions.
3. New businesses are either folding quickly (before the one-year mark) or getting acquihired, because technology makes the feedback cycle of whether or not an idea is going to work faster.
1. Despite EBay and freelancing self-employment has steadily declined from at least the 1970s[1]. I read somewhere once this has been go inning on for more than 100 years.
2. As shown in the main graph of the original post this has been going on since themid-1970s. So it's secular not cyclical.
3. The graph in the original post shows business "less than a year old" so they don't need to make it to the one year anniversary. So this is not caused by survivorship bias.
I also have a very technology focused worldview but we need to keep in mind while awesome and very important it is only a tiny fraction of US employment and GDP.
[1] http://blogs.hbr.org/2014/02/where-are-all-the-self-employed...
Banks no longer want to take risks on HELOCs so the qualification standards for getting them are pretty insane. As a result, business owners who used HELOCs as a way to deal with seasonal changes in demand or just as a way to have funding to get a business off of the ground no longer have that option.
See http://www.clevelandfed.org/research/commentary/2010/2010-18...
http://pascal.iseg.utl.pt/~aafonso/eif/pdf/crrinf81.pdf
Austrian economics is great, but it often doesn't take into account that information neither free nor perfect.
edit: Yes, nfib, forgive my typo. I don't agree with how you're interpreting the scope of the discussion.
This is an interesting narrative that fits well with the current anti-bank populist sentiment, but I'm not sure the data supports it.
According to FRED data, Outstanding Consumer Credit contracted some after the financial crisis, as banks got their balance sheets in order, but it quickly spiked back to pre-recession levels, and has been growing at historically consistent rates ever since. Mortgage rates also hit all-time lows during the aftermath, which benefited consumers (though application conditions tightened).
http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=z...
There's clearly a lower slope on the log-scale than there was pre-recession, but it is still increasing.
I haven't seen an update, but the Cleveland Fed wrote an article about this specific measure of commercial lending in 2011;
http://www.clevelandfed.org/research/trends/2011/0211/01banf...
Absolutely. Credit contracted pretty much across the board from 2008 to about 2010. I'm just not sure the story is "banks were lending to rich companies at low rates while the little guy couldn't get a loan". It seems to me there was a hiccup, then it was business as usual.
Let's not forget easy credit was one cause of the depth and length of the Great Recession. I think the ease at which credit was available for a decade pre-recession has skewed our generation's view of "normal" credit conditions.
http://www.census.gov/ces/dataproducts/datasets/lbd.html
http://www.census.gov/ces/dataproducts/bds/overview.html
Methodology:
http://www.census.gov/ces/pdf/CES-WP-02-17.pdf
Looking more carefully, I think the numbers tell a completely different story - this is not about the decline in entrepreneurship, but more about the rise of contingent workers and one-person businesses. Their definition of firm is a business that has paid employees and not all contingent workers count under that definition because they are often independent contractors or employees of a third party agency. The broader availability of all kinds of services from legal to insurance to accounting to technology to logistics to HR/staffing also allows 1-person businesses to handle more than they ever have, while potential legal and regulatory concerns have raised the cost of hiring the first employee. This is not about consolidation but bifurcation.
This is exactly what's happening in the Netherlands as well. Lot's of one-man companies. Our government is looking to stop the growth because of some tax dedications they can claim.
What I find interesting about this is that because these are run on a shoestring budget, they end up being a testing ground for ideas that are actually profitable.
In the Valley, technology has had the effect of making it easier to create new businesses (startups), so I can see why the HN crowd would assume that consolidation represents a negative trend. But the fact is that in the rest of the economy, technology has enabled consolidation and driven small businesses either into closing down or being acquired. Technology pushes out the boundary at which diseconomies of scale overtake economies of scale, enabling larger businesses to be more efficient.
Take a company like Amazon or Wal-Mart. Technology enables those companies to operate at massive scales, and using technology, they can replace thousands of smaller businesses while operating much more efficiently.
I suppose the other relevant trend has been what has happened in the financial markets. 1978-present was a period of massive M&A activity. Those with more capital spent it buying out those with less capital, and as a result industries that used to have dozens of competitors now have a handful.
1) That's a particularly horrendous timeframe to try and draw long term conclusions from. 2) Small business people are more conservative than ever right now (ie not starting businesses). Large enterprises have also suffered from this same conservative approach (sitting on massive piles of cash vs investing) It's a very conservative business climate across the spectrum. 3) Some have argued that larger companies have gotten more nimble at competing in the last decade and so the opportunities aren't always there for small businesses to move into gaps 4) Healthcare costs have skyrocketed in the last 10 years and have been risky (losing coverage) which has a very real dampening effect on individuals quitting corporate jobs to start businesses. There's a pocket of people who believe the ACA will have one of it's biggest impacts in this area (workforce mobility has also declined in last 10 years)
This is good stuff and worth watching but I would want to wait until the end of 2016 for some of the above to play out before drawing long terms conclusions around the US economy.
In the short term, people start businesses when they are optimistic or at least naive about the economy. And the sort of people who historically have started small businesses as a means to achieve economic mobility are exactly the people who are likely to be least optimistic these days.
Maybe some of the consolidation is due to the increasing importance of supply-chain at the expense of location in low-margin businesses.
-JM Keynes
We already have a zombie economy. Well-connected people can fail in bad faith, break the law, and nothing bad ever happens to them. A few seats may be exchanged, but it's the same set of (mostly, inept and morally bankrupt) people in charge.
Has anything been learned from the fiasco of 2008? Not really. We've added some regulations, but we still have the same people running the corporate economy and, while they may be short-sighted and greedy, they're not stupid and will find ways around this set of regulations just as they did the last ones.
Now, on the matter of small businesses: the question of whether "creative destruction" is good comes down to, "why did those businesses fail?" If a restaurant fails because it's badly run and produces a low-quality product, that's a good thing. If it fails because the local economy has gone to shit, that's a bad thing. I think that most of the change is an increasing rate of the latter.
On the macro scale, I don't think the proportion of businesses that "deserve" to fail has increased. If anything, it's lower because it's harder (outside of the Valley) to start one.
That said, the real problem isn't that businesses are failing. That's inevitable. It's that new ones aren't being created (because no one has the capital).
If capital is unavailable intentionally by central control of the economy, the talent has a negative value (mismanagement destroyed the company, perhaps) and the resources are regulated away except for grandfather clause'd incumbents, then this good idea doesn't happen.
If it did happen, it would be good, but I believe it no longer happens.
Maybe established companies are seeing more growth. Not everyone wants to work for a new/struggling company, a lot or people want job security (if there is such a thing).
I think part of this could be the decline or brick and mortar stores.
Nowadays I probably wouldnt want to open a Hardware store vs the 70s. We have companies like Home Depot who drive the smaller guys out but they also create a lot more jobs and have better benefits than a Mom and Pop hardware store can provide.
So is it a good thing, yes and no depending on how you look at it. I really need more info on the factors that are causing the decline.
When has that ever been the case? Small companies have always been the growth engine of the US economy, and others as well. A small company can grow 100x in a couple of years and it doesn't seem weird, whereas a large company growing even 2x would be remarkable. Even if 95% of those small companies totally fail, they're still likely to generate more growth than big companies. It's not likely to be a coincidence that declining entrepreneurship and stagnant wages (everywhere but Silicon Valley) have gone hand in hand for a while now. Yes, people seek security. That's fine, perhaps even wise, but when everyone's running for their lives there's not going to be much growth or innovation.
As of December 31, 2004, our Company employed
approximately 50,000 persons, compared to
approximately 49,000 at the end of 2003
We refer to our employees as "associates."
As of December 31, 2009 and 2008, our Company
had approximately 92,800 and 92,400 associates,
If you think 1000 smaller companies would hire some 40,000 people 2x over the course of 5 years, you've got to be kidding. Small companies may grow "by 10 fold", but thats because one employee becomes 10 employees rather quickly.
Fewer small businesses is a bad thing, to such an obviously huge degree that I'm amazed I even have to explain it - especially here. Really, all you "skeptics" need to do is educate yourselves.
[1] https://www.census.gov/econ/smallbus.html [2] http://www.sba.gov/content/small-business-trends
How can a one person company grow the economy and provide jobs?
Do note, independent contractors are considered 1-man companies. Surely, these are NOT "small businesses", but simply employees whose employer is too lazy to get them federal benefits.
Again, large companies who are taking advantage of the tax code... which pads the small business numbers. (In this case, they take advantage of the fact that they don't have to pay payroll taxes on Independent Contractors).
Hedge Fund managers also come in from this side. They can be independent contractors that are responsible for millions of dollars. IIRC, there were some regulations here that benefit the creation of "new independent companies"... usually employing only one person.
If the company doesn't want to make them regular employees, they have to go through a body shop. else the IRS may realize the game, and require the company to pay back W2 type taxes, interest and penalties, never-mind that the individuals have been playing their FICA taxes (both "shares") etc.
I'm not sure this is a big problem. I'm particularly unsure what the problem would be with "hedge fund managers" (aside from our required Two Minute Hate). What major expenses do they have that can make a noticeable dent in their outsized incomes? Surely they're sufficiently big fish they don't get away with cheating on the FICA taxes? Etc.
(I say this as the son of a serial small businessman, who's watched him thread the needle of the IRS's requirements for much of his life.)
Does this look like an Independent Contracting gig to you? http://vectormarketing.com/
Anyway, the important bit is that "small businesses" are poorly classified in the USA. A lot of one-man shops are basically poorly-treated employees, skirting the law so that they can ignore certain taxes.
Yes, there has been growth in "small businesses", but unless we get more data, there is no way to tell if small businesses are actually growing, or if companies are simply shedding employees for independent contractors to avoid payroll taxes.
Do you think these small companies the article said are failing are actually "companies" in the traditional sense or one man operations combined with "tax saving" contractors?
It seems we may need more data to draw conclusions.
IE: A company fires 10,000 employees ("losing" large business employees), and then "hires" 10,000 independent contractors. Given how the statistics work... this counts as "+10,000 small business jobs".
As long as the tax code benefits "small businesses", we can expect a degree of corruption and fraud.
http://www.treasury.gov/resource-center/tax-policy/tax-analy...
The current methodologies for determining "small businesses" are inadequate. The truth of the matter is, large companies (like Coke) are increasingly owning subsidiary companies which technically count as a Small Business.
The most audacious of which, are Hedge Funds, which due to their small number of employees... are considered small businesses. http://www.huffingtonpost.com/2012/03/21/small-business-tax-...
Do you really want to know why "small businesses" are making jobs? Because large companies are reorganizing themselves as a bunch of small companies to take advantage of tax benefits.
I'm talking about Green Mountain Coffee, Honest Tea, and other subsidiaries of Coca-Cola which count as small businesses, despite being fully owned by larger businesses.
Consider "Honest Tea", which was 40% owned by Coke since its inception. With its paltry 112 employees, it is considered a small business by the American Tax Code.
But lets be frank here. Now that "Honest Tea" is 100% owned by Coca-cola, it is nowhere near a small business.
When a large company reorganizes itself so that 1 million of its jobs are moved into subsidiary companies... that isn't "Small Businesses making jobs", that's "Large Businesses taking advantage of dumb tax code".
And as long as the "Small Business Myth" remains, you can expect "large business" to reorganize themselves to take advantage of tax benefits.
You cant compare a company going through that first big growth. If you have a million dollar a year company grow by 100x to 100 million in a year or more is that really providing more growth than the company I work for which grew by ~101 million over Q1 last year. Which is helping the economy more?
What happens to the employees when the small company is bought out or fails to grow the next year. Conversely what happens next year if my company shrinks by that same 101 million in Q1 2015? We probably wouldn't start laying people off but would the small company?
This is also interesting it provides a little insight into why small companies may be struggling whereas larger ones are seeing growth: http://www.forbes.com/sites/ianshepherdson/2013/09/10/small-...
That's not as clear as people claim.
The common definition of 'small business' when people say that 'Small business create the most jobs' is a company with fewer than 500 employees. That's over 99.5% of companies in the US, so of course they create the most jobs.
If you change the definition of a small business to fewer than 50 employees, then only 1/3 of workers are working for 'small businesses'. These companies are also the first to lay off employees and the last to hire in recessions due to their smaller balance sheets.
The whole thing is worth a read, but the gist;
It makes for a less popular stump speech, but large firms
are a vital player when it comes to job creation. Over the
past two decades, for example, small and mid-sized businesses
have held a larger share of the country’s overall employment
(29 percent and 27 percent, respectively) than they have of
total jobs added (16 percent and 19 percent). During the same
period, companies with more than 500 workers employed about
45 percent of the workforce yet contributed 65 percent of the
jobs created since 1990.
Those jobs may be more valuable, too, considering large firms
have historically paid significantly higher salaries than
their smaller counterparts. On average, small business
employees currently earn about 50 percent lower wages than
those paid to workers at large companies.
http://www.sba.gov/content/what-sbas-definition-small-busine...
Examples:
- Manufacturing: Maximum number of employees may range from 500 to 1500, depending on the type of product manufactured;
- Wholesaling: Maximum number of employees may range from 100 to 500 depending on the particular product being provided;
- Services: Annual receipts may not exceed $2.5 to $21.5 million, depending on the particular service being provided
Related:http://flipchartfairytales.wordpress.com/2014/02/26/america-...
While the full data may actually show no correlation, his highlights show the correlation "business friendliness -> lower business creation."
The main problem is general economic disenfranchisement. When truck drivers had powerful unions (today, many unions are corrupt and weak, with union leadership buddied up to management) and made what would be six-figure salaries today, while living in houses where the land was effectively free (i.e. the cost of the house was the construction cost alone), it was possible for people in the middle class to accrue real savings. College tuitions were reasonable, because you could get a good job from a (well-funded, cheap) state school and so there wasn't an arms race to get into elite colleges.
The idea that a working-class family could bankroll a business seems insane now, but it wasn't, 30 years ago. The Satanic Trinity of housing, healthcare, and tuition hadn't been re-summoned yet, so average people had money to do things like start companies after a couple decades of working.
The Boomers pulled up the ladder, and made life for the rest of us a race to the bottom. Now, college is expensive, healthcare is a long-tail risk for pretty much anyone (even the "good" insurance policies have exclusions) and housing is obnoxiously expensive anywhere that there are jobs. Add to this the advent of consumer debt (which breaks the Fordist correlation between worker prosperity and the health of the economy) and you have a world in which almost no individuals have capital, and people are stuck relying on a few wealthy individuals and large (usually corrupt) institutions.
When most people don't have any money, fewer small businesses will be formed. It's that simple. These businesses aren't being created because people don't have the means.
Are you sure that's true after adjusting for inflation, at least in the ICC regulated days?
Teamsters, though ... two specific incidents around the same time when I was coming of age helped turn me totally against trade unions, the UMW murder of Joseph Yablonski, his wife and daughter, and at the local level in the Teamster's union and locally to me, the murder of one John Galt (oh, the irony) by shooting his explosives laden truck (which could have killed others, it certainly did a number on the shooters on the overpass he was approaching).
Edit - might there be a difference if you own the truck vs. just being a driver? I don't know the details of the industry.
I have an uncle who's a repo man. 80% of his business is collecting big rigs when the owner falls behind in payments.
Trucking is an incredibly tough industry to be in. If you don't own the truck, you have a monthly payment that's almost equal to your house payment. Throw in gas prices going through the roof, and you're lucky to make a decent salary,
We don't build stuff no more.
http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=z...