Sunday, August 24, 2014

Exporting Entrepreneurial American Socialism

Let's face it.  For the past 65 years, what has been heralded as entrepreneurship has largely been a concession that raw capitalism does not work without the barely hidden hand of the State.  From its birth in America during the second half of WWII, anti-competitive incentives were deemed necessary to induce scientists, engineers and industrialists to overcome the technological superiority of the Third Reich.  Through the cunning use of excessive profits in military and government procurement (without which the American entrepreneurial milieu would have been still-born), to protectionist concessions to ultra-wealthy investors, to modern revenue shifting and tax base erosion, the world became entranced by the formulaic illusion we marketed under the monikers of Silicon Valley, Research Triangle, Boston, and the like.

The ingredients of that illusion included a variety of schemes including: isolation of ideas behind the protectionist walls we politely call intellectual property; underwriting credit market ignorance with public funds; and, persistently holding 'capital-access summits' in hopes that through sufficient convening, we could overcome our fundamental incapacity towards capital markets adaptation.  But the problem with our incapacity to understand the economics of an innovation-fueled economy has its roots not in Silicon Valley but rather in the manipulations a century ago - the illusion provided by socialized infrastructure and property finance.  There would be no Stanford but for the socialized rail inducements demanded by its namesake from Congress when he concluded that building a railroad across the mountains was difficult.  And by the way, if you think out-sourcing of labor to China is a modern phenomenon, think again.  Much of the dynamite that blasted rail fortunes into the pockets of California industrialists and financiers was laid by, you guessed it, underpaid Chinese.  Laying track was never profitable.  Forcing Congress to grant land and money for each linear foot and degree of grade was.  Thirty year mortgages and thirty year Treasuries are not randomly equal in their duration.  Take a look at the Fed's balance sheet and ask yourself why it's not filled with market assets.  It's because both Treasuries and mortgages on their own didn't work.  With government subsidy, they create the illusion of working… until they don't.

I've been interested in the resurgence of international efforts to use sovereign balance sheets (citizens' monies) to subsidize banks in an attempt to get capital flowing to entrepreneurial ventures.  From the U.S. Small Business Administration to the state banks in China, this idea has been frequently attempted and, to date, has not succeeded.  And the reasons for the systemic failure are quite simple.

1.         The State as underwriter cannot indict its own asset origination.  Whether its negligence on the part of sanctioned credit rating agencies lying about mortgage quality to patent offices issuing fraudulent patents, no state agency to date has evidenced the ability to impose qualitative critique on its own promulgation of 'assets' and therefore has no capacity to measure asset risk.  If one wishes to see innovative small business grow, one has to first insure that innovative isn't a façade for "ignorant of the activities of others."

2.         Most businesses aren't.  The recent proliferation of low- to no-revenue acquisition transactions does not vindicate the notion that a business exists because someone bought it.  If you closely examine the frequently hyped corporate acquisitions, it takes no time to realize that the acquiring companies are providing liquidity for their venture firm benefactors seeking exits - not purchasing accretive assets.  In the end, the common equity shareholder is losing for the excessive gains flowing to the venture partners.  If a market or a country doesn't have this nepotism, it cannot build free market entrepreneurship.  And I'm not suggesting that this be done to reinforce the illusion.

3.         It's customer - not capital - access that's the real problem.  Since the formation of the WTO, the world was supposedly aspiring to the reduction of obstacles to trade.  And it's fair to say that in internet and telecom enabled businesses, this aspiration has been partially achieved.  But for the majority of business, multi-lateral and bi-lateral agreements have been overweight in their favoritism to certain industries while leaving the majority of industry in the cold.  Governments who really want to support entrepreneurship should aspire to being premium customers - not bad underwriting surrogates.

Building a system equivalent to the past 30 years of American entrepreneurial socialism may present a political expediency to short-sighted governments.  But any careful examination will conclude that alternatives may be worth considering.  In a functioning system - operating without State subsidy and taxpayer money - one might observe:

1.         Rights need to be granted for trade use, not for speculation and imagination.  The world receives no benefit for granting proprietary rights to someone who does not practice or intend to practice their innovative ideas in actual output.  Restraint of hypothetical markets or research with hypothetical claims of invention are actually ludicrous. 

2.         Connecting innovation to existing impulses with existing production, sales, distribution, and infrastructure is far more accretive than forming redundant companies with redundant capabilities.  This means that the focus of the public sector is on facilitating communication - not mandating public policy through the pocket of the Treasury.

3.         It's still all about the customer.  In a non-interventionist functioning capitalist marketplace, the consumer affirms the value attributed by the producer or servicer rather than having the producer dictate a state-sanctioned monopoly mandated premium.  In short, if the consumer, participant or community seeks to partake in a mediated experience, than the same community attributes the premium they are willing to exchange for what they receive.  Regression to commodity pricing is the perverse extension of market mean reversion which is a legacy of Adam Smith - not a necessity of markets. 

When the public sector underwrites any sector - banking, suppliers or the like - with the public treasury, it must do so with the explicit objective of merely overcoming a short term market failure.  Persistence in such undertakings over an extended period of time should be called what it is: state intermediated socialism for targeted benefit.  Since the GFC, the public has born the expense of this type of intervention without receiving the public good associated therewith.  If we're going to aspire to market interactions, let's call a spade a spade and stop misleading the public with policies that inure to their detriment.

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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave