Economics 101

Joseph W. Bartlett,, Counsel, Reitler Kailas & Rosenblatt LLC

The question arises in my mind whether a summary index could be organized to track and elevate it to its proper place and level of influence that portion of the U.S. economy composed of the contributions to GDP and other economic indicators from the activities of emerging growth companies (called “EGCs” or “gazelles”) and their principals, the index helping all hands, including the Fed and Treasury economists, to adjust their view of economic growth in the U.S. to take into account small business creation and operations as a vital element of the economy, an element which often is overlooked when forecasting overall GDP and constituent elements such as job creation. As a business/academic colleague of mine likes to say, you can only measure what can be measured. The question is whether one can measure the impact of the start-up economy once one is shown the ropes, so to speak, and to adjust the snapshots and forecasts of U.S. growth accordingly.

As a novice, I was struck by certain aspects of current media coverage, including Friday, April 29th, The New York Times front page, “The Recovery’s Two Sides: Weak Growth Even as Hiring Surges” and “Why is Productivity So Weak? Three Theories” (copies attached). The experts are confused by the apparent lack of improvement in productivity.

Quoting from the first article. [1]

“ … the apparent lack of improvement in productivity — the output of individual workers — despite dazzling advances in Silicon Valley, America’s technological frontier, and a continuing economic recovery that is nearing its seventh anniversary.”

Then from a second article. [2]

“Maybe we just aren’t counting things right — or, to use the economists’ preferred term, there is measurement error. [3]

“After all, entire industries are being transformed in ways hard to account for in data on gross domestic product, particularly in technology and services. Having a high-powered computer in our pockets and social networks that let us stay in touch with friends may make us better off than the narrow math of gross domestic product — which counts only what we pay for — would suggest.

“Think about a business that is investing for the future. It hires a bunch of people and opens new offices and builds new factories. But while it is doing all that stuff, its actual productivity is quite low. It has a lot of people working a lot of hours, but very low economic output until its operations are fully up to speed.”

“Still, there could be enough going on below the surface of those overall numbers that the optimistic case remains plausible. To use one example, engineers at several companies are hard at work trying to perfect driverless cars. At present, they are a sap on productivity — they put in many thousands of hours of work with no economic output to show for it. But, if successful, their work could radically increase the nation’s productivity in the decades ahead.

“Apply the same across a wide range of fields — industrial goods, pharmaceuticals and medicine, financial technology firms — and optimism becomes more plausible. That’s the scenario we should all hope is occurring: Slow productivity growth now is just a down payment on a much brighter future.”

And then a lead article in weekend Wall Street Journal [4] which tracks growth triggered by the “liberation” of “common people to be creative.” The historical analysis is summarized in the excerpts in Appendix A and the author’s conclusion is that liberation of the common people to be creative has resulted, and continues to result, in the “coupling of ideas in [their] heads, in turn yielding an “explosion of betterments” because as the author quotes from a recent book “ideas started having sex … .” [5]

Summing up the historical analysis relevant to the theme of this essay, the Great Enrichment is “the most important secular event since human beings first domesticated wheat and horses. It has been and will continue to be more important historically than the rise and fall of empires or the class struggle in all hitherto existing societies. Empire did not enrich Britain. America’s success did not depend on slavery. Power did not lead to plenty, and exploitation was not plenty’s engine. Progress toward French-style equality of outcome was achieved not by taxation and redistribution but by the Scots’ very different notion of equality. The real engine was the expanding ideology of classical liberalism.”

Note a couple of provocative indications in the above The Wall Street Journal writer talks about the ”liberation” of the “common [6] people” to be “creative” in the “compiling of ideas in their heads. The point is that the start-up early stage economy goes well beyond Stamford and MIT graduates in physics. Two workmen in X business notice each other’s daily routine and one says, ”You know, Louie, if we engineered a gadget to do x and y together,” he shapes his hands to show what he means, “we could save a lot of money and get the job done faster.”  They meet with Louie’s brother-in-law, a lawyer, file a patent application and the business starts making and shipping the device; they even raise the expansion round by virtue of Rule 506(c) and SeedInvest.

For an example from my personal portfolio …

In light of the above, should not the analysts building the growth measurement tools concede that automation and globalization are melting down, at various levels, the historic criteria of economic growth as they occurred in the good old days … steel mills, automobile manufacturers, mining companies, heavy industry in general operating assembly lines with multiple welders, fork lift operators, machinists et al. … union members. Two of my three children successfully founded and are operating emerging growth companies drawing steady and officially reported wages and benefits increasingly based on seniority. Given the melt down, the analysis should not stop at that point. Should not all hands ask whether we are paying adequate attention to the continuing, largely self-propelled growth of small business enterprises a/k/a emerging growth companies which are multiplying at a relatively rapid rate, courtesy of: the bipartisan JOBS Act; technological innovation all over the map; tax benefits (1202 is now permanent); the experience of HPPOs (hybrid public private organizations) gaining liquidity for shareholders on secondary exchanges; Online Dating Services between EGCs and investors, run by “curators;” pledge funds; DBL (i.e., social impact) investing; “testing the waters” for On Ramp and Title IV flotations before the potential registrants need to open their wallets; the upward curve of Angel Capital Association member networks, often syndicating deals intramurally; Blue Sky pre-emption; the 100 percent (almost anyway) penetration of university campuses by tech centers which, among other things, migrate the technology from the laboratories into spin outs manned by, e.g., graduate students; and finally, the impact (potentially at least) of democratizing the opportunities for Joe the Plumber (Title III, Rule 504 and Rule 147, and other legal and semi-legal openings including the revival of Business Development Companies) to invest in potential gazelles. See the link to a paper by Jeff Feldman on closing the 99%/1% gap by opening up the creative destruction lottery to winners in the gazelle sweepstakes.

By way of contrast, the alacrity at the Fortune 500 (or 2000) level is often for (a) M&A (two become one and competitors are swallowed); and (b) for private equity fund investments which slenderize the target by reducing “redundant” and “superfluous” activity. How about focusing the crucial measurements at the other end of the conveyor belt [7]  … where it all starts … and keeping indices of that activity in the routine of taking the patient’s (the U.S. Economy’s) temperature for purposes of prescribing the best medicine and health care?

An index so created would need to take into account a variety of factors in today’s U.S. economy which are largely left unnoticed. Thus, as mentioned in the second Times piece cited, when a start-up (“Newco”) launches, there is often no payroll as such. The workers are the founders and they are frequently “paid” in equity of indeterminate value … “payroll” which doesn’t factor into traditional measurements. As Newco grows, it will often do so on the backs of partners … again, not employees but independent contractors (although a number of them should be classified as employees). In the next phase, the workers may get the minimum wage but the bulk of their earnings may well be stock options or restricted stock grants.

Newco itself is not a reporting company although its shares may trade on a secondary exchanges … a HPPO, in other words (a hybrid public private organization). A significant percentage of all start-ups tank but the players, blessed with experience on what works and what doesn’t, will use the Newco I experience in founding Newco II.

In short, it is tricky, in a way, to measure the GDP growth in the start-up segment of the economy by traditional methods … the rewards emanating from the herd of new and growing companies organized, if only informally in some cases, to travel from (my phrase) “the embryo to the IPO” i.e., “gazelles.” I personally see the gazelle herd up close from time to time. (Two of my three kids are founders of successful gazelles.) And, the question is whether this segment (if that’s the right word) of the U.S. economy is currently hiding in plain sight? To be sure, shrinkage at the classic assembly line is having a traumatic impact on Joe the Plumber and fueling the impact behind the Neo Jacobins and their leader (for the moment) Donald Robespierre Trump, With, however, a well analyzed and published emphasis on with those emanating from what I characterize as the Makeover, [8] could we not avoid the new version of the Committee on Public Safety?

In short, why don’t we take a crack at it?

[1] Schwartz, “The Recovery’s Two Sides: Weak Growth Even as Hiring Surges,” NYT, Apr. 28, 2016.

[2] Irwin, “Why is Productivity So Weak? Three Theories,” NYT, Apr. 28, 2016.

[3] In The NY Times, May 28, 2016, B2, the author posits the classic the classic explanation for government errors … tight budgets,

“In 11 of the last 15 years, a listless January, February and March were followed by a snapback in economic expansion in the next quarter, a trend Ms. Swonk said could not be explained by “polar vortexes and other one-off factors.”

“It could be everything from a change in the structure of the economy to mismeasurement,” Ms. Swonk said. Government agencies are working to improve their methods, she said, but budgets are tight in Washington and it has been difficult for federal statisticians to keep up with the broader shift from manufacturing to services as a growth engine in recent decades.” Schwartz, “Consumer Spending and Housing Lift Economy, but It’s Still Weak,”

Why Federal statisticians would get smarter if they were paid more or there were more of them? No answer from this former bureaucrat.

[4] McClosky, “How the West (and the Rest) Got Rich,” WSJ, May 20, 2016.

[5] Ridley The Rational Optimist (2010), Jumping on the bandwagon is David Brooks, “Where America is Working,” NY Times, June 3, 2016.

But there’s another America out there, pointing to a different political debate. For while people are flooding out of the Midwest, they are flooding into the South and the West. The financial crisis knocked many Sun Belt cities to their knees, but they are back up and running. Jobs and people are now heading to Orlando, Phoenix, Nashville, Charlotte, Denver and beyond.

There are two kinds of places that are getting it right. The first we might call Richard Florida cities, after the writer who champions them. These are dense, highly educated, highly communal places with plenty of hipsters. These cities, like Austin, Seattle and San Francisco, have lots of innovation, lots of cultural amenities, but high housing prices and lots of inequality.

The second kind of cities we might call Joel Kotkin cities, after the writer who champions them. These are opportunity cities like Houston, Dallas and Salt Lake City. These places are less regulated, so it’s easier to start a business. They are sprawling with easy, hodgepodge housing construction, so the cost of living is low. Immigrants flock to them.

We should be focusing on the growing, dynamic places and figuring out how to use those models to nurture inclusive opportunity and rejuvenate the places that aren’t.

[6] Emphasis added.

[7] Bartlett, “From the Embryo to the IPO, Courtesy of the Conveyor Belt (Plus a Tax-Efficient Alternative to the Carried Interest)” The Journal of Private Equity Winter 2011, Copyright (c) 2011, Institutional Investor, Inc.

[8] and see Appendix B for a copy of the original.

Appendix A

“What enriched the modern world wasn’t capital stolen from workers or capital virtuously saved, nor was it institutions for routinely accumulating it. Capital and the rule of law were necessary, of course, but so was a labor force and liquid water and the arrow of time.

The capital became productive because of ideas for betterment—ideas enacted by a country carpenter or a boy telegrapher or a teenage Seattle computer whiz. As Matt Ridley put it in his book “The Rational Optimist” (2010), what happened over the past two centuries is that “ideas started having sex.” The idea of a railroad was a coupling of high-pressure steam engines with cars running on coal-mining rails. The idea for a lawn mower coupled a miniature gasoline engine with a miniature mechanical reaper. And so on, through every imaginable sort of invention. The coupling of ideas in the heads of the common people yielded an explosion of betterments.

Why did ideas so suddenly start having sex, there and then? Why did it all start at first in Holland about 1600 and then England about 1700 and then the North American colonies and England’s impoverished neighbor, Scotland, and then Belgium and northern France and the Rhineland?

The answer, in a word, is “liberty.” Liberated people, it turns out, are ingenious. Slaves, serfs, subordinated women, people frozen in a hierarchy of lords or bureaucrats are not. By certain accidents of European politics, having nothing to do with deep European virtue, more and more Europeans were liberated. From Luther’s reformation through the Dutch revolt against Spain after 1568 and England’s turmoil in the Civil War of the 1640s, down to the American and French revolutions, Europeans came to believe that common people should be liberated to have a go. You might call it: life, liberty and the pursuit of happiness.

While all this deep thinking was roiling the intelligentsia of Europe, the commercial bourgeoisie—despised by the right and the left, and by many in the middle, too—created the Great Enrichment and the modern world. The Enrichment gigantically improved our lives. In doing so, it proved that both social Darwinism and economic Marxism were mistaken. The supposedly inferior races and classes and ethnicities proved not to be so. The exploited proletariat was not driven into misery; it was enriched. It turned out that ordinary men and women didn’t need to be directed from above, and when honored and left alone, became immensely creative.

The Great Enrichment has restarted history. It will end poverty. For a good part of humankind, it already has. China and India, which have adopted some of economic liberalism, have exploded in growth. Brazil, Russia and South Africa, not to speak of the European Union—all of them fond of planning and protectionism and level playing fields—have stagnated.” —  McClosky, “How the West (and the Rest) Got Rich,” WSJ, May 20, 2016.

Appendix B

The Makeover

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