The economy looms large in this year’s Presidential race. Romney is portraying himself as a Harvard MBA businessman who can bring fiscal responsibility to the nation and restart the ecomony.
There are three concepts that most people don’t seem to understand. I’m hoping this will clarify them.
Business is the activity of developing a product, finding a market, and bringing that product to that market. If a business can sell the product for more than it costs to manufacture and deliver the product, the business makes a profit. If a business spends more than it can make on a product, it loses money and eventually goes bankrupt.
Finance is the activity of buying and selling money. Banks are financial institutions. Creating loans, packaging the loans into (ironically named) securities that can be bought and sold, and redirecting the flow of money are all finance activities.
Finance does not produce anything directly. Indeed, finance deals in a commodity product (cash). Financial firms are paid by facilitating the exchange of money between two other parties, and being paid as a percentage of the transaction.
After a financial transaction, money that was previous available to produce goods, employ workers, and create tangible products and services is no longer available to the businesses that do those thing. It’s been taken out of the system into the coffers of the financial firm in the form of transaction costs.
(And indeed, there are some actual costs associated with paying the salaries of the bankers who do due diligence, who structure the deals, and who fill out all the necessary paperwork. The percentage-of-transaction-based compensation provides them rewards proportional to the value others have created, not proportional to the work they’ve actually done.)
Business Doesn’t Create Jobs
The misconception everyone seems to have is that businesses create jobs. That’s true in the sense that business provides the mechanism for people to contribute to making goods and services. But businesses don’t create jobs.
A good businessperson tries to reduce costs and run as efficiently as possible. That’s why automation so revolutionized the world—we could do more work with far fewer people. That’s why businesses pursue productivity, so they can scale up their production faster than they need to scale up their headcount.
Any businessperson who is acting in the interest of the bottom line should be trying to slow job growth or actively shed jobs within their company.
Jobs are created when a business experiences so much demand that it has no choice except to hire more people to cope with the demand. The demand drives the business to create more jobs.
Someone with the business experience of presiding over a growing business does not know how to create jobs; they know how to create demand for their specific products and services. This is a great skill for growing an individual business.
Growing a business isn’t the same as growing an economy. As Apple grows demand for its products, it grows demand in no small part by taking business away from its competitors. Apple does well, but Microsoft does less well that it otherwise would. Getting one business to do better is not the same thing at all as growing an overall economy so everyone does better.
Finance Isn’t The Same as Business
Finance skills have to do with sales and deal structure, not with making the people, process, logistics, and marketing decisions that build a business capable of mass production of goods or services. In fact, since financial firms are rewarded as a percentage of other people’s value, the best-run firms from a business perspective can increase their profits by simply seeking out higher-value transaction that require the same amount of work to carry out as lower-value transactions.
The skills needed to put together a money-capturing financial transaction that buys and sells businesses simply have very little to do with the skills needed to build and run the businesses being bought and sold.
It’s possible that in a large-enough financial services firm, the managers must develop business skill with respect to managing the analysts and bankers who put together the transactions.
We Want Jobs!
What most Americans are worried about is job creation. They’re asking “will I be able to make a living and get paid a fair and decent wage?”
That depends on the ability to build the economy overall. To return to the Apple/Microsoft example, what’s needed is for both Apple and Microsoft to grow (along with gazillions of small entrepreneurial businesses, which is where most new jobs get added to the economy).
Stimulating an overall economy is an enormously complicated task. It involves establishing the rules and regulations of business to create a playing field for businesses to compete. Urban planning, architecture, public works projects, and so on, are the province of economic development.
Even if you have the right infrastructure and resources all lined up, you need to get consumers to demand products. Once they demand enough products, businesses will have to hire to meet demand, and the economy revs back up to life. You need both the infrastructure and the demand to get the economy moving.
There are different economic theories on how to kick start consumer demand. It’s way beyond the scope of this article to discuss them. Suffice to say that there are many factors that may be keeping people from spending money: too much personal debt, insecurity about the future, limited earning potential caused by lack of marketable skills, etc. As such, stimulating demand may require approaches that address all of these things.
Neither Candidate Knowns How to Create Jobs
Which candidate will be able to create conditions that create jobs? I have no idea.
What I can say is that neither candidate has experience that inspires confidence in me.
Romney? I’m Not Confident.
Romney earned his money in finance, not in business. He bought and sold businesses, using fancy borrowing techniques to get his money out while saddling the businesses with vast amounts of debt. That isn’t a recipe for job creation.
To the extent that he has direct business experience, he hired and managed people at Bain Capital. But growing a single business isn’t the same as creating conditions for businesses across the board to do better. And if once considers the collateral damage of the debt Bain Capital imposed on the companies it bought and sold, it’s not at all clear that the company is successful from a societal point of view (which is the point of view a President needs to take).
Furthermore, the statements he’s made about reducing taxes, raising military spending, etc., simply don’t add up math-wise.
Romney’s time as Governor in Massachusetts may provide clues to his ability to stimulate an economy, except (a) it’s unclear that a Governor actually does much to influence a State’s economy, and (b) under Romney, Massachusetts did reasonably well in absolute terms, but quite poorly relative to the rest of the country. (In other words, the overall economy seemed to be improving, but Massachusetts improved less than other states. If we do decide that a Governor makes a difference, Romney significantly underperformed other Governors.)
Obama? I’m Not Confident.
Obama’s experience has been in community organizing, not economic development. He is a smart man, and may have a grasp of economic principles that doesn’t come through when he is speaking to a national audience. I’ve been singularly unimpressed with his choice of advisors and equally unimpressed with his reaction to the 2008 crash, which has been to change nothing structurally to insure that it doesn’t happen again.
Congress Won’t Do it
Even if the President has a wonderful plan, remember that it’s Congress that has to adopt the plan. Given the current state of the legislature, it’s hard to imagine enough bipartisan sentiment to pass even the most perfect economic recovery plan.
- Business, finance, and economic development are different. Expertise in one doesn’t translate to the others.
- Romney’s experience is in finance. Obama’s is in community organizing and law. Neither has much experience in business, and even if they did, it’s not clear business experience is relevant to overall job creation.
- Romney’s economic track record in Massachusetts was underwhelming, but since Governors have little effect on a state’s economy, that may mean nothing.
- The economy has improved under Obama by many measures, though I don’t get the impression he really has much of a theory as to how to really get things moving again.