Category Archives: Entrepreneurship

Eileen Norcross on News Channel 8 Capital Insider discussing Virginia and the fiscal cliff

Last week I appeared on NewsChannel 8’s Capital Insider to discuss how the fiscal cliff affects Virginia. There are several potential effects depending on what the final package looks like. Let’s assume the deductions for the Child Care Tax Credit, EITC, and capital depreciation go away. This means, according to The Pew Center, where the state’s tax code is linked to the federal (like Virginia) tax revenues will increase. That’s because removing income tax deductions increases Adjusted Gross Income (AGI) on the individual’s income tax filing (or on the corporation’s filing) thus the income on which the government may levy tax increases. According to fellow Mercatus scholar, Jason Fichtner, that could amount to millions of dollars for a state.

On the federal budget side of the equation,the $109 billion in potential reductions is now equally shared between defense and non-defense spending. Of concern is the extent to which the region’s economy is dependent on this for employment. Nearly 20 percent of the region’s economy is linked to federal spending. Two points: The cuts are reductions in the rate of growth in spending. For defense spending, they are relatively small cuts representing a return to 2007 spending levels as Veronique points out. So, these reductions not likely to bring about the major shakeup in the regional economy that some fear. Secondly, the fact that these cuts are causing worry is well-taken. It highlights the importance of diversification in an economy.

Where revenues, or GDP, or employment in a region is too closely tied to one industry, a very large and sudden change in that industry can spell trouble. An analogy: New Jersey’s and New York’s dependence on financial industry revenues via their income tax structure led to a revenue shock when the market crashed in 2008, as the New York Fed notes.

On transportation spending there are some good proposals on the table in the legislature and the executive. Some involve raising the gas tax (which hasn’t been increased since 1986), and others involve tolls. The best way to raise transportation revenues is via taxes or fees that are linked to those using the roads. Now is no time to start punching more holes in the tax code to give breaks to favored industries (even if they are making Academy-award quality films) or to encourage particular activities.

Virginia’s in a good starting position to handle what may be in store for the US over the coming years. Virginia has a relatively flat tax structure with low rates. It has a good regulatory environment. This is one reason why people and businesses have located here.

Keep the tax and regulatory rules fair and non-discriminatory and let the entrepreneurs discover the opportunities. Don’t develop an appetite for debt financing. A tax system  is meant to collect revenues and not engineer individual or corporate behavior. Today, Virginia beats all of its neighbors in terms of economic freedom by a long shot. The goal for Virginia policymakers: keep it this way.

Here’s the clip

A public failure for a successful grocery chain

DC area entrepreneur Gary Cha owns a successful small chain of grocery stores called Yes! Organic Market. His business model is based on identifying neighborhoods that are not well-served by other grocery stores and opening up locations to provide residents with fresh produce and healthy food in their neighborhoods. Until his most recent location in southeast DC, Cha had never received subsidies for opening his stores. Rather, he chose locations with the duel objective of making a profit and providing his customers with access to groceries.

His most recent store, however, received a $900,000 subsidy to open in a location in DC’s Anacostia neighborhood that is not well-served by current grocery stores. After two years, the location is closing. Cha is very remorseful about the closure, and has lost about a million dollars of his own money in the effort. Cha and others have attributed the southeast location’s problem to the site’s access. As he told Washington City Paper:

“East of the river, I think, is a great place to do business,” he says. “And I think if I find another location with easier access, I may be the first going back there.”

The demand is there, he’s sure. Ever the self-critic, Cha just believes he needs to step up his game. “I know there’s a need for grocery stores,” he says. “I have to be a better businessperson. I just have to be better.”

While Cha places the blame fully on himself, it might also be worth placing some of the blame on the process with which this store opened. Unlike the other locations which Cha invested in privately, this one was subsidized. His other locations are still in business from his 14th Street location, with a Whole Foods now just down the street, to his Brookland location in an area that still does not have many grocery options. His business model relies on charging a premium for food that is not otherwise available in the neighborhood, but as he said, opening in the Anacostia location would have been too great of a risk without public money. This is not to say that all businesses that receive subsidies will fail, but this one example provides for support for free enterprise over subsidies for businesses that seek to meet public policy goals.

Small steps in VA occupational licensing reform

On July 1, hair braiding in Virginia will be deregulated. People will be free to braid hair without any license from the state saying that they are qualified to do so. The final requirements will be lifted after a 2004 move which reduced the requirement for hair braiders from a 1,500-hour course required of other cosmetologists to a 170-hour course.

The policy change came on the recommendation of the Governor’s Commission on Government Reform and Restructuring, which also recommended deregulation of landscape architecture, interior design, polygraph administrators, and mold inspectors, but only the recommendation with respect to hair braiding was adopted.

In Utah, however, hair braiders still face a much higher occupational hurdle. The Institute for Justice is suing the state in the U.S. District Court for requiring a 2000-hour cosmetology course for anyone who wants to braid hair in the state. As IJ explains:

Jestina Clayton, a college graduate, wife, mother of two and refugee from Sierra Leone’s civil war has been braiding hair for most of her life.  Now she wants to use her considerable skills to help provide for her family while her husband finishes his education.  But the state of Utah says she may not be paid to braid unless she first spends thousands of dollars on 2,000 hours of government-mandated cosmetology training—not one hour of which actually teaches her how to braid hair.  In the same number of class hours, a person also could qualify to be an armed security guard, mortgage loan originator, real estate sales agent, EMT and lawyer—combined.  Such arbitrary and excessive government-imposed licensing on such an ordinary, safe and uncomplicated practice as hairbraiding is not only outrageous, it is unconstitutional.

Unsurprisingly, cosmetologists favor keeping the law in place to protect their own investment and to restrict their potential competition. The case represents the absurdity of occupational licensing requirements and their detrimental impact on economic growth. However, the requirements that remain after streamlining efforts in Virginia beg the question of why we need licensing for just about any profession. Every exchange carries a risk that the consumer will be disappointed with her purchase, but by stifling competition we hurt consumers rather than helping them.

Occupational licensing requirements seem to be designed behind the idea that sub-par businesses are out to get their consumers. This is exactly the type of business that competition, rather than regulation, successfully eliminates. Selling consumers a poor service one time is not a winning business model, and online review services like Yelp are making it less and less possible to stay in business without providing a service that consumers love.

The case could be made that consumers can suffer irreparable damage from poor services, such as contracting an infection from an unsanitary manicure (though this type of risk seems unlikely in hairbraiding or interior design). Even so, the correct policy angle to take isn’t whether consumers would be harmed in a perfect world, but whether or not government does a better job eliminating this harm than competition and consumer choice among salons. Furthermore, without occupational licensing, consumers have legal recourse to sue in cases of damages, acting as an additional incentive for businesses to provide quality services.

In all but the most extreme cases, it’s clear that occupational licensing makes consumers worse off and limits job growth and economic productivity for the benefit of limiting competition for existing firms. Virginia offers a successful model of standing up to vested interests in favor of market competition but still has much room for improvement.

Do video game makers need subsidies from Rhode Island?

Curt Schilling is a former Red Sox pitcher. In 2010, his video game production business, 38 Studio was enticed to move from Massachusetts to Rhode Island with a $75 million loan guarantee from the state’s Economic Development Corporation (EDC). The bet Rhode Island placed was that 38 Studio (named after Schilling’s Red Sox number) would bring 450 jobs to the Ocean State. On May 1, the company failed to make a $1.1 million payment to the EDC. If the company tanks, Rhode Island taxpayers must pay for the loan. Schilling would like another chance and met with the Governor today to discuss further subsidies for the company’s second game, Copernicus. To his credit, Governor Lincoln Chafee was opposed to the initial loan guarantee which was made by his predecessor.

Rhode Island is of course not the only state with Economic Development Corporations offering taxpayer-subsidized corporate bait to lure companies into their states with the promise of jobs and prosperity. Policymakers simply do not think there’s any harm in it. But as Rhode Island’s bet on Schilling’s company shows – unless the party making the loan (the EDC and former Governor Carcieri) has skin in the game (in the form of their own capital) the potential for moral hazard exists. That is, the risks of a potential loss are downplayed or ignored by government officials because they are being borne by another party – the taxpayer. Moral hazard may also encourage the company getting the subsidized loan to take on undue risk.

Put this subsidy in the context of what taxpayers are already facing in Rhode Island. Pension and health care obligations rising quickly at both the state and municipal levels. Providence, West Warwick and Woonsocket are all perilously close to bankruptcy.

Scott Shackford at Reason sums it up thusly, “And while Rhode Island is throwing taxpayer money at elves and faeries, its cities are going bankrupt.”

And for more on how targeted subsidies produces distorted decision making read Matt’s work: Why Favor Manufacturing? and listen to his discussion with Kojo Nnamdi on Targeted Business Incentives and Transparency.

 

 

The Economy as an Ecosystem

On Wednesday I testified before the Senate Committee on Small Business and Entrepreneurship. The title of the hearing was “Perspectives from the Entrepreneurial Ecosystem: Creating Jobs and Growing Businesses through Entrepreneurship.”

It was a less-formal type of hearing than I have done before. There were lots of witnesses, no formal oral statements, and we could more or less raise our placards whenever we wanted to talk.

In my one-minute introduction, I noted that George Mason University came to national prominence in 1986 when James Buchanan won the Nobel Prize here for his pioneering work in public choice. (Vernon Smith, another active researcher in the field of public choice, would become Mason’s second Nobel laureate in 2002). I then said:

Public choice focuses on the ways in which government policies are actually determined and carried out. And I think this weighs on entrepreneurship, in particular. I, too, appreciate the ecological metaphor. I think it is a really appropriate metaphor. Recently, I’ve been looking at the public choice ways in which the ecology of entrepreneurship can sometimes be interfered with. Just like a natural ecology, entrepreneurial ecologies need to be a bottom-up process. And quite often can be subject to interference from governments.

I was pleased that the Committee’s chairwoman, Senator Landrieu (D-LA) largely agreed with me. Channeling her inner-Hayek, she replied:

That is an excellent point and I hope that we’ll have a little bit more of thought provoking comments about that. Just like governments can ruin physical infrastructure—I mean physical and natural environments—governments can also, with the wrong policies, disrupt the… I don’t know if you’d call it ‘natural,’…but the strength, the dormant strength or natural strength of a people to grow jobs and produce wealth.

Unfortunately, not all of her comments were so Hayekian. Another of the witnesses was tech-entrepreneur-turned-academic, Vivek Wadhwa. Today he wrote about the hearing in the Washington Post:

Government leaders — at least some of those present — actually seemed to believe they could, through legislation and spending, increase entrepreneurship and innovation. They asked questions such as: What legislation can we enact to build innovation ecosystems, facilitate mentorship, and teach entrepreneurship? They didn’t seem to understand that these are things entrepreneurs do—not governments.

I couldn’t agree more.

New Research on Freedom and Entrepreneurship

Here are a few findings from my recent paper with Joshua Hall and John Pulito titled “Freedom and Entrepreneurship: New Evidence from the 50 States”

  • Humans are entrepreneurial by nature. We desire to improve our material well-being, which drives us to innovate, often through new business creation. Despite the ever-present tendency toward entrepreneurship, public policy can have a significant impact on the incentives for entrepreneurial activity. Economists often call these incentives the “rules of the game.”
  • When making the decision to take on a new business, entrepreneurs must weigh the risks against the potential payout. Policy makers have the power to raise the cost of starting a new business by raising taxes or increasing regulatory costs, and they have the power to lower the cost by pursuing stable and consistent public policy initiatives consistent with economic freedom, such as low, broad-based taxes and prudent regulation.
  • Previous research has demonstrated that “rules of the game” favoring lower taxes and limited regulation—as measured by economic freedom indices—encourage entrepreneurship. Studies have found similar results both in comparisons across the states and in comparisons across countries. “Freedom and Entrepreneurship: New Evidence from the 50 States” uses an index of freedom, the Mercatus Center at George Mason University’s Freedom in the 50 States by Will Ruger and Jason Sorens. The study confirms earlier results: economic freedom permits higher levels of entrepreneurship, as measured by the creation of new businesses.
  • Freedom in the 50 States includes measures of both economic and personal freedom. Personal freedom had not previously been studied as a factor in the entrepreneurship level, and this study found that it did not in fact have a significant impact on business creation. Only economic freedom appears to have a positive impact on entrepreneurship, although personal freedom is of course important for other reasons.
  • This additional evidence that economic freedom is correlated with entrepreneurship should encourage policy makers to pursue changes that increase their states’ economic freedom. The evidence suggests that by increasing economic freedom, policy makers have significant power to improve their states’ climate for new business creation. For example, if policy makers in Ohio— which currently ranks 32nd in the Freedom in the 50 States’ Economic Freedom index—increased the state’s ranking to the level of Nevada, which ranks 23rd, Ohio residents could expect to see a 33 percent increase in new business creation. Lower tax rates, lower regulatory burdens, and lower barriers to trade can all encourage citizens to pursue their drive toward entrepreneurship.

Click here to read the paper in its entirety.