Are Firms Entrepreneurial?

Most firms and business people are in my view rent seekers rather than entrepreneurs. This statement ofcourse immediately begs the question: what is the difference? According to Investopedia, rent seekers are organizations or people which use "their resources to obtain an economic gain from others without reciprocating any benefits back to society through wealth creation." Entrepreneurs by contrast are risk takers who obtain an economic gain from other but in return they give something of value back. The free market economic system depends on entities being entrepreneurial. This way new products, service and ideas percolate through the economy enriching all of us in the process.

However, what happens when entities within an economy start engaging in rent seeking behavior instead of entrepreneurial behavior? Instead of developing new products or new kinds of services, such entities increasingly seek to lock in the advantages that originally gave them the edge over their competitors. The net result is that consumers are saddled with increasingly higher prices and less advanced products and services. Often these effects take hold gradually. Consumers are then like the proverbial frog in a pot which is gradually brought to a boil. As the change in temperature is slow, the frog does not realize about the increasing danger and is thus cooked alive. Similarly, when entities start engaging in rent seeking behavior, the products and services that their consumers buy gradually deteriorate in quality. Without realizing it, the expectations of their consumers gradually diminish. What would have once been considered low quality becomes routine and what used to be routine now becomes a mark of quality. Why don't consumers realize what is going on? There are various types of rent seeking activities many of which are often difficult to distinguish from entrepreneurial ones. In any case, the change in behavior is seldom sudden but instead takes place over a period (sometimes a very long period) of time.

There are many examples of rent seeking behavior in the corporate world. Virtually the entire car industry has engaged in such behavior for much of its existence. In the 1950s and 60s, the emphasis was on producing flashy cars with tail fins and spikes and other such accoutrements. Technological development such as developing new kinds of engine technology or even improving the existing technology was a very low priority. Many manufacturers did not even seek the kind of production efficiencies that would result in increasing quality and lowering costs. Most of such companies were the industry's market leaders. Those companies that were more entrepreneurial and sought out the production efficiencies eventually usurped the pole position occupied the market leaders.

In another example, General Motors was one of the first companies to develop an all electric car back in the 1990s. What happened next is a beautiful example of rent seeking. The company not only abandoned the technology it had developed, it also recalled all the cars it had made and physically destroyed them. This despite the consumers pleading to be allowed to keep these cars.

Oil companies are another case of firms engaged in rent seeking behavior. All of them are aware that there is a finite supply of the commodity. At some point, viable alternatives will need to be developed. All of them devote far more resources to marketing and public relations than to developing alternatives to oil - a step that is going to be necessary for them to remain relevant in a post oil world.

Even technology companies which are supposed to be highly entrepreneurial and operating in a fast changing environment behave in rent seeking ways. The rush to patent and copyright software tools, algorithms and protocols is an example of this.

Economic theory insists that such behavior is unsustainable in the long run. Most business people also subscribe to a similar view. Why then would any organization, much less a profit seeking one, engage in activities that are essentially rent seeking in nature? One answer is that successful rent seeking activities act as toll gates. They will generate steady and usually large sums of money for very little effort. Another effect of successful rent seeking is that competition is stymied or at least dampened for a period of time. This allows for extra-ordinary profits which can sometimes border (or even be) monopolistic. Rent seeking activities can also be encouraged by sometimes strong network effects. Many industries have a winner take most characteristic. Once one company has established itself and taken advantage of network effects, it can be very hard to dislodge. This increases the inducement to do rent seeking. Furthermore, we must keep in mind that truly entrepreneurial activities are very hard to do on a consistent basis. They are also risky with an uncertain payoff. Rent seeking on the other hand is much easier to do with a more certain payoff. Most managers specially in public companies are evaluated on a yearly or even a quarterly basis. By the time any negative effects of rent seeking become evident, an individual manager will have moved on or retired. It is thus not surprising that organizations specially as they grow larger would engage in rent seeking activities.

Related articles

• What is an entrepreneur? (only1cornerstone.wordpress.com)
• Rent-seeking is not capitalism (ourdinnertable.wordpress.com)
• Are You An Entrepreneur Or A Business Owner? (twistimage.com)
• Rent Seeking As A Corporation's Social Responsibility (reason.com)
• Financialization Era - how banking welfare captured our economy and ravaged the wealth of the working and middle class. Building profits through financial debt leverage. (xkorpion.wordpress.com)

The Point of Economic Growth

Over the last half century or so, virtually everyone has become fixated on economic growth in general and GDP growth in particular. The leading opinion - indeed everyone's opinion - is that economic growth will automatically lead to higher incomes for all strata of society and that is "a good thing". A rising tide lifts all boats. However, in all this mania for economic growth come what may, an important question is frequently ignored. What is the point?

At certain levels of development, a focus on economic growth is justified. For example, when an economy is trying to move from beyond subsistence level, there is naturally a focus on economic growth and GDP growth in particular. Indeed this focus is natural as the economy moves into the middle income level. It is at this level and beyond that a blind focus on economic growth (and GDP growth in particular) starts to become problematic in my opinion.

How does an economy grow? Economists can come with all sorts of explanations regarding how economies grow. Most of these will focus on increasing use of some combination of land, labor and capital. Ultimately, economies grow because people buy more things. It does not matter whether these people live within a particular geographic boundary or outside it. Marketers generally distinguish between consumer and business markets. While both have their unique characteristics and require different marketing techniques, in the final analysis, business markets exist because of consumer markets. Businesses only buy various goods and services because ultimately some consumer somewhere is buying an end product that incorporates part or whole of what the business sells. So if economies grow because people buy more things, how do you get people to buy more? In other words, how do you get people living within a particular economy to buy increasing quantities of the goods and services that that economy produces or imports.

Generally speaking, consumption is increased when consumers either buy more of something or they buy that thing more frequently or some combination of the two. When economic development is at a low level, large numbers of people lack basic things like access to housing, water or even basic personal items like for example soap. Economic development is accompanied by a concomitant rise of manufacturing jobs which pay sufficiently well that basic necessities are taken care of and people can think of buying occasional luxuries. At the same time, there is an increase in the demand for and consequently supply of education which enables people to further improve their prospects in the job market. A virtuous cycle is set in motion in which developments like the ones just mentioned engender further economic growth which enables businesses to expand and offer larger varieties of goods and services which increases demand for them and so on. And so the economy gradually rises from a low, generally subsistence level to increasingly affluent levels. Markets expand and consumption increases.

The potential problem arises when growth raises an economy to a middle income level and beyond. At this point, raising consumption starts becoming increasingly harder. This is due to the fact that larger and larger number of people have access to the goods and services that they desire. No one can continue to consume goods and services indefinitely. When this point starts to be reached, then increase in consumption come about partly as a result of population growth and partly as a result of increasing consumption of luxuries.

It is at around this point that the question raised above needs to be asked. Stated in another way, the question is what does a blind faith in unimpeded economic growth accomplish? Does it result in a happier populace? Research seems to indicate otherwise. Does it make for a wiser population? There is no evidence for that. Does that make for a population that achieves great self fulfillment? Apparently not. So then beyond a certain level, exactly what is the point of blind economic growth?

Globalization's Dirty Secret

There is a dirty little secret regarding globalization that almost no one is willing to talk about. The secret is that no matter what developing countries do, they can never hope to attain the same sort of lifestyle for the majority of their people as that currently being enjoyed by the developed nations. Indeed the problem is that even developed countries cannot enjoy their current lifestyle forever.

The reason for this assertion is that our civilization and consequently our lifestyles are based on a throwaway culture. Take an example from Pakistan. An ink-jet printer here costs approximately Rs. 3000 (roughly $35). This comes complete with a black and a color ink cartridge. If you add a mere Rs 100 (a little more than a dollar) to the cost of replacing the black and color cartridges, you can buy a brand new ink-jet printer. With these economics, it starts to make sense to throw away the old printer and simply buy a new one. And therein lies the problem. You end up throwing away a perfectly good and usable printer and unnecessarily buying a new one simply because the way the printer and the cartridges are priced. Multiply this across an economy and the problem emerges. Buy virtually any food item. Almost all come in nice, attractive packages which are designed to be thrown away once the item is consumed. Usually the containers are made of non-biodegradable materials. The result is overflowing landfills and more importantly an excessive use of resources.

Nowadays, we keep hearing of peaks for various kinds of commodities. There is peak oil, peak water and even peak soil. There is a sense that we are taking our the necessary raw materials from the ground at an ever increasing rate. The problem is that once the non-renewable resources are used up, they are gone forever. Once a particular seam of iron ore has been mined, it is gone forever. Even the renewable resources are being used up at a non-renewable rate. The question is why?

I feel that this issue goes to the heart of the problem with today's economic system. Every single one of us has been fed the mantra of continuous economic growth our entire lives. Recessions are bad and to be avoided at all costs. If they cannot be avoided, then steps must be taken to minimize their impact and restart growth at the earliest possible. Growth, growth, growth. At all costs the economy must grow. This is dinned into us from our earliest childhood and reinforced continuously throughout our education. What virtually no one seems to ask nowadays is what is the point of all this growth?

To come back to my earlier point; given the constraints on resource availability, there is simply not enough raw material left in the ground to catapult the majority populations of the developing countries into the kind of lifestyles that the developed countries currently enjoy. This is an issue that will increasingly come to the fore as these countries develop their economies using the same paradigms that the developed countries used at similar stages of development. And as this realization starts sinking in amongst the populations of the developing countries, the potential for conflict will start to increase. Unfortunately, given the myopic leadership that almost all countries currently have (barring a few individuals who probably will not have much impact on the sea of mediocrity that surrounds them), the chances of peacefully managing these conflicts appear to be remote at this juncture.

Demographic Change

Capitalism is an unstable system. More specifically, the Anglo-American version is unstable. This is a point that I have made in an earlier post but it is worth repeating again. The currently accepted paradigm assumes infinite growth. This is usually defined as growth in the bottom line which is a measure of the supremacy of the financial system in the recent past that this one measure overshadows any other. Growth in the bottom line can come either by increasing sales or by cutting costs or by a combination of both. Increasing sales in turn can come by either increasing the number of units sold (whatever those units may be) or by increasing the price per unit or again by some combination of both. In practice, it is not always possible to keep on increasing the price per unit so there is usually an element of increasing the number of units sold involved. Increasing the number of units again involves either inducing more and more people to buy the producer's goods and services or inducing the same number of people to keep increasing their purchases or a combination of both. Again, in practice, it is this combination of both that is employed by producers.

From prehistory till the dawn of the industrial age, the global human population was largely static but very slowly increasing if seen from a perspective of several centuries at a time. Periodic crises would knock back the population severely. For example, there is evidence to suggest that an ancient volcanic explosion may have resulted in an abrupt and dramatic decrease in human population although this is not accepted by everyone. In historic times, the black plague caused massive population decrease in Europe and around the world. Collapse of empires such as the decline of the Roman Empire were another reason for population decreases. Population levels would then recover until the next crisis. Despite the crises, there was still a gradual increase in population levels. The industrial age saw a very rapid increase in population. This was caused by improvements in medicine and sanitation which dramatically lowered overall mortality rates as well as maternal mortality rates.

In the past, before improvements in medical care, when mortality rates were high and specially infant mortality rates were high, it made sense for people to have large families. This way, it could be ensured that some children would survive to adulthood. As agricultural productivity increased over time, the population would grow to take advantage of the extra food. This was what led Malthus to make his grim predictions. As mentioned above, the industrial age brought improvements in medicine and sanitation that caused mortality rates to fall. However, birth rates continued to stay high. The result was a population explosion at first in Europe and North America and then in the latter part of the 20th century in most of the rest of the world. It seemed only a matter of time before the worst predictions of Malthus would start playing out.

But then something strange started to happen. For the first time, people gradually started restricting the number of children they had. This trend started first in the developed economies and has now spread to the rest of the world. It happened unevenly and slowly at first. The end of the Second World War actually caused an increase in births - the so called baby boom in the US. Now however, it is firmly established that the birth rates have fallen to below replacement levels in most parts of the world. This is an unprecedented situation. Below replacement birth rate means that over time, the population grows older and starts to decline. Japan is most advanced in this trend with most of Europe following. The US is currently maintaining its birth rate at a replacement level thanks mainly to immigration. The birth rates in developing economies have also mostly fallen to below replacement levels although a high birth rate in the recent past means that there is a large bulge of young people currently working its way through. Over time however, these countries will also experience a graying and then a declining population.

What does this mean for businesses? Earlier I had said that one way to increase the bottom line is to increase the number of units sold and one way of doing this is to sell to larger numbers. How does a declining birth rate affect this calculus? In later posts, I will be exploring this question and some implications of a declining birth rate for businesses and the economy.

Innovation

Innovation is the life source in the world today. For a long time, it has been taken as a given that the world is changing at an increasing rate and the only way for companies and people to cope with this increasing rate of change is innovation. So what exactly is innovation?

Wikipedia defines innovation as "a new way of doing something." Additional definitions of innovation can be found at the Innovation Zen blog. The key take away here is that innovation involves doing something in a new fashion. In every industry or market, there evolves a consensus on doing things. Innovation comes when someone, usually an outsider, discovers a new way of doing these things. Or a discovery or invention renders the product or service obsolete. What is interesting about innovation is that incumbents are usually not the people who innovate. This is in many respects surprising when one considers that the incumbents should be most aware of discoveries or inventions or trends that will affect them. After all, their very survival depends on it.

Case after case in industry after industry has shown companies being caught flat footed and in many cases going out of existence. Delving into the (relatively) remote past, coach makers failed to see the arrival of the automobile as a threat and an entire industry was extinguished to be replaced by another. More recently, in computers, mainframe manufacturers almost went under under the onslaught of the personal computer. In both cases, new players on the scene pulled the rug from under the feet of the incumbents. For a more recent example, take the music industry. When the Internet came along, there arose the question of what to do with the medium. The music industry viewed the new medium as a threat to its lucrative sales of CDs. Also, in the beginning, no one was sure exactly how to make use of this new medium. Then Napster came along and showed how music could be efficiently distributed to large numbers simultaneously. The industry's response? Sue Napster out of existence. However, by then the cat was out of the bag and for the next 15 years, the music industry struggled with the rise of online music. Even now, it is only reluctantly coming round to viewing the Internet as a new medium. Only now is it reluctantly acknowledging that the old business model is dead and a new one has to be found.

So now the question is why are incumbents so blind? Why does innovation typically not come from them? Part of the reason is that incumbents, being so close to the action, fail to see the wood for the trees. Also, when a new innovation comes along, it often is not seen as a potential threat because of (usually) teething problems. A third reason is that over time, large corporations have ceased to be well springs of research and innovation. Instead they have tended to become rent seekers. So for a variety of reasons, well established companies cease to be innovative and thus lose their edge and often their very existence.

Needs & Wants

What are the basic motivators that drives a person. Anyone who has worked in a transnational corporation has come across Maslow's Hierarchy. If we think in these terms, then what are the basic motivators for a person. I believe that the very basic motivating factors driving a person are just two: food & security. These are primal needs. Without them no one can survive for very long. Food is a need. Without it there is no survival. What kind of food to eat is a want. Similarly security is a need. What kind of security is a want. If we go up the hierarchy of needs/wants a little, there is the need for sex. This group of three: food, security & sex are basic needs. I have not put sex as a primal need. The reason for that is that sex is not necessary for the survival of the individual unlike food & security. However it is a strong motivating factor - so strong that it has to be categorized as a basic need. This troika is also expressed colloquially as wine, women & song: the three standing respectively for food, sex & security. While the first two are logical juxtapositions, the third one may seem odd. What has song and security got to do with each other? The answer is simple. An insecure person - insecure in the sense of not having enough to eat and having no shelter would never dream of indulging in song or rather the larger category of entertainment. A recreational activity like this requires a minimum level of security in order to carry out.

We have identified two level of needs. Primary needs: food & shelter and basic needs: food, sex & shelter. These needs are expressed in many different ways. The ways in which they are expressed are called wants. The ways in which these basic needs are expressed have resulted in some of the oldest economic activities. Let us go up the needs/wants hierarchy a little more. Once the primary needs (& hopefully the basic needs) are met, a person starts thinking about meeting the higher level of needs. What are these higher level needs?

Humans are material, social and spiritual creatures. The basic needs are essential material needs. But there are other needs that need to be met if a person is not to be a one-dimensional being. Being social creatures, humans have an inherent need to develop emotional attachments. These bonds are primarily towards family; then acquaintances (including friends), then clan and/or religious community members and finally all others. It has been shown that these emotional attachments are literally necessary for a long & healthy life. No man is an island unto himself - atleast not for long. The need for emotional attachment is expressed in different ways. Along with the need for emotional attachment is the need to communicate. These two needs - the need for emotional attachment and the need to communicate are fundamental needs.

So now the needs hierarchy is becoming clearer. First there are the primary needs: food and security. Without them, survival is not possible. Then there is the basic need: sex. Food, security and sex are extremely powerful driving factors.Then there are the fundamental needs: emotional attachment and the need to communicate. Fundamental needs have to be met at some level and different people have different levels at which they satisfy these needs. Going up the needs/wants hierarchy further, we enter the realm of higher needs. These are spiritual in nature. They nourish the nebulous entity known as the human spirit. At the root of these needs lies the need to learn/explore. Learning and exploration are in may respects two sides of the same coin. Learning anything inherently has strong aspects of exploration while exploration inherently strongly involves aspect of learning. Learning/exploration can be either internal or external or both. If it is internal, then it can lead to the highest level of Maslow's hierarchy - self actualization. So there we have it. A complete hierarchy of needs (or atleast as complete as I can think of). To recap: Primary

• Food
• Security

Basic

• Sex

Fundamental

• Emotional attachment
• Communicate

Spiritual

• Learning
• Exploration

Wants are essentially an expression of these needs. All economic activities are ultimately designed to meet one or more of these needs.

Private Profits, Public Losses

We have grown used to not paying the full cost for the goods and services that we consume. Partly this is because of the free goods and services that nature provides for us and partly this is because we have a system whereby losses are socialized but profits are privatized. The result is both over consumption and too much pollution.

Many of the goods and services that nature provides for free are simply not appreciated by most of us. For example, mangrove trees are known to mitigate the impact of storms and sea surges. Much of the damage caused by the tsunami of 2004 would have been lessened if the mangrove swamps had not been cut down. Instead, these were deemed to be of no economic value. Cutting them down and replacing them with hotels was thought to bring greater economic value to the region. Instead, these areas faced the full impact of the sea. A good article of the type of under appreciated services provided for free by nature can be found here. As this article points out, a new type of accounting is needed; one that takes into account the cost of the goods and services provided by nature. The problem is that the negative impact for an individual consumer is too diffuse. That is why the cost of pollution can be socialized.