Sunday, June 24, 2012

Some Brief Thoughts on Risk Taking and Growth

I have often heard variations on the theme that exposing people to additional risk is likely to drive growth by a more efficient allocation of resources. Linked to this, I also observe a tendency to describe entrepreneurs as being lean and hungry, as if the thought of not being able to put food on the table is part of the driving motivation.

I have serious doubts about the accuracy of this description. From what I've read of the entrepreneurial literature, most entrepreneurs fall into one of two camps, both better described as fat and happy rather than lean and hungry. One type is the upper middle to upper class individual from a stable family who generally combines drive with a substantial ability to earn a good salary as an employee if their venture fails. This individual does tend to load up on debt in starting their enterprise. However, this hardly means the individual faces outsize risk, at worst they declare bankruptcy, lose a bunch of stuff they bought with other people's money, and go work for the man as a faceless suit.

The other type is generally an older couple whose kids are reaching self-sufficiency. These couple's frequently use their own assets to start a business, so have more exposure than their younger counterparts, but they frequently are able to shelter a significant portion of their assets in case their venture does go under. These individuals also tend to have had successful careers and have a good idea how to run a business, their experience means they are taking a lot less risk.

In both these cases, it is more accurate to note that their risk taking is not despite their security but because of it. Individuals without this security will often take a secure, minimum wage job now over a chance at much higher returns later. When the basic essentials for one's culture (this of course expands with a society's wealth, there doesn't seem to be a hereditary notion of what is essential to living in a given culture) are potential losses from taking risk, individuals instead seek security, leading to these individual's not reaching their potential in society, eroding the ability of the market to assign rewards based on merit and economic efficiency.

This can be generalized to historical economic growth as well, I don't believe that it is insignificant that economic growth takes off when safe assets are diversifying, something that separates capitalist takeoff from earlier periods is the diversity of investment instruments available (notably government bonds but also other limited liability organizations that are available for investment) compared with agrarian economies where the only truly safe asset is land.

This links into my earlier post, in customary economies most economic actors are highly diversified because risk exposure in any one area could easily lead to destitution and perhaps starvation. Market economies rely on specialization and specialization relies on individuals feeling secure that this specialization won't lead them to insecurity of life and property. In countries with underdeveloped markets it is remarkable how diverse an individual's activities are, there is little sign of specialization. I saw a lot of this in Zambia, few people could point to one job as what they do. Instead, they farmed, worked at the clinic, sold clothing, and invested their time and capital in a variety of ventures. Without a true safety net, this is essential, only through diversification can an individual gain security. Of course, this also makes specialization, and true market integration, difficult or impossible. Spreading one's efforts across so many areas leaves one a jack of all trades, master of none.

Sorry for the digression, my main point is that there is substantial grounds for questioning the perspective advocated for by men like Paul Ryan that the state should step back from providing security in order to promote growth through exposing individuals to risk. Based on pretty much everything I've ever read on the topics of economic growth, history, entrepreneurship, economic and political psychology, etc. the likely result of this is not a stronger market and economic growth, but rather an involutionary diversion of resources into the customary economic and a greater diversity of individual efforts, rather than the specialization which is one of the primary signatures of a developed market economy. Risk takers are those that are fat and happy, not those that are lean and scared. If we want economic growth, the route to it is to provide everyone with a safety net that will allow them to take greater risks, whether it is risking time or capital, so that economic gains can flow based on merit rather than based on how exposed an individual is to the downsides of their action. Bankruptcy seems to be a sufficient threat to instill discipline, adding limitations in their children's chances, limitations to their own ability to achieve success, limitations on access to medical care, and if we're going all in on the idea of assigning risk to individuals, starvation to the risks individual's face seems like an impediment to growth to me.

1 comment:

  1. Thanks for the sensible critique. Me & my neighbor were just preparing to do some research on this. We got a book from our local library but I think I learned better from this post. Breeches