Simon Johnson's Blog, page 23
October 18, 2013
Bad Government Software
By James Kwak
Ezra Klein, one of the biggest supporters of Obamacare the statute, has already called the launch of Obamacare a “disaster,” and it looks like things are now getting worse: as people are actually able to buy insurance, the data being passed to health insurers are riddled with errors (something Klein anticipated), in effect requiring applications to be verified over the phone. Bad software is one of my blogging sidelights, so I wanted to find out who built this particular example, and I found Farhad Manjoo’s WSJ column, which fingered CGI, a big old IT consulting firm (meaning that they do big, custom, software development projects, mainly for big companies). (See here for more on CGI.)
CGI was a distant competitor of my old company. I don’t recall facing them head-to-head in any deals (although my memory could be failing me), but they claimed to make insurance claim systems, which is the business we were in. So I don’t have an opinion on them specifically, but I do have an opinion on the general category of big IT consulting firms: they do crappy work, at least when they are building systems from scratch. (They generally do better when installing products developed by real software companies.)
The data centers of the world’s largest companies are littered with difficult-to-use, inflexible, expensive, error-riddled software. Some of it was put there by their in-house IT departments; most of it was custom jobs purchased from consulting firms. As an ordinary human being, most of it is hidden from you (except in your capacity as an employee of one of these companies), but you do get occasional glimpses: peeking at the screen of the airline ticket agent, for example. Or occasionally you’ll be on some otherwise consumer-friendly website and you’ll call up some data about your account (utility and insurance companies are likely candidates) and you’ll see your data, truncated, in all caps, poorly formatted—you’re getting a glimpse into the horror of the mainframe behind the pretty web screens.
Why is so much software so bad? There are lots of reasons. Writing good software is hard to begin with.* Big, custom projects are unique by definition, so they are sold as promises, not as finished products. Every vendor promises the same thing, so the one who promises to do it at the lowest cost often wins; when the project turns out late, bad, and over budget, too many executives have too much invested in its success to admit defeat. Consulting firms, which bill by the hour, make money by staffing projects with lots of people at relatively low cost, which is absolutely the wrong way to develop software; the productivity differentials in software are so vast that you can often get ten times as much output (of quality software) for less than twice the price, while a bad developer will do more harm than good to a project.
Sure, not every company is equally bad at either building software or buying software that works. Manjoo points the finger at one thing that is at least partly to blame: government procurement. Buying software, in the form of finished products or custom projects, is hard, and there are lots of reasons to believe the federal government is especially bad at it. The underlying problem is that government technology procurement is the province of a handful of big contractors and a handful of officials at the agencies who do the buying, and neither side has any real incentive for things to change.
As others have noted, the failure of healthcare.gov is not unique in the annals of government technology projects. But it is surprising that the Obama administration—which has tried to build a reputation for competence—did so spectacularly badly on its flagship project. Most likely, there were just not enough people in the chain of command who had enough understanding of technology to realize that things were going horribly wrong, which is a pretty clear management failure on the part of the administration.
* Although it’s not that clear that this was a particularly hard project. The thing that makes enterprise software difficult is integration to multiple back-end systems. I was surprised to learn that the integration to health insurers is done via daily files, which is just about the easiest way to do it. (Basically, healthcare.gov just has to generate one file per day, per insurer, listing all the people who bought coverage from that insurer, along with their details.) I live in Massachusetts, and judging from our exchange (thank you, Mitt Romney!) there isn’t any other integration: just some qualification logic and then the presentation of a menu of options.



October 16, 2013
A Few Quick Thoughts
By James Kwak
It pains me to see so much blogging fodder passing before my eyes and not have any time to do it justice. But here are a few thoughts:
Why does anyone think that anyone cares about what a rating agency has to say about Treasury debt? Credit ratings matter for obscure companies because they represent new information that is not otherwise available to investors. In the case of the U.S. Treasury, all the information you need to know is plastered across the front page of the world’s newspapers, all the time. Your not going to change your opinion because of something that Fitch says.
Since the debt ceiling mess started heating up, the yield on the one-month T-bill has increased from about 2 basis points (the rough average for September) to 32 bp. It makes sense to me that, if you absolutely have to get your cash back on October 31, it might make sense to be nervous about a bill coming due on that day. But otherwise, there is no chance that you won’t get your principal back. Does anyone think that the government won’t get its borrowing authority back one of these days or months? And does anyone think the Treasury won’t go back and redeem all the bills that came due during the hiatus? Which is why I’m not particularly worried about my holdings of the Vanguard Short-Term Treasury fund.
I am probably one of the few liberals who don’t think the Tea Party caucus is engaged in irresponsible hostage-taking. Sure, I disagree with their policy objectives, and they are risking economic catastrophe by trying to force the government into default. But they are also fighting for a principle, misguided as it may be: Obamacare is evil, and should be stopped. The debt ceiling is an absurdity that should not exist. But since it does exist, it is leverage that conservatives can use to try to achieve their policy goals. The problem is that the debt ceiling exists; given its existence, you can’t blame people for using it for their ends. It’s like the filibuster: you can say that the 60-vote requirement is bad, but you can’t blame people for taking advantage of it. As Norman Ornstein said (quoted in White House Burning, p. 103), “If you hold one-half of one-third of the reins of power in Washington, and are willing to use and maintain that kind of discipline even if you will bring the entire temple down around your head, there is a pretty good chance that you are going to get your way.”
Warning: If we get through this crisis alive, it’s because there are just enough Republicans who are just moderate enough to get sixty votes in the Senate, and John Boehner is enough of a realist (or a coward) that he doesn’t want to be known as the man who single-handedly caused a default (by refusing to let a compromise bill come to the floor). One more round of Tea Party elections, and Eric Cantor or Paul Ryan as speaker, and all bets are off.



October 2, 2013
Fiscal Madness And Entrepreneurship
By Simon Johnson.
This post draws on points discussed in class #7 of Entrepreneurship without Borders, a course at MIT Sloan. More details on the course are here.
With the US government in partial shutdown (including suspending a significant amount of research and development activity) and the very real threat of a default on US government debt looming, now is a good time to ask – can the US maintain its edge in technology-based entrepreneurship? What would it take to squander the advantages we currently have? Can other countries catch up or surpass us on this important dimension that matters a great deal for technological innovation, productivity improvement, and job growth?
Consider, for example, Germany, which has a strong small and medium-scale business sector, but traditionally not the kind of “home run” entrepreneurs seen in Silicon Valley.
In part this may be due to culture. In particular, Silicon Valley and perhaps the US in general are relatively tolerant of failure – failing with a start-up is often regarded as valuable experience. In contrast, in Germany there is stigma attached to business failure. In comparing across countries, ask questions about where top engineering talent wants to go to work – in Germany the preference seems to be large companies.
But there is also an important difference in capital markets – it is much easier to go public with a relatively young company in the US compared with Germany. The lack of an initial public offering (IPO) exit may limit the appeal to venture capitalists. The Neuer Markt, introduced for tech startups in the 1990s, was not a success – damaged by the Internet bubble bursting and some fraud. The recent US JOBS Act lowers disclosure requirements for some companies and makes it easier to engage in “crowd sourcing” of capital. Does this help or hurt entrepreneurial start-ups? The answer presumably depends on whether investors get treated well or badly by companies and by the investment banks that represent them.
German venture capital (VC) funds are more dependent on wealthy families; pension funds and endowments in have been prominent limited partners (LPs) in the United States. German funds tend to be smaller – investing less and willing to exit for lower amounts. As a result, there is less inclination to look for and bet on potential “home runs”. Some US venture capital funds derive most of their returns from the small number of investments that return 10 times the original outside investment (or more).
This is really helpful if you want to attract the best and the brightest potential entrepreneurs from around the world. People who want to hit business home runs would like to be funded by VC funds that are willing to place big bets. In this case, it makes sense not to see failure as a negative – perhaps actually making it easier to get backing for the next venture; in part, culture can be an outcome of economic incentives. (This point is made clearly and with math by Ramana Nanda and Matthew Rhodes-Kropf in their paper, “Innovation and the Financial Guillotine“.)
All of these long-standing advantages would be wiped out if the US defaults on its federal government debt. That would be the end of the world’s safest asset. Our value as a safe haven would disappear. And forget about taking your company public any time soon.
Most likely venture capital and most other sources of funding for business would dry up completely.
Playing games with the debt ceiling is a very bad idea – threatening to blow up innovation along with the rest of the US economy.



Economic Statecraft, Women, and the Federal Reserve
By Simon Johnson.
This post draws on issues discussed in class #6 of Entrepreneurship without Borders, a course at MIT Sloan. The syllabus and other materials are available here.
The US has a long and generally successful track record of using “economic statecraft” to advance its positions and values in the world. We helped rebuild Europe and Japan after World War II, with a judicious mixture of aid and access to the US market. Similarly, as the Iron Curtain fell after 1989, the US stepped in with targeted financial support and general encouragement to converge on the European Union’s political and economic institutions. The International Monetary Fund (IMF) and the World Bank, where the US has a big voice, have also played positive roles in many instances over the past 70 years.
No policy is perfect or without controversy. But surely this approach is better than relying primarily on military power in the way preferred by former dominant powers – think of Rome, the Ottomans, or even the British Empire (where there was some commerce, but also a lot of coercion.) But can we continue to apply the same economics-first approach to the next frontier for economic development – women’s rights? Whether Janet Yellen becomes the next Chair of the Federal Reserve will provide some insight into the answer to that question.
Analysts of economic development often point to “human capital” – meaning education, skills, and abilities – as a key determinant of which countries become rich. Similarly, entrepreneurs typically stress the importance of skilled labor in determining where they locate and build their companies. And there is no question that technological change has increased the advantages, in the US and around the world, to people who are skilled at working with computers (see this recent piece by David Autor and David Dorn; Professor Autor is my colleague at MIT).
With skills at such a premium, we should perhaps expect countries to put as many resources as possible into bringing everyone as much education as possible. But this is not in fact what we see, particularly with regard to girls and women in many places.
Women work hard everywhere. One question is whether this work is remunerated and picked up in official gross domestic product statistics. But the bigger issue is whether women have access to all available opportunities, including in the schooling system – as emphasized by Heidi Crebo-Rediker, former chief economist at the State Department (see my write-up of her June speech here).
Telling a country to suddenly find jobs for a lot more people obviously would not make sense – and that is not what this policy is about. But increasing the ability to women to become entrepreneurs and create jobs is not just a smart way to boost medium-term growth; it is also completely sensible and long overdue economic policy. See this recent report from the Global Entrepreneurship Monitor on where female entrepreneurship is already strong – and where a boost could make a difference over the next 10-20 years; the numbers for the Middle East and North Africa are striking.
Under the leadership of Christine Lagarde, the IMF has taken this issue on board and is working with governments to make sure fiscal and social support systems are more balanced across the sexes – for example, flagging and discouraging penalties in the tax system when spouses work. Public investment in childcare often makes a great deal of sense also – and this has been embraced, at least on paper, by the current government in Japan. If female labor force participation increases – and if these women get good jobs at good ways – this will greatly help with the fiscal costs associated with a declining and ageing population in Japan.
Perhaps the IMF can develop and regularly publish a set of indicators, along the lines of the World Bank’s Doing Business reports, but focused on the varieties of fiscal discrimination that all kinds of groups face (including, but not limited to women).
I subscribe to Daron Acemoglu’s view that the “root causes” of economic growth include creating opportunities for meaningful participation – with property rights and a fair legal system – by a broad cross-section of society (Professor Acemoglu and I are co-authors on a number of papers that make this point). In this context, it makes complete sense to bring transparency and pressure on all parts of the tax code that discourage women from working.
The State Department says Economic Statecraft “means both harnessing global economic forces to advance America’s foreign policy and employing the tools of foreign policy to shore up our economic strength.”
But any sensible economic policy begins at home – including with the role models we create. (Of course, our tax code also needs to be addressed; see my June NYT.com column for more details)
As one very specific but topical example, consider the Federal Reserve System. Beginning in 1913, the first 55 people appointed as Federal Reserve Governors were men. Nancy H. Teeters was the first woman was appointed Governor, in 1978, and Martha R. Seger was the second, serving from 1984 to 1991. There have been 89 Governors to date, of whom a total of 8 have been women.
There has been a shift towards more female participation in the past two decades, when another six women have become Governors: Susan M. Philips (1991-98); Janet L. Yellen (1994-97 and again, as Vice Chair, from October 2010); Alice M. Rivlin (1996-99); Susan S. Bies (2001-07); Elizabeth A. Duke (2008-13), and Sarah B. Raskin (from 2010). Because three of the seven Governors have been women until recently, it would be a surprise if President Obama allows female participation on the Board to drop sharply.
President Obama should nominate Janet Yellen as Fed Chair. She is the most qualified candidate ever, in my view. As well as overwhelming support from Democratic Senators, leading Republicans may heed Sheila Bair’s advice and also throw their weight behind Ms. Yellen.
We can talk all we want about what others around the world should do. Ultimately, people assess the United States – and follow our leadership or not – based on what we actually do.
An edited version of this post appeared on the NYT.com’s Economix blog last week; it is used here with permission. If you would like to reproduce this material, please ask the New York Times.



September 26, 2013
The Wall Street Takeover, Part 2
By James Kwak
Five years later, and things seem marginally better in some areas (the CFPB exists), significantly worse in others (LIBOR, money laundering, London Whale, etc.). There has been some debate recently about whether we have a safer financial system today than before Lehman collapsed. But the fundamental issue, as Simon and I discussed in 13 Bankers, is whether our political system will put the interests of society at large ahead of the interests of large financial institutions. On that score, there is little to be encouraged about.
In 2002, Art Wilmarth wrote a mammoth (262 pages) article titled “The Transformation of the U.S. Financial Services Industry, 1975–2000.” In that article, he identified many of the key trends in the financial sector—consolidation, deregulation, breakdown of Glass-Steagall, complex products, increased risk-taking—that would not only produce a financial crisis but make it so destabilizing for the economy later in the decade. Now he has written a shorter (164 pages) article, “Turning a Blind Eye: Why Washington Keeps Giving into Wall Street,” on the key question: why our government doesn’t do anything about it, even after the financial crisis.
Much of the material will be familiar to readers of this blog and others who follow the misdeeds of the megabanks closely. But Wilmarth provides a nearly comprehensive catalog of all the things we should be outraged about. Reading it, I remembered so many instances where Wall Street blocked or delayed sensible regulatory policies, or regulators pushed for Wall Street’s interests—the watering down of mark-to-market accounting, the artificial inflation of the mortgage settlement by giving dubious credits to banks for doing things that were in their own interests, and so on—that I had forgotten about or not thought about recently because they had been crowded out of my mind by successive waves of revelations.
According to Wilmarth, the fundamental problem, and the reason things don’t get significantly better, is the political power of major financial institutions. This power takes on many forms: campaign contributions, lobbying, regulatory capture in various flavors, and simply being “too big to jail.” Wilmarth tries to end his article on an optimistic note: even though Wall Street appears to be just as influential as it was before the financial crisis, perhaps the magnitude of its victory will trigger a popular backlash. I find it hard to be so hopeful: if we couldn’t get the job done in 2009–2010, when the financial crisis was on everyone’s minds, how will we be able to do it now? This is especially true with a Democratic president who is completely uninterested in dealing with the problem—and a Democratic nominee on deck who has never shown any inclination to take on Wall Street. (We can safely assume that the Republican nominee will be against any substantive regulation of the financial sector.) In any case, Wilmarth’s article does a great job of pointing exactly where we should be looking.



September 20, 2013
Starting With Chile
By Simon Johnson
This is a summary of class #5 in Entrepreneurship without Borders, a course at MIT Sloan. For links to the course syllabus and summaries of earlier sessions, see this post.
Chile has experienced strong and relatively sustained economic growth in recent decades. The economy has also proved more resilient to outside shocks (including to the price of copper, the largest export) than many others. This is a case of good macroeconomic management, including by the central bank. But there remains the question of how to create enough jobs and increase income levels – including for people at the lower end of the income distribution.
Start-Up Chile is an innovative approach to changing the culture about new ventures (see these FAQS). By enticing would-be entrepreneurs with relatively small grants to spend at least 6-7 months in Chile, this initiative hopes to create role models and stronger connections between young Chilean people and global business opportunities. If the entrepreneurs move on – as many do – perhaps this just helps build Chile’s position in global networks. See this recent assessment, or the organization’s own 3 minute video pitch.
Measured in terms of the World Bank’s Doing Business Indicators, Chile is good on average (ranked #37 overall and #32 on starting a business; contract enforcement seems acceptable). The weaker points include obtaining construction permits and how long it takes for a failed company to complete the process of insolvency. Remember that these data get at averages and are not location- or sector-specific within a country. Still, it is a noteworthy and somewhat disappointing that – despite a push towards entrepreneurship – Chile is moving down, not up, in the Doing Business rankings.
The major constraints on Chilean start-ups are likely: access to talent, willingness of customers to buy from start-ups, and the availability of venture capital on reasonable terms.
It is often better to locate close to demanding customers. There can also be advantages to being geographically close to tough competitors. Ability to attract and retain skilled labor and management talent may prove decisive. Agglomeration effects are strong and building a “hub” can be helpful.
Concern about family businesses having a lot of market power is standard in many emerging markets – and Chile is no exception. One advantage of Endeavor, as discussed in our last class, is that it builds on exactly this structure – encouraging the local “big fish” to behave more positively towards start-ups. This works because their founding board members watch each other and engage in the details. This is about nudging the culture of the business elite, in order to create the space for start-ups.
The application form at Start-UP Chile asks the right questions. It’s clear that the organizers have learned a great deal about how to run this process, and this is great (and fairly inexpensive) marketing for Chile. But are they selecting entrepreneurs with break through ideas?
What is the best return on public money and how can build private involvement? Are the Start-Up visitors sufficiently integrated with university activities, e.g., what students see and work on?



September 18, 2013
Five Years Later
By James Kwak
Five years ago, Lehman brothers went bankrupt, AIG was nationalized, Ben Bernanke stared into an abyss, and Mohamed El-Erian asked his wife to take out as much cash from the ATM as she could. And Simon and I started blogging.
I already wrote my anniversary reflections on the financial crisis for The Atlantic. Here I wanted to talk a bit about how this blog started.
This is a story I’ve told in person many times, so you should bear in mind that the stories we tell often are the ones we tend to misremember the most, for neurological reasons. As I recall, on Thursday, September 18, Henry Paulson presented his initial, three-page proposal for TARP. At the time, I was in something like my third week of law school, having just left the company where I worked for seven years. Simon had left the IMF I think the month before. I remember thinking the thought that I’m sure many of you had: if Treasury bought toxic assets at fair market value, that would only lock in banks’ losses and prove that they were insolvent; if it paid book value or something close to it, that would help the banks but would be a massive taxpayer subsidy. The next day, however, as far as I could tell, the media basically missed this point. On Saturday I talked to Simon and suggested writing an op-ed about what seemed to me (and probably ten thousand other people) a crucial problem, and on Sunday we drafted something.
On Monday, the Washington Post contacted Simon (remember, he had just left the IMF the month before) and asked if he had anything to say about the impending collapse of modern society—which, by chance, he did. But our draft was far too long (I didn’t know about the 800-word rule, which is a standard for print opinion articles), so we cut it down to focus on the governance issue, which turned out to be far more important than I think we even suspected at the time. (Think about TARP, PPIP, Neil Barofsky, Elizabeth Warren, et al.) I skipped my torts class to do the final edits—but I did tell the professor in advance. We had some excess material on the pricing issue, so Simon submitted that to Martin Wolf’s online forum at the FT.
And I thought I was done—I would go back to taking classes and enjoying having no real responsibilities (other than familial) after eleven years of work. Simon, though, pitched the idea of a blog, and that’s how The Baseline Scenario began. Like any blog, we had virtually no readers at the beginning, but we got cited by some of the big fish (like Mark Thoma, to whom I am forever grateful), and things grew from there. I remember thinking that if we didn’t get to 10,000 daily page views or something (I forget the actual number) within six months I would stop, and for a while it looked like we wouldn’t get there. But then Simon wrote a post about the American oligarchs, Bill Moyers invited him on TV, Krugman cited us a couple of times, and I was stuck.
Then there was the Atlantic article, which opened up the possibility of writing a book, which seemed like a fun thing to do—and it seemed unlikely I would ever have the opportunity again. The book was popular—in part because the SEC sued Goldman Sachs two weeks after it was published, so Bill Moyers devoted almost an entire show to us—and, to my surprise, made it possible for me to become a professor. And that’s how I became a professor, rather than a lawyer (which was the plan when I went back to school).
So why am I boring you with the story of this latest chapter in my life? To me, these past five years have been a lesson on the overwhelming importance of serendipity. There was a dramatic financial crisis, which gave us something to write about. I had just left my job and enrolled in the easiest law school in the country, which gave me time to think and to write. Simon had just left his job, which meant he could take positions in public other than those of the IMF. The Washington Post asked him out of the blue if he had anything to submit. (For ordinary mortals like us, it’s pretty hard to crack print op-ed sections.) I had dinner with some of my new classmates and ended up explaining CDOs and CDSs to them, which was the inspiration for our “beginners” posts. Bill Moyers read Simon’s post. The SEC sued Goldman just as our book came out. And, during my last year in law school, the UConn law school was hiring. (UConn is one of only two law schools within an hour of my house, and I wasn’t about to move.) And there was plenty of what turned out to be good fortune in earlier years, as well, such as my not getting a job as a history professor, which would have sent me down a completely different path.
As I’ve gotten older, I’ve become more and more convinced that we get where we are because of luck as much as anything else, in the business world as well as the academic world. This is one reason I have the positions that I do on taxes and social insurance.
That’s also one of themes of Michael Lewis’s story for This American Life a about Emir Kamenica, who resolutely insists that he is where he is because of a freak occurrence—an English teacher reading an essay he plagiarized from a Bosnian novel (stolen from a library as he was escaping a war that killed his father) and getting him into a good private school. The people who think that they deserve everything they have because they are geniuses and worked hard all their lives are, in more or less Lewis’s words, “just like every miserable bond trader at Goldman Sachs.” And who wants to be like that?



September 17, 2013
Entrepreneurial Endeavor
By Simon Johnson
Below is a summary of points from Class #4 of Entrepreneurship without Borders, a course at MIT Sloan. Use this link to look at earlier sessions.
The conventional view about entrepreneurship in emerging markets is that it is difficult or perhaps impossible for new start-ups to have a great deal of impact. Local markets are dominated by big players who have a great deal of power and who can make life difficult for young competitors (e.g., a frequent complaint in South Korea). Weak institutions, such as contracts that are hard to enforce, tip the balance towards large incumbents – many of which are based on a long-standing family business.
There is also often a culture (social norms and expectations) that does not view failure as a positive learning experience. And access to capital and other critical inputs (e.g., talented workers) may be limited or not available to entrepreneurs at a price that makes the firm viable – or that allows for rapid growth.
Endeavor is an organization that works hard to address these issues, particularly by creating a local and global network of people who want to help entrepreneurs. These communities have done very well in some countries – including in South America (see this visual representation of Endeavor’s impact in Argentina).
Direct state financial support to specific entrepreneurial firms – or even to particular sectors – is rarely successful. Subsidies often lead to unintended consequences, come under political pressure, and prove hard to sustain – for example, when there is a change in government.
In contrast, creating a strong technology development environment can be very helpful. In part this can be based on activities by large local companies and even multinationals (e.g., early in the case of software development in India), as long as people and ideas can migrate into the start-up sector. Endeavor has had great success – see their metrics – by focusing on developing trust among key people, including entrepreneurs, influential established business leaders, and governments. (I’ve been an adviser to Endeavor in the past, and I highly recommend participation in their International Selection Panels – where outside experts interview candidates and determine which specific people should receive Endeavor support.)
Universities often play a critical role in this regard – with government policy having an important role, in terms of supporting research and also facilitating technology licensing and transfer (e.g., see the work of Ed Roberts on MIT). There also needs to be a culture of cooperation between universities and business. Reportedly, one difference between southern Germany and northern Italy is that universities and companies work together closely in the former but not as much in the latter. This matters for productivity growth rates, innovation, and the changing basis of international competitiveness.
For any country, competing on the basis of cheap labor alone is not a good idea. Sooner or later, alternative suppliers will develop with even lower wage costs. Companies – and countries – need to develop an ability to develop and apply technologies to local conditions, and to figure out where else they can sell the same or similar ideas.
Helping entrepreneurs go global is a great idea, but definitely not easy to implement. Endeavor input often helps entrepreneurs think this through carefully (and this is often where teams of MIT students, for example as part of our GLAB course, prove helpful).
Applying Daron Acemoglu’s approach to economic development (on which I have also worked), the biggest positive impact must be when the broader political and economic institutions in the country – as well as human capital and culture – tilt towards supporting private business development. This is one lesson from the success of manufacturing exports in East Asia since 1960.
When entrepreneurs are successful, based on becoming internationally competitive, they have an interest in maintaining an open economy and a relatively fair playing field. But how broadly are those benefits shared, both immediately and over time?



September 13, 2013
Thinking About Doing Business
By Simon Johnson
In class #1 of Entrepreneurship without Borders (at MIT Sloan) we discussed attitudes towards starting a new business. In many countries, people want to become entrepreneurs, but they can access only limited types of opportunities. Relatively small established elites, often with strong political connections, are able to mobilize the resources needed to build a company that can do well. Class #2 focused on the details of the current situation in Portugal – the macroeconomy will presumably begin to improve and the basic enforceability of legal contracts seems fine, but we do yet see a breakthrough in companies being created by new entrepreneurs. Below is a summary of the discussion in class #3.
The World Bank’s Doing Business indicators offer a rich set of data with many insights into the various barriers facing small and medium-sized business – as well as potential entrepreneurs. These numbers provide a first-pass comparison across countries focused on (a) regulation, and (b) contract enforcement.
Singapore and Hong Kong are the impressive leaders of the pack (see Table 1.1 on page 3 of the executive summary of this report). Countries can grow with an unfavorable environment, measured in this way, but this is more likely with a great deal of natural resources (e.g., offshore oil in Angola, ranked #172). For most countries, it would be wise to look for a set of reforms that make it easier to do business.
Experience in Georgia since the mid-2000s is encouraging. The government used the Doing Business indicators and related work to target their priorities – and made a great deal of progress, for example in terms of reducing the number of licenses required (for all kinds of activities) and creating a legal fast-track for applications (i.e., pay a premium and get your passport faster).
Regulatory simplification also makes it easier to reduce corruption – the available evidence (from Transparency International; see Appendix C, Table 1, “Bribery rates around the world”) is that Georgia made great progress on that front also.
More generally, some former communist countries have made significant headway in shedding their bureaucratic traditions. There have also been impressive improvements in sub-Saharan Africa.
The cost and complexity of regulation may be easier to address than legal institutions (i.e., contract enforcement, insolvency regimes, credit information, legal rights of creditors, borrowers, shareholders).
Countries that rank surprisingly low, given their recent economic performance, in the Doing Business rankings include China and India. In China, this may be an indication it is easier to do business with an official partner of some kind – being a purely private start-up is not always so easy. And while India varies across sectors – e.g., software continues to be strong – there is plenty of onerous regulation for bricks-and-mortar businesses.
The Doing Business measures are not intended to pick up the size or nature of the opportunity for entrepreneurs. Is there a big domestic market (e.g., China)? Is there skilled labor – the talent – that wants to stay put and is available either at lower cost than elsewhere or otherwise better motivated (e.g., Indian software, complemented now by people who have been successful entrepreneurs in the US)?
Perhaps the most sensitive issue of all is labor regulation. Entrepreneurs want to be able to hire people – and to fire them when they don’t perform or the business does not work out. This does not sit well with existing labor law in some places – and it is a particularly contentious issue in peripheral Europe (although changes have been made in Portugal and other places). The World Bank no longer emphasizes this reform – it is mentioned in the Doing Business report but not as part of the main indicators.
The Acemoglu perspective – which I share – is that longer-run institutions tend to predominate. Reforms in the business environment are possible, and changes at the margin or in some exceptional countries can take place. But it is hard to escape a long tradition of concentrated power in which only a few people get good opportunities. And resistance to reform can also come from people in relatively protected positions – previously safe government jobs or regulated professions.
It is also very difficult to compensate people for any loss of power (or job security) as a result of reforms. Even if they are offered compensation, such promises are not typically credible – once a group has given up power (or safe jobs), there is no incentive to actually provide the compensation.
The bigger question is: how much progress can you make with specific Doing Business-type reforms? Does this change the political economy of a country – making it more pro-growth or creating broader opportunities for more people?
What kind of reforms just end up concentrating more power in fewer hands?



September 12, 2013
Where are the European Entrepreneurs?
By Simon Johnson
This post is based on class #2 in my MIT Sloan course, Entrepreneurship Without Borders. An edited version appeared this morning on the NYT.com’s Economix blog.
Europe today is relatively rich on average, and there is undeniable potential for further convergence towards Northern levels in use of technology, organization of firms, and productivity levels. We witnessed some impressive economic improvements over the past 20 years as Eastern Europe left behind its communist system – in part due to the creation of dynamic new firms (e.g., in Poland) and in part as a result of investments by foreign companies (e.g., in Hungary). But the extent of North-South productivity convergence within Europe has proved disappointing since the formation of the euro area in the late 1990s.
Southern peripheral Europe is now in the midst of a serious economic crisis – precipitated by the realization that sovereign debt may actually be quite risky. The immediate financial market pressure receded last year when the European Central Bank indicated that it will intervene to keep yields (i.e., interest rates on government debt) at manageable levels, but there is still the critical question of when growth will turn – and what rate of growth is sustainable in the medium term.
Does economic crisis of this type lead to more entrepreneurship – in a form that will put these economies onto a stronger growth path? Or does the contraction of credit and pressure on consumers and firms mean that it is much harder for a new business to get started?
Portugal is a good place to look for some specific answers – and perhaps for clues to what may happen more broadly in Europe.
By some measures, Portugal is making good progress in terms of stabilizing its economy and getting public debt under control. A presentation in April by Vitor Gaspar, then finance minister, made a strong case that Portugal is on the mend – and should be seen more like Ireland than like Greece. Certainly the budget picture has improved and growth in the second quarter was better than expected.
But any macroeconomic recovery requires either existing firms to grow or new firms to form – this is what creates jobs. In terms of individual stories there are definitely some positive signs – including from this recent New York Times coverage of firms that are increasing exports, in part because domestic market prospects are not strong.
And there are broader indications that corporate performance is gradually recovering across the board. Large investment projects are unlikely to face political obstacles – although the overall level of political uncertainty remains an issue (and Mr. Gaspar resigned in July).
For smaller firms, there are numerous discouraging barriers to entry and growth, and the Portuguese government has not made it a priority to address these.
The World Bank’s Doing Business indicators provide a useful window into some of the concrete issues. Obtaining construction permits is a big problem (measured relative to other countries in this extensive database). And access to credit in Portugal is dismal, according to these measures — credit access worsened from 2012 to 2103 (Portugal’s rank fell from 97th in the world to 104th). This is not just the crisis; the available indications are that it was also hard to obtain credit before the government’s finances were viewed as problematic.
To be fair, the basic enforcement of contracts in Portugal is good (ranking 22nd in the world, according to the World Bank) – collecting on a bad debt or enforcing a noncompete clause in an employment contract is not much harder than in London or New York. And while there may be some corruption involved in real estate transactions, it does not seem to endemic in all areas of economic activity.
Still, something more should be done – and not just in Portugal. The prospects for a rapid recovery in Italy also do not look good, if you focus on the potential for new business growth.
The broader picture is that the euro has not depreciated, so the incentive to export is more muted and the ability to compete against imports on the basis of price is less than in some crises (e.g., what happened in Asia after the 1997-98 crisis there or in Argentina after the currency board collapsed in early 2002.)
Economists like to talk about restoring price competitiveness – but this is code for cutting wages, which is never popular politically. Portugal is no exception, although there has been an impressive decline in annual compensation that on average is probably around 10 percent (in part through not paying the so-called 13th month bonus).
The best hope in peripheral Europe is the creation of new firms and the expansion of firms that are currently small. Cutting regulation and red tape would be enormously helpful. Making it easier for firms to go out of business would also make sense – start-ups need to be able to fail in a clean and relatively painless way when things do not go well. Simplifying the tax system would also help.
I’m not in favor of the government trying to pick winners – or even, once fiscal order is restored, putting money into any kind of venture fund or providing tax breaks or subsidies for particular sectors. This kind of policy has gone wrong in Portugal (and many other places) in the past.
But there must be broader ways for the government to make it easier to commercialize technology developed in universities. And matching big international firms with pockets of technology, for example around biotech development related to agricultural inputs, could make sense. Facilitating these activities does not necessarily require a significant capital outlay.
In January 2012, Peter Boone and I were pessimistic about the macroeconomic outlook – and I’m glad that our worst-case scenarios have not materialized. In part, the European Central Bank has been able to signal support for troubled governments without actually having to commit a great deal of additional credit.
We do not know how long it will be possible to sustain this policy – and eventually countries like Portugal must find their way back to growth. But in the decade before the crisis, Portuguese growth was anemic – around 1 percent per year (see Mr. Gaspar’s presentation, above).
Portugal has lots of talented, energetic people – as well as some strong engineering schools and outstanding physical infrastructure. The weather and the food are excellent. This is a friendly place where contracts can be enforced.
What would it take to move Portugal to a higher medium-term growth rate?



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