Risk-spreading and the entrepreneurial spirit

Social insurance encourages entrepreneurship by making entrepreneurial failure less personally catastrophic.

I’m with Steve: risk-spreading is a great theme for the Democrats. It fits in with my favorite proposal for a five-word summary of Democratic domestic policy: “We’re all in this together.” That’s something Americans believe.

But Americans also believe what is also true: that risk-taking is a great engine of progress. So it’s essential to make the point that risk-spreading actually encourages risk-taking: you can be much more daring in your high-wire act if you’re working with a safety net.

As Megan McArdle (“Jane Galt”) has pointed out, making life harder on those who go bankrupt discourages entrepreneurship. So if we argue skilfully, we can be seen as promoting both security and risk-taking.

Footnote “We’re all in it together” ideas have more appeal in wartime than they do in peacetime, since war tends to make us think of a larger “us” against an external “them,” while peace allows us to focus on internal divisions. So there may be a tension in practice between running a saner foreign policy and attracting political support for a sounder domestic policy. However, there seems to be little danger of a sensible foreign policy over the next two years.

Second footnote When I was young and irresponsible, I worked for Edwin Land at Polaroid. One of his slogans was “No person, and no company, incapable of failing cheerfully will ever achieve anything great.” It’s well known that one of the engines of Silicon Valley’s success is a culture in which having founded a company that crashed and burned is a resume entry, not the end of a career. Megan promises a book on these themes.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

7 thoughts on “Risk-spreading and the entrepreneurial spirit”

  1. Despair and passivity are the enemies of both community and progress. Safety nets are protection against both.
    In the mid-1970's there was a study that showed that Social Security had the effect of INCREASING the degree to which poor people save and plan for retirement.
    Not surprisingly, this study was unpopular with Martin Feldman and the cons (I think it was actually done by his Bureau) and has all but disappeared from the literature. The rightwing's faith-based position is that fear and insecurity are good for little people. Only the wealthy and the great corporations will be uncorrupted by guarantees – because their power and riches show that they are the Elect. (I'm not sneering. I'm serious.)

  2. Rescinding the bankruptcy "reform" is a start. Getting some sort of universal healthcare scheme going is next in terms of encouraging an entrepreneurial environment. Older farts like me and my friends with families, mortgages, etc. just can't take the risk of starting companies without a health plan, and it's prohibitively expensive and a huge hassle, especially if you want to start out with fewer than 10 people. That's one reason why it's a young person's game right now.
    I'm seeing more and more software startups in Scandinavia, where they combine good national healthcare, a reasonable safety net, a well-educated workforce, and not so many roadblocks for starting small companies as some of the other EU countries.

  3. Of course, there's a converse to "risk-spreading encourages risk-taking," and it's what usually concerns me about Social Democratic-style policies. One way to discourage risk is by increasing the penalties of failure; the other way is to decrease the rewards of success. So high marginal tax rates, for instance, worry me because they greatly reduce the benefits of exactly the sort of entrepreneurial risk-taking we want to encourage.
    It occurs to me that you might have (inadvertently) made a case for a quasi-Charles-Murray style tax policy: a strong safety net at the bottom, financed by a flat tax structure above. This potentially would increase entrepreneurship at both ends (though at the expense of traditional Democratic equality concerns, so I'd be shocked if you actually supported this). The Austrian in me says this is bad because it causes people to take risks that the unadjusted payoffs say aren't worthwhile. But they don't pay because people have a subjective resistance to risk; if well-structured this policy could (possibly) correct for the gap between individual concerns about risk and the overall benefits of a more dynamic economy.
    Now, that's not to say I necessarily buy this either; all the other traditional libertarian critiques apply, including above all "do you really think the government would manage to get the program set up right?" But it's an interesting idea.

  4. Jadagul:
    As the insurance markets and the joint-stock company both illustrate, lots of business ventures that don't pay due to risk aversion as long as the losses are left to lie where they fall can be made to pay if the expected utility loss associated with the risks is decreased by spreading the risks around. But adverse selection, moral hazard, and the problem of random events already resolved guarantee that many beneficial risk-spreading arranagments cannot be arrived at consensually. That must be true even in Austria.

  5. As I said, the Austrian (economic school, not country; think Ludwig von Mises) in me thinks this is a problem. I think the Austrian is wrong, for basically the reasons you state. My concerns lie in other directions: I'm worried that we'll slash the benefits of risk enough to actually make risks less attractive, and I don't trust the government to do a good job of implementing well a policy that may be good in theory.

  6. Jadagul wrote, "So high marginal tax rates, for instance, worry me because they greatly reduce the benefits of exactly the sort of entrepreneurial risk-taking we want to encourage."
    Depends what you're taxing. A lot of income collected in the upper brackets is nothing more than rent collection, which can be taxed heavily with no ill economic effect (on efficiency) whatsoever.

  7. liberal, when you raise marginal taxes it's probably true that much of what you're taxing isn't entrepreneurship. But most entrepreneurship is being taxed: the most important kind of entrepreneurial activities tend towards "relatively small chance of large payoff, probably all at once." There's a big difference between a 10% chance of making $20 million and a 10% chance of making $12 million. I'm not sure how you write the tax to collect on what you claim are rents (I think much less of it is rent than I suspect you do) without also nailing the entrepreneurs we want to encourage. The efficiency losses from preventing the founding of one Apple or Google or Yahoo or Viaweb are pretty high.

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