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Technological innovation key to productivity

In the second and final part of our question-and-answer session on the Island's economy, Bermuda College lecturer Craig Simmons shares his hopes for 2016

•QUESTION: To what extent do we have reason to be optimistic or pessimistic for the year ahead?

ANSWER: As a general rule of thumb, when market participants are overly optimistic — as they were in the real estate market prior to the recession — you should, at the very least, veer on the side of caution. And, when market participants are overly pessimistic — as they are now — you should be optimistic. Few people alive today have had or will have the opportunity to purchase commercial or residential real estate or equities at today's low prices.

At the heart of people's negative outlook is the inability to think and act independently or courageously. Pluralistic ignorance has us trapped into thinking what we think other people think. John Keynes used the metaphor of a beauty contest, in which the winner is the person who picks the contestant that others think is most beautiful, to make this point. This is one of the reasons why entrepreneurship and investing aren't for everyone.

•QUESTION: What would you like to see done to improve our chances of economic recovery?

ANSWER: The speed with which one is able to discharge one's debt is painfully slow. This is what distinguishes the United States economy from most others and helps explain how they were able to throw off the effects of a financial crisis that started in late 2007 and move into recovery mode by the second quarter of 2009 — for a mere 18 months in recession versus our 60 months. One indicator of this painfully slow process is the speed with which non-performing loans are decreasing. The ability to fail quickly and move on to the next prospect is a feature of a dynamic economy. Except for the international business sector, the local economy is far from dynamic.

Technological innovation is the most important source of productivity and growth. It is more important than education, foreign investment, or the size of the labour force. For an economy as small as ours, the law is an important source of technological innovation. Limited liability company statues were a boon for growth in jurisdictions that adopted them. Our international business sector has grown precisely because of legal innovations in the areas of captive insurance, reinsurance, fund management and insolvency law.

Elements of Bermudian law are on the cutting edge — especially in respect of regulatory competition. But, when it comes to simple discharging of household indebtedness, Bermuda is a laggard.

Small and medium-sized enterprises could benefit from the creation of a loan and equity facility designed specifically for the challenges they face. I prefer equity financing since it creates a better alignment of incentives between lender and borrower than debt financing. As a result, an equity financier has greater skin-in-the-game as part owner, sharing in the profits if and only if they are earned.

Unlike large enterprises that need credit for purchases of plant and equipment, SME, more often than not, need loans or equity to cover operating losses associated with establishing their place in a chosen market. Further, SME are major job creators and, without knowing it, they provide economic stability. For example, the restaurant business is volatile — it has a high turnover. But, at any point in time, there is never a shortage of restaurants — the bad ones quickly go out of business. Volatility at the micro-level leads to stability in the sector as a whole. Large businesses, like large mammals — elephants and whales — do not handle volatility well. They need a steady stream of large revenues to stay afloat.

Empirical work by Thomas Åstebro sheds light on the performance of SME. Of 500,000 businesses founded in 1996 in a US Census Bureau sample, 50 per cent had failed within six years, less than 10 per cent achieved sales of more than $1 million, and 1 per cent had achieved more than $10 million in sales. The entrepreneurs running these SME earn, on average, low returns on their investment. Even when encountering losses, they persist for long periods before giving up. Only a few are extremely successful.

It is entrepreneurs' uncalculated risk-taking and their willingness to accept the downside — bankruptcy and humiliation — for the sake of others that makes them the engine of growth and some of the most respectable people in our society. The extent to which government should involve itself in a loan or equity facility for SME is unclear. Governments around the world have tried copying the success stories of South Korea, Israel and California's Silicon Valley. We will have to find our own way, perhaps by relying on the top 1 per cent of income earners for sources of venture capital and private equity to this most worthy of causes.

Craig Simmons (Photograph by Akil Simmons)

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Published January 04, 2016 at 8:00 am (Updated January 04, 2016 at 8:31 am)

Technological innovation key to productivity

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