It's The Economy, Stupid

There has been a few stories in the media recently about business closures in New Brunswick.  Does it portend doom?  Is the economy about to collapse?

Relax.  Within two years of starting, 11.4% of all businesses across Canada go out of business.  This is known as the business exit rate.  Across Canada, almost 130,000 businesses will go out of business within two years of starting.  The better metric is business starts.  If the entry rate is higher than the exit rate for a prolonged period of time that is one sign of a strong economy.  If the exit rate is higher, it could be a warning sign.

The private sector economy is best viewed as a kind of Serengeti Plain – a wild place where the strong survive and the weak die off quickly.  This Schumpeterian dynamism is important.  We want to be a place where people can quickly test new business ideas – get in the market quick – fail fast – get out, start over.   It can be painful to see an entrepreneur go out of business but that is the nature of a dynamic economy.  We would never get innovation without the Serengeti Plain.  We would never see a focus on productivity and prices would be bloated without the Serengeti Plain.  Many economists suggests that wealth consolidates in even fewer hands if there is no competition to beat down excessive profits (although there may be less wealth to begin with).

I haven’t seen these numbers for New Brunswick.  I have taken a look at other data that suggests the Serengeti Plain is not as alive in New Brunswick as elsewhere. More incumbents, less business churn.  I’m not sure about this and it would take more research but if this is the case it is not a good thing.  From the individual business perspective being in a protected or sheltered industry or being in a geographic location where no competition arises feels good but for the economy and the public interest overall it is not particularly good.  Less innovation, higher prices and – more importantly – firms ill equipped to tackle external competition when it comes.

A few years ago I used the example of business cards.  When I started this business more than a decade ago I paid over $100 to get a box of business cards from a local vendor.  Now I can order that same set of business cards for 84% less from a vendor in the United States – thousands of kilometres away.

Government policy should be structured to encourage the Serengeti Plain.  There should be enough risk capital around to absorb the losses associated with the Serengeti Plain.  National banks should have the same risk tolerance in New Brunswick as they do in Ontario (ooops, can anyone confirm this?).  Governments should certainly not pump in more cash to try and keep a firm alive just because they were an initial contributor and are worried about being associated with a loss.  Let it go under.  Likely the entrepreneur will get back up and get back on the Plain (unless she is blackballed because of one failure).