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First, Stop Digging
Before helping small businesses access capital, the government must ensure that the days of lockdowns and riots are over
By Ramon P. DeGennaro
Much of the country’s economic vitality has been damaged or even lost since COVID-19 appeared. So, the single most important thing that policymakers can do to help small businesses—even before assisting them in accessing new capital—is to restore a stable business environment.
Obviously, businesses cannot flourish until the economy fully reopens—and stays open. Most people understand that a locked-down business cannot make ends meet. Most also know that limits on gatherings hurt restaurants, bars, sporting events, concerts and other businesses, including the huge array of companies that support and supply them.
The problem with accessing capital, though, is deeper than government lockdowns or other restrictions; it’s an information problem. In a perfectly competitive market, if a business is good, then it will get funded; if it’s not, then it won’t. Unfortunately, we don’t live in that world. We live in a world with information problems. How do we know whether a business is good or not?
That’s a tough question, even under the best of circumstances. There are many sources of risk, including micro variables (such as production costs, sales volume and competitors’ reactions) and macro variables (such as the general level of economic activity). In the COVID-19 world, these risks are greatly magnified. The level of economic activity and business earnings will surely be lower than before the pandemic, but by how much? No one knows, and few have even a good guess.
Perhaps worse yet, in addition to the increases in the usual risks, businesses now face political uncertainty: political entities can now shut down not just your business, but also whatever other business they choose, and on virtually any pretense. Even if you are allowed to remain open, it doesn’t help much if your customers aren’t allowed to leave their homes, or if they can’t afford your goods and services. Capital providers will hesitate to invest, and if they do, they will only do so on tougher terms than before.
Unfortunately, the problem is even worse than that. Reopening the economy is a necessary step for small businesses to raise capital, but it isn’t sufficient. That’s because investors, like anyone else, look beyond the present. Would you invest your money in, say, a restaurant today, knowing that the authorities might shut it down next month or next year because of a resurgence in COVID cases or the arrival of another virus? No, or at least not without demanding a very high return. The business environment would be too unstable. Capital providers would understandably be reluctant to invest under these circumstances. It’s just too risky.
This means that, in addition to reopening, authorities must restore a stable business environment. “Stable” doesn’t mean eliminating all risk; that’s impossible. But before the pandemic, investors in the United States could count on government authorities to provide secure property rights and, in most areas, acceptably low levels of violence. Unlike in countries such as Iraq, Somalia or Venezuela, U.S. entrepreneurs should be confident that if they open that second restaurant across town, they’ll be able to operate it without fear of government authorities closing it down or rioters burning it.
To return to a stable business environment, authorities must credibly commit to no more lockdowns and provide assurance that they can protect businesses from rioters and looters. This is a tall order that policymakers ignored when making the decisions that brought us to where we are now.
We have suffered a permanent loss in output so far, yes, but with less secure property rights and increased violence, that loss grows ever worse. No one will provide capital to small businesses and startups under such circumstances. We are following a recipe that has produced poverty around the world. The longer a full reopening is delayed, the more likely that the daily loss will increase. Work not done Monday probably can be done Tuesday, but work not done in March probably cannot be done in December.
Government bailouts cannot solve these problems. Suppose I make a living repairing and maintaining restaurant equipment. If my business is forced to close, either directly or because my customers are forced to close and no longer need my services, then a bailout forces me to turn my attention to the paperwork required to file and collect the assistance. Even if the bailout makes it possible for me to find a job in another industry, I may not be as good at it as I was in the restaurant equipment business, which means the value of my skilled labor has been diminished or even destroyed by government edict.
We have dug ourselves a very deep hole. The first order of business is to stop digging and ensure that the economy remains open. Restoring confidence in secure property rights and ensuring safety will take much longer and be much, much more difficult.
This is the eighth and final piece in a series of articles that examines ways to help entrepreneurs who are seeking to start small businesses in the wake of the pandemic to access the capital they need. The first article in this series provides an overview of the challenges facing would-be entrepreneurs in the coronavirus economy. The second article concerns offering small businesses guaranteed access to credit. The third article examines the rules governing investors in startups. The fourth article concerns easing restrictions on lending by small banks. The fifth article proposes easing restrictions on the sale of securities by small startups. The sixth article argues that Congress should ease restrictions on peer-to-peer lending. The seventh article proposes several reforms to the Small Business Administration.