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Death Throes of the Middle Class 2

People feel too insecure to start new businesses.

By Petrarch  |  October 14, 2010

Ordinary Americans are running scared these days - scared that they'll lose their job and never find another, scared that for the first time in American history their children will be worse off than they were, scared that the American dream is ending.

In point of fact, they're quite right to be afraid.  As we saw in the first article in this series, economic security defines what it means to be middle class - and with the collapse of the job market, that security is gone.  Nobody can be assured of having a job tomorrow or of finding a new one before losing everything it's taken a lifetime to build.

Obviously, this situation is very bad for the country and very bad for the people.  Unfortunately, it's directly bad for the economy as well.  Not just for the obvious reason of people not spending money - many of our purchases come from China anyway.  The truly unfortunate aspect of the situation is that with the middle classes so legitimately fearful, they will not be founding the small businesses that are the leading source of... new jobs.

An Appetite for Risk

It is a truism in the financial industry that reward is supposed to be directly related to risk.  Treasury bonds, backed by the full faith and credit of the United States, carry a very low interest rate of return.  Junk bonds in some dicey company offer a far higher return because there's a significant possibility that the company will go bust and you'll get nothing back.

The art of being a financier is identifying the mismatches between risk and reward before everybody else does.  Sooner or later the world will realize that the U.S. owes far more than it can ever plausibly repay, therefore the risk is not zero as has always been assumed, and the demanded return will go up considerably.  In the other direction, a canny investor might read a small article in the back of a newspaper stating that a particular scientist has made a startling breakthrough, identify the previously unknown company the scientist works for, and invest in its stocks or bonds before word gets around.

By definition, all of this activity is risky.  You never know if a company really will be successful until it actually is.  The more likely success seems, the more other people will know about it and the more competition you'll have; the returns on your investment will be less.

Insanely risky investments can sometimes lead to unimaginable wealth, as when George Soros broke the Bank of England.  More often it leads to bankruptcy, which is why we are not George Soros.  However, that's why most famously rich self-made people have been bankrupt failures several times before they succeed.

As we saw earlier, being middle class means reducing risk as much as possible.  A single twentysomething can take a chance working for a tech startup; if it fails, they can move back in with Mom for a while.  If you're married that's somewhat less practical; if you have children, it becomes very impractical and highly unappealing to boot - so married parents generally prefer a more stable employment without the chance of great success, but a smaller chance of catastrophic failure.

The more secure the baseline salary, the more willing middle-class people are to take risks elsewhere.  If you are in a secure government job from which you can't be fired, you might try to start a business on the side - if it doesn't work, you've still got your day job.

People with private-sector jobs also start side businesses, of course, but that's become much more difficult.  With layoffs so prevalent and new work hard to find, any extra dollars are more prudently saved than put into a startup that might die; any extra hours are best spent ostentatiously burning the midnight oil at what once was merely your day job, in hopes of being the last to get the boot.  The risk of entrepreneurship is perceived as greater and for most people, the risk is simply too great.

The Road Not Taken

Even when the side-business starts to be successful, there comes a time when it can't grow any more without full-time leadership.  Then comes the agonizing decision to "quit your day job" and go out on the limb of entrepreneurship.

In good times, people are more willing to do this because "I can always find another job if I have to."  Would any sane person be so sanguine today?  Not only is a new small business more likely to fail because times are hard, but finding another normal job is far harder than it used to be.  The expected returns are lower and the risk is too great.

Most small businesses fail, and always have.  But many don't - and those that don't are the source of most new jobs in America.

A small business that isn't started will never hire anyone.  A small business that is started and is successful, but where the founder doesn't have the confidence to quit his day job and take care of his baby business whole-hog, will probably not become a wildly successful startup that provides employment to thousands.

Starting a small business always involves risk.  When ordinary middle-class employment could be counted on, ordinary middle-class people had enough appetite for risk to try to start something new.  Now, though, just living involves as much risk as most people can handle; they don't want any more.

The only people who might consider starting a business are those already rich.  Not only there are far fewer of them, they, too are well aware that the risks of failure have been increased greatly in the current political climate.

If the government wants employment to increase, increasing the potential rewards of new business - lowering taxes - is certainly helpful, but by itself, it won't be enough.

What's needed is to reduce the risks involved by making normal jobs easier to find.  Reducing paperwork and employment regulations would help.  So would lower taxes on business - as we've seen, government's share of the cost of employees is astronomical.  Beat back the thicket of government impediments and we'd start seeing some action on the jobs front.

Unfortunately, our current government is doing exactly the opposite, while the death throes of the middle class continue.  What we need is a new government with a saner view of things.

Otherwise, we might really see the death of the middle class - not at the hands of the plutocrats, but at the hands of the bureaucrats who throttled our economy to death.