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Playing it safe puts the economy at risk Add to ...

It has been said that the early bird gets the worm. While that may be true for birds, rodents know that the second mouse gets the cheese. Be it out of wisdom or simple laziness, sometimes it pays to be late to the game. Occasionally sitting back and letting the situation unfold is a better plan than immediate action.

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It’s called playing it safe – and in 2013, a lot of companies are happy doing just that.

Anyone who has studied economic theory will recall the three factors of production – land, labour and capital. All commerce is based on some combination of these three, or so we have been taught.

Yet there exists a fourth factor of production: risk. Without it, the economy is not possible. Land, labour and capital will never spontaneously combine on their own without some brave entrepreneurs testing their ideas.

But the economy is currently suffering from a nasty case of risk aversion – lots of tardy mice, but eager early birds are scarce. Corporate balance sheets in North America are in excellent shape yet few CEOs want to be the first to stick their necks out and invest in this tepid environment.

When everyone wants to be the second mouse, bigger problems arise. The macro-economy falters. Overall spending – what economists call “aggregate demand” – is diminished while businesses wait for others to make the first move. It’s like those terribly awkward first 45 minutes at the high school dance when no one has built up the nerve to ask anyone to dance. Everyone stares at their shoes as the music echoes across the empty gym floor.

Business schools and MBAs have whipped risk management into a quasi-science, with positive and negative consequences.

The positive is that companies are now better equipped to gauge the level of risk associated with any particular investment. But the negative is that, too often, risk management hampers innovation and creativity.

What should be a tool to make better decisions has sometimes led companies to make no decisions at all. Risk management should liberate companies. Instead, it has enslaved some.

It’s a policy conundrum for governments and central banks. Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty have wagged their fingers at the business community for sitting on dead money. When rock-bottom interest rates and a favourable corporate tax environment are insufficient to stimulate business investment, what’s left other than moral

suasion?

Yet by and large, businesses are happy to sit back and play the role of the second mouse. They’ve got shareholders – most of them impatient–and no one wants to explain to them why money was gambled and lost.

The danger for small, independently owned businesses is even greater. Those lacking steady cash flow or easy access to lots of capital are especially vulnerable. Even one bad decision could sink the entire operation.

Unlike the first three factors of production, risk can’t be quantified and measured. At best, you can gauge levels of risk aversion by observing corporate and individual behaviour. But risk isn’t tangible.

The other factors of production can be increased through policy tools. Capital can be made cheaper and land can be rezoned. Even labour can be increased through immigration and greater emphasis on post-secondary education and skills training.

But how can government policy increase business appetite for risk?

Reducing unnecessary red tape, improving market access with foreign trade agreements, and providing stability in tax policy are three obvious suggestions. Anything that reduces uncertainty will automatically reduce risk. With varying degrees of success, governments in Canada are attempting to do just that.

Still, a willingness to take on risk has to come from within the company or individual. No policy measure can fully overcome risk aversion if businesses allow themselves to be paralyzed by risk.

Be they the early birds or the second mice, sensible strategies for companies will differ. At the moment, Canada seems a little heavy with mice. A few more early birds – the innovators, the inventors, the creative geniuses – would be preferable. The risk may be greater, but the potential payoff is almost immeasurable.

Todd Hirsch is the Calgary-based chief economist of ATB Financial and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.

 

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