Entrepreneurship as a Stabilizing Force Through U.S. Recessions

Defining Entrepreneurship and the Austrian School

Entrepreneurship is defined differently depending on who is asked. Cantor and Cox (2009), in their work Literature & the Economics of Liberty: Spontaneous Order in Culture, report that the focus of the Austrian School of economics is on "entrepreneurial behavior, the unceasing efforts of businessmen to adjust to the never-ending changes in the economic world. More than any other school, the Austrians insist on the importance of uncertainty and risk as economic factors. In their view, the entrepreneur is constantly anticipating an uncertain future, trying to predict changes in demand and to figure out new economies of production for satisfying it. Thus, for the Austrian School, the entrepreneur becomes a kind of artist. Indeed, the Austrians stress the creativity of the entrepreneur. Like an artist, he is a visionary, a risk-taker, and a pioneer, and if he is to be successful, he will generally be found running counter to the crowd, or at least ahead of it. The Austrian School views economic activity as creative in the first place; from its perspective, to show an artist implicated in the commercial world is perfectly compatible with asserting his freedom and individuality." (Cantor and Cox, 2009)

This freedom is understood to be inherent to the view of economic activity as creative. The model of economic order that emerges from this perspective is referred to as "spontaneous order," which has as one of its most cogent features a "large-scale shift in thinking that can be described as the movement from top-down to bottom-up models of order." (Cantor and Cox, 2009, p. 21)

This belief is stated to have begun with the work of economists including Adam Smith and, "more broadly, the Scottish Enlightenment thinkers with whom he is associated. Indeed, the great contribution of economics to thought in general has been a way of conceiving order that need not be imposed from above on phenomena but can grow up out of them — an order generated by the phenomena themselves." (Cantor and Cox, 2009, p. 22) In a modern economy, "the relevant and crucial knowledge — of consumer desires and the means for satisfying them — is always of necessity widely dispersed and only market prices can coordinate the information, giving entrepreneurs the signals they need to work toward bringing supply in line with demand." (p. 22)

The economic crisis of the 1980s, often referred to as the debt crisis, is attributed by many analysts to the "petrodollar recycling of the 1970s." This crisis was characterized by sharply rising oil prices. During this period, commercial banks eagerly made loans to governments and entities owned by states and private companies in developing countries, with these loans backed by petrodollars from Middle Eastern oil-producing nations. During this frenzy of borrowing and lending, activity halted suddenly with the recession of the early 1980s. The drop in oil prices, the strength of the dollar, and high global interest rates "depleted the foreign exchange reserves that debtor countries relied upon for international financial transactions." (Carrasco, n.d.)

The 1980 Economic and Debt Crisis

The "case-by-case" debt restructuring negotiations that followed are credited with having saved the international financial system from collapse — an approach referred to as the "muddling through" method, which involved multi-phase work-out arrangements. This approach required commercial banks to agree to two key conditions: (1) provide new loans to debtor countries, and (2) stretch out external debt payments (Carrasco, n.d., p. 1). These reforms focused on "longer-term and deeper structural reforms in debtor countries." (Carrasco, n.d., p. 1) New commercial banking options emerged as the entrepreneurial response following this period of economic crisis.

The savings and loan crisis of 1986 is reported to have begun due to "unmanaged asset/liability gaps that led to interest rate exposures, speculative investments in junk bonds and service industries, fraud, and massive losses from lending to and investing in the U.S. commercial real estate sector." (Carrasco, n.d., p. 1) Initial estimates for resolving this crisis ranged from $30 to $50 billion, but the actual cost reached $153 billion. Entrepreneurs actively created new financial alternatives in the period that followed, developments that fed directly into the junk bond market collapse of 1989.

The 1986 Savings and Loan Crisis

Hylton (1990), writing in "The Drexel Collapse; 'Junk Bonds' Advance; Traders are Surprised," reported a strong rise in the prices of junk bonds in moderately active trading following Drexel Burnham Lambert's filing for Chapter 11 bankruptcy protection. Traders stressed that the market had shown a strong response, though unanswered questions remained regarding the bond inventory held by Drexel. David Frum (1990), in his National Review article "Bearing Down on Milken — Michael Milken and Junk Bond Collapse," observed:

The 1989 Junk Bond Market Collapse

"Productivity grew at a faster pace in the 1980s than at any time since 1973; manufacturing productivity, at its fastest pace since World War II. No, junk bonds don't get all the credit — new technologies and deregulation also helped — but they do deserve some." (Hylton, 1990, p. 1)

Frum further reported that the junk bond market had entered increasingly treacherous financial waters: "Takeovers financed by junk got the stock market moving up again after the ordinary investor called it quits in October 1987 — but they also inflated asset prices so radically that more of the new managements found, when they strode into their new executive suites, that they had overpaid for the company and their debt charges were crippling. Milken had dreamed up more and more exotic refinancings for them: payment-in-kind bonds and zero-coupon bonds, all of which delayed the grim moment of cash settlement." (p. 1)

Frum observed that ingenuity could not delay gravity forever. By 1988, company defaults had increased significantly, with even larger firms defaulting — among them Integrated Resources, Eastern Airlines, SCI Television, Southmark, and Griffin Resorts (Frum, 1990, p. 2). The junk bond market ultimately collapsed in June 1989. Creative finance had flourished during the Drexel era, with capital relatively easy to raise, but greed turned a "clever innovation into first a fad and then a craze. The result was, as it always is, that sharp market correction known as a crash. In other words, what happened is exactly what advocates of open financial markets should have expected: with the usual noise, mess, and confusion, we are stumbling toward the efficient outcome." (Frum, 1990)

Frum further reported that U.S. industry was behaviorally transformed through the takeovers and leveraged buyouts they financed (Hylton, 1990, p. 1). Multiple layers of management were removed and consolidated compared to the 1970s model, and capital markets were driven by junk-financed takeovers and leveraged buyouts — a boom for young and innovative companies. However, while manufacturing grew, Wall Street "got floppy. Deals began to be made merely to generate fees; share prices approached tulip-craze levels. It was a classic case of a market success attracting new money which in turn needed new applications in which to invest, forcing prices and the market up and seeping into ever-riskier areas. And the longer it went on, the riskier it became." (Hylton, 1990, p. 1)