What is the connection between Russell Crowe and the difficulty that small businesses are experiencing getting bank loans? In this blog post I’m going to attempt to find it but before I do we first need to solve the question thrown up by this post’s title: are we in fact in recession?
The official answer is, of course, no: so far we’ve only experienced one quarter of economic contraction (in Q4 2011) when two are required for a recession proper. In addition, news today of accelerating growth in the UK services sector (FT – registration required) is causing many economists to revise their previous forecasts and predict a revival of UK economic growth across the board.
These predictions however are but one voice among many and it seems that the consensus is not as optimistic. Long term, the picture doesn’t seem rosy – especially for small businesses. As the double edged sword of inflation causes costs to rise and consumer spending power to diminish, small business confidence is sinking lower and lower.
In such an economic climate the temptation is to batten down the hatches, cut costs and try to ride out the storm. Of course, the effect of many businesses doing this at the same time only leads to worsening economic conditions, higher unemployment, less household spending and increased chances of going out of business. Is there any way for a small firm to break the cycle?
This is where Russell Crowe comes in.
Okay, not really Russell Crowe but one of the characters he’s played in the movies: John Forbes Nash Jr – mathematician, troubled genius, subject of the film ‘A Beautiful Mind’ and potentially the provider of key insights in how to manage a small business during a time of economic contraction.
Nash’s principal field of study was game theory a branch of mathematics that studies circumstances, in games or otherwise, where the success of one ‘player’ depends on the choices made by other ‘players’. One of Nash’s most famous contributions to this field was the concept of Nash Equilibrium.
In very simplistic terms, a Nash equilibrium is a situation in a game involving two or more players where, for any player, changing one’s own strategy without the other players changing their strategies leads to no benefit. In other words, every player is locked into playing the same strategy in order to avoid their opponents gaining an advantage – regardless of whether the combined strategies are beneficial to all the players overall. In some instances of Nash equilibrium, all the players could increase their pay-offs if they could all agree on changing their strategies to some new solution of the game.
(Those who’ve seen the film ‘A Beautiful Mind’ should think back to the scene in the bar where Russel Crowe convinces his horny mathematician colleagues to all agree to ignore the unattainable blonde and instead concentrate their attentions on her less physically well endowed friends. This way all of them get a fair crack at going home with a date rather than following their natural proclivity to compete for (and get rebuffed by) the blonde thereby ruining their chances with the other girls ).
The most famous example of a Nash equilibrium is the Prisoners’ Dilemma where two prisoners are questioned independently. If both stick to their story then neither can be prosecuted but if one ‘defects’ and implicates his partner he escapes prosecution while the other goes to jail. The outcome that is best for both players overall is to stick to their stories but the Nash equilibrium has both players defecting – because each serves his own short term interests in doing so – and both players therefore facing prosecution.
So how do Nash equilibriums inform our perception of the current UK business climate?
Applying game theory principles to economics is nothing new – in fact, Nash was awarded a Nobel Memorial Prize in Economic Sciences in 1994 – and I am a strict amateur so what follows should be taken with more than a pinch of salt. Nevertheless, I think there are insights to be gleaned.
Let us remember that the UK is no longer the workshop of the world as it was in the 19th Century. Manufacturing and exporting is no longer our main game. Economic health in this country depends to a large extent on consumer spending power. When that spending power is diminished, as has happened recently, large retailers and service companies take a hit to their revenues and start cutting costs. Which often means layoffs, leading to greater unemployment and further reduced spending on the high street. No individual large company can go against this trend as they can’t spend money on growth when there is no market (i.e. employed consumers) to take their product. Large companies answer to their shareholders (read pension funds) who would see such risk taking as reckless and unwarranted. Each large company is locked into a strategy of downsizing and cost cutting until the economic situation somehow improves, even though the most profitable strategy all round would be for them all to spend more, pay more wages, raise consumer spending power and create a larger market for their goods and services.
So when does this cycle end? Inevitably when the reduced spending of large companies allows small businesses to start making inroads into the market space concede by those large firms. Almost always, small businesses lead the charge to recovery (FT).
So what lesson can a small business take from this possibly over-extended metaphor?
At the moment finance which allows small businesses to expand is incredibly hard to come by as the banks are trapped in a Nash equilibrium of their own (making). But there are opportunities out there for the small businesses who are brave enough to seek them out – small firms are not trapped in the same cost-cutting and employment slashing cycle as the publicly traded companies – and growth is possible.
I’m not advocating stupid risk taking or risk taking for its own sake but, if you’ve got a great idea and confidence in the abilities and resources of your company, now could be the time to attempt to break into the ground being rapidly vacated by the large companies. And alternative funding sources like those mentioned in the last post could provide the capital you need to do so (but be wary of venture capital funds).
Who knows, maybe Russell Crowe can save the economy after all…