Tuesday, December 30, 2008

Trends for 2009: The Rise of Informal Work

December 30, 2008

The crushing costs of formal business (State and local government taxes and junk fees rising to pay for unaffordable pensions, etc.) and the implosion of the debt-bubble economy will drive millions into the informal economy of barter, trade and "underground" (cash) work.

As small businesses close their doors and corporations lay off thousands, the unemployed will of necessity shift their focus from finding a new formal job (essentially impossible for most) to fashioning a livelihood in the informal economy.

One example of the informal economy is online businesses--people who make a living selling used items on eBay and other venues. Such businesses can be operated at home and do not require storefronts, rent to commercial landlords, employees, etc., and because they don't require a formal presence then they also fly beneath all the government junk fees imposed on formal businesses.

I have mentioned such informal businesses recently, and the easiest way to grasp the range of possibilities is this: whatever someone did formally, they can do informally.

Chef had a high fixed-cost restaurant which bankrupted him/her? Now he/she prepares meals at home and delivers them to neighbors/old customers for cash. No restaurant, no skyhigh rent, no employees, no payroll taxes, no business licenses, inspection fees, no sales tax, etc. Every dime beyond the cost of food and utilities to prepare the meals stays in Chef's pocket rather than going to the commercial landlords and local government via taxes and fees.

All the customers who couldn't afford $30 meals at the restaurant can afford $10. Everybody wins except commercial landlords (soon to be bankrupt) and local government (soon to be insolvent). How can you bankrupt all the businesses and not go bankrupt yourself?

As long as Chef reports net income on Schedule C, he/she is good to go with Federal and State tax authorities.

Now run the same scenario for mechanics, accountants, therapists, even auto sales--just rent a house with a big yard or an apartment with a big parking lot and away you go; the savvy entrepreneur who moves his/her inventory can stock a few vehicles at a time. No need for a huge lot, high overhead, employees or junk fees. It's cash and carry.

Lumber yard? Come to my backyard lot. Whatever I don't have I can order from a jobber and have delivered to your site.

This is the result of raising the fixed costs of starting and running a small business to such a backbreaking level that few formal businesses can survive.

One example of hundreds/thousands: 20 years ago I paid about $200 for a building permit for a $40,000 starter home. (Not in California, in Hawaii.) Locally in California you pay $350 just to have a staffer "review" your plans--even for a modest bathroom renovation. If they reject your plan for some reason, you still pay the fee. If they approve your project, the permit is much, much more. Oh, and they charge you for the electrical and plumbing permits, too.

Yes, I understand the movement to charge end users of government services; those who use the services should pay. Fair enough. But then what's happening to the 8.5% sales tax we pay, the $10,000 property taxes we pay, and the hundreds or thousands in other fees and income taxes we pay? Why don't those taxes go down if end users are picking up the tabs for "government services"?

Why have state and local government budgets all climbed by 30%-50% in a mere decade?

In a way, it doesn't matter; very few can operate a formal business profitably, and so they close their doors and scrape up a living in the informal cash economy. Local government will see its revenues wither and eventually insolvency will force a radical re-thinking of government revenues, expenses and services.

Until then, watch for the informal economy to grow and the formal economy to wither.

Until recently, the "growth sectors" of the U.S. economy were government and healthcare a.k.a. sick-care. As tax revenues plummet, then all government hiring below the Federal level will reverse into lay-offs. As for healthcare: as formal employment declines, so too will the funds flowing into insurance and healthcare via employers. As employers go belly up, the torrent of money flowing into healthcare will dry up.

Never mind that people want and need care; they can't afford $50,000 for tests and a few visits, or $120,000 for a procedure. Once employers stop paying premiums, then the healthcare industry will find its non-Medicaid/Medicare revenues declining. The future in healthcare is cash and carry, too; few recognize that yet, but more will as the formal economy continues down its high-fixed cost/debt-implosion death-spiral.

Those who survived the collapse of the Soviet Empire have experience with informal economies. Many of you have heard of Dmitri Orlov's Reinventing Collapse: The Soviet Example and American Prospects . We turn now to correspondent A.C.'s commentary on the informal economy in Eastern Europe after the Iron Curtain fell. (A.C. was responding to a previous entry, End of Work, End of Affluence III: The Rise of Informal Businesses, December 10, 2008).

"I greatly enjoyed your post on the rise of informal businesses. Having grown up during the post-communism collapse in Romania, I say that yes, you are right, this is how the things play out.

One observation: government fees/taxes are a fixed cost to businesses, but the government has fixed costs too. Yes, it can downsize some employees, but usually not too much. Also, people react quite vehemently to forced pay cuts. So the solution is monetizing the debt -- printing money (yes, only the Federal gov can do that but they will likely do it because of Social Security and Medicare). Then just lie in statistics about inflation.

Government employees end up being paid a pittance in terms of purchasing power, and then they also joyfully join the informal economy, under the form of corruption. I often see comparisons between the rate of corruption in the developed world, and the rate in the developing world, but I would like to see how the comparison will look like when government officials cannot afford both housing and food from their salary.

Such corruption does not take the form of an outright request for money, just that processing of papers, etc. will take a really looong time, but somehow gets done immediately if the client shows up by chance with a handbag that is placed quite ostensibly far away from the place where he is sitting. The policeman at a traffic stop finds some banknotes mixed in the insurance papers -- the motorist cannot be accused of anything, who is to blame for mixing some papers? and so on.

Another thing to expect is a much higher petty crime rate. A few years ago I was talking to a policewoman in Palo Alto, who was telling me of how the crime rate has risen in the past recession when unemployment increased by a few percentage point. I heartily laughed, and asked her to imagine how it was in mono-industrial towns in Eastern Europe where unemployment went from 0 to 60% in a few months.

The good thing is that the largest increases in this situation are in nonviolent crime, as most "marginally criminal" people (i.e. who would consider turning to crime when no other options are available) do not have a murderer's mindset. The basic rule is that anything not bolted down gets stolen. Kids were stealing flowers and vegetables from our garden to go sell them in the marketplace. Wheels got stolen from cars quite frequently, and once someone stole a fencepost from our yard.

On a weekend, we planted some small young fruit trees on a piece of land that we had on the outskirts of the city... I hauled water all day uphill while my father was digging the holes. Came back the following weekend to see how the trees were doing... they had been dug out and stolen. Unsurprisingly, the crime rate came down dramatically as the economy improved.

If any of your readers make plans to buy a house a year or two from now when prices will hit bottom, they should make sure that it is not in an area governed by a Home Owner's Association (HOA). Want to have a vegetable garden? Not possible, you are supposed to have an expensive and useless lawn. Want to raise small animals (rabbits, chicken, maybe buy a piglet and fatten it for a few months? Not allowed. Need a fence to diminish the likelyhood of stuff getting stolen and to make sure kids don't play in the street? Not allowed. Want to run a home-based business? Nope. Need/want to have tenants for an extra buck? Verboten. Want to build/remodel a house to be as energy-efficient as possible? Don't even think about it.

Right now all the above things are probably possible in the countryside, but most people live in large cities because that's where the jobs are. It's easy to say "just move to the country", but then how will you set aside money for children's college and for a proper retirement?

By the way of retirement :-) In order to avoid a very quick monetization of debt, when it comes to Social Security, the government has one more option --- nationalize individual retirement accounts (done in Argentina a month or so ago). Your IRA/401(k) savings are replaced with a special government bond with a generous inflation-indexed interest rate, which starts being payable at the date of retirement. The actual money in your account is used to fund the current government obligations. By the time you retired, real inflation will have eaten away most of the bond payments' purchasing power.

America does have, however, one thing going strong for it, that Eastern European countries did not: for most Americans, immigrating elsewhere is not an option. This means that the brightest and the most enterprising folk will stay in the country and try to improve things, as opposed to just leaving. That makes for high unemployment in the short run, but for a quicker recovery in the long run.

As for the cost/value of used goods: you may also consider that in very hard times the sale value of a stolen or even garage sale item is not related to the price at which a new good would sell, but to whatever the thief/seller can unload it for, even if that is a total pittance. Pair of good skis for 30$? Hey, that's food for a couple of days, so what if a practically similar pair can be found in the store for $200 (which would itself be a 60% discount from the previous year).

Why would the price in the store be $200 and not come down to $30, even if that means pitifully low sale volumes and most stores going out of business? There is an answer to that:

While the price of commodities and new manufactured goods will decline, they cannot really stay for a long time under the production cost, because then production facilities (factories/mines/oil wells) get shut down (unless they are subsidized by some government). When the price you get for products is under the cost of raw material inputs, you shut down the production facility (even if you may keep paying part of workers to stay idle, if you are lucky to get some government subsidies).

So a lot of production facilities may go bankrupt, and supply can diminish drastically until it meets demand, but the price would still not fall below the price of raw materials + transport + packaging. Existing stocks of products may be unloaded at a loss, but production facilities cannot function permanently this way. On the other hand, wages can fall to almost zero, with wages of service sector workers falling with them too. So this is why in Eastern Europe in the early 1990s you saw simultaneously:

(1) very low wages and high unemployment;

(2) very low service sector prices, i.e. a few cents/dollars for a hairdo / nail job / dentist visit, as the service sector people cannot go into hibernation to stop eating and diminish production;

(3) prices for new/imported manufactured goods that were very cheap compared to what they would sell in the West (global market segmentation), but EXPENSIVE in terms of local incomes (price cannot fall below raw material costs on a permanent basis), and with VERY low sale volumes. Yes, 90% of the (state-owned) retailers and manufacturers went bankrupt and eventually disappeared.

(4) very low prices, and high sales volumes (read: large flea markets) for anything second-hand.

Another thing to note is that if wages fall dramatically, then it becomes profitable to establish production facilities in the US again. In November 2007 we took a vacation in Florida, and my first thought at the sight of the massive wall of dark, empty condo towers north of Miami was: "Five years from now, a smart entrepreneur will buy a few of them for a pittance, build a factory next door and a light rail line from the apartments to the factory (roads were never adjusted to the projected population density), and offer people a factory job + housing package, which the homeless crowds will gladly take. The catch is that the salary would be very small of course. Heck, probably the state will buy the condos or confiscate them from the banks for not paying taxes, and offer them at zero rent to entrepreneurs, just to generate jobs".

Thank you, A.C. for a multi-faceted commentary based on experience. We turn now to correspondent Freeacre for a report that shows it's not just small businesses being driven under by absurd government junk fees:

"I so needed to build an additional bathroom onto my home in Tahoe when I lived there. I could have created a small, but nice, little apartment that I could have rented out to help keep a roof over my head. I had a housemate who was a carpenter, who would have worked for rent. . . But Nooooo. In order to build a bathroom, it would have required $5,000 upfront just for the building permit!! Extortion!

Now we are in Oregon and fighting the county tooth and nail regarding these ridiculous $30-40,000 individual sewage treatment monstrosities that they want to require us to install. They will require a separate phone line, a $400 per year maintenance fee, and a license as a water treatment plant to put in - for a nitrogen reduction situation that is only projected by a flawed computer model to be a problem in 120 years! And, they don't even treat for real problems like chemical and pharmaceutical pollution.

The latest insult is that the money supposedly set aside to help poorer people put in these things is $65,000 light now because they gave it to a staff person to answer our e-mails. They blame it on us getting involved in the public process!

It's not just the small business owners, it's the citizenry as a whole that these parasites are sucking dry. We are in the process of organizing a local Grange that will have an on-site Farmers Market and Trading Post. We will trade and barter food, goods and services when the economic grid goes down, and they can kiss our collective butts. I can hardly wait for the county to have to lay off those SOBs. If they continue to insist that we put in a nitrogen reduction system, we'll just purchase a $1,000 composting toilet. They we can tell them to "eat dung and die." And, we can use the compost for the garden.

The government, the banks, and the investment class are all in the process of killing the geese that lay the golden eggs. Nothing will change until we get them off our backs.

For fun, Charles, I have sent the county your article just to mess with their heads. Ha!"

Thank you, Freeacre, for an eye-opening report. Here are a few other "hard times/debt-bubble implosion"-related titles to explore:

The Richest Man in Babylon
Only Yesterday: An Informal History of the 1920's
Since Yesterday: The 1930's in America, Sept. 3, 1929 to Sept. 3, 1939
Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders
Collapse: How Societies Choose to Fail or Succeed

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