It’s sad when an enterprise fails. Each one represents someone’s hopes and ambitions. Some are poorly thought out, some cynical cash grabs, but many startups represent people’s well-intentioned efforts to provide for themselves and their loved ones. Every failure is someone’s dashed dream. As sad as this is, it’s good that bad firms and bad products fail. It would be better if every idea were good and every undertaking created value. That’s not going to happen on this side of eternity, however. Given that people make mistakes, it’s important to have some kind of social mechanism that corrects them. In a free market, failure is that mechanism.
“It’s good that bad firms and bad products fail” is exactly what you would expect a heartless economist to write. “Serves you right,” you can imagine a stern, portly, monocled fellow in a suit that fits too tightly huffing when observing someone with the temerity to waste society’s resources. “Perhaps you should die, along with your business, and decrease the surplus population. Survival of the fittest, you know.”
That’s not how it works. No actual organisms have to die when a business “dies.” When a business dies, it frees up the resources it had tied up in a venture that, sadly, did not pan out. It is important that those resources be freed up for other ventures instead of remaining under-used. Free market competition has Darwinian elements, but it’s not “Darwinian” in that the free market is, like nature, red in tooth and claw. It’s “Darwinian” in that it features variation and selection, with those ideas and enterprises best adapted to their surroundings being the ones that survive.
Variation? It comes from innovation. Joseph Schumpeter uses the evolutionary metaphor specifically in his discussion of “creative destruction.” Here’s Schumpeter, from p. 83 of Capitalism, Socialism, and Democracy:
The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. … The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation–if I may use that biological term–that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in.
And selection? In a free market, selection happens on the basis of profits and losses. There is no Great Mind that can understand, evaluate, and articulate what makes an innovation “good” or “bad.” That knowledge emerges from competition whereby innumerable consumers vote with the fruit of their labors–handily summarized in mostly-electronic chits we call dollars and cents–for or against the “candidates” producers put on offer. Crucially, the money-measured cost of producing something represents consumers’ votes for something else to be done with the necessary resources. If you have to pay $5 for a box of pens for your tire shop, you’re overcoming 500 one-cent votes for the pens to be used doing something else. You should only buy the pens if you can use them to create tire repairs for which people will pay you at least $5.01.
People vote on your product when you bring it to market. If their votes for what you are doing add up to more than their votes for something else, then congratulations: your services repairing tires have been selected…for now. If their votes don’t add up to more than their votes for something else, then they’re coming together and telling you “do something else.”
It is wise to listen. When a company records a loss, it tells them to turn from their wicked ways. When a company records enough losses, it is people telling them to let go of the resources they have procured and go do something else. To ignore the clamor is to persist in holding resources in lower-value uses as judged by other people with a say in the matter–namely, everyone who votes with their own money for or against your idea.
What would happen if we didn’t let businesses fail? We see the answer when we look at the overlap between business and politics. We would probably still have New Coke. The Wall Street Journal asks “Why Is America Still Flying the A-10 Warthog, a Cold War Relic?” and answers (predictably, unfortunately), “Lawmakers protecting jobs and commerce for their districts block the military from retiring outdated equipment, impairing efforts to counter rapidly modernizing Chinese forces.” Nothing as serious as national survival might be at stake when we’re talking about propping up companies that should have been allowed to go bankrupt years ago, but we’re stuck with lower standards of living than we would otherwise enjoy.
Consider the efforts to challenge the major sports leagues since World War II. In the late 1940s, the All-America Football Conference challenged the NFL but ultimately folded, with the Cleveland Browns, Baltimore Colts, and San Francisco 49ers joining the NFL. The Browns, incidentally, are an interesting case. They won four NFL Championships and ten Conference Championships before the merger, but they remain, along with the Detroit Lions, Jacksonville Jaguars, and Houston Texans, one of the only teams that have never played in a Super Bowl.
The 1960s and 1970s were a little kinder to startups. For a brief but glorious decade in the 1960s, the American Football League competed successfully with the National Football League, and the leagues merged in 1970. The World Hockey Association ran a tumultuous operation during the 1970s before four of its teams merged with the NHL (the Edmonton Oilers, Hartford Whalers, Quebec Nordiques, and Winnipeg Jets). The American Basketball Association overlapped the AFL and WHA, and while the Denver Nuggets, Brooklyn Nets, Indiana Pacers, and San Antonio Spurs are all that remain, the league succeeded in that its owners got the merger with the NBA that they were after. The World Football League was not so lucky.
Later efforts were less successful. The first incarnation of the United States Football League tried to go head-to-head with the NFL and failed. The Canadian Football League ventured south of the border and welcomed several American teams in a move that did not work out. The World League of American Football worked with the NFL, but no one paid attention to what was happening with the North American teams and it rebranded and relaunched as NFL Europe before it ceased in 2007. The first incarnation of the XFL failed. The Alliance of American Football, which also tried to work as an NFL minor league, didn’t last a year. It remains to be seen how the new versions of the XFL and the USFL will fare. Thanks to Ebay and thrift stores, Birmingham’s entries into these ill-fated leagues are memorialized with pennants on my office wall and shirts in my closet.
Now imagine what the world would look like if these enterprises (and so many others) hadn’t been allowed to fail. We would have too much labor and capital dedicated to producing football no one wants to watch. One of my colleagues worked for the Birmingham Barracudas back in the mid-90s. I doubt the world would be a better place if the Barracudas were still squandering her talents.
Does this mean it would be good if the new incarnations of the USFL and XFL were to fail? No, it doesn’t. I sincerely hope they succeed and spend many decades creating more value than they consume. While it wouldn’t be good if they did fail, it’s good that they might fail. First, the prospect of failure makes us think a little harder before we potentially squander humanity’s blood and treasure. Second, if it turns out that Spring professional football is a dud yet again, then the resources tied up producing it need to be let go of so they can be used for something else.
Art Carden is Professor of Economics & Medical Properties Trust Fellow at Samford University, and he is by his own admission as Koched up as they come: he has an award named for Charles G. Koch in his office, he does a lot of work for and is affiliated with an array of Koch-related organizations, and he has applied for and received money from the Charles Koch Foundation to host on-campus events.