Risk and RewardBy Ed Stephens Jr.
Special to the Saipan Tribune
One of the first things you notice about the Saipan economy is that those who have the power and money (the political class) are not the ones who take the financial risks and do the work (the business and labor classes). Much of the Western world has now followed this model, and it will get the same results as the Commonwealth did, which is why I’m so interested in Asia: Asia is the only bet left.
Any economist worth a darn will tell you that, in the long run, any economy that has a skewed relationship between risk and reward will eventually stagnate and decline, because there will be insufficient incentive to take risk. Everybody wants a free ride and a turn playing with the radio, but nobody wants to work on the engine or buy the gas.
As we ponder the risk vs. reward idea, let’s look at the structure of a certain industry. After reading it, I’ll give you a chance to identify the industry.
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After receiving revenues from operations, the business applies them to the following expenses and distributions:
1). Suppliers are paid what they are owed. So this is a fixed expense.
2). Commissions (typically 5 to 10 percent of operating revenues) are paid for certain access rights to facilities. So this is a variable expense.
3). A class of investors and financiers is paid, with this category typically accounting for 30 percent of gross receipts. I’ll categorize this as debt, or quasi-debt.
4). After the above expenditures are made, certain stakeholders, who are also workers, are then paid a fixed amount of money (typically $15,000 per share) for their participation. I’ll categorize this as, essentially, preferred equity.
5). Other stakeholders, also workers who are the managers, hold another class of shares, and they receive what remains of the distributable cash. We can call this common equity.
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Wow, pretty sophisticated, eh? For one thing, we’ve got a comprehensive spectrum of risk being matched with reward here. And, for another thing, we’ve got an interesting labor angle, given that the workers are paid as risk-sharing stakeholders, not as salary-drawing slugs; there is, essentially, zero cost of labor, since labor is actually an investor. Furthermore, the usual incentives for management to loot the shareholders (which is common in large companies) is absent, since in this case, the management is the shareholders.
Now for a quiz. The above structure applies to which industry?
A). Tourism marketing for a Saipan-based corporation.
B). Sales of condominium time shares in Hawaii.
C). Pirate operations in Somalia.
The answer is ©, pirate operations in Somalia. This was the topic of a recent report issued by the United Nations, from which I’ve summarized some of the facts, and I have also added a little bit of financial conjecture to fill in the blanks.
I’ll post the relevant link at SaipanBlog.com. It’s interesting reading.
Before going out on a mission, the pirates assemble suppliers (for clothes, food, weapons, etc.), militiamen (for the land-based operations after a captured ship is anchored) and sea-going fighters (the actual pirates, or course). The higher the risk a participant faces, the larger their potential rewards are. So we’ve essentially got vendors, fighters of the lower risk (militia), and fighters of the higher risk (pirates), all gathering together for the action, and allocating the risks and rewards every bit as intelligently as a University of Chicago MBA would.
Their operating revenues? That’s the loot from ransom.
My intent is not to glamorize the exploits of pirates and robbers. My intent is to illustrate how the laws of risk, reward, incentive, and goal attainment are universal (even when boiled down to the raw elements of rag-tag outlaws.) Those who have skin in the game behave differently than those who don’t, and they manage to get things done by heeding the laws of risk and reward.
I’m not saying that Saipan should think like a pirate. But thinking like a bureaucrat does have its consequences, which are as visible as the crumbling economy and its decaying infrastructure. Saipan is too small to be of global consequence, but when larger economies wind up in the same position, it will have global repercussions.
Ed is a pilot, economist, and writer. He holds a degree in economics from UCLA and is a former U.S. naval officer. His column runs every Friday. Visit Ed at TropicalEd.com and SaipanBlog.com.
