Local Stock Exchanges: The Next Wave of Community Economy Building
Twenty-Seventh Annual E. F. Schumacher Lectures
October 2007, Great Barrington, Massachusetts
Edited by Hildegarde Hannum
Copyright © 2011 New Economics Institute and Michael Shuman
You could listen to the audio recording of this lecture below:
By Michael H. Shuman
Introduction by Susan Witt,
E. F. Schumacher Society
It is my pleasure to introduce Michael Shuman, who is perhaps the local economic movement’s greatest asset. He has a knack for determining the multiple policies and projects needed to build local economies. With his clarity of thinking, Michael recognizes that to make meaningful change requires structural change in our institutions themselves.
Trained in economics and law at Stanford, he went on to work with extraordinary individuals when he was a young man, beginning with David Brower, whom many of you know from his Schumacher lecture in 1992 but also from his enormous contribution to the environmental movement. Michael was deeply influenced by Jane Jacobs (someone very close to my heart, whom the world lost in 2006), especially by her recognition of the importance of local economies and the role of import substitution in strengthening them.
With Judy Wicks, president and CEO of the White Dog Café in Philadelphia, Michael helped form a new organization in 2001 called BALLE, the Business Alliance for Living Local Economies, which in just six years has grown to have chapters in 55 towns where local businesses are collaborating to create sustainable local economies. [As of 2010, BALLE has more than 80 chapters.]
Michael is both a speaker and a prolific writer, who is not afraid to challenge foundations and corporations in his writing. He has been a consultant to towns and regions on what it takes to move to local economies. Just recently my colleague Chris Lindstrom and I were invited to Martha’s Vineyard to talk about initiating Martha’s Dollars for the Vineyard. Michael had been there before us and paved the way. He had prepared a “leakage analysis” for the Martha’s Vineyard Commission, presenting ideas for keeping wealth circulating in the island’s economy. One of the tools he suggested was local currencies, so off we went.
A strategic thinker, one who is comfortable in the realm of finance, he has spent time thinking through what a local stock market would entail so that investors can be assured that their investments are going back into a local economy. That is the topic he has chosen to speak on today.
Michael is the father of two and lives in Washington, D.C. He’s funny, he’s smart, he’s engaging, and we’re delighted that he is speaking for us today..
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Almost every great modern thinker who has been a mentor of mine—from Wendell Berry to Gar Alperovitz, from Bob Swann to Jane Jacobs, from Amory Lovins to Hazel Henderson—has delivered an E. F. Schumacher Lecture, and I can’t imagine a higher honor than speaking before you today.
There are also several individuals, whose names you may not recognize, who have also been co-creators of the ideas I want to share with you today about local stock markets: John Katovich, Don Shaffer, Betsy Power, and Jenny Kassan have been amazing teachers in the field of domestic financial markets; George Chmael and Jeffrey Wells have helped me apply these ideas to the challenges of development of the global South. So please think of me today as just the megaphone for these pioneers and many others who have been thinking hard about local stock exchanges, which I consider to be the next great wave of community economy building.
I’d like to make six arguments today:
First, we can say with growing confidence that the basic requirement for local prosperity both here and abroad is an entrepreneurial community, a locale rooted in small businesses producing a diversity of competitive goods and services for local needs.
Second, a key characteristic of an entrepreneurial community, as E. F. Schumacher disciples know instinctively, is a critical mass of locally owned businesses.
Third, the most significant missing piece in efforts to promote entrepreneurial communities is local finance, which would expand the reach and power of local ownership.
Fourth, a logical requirement for building up the structures of local finance is the replication of what markets have done nationally and globally. We need to make it easier, cheaper, and more effective to issue, evaluate, create, and trade local stock—in other words, to create a system that links ownership with place and allows people to reinvest their retirement funds and other savings directly in their community
Fifth, the creation of local stock offers myriad benefits to investors, entrepreneurs, and communities.
Sixth, a local stock exchange is an idea that may seem a generation away but in fact is already being implemented, both domestically and globally. The future of local stock markets, I will argue, is now, although there is much we can and need to do to accelerate this concept.
I. The Importance of Entrepreneurial Communities.
The late Reverend Leon Sullivan of Philadelphia understood the critical importance of ownership as he sought to move his Philadelphia parishioners out of poverty. In 1962 he asked fifty members of his church to contribute $10 a month for thirty-six months into what was effectively a community corporation. “This amounted to $360,” recalled Sullivan in Build, Brother, Build, “or the price of a good television set.” Contributions over the first sixteen months went into a charitable trust for scholarships, and the rest were invested in a for-profit corporation called Zion Investment Associates, with each participant receiving one voting share of stock. Shares could be sold back, but any participant who quit would not be permitted to return.
The demand for membership in this corporation far exceeded Sullivan's expectations, and the number of shareholders grew from 600 in 1965 to 3,000 by 1968. Zion then built the nation’s first black-owned apartment building in an all-white neighborhood, a shopping center with stores run by black entrepreneurs, a black-owned aerospace company, and Progress Garment Manufacturing Enterprises. Forty percent of profits went to shareholders, another 40 percent to a nonprofit, and 20 percent to the shopping center’s workforce. The nonprofit then set up a technical school to train black entrepreneurs and managers.
Sullivan's antipoverty vision was striking because it was simultaneously pro-business, pro-community, and pro-ownership. He urged his parishioners to pool their investment power on behalf of the community so that they could create a genuine economic engine, the benefits of which would inure to the long-term benefit of community members, both as individual and collective owners of the enterprises. This is what I mean by an entrepreneurial community, a locale made up of dynamic, competitive, and expanding small businesses linked umbilically to nearby residents through local ownership.
Today, the world is finally catching up with Rev. Sullivan. A consensus is emerging that ending poverty in the most distressed corners of the planet requires the seeding and spreading of entrepreneurial communities. Microbusinesses owned by the poor are all the rage in global development these days, even in the programs of huge institutions like the World Bank and International Monetary Fund. In TheMystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, Peruvian economist Hernando de Soto shows the importance of legal reforms in order toclear ownership title to land and capital so that microentrepreneurs can put their inputs to practical and productive purposes. Mohammed Yunus recently won the Nobel Peace Prize for his efforts to bring micro-entrepreneurs into the financial mainstream through microcredit and micro-ownership. Now the emergence of web tools like Prosper.com and Kiva.org is enabling even the smallest entrepreneurs to find lenders worldwide. These very small enterprises are actually the businesses that are most likely to make a real difference for the world’s poor. While larger firms typically allow only highly educated, trained, and skilled leaders to assume entrepreneurial roles, smaller firms provide the poor with more significant managerial opportunities. As Rev. Sullivan recognized, ceasing to be poor calls for taking charge of one’s own economic destiny. For those who cannot afford the formal education that could lift them out of poverty, diverse small businesses serve essentially as community colleges; they are especially good at inculcating lifelong work habits, technical skills, and business values. For example, the Grameen Bank’s Village Phone Program, which helps entrepreneurs in Bangladesh set up phone-based businesses in communities where no telecommunications previously existed, promotes technological and financial literacy.
International developers clearly comprehend the importance of micro-enterprise, which is pro-business and pro-ownership, but they do not yet fully appreciate the importance of community. Here’s why it matters: If the most successful micro-entrepreneurs in a poor community are bought out, sell off their assets, and the new owners move the business elsewhere, the community will hardly be better off. The mark of a truly successful entrepreneurial community has to be not only its abstract measures of employment, income, and investment but also, as E. F. Schumacher emphasized, the degree to which its enterprises are “human scale” and locally owned, since that insures steady growth of employment, income and investment. And at the cutting edge of promoting entrepreneurial communities has been a growing movement of “local living economies.”
II. The Importance of Locally Owned Enterprises
When the Business Alliance for Local Living Economies (BALLE) was launched in 2001, one of the first board meetings focused on the organization’s name. David Korten, a founding board member, had just written several essays about the importance of “living economies” for ecosystems, workforces, consumers, and other stakeholders. I pointed out that what was holding us together as a board was not only the belief that an economy has to be “living” but also that it has to be “locally rooted,” with local ownership its cornerstone. That conversation gave birth to the term “local living economies.”
Today this concept is spreading with brushfire speed. A growing number of policymakers, economic developers, businesspeople, chambers of commerce, foundations, and nonprofits are redirecting their resources to nurture local businesses. More than 100 communities now have highly organized networks of local businesses affiliated with both BALLE and the American Independent Business Alliance Association (AMIBA). Hundreds of others, following the prescriptions of the Post-Carbon Institute and Transition Towns, are undertaking important initiatives for localization. One factor propelling this movement is a growing body of empirical evidence that locally owned enterprises, becausethey are locally owned, contribute far more to a community’s well-being than nonlocal enterprises do—and therefore are essential tools for ending poverty here and abroad.
I want to give you several reasons why local ownership matters. The first is that—surprise!—local businesses don’t move. They don’t have ambitions to pump up their rate of return by a few points by moving to Mexico or Malaysia. Because they stay put, they also tend to have long-term relationships with the proprietors of other local businesses around them, which increases local spending.
Recent evidence suggests that because small businesses tend to buy local, they have a greater “economic multiplier,” the much desired circulation of a dollar many times in a community, which lies at the heart of economic development. A 2002 case study by Civic Economics (“Economic Impact Analysis,” at www.civiceconomics.com) analyzed the relative impact of a proposed Borders bookstore in Austin, Texas, as compared to two local bookstores. The researchers found that $100 spent at Borders would re-circulate $13 in the Austin economy, while the same amount spent at the local bookstores would re-circulate $45. Roughly speaking, every time you spend your money at a local bookstore you provide three times the job impacts, three times the income and wealth impacts, three times the tax impacts. We’re not talking small potatoes of difference here. Why the difference? Unlike Borders, the local bookstores had a high-level management team, used local business services such as lawyers and accountants, advertised locally, and enjoyed a stream of profits coming into the community.
Another study, performed by Iowa State University, found that if you build an ethanol plant with no local ownership, 140 jobs will be created. By increasing local ownership to 73 percent, the multiplier effect more than doubles the number of jobs to 300. A study released in 2006 concluded that if San Franciscans shifted just ten cents of every dollar of their spending from chain stores to local retailers, they would add nearly 1,300 more jobs to the city’s economy and increase the city’s output by $200 million annually. To put this in depressing terms, if 10 percent of San Franciscans’ purchasing drifted from local stores to chains, the city could lose1,300 jobs and $200 million of annual output. In all, more than a dozen studies here and abroad have confirmed these results. While the numbers vary from study to study, they all point in the same direction and suggest that for every dollar of spending, a local business will contribute two to four times as much economic benefit to a community as an equivalent nonlocal business.
A second feature of local businesses is that they are reliable, long-term wealth generators for the community. Jobs that come to a community through high-profile attraction or retention deals must be discounted because of the probability that the jobs will not materialize. Twenty-four hours ago I was in Oregon, where I was challenging members of the economic development establishment because of their obsession with business attraction and retention. I pointed out to them that in 2003 there was a local investigative report, done by The Register-Guard newspaper in Eugene, that looked at the impact in Lane County of five years of giving away $6 million in tax abatements. Ninety-five percent of the money went to six large nonlocal businesses. Three of them came, took the benefits, and in a year or two shut down and moved to another gullible jurisdiction in Asia. Two came, took the benefits, stayed, but under delivered the jobs they had promised. Only one was more or less on target. The other 5 percent of these tax abatements went to about 100 local businesses, which made modest job promises but pretty much delivered what they promised. The bottom line was stunning: in tax abatement terms a new local job cost only about $2,100 of business tax forgiveness. The cost of a job produced by the nonlocal companies was $22,000. But remember, some of those businesses came and went. In net job terms the cost of getting a new job from an outside business was $67,200—over thirty times more expensive.
The immobility of local businesses also makes them more adept at preserving natural capital. Without a departure option in their strategic planning, they are more likely to embrace reasonable public efforts to raise labor and environmental standards than to flee. The proximity of most small businesses to their customers and other stakeholders also increases the likelihood of their having to face, both morally and legally, the social and ecological impacts of their actions, which motivates them to behave more responsibly. Responsibility and peer pressure are necessary (if insufficient) conditions for sustainability.
Third, local businesses tend to be small. The size of small businesses can anchor “walkable,” “smart growth” communities, where people live closer to their workplace, their shopping, and their schools, which in turn minimizes the requirements for expensive, polluting, and time-wasting automobiles. The unique homegrown character of many small businesses—particularly retail and food or hospitality industries—makes them better magnets for tourism. The entrepreneurial opportunities offered by small-business economies lay the foundation for what Richard Florida calls “the creative economy,” which can better attract and retain the best and the brightest than can large-business economies that offer only a few elite jobs and many factory jobs. In The Rise of the Creative Class Florida argues that a successful creative economy has to be diverse, tolerant, and fun. That’s what young people want to stay around for, not for the jobs as hamburger flippers, check-out clerks, or assembly-line workers that dominate a typical nonlocal economy.
Fourth, there is a growing body of evidence that local businesses are linked directly to greater levels of social equality. In 1946 two noted social scientists, C. Wright Mills and Melville Ulmer, compared U.S. communities dominated by at least one large manufacturer to those with many small businesses. They found that small-business communities provided residents with a more balanced economic and civic life than big-business cities. In 2001 the late Thomas Lyson, professor of rural sociology at Cornell University, updated this study by looking at 226 manufacturing-dependent counties in the United States. He too concluded that communities dependent on outside companies are subject to greater inequality, lower levels of well-being, and higher rates of social disruption as compared to communities where the economy is more diversified.
Now, what I’ve just shared with you is basically common sense. You’ve probably heard it before, many times. But it is worth reflecting for a moment on just how far these arguments have come over the past generation. Early E. F. Schumacher lecturers who said these things were regarded as heretics. But today acceptance of the benefits of strong local economies has become mainstream. Everywhere you go in this country you see signs that say, “We Serve Local Lamb,” “We Are a Local Bank,” “We Manufacture Local Jewelry," "Locally Owned Video Store.” What you won’t see is a sign that boasts, “We’re Not Local—Buy From Us." The American consumer, having “gone global” and returned with tainted toys and poisoned pets, is now rushing to embrace local goods and services in droves. Even the cover of Time magazine has urged Americans to “Forget Organic, Eat Local.”
III. The Financial Missing Link
Winning the hearts and minds of the American consumer is, however, only one step toward localization. As I emphasize in The Small-Mart Revolution, what we ultimately need is a total overhaul of economic development, including six new kinds of activity:
Local Planning: We need to refocus economic planning away from how a community can achieve one or two comparative advantages in the global economy through exports. Instead, we need to show a community how it can grow new local businesses to plug the leaks of dollars spent on outside goods and services that could be produced locally.
Local Entrepreneurship: We need to reorient entrepreneurship initiatives—whether community-college classes, mentorship networks, physical incubators, or youth business clubs—to highlight the importance of local ownership.
Local Business Alliances: We need to move beyond traditional Chambers of Commerce and Rotary Clubs, which too often are bland talk-shops dominated by global companies, and create instead networks of local businesses dedicated to increasing their competitiveness through what I call “meta-businesses”—that is, economic development initiatives that are self-financing and increase the competitiveness of all local businesses. An example would be a local shopping mall like Pike’s Market in Seattle, where many local businesses thrive by being part of a great destination for shoppers.
Local Finance: We need to create new financial instruments that link lenders and investors, not with Fortune 500 companies but with local businesses. More on this in a moment.
Local Purchasing: We need to spread “Think Local First” campaigns that help mindful consumers identify which products are locally made, which businesses are locally owned, and which local deals will save them money.
Local Public Policy: We need to defund most of what pretends to be economic development these days—the annual expenditure of more than $100 billion per year by federal, state, and local agencies to attract or retain nonlocal businesses—and refocus scarce public time and money on the foregoing ideas.
Over the past decade I’ve visited several hundred communities in America to help them act on these ideas. Progress can be seen everywhere:
• “Leakage analysis,” which uncovers opportunities for local import replacement, is finally coming into vogue and has been successfully used in such varied places as Spokane (Washington), St. Lawrence County (New York), the Hudson Valley (New York), the Katahdin region (Maine), Detroit (Michigan), and most recently on Martha’s Vineyard (Massachusetts).
• There are 1000 incubators in North America that have increased the five-year survival rate of small-business start-ups to 87 percent.
• Local business alliances are improving the competitiveness of their member firms by promoting farm-to-school programs, direct-delivery enterprises, and collective procurement of “green power” from local utilities.
• A wide array of tools linked with “Think Local First” campaigns is being successfully prototyped, including local business directories, coupon books, official Local First Weeks, local currencies like the E. F. Schumacher Society’s BerkShares, and local credit, debit, and gift cards.
• Even in the public policy arena, amazing changes are happening. AUSA Todayheadline of August 22, 2006, said, “Business Incentives Lose Luster for States.” The subhead was, “Some Question the Value to Local Economies.”
The only area where innovation leading to localization seems stagnant, where the barriers to progress remain huge, is local finance. Allow me to perform a little experiment here:
How many of you use a local bank or credit union? I see nearly all the hands are up.
How many of you have pension funds?A good number of hands.
Of those with pension funds, how many are primarily invested in local business? So… where are all the hands now?
Here’s my point. If you, arguably among the most local-economy-minded people in this country, are not placing your pension funds in local business, no one is. Think about it. Approximately 58 percent of the Gross Domestic Product is made up of place-based businesses and institutions—that is, entities that don’t move globally, such as small businesses, nonprofits, and governmental agencies. More than half of the competitive economy is place-based, and yet we are investing almost none of our savings in it. All of us, even locavores like you and me, are over-investing in the Fortune 500 companies we distrust and under-investing in the local businesses we know are essential for community well-being. This is what even economists might drolly call a “misallocation of resources.”
Why have capital markets failed so miserably when it comes to the place-based economy? Some would argue that small businesses simply aren’t profitable. But this claim is certainly incorrect. In the United States sole proprietorships (which tend to be small and local) are more than three times as profitable as corporations (which include most global companies), with partnerships falling somewhere in between. Small businesses in the United States produce 60 to 80 percent of all new jobs as well as thirteen to fourteen times as many patents as large businesses.
It’s worth adding here that highly profitable small businesses include not only those we would expect, such as high-end restaurants or construction companies, but also manufacturing companies, banks, and regional chain stores. In fact, successful small businesses can be found in every sector of the economy. If one looks at the 1100 sectors of the North American Industrial Classification System and asks in how many are there more examples of competitive large businesses than small, the answer is a mere seven. In 1,093 of these categories there are more examples of successful small businesses than successful large businesses. A smart entrepreneur in North America therefore can find a profitable small-scale model for almost any kind of business.
Additionally, as I elaborated in a lecture I gave in Great Barrington at the annual meeting of the Community Land Trust of the Southern Berkshires in 2002, trends in the global economy are actually shrinking economies of scale for all kinds of business. Rising oil prices, for example, are increasing the relative competitiveness of local production linked with local consumption. Mounting environmental concerns about global warming from fossil fuel use may well lead governments to impose “green” taxes, which will further raise oil prices. The Internet revolution is increasingly allowing any community to participate in almost any industry. Industrialized countries like ours are all spending proportionately more of their disposable incomes on local services (like health care and education) than on goods—and services are inherently local.
The fact that far less capital is flowing to small enterprises than ought to be does not imply that small enterprises are unprofitable or risky; rather, it reflects the absence of institutions linking small companies with small investors. Under U.S. securities laws, which were enacted during the early Jurassic Period, accredited investors—people with over one million dollars in assets, or about 2 percent of our population—are allowed to invest freely in any business. The rest of us can do so only if an entrepreneur pays a lawyer $25,000 to $100,000 to generate a thick, tiny-print document known as a private placement memorandum or a public offering statement. Most small-business owners understandably say: “Forget it! It’s not worth the cost and the hassle.”
But this is only the beginning of the story. A quiet revolution in local finance is now under way.
IV. The Vision of Local Stock Exchanges
Throughout most of this country’s history, securities were issued by local companies based in specific states, were traded on stock exchanges within each state, and were regulated by each state. Some state exchanges were efficient, honest, and successful, while others were sloppy, corrupt, and uneconomic. After the Great Depression hit, Congress stepped in to place the entire industry under national supervision. Mindful of the principles of federalism, it established a two-tiered regulatory regime—a national system, overseen by the Securities and Exchange Commission (SEC), for the creation and trading of stocks across the country, and state systems, overseen primarily by state regulators, for the creation and trading of local stock within a given state.
For a number of understandable reasons the state systems largely fell into desuetude. The priority of most companies selling stock was to get as much capital as possible from as many investors as possible, irrespective of where they lived. Creating stocks tradable on national secondary markets offered greater demand for the stock, greater liquidity (that is, the ability to have ready cash to buy and sell the stock), and greater opportunities for profit from the secondary trading of the securities. But the possibilityof local stocks and local exchanges has been, and remains, firmly embedded in U.S. law. It’s a sleeping giant.
Every now and then a story comes along that reminds us of the existence of the state systems. For example, when Ben & Jerry’s first issued public stock, it was basically a statewide offering. You had to be a Vermont resident to buy or sell the securities. Subsequent stock issues by Ben & Jerry’s, however, were conventional national offerings. Gradually the company lost its tether to Vermont and ultimately was purchased by Unilever in a hostile takeover.
The prevailing view is that it’s difficult and expensive to do any of the five essential pieces of successful state stock exchanges—to create local stock, to sell it initially, to evaluate it, to trade it, and to assemble it into diversified portfolios. It’s worth mentioning that historically these same tasks confronted investors interested in larger companies. But throughout the nineteenth and twentieth centuries new financial intermediaries emerged, making it possible to restructure companies so that they had tradable stock shares, to evaluate the worth of shares, and to exchange shares on various public stock markets. My point here is that we already know how to do these tasks pretty well. Now we need to apply our know-how to the local companies.
1. Creating Local Stocks
The first task is to reorganize a great local company so it has shares that outside investors can buy. Pennsylvania, Massachusetts, and New York are examples of states where it is difficult and expensive to create local stock, but there are some states that have already streamlined this process. New Mexico’s public law 27-J, for example, allows you to fill out a few simple forms, send in $300, and—volia!—you can sell stock to unaccredited residents of the state.
Yet even in jurisdictions where larger legal expenses loom, there are ways one can tiptoe around them, as the people of Powell, Wyoming, demonstrated. In 1999, when the community of 5,200 lost its general store and failed to lure a big-box store to take its place, residents decided to build their own general store. They secured the funds they needed to get what they called The Mercantile up and running from a small stock issue. Formally, you had to be a resident of Wyoming to buy and sell the stock, but effectively shares were sold only to members of the community. “The Merc” started selling its stock like Girl Scout cookies, door to door, for $500 a share. The local newspaper editor promoted the stock in his column, and ads contained testimonials from stock purchasers, whose ages ranged from 9 to 94. After $325,000 was raised from 328 investors, the store opened in July 2002 and began selling clothing, shoes and accessories. The Powell Merc made money “from day one,” according to its chairman, a retired pharmacist, and it cleared $500,000 in sales in the first year. It’s now a tourist destination, with busloads of visitors going to see the Powell miracle, and it has inspired other communities to replicate the model—Washakie Wear in Worland, Wyoming; Our Store in Torrington, Wyoming; and the Garnet Mercantile in Ely, Nevada.
Ultimately, there is no good reason why an entrepreneurial lawyer couldn’t set up a technical assistance service that issued stock in a low-cost, fill-in-the-blanks kind of way. Like an underwriter, he or she could take a small percentage of the stock issue as payment. For many years, Nolo Press in Berkeley has been carrying forms, do-it-yourself books, DVDs, and other tools that enable non-lawyers to do their own trusts, wills, estates, divorces, and so forth. There is nothing particularly exotic about drawing up a similar cookbook-like template to facilitate public securities offerings. Recently, a new campaign in Oakland called Cutting Edge Capital has begun to offer direct public offerings for $5,000-$10,000, a fraction of the $50,000 or $100,000 charged by corporate lawyers.
2. Initial Sales of Stock
Once the local stock is created, a second task looms large: the initial sale. Most companies don’t have the entire community involved, as Powell did, though this is an intriguing model for other small towns. Still, it’s interesting to note that even in New Mexico, where it’s easy and inexpensive to create stock, almost no one does it. The reason is that no one has the time, expertise, or ability to sell the stock. How might a New Mexican small business that created local stock on the cheap actually sell its shares? When a big company goes public, an underwriter usually steps in and for a flat fee or a percentage sells the initial public offering through a network of broker-dealers. Unfortunately, few broker-dealers or underwriters, not just in New Mexico but anywhere, consider the small potatoes of, say, a $1 million stock offering worth the transaction costs of performing due diligence on a small company. From the standpoint of a New Mexican business, why bother to use Public Law 27-J when you then have to spend months selling the stock rather than tending to the development of your business?
There are several interesting ways to meet this challenge. It’s not far-fetched to imagine a new breed of broker-dealer who specializes in small-stock sales, someone who patiently develops a list of investors in the state who might be interested in local stocks and lets them know, perhaps monthly, about the latest offerings available for purchase. Alternatively, a company going public is now legally permitted to sell and buy back shares of its own stock on its website. And for some companies, presenting the public with local stock might actually be a useful way of building interest and buzz about a product before it enters the market.
3. Trading Stocks
The third task is to create a platform for buying and selling shares. If we conceptualized a brick-and-mortar building where brokers and investors run around the floor screaming at one another as they do at the New York Stock Exchange, the formation of a local stock exchange would be prohibitively difficult and expensive. But who needs exorbitant buildings and real estate? A local stock exchange can and should be virtual. E-trade and TD-Ameritrade are just two of dozens of internet platforms that provide investors (accredited or not) with portals to stock markets, whether floor based like the New York Stock Exchange or virtual like the NASDAQ.
We used to think that a big infrastructure was needed to make business loans, but now we can do it electronically. Prosper.com and Kiva.org have made deals no more expensive than a few pennies on the dollar and no harder to execute than a mouse click. It’s not a stretch of our imagination to envision an entrepreneur creating an internet-based product in which states and localities can set up their own exchanges.
For the past two years I have been working with John Katovich, Vice President of the NASDAQ, on a new trading platform we call Local Exchange. Together with two dozen other securities experts, investors, foundations, philanthropists, lawyers, and thinkers, we have been sketching the nuts and bolts. Local Exchange would essentially enable a state or locality to create a portal for its own exchange. Each portal could set its own criteria for businesses to be listed and its own rules for operation. Here are some of the ways a local portal might differ from conventional stock exchanges today:
• Only local investors would be allowed to buy or sell shares.
• The criteria for companies to be listed might be far more demanding. Besides insisting on local ownership, the portal might accept only businesses paying living wages and surpassing certain standards of sustainability. Companies might be expected to maintain open-book accounting to enable investor inspection. Any firm guilty of fraud or other crimes might be banned.
• Investors might be required to hold onto stocks for days or even months before selling them. Alternatively, special fees akin to Tobin taxes might be imposed on fast transactions. These tweaks would ensure that local exchanges were used for long-term investment rather than short-term speculation.
Local exchange is, of course, just one initiative. One can easily imagine other companies, whether innovators or copycats, offering their own local exchanges products, some emphasizing certain sectors like food and others emphasizing companies representative of certain values like labor rights. Pioneers in the United Kingdom are setting in motion an exchange for social enterprises—that is, for revenue-generating nonprofits. Another company, Mission Markets in New York, has indicated that it is interested in creating local portals for its exchange platform.
4. Evaluating Stocks
A well-constructed stock exchange ought to provide investors with objective and fair evaluations of small businesses. This will keep the whole enterprise honest. Some see this as a fatal defect for local stocks, since the costs of due diligence for each small company are high compared to the total value of the shares. And yet if that were true, banks and other financial institutions would never lend money to small businesses (lending arguably requires even more due diligence than investing). In fact, new tools for efficiently gathering reliable information on small-business performance are becoming available every day. It will not be long before specialty companies emerge that are essentially the Moodys or Standard & Poors for small-scale stock issues. On the web right now you can find a project led by Betsy Power and Paul Hawken of the Natural Capital Institute called Wiser Business. It is essentially a Wikipedia for socially responsible businesses that invites the companies and website users to continually add, modify, and improve posted information about the performance of different businesses.
Perhaps the most ambitious rating system is being pioneered by B-Lab, a company launched by three successful business veterans. Jay Coen Gilbert and Bart Houlahan started and then sold a major clothing business called AND 1; Andrew Kassoy was a partner at MSC Capital, which had managed the money of, among others, billionaire Michael Dell. Together they have developed an elegant model for evaluating companies’ social responsibility with respect to labor, environment, stakeholder governance, charity, and community. To be designated a B-Corporation (the B stands for “beneficial”) a company must achieve a reasonable composite score as well as add provisions to its bylaws that ensure the board’s responsiveness to these multiple bottom lines. Participating companies are then advertised by B-Lab as being particularly worthy companies, which of course challenges non-B companies to rise to the higher standard. Crucially, one-fifth of the B-Corp score relates to local ownership, local purchasing, and community performance generally.
5. Creating Diversified Portfolios
A fifth task for overhauling community finance is to set up intermediaries to create diversified portfolios of local stock. Even if Joe’s Deli seems like a gold mine, none of us should put more than a small fraction of our savings into it. There’s a need for a wide range of new intermediaries to present local investors with choices that fit their own particular tolerance for risk. The principal obstacle here is the absence of local stock. Can anyone doubt that once local stock and trading platforms become available, a variety of diversified funds will follow? Local venture funds might focus on a small number of high-growth, high-risk businesses; local-ownership and import-replacement hedge funds might apply new theories about options and derivatives to combine differing types of high-risk local investments. Both venture and hedge funds, however, are at present legally open only to very wealthy investors, so it is of great urgency that mutual funds also enter the scene. The U.S. Employment Retirement Investment Security Act (ERISA) sets out rules of fiduciary responsibility for the managers of pension and mutual funds managing 401(k), 403(b), and other employee savings accounts. The absence of a track record from any investment funds specializing in small businesses makes pension and mutual fund managers fear that they will risk violating their ERISA-defined fiduciary responsibilities if they put money in them. Of course, this is a chicken-or-egg problem: you need a track record to attract institutional investment, but without institutional investment there is no track record. The problem is as much psychological as legal, since almost every state defines “fiduciary responsibility” in broad terms. The largest public pension fund in the country, CalPERS, has already undertaken some modest experiments investing in California-owned, low-income housing. The bigger obstacle, though, is the conservative attitude held by most fund managers. Once a few funds begin investing locally, I believe others will join them.
I should note that when I wrote The Small-Mart Revolution, I characterized each of our five tasks as challenges, as difficulties standing in the way of the creation of local stock markets. Since I finished the book, so many innovations have been made so quickly that I think it’s safe to say the big question concerning local stock exchanges is not ifthey will occur but when. The remaining obstacles are neither financial nor technical but legal, and I believe there are a number of strategies that can be used to overcome them. So let’s focus next on the overall value of this model for entrepreneurial communities.
V. Why the Model is Attractive to Entrepreneurs and Investors
One can certainly think of reasons why many small businesses would want to follow the model of the Powell Merc and why many investors would be eager to participate in a local exchange. It’s undeniable that thousands of companies and millions of small investors would be excited by the concept. Entrepreneurs who previously had access only to debt capital would now have fresh sources of equity capital. Investors who previously had to put their savings and retirement funds into distant and disconnected Fortune 500 companies would love to have the opportunity to invest in businesses in their own communities.
While a control-minded entrepreneur might resist taking on outside investors, there are many kinds of local ownership structures that limit this problem. For example, there can be a two-tiered structure of stock—common and preferred—so that the entrepreneur can control the common stock while the preferred stock, whose owners don’t vote for the board and can’t have control of the company, can be held by the community.
Entrepreneurs still unsure of the value of “going public” locally might also consider two powerful advantages local stock can confer. First, a direct public offering provides another option for exit and cashing out, but also one that does not require selling out to a national or global chain and destroying the value of the company for the home community. Second, entrepreneurs would probably see an escalation of value in their companies because of the enlarged pool of people available to buy and sell these shares. The valuation of traded shares of stock for a typical company on the New York Stock Exchange is about fifteen times annual earnings. Buy the same company through a private, one-on-one negotiation, and the price is probably closer to three times annual earnings. The value of stocks on local exchanges would likely fall somewhere between conventional stock exchanges and private exchanges, perhaps with a price-to-earnings ratio of seven to one. That extra value—seven times earnings instead of three, essentially a doubling—could be pocketed by both local shareholders and local entrepreneurs.
A local stock exchange ultimately boosts the likelihood of success for locally owned businesses, which are critical to a community’s economic, social, and political vitality. By offering residents local investment opportunities, it can plug existing capital leaks and offer an exciting new project for community action. For some securities, like preferred shares, it might also invite and attract new outside investors.
To be sure, few local stocks would offer the kind of gigantic returns often sought, but rarely achieved, by professional investors. But the real problem here is investors’ expectations. We live in a peculiar moment, when memories about the years during which various stock markets yielded double-digit gains are sharper than those about the years during which the same markets yielded double-digit losses. Between 1900 and 2005, in fact, the inflation-adjusted rate of return for the Dow Jones Industries has been about 5.5 percent per year. Investors more averse to risk these days can earn roughly 2 to 5 percent in certificates of deposits, money market accounts, high-grade corporate bonds, and tax-free public bonds. A recent study from Princeton found that the returns on highly touted venture and hedge funds between 1996 and 2003 were actually no better than Standard & Poor’s 500 index funds, and many have recently gone belly up. No one really knows the performance of these funds because they—and their reporting standards—are largely unregulated. The point is that historically a reasonable expectation for an investor has been in the range of 3 to 6 percent per year, not 15 to 20 percent. With this more sober standard, what some call a “living rate of return,” many local businesses are fabulous bets. For small investors in a community—like Reverend Sullivan’s parishioners or like many of us—the expectations of a high return are far less important than the confidence that one’s money is nourishing a local entrepreneurial community.
There remains a valid concern about the riskiness of an investment portfolio that lacks geographic diversity. As the business cycle in a community slows, could all of its securities be imperiled and bring down the local stock exchange? In fact, place-based investments tend to reduce risk. Local investment allows investors to inspect the company in which they are investing, to “reality test” claims made on paper, to sample goods and services, and to sniff out WorldCom-style fraud by talking with company insiders. Local investment also allows local businesses to harness the enthusiasm of their consumers, if they become investors, as marketers and promoters.
When you invest your money in one place, and especially if it’s a small place, a little bit of money can go very far in increasing the multiplier, thus improving the business climate for all linked local investments. About twenty years ago South Shore Bank decided to extend home-improvement loans to 10,000 adjacent properties in a low-income neighborhood in Chicago. Skeptics warned the bank not to put all its eggs in the same local basket. What happened, however, was that these home improvements stimulated multipliers that raised the overall property value of the neighborhood, enhanced underlying loan security, and reducedthe risk of the lending portfolio.
Finally, local investment offers the possibility of putting one’s money into multiple businesses that buy and sell from one another, perhaps the component firms of an industrial ecology park where, for example, the waste heat from a smelter business is an input for a greenhouse business. Such investments, if carefully structured, can reduce the risk of any one firm failing. You could even put together a local portfolio of the constituent businesses of an industrial ecology project, thereby investing in all of these businesses and helping them to succeed. This is a kind of local synergy that you could never enjoy by investing blindly in Fortune 500 companies.
VI. The Challenges of Implementation
Earlier I suggested that the only real remaining obstacle to a local stock exchange is a legal one. And here it’s important to underscore how backward U.S. securities law is. At its heart is a belief that unaccredited investors need to be protected. But protection has mutated into exclusion. Think about how many other ways small investors could be protected. The law might say that you must show your previous year’s tax return to any small business you want to invest in and you can’t put more than, say, 1 percent of your taxable income from that year into the company. That’s restrictive because it prevents you from losing all your money, but it does not exclude you from investing locally.
If I walk into a casino, which I can do in almost any state in this country, does anyone say, “Excuse me, Mr. Shuman, can you prove that you are an accredited gambler?” That never happens. Or does someone give me a thick book and say, “Please scrutinize all the risks of playing blackjack before you put your money on the table.” That never happens either. There is one universe of local activity called gambling, where you can lose everything in no time, and that’s allowed. And there’s another universe called small-business securities, where, if we put a small bit of money into businesses without wasting thousands of dollars on lawyers, we’ll go to jail. We ultimately must resolve this contradiction.
Even if we work within the U.S. securities system as it now exists, there is a lot that can be done to move the local exchange idea forward. States can overhaul their securities laws to be like New Mexico’s. An underwriting service could be set up right now to help businesses create local stock on the cheap. Companies can set up websites to sell stocks inexpensively. Existing U.S. stock exchanges, of which there are only about a half dozen left in this country, also have legal authority to experiment with local exchanges.
Some aspects of U S. securities law remain fairly murky, and things may well work in our favor as the SEC thinks these issues through. For example, if there are twenty local companies with websites that encourage visitors to buy their stock, why shouldn’t it be possible to create one website template that links all twenty companies in one place? If those twenty companies were based in Great Barrington, why not create one web page where you could buy stock from each of them?
Most countries have much smarter securities laws than we do, which also may create intriguing openings for local investment. Small businesses in Great Barrington might set up their own stock exchange in Bulgaria, and residents of Great Barrington could go online and locate that exchange for investing locally. This may well be legal before you’re allowed to do it in Great Barrington. In other words, more permissive systems abroad may speed up reforms here in the United States.
Another possible opening: Why not create a modest tax credit in Massachusetts for every taxpayer in the state who puts his or her money into local business? The state of Maine currently gives its residents a 40 percent tax credit for every dollar they put in a qualified Maine enterprise. What is a “qualified Maine enterprise”? Well, if you put your money into a nonlocal bank that has created a branch in Maine, you qualify. If you put your money into a global advanced manufacturing company that has set up a factory in the state, that qualifies. But if it’s a genuine local business, you don’t qualify. This is insane. Simply changing about ten or so words in the Maine code, applying the 40 percent tax credit exclusively to investment in truly local enterprise in Maine, would substantially improve the investment environment in the state. Now frankly, who needs a 40 percent credit? Even 5 percent might do the job. Suddenly every mainstream investment institution would ask, “How can we take advantage of this incentive?” Pension funds, mutual funds, venture funds, hedge funds—they would all focus their attention on the securities reforms.
It is not enough to think about implementing entrepreneurial communities nationally. We need to take these ideas to the global level. Most poor communities on the planet are not without investable capital; they are simply exporting their capital back to “first world” investors. Our mission must be to help them keep their capital at home. We must provide everyone with the tools for localizing finance. Why shouldn’t residents in Lagos be able to invest in a new farmers’ market or in a portfolio of farmers’
If we begin to spread this kind of innovation, literally trillions of dollars currently being unwisely invested in global businesses could be shifted to local economy building and grassroots enterprises. One of the ways to do this, I believe, is by building a worldwide network of small businesses that will share state-of-the-art technology and business designs for helping small-scale businesses work more effectively. We need to create a Wikipedia of the best designs for local enterprises.
In 1992 Richard Jefferson used his U.S. training in biosciences to found CAMBIA, a nonprofit agricultural research center based in Australia. Its website, BioForge.net, provides a forum for scientists from North and South to openly share information, research, projects, and innovations in fields like agriculture and pharmaceuticals. They do not charge a penny for that information. “The idea that we should feed the world is paternalistic, patronizing silliness,” says Jefferson; “The world can feed itself if we can lower the cost of innovation.” Similar research centers with global libraries of small-scale business plans and community investment circles could speed the democratization of equity finance envisioned here.
Several millennia of human history have yielded a succession of market tools to facilitate investment in the world’s major corporations: private equity deals, exclusive trading clubs, limited-membership stock exchanges, and ultimately public markets. Institutional intermediaries have sprung up to facilitate these transactions, including hedge, mutual, venture, and index funds. Today these markets and intermediaries are playing a positive role as they spread valuable information, provide liquidity, and minimize transaction costs for investors, yet all of their innovations remain largely disconnected from entrepreneurial communities and are instead being used exclusively by large enterprises that often have no home base whatsoever. This focus on enterprises without community ties must end. We need to re-channel all this capital, starting with our own, back into community-owned businesses.
Most enterprises, including those in developed countries, are small and essentially off the radar screens of equity markets. The absence of local exchanges to facilitate investment in these enterprises is a huge market failure that stalls serious progress in international development and runs totally counter to the United Nations Millennium Development Goals of improving the financial situation of the world’s neediest people.
We can rectify this failure and at the same time democratize finance by improving on the ideas for local stock markets that I have outlined today and integrating them into the existing system. A new wave of micro-equity innovation is coming that will be even more profound than the wave of micro-lending innovation over the past generation. There are undoubtedly those who will call for strengthening national legal dikes against this wave, arguing that investment should remain the province of rich investors and global companies. I believe we should call for just the opposite—for national governments and global institutions to overhaul the laws and institutions so that small investors and small companies can find one another everywhere.
Only by dismantling the barriers to being inventive in microfinance, giving every individual on this planet the opportunity to follow his or her dream, will we be able to unleash the power of millions of new entrepreneurial communities worldwide that can grow their way out of poverty through their own innovations in business and investment.
As the Reverend Leon Sullivan used to say: "If others can build a house, we can build one too. If others can build a bridge, we can build one too. If others can build schools, factories, industries, and banks, we can build them too. Whatever others can do, we can do. Properly motivated, a man [sic] can do almost anything.”
Question and Answer Period
I was glad to hear you talk about local finance, but what you didn’t discuss is the Federal Reserve. Nor did you mention how corporations are mandated to essentially create a profit or whether dismantling corporate structures as they stand today is necessary for local institutions to blossom.
One of the things the B-Corporation folks are doing—and this is an aspect of their work that is really appealing—is helping mainstream corporations amend their bylaws to include triple bottom lines. Unless a company changes its mission to embrace social criteria beyond profit, it cannot get a strong B-Corporation grade.
The reason I didn’t talk about the Federal Reserve and other national institutions is that I have no faith that they can or will do the right thing. That’s why we’re tiptoeing around them. We’re essentially creating thousands of our own Federal Reserves by linking local currencies and local stock, creating a holy alliance of one set of local tools for local consumption and another set for local investment.
Let’s say I wake up on Monday morning feeling very inspired to sell my Apple stock, which would be a little painful, but I could do that. Yet from what you said, it sounds as though right now in Great Barrington I don’t have a place where I can go and buy stocks in local businesses. So if I wanted to sell my Apple stock and invest locally, what would I do?
The truth is that you have almost no local options. Most of my own retirement money is not localized because I haven’t figured out how to do it in Washington, DC. As I mentioned, there are some pioneering funds, like CalPERs, but even these are focused on local housing and real estate, not local businesses. You really are stuck. You can put money in other kinds of physical assets in your community, such as land or businesses (with which you can strike one-on-one investment deals), but right now there is no systematic way for you to invest your money in a diversified portfolio of local businesses.
Is there a benefit to my community if I do private lending?
Yes, there could be. That’s something the E. F. Schumacher Society has done exceptionally well. It has worked side by side with a local bank to organize depositors to make their accounts available to the bank as collateral for small-businesses loans that both the bank and the Society approved. As long as you stay in the debit capital universe, there is a lot you can do without invoking the wrath of the SEC. The moment you move into equities, you’re in no man’s land (or no woman’s land or no person’s land).
Could you talk about the connections and differences between local-first campaigns and local currencies? Is one an evolutionary step toward the other? Do you need to make a choice between one or the other?
I think local-fir s t campaigns, buy-local campaigns, and the various tools associated with those campaigns—such as local debit or gift cards—are attempting to accomplish much of the mission of local currencies by trying to re-circulate purchasing power within the community and stimulate the local multiplier. It may well be useful to pick one strategy, make it work, and then start to launch complementary strategies.
But frankly, we need experiments with all kinds of strategies, including local currencies. Many communities around the country are curious about and interested in what’s happening with BerkShares. And they’re equally interested in Local First innovations, like local debit cards and local gift cards. So yes, let a thousand flowers bloom, and then let’s share the lessons learned.
Historically, those most interested in currency experiments were populist, either on the anarchistic left or libertarian right. Local First, in contrast, is targeting the political mainstream, knowing that people who already carry debit or credit or gift cards in their wallet won’t have any trouble embracing these innovations; local currency on the other hand requires participants to adapt to a new system.
Until hearing what you have said, the best argument I could come up with for local currencies is the. visibility of the bills. With local-first campaigns you’re dependent on somebody giving you a report, whereas with local currency you actually see it moving around
Yes, but Local First also can have physical parts. Some of the designs for local gift cards look a lot like local currency, so the two may well become hopelessly and wonderfully intermingled.
I was wondering what your thoughts are with regard to using local currency for the model you propose of local stock investment and how efficiently that might shortcut some of the limitations of SEC regulations. Would it be possible to make local-currency investments with BerkShares, which I think are now vastly underutilized? And how do you see loans in BerkShares being made with, say, a smaller fractional reserve and lower debt ratio compared to the dollar, affecting local money supply and money available for investment in local business?
This sounds like a final exam in macro-economics.
I’ll be concise. It’s a BALLE question. Could the issue-shares platform be developed for your BALLE project?
The answer to these interesting questions is sure. Why not? If BerkShares become widely accepted and people understand them as having solid value, why not begin to use them for investment? And I don’t see any reason why one could not start using BerkShares for debt. As the E. F. Schumacher Society demonstrated with Deli Dollars, small debt notes that support a particular business naturally begin to circulate as a local currency. Why not do this in reverse and issue Berkshares, not for cash but for promises of debt repayment? All of us are operating on the fringes of a fractional reserve system that could fail catastrophically, and so we should certainly continue experimenting.
I think BALLE would love to have in every one of its member communities some form of local currency that promotes local expenditure and some form of local stock that promotes local investing. If at the end of ten or fifteen years of experiments we can decide that there is one magic combination that really works and spread it everywhere, all the more power to us. I suspect it will not work out neatly that way. There are always going to be differences in the way various communities approach this, ways that reflect their values and their culture and aesthetics. When you listen to Bernard Lietauer talk about 3000 or 4000 local currencies and you know they come in as many shapes and sizes with as many different rules, you don’t want to unreasonably cut off experimentation by pronouncing any one approach as “the answer.”
Localism is now gathering strength everywhere, so much so that “localwashing” is becoming equally prevalent. HSBC calls itself the world’s local bank, ROK the nation’s local builder, and there’s even a website called shoplocal.com that doesn’t have a single local business on it. Everyone wants a piece of the local action, which shows that we’re on to something.
But I think this is also the moment when we have to push ourselves harder. Yes, it’s impressive that we have come this far. All of us can congratulate ourselves a little bit. But there’s a lot more pushing we need to do.
A theme that has come through in all three of today’s talks is the need to make the poverty and suffering of most of the people in this country the new centerpiece of our work. We’re not just conducting experiments. We are trying to change the heart and soul of this nation and the heart and soul of the world. You know, people often say, “Oh, we can’t afford to do this kind of local economy building because it’s too expensive." We should reply, “We can’t afford not to do it.”
Michael H. Shuman is Director of Research and Economic Development for the Business Alliance for Local Living Economies (BALLE).
An economist, attorney, author, and entrepreneur, Shuman is one of the nation’s leading experts on community economics and the advantages of small-scale businesses in an era of globalization. He received an A.B. with distinction in economics and international relations from Stanford University in 1979 and a J.D. from Stanford Law School in 1982. From 1987 to 1990 he was a W. K. Kellogg National Leadership Fellow. He is also a member of both the State Bar of California and the District of Columbia Bar.
Shuman has authored, co-authored, or edited seven books, including The Small Mart Revolution: How Local Businesses Are Beating the Global Competition(2006) and Going Local: Creating Self-Reliant Communities in the Global Age(1998). The Small-Mart Revolutionreceived a bronze medal for best business book by the Independent Publishers’ Association.
He has recently completed three projects: One, funded by the McCune Foundation in New Mexico, analyzes the impacts of localizing the food system on the state’s economy and greenhouse gas emissions (www.dreamingnewmexico.org); one, funded by the W. K. Kellogg Foundation, identifies income tax and public spending inequities facing small business in 15 states; and one, funded by the Bill & Melinda Gates Foundation and the Kellogg Foundation, presents case studies of 24 local food businesses worldwide (www.communityfoodenterprise.org).