Small Business Saturday – Good Intentions, Bad Economics

small-business-saturday-2015First there was Black Friday, then Cyber Monday, and now there is Small Business Saturday, a day intended to promote shopping at small local businesses for the holiday season as a way to support their livelihood, enhance the local community and even help the environment. While certainly well-intentioned, the movement is misguided and can actually end up hurting more than it helps.

Ironically, the term Small Business Saturday was conceived and promoted by the financial services giant American Express, which also holds a trademark on the term. Nevertheless, the idea – to encourage consumers to shop at small local brick-and-mortar retail shops – has been around for awhile.

The claimed benefits are numerous, but they mostly center around the supposed idea of ‘keeping the money in the local community,’ which in turn supports those businesses, creates local jobs and even has a multiplier effect as the money spent locally circulates around the community more than money that is sent off to say,

Like many economic fallacies, there is always a grain of truth that makes it potent and appealing to the logic of its believers. It is somewhat true that if you buy a television set online, that money is sent to the online retailer, who is probably not based in your local community. Whereas if you buy the same set from Bob’s Great TVs down the street, Bob has the money in hand which he may very well spend at the local car repair shop that you own. A much better situation, right?

Unfortunately, this only considers half of the equation. The art of economics is always to observe both the seen and the unseen. If the television set is about the same price at Bob’s as it is online, and you enjoy the service Bob gives and know you can take the set back to him if you have problems, then that’s great! There is nothing wrong per se with buying local, especially when you want to, or would have done so anyway, because you value the product and accompanying services more than the lowest possible cost.

The problem arises when people believe you should shop local just because it is local, and not because the services and prices are just as good or better than in the larger neighboring town or online. For example, let’s say the television from Bob’s is more expensive than the exact same set at the big-box retailer or online, perhaps hundreds of dollars more. You may enjoy Bob’s friendliness and additional help or services, but at what point is the extra cost worth that extra friendliness?

In other words, if you decide to shop local at Bob’s, you are no longer doing so because you value his product and services more than the cost; you are now paying more than you think that TV set is worth. You can still decide to shop at Bob’s because you like Bob and you want to see Bob’s Great TVs do well, but the nature of the transaction has changed.

Previously, it was a business transaction where both sides were happy because they were getting something they value more. Bob valued your dollars more than the TV, and you valued the TV more than your dollars. But now the transaction is more like a charitable contribution. You are giving away more dollars than you want to in exchange for a sense of feeling good and keeping Bob’s business going. People may still choose to do this, and they have every right to do so, but this eventually leads to less wealth for the local community as a whole and makes Bob worse off in the long run.

First, consider that if you save hundreds of dollars buying that TV online, you now have hundreds of dollars to spend elsewhere, which could include spending it at local shops and services such as restaurants or haircuts. This points to the main issue at hand: it is the geographic expansion of business and specialization, and the resulting lowering of costs and better resource utilization that creates the wealth we enjoy!

To illustrate this concept, imagine an extreme example where everything you purchased had to be within your local community, say a ten square mile area. For starters, some commodities and resources would not even be available, such as orange juice (unless you lived in Florida.) What about the local pizza place? Would it be able to get all of the ingredients it needed from other people in town, let alone the heavy-duty equipment to roll out the dough and bake the pies?

More importantly, it is specialization that allows us to become wealthy. The more local the economy, the smaller the market, and the smaller the market, the less opportunity for specialization. Nobody would invest billions in a semiconductor factory if they could only sell microchips to their neighbors. A purely local economy would look like economies in early America – very poor (although even early settlers traded with countries overseas!)

It is true that buying that TV online instead of from Bob may hurt Bob’s sales in the short-run. A dynamic and expanding economy that is constantly finding more ways to specialize and create wealth may diminish or destroy some jobs in the process. By subsidizing Bob with your business you have good intentions, but if his business model is not viable, you are only delaying the inevitable for Bob.

It would be better for Bob to start adapting to the changing market earlier rather than later. Perhaps Bob could change his business model to sell cheap TVs and offer them at cost to consumers (ordering them online himself), but make a profit by installing and servicing them in people’s homes, something that cannot be done online.

In conclusion, the ‘shop local’ movement is well-intentioned, and there is nothing wrong with buying things locally because you like the product or service. But don’t fall into the trap that you are helping the economy more by shopping local. Pressuring people to buy local – simply for the sake of buying local – will only result in higher prices, a smaller selection, and less wealth for everyone to enjoy.

Chris Kuiper, CFA is currently a student and researcher at George Mason University, pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.