Category Archives: Economy

Public and Private

Through college and law school, the defining distinction seemed to be public and private.

Besides the obvious constitutional and political questions there — whether seen the lens of political philosophy, American jurisprudence, or MSNBC or Fox News, there was the spillover into how one viewed economic efficiency and innovation.  The public and the private became shorthand for the government is inefficient and the private sector is efficient and innovative.

The latter needs to be re-thought as a full blown blanket statement.  The key economic distinctions might be bureaucracy/non-bureaucracy that in the aggregate leads to efficiency and innovation. Plenty if not most private workspaces are not innovative.   More on this elsewhere on the blog, but this quote by Steve Case is on point:

I realized the world of business really separates into…two groups. The attackers are the entrepreneurs who are disrupting the status quo, trying to change the world, take the hill, anything is possible, and have nothing to lose in most cases. They’re driven by passion and the idea and intensity. Large organizations — and it’s true of Fortune 500s and it’s also true of governments and other large organizations — are defenders. These guys aren’t trying to pursue the art of the possible, how to maximize opportunity. They actually are trying to minimize the downside, and hedge risk. They’re trying to de-risk situations. Entrepreneurs can’t even think this way. It’s not even a concept they understand.

The Traditional Notions and Modern Reality of Bank Debt

As familiar over the last few years as they have faced so much incoming fire, banks defend their necessary role in the economy by trumpeting out the role they play in the economy in diverting savings and other stores of capital into investment for business owners who provide jobs.

Yet, we know from reporting as well as first-hand stories, that so many smaller and medium-sized businesses don’t feel that they can get loans and bigger companies that can rely on the capital markets rather than bank lending for investment capital.

Some evidence from Britain as to why (quoting Buttonwood of the Economist discussing a speech by Lord Turner, a former head of the UK’s FSA, given in New Delhi):

Debt is useful, in theory, if it allows business to accumulate capital or consumers to smooth their consumption over their lives. In practice, however, debt is used to finance the purchase of existing assets, leading to bubbles. He cites an estimate that only 15% of British bank lending is used for capital investment.

I don’t know, but perhaps consumer debt is easier to score and securitize and lending to investors (which drives up asset prices) is more profitable.

The Economic Hourglass

There is a thesis of the shrinking middle out there, which if accurate, cannot herald good things:  See here:

In Manhattan, the upscale clothing retailer Barneys will replace the bankrupt discounter Loehmann’s, whose Chelsea store closes in a few weeks. Across the country, Olive Garden and Red Lobster restaurants are struggling, while fine-dining chains like Capital Grille are thriving. And at General Electric, the increase in demand for high-end dishwashers and refrigerators dwarfs sales growth of mass-market models.

The Chinese Hedge

A one-way on-call fleet of jets out of China (like high-end real estate in Manhattan and London) might be a strong business, based on this view out of China in the FT:

Until a few years ago, David Shambaugh, director of the China Policy Program at George Washington University and a leading expert on China’s political system, was a strong proponent of this view. But he has changed his mind and now believes that the party is in a state of decline that echoes the dying days of Chinese dynasties throughout history.

The signs include a hollow state ideology that society does not believe in but ritualistically feigns compliance with, worsening corruption, failure to provide the public with adequate social welfare and a pervasive public sense of insecurity and frustration. Other signs include increasing social and ethnic unrest, elite factionalism, over-taxation with the proceeds mostly going into officials’ pockets, serious and worsening income inequality and no reliable rule of law.

Shambaugh says a powerful indicator of just how little faith exists in the system is the number of wealthy Chinese elites with offshore assets and property, offshore bank accounts and children studying in western universities.

“These individuals are ready to bolt at a moment’s notice, as soon as the political system is in its endgame – but they will remain in China in order to extract every last Renminbi possible until that time,” he says. “Their hedging behaviour speaks volumes about the fragile stability of the party state in China today.”

The Divorce of Investment From Profits

One economic trend of recent years, more than any, begs the question of whether we as an economy have lost our edge.  As the FT reports:

Profits in the US are at an all-time high but, perversely, investment is stagnant.

According to GMO, the asset manager, profits and overall net investment in the US tracked each other closely until the late 1980s, with both about 9 per cent of gross domestic product. Then the relationship began to break down. After the recession, from 2009, it went haywire. Pre-tax corporate profits are now at record highs – more than 12 per cent of GDP – while net investment is barely 4 per cent of output. The pattern is similar, although less stark, when looking at corporate investment specifically.

This change is profoundly odd. Economic theory says investment is driven by profitable opportunities on one side and the cost of capital on the other. High profits suggest there are decent opportunities to make money; historic lows in interest rates and highs in the stock market mean that capital is dirt cheap. Yet investment does not follow.

“We have this strange thing that the return on capital really does seem to be high, the cost of equity capital is low, and yet we’re getting a lot of share buybacks and not much investment,” says Ben Inker, co-head of asset allocation at GMO. “It just feels a bit weird.”

Simply put, big corporations are no longer investing in innovation, despite having the money to do so.  The breakage of the link presents a new economic puzzle based on economic history and theory.

Two potential explanations for this are that 1) there are no innovative projects to invest in; and 2) there are such projects, but big companies do not have the incentive or access to invest in them.

For the purposes of this blog, we will assume the first is just not true:  Startup tech activity suggests that people are more entrepreneurial than ever.

We will explore the second explanation in several subsequent posts.

Profits in the Intangible Economy

Not clear where Krugman is going in his blog today, and neither is he, but it looks to be somewhere interesting.

But there is at least one important respect in which the 21st-century economy is different in a way that ought to have a significant effect on macroeconomics: the much larger role of rents on intangible assets. This isn’t an original insight, but I haven’t been finding systematic analyses of the point.

What do I mean by the role of rents? Consider the changing identity of the most valuable company in America. For a long time, it was GM, then Exxon, then IBM. These were companies with huge visible production activities: GM had more than 400,000 employees, which was amazing when you consider that the overall national work force was much smaller than the one we have today, Exxon had oil refineries. IBM was an information technology company, but it still had many of the attributes of an old-style manufacturing giant, with many factories and a large, well-paid work force.

But now it’s Apple, which has hardly any employees and does hardly any manufacturing. The company tries, through fairly desperate PR efforts, to claim that it is indirectly responsible for lots of US jobs, but never mind. The reality is that the company is basically built around technology, design, and a brand identity.

There was an old Dilbert in which the pointy-haired boss explained that the company had discovered that despite its slogan, people weren’t its most important asset — money was, and people only came in at #8 or something. Actually, in Apple’s case market position is its most important asset.

There are a couple of obvious implications from this change in the nature of corporate success. One is that profits are no longer anything remotely resembling a “natural” aspect of the economy; they’re very much an artifact of antitrust policy or the lack thereof, intellectual property policy, etc. Another is that a lot of what we consider output is “produced” at low or zero marginal cost.

This jumps out at me.  When an economy moves toward where “intangible” assets are the economic driver, the level of reward is tied immensely to the regulatory rules of the reward which limit or allow competition.  So, for Apple, most would probably disagree that anyone could completely copy the iPhone from design to software to icon to Apple logo.  We might call that theft, and from an economic perspective, it would drive profits to zero and would reduce any incentive to come up with iPhone.

On the other end of the spectrum, many would probably disagree that by coming up with the iPhone, no one else was allowed to see a smartphone with a touchscreen, apps, etc.  From an economic perspective, this would make Apple’s profits even larger.

The current situation lies somewhere in between. The rules of the road that govern this are antitrust and intellectual property, as well as some other legal rules.  The push and pull determines where we end up in the wide spectrum between those poles.

One question that follows then from Krugman’s question and my analysis is whether it make sense for the same antitrust and IP rules that governed when tangible assets were the key driver to today’s world of intangible assets.

Maybe, maybe not.

The Finance Tail Wagging the Dog

Interesting ratio re: finance for the sake of generating economic growth versus finance for the sake of finance:

Most of the finance the expanding banks provided, and the innovations they fostered, spurred economic growth, but a good chunk of it just inflated the size of the financial sector as banks created ever more securities to buy and sell from one another. McKinsey, a consultancy, reckons that about a third of the increase in the world’s debt-to-GDP ratio in the years before the crisis came from banks increasing the size of their balance-sheets; bond issuance by banks during this period was about five times larger than by companies. This trend accelerated after 1995, with only a quarter of the increase in debt to GDP coming from households and companies, an “astonishingly small share, given that this is the fundamental purpose of finance”, McKinsey says.

So, according to McKinsey, 25% of finance is funding the main street economy; the other 75% is arguably a casino.

Career Shorts

This has been sitting in my draft folder for months now, having been forgotten. Appropriately, I found this today and am posting.

This is the economist, Tyler Cowen, on career choice as distortion by short-term signaling issues.

“I think about this a lot: you’re young, you come from a smart, wealthy family, you’re somehow supposed to show that you’re successful quite quickly. Banking, law, consultancy allow you to do this; engineering, science and entrepreneurship less so. Your friends expect it, your parents, your potential mates do … So we see so many talented people very quickly having to signal how smart they are but that may not be the longest-term social productivity.”

The Curious Life of A Turkey

Another of what is becoming periodic posts with wisdom from Taleb’s Antifragile:

This one involves seeing opportunity: being a turkey in reverse:

“A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.” The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So with the butcher surprising it, the turkey will have a revision of belief — right when its confidence in the statement that the butcher loves turkeys is maximal and “it is very quiet” and soothingly predictable in the life of the turkey. This example builds on an adaptation of a metaphor by Bertrand Russell. The key here is that such a surprise will be a Black Swan event; but just for the turkey, not for the butcher.

“We can also see from the turkey story the mother of all harmful mistakes: mistaking absence of evidence (of harm) for evidence of absence, a mistake that we will see tends to prevail in intellectual circles and one that is grounded in the social sciences.

“So our mission in life becomes simply “how not to be a turkey,” or, if possible, how to be a turkey in reverse — antifragile, that is. “Not being a turkey” starts with figuring out the difference between true and manufactured stability.”

Being a turkey in reverse is about seeing beyond stability in life and markets, stability that is usually manufactured, but that has terror and disorder lurking right under the surface.  That’s where the opportunity might be.

PC Tectonics

The launch of Windows 8 — after a half-decade or so of tablets and smartphone — failed to arrest and, indeed, accelerated the major drift that was happening away from a WinTel world.  The FT reports the biggest ever drop (14%) in PC sales in the first quarter, noting in a quote by Bob O’Donnell, an IDC analyst:

“At this point, unfortunately, it seems clear that the Windows 8 launch not only failed to provide a positive boost to the PC market, but appears to have slowed it. The radical changes to the [user interface], removal of the familiar Start button, and the costs associated with touch have made PCs a less attractive alternative to dedicated tablets and other competitive devices.”

In essence, Windows is playing too far off its own turf now to catch up.

Like the effect of continental breakup and the resultant effect on evolutionary diversity of birds and mammals, I think Levie gets its right today when he tweeted:

The effect of a drop in PC sales is far-reaching: less PCs -> less MS dominance -> more heterogeneity -> more startup opportunity