Dec 192012
 

17 December 2012, the San Francisco Chronicle had a story—”Solar Power Adds to Non-Users’ Costs“—that provides background for a very good Microeconomics test question:

Q: Under what circumstances can the combination of a decrease in demand and an increase in supply lead to an increase in prices?

The short answer, of course, is, “When government interferes with the market process.”

If you are required to show your work, here’s what you do:

First, note that the own-price demand elasticity for electricity tends to be low for most consumers, meaning that one tends to consume the same quantity, seemingly regardless of the price. For example, one would not expect someone to throw open the windows in the middle of summer, with the air conditioner turned to its lowest setting, if the price of electricity fell substantially. More likely one would continue to consume electricity at approximately the same rate and use the cost savings on something that had a higher own-price elasticity of demand, like those things that collect in one’s shopping cart at Amazon.com, but one rarely gets around to ordering for delivery.

You can illustrate it this way:

Vertical Demand Curve in Equilibrium

Fig. 1 : Vertical Demand Curve in Equilibrium

This is very similar to the textbook Supply & Demand graph, but with the Demand curve at the same quantity demanded for every price. (Of course, this is not realistic for all prices, and the real world is not so well-behaved. Such is the nature of economic models.)

As indicated in the article above, the increase in solar panels being installed on the roofs of residential and commercial buildings in California is causing a decrease in overall demand for conventional electricity.

In an unregulated market, we might illustrate it this way:

Vertical Demand Curve with Shift in Demand

Fig. 2 : Vertical Demand Curve with Shift in Demand

As the demand decreases, due to the existence of solar-powered substitutes, price tends to fall.  In an unregulated market, executives and shareholders in waning industries receive signals in the form of accumulating inventories—unsold output—that they either should reduce their prices, reduce their output, or both.  If the trend continues—as happened with sailing ships, tools for making whale oil, steam locomotives, buggy whips, etc. in earlier generations—the executives and shareholders receive signals that they should consider whether liquidating and reallocating their existing resources might be more profitable than clinging to a dying firm or industry.  (Schumpeter referred to this as ‘creative destruction‘.)

However, in a regulated market, suppliers and regulators agree on a price and fix it ex ante.  Typically, the price is below the equilibrium, at least in the first iteration, so that consumers will be happy and express their gratitude to the politicians who oversee the regulators.  (This sometimes is referred to as ‘the iron triangle‘ of regulation, and it is related to the concept of ‘regulatory capture‘.)

We can illustrate it this way:

Vertical Demand Curve with Regulated Price

Fig. 3 : Vertical Demand Curve with Regulated Price

Here, the regulated price (Pr) is below the equilibrium price that would clear the market, but is at least as high as is needed to generate sufficient revenues to cover the costs of production.  The executives and shareholders of regulated firms generally are rewarded for their cooperation with monopoly rights in the form of franchises that grant them the exclusive right to serve a particular geographic region.

The firm’s total revenue is illustrated as area of the pink rectangle below, which is price * quantity.  It is possible that a firm’s executives and shareholders might want to increase output, so that the firm could sell the excess into neighboring markets, but the jurisdictions of most regulated industries do not adjoin jurisdictions where competitors are unregulated.  Most likely, every neighboring territory is served by a different monopolist franchisee.

Vertical Demand Curve with Regulated Price / Total Revenue

Fig. 4 : Vertical Demand Curve with Regulated Price / Total Revenue

Returning to Fig. 2, as solar panels reduce demand for conventional electricity, the demand curve shifts to the left.

Vertical Demand Curve with Regulated Price and Demand Shift

Fig. 5 : Vertical Demand Curve with Regulated Price and Demand Shift

Because the electricity providers’ prices are fixed by regulation, and they have very high fixed costs, they are loath to lower their prices.  In fact, the fixed costs of maintaining a capital base that consists of indivisible centralized facilities, power lines, poles and waterproof underground conduits, substations, and other large and expensive infrastructure can vastly exceed the variable costs of fuel and peak-time labor, and these large fixed costs are the primary drivers of the price that suppliers and regulators agreed to previously.

Now, with a smaller consumer base, the utility operators have fewer customers to divide their fixed costs among.  In order to arrive at a rectangle with the same area as the pink one in Fig. 4, given that the utility operators not only cannot force consumers to buy conventional electricity, but are required to buy the excess electricity produced by the owners of the solar panels.  In other words, the suppliers are doubly pinched, and their only savings are in the form of electricity purchased at full retail from their customers, accompanied by a relatively slight decrease in variable fuel costs.

The only viable alternative in this situation is for the operators of the regulated conventional electricity utilities to petition the regulators for a price increase to be passed along to the remaining conventional electricity consumers.

Vertical Demand Curve with Regulated Price / Price Increase

Fig. 6 : Vertical Demand Curve with Regulated Price / Price Increase

Considering that solar energy becomes more economically viable, when its primary competitor—conventional electricity—becomes more expensive, the rising prices in this scenario create an incentive for even more consumers to adopt solar energy, thereby shifting the demand curve even further leftward toward zero… creating yet more upward price pressure.

And, in this way, regulation creates an environment, in which a decrease in demand can lead to an increase in price.

Invest accordingly.

Prof. Evans

Nov 262012
 

The vast majority of firms do not pay dividends, which renders the use of dividend discounting methods for estimating their values moot. In this case, one can use discounted expected cash flows: net income (NI), operating cash flows (OCF), or free cash flows (FCF), depending on the level of sophistication required by the analyst.  However, all of these require the analysis of the firm’s financial statements, which might involve more effort than one is willing to expend in a preliminary analysis.

With publicly traded firms that do not pay dividends, another option exists using the price/earnings ratio (P/E).

Remember that:

NI = Dividends + Retained Earnings

P/E = Equity/NI

NI is the pool of funds from which a firm would pay dividends if it paid dividends, and dividend discounting models assume that all of the value of the firm is paid out to shareholders in the form of a dividend (D).

In this way, we can see P/E = Equity/NI as being similar to P/E = price-of-equity (P) / D:

P/E = Price / Dividend = P / D

To use this in our dividend discount formula, we need to take the reciprocal:

P/E ratio discounting formula

where

re : return on equity / cost of equity
D : dividend
P : price
P/E : price/earnings ratio
g : growth rate

Start with the P/E ratio, take its reciprocal (1 ÷ P/E), multiply by (1+g), and then add g.

You can practice this in the WACC Quiz, by clicking the Practice link above.

I hope that this helps.

Prof. Evans

Nov 152012
 

3 November 2012, Clayton Christensen, whose earlier works I have found inspirational and illuminating, published an article in the New York Times—”A Capitalist’s Dilemma, Whoever Wins on Tuesday“—that starts with a reasonable premise, and veers hopelessly off course.

To Wit: “Whatever happens on Election Day, Americans will keep asking the same question: When will this economy get better?”

Fair enough. That is a very reasonable question, and it is a very reasonable expectation that Americans will keep asking it.

So far, so good.

Then, we get this:

“The Fed has been injecting more and more capital into the economy…”

<facepalm>

The Fed has been pumping more and more money into the economy. The value of money is measured by the ratio of units in circulation to the value of stuff. If the number of units in circulation increases faster than the quantity, value, or both of stuff, then prices rise.

Capital is the long-term means of production: drill presses, trucks, robots, etc.. The Fed doesn’t have any of that, and Fed governors are not in a position to command others to make such things available.

The Fed lends money to the US Treasury, buys toxic assets from commercial banks, and regulates banks. It isn’t a hardware store.

Now, if one is sitting on a lot of money that one can convert into capital assets, then one might adopt the financier’s habit of referring to that money as capital, but one should avoid conflating fiat inflation with the means of production.

“And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations.”

Firms are supposed to keep pools of cash as a kind of self-insurance policy against slow economic times. We call this ‘working capital’. When the future is even scarier than normal, the prudent thing to do is to hold more cash. The ‘Fiscal Cliff’, Pres. Obama’s political rhetoric expressing open disdain for those who are wealthier than he, the unknowable effects of Obamacare, the ongoing transition away from a capital/labor economy toward a service/knowledge economy, and the specter of another decade of ‘Bush’s war’ are enough to render all expectations of the future little more than random bets and wild guesses.

And, no one gets fired for playing it safe. So, until things settle down, executives play it safe.

“Billions in capital is also sitting inert and uninvested at private equity funds.”

Does Prof. Christensen believe that fund managers have piles of big, canvas sacks with dollar signs on them, filled with cash… like Scrooge McDuck or the dapper little fellow from the Monopoly™ game?!?

The money is invested somewhere, most likely US Treasury debt, because the US Treasury has a reputation of always paying its debts… even if it has to print more money to do so. In these highly uncertain times, the safest bet is the safest bet.

“Empowering innovations create jobs, because they require more and more people who can build, distribute, sell[,] and service these products.”

Sadly… no, no, no, and no.

Build: Factories are increasingly automated, and when meat-that-talks is needed, one hires labor where it is cheap; i.e. Latin America, Southeast Asia, and increasingly Sub-Saharan Africa.

Distribute: DHL, FedEx, UPS, already have that pretty well covered.

Sell: Amazon.com.

Service: What is that? Throw it away and buy a new one.

“[T]he Toyota Prius hybrid is a marvelous product.”

Except that [o]nly 35 percent of hybrid car owners bought a hybrid again when they purchased a new vehicle in 2011.

“‘[E]fficiency’ innovations… almost always reduce the net number of jobs…”

This one is spot-on. It is unfortunate that Christensen did not make it the centerpiece of his analysis.

“The economic machine is out of balance and losing its horsepower. But why?”

Peter Drucker answered this question in Post-Capitalist Society, which was written nearly twenty years ago, and reads today like a play-by-play account of what happened in the 1990s and 2000s.

[Reread the sentence above, click on the link, and buy the book. You can thank me later.]

Also, the total value of goods manufactured in the USA continues to exceed the value of goods manufactured in China.

The scorpion’s sting is in the tail. Toward the end of the article, Christensen states, “We can use capital with abandon now, because it’s abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs.”

No one knows where the ‘jobs’ of the future will be. Social engineering always fails. In the 1960s, it was plastics; in the 1980s, software development; in the 1990s, Dot.Com… No one knows what it will be next decade.

“[T]he [capital gains tax] rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.”

It might have made sense a century ago, when technology changed slowly, to make it costly to change plans quickly in response to new information, but Christensen’s advice in a highly dynamic—even chaotic—integrated global economy would create an incentive to keep sub-optimal plans running beyond their use-by dates.

“Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue.”

This suffers from two fatal flaws. 1) The universe does not end at the US border. 2) If capital gains represent a trivial portion of the federal budget, then eliminate the cost of collecting and enforcing them and call for their repeal. Leave the money in the owners’ hands, rather than seize it at gunpoint, if it is hardly worth collecting.

“It’s true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.”

Indeed, times have changed, but that does not mean that this time is different, as Christensen seems to assume. We are in the latter stages of a transition as profound as the 18th Century Industrial Revolution, from a capital/labor division—in which semi-literate proletarians drive industrial machines—to a knowledge/service division, in which skilled workers are the ‘capital’ and are not interchangeable.

However, the wealthy will invest where they expect the greatest opportunities are, as has been the case since the Renaissance a half millennium ago. When princes, presidents, and parliamentarians create uncertainty, the wealthy will hunker down and wait until circumstances stabilize.

Christensen started with the premise that the president and the Fed do not have the power to fix things, and then concluded that the IRS does have such power.

This conclusion is counterintuitive. An alternative would be for presidents, princes, and parliamentarians to enforce transparency, and otherwise to mind their knitting, rather than concern themselves with affairs that are beyond their abilities.

Invest accordingly.

Prof. Evans

Nov 042012
 

When I was a child, I had a book of jokes that contained the story—if memory, after nearly a half-century, serves*—of Little Mable Moneybags. This story reminds me of the attitudes of many vocal activists—both libertarian and social welfarist—who live in North America and Western Europe.


Little Mable Moneybags was a very lucky little girl, who had been born into a very lucky family. One day in school, her teacher asked her to write a story about a poor family. This is what she wrote:

Once upon a time, there was a frightfully poor family. They were all frightfully, frightfully poor.

The mommy was poor, and the daddy was poor. The little girl was poor, and her teddy bears were all poor. The kitty was poor, and the puppy was poor.

The chauffeur was poor, and the chef was poor. The butler was poor, and the upstairs and the downstairs maids were poor.

The groundskeeper was poor, and security guards were poor.

They were all frightfully, frightfully poor.


Whenever I get mail with the smiling face of a celebrity or millionaire on the letterhead, extolling the virtues of and asking me to send money to a lobbying group or ‘non-partisan public policy research institute’ that is dedicated to reducing regulation and taxes or increasing regulation and taxes, I think of Little Mable Moneybags, and wonder why so many libertarians and social welfarists seem to be oblivious to the poor in any meaningful way. They all want me to donate my money and time to lobby for tax-cuts that benefit only those who actually pay taxes or tax-increases that ultimately go to government employees.

While I recognize that everyone who pays taxes benefits directly from tax cuts, everyone—individual and multinational firm, alike— who receives government subsidies benefits from tax increases, and everyone benefits indirectly an optimal level of regulation, those who benefit the most almost never are among those least able to protect their own interests.

If I am going to expend an effort to promote liberty, minimal government, and individual responsibility, I am going to be much more interested in helping the poor extricate themselves from the social welfare bureaucracy than in promoting the pet causes of individuals who earn more than I do.

If I am going to expend an effort to help the poor, I am going to be much more interested in helping the poor extricate themselves from the social welfare bureaucracy than in expanding it and perpetuating the cycle of dependency.

And, in particular, if am going to expend an effort to promote liberty, minimal government, individual responsibility among the poor, I am going to focus my attention on the 5.5 billion who live outside the OECD who are really poor.

In the meantime, the mailers go straight into the recycling bin.

Invest accordingly.

Prof. Evans

_____
* If you are a copyright holder who feels that this, in any way, violates your rights, contact me immediately to provide proof of ownership, and to let me know your intentions.

Nov 042012
 

We examine the effect of securities laws on stock market development in 49 countries. We find little evidence that public enforcement benefits stock markets, but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets.”
(La Porta, Lopez-de-Silanes & Shleifer 2006)

In general—and vastly oversimplified—regulatory regimes fall into three categories: Authoritarianism, Anarchism, and Transparency.

The term authoritarianism here refers to what one might think of as over-regulation, as when entrepreneurs in a particular country must seek permission—perhaps even an act of parliament or specific permission from the ruling junta—before being allowed to register a new firm.

The term anarchism here refers to a de facto, even if not a de jure lack of government oversight, where regulations either do not exist or exist but are not enforced.

The term transparency here refers to a regime, in which individuals are more or less free to do as they want, but must make public disclosures of actions or decisions of material importance.

Markets that could be described as ‘authoritarian’ tend not to attract much capital from investors outside those jurisdictions, and investors within those jurisdiction—particularly those who are not politically connected—often tend to prefer to invest abroad. This is in large measure, because they are highly constrained in how they can respond to new information, changing supply conditions for inputs, and evolving demand conditions among consumers.

For example, if one were required to declare the precise nature of one’s enterprise as a condition of registration and permission to operate, and one were forbidden to deviate in the future from this stated purpose in response to changing expectations, regulatory inflexibility might create an incentive for one to take one’s business to a jurisdiction less plagued by bureaucratic micro-management.

At the other extreme, ‘anarchic’ markets tend not attract much capital from outside those jurisdictions, and investors within those jurisdictions—particularly those who are not politically connected—often tend to prefer to invest abroad. This is in large measure, because they have little recourse to dispassionate enforcement institutions, like unbiased judges, neutral regulators, and incorrupt police.

For example, if one were subject to routine breach of contract, expropriation of property, or threat of violence, regulatory apathy might create an incentive for one to take one’s business to a jurisdiction less plagued by uncertainty.

Between these two extremes are ‘transparent’ markets, which one tends to find in English-speaking countries and non-English-speaking countries where the legal systems have been based on or even borrowed from England or the USA (and possibly the commercial code from Germany). In these countries, one has a relatively free hand to organize one’s affairs as one sees fit and to change plans as needed.

For example, in Australia, Canada, the UK, the USA, etc., one can incorporate, regardless of one’s standing in the community, family membership, political affiliation, or even criminal background. One does not need to declare the specific purpose of one’s firm—the boilerplate ‘purpose’ being “to engage in any lawful activity”—seek sponsorship or permission to incorporate, or submit to a background check. One submits articles of incorporation, pays a fee, and stays current with one’s filing requirements.

The executives of privately held firms must communicate all decisions and actions that have a material impact on the firm to their shareholders, or risk civil or even criminal complaint. The executives of publicly traded firms must file public disclosures for seemingly trivial matters, or risk regulatory penalties.

Jurisdictions where transparency is the order of the day tend to attract both domestic and global investment, have efficient and liquid markets, and recover from crises robustly.

The optimal level of regulation lies somewhere between authoritarianism and anarchism, in which executives are free to form expectations, make plans, take action, and to modify their plans in light of new information—including rumor, superstition, and noise—changing supply conditions for inputs, and evolving demand conditions among consumers.

Invest accordingly.

Prof. Evans

_____
La Porta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer, 2006. “What Works In Securities Laws?” Journal of Finance 61(1), 1-32.

[possibly available at: http://works.bepress.com/cgi/viewcontent.cgi?article=1000&context=florencio_lopez_de_silanes]

[2003 Working Paper available at: http://www.nber.org/papers/w9882]

Aug 022012
 

In April 2011 Edward Glaeser wrote, “Over the last decade, January temperature continues to predict growth throughout the entire United States.”

In May 2006, Paul Graham wrote that, in order for an area to be a ‘Silicon Valley’, it needs wealthy individuals, entertainment, a relatively lax attitude toward regulation, and a world-class university.

South Florida has all of those in abundance, except for the world-class university.

Connect the dots, and you get a business plan. The administrators — especially the fundraisers — of the University of Miami, Florida International University, Florida Atlantic University, and Nova Southeastern University should be tripping over each other in the quest to hire a couple of Nobel Prize winners in Chemistry, Economics, Medicine, or Physics.

They even could specialize, the one taking Medicine; the other, Economics; the next, Chemistry or Physics.

Granted, the region probably would become known as Silicon Beach or Silicon Swamp — neither of which captures the essence of what lies more than a half mile (1 km) west of the ocean — but there’s no point in fighting the public’s branding expectations.

Already, the headquarters of AutoNation, Burger King, Citrix, DHL USA, Office Depot, Ralph Lauren, Ryder, and a lot of other lesser-known companies are down here. There is a very healthy culture of entrepreneurship here, and I expect that young individuals in technical fields could do worse than to look in South Florida for prospective spouses.

South Florida has gone from being literally the end of the road to The Gateway of the Americas. It is time to take that next, logical step and invest in the region’s blossoming into a truly world-class hub.

Or, we can scratch our heads in wonder, as the geeks and nerds go to the middle of the desert.

Invest accordingly.

Prof. Evans

Jan 032012
 

While responding to a Facebook post, about these final stages of the transition from a hodge-podge of nation-based Capital vs Labor economies to an integrated global Knowledge vs Service economy, it occurred to me that lovers of classical liberalism might be dismayed to see capitalism actually end up being its own undoing, as leftists have predicted… but not as leftists have predicted.

That is, not for economic reasons, but for political reasons.

In other words, the one perfect jewel that classical liberals hold so dear might perform precisely as advertised, but be surrounded by unappreciative drones who are two paychecks from reverting to savagery and outnumber the enlightened 99:1 by many accounts.

I exaggerate, but only for effect.

Imagine for a moment that an economy is going through a massive transition, such that:

  • A century ago, about 40% of the US workforce was engaged in agriculture. Today, it is a bit less than 2%.
  • A half-century ago, about 40-50% of the US workforce was engaged in manufacturing and distribution. Today, it is somewhere around 10% and falling.
  • A lot of white collar occupations are being taken over by software, including bookkeeping, accounting, paralegal, inventory control, etc.
  • Throw in about 10% working in various levels of government, and that leaves around 75-80% looking for something useful to do. In general, the choice is between a) high-end knowledge work, like entrepreneurship, industrial design, etc., and b) locally delivered personal services like pepper spraying peaceful protestors, automobile maintenance, etc.

That leaves a lot of idle hands.

Now, imagine that those hands get to vote.

All the eloquent arguments, apodictic truths, and hermetic logic in the world will not sway an electorate in thrall to populist demagogues, be their shirts red, brown, or black.

If my one, tiny voice mattered, I’d do what I could to get the humanitarians to stop hanging out with left-wing populists, and to get the classical liberals to stop hanging out with right-wing populists.

The false dichotomy of Eat the Rich vs Eat the Poor is a loser’s game.

The most charitable act that one can undertake to help the poor is to start a business and hire them. The most selfish act that one can undertake to keep the poor from storming the Bastille is to make sure that they have enough bread and circuses.

Invest accordingly.

Prof. Evans

Dec 092011
 

The Third Way

Wilhelm Röpke (1899-1966) is credited by many as one of the architects of the post-WWII German Economic Miracle, driven by the implementation of the Social Market Economy that is advocated by adherents of ORDO Liberalism, and associated with the Freiburg School of political economy.

(The term ORDO refers to an academic journal established in 1948 by the founders of the Social Market Economy movement in Europe following WWII.)

ORDO Liberals see a distinction between laissez-faire and Classical Liberalism that is very similar to what Karl Polanyi (1886-1964) describes in his book, The Great Transformation.

Essentially, laissez-faire is about means and Classical Liberalism is about ends, and there is no guarantee that laissez-faire will lead to Classical Liberalism. Evidence includes cartels, ‘old boy’ networks, cronyism, Unconscionable Contract, etc., all of which can exist under laissez-faire, but are very different from the ends that Classical Liberals advocate.

Some of the most repressive societies are those that have evolved in remote tribal villages, so far removed from formal government that it essentially does not exist.

On the other hand, the opposite of laissez-faire, statism, has led to unfathomable horrors including the twin extremes of National (‘right-wing’) Socialism and International (‘left-wing’) Socialism, the Khmer Rouge, and numerous Middle Eastern dictatorships, along with watered-down versions of in Cuba, Myanmar (Burma), Venezuela, Zimbabwe, et al., ad nauseam.

Statists see this not so much as a distinction between laissez-faire and Classical Liberalism, but as an inevitable consequence of laissez-faire, and they argue that government regulators and enforcers should achieve desired ends by whatever means are deemed acceptable.

In post-WWII Germany, the heavy hand of government was used to create a social safety net for the socioeconomic bottom-most while allowing market participants to allocate resources. So long as individuals employed means and achieved ends that were acceptable to government regulators, they were left to do as they wished. When someone in power determined that either the means or the ends were unacceptable, government agents stepped in to redirect the resources.

For the decade after the War, politicians and regulators steered the German economy down this middle way with some success, avoiding the excesses of command-&-control socialism at one extreme and the kind of anarchic chaos seen later in Russia following the fall of the Soviet Union at the other extreme. China’s rulers appear to be attempting to follow a similar path today.

If politicians and regulators are united in their belief that Classical Liberalism is the ultimate end, and that the constrained laissez-faire of the market is the most efficient means to achieve that end, with occasional intervention, then an ORDO Liberal policy regime can work.

There is, of course, no guarantee that subsequent generations of politicians and regulators will not err on the side of command-&-control, as happened in Germany in the last quarter of the 20th Century. Where individuals wield power, the danger always exists that they will use it in pursuit of personal agendas, even at the expense of the community as a whole.

Sovereignty without Sovereigns

Today, as we transition from capital/labor national economies to an integrated knowledge/service global economy, we face an altogether different set of challenges. The question today is not, “Will statutes and regulations be overly burdensome?” but “How can transnational firms and networks be hindered in forming cartels in the absence of a global statutory and regulatory authority?

In other words, the danger today is not that the agents of a national government might tax or regulate a firm or industry out of existence, but that the executives of transnational firms and networks will enter into contractual arrangements that create artificial monopolies or otherwise exploit their positions to the detriment of consumers.

Granted, Dominium is less of a concern than Imperium, but it is a concern, when it results in higher costs for those least able to afford them. At the extreme, executives gain a kind of sovereignty by being beyond the reach of any particular government other than the ones that they happen to be standing in.

An example of this is illustrated in a recent Bloomberg story, “U.S. Studies Derivatives That ‘Game’ Tax Rules” that describes some of the difficulties that US legislators and regulators are facing in their quest to control the executives of financial firms and the participants in derivatives markets.

A major part of the problem is the fact that all financial assets are either contracts or titles that derive their existence from individual agreements and social institutions. They can be transferred quasi-instantaneously; encoded, shredded, and stored transnationally; and accessed, reassembled, and decoded from any jurisdiction.

The only things preventing the establishment of a peer-to-peer asset exchange that exists purely on the Internet are inertia and convenience. The tools and designs have existed for more than a decade. As long as the cost of the status quo remains less than the benefit, individuals will resort to status quo organizations, but if legislators and regulators raise the cost of doing business conventionally much more, then transitioning to something else becomes a viable alternative.

Even in the absence of overt blundering, the relative benefits of technological innovations are growing at exponential rates, and the tipping over into a new order that is out of the reach of any national government probably will come no matter what politicians do in any particular jurisdiction.

In such a world, the idea of a Third Way becomes untenable, as no national regulator or enforcer will be strong enough to compel laissez-faire to lead to Classical Liberalism.

Where things will lead, like all else in the future, is unknowable, but it is not unimaginable. I will explore some possibilities in Part 2 of this essay.

Invest accordingly.

Prof. Evans

Dec 072011
 

Röpke on Imperium & Dominium

In addition to advocating the Social Market Economy, for which he is most famous, Wilhelm Röpke (1899-1966) distinguished between two types of colonialism that are of immense relevance to understanding the world today, as we transition from multiple capital/labor national economies to an integrated knowledge/service global economy.

Röpke referred to these as Imperium and Dominium. [warning: PDF] Imperium refers to political sovereignty, and it is projected at the point of a gun. Dominium refers to economic sovereignty, and it is projected at the point of a pen used to sign a contract.

Röpke recognized that both Imperium and Dominium are forms of domination, and that Imperium is by far the more violent of the two. In other words, if one were going to be dominated by a foreign power, one would be better off if that power were Nike and not the CIA. Still, one would be dominated, and one might be expected to chafe at that.

Historically, Imperium has been more potent than Dominium, e.g. the Roman, Ottoman, Spanish, British, etc. Empires. It was not until the 20th Century and the birth of the multinational corporation that Dominium began to emerge as a potent political force. As borders become increasingly meaningless today, corporate Dominium is supplanting government Imperium as the predominant means for projecting influence and power worldwide.

While agents of the US military drop bombs, executives of Chinese firms are buying controlling interests in the Panama Canal, Freeport (Bahamas), and other Western Hemisphere commercial infrastructure. In the long run, US taxpayers will tire of paying for adventures in nation building on their behalf, while one expects that the demand for global transportation will continue for the foreseeable future.

(And, make no mistake of it, the Americans might be flat-footed and incompetent imperialists, but they are master dominialists!)

As we have seen in the Middle East in 2011, when enough individuals realize that the real power is in transnational commerce, and that politicians and regulators govern at the pleasure of the people, their relationships with their rulers can change radically.

Colonialism

This is not to say that that future will be all roses, ice cream, and singing unicorns. Quite the contrary, colonialism and other forms of domination will persist, but in different forms from before.

One of the distinguishing characteristics of a colony is that it is a jurisdiction that exports raw materials and imports finished goods from the jurisdiction to which the raw materials were exported.

For example, historically, British weavers imported cotton and silk from India and exported finished cloth and apparel to India. In this way, the weavers were able to acquire raw materials at commodity prices and sell their output at significantly higher monopoly (one producer) or oligopoly (a small number of producers) prices.

Independence from British weavers was such an issue for Gandhi that he wove his own cloth as a sign of protest, and the spinning wheel became such an important symbol of Indian independence that it adorns the national flag of India.

Over the past century, the economic center of gravity has shifted away from agriculture to manufacturing to knowledge, and the nature of colonialism has changed.

Today, China, India, and Russia export large numbers of students and entrepreneurs — the raw materials of a knowledge economy — to North America and Western Europe, where they conduct research and produce commercial goods that find their way into textbooks, software, and other information goods that are then exported back to their homelands.

From this perspective, one can argue that colonialism never went away; it just changed industries. The raw material today is not fiber, grain, or rubber, but human capital.

As Röpke pointed out, today’s colonialism is not based on the imperialism of the past, which was imposed at the point of a gun in the employ of an East India Company; it is based on ‘dominialism’, which originates in commercial transactions.

While such distinctions have merit, and they appeal to academics and public intellectuals, from the perspective of the student in Shanghai, Bangalore, or Lahore… or São Paulo, or St. Petersburg, or Kiev, or La Paz, or pretty much anywhere outside of the G7 countries, such distinctions might ring hollow. Technically, it is true that one chooses to engage in transactions, but when those transactions relate to food, shelter, clothing, textbooks, and entertainment, the balance of economic power is tilted toward the supplier of the finished goods and away from the individual consumer.

Fading Power

The seat of global power is shifting from parliaments to boardrooms as corporations supplant governments, and today’s colonial masters of the people of the middle-income countries of the world are not France, the UK, or the USA, but Microsoft, Sony, and Wiley & Sons.

Whether this is ‘good’ or ‘bad’ or ‘right’ or ‘wrong’ is irrelevant. The fact is that the individuals in the middle-income countries outnumber the individuals in the G7 countries nearly 10:1, and they bear the brunt of Dominium. There was a time in India, when the British Empire seemed impervious… till Gandhi came along.

Today, Microsoft, Sony, and Wiley & Sons might seem impervious, but they enjoy their monopoly positions only so long as the people in the Middle Income countries do not realize that nothing stops them from being home to BookBoon, Khan Academy, or any of a multitude of other information services that requires effectively no capital investment.

As there is a cost for every benefit, and there’s no such thing as a free lunch, there is a benefit lurking with every cost, and chaos equals opportunity. The real game is not political but commercial. Currently, is being played in Silicon Valley, Manhattan, Mexico City, Miami, Shanghai, Singapore, and Bangalore.

Nothing stops it from being played in Accra, Addis Ababa, Dhaka, Kingston, Jakarta, Lahore, Montevideo, Tegucigalpa, or anywhere else.

Invest accordingly.

Prof. Evans

Dec 022011
 

MSNBC is running an article entitled “Nine Jobs That Humans May Lose to Robots” that lists nine professions that are becoming increasingly automated:

  • Astronauts
  • Babysitters
  • Drivers
  • Journalists
  • Lawyers and Paralegals
  • Pharmacists
  • Rescuers
  • Soldiers
  • Store Clerks

We can expect to see more articles like this as we continue the transition that began in the final decades of the 20th Century, from an economic order driven by capital and labor to one that is driven by knowledge and service, in which the capitalist no longer can be caricatured by a Dickensian factory owner, but instead by Scott Adams’s Dilbert, a highly talented employee with specialized skills, as Peter Drucker explains in his 1993 Post-Capitalist Society.

Today, nearly a quarter-century on, we can look back to see how accurate Drucker’s predictions were, as Massachusetts Institute of Technology economists, Erik Brynjolfsson and Andrew McAfee, do in their 2011 Race against the Machine, and except for the specific technologies that Drucker cites, he was spot-on.

If you can do your job from your sofa, then that sofa can be within walking distance of your employer’s headquarters, across town, or in Jakarta. If a robot, a piece of software, or someone in Jakarta can do your job, and you are in the Global North/West, then this would be a very good time to start thinking about a career change.

In general, you have two options:

Innovation and Entrepreneurship

There is no silver bullet here. All you can do is follow your heart and heed no one’s counsel but your own. The first few times out, you probably will fall flat on your face, but console yourself with the knowledge that 95% of science is wrong, meaning that most hypotheses are rejected during the experimentation phase. However, that 5% that works is where the frontiers of knowledge and experience are expanded.

Some platitudes might be useful, but feel free to replace them with your own:

  • Follow your heart, and the money will take care of itself.
  • Set aside 20% of what you spend on equipment, and six months’ rent, so that you can cover your bills during slow periods.
  • If you create texts, music, videos, software, etc., give your work away for free.
  • Network as if your life depended on it, and remember that it is a sad dog that wag its own tail.
  • Always be learning, and be prepared to change product lines or career tracks about once every five years.

If you won the lottery, what would you do with your day? You undoubtedly are not the only human alive who is driven by whatever your answer is. There is your business plan. Don’t draft revenue projections until you’ve made several sales; you cannot predict your cash flows, if you’ve never had any. And remember that innovation is what has not been done before. If the people around you think that your idea is ludicrous, then you’re probably onto something good; if others think that your plan makes sense, then the idea is already past its expiration date, and it is already part of the background noise.

You will make mistakes and have regrets. You’ll get knocked down; get up again, and don’t let anything keep you down.

Crafts

By ‘crafts’ I mean anything that must be done locally, including landscaping, plumbing, home repair, nursing, firefighting, automotive maintenance, etc. If the idea of an activity’s being outsourced overseas is absurd, then it is a craft.

You don’t have to be a hairdresser or manicurist; you can own the shop and hire hairdressers and manicurists. John D. Rockefeller famously said that he would prefer to have 1% of the money earned by 100 others than 100% that he had to earn himself.


Whichever route you choose, do not let yourself get lulled into the false security of a ‘job’. No such thing as a job exists, as is easy to see, if one considers that, if one normally works 40 hours per week, and then starts pulling ten hours of overtime per week, one does not report that one has 1.25 jobs; similarly, if one’s schedule were cut from 40 to 30 hours per week, one would not complain that one had 3/4ths of a job.

If you measure the value of your time in dollars per hour (or euros, or pesos, or yen, or yuan, or shekels, or lira, or dinar, or whatever), then you are saying that each hour of your time is as valuable as every other hour, which means that whatever you do to earn that money is ripe for automation.

If you earn $10 or $20 per hour driving a cash register, keep an eye open for self-checkout stations to be installed where you work. Ditto paralegals and bookkeepers, secretaries and executive assistants, etc.

The global economy is increasingly integrated, and borders are fading fictions. There is a cost for every benefit, and an opportunity hiding within every cost.

And… the machines are lurking… watching… biding their time… Make your peace with them.

Invest accordingly.

Prof. Evans