Category Archives: Economics

What Do the Markets Want, and Should We Care?

Posted on June 29, 2010 | Leave a comment

Do financial markets put pressure on nations? Sometimes. How is that pressure measured? Often, in the bond markets, where interest rates are a measure of investor confidence. But this is far from axiomatic and business and economics journalists may be confused and confusing us.

Liz Alderman reports in the New York Times that two years ago Ireland adopted “the type of austerity measures that financial markets are now pressing on most advanced industrial nations.”

Are financial markets really pressing nations to adopt austerity measures? Paul Krugman, who has consistently argued for deficit spending to help end the global economic downturn, doesn’t think so. He agrees that “bond investors have turned on governments with intractable deficits. But,” he continues, “there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.”

If countries have adopted the measures allegedly pressed on them by the financial markets and yet failed to appease those markets, are we perhaps attributing demands to markets that those markets do not share?

Indeed, Alderman observed,  “Despite its strenuous efforts, Ireland has been thrust into the same ignominious category as Portugal, Italy, Greece and Spain. It now pays a hefty three percentage points more than Germany on its benchmark bonds, in part because investors fear that the austerity program, by retarding growth and so far failing to reduce borrowing, will make it harder for Dublin to pay its bills rather than easier. “

So why claim that the market is clamoring for austerity measures?

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Mainstream Media is 2.5 Hours Ahead of Blogs, and Why We Don’t Want to Know This

Posted on July 13, 2009 | Leave a comment

A recent paper by researchers at Cornell and Stanford confirmed what media watchers have observed over the last few years: the blogosphere tends to pick up topics covered in the mainstream media and keep them in circulation. And the reverse is occasionally true: sometimes topics acquire momentum in blogs before becoming important in mainstream media. The publication of the paper was reported today in the New york Times.

As the paper acknowledges, this general description of the interaction between blogs and mainstream media is nothing new. The authors have brought some rigor to the study of this media phenomenon, though, by building analytical tools that can quantify some characteristics of the news cycle. The researchers found, for example, that the usage of a given phrase tends to peak in mainstream online media some 2.5 hours before it peaks in blogs.

It’s a good study, and it’s backed up by some pretty cool tools that the researchers developed to identify common phrases and their variants, like “lipstick on a pig,” that serve as “signatures” for certain stories, and track and timestamp them as they appear across an giant set of online media. They can even identify which media outlets tend to lead the pack in picking up on stories before they become popular elsewhere. (Top two: hotair.com and talkingpointsmemo.com.)

The study even found a simple formula to describe and predict editorial judgement. The researchers found that “news sources imitate each other’s decisions about what to cover, but subject to recency effects penalizing older content.”

Nice. But I have a problem with all of this. First off, I don’t think that news organizations and blogs can harness the insights that flow from such a tool for any sustained benefit. It’s not obvious that publications that lead the news cycle can aggregate a larger audience or generate more advertising revenue than other sites.

Worse, I fear that a fine-grained understanding the news cycle will do more harm than good. Such tools have always been embraced by spinmeisters seeking to influence the news cycle. As these tools get better they become part of an influence arms race in which no one wins. All sides compete to control the news cycle, and achieve little more than the destruction of news, yielding no benefit to the public or the the civic function the news media is intended to serve.

This reminds me of a recent article by Cornell economist Robert H. Frank. Frank challenges the conventional wisdom, flowing from Adam Smith’s notion of the “invisible hand,” that greed and competition end up producing the greatest good for all. On the contrary, competition can be wasteful and destructive, in economic systems and in the natural world. Frank suggests that the natural selection described by Darwin is a better framework for describing economic behavior than the invisible hand.

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species.

In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles with other males for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods.

Frank notes that elk would be better off if they could agree to limit the size of their antlers. They can’t. But humans sometimes can come to such agreements, and would be better off if they did. “Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race,” Frank writes.

So I see advances such as the study by the folks at Cornell and Stanford in a negative light. If only we could just not go there, I think we’d all be better off.

What do you think?

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Costly Regulations Welcomed by Business

Posted on June 7, 2009 | Leave a comment

Certainty has value. Sometimes it’s more attractive to have your costs increase by predictable amount than stay the same. It is if you face uncertainty about whether and how much your costs might someday rise. This is the principle behind two recent examples of business leaders welcoming the bad news of higher costs because it was accompanied by certainty.

First came new U.S. federal fuel-efficiency standards.  Automakers have long fought attempts to impose higher fuel efficiency standards. Opponents of these new standards cite the costs of complying as a key reason that they are a terrible idea that will harm car companies and consumers. Yet the automakers have accepted these new rules and seem, publicly at least, downright pleased with them. True, GM and Chrysler make feel indebted to the federal government for its efforts to save them. But the automakers also recognize that a single, certain, national mileage standard is better than the unpredictability and confusion of competing state standards.

“GM is fully committed to this new approach,” said CEO Fritz Henderson in a statement  “GM and the auto industry benefit by having more consistency and certainty to guide our product plans.” (Quoted in CNET.)

Even Ford, which so far has not received government support, has also embraced the standards, according to a recent report:

“We are pleased that President Obama is taking decisive and positive action as we work together toward one national standard for vehicle fuel economy and greenhouse gas emissions that will be good for the environment and the economy,” Ford said in a statement.

The certainty/cost dynamic is also in evidence in the run up to the climate change summit planned for this December in Copenhagen. There is no doubt that complying with new emissions regulations will impose costs on applicable industries and companies. But a recent article in the Wall Street Journal emphasized business leaders’ desire for certainty over avoiding the costs of new regulations. According to the article: “Chiefs of some of the world’s largest companies are urging global leaders to cut a strong deal this December to curb pollution, saying they need certainty on emissions targets to be able to make long-term investment decisions.”

While businesses will always want to minimize their costs, they also care about the predictability of their operating environment and the levelness of the playing field. These two examples show how how a political process can change the playing field in a way that is good for business and society.

What do you think?

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Where Were They? Bashing Economists and other Experts

Posted on May 1, 2009 | 3 Comments

In the wake of the financial catastrophe that is unfolding in slow motion across the globe, a lot is being written about the economics profession. Where were the economists? Why didn’t they predict this? Two recent articles, one by Peter Coy, economist editor at BusinessWeek, and one by economics professor Barry Eichengreen at the University of California, Berkeley, published in The National Interest, provide interesting answers to those questions.

One of the things that bothers me about the attack on the economics profession is that they are used to justify the view that expertise of all kinds is overrated. With the democratizing (one might say lowest-common-denominating) force of the Internet, it’s become popular to predict the irrelevance of expertise and the end of the dominance of professionals of all types (from journalists to film makers). And, sorry to veer into politics here, but the fact that the Bush administration was so often dismissive of the role of  science and expertise in policy making seemed to have galvanized those would believe that any challenge, no matter how complex, can be met with gut instinct and values alone. That camp seem to be consider “expertise” to be a false god or an egghead preoccupation.

I sure hope expertise doesn’t become obsolete. While it might sometimes be misguided or misused, our society has become way to complex to navigate by gut instinct alone.

These two articles argue, in part, that the trouble with economics here is not that it was misguided, but that it was misused–specifically, that important elements of it were suppressed and ignored.

Coy emphasizes flaws with technical approaches to economics, and dwells on the fact that, with the damage done, economists now find themselves in violent disagreement about how to repair it and move forward:

People are starting to wonder: What good are economists anyway? A commenter on a housing blog wrote recently that economists did a worse job of forecasting the housing market than either his father, who has no formal education, or his mother, who got up to second grade. “If you are an economist and did not see this coming, you should seriously reconsider the value of your education and maybe do something with a tangible value to society, like picking vegetables,” he wrote on patrick.net
The rap on economists, only somewhat exaggerated, is that they are overconfident, unrealistic, and political. They claim a precision that neither their raw material nor their skill warrants. Too many assume that people behave like the mythical homo economicus, who is hyperrational and omniscient. And they take sides in quarrels that freeze the progress of research. Those few who defy the conventional wisdom are ignored.

Stieglitz says that a rich vein of theory was available to explain, predict and avoid the current crisis but that social forces suppressed some views and brought others to the survey. How could the economics profession be so misguided? The problem, he suggests,

lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking. It discouraged whistle-blowing, not just by risk-management officers in large financial institutions, but also by the economists whose scholarship provided intellectual justification for the financial institutions’ decisions. The consequence was that scholarship that warned of potential disaster was ignored.

… The top PhD-granting departments only rarely send their graduates to positions in banking or business—most go on to other universities. But their faculties do not object to the occasional high-paying consulting gig. They don’t mind serving as the entertainment at beachside and ski-slope retreats hosted by investment banks for their important clients.

Generous speaker’s fees were thus available to those prepared to drink the Kool-Aid….What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. … The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object

The problem, I think, is not too much intellect. It’s not enought intellectual honesty. I hope we can take that to heart.

If you have any thoughts on what’s wrong with economists, or anything else, I’d love to hear them.

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Distributing the Enormous Costs of Recovery

Posted on March 31, 2009 | Leave a comment

Here’s a request for some insight from you economically sophisticated readers.

There are some eye-catching stats about thedestruction of wealth that the the global recession has wrought. Stephen Schwarzman, CEO of private equity firm Blackstone Group, said recently that some 45 percent of the world’s wealth has been destroyed by the global economic downturn.

Lawrence Summers
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Lawrence Summers, director of President Obama’s National Economic Council, recently said in a speech

On a global basis, $50 trillion dollars in global wealth has been erased over the last 18 months. This includes $7 trillion dollars in US stock market wealth which has vanished, and $6 trillion dollars in housing wealth that has been destroyed.

Economics is not Physics and Wealth is not Energy

Now, you can be forgiven for wondering how you can destroy wealth or, for that matter, create it.  But wealth is not like energy. The first law of thermodynamics states that energy can neither be created nor destroyed; it only seems that way when it is changed from one form to another. But wealth, unfortunately, can simply vanish.

What I am wondering abut today is not where all that wealth went, but how the enormous costs of enduring the downturn and promoting a recovery will be allocated across the citizenry.

Revealing the Winners and Losers

The various options for creating economic stimulus and weathering the recession have each has a price tag and, an expected cost, and comes with certain promises of speed, effectiveness and efficiency.  What I don’t hear debated much, though, is how the costs of intervention are distributed across society.

If government refrained from intervening at all, there are some individuals, mostly the very wealthy, who might lose a lot of their wealth but would otherwise barely be inconvenienced. Meanwhile, a massive and painful economic shock would be inflicted on the more vulnerable members of society.

If the government opted not to support certain holders of underwater mortgages, say, some millions of them might be plunged into severe personal financial crisis. But possibly the cost to others might be contained. There are, of course, costs that society would end up bearing, one way or another, in order to deal with the presence of millions of destitute people. I don’t have a good way of calculating how the total cost of somehow mitigating the impact of the creation of a multi-million strong underclass would compare with the cost of rewriting those mortgages. And the holders of those mortgage: are they worse off because they have been forced to accept less favorable terms, or are they better off, because they have preserved some income and avoided being swamped with foreclosures.

Kicking Costs Down the Road?

Some argue that large-scale deficit spending benefits the current population at the expense of future generations. But it depends how that spending is accomplished. Debt-funded spending could distort the federal budget in the future, perhaps threatening entitlement programs; printing money to fund new spending, however, could lead to inflation, which would benefit asset owners and holders of fix-rate debt at the expense of creditors.

Each of the rescue and recovery programs–from propping up banks and insurance companies to rescuing detroit to supporting mortgage holders to stimulous spending on healthcare, infrastructure and eduction–all of them has a cost/benefit profile.

Interests Are Not Always Aligned

Consider for a minute, these different classes of individuals. They all stand to bear the costs and the benefits of various programs differently:

  • Bank investors
  • Inventors generally
  • Bank creditors
  • Homeowner with underwater mortgages
  • Citizens today
  • Citizens in the future

Invitation to Shed Some Light

My economics training has taught me to recognize that the winners and losers vary (as does how much is won or lost) with the design of the recovery program. What I would love is for someone to show me a framework that shows explicitly how the different programs divvy up the gains and losses. If you can help, please chime in.

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AIG: Before You Break Something …

Posted on March 17, 2009 | Leave a comment

The case of AIG is so infuriating that, if you’re as mad as I am, you should do something to let off a little steam–play a game of squash, chop wood, write a blog post–before you do something you may come to regret, such as abrogating legal contracts to avoid paying those bloody bonuses.

I happen to agree with Andrew Ross Sorkin and others:  “If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.”

Humiliate the Boneheads

I have never created nor benefited from an incentive compensation system as boneheaded as the one at AIG that obligates the company pay out millions of dollars in bonuses to the people who lost billions and wrecked a company. To me, the point is not how shameful it is to pay out that money; that money was promised by people legally able to make those promises and legally obligated to keep them. The point is that the people who made those promises are incompetent and/or corrupt.  What kind of “incentive” comp system rewards catastrophic failure? The bonus plan never should have been written the way that it was. And the chain of command and web of advisors who approved it or looked the other way should be called out and publicly humiliated. As far as I know, they broke no laws. But what they did is a clear sign of a corrupt corporate money culture that mocks the principles that true capitalists hold dear.

Ban “Too Big to Fail”

I believe the Fed and the Treasury when they characterize AIG as too big to fail. I do not fault them, then, for doing what they think is necessary to save that festering institution. A lesson of this dilemma, though, is that if you don’t want the government running big sections of your economy, don’t allow institutions to become too big to fail in the first place. Regulations should prevent companies from attaining a size such that their collapse necessitates major government intervention.

Too-big-to-fail companies are by definition backed by the government. When they become “too big” they implicitly obtain government guarantees, which creates perverse incentives and confers an unfair, uneconomic advantage that some people mistake for economies of scale.

Tired of government bailouts of private-sector institutions? Don’t permit them to get too big to fail.

How to Get the Bonus Money Back

So AIG should pay those bonuses. But it doesn’t mean that the recipients should keep the dough. New York Attorney General Andrew Cuomo vowed to sue AIG to force the disclosure of the identities of bonus recipients. Someone should advise those high rollers to come together and voluntarily return most of the money. If word of their identity leaks, I would expect the scrutiny by an irate public to make their lives exceedingly unpleasant. So it may be in their interest to be able to claim they’ve done the right thing. They could even come out looking like leaders, setting a standard for accountability that their own corporate leadership failed to meet.

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Why New York Is Well Positioned

Posted on February 12, 2009 | Leave a comment

I attended a breakfast seminar today titled “Raising Funds in Turbulent Times.” It was a panel of VCs moderated by my former boss, Gene De Rose. (Gene used to be CEO of Jupiter Communications, the company that became JupiterResearch where I was president until the end of last year.)

The VCs on the panel were:

  • Kim Bangash, Orchid Ventures
  • Brad Burnham, Union Square Ventures
  • Warren Lee, Canaan Partners
  • Danny Schultz,  DFJ Gotham Ventures

There was good discussion about how to approach a VC, what they look for in a pitch and an an entrepreneur, and how the economic climate has altered the fund raising process.

At a time of economic gloom, it was refreshing to hear Brad Burnham’s take on why New York is a good place to build a startup. His firm invests in technology enabled services in media, marketing and some other verticals. In Burham’s view, IT infrastructure is mature and doesn’t look like a promising sector in the near term. It was never NYC’s strength. Where the action and opportunity are, he believes, are in human factors, design, user experience and the like–areas where NYC is rich in talent.

He also sees a silver lining in the implosion of Wall Street, which will no longer be in a position to pay the unjustifiably large salaries that drew so many people with useful skills, from quants, Java coders, away from other more useful fields. It will become a fertile talent market for growing companies.

Warren Lee, of Canaan, agreed with this assessment and observed that in this period of financial austerity, large companies are cutting innovation budgets. They will look up in 3 years, he says, and ask, “What is our growth strategy?” and find they have none. They will then be induced to look for new exploitable oportunities to the  crop of startups that have been developing the next wave of cool ideas, unleasing a period of acquisitions.

A positive take for entrepreneurs and the companies that back them.

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Posted in Commerce, Economics, New York

Prosperity and Decay

Posted on January 12, 2009 | 4 Comments

There is a rising chorus of consensus that the United States is sorely in need of updated infrastructure. Since it’s also sorely in need of economic stimulus, infrastructure investment is on the short list and will account for a significant part of Obama’s stimulus plan.

The incoming Obama administration and a group called Building America’s Future cite a 2005 study by American Society of Civil Engineers (ASCE) that gave a “D” grade to US infrastructure and found that $1.6 trillion in spending over 5 years would be needed to mitigate shortcomings in this country’s roads, bridges, freight and commuter rail networks, air traffic control system and airports, metropolitan transit systems and drinking and waste water facilities, among other areas. Thomas Friedman recently (and periodically) vented his frustration with the poor quality of our infrastructure compared to many of the formerly Third-World countries he visits.

We are now experiencing the brutal end of long cycle of prosperity. Between 2002 and 2005 the Dow Jones Industrial average was up 83% from trough to peak.  During that same period, real per capita GDP rose more than 9%.

How is it that this country can emerge from a sustained period of prosperity with its infrastructure in shambles? Are we spending on the wrong things? Are we favoring a dynamic private sector with low taxes while starving the public sector? Isn’t it obvious that something’s very wrong with this picture?

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Posted in Economics

Microsoft and the Limits of Scale

Posted on May 8, 2008 | Comments Off

Why has Microsoft found it so difficult to fulfill its online ambitions? After all, according to comScore, Microsoft properties attract a vast number of visitors, not too far behind Google properties (in the US, 121M vs. 137M). With such a gigantic audience, all that would seem to be missing in its competition with Google is a competitive search experience. Doesn’t it seem that Microsoft would have as good a shot as any company to field a competitive experience, considering the vastness of its resources compared to Google:

Over 4 times as many employees
Over 5 times as many employees in R&D
Over 3 times as much R&D spending
Nearly $12 billion in cash on hand as of March 31 (a hair less than Google’s cash on hand).

All of this is surely enough to neutralize scale economies as barrier to entry, as I wrote about yesterday.

But those vast resources are spread across multiple Microsoft businesses. And Microsoft’s Online Services Business is losing a billion dollars a year. Meanwhile, the company cannot afford to neglect its cash cow and other emerging businesses either. So focus is one advantage that Google has. Another would have to be incumbency, Porter’s #5 mentioned in yesterday’s post. No matter how many resources you throw at competing with Google, you can hope–for but not count on–matching or exceeding the technological breakthroughs that have given them this lead.

Acquiring to Change the Playing Field

Microsoft seems to have reached this conclusion, leading them to make an aggressive acquisition bid that they hoped would allow them to reap further scale benefits and enhance their competitive position not so much in search but in the portal and display advertising business. That logic still applies. The question is whether Microsoft will turn its attention to acquiring some other online player with a similar rationale.

Hence today’s reports that Microsoft has been in talks with Facebook.

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Posted in Economics, Media

Earth Day Economics

Posted on April 23, 2008 | Comments Off

In honor of Earth Day, I wanted to go back to the idea I wrote about last month: “How concepts are defined–the clarity and the scope of the definition–has an enormous influence on the usefulness of the concept.”

Then I wrote about the limits of economics in explaining human behavior. Since then, I stumbled on an utterly fascinating economics paper (from 1991) that proposed to explain why economics has traditionally failed the environment.

["Towards an Environmental Macroeconomics," by Herman E. Daly, published in Land Economics, Vol. 67, No. 2 (May, 1991), pp. 255-259]

Of course policies like carbon taxes or cap-and-trade are intended to yoke the forces of economics to environment choice-making. A major challenge in making those policies effective, though, is determining an appropriate value to place on something like a ton of atmospheric carbon.

Part of the reason that is hard is that we don’t have a concept of the optimum scale of global economic activity. This paper offered the insight that microeconomics, which describes the behavior of individual actors in an economic system, possesses concepts, such as “optimum scale,” that had not been extended to macroeconomics, leaving macroeconomics mute on some key questions.

Here’s how the paper explains “optimal scale,” an explanation that will be familiar to anyone who’s ever studied microeconomics.

An activity is identified, be it producing shoes or consumign ice cream. A cost function and a benefit function for the activity in question are defined. Good reasons are given for believing that marginal costs increase and marginal benefits decline as the scale of the activity grows. The message of microeconomics is to expand the scale of the activity in question up to the point where marginal costs equal marginal benefits, a condition which defines the optimal scale.

So far, so good.

when we move to macroeconomics, however, we never again hear about optimal scale. There is apparently no optimal scale for the macro economy. There are no cost and benefit functions defined for growth in scale of the economy as a whole. It just doesn’t matter how many people there are, or how much they each consume, as long as the proportions and relative prices are right!… I will admit that if the ecosystem can grow indefinitely then so can the aggregate economy. But, until the surface of the earth begins to grow at a rate equal to the rate of interest, one should not take this answer to seriously.

Since this paper was published, there has been further theoretical work aimed at extending the scope of economic concepts to make economics more useful for shaping decision making at the macro, environmental scale. But we obviously have a long way to go. Here’s to progress.

Happy Earth Day. (A day late.)

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Posted in Economics