Relevant and even prescient commentary on news, politics and the economy.

The End of the Japanese Miracle… and the American One

Scott Alexander at Slate Star Codex has a very good post on cost disease. It definitely betrays a strong libertarian or conservative bias, but is nevertheless, worth reading.

The piece that resonates with me is posted below. It has some good insights, one or two that are questionable (for anyone not firmly ensconced on the right), but overall it methodically works its way to one hell of a punch-in-the-gut truth in last sentence.

Imagine if tomorrow, the price of water dectupled. Suddenly people have to choose between drinking and washing dishes. Activists argue that taking a shower is a basic human right, and grumpy talk show hosts point out that in their day, parents taught their children not to waste water. A coalition promotes laws ensuring government-subsidized free water for poor families; a Fox News investigative report shows that some people receiving water on the government dime are taking long luxurious showers. Everyone gets really angry and there’s lots of talk about basic compassion and personal responsibility and whatever but all of this is secondary to why does water costs ten times what it used to?

I think this is the basic intuition behind so many people, even those who genuinely want to help the poor, are afraid of “tax and spend” policies. In the context of cost disease, these look like industries constantly doubling, tripling, or dectupling their price, and the government saying “Okay, fine,” and increasing taxes however much it costs to pay for whatever they’re demanding now.

If we give everyone free college education, that solves a big social problem. It also locks in a price which is ten times too high for no reason. This isn’t fair to the government, which has to pay ten times more than it should. It’s not fair to the poor people, who have to face the stigma of accepting handouts for something they could easily have afforded themselves if it was at its proper price. And it’s not fair to future generations if colleges take this opportunity to increase the cost by twenty times, and then our children have to subsidize that.

I’m not sure how many people currently opposed to paying for free health care, or free college, or whatever, would be happy to pay for health care that cost less, that was less wasteful and more efficient, and whose price we expected to go down rather than up with every passing year. I expect it would be a lot.

And if it isn’t, who cares? The people who want to help the poor have enough political capital to spend eg $500 billion on Medicaid; if that were to go ten times further, then everyone could get the health care they need without any more political action needed. If some government program found a way to give poor people good health insurance for a few hundred dollars a year, college tuition for about a thousand, and housing for only two-thirds what it costs now, that would be the greatest anti-poverty advance in history. That program is called “having things be as efficient as they were a few decades ago”.

I should note that the spending examples cited in the above paragraphs have numerical support earlier in Alexander’s post. But the problem with the post is the lack of a satisfactory answer to the question it raises: what caused the massive declines in efficiency we saw in many vital parts of the US economy?

And here I am pleased to say I can help. I actually provided an answer to that question in a post I wrote six years ago explaining why Japan grew so rapidly after WW2 and what policy changes led to the end of its rapid rise.

I encourage you to read my post, but it comes down to this: the Japanese Miracle ended when its fabled bureaucracy became far less of a test- and performance-based meritocracy.  This was done with the noble cause of broadening inclusion, which of course, was severely lacking in the old system.  But the baby was thrown out with the bathwater.  The new system ended up just as unfair as the old one, but in very different ways.  Unfortunately, it also became a lot less efficient.  Test scores turned out to be positively correlated with performance.   Highly correlated.  It didn’t take long for the public to notice the change.  The deference once afforded to entities like MITI dwindled and died.  Soon the ministries could no longer command the respect they needed to actually run the economy, much less the competence to do it well.  But the now enfeebled bureaucracy could still influence events.  It went on to buy into Reaganomics (tax cuts, smaller government, and a trade policy that was less export oriented). Put another way: Japan Inc. started hiring suckers, and predictably the suckers got suckered.

The parallels with the US are obvious. That isn’t to say  all is doom and gloom for either Japan or the US. Both countries remain rich, prosperous, and innovative. But Japan no longer inspires the world as it once did. The Japanese Miracle ended decades ago. And I have a real fear that America’s best moment may also in the past. Policies that elevate mediocrity achieve just that.  And they are awfully hard to reverse.

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Innovation, production, and infrastrucutre

Stormy, Movie Guy, and Dan Becker in 2009 have been writing about trade imbalances and consequences since 2006.

An excerpt from one of Dan’s posts:

I have written at AB that my thoughts about when the flash point was for our change to a focus on making money from money was the first Reagan election. I do believe this is the case however, having finished reading Richard J Elkus’ book, Winner Take All, I now have learned of a perspective as to why it flashed and why we are bailing out finance with more money and fewer questions than bailing out the auto industry. I also see just how back ass-ward this bailing out concern is.
You see, the thought that the purpose of business is to make money was not always the winner in the argument. The argument has been back and forth for ages. It is part of the class war. In fact, there was a movie in 1954 with William Holden looking at this issue called Executive Suite.

…McDonald Walling, who oversees the company’s manufacturing plant and is preparing to test a new molding process… process did not go well in his absence. On the way home, he complains to his wife Mary that financial analyst Loren Phineas Shaw focuses on the bottom line at the expense of the company’s creativity…McDonald speaks passionately about the company, condemning Shaw’s short-sighted emphasis on quick profits as “a lack of faith in the future.” After McDonald outlines his vision for restoring the company to its former high standards, the board unanimously elects him president.

We have not always thought that the purpose of business is just to make money.

Mr. Elkus’ (MBA) thesis is that in the 60′s, two laws of economic process were formalized and presented that were the guiding thoughts influencing economic development. Both lines of thinking came from viewing the same show: semiconductors. One is by Mr. Bruce Henderson (engineer and MBA degrees) the other by Mr. Gordon Moore (PhD chemistry). Both addressed the relationship of costs and production. I note the degrees of each just as a curiosity.

Mr. Henderson, watching Texas Instrument, came up with the Experience Curve. In it’s simplest form it states that unit cost goes down over time as experience increases.

But, this was just the bases for a broader concept, a “strategy” for guiding business development: Stars, Cash Cows and Dogs.

As a particular industry matures and its growth slows, all business units become either cash cows or dogs. The natural cycle for most business units is that they start as question marks, then turn into stars. Eventually the market stops growing thus the business unit becomes a cash cow. At the end of the cycle the cash cow turns into a dog.
The overall goal of this ranking was to help corporate analysts decide which of their business units to fund, and how much; and which units to sell.

This was and appears to still be a very big concept. Big as in influential. Via Wiki:

The Economist magazine stated that Henderson did more to change the way business is done in the United States than any other man in American business history. Well known to many now is the famous Growth Share Matrix (‘cash cow’) and the ‘Experience curve’. His books were published in 27 languages.

Huge influence. Taught throughout our business schools according to Mr. Elkus and Wiki. Came about in 1970.
Mr. Moore, being a founder of semiconductor manufacturing businesses, namely Intel, came up with Moore’s Law. In it’s simplest form, it states that there would be “a doubling of computing power per given area of silicon every year at basically the same cost…”

Mr. Elkus’s thesis is that both describe models, ultimately truths regarding making money. Both are used as strategies for basing an economy upon. Only one is truly sustainable and makes all of America’s dreams possible. Japan picked that one.

He comes to this by way of his involvement with Ampex. Ampex owned video recording “…controlling nearly 100 percent of the world’s video recording patents and more than 70 % of the market”. Mr. Elkus literally introduced the first video recorder for home use, September 2, 1970 in NY. In the next few days, Ampex stock climbed 50%. Only one VP attended, no other top/senior management. “It was not a good sign.”His lesson from the event: “The introduction of Instavideo set in motion a long chain of events, resulting not only in the explosion of consumer electronics into nearly every facet of daily life but in a global shift in economic power to Asia.”

In the same year, he saw a presentation of high definition video by Japan’s “primary” broadcasting company, NHK. It is at this point in the story Mr. Elkus relays the concept of convergence of technology. The ability to record video on a consumer level scale represented the ability to store and process massive amounts of data. This ability converging with digital video presentation meant that the entire information economy would be exponentially growing based on Moore’s Law. Mr. Henderson’s potential Star. Moore’s law also meant that as the ability to process ever larger amounts of data on ever smaller media, the cost would be ever greater. Mr. Henderson’s potential Dog. What to do?

Mr. Elkus knew Ampex needed a partner that could take the technology to the consumer. Coming up with the technology, he recognized is only part of the expertise and cost, the other is the ability to manufacture it such that technology, in short, is dummy proof in the hands of the consumer. It is an ability all of it’s own. Mr. Elkus wanted Magnavox or Motorola as partners; keep it in the country. The boss said no, feared competition so went with Toshiba. This gets us to the next part of Mr. Elkus’ thesis: Infrastructure. Which gets to the final cog in the process: investment.

Using his experience with Ampex’s Instavideo, Mr. Elkus presents the counter to Mr. Henderson’s Stars, Cash Cow’s and Dogs: Investment, Convergence and Infrastructure. A relational model that follows the production law of Moore.

What the thesis of Investment, Convergence and Infrastructure means to a nation is presented in the tracing of the loss of our manufacturing base to initially Japan and ultimately to all of Asia. It is the counter to Mr. Henderson’s model which is basically just focusing on the money. It is the movie Executive Suite for real only for us, the story ending is looking different.

The relationship of Investment, Convergence and Infrastructure is presented early in the book via Zenith. There was a fight for control of the board as reported by the AP 11/1988. A couple Wall Streeters wanted Zenith to dump the “money-losing television business”. The dog. The article also noted: “for an outsider, jumping into the TV business would be like trying to hop onto a speeding train…” In the end, Zenith a company that “helped establish the standards for high definition television in the US,… contributing significant technology for the potential development of the industry” was gone by 1996 to LG of Korea “for a fraction of what it now costs to build a single display manufacturing facility”. We lost our infrastructure and thus the advantage of economic growth based on convergence and all the knowledge that is the result there of because of our focus on cash flow as the bases for deciding on where to invest.

Using a simpler example:

In 1964, one year before Gordon Moore wrote his prophetic article, semiconductor sales reached $1 billion. Today sales are in excess of $260 billion, it is projected that in a dozen years the number may reach $1 trillion. And growth in revenue has occurred while prices have dropped at an average compound rate of 29 % annually…But that is really chump change when you realize that $260 billion of silicon makes possible a $2 trillion electronic systems industry today…So it is possible to imagine an electronic systems market approaching $4 trillion to $5 trillion in the next twelve to fifteen years—an amount equal to the current GDP of Japan…

The error of US having followed Henderson, which if I understand Elkus properly, I conclude has lead to NAFTA, outsourcing jobs and ultimately the fight over whether to save our auto industry (which I noted is the last “infrastructure” we have that uses “convergence” via “investment”) verses little questioning to save the banks is summarized thusly:

The common denominator driving the world of information and its communications infrastructure was the need to store, process and distribute extraordinary amounts of digital information. [Store = Ampex. Process = Intel. Distribute = Zenith.] If one understands HDTV as the result of learning how to process massive amounts of digital information, as both a convergence and catalyst in the digital revolution, then it should be easy to see that the need to process that information is not limited to the HDTV display and a pretty picture….

It now costs upward of $10 billion to build just one semiconductor manufacturing plant. $3 billion to build a single display fabrication facility. Zenith was sold for $350 million. Based on Measuring Worth, 1996 to 2008 these money minds following Henderson, sold Zenith for 1/6th the cost required to build just one display panel plant in 2008. This number differential is the total fallacy in Henderson. How do you know? How do you know what really is the next big thing? How can you be sure that nothing else will come of what you have? It is the “The Guitar Player”. But worst of all as shown in the example of selling Zenith, is just how short sighted Henderson’s thinking and thus American business thinking is in general. If I may, Henderson’s thinking is analogous to watching your rear view mirror while driving forward as you decide whether to turn or drive straight. Henderson’s thinking is the point of thought that began the money from money economy. It is the thought that lead us to a purposeless existence of no substance because it leaves unanswered the question of why do we want to earn money or create wealth, for what purpose.

Mr. Elkus gave a talk at The Commonwealth Club in California on 9/3/08. It covers a time line of what he is writes in his book. It is one hour long, but well worth the time, especially the question at the end regarding Apple’s business arrangement regarding it’s Iphone as the questioner brings up “competitive advantage” and money from royalties. You know, that information/service economy model that has gotten us to the point that the biggest service sector (finance) took down the economy and the next largest is unaffordable(health care).
The most profound comment by Mr. Elkus during this lecture is: If you don’t have the infrastructure, then you don’t know what’s possible.

How far reaching is this persepctive of Investment, Convergence and Infrastructure? Mr. Elkus suggests that even our education system is influenced by it.

When a nation’s politics and economics fall out of step with its education system, the cost of reengagement is extraordinarily high.

Therefore any attempt to explain the plight of education in America must look first at the country’s current political and economic attitudes. They are directly linked.

Eventually, because of the exponential acceleration in convergence, infrastructure, and investment, there’s a cascading effect, and the loss of one industry begins to threaten the stability of others.

These events are noticed by the educational community, which must provide a measure of career guidance for its student population and thus looks to political, economic, and business leaders for answers.

We have Intel fortunately, but we don’t have the infrastructure of Zenith which would have been using Intels output to market Ampex’s technology which lead to the Iphone.

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Innovation and production

 Yves Smith points to a MIT study on how much bigger the conversation should be than the political arguments of offshoring and outsourcing suggest.  And the complexities of applying ‘just in time’ sorts of global production systems through a complicated supply chain.

From that post is this excerpt:

And a new report by MIT on innovation and production (hat tip Marcy Wheeler) has an almost desperate undertone. It starts by pointing out how the data understate how bad the competitive erosion is:

One of the key danger points identified in these reports is the declining weight of the U.S. in the global economy. Even though the U.S. share of world manufactured output has held fairly steady over the past decade, economists have pointed out that this reflects good results in only a few industrial sectors. And even in those sectors, what appear to be productivity gains may be the result of underestimating the value of imported components. A close look at the composition of a worsening trade deficit shows that even in high-tech sectors the U.S. has a deteriorating picture. While the output of U.S. high tech manufacturing is still the largest in the world and accounted for $390 billion of global value added in high-tech manufacturing in 2010, U.S. share of this world market has been declining, from 34 percent in 1998 to 28 percent in 2010, as other countries made big strides ahead into this market segment.
Jobs are another huge concern. The great spike in unemployment over the past five years was disproportionately due to loss of manufacturing jobs. And as the economy revived, such jobs were very slow to return. In fact it is clear that many of them never will.

It makes clear how far hollowing out has gone in the manufacturing sector, and how the economy has lost so many components critical to innovation that it isn’t clear how to restore them. The researchers went beyond the venture capital darlings to find what it called “Main Street Manufacturers.” It found they were at a serious disadvantage due to the lack of firms with complimentary know-how in their ecosystem. After quoting the experience of one firm, the authors noted:

Read more at Naked Capitalism

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Taxes and job creators

Via Robert Waldmann Richard Thaler at Bloomberg provides a different take on innovators and job creators:

A recurring theme of this year’s presidential campaign is the need to encourage the formation of new businesses. Republicans in general, and Mitt Romney in particular, have stressed that the best way to stimulate such startups is via low tax rates on high-income earners.

In other words, this is a strategy that emphasizes maximizing the after-tax returns if and when you hit it big. Yet if you think about the way most new businesses are started, it should be clear that these tax incentives have very little to do with the decisions facing most new entrepreneurs.

The typical business startup (think Joe the Plumber) begins with an initial stake that has been saved or borrowed, and 97 percent of small-business owners make less than $250,000 a year. It is a good bet that when Bill Gates, Steve Jobs and Larry Page were creating their new businesses in their proverbial garages, they weren’t giving much thought to the tax rate they would have to pay if they struck it rich.

The essence of Stewart’s idea goes to the heart of why our economy is largely organized around limited-liability public corporations. When successful entrepreneurs decide to take their businesses public, they are selling some of the upside to other shareholders in return for making sure that they can’t lose all their wealth if something at the company goes wrong.

So-Called Reform

What about smaller startups that don’t begin their lives as corporations? One thing that would help stimulate this sort of business creation is making sure that a business bankruptcy is not ruinous to the entrepreneur’s family. But the Republican- sponsored bankruptcy “reform” law of 2005 changed the rules in the opposite direction. For someone who uses a credit card to help open a bakery or landscaping business, this law raised the cost of failure.

Austin Goolsby speaks to the issue on the Jon Stewart Show,  and Jon is spot on.

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CGI 2011 – Developing Green Technology

Van Jones of Rebuild the Dream introduces the two presenters by noting that we are in the “post-Whale oil” strategy for liquid fuels; using algae and biomass technologies. Jonathan Wolfson, CEO of Solazyme, Inc. opens by thanking his investors and then stating,  “We make oil.”  He declares that oil is not going away, and is not going to be replaced; the choice is what type of oil we are going to use of the three types: petroleum, plant, and animal.

It’s fairly easy to figure out where he is heading.  As Van Jones noted, we tried animal, and we’re using petroleum now.  Peak oil is past or, at best, demand for petroleum is going to outstrip supply even if we find and refine more and more of it.

Wolfson notes that the developed world uses oil for everything, with a concomitant increase in price as demand rises and the world becomes more developed.  He dismisses the inorganic alternatives without even bothering with environmental concerns: natural gas, fracking, and coal liquefaction are all non-renewable, and therefore doomed as an alternative.  Working on renewable oil: biomass conversion, plant sugars, photosynthesis and microalgae to convert sugar to oil.  Does not require changes in current processing system; renewable oil is fungible with the dinosaur-based creation.  Have created a hearty-healthy oil that is similar to olive oil in other ways; have an alliance with a French company.

Solazyme told potential private-sector partners that their technology could produce $1.50/gallon oil. Response was always: don’t talk about costs until you can show us you can scale. So made a deal with the U.S. Navy, and are delivering “the promise of advanced biofuel.”

Following Wolfson is his major investor, Deputy Assistant Secretary of the Navy for Energy Thomas Hicks. Hicks is well-versed in the Total Cost of Ownership:  “The Navy simply relies too much on fossil fuels…degrades our national security…and ultimately endangers our planet.” We have young men and women in Afghanistan protecting fuel convoys that begin in Pakistan. Multiple convoys per day; for every 50 fuel convoys, we have one Marine who is killed or wounded. “That is too high a price to pay for fuel.”

Hicks is leveraging the Marine Corps is reducing that dependence, through demonstration in Quantico. Took the winning technologies and moved them into combat zone in May—and then in September into Afghanistan. Solar tents, solar blankets, LED lights—resulted in a 30-90% reduction in fuel use.  Patrols able to travel three weeks, not two days, without a Battery Resupply. Now equipping all units in Afghanistan, with a payoff timeframe of six months.  Still looking for more, but it’s a great start.

Admits ongoing operations in “Afghanistan, Iraq, and Libya.” Additional cost for fuel last year ($38/barrel increase) was about $1B ($1,000,000,000)—which comes out of the extant fuel  budget, not as an additional appropriation.  (In this manner, the U.S. Navy is like a family.) The price volatility of the fuel has a direct impact on ability to engage in efforts, including support.

So the Navy has started an effort to move to 50/50 use of renewable/biomass fuel and oils at a price comparable to that of petroleum.  If they can do it, why cannot—has not—private enterprise??

The Navy intends to lead an energy revolution; they have a $1B RFI out, closing at the end of the month, in their continuing attempt to find alternative fuels. “Together we can build a new energy future, a new energy economy.”  Again, why do I have to hear this from the Navy, when everyone tells us that the private sector is the leader?

Hicks and Wolfson agree that have a climate that is built for technological innovation. Hicks notes, again, that it worries him that the Navy, not the private sector, is out in front on alternative energy exploration. Speaker from the floor notes that there has been a paradigm shift since a single person took out the power grid in CA and AZ.  Energy efficiency retrofitting will put people back to work (as it does in NYC). Will launch a career some time in 2012—not on Earth Day, but on a day—with 50/50 blended fuel all through, including the backup generator. By far the largest purchase, excluding ethanol., in history, per Mr. Wolfson.

Are you certain the extant energy company leaders—and, yes, I am including Jim Rogers of Duke Energy, who has been talking this game for at least twenty years—are really “job creators”?

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Health Care FYI

The quality of the posts at Disruptive Women in Health Care(r) varies widely, but their special issues bring out the best and leave most of the chaff behind.

Their latest eBook is Innovation Nation: Recognizing the Benefits of Innovation in Health Care. The PDF (direct link here) collects a series of posts from December, and includes references and research links that formed the basis of their posts and ancillary material dealing with innovation and research in both the specifics of health care/medicine and general research.

Worth a look to see how people who work in the field view their future.

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Dylan Ratigan Town Hall Session on Jobs, Innovation

Hat tip Yves Smith for pointing us to this:

8 PM EST Watch Dylan Ratigan Town Hall Session on Jobs, Innovation

Check in here at 8 PM to watch the Dylan Ratigan “Innovation in America” panel discussion as part of its Steel On Wheels Tour tonight at 8pm EST at the University of Denver.

The panel will include Andrew Jenks, from MTV’s World of Jenks, Nicole Glaros, Managing Director of TechStars Boulder, and Matt Miller of The Washington Post and host of Left, Right & Center.

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Mashup Post: Two Marks

No original content here, just two posts that make even more sense together:

  1. Mark Thoma proves he’s an economist (not just an econometrician) by reminding everyone of the Opportunity Cost of the Oughts from a long-term perspective*:
    ((Rdan…Attribution of the quote is in error due to a format error at Mark’s…the original is from Joseph Stiglitz at Korean Herald)
    [T]he worst effects were on our human capital, our most precious resource. Absurdly generous compensation in the financial sector induced some of our best minds to go into banking. Who knows how many Borlaugs there might have been among those enticed by the riches of Wall Street and the City of London? If we lost even one, our world was made immeasurably poorer.

  2. Mark Cuban summarizes the effect of that skew in the short term**:
    The beautiful thing about this country is that we like to work hard, and we like to take chances. Unfortunately, over the last 15 years, the incentives have been to take chances as a financial engineer rather than as an entrepreneur. We give far more money to people who play games with financial instruments than we give to people who come up with ideas for the next big thing. That needs to change if we want to remain a leader in this world. [emphasis his]

I have quibbles, but the direction and magnitude of the two above is correct: a massive reallocation of incentives that diverted talent from potential paradigm-shifting development to incremental risk re-allocation and obfuscation. The rest of us were just, well, marks. *Maybe more on this one later, from another angle. **Though he has a rather generous, imnvho, definition of an “investor.” But even by that weak definition, his point stands.

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If You’re Marking a Curve, you need to identify an equilibrium point

Via the must-read Susan of Texas, Ezra Klein finally comes to some of his senses:

couldn’t get an answer to a very simple question: What level of spending on health care was optimal for innovation? Should we double spending? Triple it? Cut it by 10 percent? Simply give a larger portion of it to drug and device manufacturers? I’d be interested in a proposal meant to maximize medical innovation. I’ve not yet seen one.

It turned out that concerns about innovation weren’t really about innovation at all. They were just about attacking universal health care ideas of a certain sort. Which is why I stopped taking them seriously. As it is, I’m less worried about squeezing out medical innovation than I am about rising medical costs squeezing out innovation in every other sector of society.

The final point is a key one; if you’re talking trade-offs and DSGE Models, you better not be looking at an area in isolation. (Or, as I noted earlier, if you’re looking at an area in isolation, you need to be able to explain what “equilibrium” means in context: quadrupling the amount diverted from the alleged business does not count.

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