Prelogue
copyright © David Ness, 2 June 2000-7 July 2001
2002/02/19 0308 UTC]
Prelogue
The bulk of this paper was written in the early part of 2000, somewhat before the major collapse of the .COM world. While this will `date' some of the discussion, I think most of the points remain valid so I have left this discussion pretty much as is. Some things change, of course. I haven't heard Jon Corzine even mention the New Economics since his election to the Senate.
Prologue
This is a complicated, but important, topic. After some introductory discussion, we develop, in three separate parts, the moral, technological and philosophical basis that can guide us through a discussion of The New Economics. In broad outline, the thesis presented here is that the confluence of many different factors produces a time of considerable turmoil. Some people interpret this as a fundamental change in the nature of the forces that govern our economic world.
The argument here is that this is a misunderstanding and a misperception. Things are, indeed, very complicated and tumultuous, but they are not fundamentally different. The times may have changed, but the laws that govern the times haven't.
The Background
Let's start by looking at the assumptions made in the discussion here. This will be followed by an overview of the principles involved in the discussion. Then we can turn to the subject of the New Economics.
An Assumption
As I finish this paper, I realize that there may be some folks out there who don't know what `Three Card Monte' is. And if they don't, then some of the side remarks in the paper that follows are pretty obscure. So suffice it to explain that this game, played either with cards or with shells and a pea, involves putting the pea under a shell, and mixing the shells (or putting a queen and two aces face down and mixing the cards). The bettor's objective is to find the queen, or the shell with the pea.
The trick is---by sleight of hand---it isn't there, so the bettor never wins---unless the dealer wants them to win to get them comfortable with increasing their bet, so that their losses will be more substantial when the time comes. In the common parlance these players are called `The Hustler' and `The Mark'. Note that there is also a role for an additional player in this drama called `The Shill' that has some real parallels in the world of the new economics.
An Overview
Jon Corzine, now a Senator from New Jersey, spent many advertising dollars during the 2000 Senate campaign confidently saying I do understand how the new economy works. He says it in one of his incredibly numerous TV ads. Now the fact that Corzine made $400m as head of Goldman Sachs proves beyond a shadow of a doubt that he understands the old economics very well, but the underlying thesis of this paper is that paraphrasing Twain, `rumors of the new economics may be premature.'
This shouldn't be read as a partisan attack. In an era where the Republican leadership gets into bed with the NRA out of an apparent desire to maintain the absolute freedom to shoot themselves in the foot---something that they have been doing with truly incredible facility---one need not be partisan to find problems with current day political pronouncements. But understanding the milieu of these pronouncements is a worthwhile task. And inuring oneself to the false promises implicit in many of them is necessary training in citizenship for today.
The purpose of this paper is to focus on the new economics, and the central claim is that it isn't so new after all. That isn't to say that there's nothing interesting going on. The confluence of several kinds of change render this a particularly interesting time, and it is not surprising that many might mistake the ebb and flow of all of these different currents for some kind of fundamental structural change.
Hyperbole aside, and now that the millennium furor has thankfully faded into well deserved oblivion, there surely is a lot going on. That it had nothing particular to do with the millennium is no surprise. Things are always changing, but there are times when lots of different sorts of change take place at once, and it is easy to mistake these `differences in degree' for `differences in kind'. Here we will take a look at many of these different forces and circumstances. Particularly important elements are:
This represents a lot of change. And it produces lots of stress. And stress can be exploited.
Hucksters, many politicians among them, take advantage of stress by seizing on the opportunities to exploit our natural concern that we may be misunderstanding some structural change in our environment. Now if the truth be known, we are lucky in the fact that real structural change is an exceedingly rare phenomenon. But we do need to understand what is going on, at least to avoid being led by the hucksters down the primrose path.
That is an important part of the purpose of this paper.
The New Economics
The new economics is a staple item in today's news. It seems widely conceded that we live in a new age dominated by some laws of supply and demand which are now dictated largely by the ability to move information over great distances with considerable speed and by software which increases in value the more widely that it is shared. Fashionable, current, modern ideas.
Wrong ideas.
What worried me, at the outset, was that I could spend the day watching hundreds of blinking screens connect the 35th floor of a Wall Street office with Hong Kong, London, Paris and Sao Paulo, and then wander outside and see two well-dressed traders, responsible for moving hundreds of millions in bonds that afternoon, lose a game of Three Card Monte to a street hustler. I mean these guys understood all there was to know about financial derivatives. They could tell their Cubes from their Spyders. But they couldn't tell that hustler they were playing against depended on his skill, not luck, to make a living. And they couldn't see that were the meat on his table.
They were well informed about the typhoon in Hong Kong. But they didn't know enough to come in out of the rain. And change the (then ubiquitous) yellow suspenders and Wall Street uniform into the garb of a Roman Centurion, and we could have seen the same game played on the Via Dolorosa in 29ad. With identical results. Hustlers 1, Marks 0.
Over that time, our networks have gotten better. Our computers have gotten better too. We can now move information reliably and faster and cheaper. It is easy to find out air ticket prices in Bangkok. One can negotiate hotel room prices in Jakarta. It takes five minutes to book a room at the Dhaka Sheraton, and another five to arrange a ticket to get you there. But more and more we have also begun to depend on needing to do things ourselves. The middle is disappearing. The squeeze on the middle of the pyramid that was so confidently, and so very wrongly (at least for two decades) predicted in ancient pieces like the HBR's Management in the 1980's (written in 1958) is finally taking place. But the causes and the effects are profoundly different. And they deserve some analysis.
Every good accountant knows the easiest way to improve productivity. Re-define it. Change what you measure. It will confuse everyone. It will throw everything up in the air. And it's easy to be a `success' if we change the rules of the game. I had a fraternity brother who ran a company that returned about 40% in profits every year. It took everyone some time, even those of us who knew him, to realize that this was generally accomplished by restating the previous year's profit into a huge loss. The `tell' in this case was the fact that the actual asset position of the company kept deteriorating. The pea was put under the first shell. And everyone looked at that shell, never under it.
Of course, no one would be fooled when they saw shrinking assets even in the face of reputed profits. Well, maybe only a few would be fooled. Well, actually perhaps lots of people never even bother to look at or think about the past. The information is hitting them too fast. It's coming in from all around the world. And the net gives us more of it, from more places, with more unknown sources than ever before.
But who would fall for changing what we measure anyway? Don't ask that of anyone who has just told you how professional looking their new report is. Today our children can generate professional looking reports at home that we would have been pleased to see come out of the graphic arts department of a major corporation a couple of decades earlier. Anyone asking whether the reports are and better in any significant way? Anyone ask if the authors learned more putting the reports together?
Strike that. And swap the first and second shells. Of course the authors learned a great deal putting the report together. They learned how to use two or three different pieces of software to generate the spreadsheets and to manipulate the beautiful graphic images. They learned about two new search engines on the net that could find even more places that had plausibly relevant source material. They learned about two new packages that would allow you to take source material and directly `graft' (maybe it should be `grift') it into the very professional (looking) report.
Of course none of this suggests that anyone ever actually bothered to learn anything about the content of the report. Time and energy was spent learning software and doing net activities. It typically wasn't spent learning the subject and doing any thinking about it. Herb Simon observed that programmed activity drives out unprogrammed activity. Working on the computer is programmed activity. Thinking is unprogrammed activity. Give me programmed activity anytime. Gresham's law of ideas at work.
The sad news is that we have, as Simon observed, a natural tendency for our programmed dinking around with the net to drive out our unprogrammed thinking about things anyway. And this is severely exacerbated by the net. If there ever was an ideal vehicle to absorb countless hours of programmed activity this is it. Navigating is easy, and there are always more places to navigate to. We become the traveller collecting symbols of our trip, beer coasters, Hard Rock Cafe Tee Shirts, instead of seeing the history, smelling the fresh grapes. We do the easy, and bound from one site to another rather than the hard thinking that might be done if we weren't so busy.
Reminds me of the Swedish definition of University Education that circulated my MIT years: University Education: Getting the information that is in the notebook of the teacher into the notebook of the student without passing through the mind of either on the way.
We have completed about two-thirds of this revolution. The next step will be to build the automated readers that will read and grade the information without bothering the reader. Then our wonderfully automated writing will be very efficiently digested by our wonderfully automated reading tools.
Fantastic productivity! Human hands (and human heads) barely have to touch anything.
Decades ago I had the pleasure of meeting a guy who in one day increased the capability of IBM to handle its computational load by more than 10%. And on a single day at that. Quite a feat in its time (at that time IBM was the major player in computation, the `Snow White' with competitors known as the `Seven Dwarfs'). A clever programming stunt? Figuring out a faster FORTRAN do-loop? No, just a decree to stop bothering to account for internal computer usage within IBM. Much more than 10% of IBM's then extant computer resources were spent accounting for how the other 80 or 90% was used. And no one cared, anyway. IBM made computers, and---if one did the accounting reasonably---they were actually pretty cheap to use internally. Stopping the collection of data that was irrelevant to decision purposes released lots of resources.
So when they tell you how productive it is that an investment advisor in Bala Cynwyd Pennsylvania can service a client in Dusseldorf, it's probably worth asking just who's ox is being gored by what. And then we can swap the first and the third shells. And so can the client in Bala who is now served by a broker in Dusseldorf---with little net economic effect.
This is the real lesson of the new economics of the Internet. Convince yourself that profits are bad. Profits are hard to earn, and they are quite self-limiting. Given honest accountants, profits are hard to fake. We can increase volume by buying advertising, and if someone will lend us the money it's easy to buy advertising. So if we can convince you Volume is Good and get you to lend us the money, we surely can give you back the Volume that you desire. But profits---they are a sticky matter. We can't buy them.
So, following our plan about changing the measure, and believing that you're too smart to be taken in by a simple `losses are good' argument, I swap the second and the third shells and tell you that we spent our profits to buy market share. We can turn share into profits anytime, of course---goes the argument. Right now, let's buy share. And now you're getting the idea: the bigger the losses, the more market share. The more market share, the more the eventual profits. But, swapping the first and third shells again, not this year. Profits are for the future. Share and scale are for the present. Only the foolish would be making money and banking it. Invest it in people. Invest it in Silicon Valley Offices. Invest it to get eyeballs to visit our site. Keep the sight on our site and don't watch the bottom line. It doesn't count anymore anyway.
As a friend used to say of Hollywood: ``Underneath all that fake tinsel---there's real genuine tinsel.'' I'd say the same about the net. Underneath the fake superficiality of the net there's some real genuine superficiality. I'll make that case in a moment.
But first, we should recognize what the net does, and pretty much does unequivocally. It makes moving information around extremely cheap, very fast and possible to do in huge quantity. The fastest way to move a whole book's worth of information from New York to Los Angeles used to be to fly it out Air Mail. Probably would have taken a couple of days (remember this was pre-FedEx or UPS). Now a million words could be moved along an Internet link in a few seconds. And it would cost next to nothing to do it.
E-Mail puts us in easy and direct contact with our families and friends. I often exchange two or three notes with my daughter who lives a thousand miles away in a single day. I am able to interact with a friend and colleague in Rotterdam as easily as I do with one of our mutual friends who lives about a mile from me. And, given modern travel, I actually see the friend from Rotterdam more often than the one who lives nearby.
But this free and easy information flow has also destroyed some of the things that we used to be able to count on. And we don't have a clue about the economic impact of any of this yet. `Shopping' used to involve lots of phone calls and lots of driving around from one shop to another. Now, it is easy to just `shop the net.' You can't have `secret' prices, and if you know a price it's cheap and easy to get that price to me, even if I am a continent away.
So, the drop in cost of information movement means that it is very difficult to protect margins---which in a previous age were generally protected by the fact that not everyone knew them. Information didn't flow freely, so I was able to make profits by using loss-leaders and getting you into purchase habits that meant I could convert that volume of traffic into a profit on a future transaction. And I could support differential pricing---seating a person paying $99 for his LA to NYC flight right next to the person paying $462 without either being the wiser. Now the prices are on the net, and instead of flying to Minneapolis from Philadelphia in an emergency for $1200, I could drive to New York and make the trip for $ 139. Cost a couple of hours in the car, and saved $ 1000. Worth it.
And it's hard to be loyal to a web site. I am reasonably loyal to my `Coffee People'. I see them most days, and we exchange pleasantries, and I know something of their interests. They know something about mine, and commonly ask me net- or computer-related questions. They ask for search engine advice, or about URLs. I get advice from them about movies, and what's going on in local entertainment. I am happier to use my `regular' Starbuck's than others that are almost equally accessible, because of this loyalty.
However, if a substantial price discrepancy were to obtain, I would quickly develop new loyalties. Personnel change frequently enough that I would only miss someone for a couple of weeks anyway. So while there's loyalty there, it isn't too deep or profound.
But even if it's not deep, it's still way more profound than my loyalty to a net site. In my earliest days I might only know how to reach amazon.com, but once I figure out how to use something like www.pricescan.com to shop all of the on-line bookstores, I'm as happy to surf to Borders or Barnes and Noble as I am to call on the Amazon. And you know, wrapped in the UPS pouch that brings them to my door, the books from each place seem to truly be the same. I like my UPS person, but I don't care at all if the book they bring me is from B&N or from Amazon. It reads just as well from either.
So information flows freely, and pretty much everyone is able to know what everyone else is paying for something. So it no longer is possible to convert my `regular business' into a profit opportunity. Today, when shopping for books, I generally visit a local Borders to see the books, and see which ones are particularly interesting. Then I pricescan them, and often find that the $50 book I saw on the shelf will be delivered to me UPS ground (delivery included) for about $40 from amazon. I take such deals, and usually the books arrive in less than 48 hours. I don't even have to carry them up my steps.
If, however, Amazon were to raise it's prices back to something near the price available in my local store, or if my local store were to cut their prices to match Amazon, then I'd switch again in a heartbeat. Indeed I did switch to bookpool.com after pricescan pointed me in that direction for several technical books. And once experience with a new seller proves that their service is essentially identical to their competition, price is very likely to dominate choices. I don't have much loyalty to any particular button in my net browser. Other than to the button that scans for prices, that is.
And these moves can take place with lightning speed, simply because it is so easy to move information around on the net. If someone offers a good price on a book that might interest my friend in Rotterdam, I can EMail him about it at very low cost to me, and he can execute a deal to buy the book at very low cost to him. Price moves can be communicated with great speed. I now get regular `weekend specials' not only from my airlines, but also from my computer disk and cassette dealer, bookstore, and other suppliers as well.
So I think that it's a myth that current market shares will ever end up being converted into much profit. It's not that I predict Amazon's demise. I just don't think that they (or anyone else for that matter) are going to make a lot of money out of the delivery of information in the form of books in a world where we have just made delivering information incredibly cheap. If my local Border's is any indication, there's apparently already more money in the Coffee that they sell to local college kids who use the place as their `civilized library/study hall' than in the selling of the books themselves anyway.
Stealing from Stein: There's no there there. Most of the market share gained by buying eyeballs, tying down buttons, forcing access software on people who don't want it or need it will vanish into other alternatives, interests and mechanisms. Several .coms `bet their company' on superbowl ads. They got the eyeballs to visit their sites, but most of the visitors apparently found the offerings uninteresting and departed, never to return. Several of the companies have shut their doors. On a different front, AOL and Gateway will try an end run around Intel and Windows. Maybe it will succeed and maybe it won't, but if it does, huge market share can shift overnight.
And if someone in the chain of distribution that stands between author and reader tries to extract profits that are `too high', it is now technologically quite possible to do an end run around the whole publishing industry, and reach directly from the author's computer to the reader's computer, cutting out all of the middlemen in the process. It's not that the middlemen perform no useful service. It's just that they cannot extract any kind of punitive price for those services, as they are now easily left out of the distribution channel if their economic contribution isn't commensurate with their price.
This is true of much more than just the book business. napster and gnutella are using emerging standards, like MP3, that cause consternation in the music publishing business, as is DVD in the movie business. Links are forming between the Artist and the Consumer, and Metallica notwithstanding, it may be that some of the profit is just about to be squeezed out of the music business.
See, the economics (old economics, that is) of the music business allow you to take a dollar's worth of talent (not deprecating artists, here as I mean to imply a dollar per copy), two or three dollars of promotion costs, and five cents worth of blank disk, and using a computer, marginal cost a penny or two, and deliver them to a distributor who delivers them to a retailer who sells them for fifteen dollars. Today I can take an MP3 file from the artist, give him/her their dollar, and use my computer to write a CD on a blank that costs me fifty cents (I don't buy the blanks in the same volume as the record companies do).
I have my record and have spent about $2. The artists have their dollar. The disk people have their money. However, we've dropped the distributors and the advertisers right out of the picture, and can put their money in our bank, That's the real new economics. The distributors and the advertisers are information people and the net has greatly diminished the potential value that they add to the transactions.
Pitching this into Today's World
Everything in its season. Economics is always interesting precisely because it isn't possible to sort out simple causes and simple effects. To clean up a common phrase `things happen'. And they often prove to feed off one another, particularly if several new (and therefore unfamiliar) things happen to happen at the same time.
In this case, there is an important confluence between a shift in the age of the population, medical advances that give us and increasingly aging population and a new technology that can reasonably purport to be a technological revolution that rivals the rise of mechanization and industrial society in the 1800s and early 1900s.
Couple this, at least as far as the Western Democracies and most of Asia are concerned, with a growing majority of the population who have never dealt with economic adversity, and who lack the kind of simple and obvious life goals that have dominated earlier generations who generally had some real adversity, or some horrible tyrants to overcome.
This is all a textbook recipe for a situation where `wants' can get far out of line with capabilities to supply those `wants'. In my Grandparents generation lots of people didn't make it to retirement age. Many of those that did, died in the first five or ten years of their retirement. It was thought normal for people to die in their 60s or 70s.
Now lots of people live into their 80s, and many live to their 90s. This is a huge difference in the proportion of the population that is post-productive. And there are important shifts in attitudes and desires as well. Later we'll take a look at the friction that is caused by this shift.
It seems clear to me that the end of the Second World War had a much larger influence on productivity, ethics and attitudes than is usually conceded. In the United States, at least, the victory over Germany and Japan provided not only a highly productive atmosphere (today we'd call it good vibes) but also an unparalleled jump in individual prosperity as the huge productive industrial engine that had been built to produce armaments and an effective military force was converted into producing houses and cars and TV sets. Life did get better year after year. Before `The War' work weeks were 44 or 48 hours. Even one car was a bit of a luxury and home ownership was a much sought after, but not always attainable goal.
After the war, cars were mass produced, and we moved from one car to two cars to many cars per family. The work week dropped to 44 hours, then to 40. Levittown gave William Levitt's name to a new way of life as apartment and row-house city dwellers bought cars and moved to the suburbs which could now be reached with their new cars. The baby boom necessitated a guaranteed stream of building new educational facilities starting with grade schools and then moving on to whole new structures such as junior highs. University, and the GI Bill, shifted from educating the very few to educating more, if not most, of the population.
In this hurricane of activity it is easy to miss seeing how much of this is due to the shift out of a war age into a time of other focus, and how much is due to `American ingenuity, stick-to-it-iveness, the ethics of hard work and the American Way.' It is difficult to predict how this will influence attitudes and desires, but not hard to see that things are quite different for the next generational shift than they were for the generation that `won the war.'
This suggests that one of the odd---and I think largely unforeseen---consequences of the technological revolution is that we are all doing much more of the `work' of our own lives than was the case before. Whether this applies to more than the middle class is a matter for future argument and discussion. But suffice it to observe here that we are gradually losing an infrastructure of technology-related workers that used to cushion many of us both from aspects of the technology and from lots of the work that has to be done.
Perhaps the first and most obvious group to nearly disappear was the telephone operator. Projections were made in the late 1940 that if phone use were to continue growing at the then prevalent rates, by the middle 1950s, every woman in the country would have to be managing phones. It is a sign of the times then, that this was assumed to be the female population. Fortunately, I guess, the touch tone phone came into being, and the need to handle switching tasks by hand gradually diminished to the point that today only a very tiny fraction of the number of people who used to do this job have to do it anymore.
And secretaries are disappearing, as are bank clerks and keypunchers. More and more of the data entry task is being placed back at the source of the data, namely the customer or user. We now regularly do the banks keypunching on our own accounts when we use the ATM machines. We now pump our own gas, clean our own windows, and pay for it with our own charge cards, and often don't interact with another human anywhere in the process.
Rephrased: Somebody's got to do the work. This is an inconvenient and uncomfortable truth. Somebody has to pick up the garbage. Even if we end up having to deliver it ourselves, somebody has got to organize sorting it, burning it, whatever. Money doesn't do work. Money may induce people to work on our behalf, but only if they can then use that money to accomplish something useful with respect to their lives.
And you can't eat money. Again, you may be able to trade money for food, if someone who grows food has something that they can do with money that is useful in their life.
And---the shells are now being moved so fast that they are a blur---its not even clear what money will be `worth' when we eventually want to spend it. Today $10,000 might buy me a new roof. But I don't need a new roof today. And when I do need one, five years from now, or ten years from now there's no telling what it will cost. If a tornado blows through, all the `roof people' may get busy and prices might go up sharply. Even if I invest my $10,000 and earn a good return, I may not be able to afford the new roof when I need it.
It's like insuring the West Coast. If the `big event' happens, then it won't much matter how well we were insured, as the claims will bankrupt the insurance companies. And even if the federal government moves in, there may be no way to restore the land if millions of acres have washed away. Insurance only works when losses and non-losses occur in a reasonable mix. No insurance company could possible survive simultaneous claims on all of their policies.
Shuffling the Shells
So the real economic question is this: I list my house for $5 million. You list yours for $5 million. We swap houses. We move the shells. Do we each now have a $5 million house? Funny, mine seems to be the same old ramshackle place it always was, and yours seems not much better. But now we're both rich.
Transparent? Obvious? At the core of lots of the current `deals' that drive the current financial community? You bet. And if we keep the money moving fast enough, maybe no one will notice that most of it is counterfeit.
Let's throw some new money into the picture just to confuse things. Say that some people `believe in the Internet' and are willing to back new ventures. So IPO money becomes easily available. It can fuel the fire of net development.
This is at least partially because many of the net startup companies have no real use for money. Lots of Internet startups have negligible capital requirements. Of course it's nice to have money to be able to pay employees, and slick offices in a modern office block never hurt, but the basic elements of the technology that are necessary to doing business on the net don't cost very much.
In reasonable quantities, computers are available for two or three thousand dollars. One can have a fully professional web-hosting operation run a web site for a few thousand dollars per month. Net expenses tend to scale nicely, as resources tend to be easy to add if the volume of business grows to support it.
So what can we do with our IPO money. Well, the terms of the IPO probably prevent us from putting much of it in the bank or into our own pockets. And we don't need much capital equipment. And salaries, while an important current expense item, will only consume our capital in the very long run. So what can we do with it? Well, we can always take a position in some other new net startup, perhaps they can productively employ the money and we'll end up getting a good return. Monetary musical chairs. The pea under the shell is moving again.
With all of this money floating around, it's no surprise that `partnerships' and `strategic alliances' are the order of the day. And if we want to acquire some other net player, we can always turn to the market and issue stock to buy them with our shares. We can always turn around and spin them back off later if it turns out we need the cash. And that's not likely to happen unless our business collapses and we need to raise capital in order to meet operating expenses. So goes the cycle in the heady days of the late 1990s.
Of course, stock is a `promissory note on the future', and it is of very questionable value if it is illiquid. If I can trade my stock, then all I have to do is find someone else who has a rosy view of the future. I can sell my stock to them and profit. If, on the other hand, I cannot sell my stock, then I must actually depend on the real value that obtains in the future, not on some else's present view of that world. This is a much tougher proposition, and valuations are much less secure than they might have been otherwise.
To make the case specific, do a post mortem on a typical net deal. `X announces the purchase of Y for $20 million'. As they say, `let's follow the money.' You can replace the X and Y (and the amount) with countless instances over the past few years.
First, we notice that the deal is actually denominated in stock. X is buying Y for $20m worth of stock. If X's stock rises, then the number of shares is usually adjusted down to keep the deal pegged. On the other hand, in the more likely event that X's stock collapses (often a buying frenzy is used as an effective cover for a situation where internal operations are in deep trouble), the deal typically isn't re-denominated. So by the time the deal is ready to consummate, the $20m may well look more like $7m or so.
Second, the stock that comes in for the deal is almost always `letter stock'. It is not a negotiable instrument. While it sometimes can be willed or put in trust, it generally cannot be sold on the open market. So it can't be converted into other assets, it is only a call on the future.
What are the business prospects for the future. We'd like to believe they are quite rosy, of course, but history teaches us otherwise. In every industry, even those that have been notoriously successful over time, the `future' is no sure thing. Here we stand in the middle of the computer revolution, but where are the companies that built the industry? The names have a faint echo: Remington Rand, TRW, SDS, Burroughs, Osborne.
So what's $7m (today's `value') in the stock of company X worth, given that you cannot trade it for anything else for at least five years? I'd guess you'd be lucky to sell the rights to that stock for 10% of face value, even if it was legal to do so. And the government will take half of that in taxes.
So, out of our $20m we end up with about $300k in cash. Nothing to sneeze at, but no yachts on the Riviera either. We've shuffled the first and third shells again. And while I was impressed by the $20m, the $300k sounds like it's in a much more reasonable ballpark.
The Moral Basis
We need to discuss morality without moralizing. A major moral shift took place around the beginning of the century when debt, as represented by mortgages, became not only acceptable but desirable. This moral shift was necessary to allow family ownership of family residence to become a most common situation. In the 1960s we have the rise of consumer finance, where the private consumption debt was added to private capital debt, and became a commonplace.
Starting in the mid-1980 there was a further shift. Gambling, which had, again, been viewed largely as an evil thru the 1960s and probably by most people into the 1970s, became a valid instrument of social policy.
Gambling
In my lifetime, gambling has moved, in the public mind, from being a substantial vice into being an instrument of social policy. In my grandfather's day, there was a touch of evil associated with gambling activities. Now our governments advertise to us to promote us into gambling. This is not the place to try to deal with the profound sociological and moral changes implicit in this. However, since `gambling' is at the core of lots of current day economic strategies, discussion of gambling is central to our purpose in this note.
To come to grips with the socio-political side of gambling, we need to understand its role in value creation, and what it does to the psychology of those who employ it as a strategy.
Central to the argument here is the notion that it is hard to understand the downside of gambling until one has encountered some losses. In the insurance business collecting the premiums isn't the problem. The problem is paying off on the losses when they occur. As long as we are winners, it's not even gambling. It's simply `effectively deploying our resources'.
As the portion of the population who lived through the depression declines, it becomes easier and easier to discount the downside of risky decisions. Of course things sometimes go down, but they always go right back up, so the amount of time we spend `at risk' is generally quite limited and manageable.
One central fact about gambling is that it does not produce or create much new value. Of course a reasonable number of people are employed in the gambling industry. And there is some reasonable `entertainment value' to the activity of gambling, so it is not completely valueless. However, these element are very small compared to the handle of the industry. So the principal focus of the gambling business is to re-distribute existing assets rather than to create new ones. There's nothing inherently wrong in this, mind you, but we also shouldn't mistake it for the net creation of any substantive values. Re-shuffling the deck doesn't may give us new hands, but it doesn't create new cards.
As is an important part of many gambling games, the principal focus of gambling activity is re-shuffling the economic deck. Indeed, the principal effect of most gambling activity seems to be to take a relatively small amount from lots of losers and give a huge amount to a very few winners while keeping enough for the house (Casino owner, State, Church ...) to make running the game worthwhile. The huge wins are attractive and they are noticed, and the small losses quickly fade from memory. The slot machines make noise when they have large payoffs. They are silent as mice when they nibble away at your fortune, preferring that no one else notice.
So gambling activity may reorder our position in society, but it doesn't rebuild or secure new values. Currently discussed schemes to `privitize' the management of social security funds are a thinly veiled example of this. We'll discuss these gambling schemes more in a moment. For our purposes here it is sufficient to recognize that gambling shuffles the deck, but doesn't make it any larger. It moves our shells, but doesn't increase the number of peas.
One of the dangers with gambling as a social policy, is that there seems to be a `winning' strategy. If one is willing to risk a great deal, and is content with only a small win, then it is possible to almost always win. If I am willing to risk $10,000 and happy to quit when I am $100 ahead, I will surely walk away from the casino almost always a winner. Indeed, we could calculate the probabilities involved and recognize that I will probably win, using this strategy, nearly 99 times out of every hundred visits.
The problem is, of course, that when I `win' I win $100, and in the (admittedly very rare) event I lose I lose $10,000. So with this strategy I am quite likely to always feel myself being `a winner', and yet it's easy to see that I can't use it to get rich in the long run.
`So what' you say. No one would think that they could convert a game that favors the house into one that favors the gambler just by adopting some quitting strategy. Well, some do. And even more do if we change the circumstances and the site from a gambling table at a casino to the trading room of a Wall Street brokerage house.
Suffice it to say, there are lots of economic schemes, get rich quick ideas, and `investment opportunities' which are a simple repackaging of risk that produces some wins at the cost of horrible losses. Ask the folks who invested in S&Ls during the Reagan years.
You see, that's what `derivatives' are. In the financial world we can repackage risk by designing clever instruments. If we are clever enough we may even be able to repackage risk so that it turns out to produce positive expected values. Indeed, this is precisely what `The House' does in opening a gambling casino. By creating the casino they are taking a risk, but it is a risk which is provably mathematically in their favor, and unless they are terribly unlucky they will reap economic benefit in the long run.
A couple of years ago a bunch of smart economists created some securities that allowed them to generate very substantial profits. Every thing was fine until an improbable market condition arose that produced huge losses. They lost major quantities of both their own and other people's money, but fortunately for them they didn't have to give back the Nobel Prize.
The psychology of gambling has been the subject of many books and papers in the psychological press. This isn't the time or the place for a profound analysis. However, there are some properties of the gambling strategy that we have to understand if we are going to be able to sort out the role of gambling as it applies to the new economics and to the politics of the modern day.
I suppose this goes without saying. Everyone involved in a gamble surely thinks that they want to win and that they can win. It doesn't matter, apparently, that almost everyone is willing to wander around outside without fear of lightning, while placing bets on the lottery that have less probability of `hitting' them than the lightning bolt. `Someone has to win,' goes the argument. True, I guess. But then I don't even know anyone from the state of the last several big winners, so apparently I wasn't very close.
And everyone really knows that they are going to lose. Listen to the interviews with the people in line to buy lottery tickets. While they are invariably making plans about what they are going to do when they win the big prize, these plans have the air of unreality about them that makes it clear that the people know they aren't going to have to put them into execution. It is clearly a mental exercise, not a real plan.
And, further, there's even a growing body of evidence that suggests that even the winners lose. The first thing to go is all of their friends, each of whom apparently---if you believe the after-the-event interviews on the subject---believes that they `own a piece' of the victory. Just a new car or a small boat mind you. When this isn't forthcoming, the friendship or family relation dissolves.
And then, most winners don't have lots of experience with money, and don't know that it's almost as easy to get in trouble with too much money as it is with not enough. The problems are different, to be sure, but they are just as real.
How does this apply to the new economics? Well the strategy of `Take a risk, you might profit' has been replaced by `Take a risk, you'll profit'. `Might' has been replaced by `will'. Take the higher risk, you'll earn a higher reward. And it's been true all my life (said by a 24-year old). In an `up' market it's true. Taking risks in improving economic times is like going with the flow of the river. If 75% of the stocks on NASDAQ go up, it's hard for a portfolio manager to put together a losing portfolio. I must be a genius, my portfolio is up.
In some situations we can insure at least a part of the risk of the gamble. In grain transactions we `hedge our bet' by covering positions with options that prevent us from taking to big a blood bath if the market runs the wrong way. And hedging always costs some part of the premium, unless we can find a foolish insurer. This will occasionally happen---apparently it did with the underwriters of `Do you want to be a Millionaire' (at this writing still a hugely successful TV show), but such situations are rare, as insurers that undercharge tend to go out of business when faced with losses, even if the losses are within normal expectations.
Wait, maybe there is some wisdom here. If what I am betting on is not merely the fact that things are getting better, but also the fact that if they get worse, then I'll turn to political action to remedy my economic ills, then I may truly have a winning---at least in my terms---strategy for dealing with economic reality. The strategy becomes: Bet on the upside, and instead of insuring your downside risk (which would cost you something) stand ready to take political action if the bet doesn't pay off.
That's just what we did with the S&Ls, to look at one example. The managers of the S&Ls borrowed money at very high rates and invested it in risky projects that had the potential for high payoff. Of course, not all of these projects paid off, and when they didn't the loans made went bad, thus washing away the reserves needed to pay back the money that had originally been lent by a largely unsuspecting public.
Of course it was a greedy public that had been convinced that they should be able to earn a secure 10-15% on their money. Seemed like a good idea at the time. But it didn't seem like such a good idea when it proved to be impossible to get the principal back, and a political firestorm arose.
This firestorm was of sufficient magnitude to cause the government to enact a bail-out. Now it should be noted that it was not the S&L managers who were being bailed out. Some of them had already departed the scene with greater or lesser amounts of cash and other assets. The principal recipients of the bail-out were the good citizens who had loaned the S&L money at high interest rates with uninsured and unsecured loans.
This story is perhaps relevant in light of the current discussion of the privatization of Social Security funds. There is every reason to believe that private investment of these funds would likely be in securities with a risk characteristic inappropriate for most of the investors. If a bad result were to obtain, then it would fall back on the government to perform another bail-out, and it would probably be politically suicidal for the government to not respond.
There is an implicit assumption that since
problems can be solved with money. This is often untrue. The same can be said of technology. If we don't have technology, then we can---all too easily---assume that getting some technology will solve our problems. We now turn to investigate that notion.
The Technological Basis
There are at least two major technological components to present day economics. The first is the technology of software, which has become an independent element of real consequence in the economy. The second aspect of technology which has an impact on our concerns is the growth of networking, and more particularly the development of the World Wide Web, providing rather substantial connection of all parts of the world with medium to high speed information pipelines.
The Technology of Software
Software is a different kind of economic `good'. And as a result the economics of software are not well understood. To come to grips with this it is useful to try to understand something of the evolution of software development, as we now have about 50 years of experience with it.
In the earliest days of the commercial computer industry, software was free. Well, it wasn't really free, but it `came along with the hardware'. Software and manuals were simply things that came along with the machine, and in my youth I well remember regularly visiting IBM offices in various cities to get free manuals for the various machines that we were just beginning to appear on our University campuses.
Not only was software free, but it was different for each machine. In the earliest days we programmed in the `machine language' of the machines themselves. These programs obviously only worked on the particular machines that they were designed for. Until higher level languages were conceived of and implemented, all programming activity was brutally specific to a particular target machine, and the manufacturer of the hardware provided only some very rudimentary software to help access it.
This implied, of course, that every time we changed machines, we threw out all of our old programs and re-wrote them for the new machine. This was expensive and time consuming work, and it gave us an incentive to stick with a particular piece of hardware well past its point of technical obsolescence just to avoid the prospect of having to rewrite all of the software that we had accumulated in the process of solving our problems. Because making the changes was so expensive, we had to wait until the economics dictating the change were overwhelming. Fortunately, we had the advantage that dropping computer prices could provide the fuel that made this possible, although still expensive.
The invention of higher level languages changed all of that. The implementations of the first compilers were often quite idiosyncratic, so code did still not move easily from one machine to the next generation. And input/output activities hadn't been regularized to the point where they were easy to deal with in most higher level languages. But with each passing generational cycle of hardware and software, the software became more general and by the late 1970s it was becoming commonplace for code written for one machine to execute on other machines without any tailoring.
This has advanced far enough now that we generally don't even talk about `writing code for a particular machine'. We generally assume that most machines will have compilers for the languages that are common today, and we assume that what ever code we might write in any of those languages will execute similarly if not identically across a wide spectrum of different computers.
Somewhere along the line, we gradually got away from having the manufacturer of the hardware write the basic software for the machines. This had begun to happen with the development of some `third party software' for unusual computer languages or for particularly efficient implementations. By the time PCs arrived on the scene, manufacturer supplied software was breathing its last gasp. The early history of PC was a repeat of this historical pattern, and the cycles were shorter and the whole process was sped up.
The end of the manufacturer supplied software era probably came with Gates' last IBM contract. While Gates may not be a brilliant programmer, he surely is a brilliant contract writer, and the development of MS-DOS as a product standing separately from IBM and its hardware gave rise to the PC clone and became the prototype for software delivery in the 1990s. It also made Gates the wealthiest human in the world.
Notwithstanding any of the above, there has been some consolidation on the so-called `WinTel Standard'. This is any of the various Windows operating systems (Win95, Win98, Win2000) operating on standard Intel (80x86) hardware. If there is a single `platform of choice', this is clearly it as of today. And due to the cost considerations we are about to discuss, if there is a first place where most ideas are implemented it is for this platform combination. If something runs on WinTel then it probably can be executed on in excess of 75% of the systems in existence.
It costs money to develop software. But these costs occur in somewhat different ways and in different magnitudes than we are commonly used to when dealing with other more conventional `products'. To understand the economics of software we have to get some grip on the costs, as these costs determine the characteristics of these goods.
It can cost a lot to produce a piece of well-functioning software. In the days machine language and assembly language programming we generally estimated costs at tens of dollar per line---and programs often had tens or hundreds of thousands of lines. Now with higher level languages dominating the programming picture it is probably meaningless to attempt any such measure as what constitutes `one line' of code means less and less in modern languages.
Major pieces of software today involve tens, hundreds or thousands of programmers and often take months or years to produce. So we are talking about costs that may be millions of dollars. On the other hand, important and useful software is still also sometimes produced by one or a few people at very reasonable costs. So there is a very wide range of the cost of creation.
One element of software cost is easy to characterize. Right from the earliest days of the industry the replication cost of the software has been near zero. A big program these days might occupy 500mb. That scale of code would most likely cost millions of dollars to generate. But it is easy to deliver it on a CD-Rom that costs less than a dollar.
So it is very inexpensive to replicate copies of software, and this quite naturally gives rise to active piracy. Today even small computers, given a CD-Rom burner that might cost a few hundred dollars at most, can duplicate the most expensive pieces of software available. And at 500mb of date for each CD, one can reproduce and carry an enormous amount of information in a pocket or small briefcase. Street maps of the whole USA would fit on one disk, as would 100 huge novels.
Documentation used to be free, and therefore it was only a cost item in the software delivery process. Then the software producers noticed that they could get away delivering either no real documentation or only `on line' documents, and rely on published books, often written by third parties, to deliver the basic information. Today's incredibly complex Windows systems are delivered with manuals which are much smaller than those that were delivered with the much simpler MS-DOS systems of the early 1980s.
So documentation has shifted from being a cost item into being a profit item. This is something which is typical of the evolution in this field. Today, many programs are actually sold as documentation, with the program being essentially a give-away in the `back of the book.' CD-Roms make that form of delivery quite effective.
Over time more and more of the documentation of programs has been put into the programs themselves, and into things that can be accessed as an auxiliary to the software. Some of this documentation is in files that can be delivered on the CD-Roms that contain the software, and other documentation is provided by access to facilities on the net. This form of documentation has some attractive properties:
Notice that they also make the book store and the computer store natural rivals. Both the book retailing and the computer retailing industries have undergone precisely the same kind of consolidation over the past decade. Since time immemorial, most bookshops were small idiosyncratic organizations. There were, of course, some exceptions: Foyles' and Blackwell's come to mind, but mostly the stores were run by individuals or partners with a strong expression of their personal tastes and interests.
So, too, with computer stores. In the 1970s and 1980s there were `Byte Shops' or `ComputerLands' in every community. But as time passed, consolidation hit both industries leaving only a handful of large players to dominate each of these industries.
What is even more interesting from our viewpoint, however, is that over this time the two kinds of stores have become more and more alike one another. Today my local CompuAdd has expanded the space given over to books from one small lane to about 25% of the floor space. And on the other side, my local Borders' sells a lot of disks that are inside the back covers of their books, and even some nice boxed sets of reasonably `serious' software. They also both have large magazine sections for computer magazines, as well, although the space devoted to computers on the magazine shelves at my local book store has been shrinking dramatically of late.
It's not clear how this will eventually turn out. Several Dalton's and Border's experiments into explicit `Software Stores' have been tried, but were apparently failures, at least in all of those that I have encountered in my visits to stores in various parts of the United States. But suffice it to say that the distinction between a computer program and its documentation is becoming harder and harder to see. And after tackling the computer industry the net pricescan-like programs seem to turn to books as their next industry of interest after computers and digital photography.
It suggests that, at least in some sense, information is information, and that we should at least consider the prospect that software is just like books, only earlier in the product life cycle.
There is one cost component in the software business where costs are increasing by leaps and bounds. This is in the category of `defense of copyright' covering both security elements and legal expenses. One of main items of discussion about US/China Trade involved attempting to get the Chinese to do something about software piracy, a common practice in China and the rest of Asia.
There is also something in the notion that copyright and security both involve establishing artificial barriers to what would otherwise be a very easy flow of information. While the easy communication of the net provides a wonderful vehicle for legitimate software delivery, it horrifies software providers with the thought that the pirate stalls of Tsim Sha Tsui might suddenly be as available to consumers all around the world as they are to those who pass thru Hong Kong.
As software became more machine independent, while at the same time the normal delivery platform became more common, some software began to develop a very long life. As was mentioned above, there was a stage in the history of the computer business 25 years ago where each hardware generation necessitated a reworking of all of the software that had been developed for the previous generation. However, since the advent of the Intel 80x86 series (and the Motorola 68xxx), most hardware has been upward compatible, so previous generations of software have continued to function. Lots of software written in the middle 1980s is still in regular use on machines that range in scale from small handheld computers like the HP200Lx all the way up to the largest multi-processor PCs.
This led to the discovery of the `upgrade' as a marketing tool. Perhaps Microsoft's most successful innovation, and the hard core of their software business, is the rolling upgrade. The way this works, each new software product is sold on the basis of the fact that it will function properly with all old data files. However, this doesn't guarantee that old software will be able to work with the data files produced by the new generation. This has the obvious consequence that if one person in an office adopts a `new' version, they are able to do their own work and can work with any other colleague's files without any difficulty, but their colleagues are quite likely to have difficulty dealing with their (new form) files. This generally soon forces the rest of the office to adopt the new software and another upgrade cycle can begin.
In some ways, the upgrade can be viewed as a virus. If one places a new version into an environment, it will gradually force all of that environment to use that version. Viewed one way, that's just what a virus does. This strategy has an important influence on the economics of software, as we will discuss in greater detail in a moment. The more widespread a particular piece of software is, the more it forces other things to be compatible with it, so broad distribution has a positive feedback effect, the broader it is the broader it becomes, driving out less widely used product in the process.
More and more users are now doing major portions of their computational effort, whether they know it explicitly or not, by accessing sites down the net. As this is done users become increasingly insensitive to what kind of computer delivers these computational cycles. As is the case in a typical client / server system, it is very difficult to know just which of the computers in the environment are doing what part of the work needed to deliver a particular result.
Indeed, most users don't have any idea about the computational environments they are accessing. There is no necessary relationship between a user's own access device and the computers being accessed. The way that software is now typically being constructed for the net, there is a rather complete independence between the access device and the devices that actually deliver the information.
In most situations we could find out what sort of device we are actually encountering as we request information down the net. However, in most cases doing this would be counterproductive, in that it would render our software sensitive to something that it didn't need to care about.
The net makes heavy use of a computational delivery structure that was developed independently, but concamitantly, with the developments that made the net such a big deal. This is the so called `Client / Server' configuration where we make some device (the Server) responsible for doing most of the heavy work, and we allow one or more Clients to access the server, place requests for work, and display the results of those requests.
On a network, where the computers may, but need not be, located in proximity to one another, this is a particularly effective way of getting work done. Lots of problems are solved, among them:
This leads to thin client strategies. There is every reason to believe that these will become more and more important as wireless connectivity begins to dominate the interconnectivity of the net. Thin clients are machines that don't have much computational power, but are focussed on the communications task of talking to other machines. Thus they tend to be good at display and at input of information, but don't have the resources to handle large data bases or huge computations. This work they leave to the Servers that they access.
The principal vehicle, from a software standpoint, of today's access technology is the `Browser'. Given its centrality, there is no surprise that the `Browser Wars' are not only the result of a rather incredible major shift in Microsoft's focus, but also the key element in the Government's anti-trust case against Microsoft. The Browser was also the key element in AOL's purchase of Netscape---the developers of the original browser who had fallen on hard times because of Microsoft's decision to give their browser product away.
The browser is the program that a user invokes to access most files on the Internet. When a user accesses most sites on the net, they return a file for the browser to display. Generally this page is in a well understood and well documented format.
This format is known as HTML (HyperText Markup Language) and it has become the lingua franca of most network communication. It implements HTML, and in this fashion allow construction and control of display on the user's screen without actually knowing much about that screen or its intimate characteristics. All of that is left up to the browser to interpret.
While it is possible to exercise detailed control over what is displayed, for the most part this is frowned upon as ineffective. If we say that something must be displayed in a format which is 12 inches wide, then it is hard to predict what kind of compromise will be made if the final display screen is only nine inches wide. If we can leave this unspecified, however, then the browser is given the opportunity to make whatever compromises might be effective in such circumstances.
This means that we are gradually getting freedom from the particulars of either the clients or the servers. This represents a second stage in the movement away from the particulars of the hardware. The first stage was to develop higher level languages which were hardware independent. However, in this generation of HLLs, there were still substantial dependencies on the Operating System, even if the underlying hardware was similar. Now that is beginning to give way as newer languages implement OS-independent facilities that remove one more level of dependency.
For example, languages like Java and Perl make a reasonable attempt to move up one level from the particulars of the operating system. In the presence of the net this is somewhat easier than it might be otherwise, because the net itself imposes some standards on the process that makes it somewhat easier to deliver OS independence, in that the net is, itself, quite OS independent, a necessary prerequisite to achieving wide acceptance.
There are lots of browsers. The big two are Netscape and Explorer. Mozilla is the `new' public domain effort, and Opera is a rather sleek European entry into the browser wars that some users prefer. The most important characteristic of these browsers is that they all deliver the HTML standard and that they are increasingly available not only on WinTel platforms, but secondarily on Unix, Be and Apple platforms as well.
The evolution of browser alternatives, and more importantly, standards for browser interpretation of HTML, again makes lots of modern software development impervious to choice of OS as well as hardware. Over the past year an increasing number of software products are being delivered via browsers, and this allows them to be used in widely diverse computational worlds. It also has the beneficial effect that documentation is easy to deliver via the same browsers that are used to deliver the products themselves.
Of course, this doesn't come without some costs, the principal of which may be dangers inherent in the prospect of allowing net files to contain `active' components. Active components are open invitations to the easy spreading of virii. Proof, perhaps, that with every advantage come concamitant and balancing disadvantages.
Active components and processes allow for easy communication and passing of information. Unfortunately if they make things easy for the `good guys' they also make things easy for the `bad guys' as well. Prior to making it easy to pass around active components, one often had to write long dissertations on how some file or model was to be accessed and used. With active components the usual instructions became `Just click on it'.
Of course, if `just clicking on it' could do something complicated, then it could also do something bad if someone unscrupulous interjected themselves into the communications channel.
The Philosophical Basis
There are some important differences between software and other economic entities that are more familiar to us. We need to investigate these differences in order to be able to understand the impact of the emergence of software as an important economic element in our lives.
The Economics of, and by, Software
This discussion provides the backstory to the issue of the emerging economics of software. It is current vogue to discuss and treat software as a commodity which does not follow the normal laws of economics, particularly with respect to the fact that software gains in value the more of it that is used.
It might be useful to spend a little time characterizing software as an economic good. Let's look at three different types of economic goods, classifying them by what happens when we share them. Goods are of three different types:
.
It `costs' to share most things that are `objects'. If there is a value to possessing an object, then sharing it costs us the benefit of its use for the time that it is shared. This is the role of what we think of as conventional economic goods. Let's call these conventional goods.
Given the costs of sharing, we don't need many rules---other than those against physical theft, of course---about how conventional goods should be handled. Except in unusual circumstances we are pretty much free to buy such goods to enjoy possessing them, and are similarly free to sell or rent rights to the conventional goods to others.
There are exceptions, of course. We are not free, for example, to buy, sell or possess certain prohibited goods such as narcotics. But this is due to a societal decision about how such goods should be treated, not anything intrinsic in the possession or use of the goods themselves.
Another kind of goods might be called artistic goods. Here we have a category of goods that can be shared with no particular cost to the possessor. If you bring your tape recorder or CD Rom burner, I can give you a copy of an expensive piece of music at what is essentially no cost to me. Sharing the object, like lending you a book that I have on my shelf, lets you enjoy it, and it hardly costs me anything.
In such cases we have to develop special rules about how these sorts of goods can be shared. We have copyright and intellectual property laws that govern sharing when there are no real substantive costs which would otherwise prevent or interfere with sharing.
Some pieces of software fall into this category. Systems that might cost us a great deal to buy might well have an inconsequential media costs, which would mean that replication costs would be inconsequential in comparison.
Software, particularly operating system software, has different properties that either of the other two categories of goods. With this software there is a positive economic benefit, in many situations, to sharing. This situation relies on the fact that it is an advantage to me to have other people use the same software that I use---particularly at the operating system level.
This happens because the more people who have my OS, the more application software is likely to be developed for it, the more likely it is to be comprehensively and completely debugged and the more likely I am to be able to hire people who know and understand the system. All of these things are positive advantages to me. The more rare my OS is, the less likely I am to be able to find support for it, and the less likely I am to be able to find cost effective alternative sources of supply of people and applications.
The Fallacy of Composition
Stores of Value
Net Economics vs. Net Commerce
Uncomfortable Political Realities
The Ennoblement of Greed
Bringing it Together
Having now established nature of the various currents that lead to the current economic climate, we can begin to bring the various threads together and establish the model that leads to the conclusions that can be made from the analysis of the situation.
The Model
It might be worth building a small model to help us understand the interaction between the new economy and social policies such as retirement and medical benefit. The attempt here is to illuminate the structural relationships that control this area of human experience. Most political attempts to over-determine solutions in this area. This is done for political reasons, but since congressmen can't repeal and rewrite the laws of economics as easily as they can their own laws, most of the proposed policies are self-contradictory and absurd.
To get a preliminary glimpse of how overdetermined some solutions are, we might trace through the obvious effect of some extreme policy. We make the policy extreme just to highlight its effect, so that consequences will be more obvious and will show up earlier.
Let's say we adopt a policy to make all retirees rich. Upon retirement you are given $5m. It's enough for that nice condo in Miami, with plenty left over. But what's the effect. Well we have a real bulge of retirees, but no bulge of younger folks who are still doing the work. So there are both more of us who need to have our roofs redone, and fewer people redoing roofs. The consequence: the price of doing roofs rises. Gradually, or perhaps with the more responsive market place that we have created with the Internet, quite quickly the prices rise. Nothing in our `policies' created more workers, so while all of the retirees are sitting on large hordes of assets, these assets have to chase a relatively fixed supply of workers and the cost of getting work done rises until the market is cleared.
We haven't accomplished much in `real' terms. We handed out piles of money, but we didn't create any new values, and so inflation simply ate up the effect of the handout. Of course in the process we certainly have caused some social re-shuffling. There's a lot of difference between retiring on $10,000 and $1,000,000, but there's much less difference between $5,010,000 and $6,000,000.
Congress can do lots of things. It can, and does, pass laws that govern most aspects of our lives. But there are also things that it cannot do, not because the Constitution prevents them, but simply because they are beyond the power and capability of the lawmakers.
At one point, the Indiana Legislature passed a law defining pi to be 22/7. The thought was, I guess, that this would make it easier on the school children, and would ease some commercial calculations. But a changing the definition of pi doesn't change anything about the nature of circles, so somewhere we're bound to run into some trouble.
Passing a law that makes everyone rich is no more possible than passing a law that makes everyone happy. I mean, it would be nice if it were possible. But it isn't. For some reason, that's fairly obvious in the case of happiness, but less so in the case of wealth.
So let's characterize the problem this way. Again we oversimplify in an attempt to preserve both sanity and clarity. We divide the population into two groups
We also divide the assets of each group into three categories:
And, by the definition of retirement, we note that the retiree effort assets are zero, i.e. retirees don't work. Following our notion of simplifying our analysis, we distinguish financial assets from other assets in two ways. First, they are intrinsically worthless---while they represent some claim on some something, they possess no value in and of themselves, other than the fact that they
Now an early argument is that worrying about earnings and interest simply muddy the water. I think we can make this argument stick. If so it is amusing to note that virtually all of the political debate that focusses on this issue actually boils down to a discussion about this, and in my view it is completely irrelevant to all issues of consequence. We'll see if I can make that case.
Now the issue should be clear. Retirees need work done. Since they have no `effort' income, they need to swap assets for work, to induce the workers to perform tasks on their behalf. In a well organized society this is done in an orderly way. Ultimately, at the death of the retiree, their assets are redistributed anyway, so in some sense the `retirement years' represent an early handover of some portion of these assets.
We have also not accounted for transfers. Through several different mechanisms, the most important of which is probably taxation-funded government programs, assets are transfered effectively transferred between the working and retired segments of the population. The scale and direction of these payments is largely established by custom and by law. The Social Security program in the United States is an example of one such program. Although it was sold politically as a banking or insurance program, it takes only a little inspection to realized that since the tax is imposed on the working population and the benefit is paid to the retired population, it actually represents a simple transfer payment from workers to retirees.
Transfer payments can be used to reconcile social behavior with untenable consequences. Social Security has been, and is, very popular because most people find it difficult to save an amount adequate to fund their own retirement. As funds ran out, we began to produce a class of impoverished older folks, and so a program to provide for forced savings thru taxation proved to be politically acceptable.
The most difficult things to model are the financial assets that complicate this otherwise pretty simple picture. Financial assets are of many different kinds. We don't want to treat them in detail, so for our purposes, most of the characteristic details are irrelevant.
We can think of financial assets as having some particular characteristics:
We have discussed, elsewhere, the odd characteristic of the present market that makes it look like some stocks are being traded like baseball cards. However, even if this is true, it is likely to be quite a passing phase only affecting the market for a brief while. In the larger picture, financial assets have no intrinsic worth to most of us.
I won't account here for Midas like behavior, where there is `value' in the mere contemplation of the stock certificates or in looking at a pile of gold bars. Other than this, it seems to me that financial assets ultimately have value because they can be swapped for `real' assets (things you can eat, live in, ride, milk, ...) or for effort. Of course they are more `liquid' because their very form makes the recipient willing to accept them independent of their form. The trick with financial instruments is, of course, that we really can only guess what economic factors will be in play at the time we may want to make any such exchanges.
Of course the odd thing about financial instruments is that while they are carefully denominated, it is by no means clear what value will be obtained as the instruments pay out. In the Russian inflation of recent years, financial instruments became worthless because even if they actually paid out the obligations, the values obtained became insignificant as the Ruble lost value.
The Realities
The Conclusions
Sidebar: Work to do
