Nostradoofus

Pundits endlessly debate who the survivors will be among traditional news sources.

It’s quite possible the answer is none.  No for-profit survivors at all.  An economist should agree this is a realistic possibility for a perfectly competitive industry with marginal costs of zero.

Remember:  big newspapers first arose because printing and delivery was expensive.  This meant an aggregator like the New York Times had much lower costs than a lowly pamphleteer.

This has been turned on its head.  The pamphleteer now has the lower costs, because he needn’t own an office, printing press and union labor, as the NYT must.

In the future, news may instead be gathered mainly by nonprofits or individuals.  It may be edited by respected, subject-specific independent editors — some sophisticated future variant of today’s best bloggers, e.g. CalculatedRisk.

This outcome is not as certain as, say, the inevitable collapse of the Los Angeles Times.  But it is realistic.

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When neither political party represents the public interest, you get nonsensical divide-by-zero errors in public sentiment.

For example, it seems the American people are so angry about the biggest wealth disparity in a century that they — suddenly are starting to like Republicans again.

You can’t make this stuff up.

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From the 16th century until about 40 years ago, “refute” had only one definition:  ”to disprove by reasoned argument or evidence.”

Linguists began to complain in the 1960’s that “refute” was increasingly used as a synonym for “deny.”  Evidence or argument was no longer required.

The latter usage became widespread in the news media in the past decade — so widespread, in fact, that it is now included as a second definition in many dictionaries.

Of course, plenty of errors and malapropisms have found their way into common English over the same period.  The nonsensical malapropism “hone in” (sharpen inward?) is now universally substituted for the original “home in.”  The misspelled “supercede” is now an acceptable substitute for the original “supersede.”  Words ending in “own” are increasingly pronounced as two syllables, i.e. “known” sounds like “knowen,” “shown” sounds like “showen.”

But unlike those harmless cases, the redefinition of “refute,” which conflates reasoned argument with simple denial, can be seen to symbolize the general decline of reasoned argument in the Anglophone world over the past generation.

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The previous post on modular bureaucracy can be summed thus:  to instantly reduce unemployment, radically simplify small business employment rules to make hiring effortless. Here is a specific suggestion.

For businesses with less than $500k gross receipts and fewer than 3 employees, all of whom are paid less than $80k/yr:

• No federal withholding (employee is responsible for his own taxes).
• Payroll tax, social security and medicare are a flat $300 per month per employee, payable by monthly automatic ACH (supported by all US banks), no paper checks.
• Federal govt provides first $100k of liability and worker’s comp insurance.

This is a classic 80/20 optimization, or more like 95/5.  Small business hiring would explode. I suspect it would bring some of the shadow economy (cash employment off the books) back into the legitimate system.

People do not appreciate the scale of the benefit this change would bring.  A huge percentage of total employment in the US is from the smallest businesses.  This move could prompt millions of sole proprietorships to hire their first employee.

Yes, it would turn worker’s comp into even more of a fraud machine — but that is a problem with worker’s comp law, not with insurance or employment law.  A properly modular bureaucracy would solve that problem separately.

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The news story du jour is to muse about why small businesses are not hiring.  Talk of tax credits, in my view, totally misses the point.

Nostradoofus essentially answered this question some time ago:  the problem is not cost, but red tape, both government and private.

The non-salary costs of hiring employees (chiefly health insurance, worker’s comp, liability insurance, legal work and tax filings) have grown far more complex and unpredictable in the past 15 years, yet are almost entirely outside the control of both employer and employee.

The problem is not so much the expense, but the trend toward ever greater UNCERTAINTY and COMPLEXITY of employing workers — the thousand small details that constantly change and that are outside the employer’s control.

This problem falls disproportionately on small business, which lacks the scale to employ specialized human resources staff to handle the complexity and unpredictable change.  Small business also lacks the financial depth to handle unpredictable changes in cost.

Repeat:  the costs themselves are not the problem.  Health insurance and pensions, for example, are both good and necessary. The problem is the UNCERTAINTY of those costs, and the COMPLEXITY of compliance.

This trend also helps explain offshoring.

To bring the problem into better focus, consider the fact that most small businesses have 0 or 1 employees.  As a result, to move the unemployment needle significantly would require that we convince a lot of solo businesspeople to hire their first employee.  This, in turn, would require convincing each of those prospective employers to do all of the following.

• File weekly, monthly and quarterly employment tax reports with at least 3 different taxing agencies.
• Expose themselves to huge penalties if they file anything incorrectly.
• Educate themselves about insurance (liability, worker’s comp, medical) and pensions.
• Shop for insurance at least once a year.
• Take on “single unknowns” like unpredictable growth in health insurance costs.
• Take on the “double unknown” of unpredictable liability exposure to employees.

Balanced against this commitment of hundreds of hours a year and a totally unpredictable financial commitment, the prospective employer has a simple alternative:  bid the work out on Elance.com.  If the employer can engage someone outside the US, they eliminate all tax filings, insurance and pensions, and almost all legal liability.  They just send cash by PayPal when the job is done.

From the perspective of the harried, overworked solo businessperson, this simplification is much more compelling than any mere cost advantage from offshoring.  Other things equal (cost and quality), offshoring is by far the better deal for the small business, because it is so much simpler.

The only policy solution here is for the US to get serious about streamlining its sclerotic employment system.  For example, one of the best arguments for nationalized health care and pensions is that they are simple and modular.  You just pay into them and get the services.  This allows both worker and employer to focus their attention on other things.

Independent modules, by their nature, offer lower performance than purpose-optimized solutions.  Viewed in isolation, modules are suboptimal.  But what they lack in efficiency, they more than make up for in simplicity and maintainability.  This is as true with government and bureaucracy as it is with software development.

It would be irrational to argue that optimization is always more important than simplicity, just as it would be irrational to argue we should write all software in assembly language, just because it will run faster.

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One of the main reasons Clinton was able to balance the budget in the 1990s was that Treasury Secretaries Robert Rubin and Larry Summers restructured U.S. sovereign debt to shorter maturities. Did this unintentionally create the conditions for artificially low interest rates, serial bubbles and sovereign debt spiral?  Read on…

Readers are probably aware that the single most important factor in Clinton’s budget surplus was the Treasury’s move to shorter-dated bonds. Short durations almost always have lower interest rates (except when they don’t — more on that in a moment). Governments have traditionally borrowed almost entirely in long-term bonds, such as 10-year and 30-year Treasuries. In the 1990s, the U.S. moved to shorter durations, resulting in instantly lower debt service costs, and a balanced budget.

The risk, which I’ve not seen mentioned anywhere, is that the federal government then becomes remarkably similar in capital structure to an investment bank, depending upon constant refinancing of huge short-term debts just to remain solvent — exactly the capital structure that killed both Bear Stearns and Lehman Brothers. With the U.S. government, it seemingly plays out in two ways.

1. Massively politicizes the Fed.  The Chairman of the Federal Reserve (who is unelected) now directly controls the size of the U.S. budget deficit simply by changing short-term interest rates, which changes the cost of the next rollover. Or, viewed from the other side, there is unprecedented pressure on the Fed to hold rates artificially low, to manage the deficit. (Maybe the serial bubbles and artificially low rates since 1996 result largely from this new pressure.)  This pressure did not exist before, because long-dated bond rates are determined by market prices, not by the Fed.

2. Massively exposes the US to a sovereign bond panic.  Suppose everyone decided for a couple of years that US T-bonds were toxic (perhaps due to war, terrorist attack, or some other unanticipated event).  If the government were mainly financed with 30-year bonds, then no big deal, they can just wait it out. But if the bonds are largely 1-year maturity, there is no way to roll over the bonds, and financial catastrophe ensues.

This is a particularly huge black swan — the move to short-dated bonds created a short-term illusion of stability, while massively increasing long-term exposure to a sovereign wipeout.

It is also very hard to get out of this situation, because the deficits are too large to roll back into more expensive 30-year bonds — just as a homeowner with an option-ARM mortgage is dreadfully exposed to interest rate swings, but cannot afford to refi back into a 30-year fixed.

The biggest danger seems to be that no one even recognizes the risk. According to Nassim Taleb, this blindness is a key feature of a black swan: unappreciated risk of a rare event with a catastrophic outcome.

Because the situation is apparently inescapable due to fiscal pressure, one might argue the United States is already in a sovereign debt spiral, one that will become visible only when short-term Treasury auctions start to fail.

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To clarify the net neutrality debate, imagine if Google made a hostile bid for Comcast.

This would place net neutrality opponents in an untenable position.  They essentially say it should be acceptable for a cable company to play favorites in internet service delivery;  but if that’s true, then there is nothing anti-competitive in Google owning a cable company.

Net neutrality opponents can’t have it both ways.  Either biased delivery is anti-competitive, or it isn’t.  If it is, then net neutrality wins. If not, then Google should be allowed to buy Comcast and throttle everyone else’s services.  Which would make no sense.

This is just a specific case of the more general fact that network-effect natural monopolies (railroads, cable companies, phone companies, Microsoft) defy normal microeconomics, because they have increasing returns to scale.  As a result, they tend to require regulation to ensure efficient market function.  In general, this regulation takes the form of forbidding bias in the freight delivered over the network.  So the railroad must carry anyone’s rail car, the phone network must carry any long-distance carrier’s call, Microsoft’s applications division should have been forced to split off from the OS division, and fiber networks should be forced to carry anyone’s traffic.

This applies only to network-effect natural monopolies, and not to other, weaker forms of market power.

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Say 3 companies simultaneously identify a big network-effect opportunity, and none has a particular tactical advantage. If rational and omniscient, each should invest up to its expected present value, or one third of the industry’s estimated PV. The net present value for the entire industry will then be zero, because all the money was spent up front in the battle for the winner-take-all #1 position.

Now move back to the real world, with uncertain, subjective estimates of market size and odds of success. Humans are known to be at their least rational in estimating NPV in low-odds, high-payoff situations (that’s why Lotto tickets sell). So presumably there is a bias for all three entrants to overestimate both the market size and their own odds of victory.

Thus all three are more likely to overinvest than to underinvest, so the industry NPV is negative.

Critically, the above experiment presumed no tactical advantage, and unlimited capital. This shows the incredible importance of tiny tactical advantages in early-stage network effect markets. In addition to being first mover, choosing the deepest-pocketed, fastest-moving VC is tactically useful in signaling to other hopefuls, as early as possible, that the game is over.

Why have US real salaries been stagnant for over a decade?  As mentioned in the previous post, part of it is undoubtedly competition from a globalized labor force.  But offshoring is not easy.  This begs the question:  aside from cost, is there some other appeal in outsourcing, despite the quality and management challenges that come with it?

In answer, consider this partial list of things you can eliminate by offshoring:

• Medical insurance
• Worker’s comp insurance
• Worker litigation risk
• Weekly, monthly, quarterly and annual tax filings
• Pension management

This is an interesting list, because it corresponds closely to the areas where US business costs and complexity have exploded in the past 20 years.  It suggests that stagnant wages and offshore competition may both result from rising costs that neither employer nor employee can control.

As partial support for this position, note that health care costs per worker have risen more in the past decade than wages rose during the Clinton years. Stated differently, if health care costs were capped, worker income might have increased significantly.  And this is just one of the unbounded, uncontrolled costs mentioned above.

It’s not just the money, but also the manager’s time and attention.  Complexity has a cost.  Eliminating the five things above, in favor of simply wiring funds, is tremendously simpler.

The US might enjoy surprising gains by applying drastic simplification and cost control to the above list.

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As you read this, recall that I generally buy the general laissez-faire, free-trade commerce argument.  Generally, but not religiously.  And, as always, the most interesting posts explore not the rules, but the exceptions.

Economists and investors have argued for a decade that moving US manufacturing capacity to China is not a problem — actually a good thing — because all the profit remains here.  The argument is reasonable, and runs something like this.

iPods are designed in the US, but made in China.  Some of the price of an iPod goes to China, but none of that is profit, because Chinese manufacturers are intensely competitive producers with consequently low return on capital.  Apple keeps nearly all the gross profit in wholesaling an iPod, while the unfortunate Guangdong manufacturer passes almost all its revenue through to its employees and capital expenditures.  Apple’s profit then funds more R&D and design work by highly paid employees in the US.

This all makes sense.  I buy it.  And it works well in other high-wage, non-mercantile countries, such as Denmark.

But the argument makes simplifying assumptions, rarely mentioned by proponents:  neutral trade balance, and stable corporate earnings as a percentage of revenue.  These assumptions have been generally false in the U.S. for over a decade.

Because they are false, the loop is broken.  The consumer spends $100 to buy an iPod from the Apple website;  about $30 of that ends up in China, essentially all with either employees or capital equipment lenders — no profit;  the remaining $70 remains in the US as gross profit to Apple.  But all of the growth in that profit over time goes not to consumers, but rather to AAPL management and shareholders, because wages have stalled for 15 years.  Meanwhile, because of the trade deficit, the $30 that went offshore doesn’t come back as revenue, but rather as loans, and thus cannot be sustained indefinitely.

Compounded over time, this situation should produce exactly what we see:  collapsing wealth and stagnant income in the middle class.

But note the problem is not directly with the free trade, nor with the export of manufacturing.  Those are benign, IF (and only if) the trade balance is neutral and at least some of the growth in corporate earnings flows through to US workers.

Both of these problems result partly from distortions in the dollar/yuan exchange rate.  We know the dollar is artificially high, based on purchasing power parities.  This, in turn, is caused partly by our reserve currency status, and partly from intervention by mercantilist central banks (China, Japan, Korea, Taiwan).  It directly exacerbates both the lopsided trade balance and the lack of US worker competitiveness.

So, while I don’t love the idea of a dollar collapse, it may be a tactical necessity until we can solve longer-term problems with competitiveness: poor K-12 education, wasted resources (prisons, military, health care), serial overindebtedness, and more.

The longer-term problem with worker competitiveness is extremely serious.  No American of any political stripe seems to be asking an obvious question: what if US wages are stagnant because US workers have grown less competitive for some other reason, and not just the cheapness of offshore labor?  Not saying it’s true, just that it’s a question worth asking.  The next post has some thoughts on US labor competitiveness.

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