management

Here is a run-down from Brad DeLong.  In addition to the analyses of particular names (I generally agree in the cases I can judge, though I would reappoint Bernanke, if only to limit market uncertainty), get this:

Trade Czar-nominee-designate-leekee. This will, I think, turn out to be a much more important job in the Obama-Biden administration than people recognize. Trade agreements are a principal way that we deploy our foreign policy soft power. And trade sanctions are, I think, going to be a principal tool in the construction of the system of global governance to fight global warming.

Via Angus (and do read his snark on TFP), here is Paul Samuelson:

Libertarians are not just bad emotional cripples. They are also bad advice givers.

(Are there "good" emotional cripples?)  Four points should be noted:

1) Paul Samuelson is one of the truly great economists of the 20th century.

2) Hayek did in fact underestimate the robustness of liberty in social welfare states, though it is worth noting that his Constitution of Liberty very much endorses a social safety net and many other policies of the German FDP of that time.

3) This is the same Paul Samuelson who argued, as late as 1989, that the performance of the Soviet economy was a refutation of Hayek's critique of central planning.

4) When I see people writing sentences of this kind, I imagine them pressing a little button which makes them temporarily less intelligent.  Because, indeed, that is how one's brain responds when one employs this kind of emotionally charged rhetoric.

As you go through life and read various writers, I want you to keep this idea of the button in mind.  As you are reading, think "Ah, he [she] is pressing the button now!"

The new claim is that a woolly mammoth could be regenerated for as little as $10 million.  The basic technique, as I understand it, is reconstructing the genome of the mammoth and modifying the DNA in the egg of a modern elephant and bringing the final-stage egg to term in an elephant mother.  It is noted that the same will be possible with Neanderthals, as it is expected that their genome will be recovered and sequenced shortly.

Didn't I read as recently as ten years ago that "Jurassic Park" scenarios were more or less impossible?  I don't expect Neanderthal man to reappear soon, but assuming the world stays (relatively) peaceful and wealthy, what is the chance of seeing one or more such beings within the next two hundred years?  Yes I know all about the law, eventual demographics, and the fear of planet-wide interspecies war, but at $10 million and over one hundred countries in the world, is not private philanthropy robust?

As one commentator asks, if we humans killed them off in the first place, does that mean we have any obligation to revive them now?

Paul Krugman presents a frightening figure. 

The figure [below] shows the real interest rates on corporate bonds, with the expected rate of inflation from the spread between 20-year TIPS and 20-year Treasury rates. All data monthly, from St. Louis Fed.

I've been saying for some time that one of the signs of a credit crunch has got to be rapidly rising real rates - in very recent weeks, that appears to be happening.  The timing suggests to me that this is more of a deflation problem than a banking-credit problem per se but at this point who cares - we can probably all agree it's more bad news.

Addendum: Greg Mankiw is also troubled by what this figure means.

Exports constitute nearly 40 percent of China's GDP--far too high a figure. (By comparison, in the U.S., exports account for about 10 percent of GDP most years.) And the global financial slowdown is already taking a terrible toll. Some 10,000 factories in southern China's Pearl River Delta area had closed by the summer of 2008. Gordon Chang, a leading China analyst, estimates that 20,000 more will shutter by the end of this year. In the third quarter of 2008, Beijing also reported its fifth consecutive quarterly drop in growth, and several private research firms expect a sharper slowdown next year. Additionally, unemployment is skyrocketing; in Wenzhou, one of the main exporting cities, about 20 percent of workers have lost their jobs, Reuters recently reported.

Here is more.  By the way, here is an article on China's retreat from environmental concerns.

I thank Clifton Chadwick for the pointer.

1. Walter Block and IQ

2. A bad year for Mavericks

3. Condy Raguet in print; order it here.

4. Policing nature, part II

Spending [on infrastructure] is up 50 percent over the last 10 years, after adjusting for inflation. As a share of the economy, it will be higher this year than in any year since 1981.

That's from another excellent column by David Leonhardt.  The real problem, of course, is the quality of our decisions on infrastructure.

Big news on the effort to alleviate the shortage of human organs:

Singapore is to allow compensation for kidney transplants and for eggs. A government proposal has been approved by a bioethics committee and legislation will be introduced early next year.

...According to the BMJ, a sum of S$10,000 was mentioned. According to the Straits Times, the health minister, Mr Khaw Boon Wan, mentioned "at least a five-figure sum, possibly even six-figure" as appropriate reimbursement. This would include expenses, such as transport and medical costs, as well as loss of earnings. Also, the donor should be covered for follow-up medical costs and higher insurance premiums as a result of losing a kidney.

In other big news the National Kidney Foundation (NKF) is reconsidering their long-held opposition to compensation for organ donors.  The NKF is surveying people on financial compensation.  Marginal Revolution readers can raise the level of discussion and perhaps help save some lives by answering the survey here (it's very short).

Thanks to Lloyd Cohen and Richard Darling for the pointers.

That's a question I used to get all of the time in the early days of this blog. I don't get it so much anymore. Because slowly but surely people are wising up to the fact that blogging is work and its a very valuable use of my time

Take yesterday for example. I wrote a longish blog post on the Union Square Ventures blog about our most recent investment, Boxee. That post got picked up on techmeme where it ran for most of the day yesterday. I don't yet know how many people visited that post yesterday but I am sure it was thousands of readers

About 75 of them left comments on the post asking for an invite to Boxee's invite only alpha. I got a bunch more invite requests on this blog where I had linked to the USV blog post yesterday.

So this morning I spent an hour, between 5am and 6am, going through all of those comments, harvesting the email addresses from disqus, and inviting everyone to try out the boxee alpha.

That's about 100 trials. Not that many when you think about it in the context of the 50,000 registered users of boxee.

But the time and energy I've put into this blog for the past five years has built a unique and very sophisticated audience. You are connectors and hubs of influence.

I know that one person out of the 100 I invited this morning will be incredibly impactful for boxee. It could be five people, it could be ten. Who knows?

But in the world of social media, word of mouth and word of link marketing, it is connectors and influencers like all of you that make the difference.

And that's one of the main reasons I keep writing, commenting, discussing, and participating in blogs, tumblr, twitter, disqus, and the social media world at large.

Its about the "realest" work I do.

The book is getting snarky reviews but if it were by an unknown, rather than by the famous Malcolm Gladwell, many people would be saying how interesting it is.  The main point, in economic language, is that human talent is heterogeneous and that the talent of a particular person must mesh with the capital structure of his or her time if major success is to result.  The book is best read as a supplement to Ludwig Lachmann's Capital and its Structure.  The main enduring insight of both Lachmann and Gladwell is simply how much we live in a world of complementarity rather than substitutability.

Nowhere in the book does the name Dean Keith Simonton (check out the headings to these links) appear nor does the phrase "multiplicative model of human success."  A lot of the content here has already been done with more rigor and empirical support and also in readable form I might add.  Everyone should read Simonton, noting that his hypotheses fare better in the arts than in politics.

If you ask too much from Outliers it will fall apart.  It is too easy to find contingency in the world and Gladwell doesn't begin to look for a theory of which contingencies are interesting or not.  For instance arguably Ludwig van Beethoven would not have been a great composer if:

1. An extra butterfly had died two million years ago.

2. The outcome of the Thirty Years' War had been different.

3. The Germany of his time had not had fortepianos.

4. His parents had conceived their child one second earlier.

5. Haydn had not paved the way.

#3 and #5 seem more interesting than #1 and #4 but that's because some contingencies just don't help us understand the world very much.  Gladwell never gives us enough theoretical structure to see why his contingencies are the relevant ones.  Simply showing the contingencies in personal histories is not, taken alone, very enlightening.

Gladwell's contingency stories skid out of control.  At one point it seems the main claim is that the steady accumulation of advantages is what matters, but once you ask which advantages end up "counting," the claim collapses into tautology.

There is also a "PC" undercurrent in the book of "don't write anyone off" but if everything is so contingent on so many factors, maybe writing people off isn't such a big deal.  It could go either way.  It depends. 

Gladwell deliberately steers us away from the contingency of genetic endowment (even for a given set of parents, which sperm got through?), but if you hold everything else fixed you can assign a very high marginal product to the genetic factor if you wish, usually up to 100 percent of a person's outcome.  That mental exercise is verboten but somehow it is OK to hold the genetic endowment constant and vary some other historical factor and regard that as a meaningful contingency.  See the discussion of Beethoven above, especially #4 on the list.

Gladwell descends into the swamp of contingency but he is unwilling to really live in it and take it seriously or, alternatively, to find a way out. 

In reality the complementarity concept is easier to work with and also more fruitful for thinking about policy implications or for that matter the implications for management or talent training.  Success is fragile but foster competing cultures based on clusters of talent motivated by rivalry and emulation.  Don't filter out the eccentrics or the risk takers.  That's about where David Hume ended up but Gladwell never gets anywhere close.

It's still a good book and a fun book.  You can order it here.

If reports are true and Barack Obama is really going to tap widely respected CBO Director Peter Orszag to head up the Office of Management and Budget (it’s like the CBO, but for the White House, so it makes sense) then I believe that would make him the highest-ranking blogger in the history of the United States of America.

Here is more.  Orszag, of course, is a very good economist.

"We just really wanted to shatter the cupcake-pizza dichotomy. It's just existed for too long."

I am a monist myself.  Here is much more information.  It is also an example of Thomas Schelling's idea of research by accident:

"[A] lot of our ideas come from just not having the proper materials," Wilder said. "Like the pupzzas came from not being able to find the large tins."

Yermack estimates that the aggregate capital investment in GM and Ford since 1980 has led to a net reduction in capital of $465 billion...This is what I find particularly disturbing: with that $465 billion, “GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan, and Volkswagen.”

Here is more.  And here are facts about GM wages.

I wrote a post about our most recent investment, Boxee, today on the Union Square Ventures blog. Boxee founder and CEO Avner Ronen wrote a post on the Boxee blog about the investment. I encourage you to click on those links and read all about Boxee. You can also click here and see what people are saying about boxee on twitter right now.

But for those who aren't going to do that and still want to know what Boxee is, I call it the "firefox of the media center software sector". That's my view anyway. Here's a ~ 2 min video that shows Boxee in action.

quick intro to boxee from boxee on Vimeo.

• Boxee Media Center hacks its way onto AppleTV
• TechCrunch post on the Boxee financing
• VentureBeat post on the Boxee financing
• AlleyInsider post on the Boxee financing
• The Deal's post on the Boxee financing

The U.S. Navy said pirates commandeered a Saudi-owned supertanker bearing more than $100 million worth of crude a few hundred miles off the Kenyan coast, an attack that sharply increases the stakes in an effort by governments and militaries to protect the world's energy-supply lines.

U.S. Navy officials said the hijacking was unprecedented for its distance from shore and the size of its target -- a ship about the length of a U.S. aircraft carrier. The attack appears also to be the first significant disruption of crude shipments in the region by pirates.

Here is the story.  Here is Peter Leeson's paper on pirates.  I don't yet see it on Amazon, but stay tuned for Peter's forthcoming book The Invisible Hook. 

I thank Brad Williams for the pointer.

Addendum: From another article:

The pirates’ profits are set to reach a record $50 million in 2008, Somali officials say. Shipping firms are usually prepared to pay, because the sums are still low compared with the value of the ships.

As secular and cyclical performance pressure mounts, leadership teams wrestle with the appropriate response.  Unfortunately, most teams end up taking the easy way out, causing long-term damage to their performance. An old Italian economist holds the key to a much more promising approach.

Taking the easy way out - and paying the price

As revenues erode, cost cutting becomes a top priority for all firms.  What are the favored approaches?  There is the great leveler – everyone is mandated to take the same percent out of their cost base.  Most can see that this makes no sense – all costs are not equal and some parts of the business are much less productive than others.  Unfortunately, this tends to be the most common approach to cost reduction. 

Some companies are slightly more sophisticated – they mandate the same percent reduction but then establish an appeals process where executives can make the case that their costs are different and require special treatment.  This gives a release valve for the executives who are most politically adept at lobbying for their special interests but it rarely provides objective metrics to make an independent judgment about the need for exceptions to the broader rule.

Support services operating as cost centers are disproportionately targets for cost reduction in challenging times.  Unfortunately, executives often fail to realize that, if these services are doing their job, they are actually critical to generating revenue and profitability.

Some companies are organized into P & L driven business units and the exercise is to prune low performing businesses – targeting them for sale or closure.  This is certainly better, but it is more of a meat cleaver than scalpel approach.

What’s the result of all of this?  Near-term performance improves because costs do come out of the business, but longer-term performance suffers as the consequences of unfocused cost cuts become visible.

Asking a different set of questions - the Pareto questions

So, what is the alternative? There’s one approach that can be implemented quickly. It  provides an opportunity for very significant cost cutting in the near-term while at the same time strengthening the longer term performance of the business.

I first wrote about this approach over five years ago as many companies were wrestling with the aftermath of the dot com bust.  It is based on a key insight by an Italian economist, Vilfredo Pareto, over one hundred years ago.  Pareto discovered that much of human activity follows the 80/20 rule – 20% of the inputs often generate 80% of the results.  He first noticed this during a study of wealth and income distribution in England.  He discovered that 20% of the population accounted for 80% of the wealth. As he explored other domains of human activity, he realized that this was a remarkably pervasive pattern.

So, what does this have to do with cost cutting?  The 80/20 rule provides the foundation for a relatively simple exercise for executives.  It involves answering the following questions:

• Which 20% of the products or services generate 80% of the profitability?
• Which 20% of the customers generate 80% of the profitability?
• Which 20% of the geographies generate 80% of the profitability?
• Which 20% of the assets generate 80% of the profitability?

These are powerful and revealing questions, yet few companies today are able to answer these questions given the way their accounting and information systems are set up. As a result, the answers are generally hidden from management view. Unfortunately, the questions themselves rarely get asked.

Accounting and information systems need to be restructured to provide greater visibility along these dimensions on an ongoing basis. But, from my experience, quick and dirty approximations of the answers to these questions can be generated relatively easily – especially if management can get comfortable with “directionally correct” answers. The results are usually eye-opening. For example, one management team discovered that the product line it thought was most profitable was actually its biggest money loser.

One caution: in answering these questions, executives often focus on one financial period.  Unfortunately, profitability of resources needs to be measured over a lifecycle, not a snapshot of one period.  For example, one can get very misleading results by looking at customer profitability over one financial quarter.  Real measures of profitability include an assessment of customer acquisition cost, the average lifetime of a customer and the margin generated from the customer for each period over that lifetime. The same principles apply to products and assets as well.  Try getting that out of today’s accounting and information systems!

Leading to the more fundamental question

Once these questions have been answered, here is the question that can focus management discussions around strategic cost cutting:  why are we continuing to invest in the 80% of the resources that generate only 20% of the profitability?  Of course, the answer is not to mechanically cut the 80% resources that are low performing in terms of profitability, but to create a series of reasonably objective screens that can be used to test whether these resources are in fact playing a productive role. Some of these screens are:

• What is the growth profile of these resources? Many business initiatives are at an early stage of investment but have already started to show promising growth potential. The key is to focus on actual revenue and profitability growth trajectories or some other form of operational leading indicator to test growth potential.
• What are potential interdependencies between these resources and the high profitability resources?  Explicit dimensions of interdependencies need to be laid out and used to test any claims in this area.
• What short-term initiatives might be taken to significantly improve the performance of these resources?  Defining explicit six month milestones for operational and financial performance improvement becomes critical to ensure results.

The causes of invisible diversification

Bottom line, though, most companies spread their resources much too thinly across too many product, customer, geography and asset plays. This is a much deeper problem than the diversification across many different businesses or business units.  Even within an individual business unit, portfolios of products, customers, geographies and assets have become broader and broader.

There are many reasons for this invisible diversification.  In far too many cases, it is the result of incremental, near-term strategic thrusts over a long period of time that have never been rationalized.  In other cases, it is the outcome of organizational fragmentation and politics and the lack of clear and uniform metrics to drive decisions on new business initiatives.

Another driver of this invisible diversification is risk aversion.  We launch portfolios of initiatives to cope with risk by placing bets across a broad front.  Unfortunately, most companies lack the discipline to remove bets even after the results are known. 

But there is also a more fundamental economic driver of this kind of invisible diversification.  Many companies have built up a large fixed cost infrastructure either on the supply chain side or on the sales and distribution side or, in too many  cases, on both sides simultaneously.  Once these infrastructures are in place, an insidious logic takes hold.  The only way to cover these costs is to drive more volume through the infrastructures, even if the incremental volume generates minimal margins.  The infrastructures begin to run the show even though they were originally deployed to support the main act. The economic logic is compelling in the short-term but can lead to deteriorating profitability over time. 

The most basic question of all

The only way to escape this bind is to pull back and question the need for these fixed cost infrastructures.  Thus a simple and relatively straightforward application of an 80/20 analysis can lead to a discussion of the most basic question of all: “what business are we really in?” This in turn requires a systematic framework for thinking about business unbundling, something that I have covered in other venues.

If companies want to move beyond marginal cost-cutting that can often hamper long-term performance, they would be well advised to apply the 80/20 analysis to their business. It can deliver quick and very deep cost restructuring that actually positions the business to perform far better in the future. It is a powerful tool for reframing the cost structures of the business through a new lens.

But that's not all folks

The Pareto 80/20 rule can be used to reframe the business across two other dimensions as well – growth platforms and institutional innovation – but these are topics for future posts.  Let me leave you with two key messages.  As competition intensifies on a global scale, companies will not be able to survive with marginal or incremental approaches to cost reduction – they must restructure and reduce costs at a much more fundamental level.  Cost reduction alone is necessary but not sufficient. Without finding powerful new sources of growth and leverage – even in trying times – cost reduction alone will only shrink the business as cost savings get competed away and captured by customers.

Brad DeLong shows a graph of how Gross Private Domestic Investment rises during the New Deal, except for the contractionary 1937-8 downturn.  The pattern is striking.

A loyal MR reader emails me a citation to Robert Higgs's book, which on Google (pp.6-7) claims that net investment was negative over the 1930-35 period.  There is talk of a "capital consumption allowance" and that allowance accounts for the difference between the gross and the net terms.  Only in 1941 did net investment exceed its 1929 level.  Here's a chart which seems consistent with these claims and which shows the difference between the net and the gross series for investment.  The waves are very similar but at different absolute levels.

Can any readers explain what is going on  In this time period, using this data, is net or gross investment a better indicator of recovery and economic conditions?  Is the pro-New Deal claim that making net investment "less negative" (but still negative) counts as a success or rather that the gross investment series is what matters? 

When I look at this data series -- whether gross or net -- I see a few monetary policy actions (initial reflation, breaking the old link to gold, increasing reserve requirements in 1936) as the dominant explanatory variables. 

President-elect Barack Obama continues to name members of his transition team. Among the latest announcements are that the National Science Foundation agency review will be led by Jim Kohlenberger — who was senior domestic policy adviser to Vice President Al Gore, where he focused on science and technology — and Henry M. Rivera, a lawyer. For the arts and humanities transition team, Obama has selected Bill Ivey, director of the Curb Center for Art, Enterprise, and Public Policy at Vanderbilt University and former chairman of the National Endowment for the Arts; Anne Luzzatto, who served in the Clinton administration as a special assistant to the president and who has more recently been vice president for meetings and outreach at the Council on Foreign Relations; and Clement Price, the Board of Governors Distinguished Service Professor of History and director of the Institute on Ethnicity, Culture, and the Modern Experience at Rutgers University at Newark.

Here is the link.  Those names are not huge surprises and of course you will again see the imprint from the Clinton administration.

1. Is National Review finally collapsing?

2. The smartest man Pete Boettke ever met; he is high on my list too.

3. Markets in everything: 19th century vampire killing kit

4. The public choice case against a GM bailout

If you don't like public spending you could do it this way: Give every voter a federal debit card. And put the money in their accounts. Tell them if they don't spend it this month, the government will take it back.

Some people will try to cheat and find ways to save the money, but probably not many.

Some people will use the money to pay down their credit cards. That's good. The less they pay in interest each month the more they can spend.

That's J Thomas from the MR comments and you can think of it as Silvio Gesell plus some modern technology.  I'm not recommending this policy, just noting that in terms of stimulating aggregate demand it both vanquish a liquidity trap and it would outperform government spending or what I call "raising taxes in the future."