With the newspaper business in apparent freefall, it's perhaps useful to tally up some of the various winners and losers among the incumbent business models as compared to 1994, the year the commercial web began to take off. It appears that there are multiple ways to be disrupted, that some industries are far better off than they were 15 years ago, and that there may be more dominos yet to fall. In roughly reverse chronological order, here's one judge's scorecard.
Industry: Newpapers
Status relative to 1994: Critically ill
Primary disruption: Unbundling
Compared to old-school stockbrokers, who were disintermediated by $10 trades, newspapers have been undone in other ways. The power of the traditional newspaper was its bundling, in economic terms, along two axes. First, subscriptions bundle content by time: readers pay for delivery of papers that don't always get read thoroughly for the sake of convenience. In addition, a daily paper contains content that a given reader ignores: look at how many hundreds of pages of a 1990s Sunday New York Times were thrown away untouched. This daily bundling allowed profitable sections (such as food/cooking, with grocery store ads) to subsidize other efforts, such as foreign news bureaus, which could not afford to pay their own freight.
Many of these facets of a newspaper have been separated out by standalone web businesses, each taking some segment of the readership and unbalancing the former cross-subsidies. Sports readers can go to the league sites (with heavy video footage), television spinouts from Fox/ESPN/CNN+Sports Illustrated, fan-driven blogs and/or message board efforts, or to any number of sites updating them on favorite cricket, soccer, or other international sports the metro dailies can barely cover, if at all. News is still primarily gathered by the usual suspects, but commented on, linked to, and re-aggregated by everyone from Google News to bloggers to ideology-driven destination sites. Daily A-Z stock charts aren't a particularly helpful way to watch the financial world, opening the door to broad distribution of previously professional-grade charting, archiving, and analytics; less professional message boards, blogs, and other mechanisms spread the wisdom (or lack thereof) of crowds.
The papers' extremely profitable classified ads were hit hard by multiple competitors. eBay then later Craigslist took over the realm of random objects, Monster and others (including the hiring firms directly) redefined the help-wanted field, and Edmunds and Cars.com along with eBay Motors improved on the car-buying experience by improving information availability and transparency. Match.com and eHarmony improved on the user experience and inventory levels of the personal ads, while real estate agents alone and in their trade association aggregated and augmented millions of property ads with photos, maps, and video walk-throughs.
In the end, most any page of a 1990s-era newspaper was challenged by an online outlet. With the readership in decline, both ad and subscription revenue spiraled downward, and the splintered nature of the competition made coordinated response impossible. In addition, the culture of "free" has affected news nearly as much as music, but far less so than books, for example. Some observers, including The Economist, have speculated that a Kindle or other reader might play a part in a revitalized news distribution business model. This makes sense: books, newspapers, and magazines emerged as business opportunities following a technology disruption, so changing the technology implies change for both reading habits and business-building.
The advertising industry has been fundamentally challenged by targeted, interactive, and well-instrumented ads and all they imply. If e-readers do reinvigorate the news business, this sector will need to move sure-footedly to regain much of the ground it has lost to Google in the past few years. While the movement away from traditional print models is highly visible, YouTube and the phenomenal rise of Internet video will also force a reshaping of television's economics.
Industry: Telecom
Status relative to 1994: Reinventing
Primary disruption: New technology platforms
The telecom industry is in the middle of a fascinating process. Back in the mid-1990s, the MIT Media Lab's Nicholas Negroponte noticed that television was moving from airwaves to cable while voice telephony was going in the opposite direction. Now, the triad of video, voice, and data is increasingly defined simply as flavors of data, and data is moving over copper, ether, and glass: what I want how I want it at any given time. The legacy telecom business model is at once getting substantial lift from the optical and wireless pieces of the picture even as the copper segments are in steep decline from wireline voice defection to VoIP or raising big questions about the need for their eventual and massive (if not total) replacement by fiber to the premise. In the current economic climate, both communications and entertainment appear to be relatively resistant to recession. In the long term, though, the huge capitalization requirements of both the strung infrastructure and the hung infrastructure, particularly in multi-billion-dollar spectrum licenses, leave ample leeway for companies or even entire sectors to get themselves in deep trouble.
Industry: Enterprise computing
Status relative to 1994: Leaner and more concentrated
Primary disruption: Offshore, network computing
In 1994, Sun Microsystems stock traded at about $3.50 a share. Six years and four 2:1 splits later, it capped out at just under $250, a tidy 1,000-fold payback. Consulting plays with invented names like Viant, Razorfish, and Lante sprouted, grew like weeds, and died. Software firms enjoyed a similar burst of prosperity: a 1994 Oracle investment increased by a factor of about 150 in 6 years, while investors everywhere vied to spot "the next Microsoft."
That progress was slowed by a confluence of headwinds, several of them directly related to Internet business model disruption. Offshore programming firms in India built on their success in year 2000 code remediation to slice margins in systems integration and later outsourcing. Virtualization and so-called cloud computing are subjecting both software and hardware to commoditization tendencies. Finally, budget pressure on CIOs introduces cost constraints and further profit pressure for software, hardware, and services.
The recipe for success going forward appears to lie in some combination of low-cost human capital (Tata, Wipro, IBM), scale (Oracle, SAP, IBM), and integration of product and service at scale (HP, IBM). Such firms as SAP and IBM have invested heavily in vertical industry expertise. Going forward, it's possible that the horizontal attack of Salesforce.com in software and the twin forces of reduced energy consumption and commodity computing (in turn applied to standardized process and data structures) could potentially combine to lower the verticalization premium.
Insurgencies -- that benefit from the combination of alternative economics and smaller labor costs -- from Google and Amazon appear to be gaining force, leaving Microsoft in particular at a crucial juncture. Dell also confronts some formidable challenges: even as the shift from desktops to laptops diminishes the power of the build-to-order model, it faces off against a reinvigorated HP, the premium-priced consumer electronics and design expertise of Apple, and the diffuse forces of clouds. For all that Dell gained from the Internet in implementing its direct model, between iTunes, consumer message boards, and cloud computing, forces related to the Net are now also causing headaches.
Industry: Music
Status relative to 1994: An empty whiteboard
Primary disruption: Unbundling, cultural norms
Much like newspapers, the music industry has been forced to adapt to the digitization and subsequent liberation of its core information product. Once music stopped being a physical artifact and instead was moved, understood, and redeployed as a fungible bit-based resource, the old model's market characteristics failed. The pricing model, the sales channel, the promotion vehicles, and the margin structure all fell apart. Selling people one song for the price of 12, trying to fight the long tail, and relying on a radio industry itself in turmoil for airplay no longer worked. Perhaps more centrally, expecting to maintain traditional "Hollywood accounting" when people's allegiances, to the extent they had any, lay with the artist spelled further doom for the old music model.
That said, both newspapers and music face parallel challenges insofar as large numbers of people now value their offerings at or near zero. Suing customers or nearby victims failed to reverse the trend and increased people's already negative feelings toward the labels. Radiohead's "name your price" downloads worked because of the gestalt of the band and its fan base; the model is unlikely to be widely implemented. Potentially in part because so much listening is done in private through earbuds, it's easy to view music behaviors as invisible and personal rather than public or accountable -- and the old economics of artists being so widely ripped off don't help the morality of the labels' positioning.
Going forward, models that more directly connect artists and labels hold promise, so maybe the final diagnosis will be disintermediation of the labels by word of mouth, hard-core touring, and/or some new discovery mechanism.
Industry: Brokerage/travel
Status relative to 2004: Transformed
Primary disruption: Disintermediation, transparency, self-service
Unlike the businesses above, both travel and brokerage served as early case studies of middlemen who charged too much for too little value getting end-run. In both cases, the dominant providers have had to reinvent their core business to survive and when they did not, the industry consolidated. Carlson Wagonlit presents one example: rather than relying on ticket-printing fees, the firm manages corporate travel spending as a coordinated service. By contrast, Rosenbluth, a competitor, was bought by American Express in 2003, and American Express in turn manages travel within a much broader set of procurement management offerings.
In brokerage, Merrill Lynch never fully adjusted to online trading and its attendant customer mindset, cost structures, and competitive landscape. For a multitude of reasons, it was bought last year. An element of unbundling also played out here and in travel: expensive transactions included advice, whether it was needed, or qualified, or not. Once the core transaction was laid bare, the advisory component failed to commend its previously overpriced premium.
In contrast, crowds, whether of investors, ecotourists, or frequent business travelers, combined to offer more and more powerful research than had been available previously. Whether of the up-to-the-minute (is the flight late?) or in the realm of long-term trends (how will India's equities markets perform in 2010?), the Net contains more and often better advice -- along with substantial noise -- than any one person could acquire, organize, or dispense. The combination of do-it-yourself research and serve-it-yourself transactions is now so deeply ingrained it's impossible to envision going back at any scale for routine interactions.
Who's next?
The bell has tolled for several old business models. Who's on the watch list? Briefly, some combination of disintermediation, unbundling, transparency, and consumer affection for free stuff could pose dangers for industries as varied as retail, television/media, pharmaceuticals, education, health care, retail banking, and automotive (which has already been hit pretty hard). Other sectors have less to worry about: e-government is increasing efficiency in some functions in some places, but entrenched ways of doing things persist more here than perhaps anywhere else, in part because of the lack of competition.
Construction, energy, and agriculture are powerful and so intensely tangible that it's hard to see digital disruption in the near term. In part, this security relates to successful defensive positioning: monitoring my home's energy usage on an hourly basis is trivial from a computational standpoint, but impossible because the electric company so jealously hoards the data. The consumer products sector has lots to worry about right now, beginning with double-digit unemployment, but the business model looks secure for the medium term.
Finally, it would be inaccurate to focus only on the losses to the forces of business model disruption. Whether it's Apple's rebirth (largely at Sony's expense) as a consumer electronics power, or Amazon's continuing resistance to any conventional sector categorization, or the unrelenting adoption of mobile phones by the world's masses, disruption also carries with it upside potential. As the global recession gives way to new varieties of prosperity, who will capitalize on the wealth of opportunity and be the success stories of 2012, or 2020?
Monday, March 30, 2009
Sunday, February 22, 2009
Early Indications February 2009 Miscellany: Trust, Loyalty, and Book Notes
1) Trust in social networks
Several recent developments point to the big questions regarding trust in social networks. First, both Facebook and MySpace announced that registered sex offenders were removed from their sites: 90,000 over two years for MySpace, and 5,500 (out of 175 million users) for Facebook, which is still responding to the same subpoena as MySpace. For Facebook especially, those are extremely small percentages. Harvard's Berkman Center published a study that asserts that online threats to teenagers generally mirror real-world issues: bullying and intimidation are the most common problems in both school hallways and on line.
In addition to thinking twice about who the person on the other end of the online interaction might be, Facebook users are uncertain as to the service's policy regarding their data. Over the past few weeks, Facebook updated the terms of service to assert broad claims. According to the San Jose Mercury News, Facebook's current policy is as follows:
"Users retain ownership rights. However, when a person posts content to Facebook, the company is automatically granted 'an irrevocable, perpetual, non-exclusive, transferable, fully paid, worldwide license (with the right to sublicense) to use, copy, publicly perform, publicly display, reformat, translate, excerpt (in whole or in part) and distribute such User Content for any purpose, commercial, advertising, or otherwise.' If a person removes content from Facebook or deletes their account, this license expires but Facebook may retain a copy of the person"s material."
The legalese of even this modified version sounds pretty one-sided. But as Facebook founder Mark Zuckerberg pointed out on the corporate blog, making virtual trust work is a very tricky business:
"People want full ownership and control of their information so they can turn off access to it at any time. At the same time, people also want to be able to bring the information others have shared with them—like email addresses, phone numbers, photos and so on—to other services and grant those services access to those people's information. These two positions are at odds with each other."
Layer Facebook's global constituencies, many litigation environments, and rapid technology change onto the company's core business model problem -- lack of monetization and the implicit pressure from investors -- and one begins to grasp how fragile online trust really is.
2) New Tactics in Wireless Retention
Even though Sprint lost 1.3 million customers in the fourth quarter of 2008, the drop was lower than expected and the company's stock surged. One tactic that will bear watching is a recently-announced customer loyalty program, similar to grocery store loyalty cards or frequent flier miles. Longtime customers and high-value subscribers are targeted: people with 10 years of loyalty, or three months on a $69.99 monthly single-line plan, will be eligible. T-Mobile is rumored to be developing a similar program.
What do the customers get? Better handset upgrade policies (including first access to the Palm Pre), free minutes, and free ringtones comprise the telecommunications benefits. Subscribers' service plans will be evaluated periodically to see if they fit evolving needs. Sprint also plans to more randomly award "Just Because" benefits such as sports or entertainment tickets.
3) Book notes
I recently read a study of innovation at The Economist that illustrated, unintentionally, the difficulty of getting startup-like behavior from employees at established institutions. Amidst the publishing collapse, The Economist has actually grown in the past few years, but in the spirit of looking beyond the headlights, in 2006 the magazine initiated a project (Red Stripe) to generate new Internet-based business models adjacent to the print operation. The ultimate ideas from the team were never formally approved, but several have seeped into deployment. Thus by one definition the team failed, but by others, its members succeeded in spurring change.
The book's subtitle -- "Incubating Innovation and Teamwork" -- hints at a deeper problem. The issue of team performance in an organization of any size or status is critical, and while much has been learned, many issues crop up reliably: people commonly feel confused about mission, view some colleagues as free riders, or are unable to incorporate learning into earlier commitments that were made in the inevitable state of not knowing what you don't know.
Similarly, innovation has been widely studied, yet few durable prescriptions can be cited. Innovation can be open or closed, inside-out or outside-in, capability-driven or requirements-driven, and on and on. The problem in both the book and the project is that the two pursuits get conflated: even if a better-performing team would have generated better or more acceptable ideas to the Economist management team, could it have made them into a profitable business? Doubtful.
That said, there's a lot to be learned about organizational behavior from Project Red Stripe. In facing a problem, for example, one approach is to strengthen your solution -- but, as the book states, "it's often as fruitful to consider how to diminish the forces working against [the team]." [83] The book also features excursions into corporate story-telling, untested assumptions, and the perils and necessity of commitment to a position or idea. On niches, for example, one advisor told the team "although there may be a gap in the market, the key is whether there's a market in the gap." [111]
In the end, the team's ideas were plenty viable: a financial information site for kids, a social networking service for NGOs ("A Facebook for good"), and an Economist video site begin a long list. Each member of the team was a salaried employee with a "home" office and function. None would enjoy the upside potential of the equity shares of a startup. In short, it feels like the term "entrepreneurial committee" might be fatally oxymoronic. But the story contains useful lessons nonetheless.
Andrew Carey, Inside Project Red Stripe: Incubating Innovation and Teamwork at The Economist (Triarchy Press, 2008)
On the same plane flight, I dipped into Don Tapscott's new study of what he calls "the net generation." Seeing samples of said demographic on a daily basis, I compared notes, and there's definitely overlap. Tapscott identifies eight "norms" to describe people born in the 1980s as they diverge from their elders:
1) Freedom and freedom of choice
2) Customization
3) Collaboration
4) Scrutiny of outsiders
5) Integrity
6) Fun, including at school and work
7) Speed
8) Innovation
All of these are readily evident when you spend time with people under 30. To call them a generation, however, overreaches the evidence. Tapscott relied on an online survey instrument that suffers from considerable self-selection bias: active net users found the survey and proceeded to discuss how actively they used and internalized various facets of the net. Based in large measure on the behavior of his admittedly talented, bright, and insightful children and their friends, Tapscott says on page 2 that "I came [in 1996] to the conclusion that the defining characteristic of an entire generation was that they were the first to be 'growing up digital.'" (emphasis added) That statement is problematic for any number of reasons; let's list four:
-Middle-class white and Asian kids, such as those in big-city U.S. and Canadian locales like Tapscott's Toronto, absolutely exhibit some of those eight traits from time to time. They are not, however, a "generation": according to the Pew Hispanic Center in 2007, only 31% of Latinos without a high school degree (that group counts for 57% of the constituency) go on line. Given that the U.S. Latin population is a) big, b) fast-growing, and c) less educated than whites, they cannot be bundled into Tapscott's "generation" without qualification.
-Just as off line, the online world is hardly homogeneous. To connect any two users of various elements of the Internet only on that basis makes as much sense as to say that everybody who drives, or watches television, is a generation. danah boyd's observations on social class differences between Facebook and MySpace users are instructive here (and absent from Tapscott's bibliography). Video-watchers and uploaders are [at least] two different species, as are flame warriors versus lurkers, or Columbine-searchers versus Amazon-shoppers. Web 2.0, Tapscott's pole star, while undeniably a powerful force is not yet universally embraced by members of any broad demographic, not even the 20-somethings.
-As far as "integrity" being a generational attribute, think about the business school students at Duke: 10% of the class of 2008 was caught cheating despite honor code posters prominently posted in the building and multiple adjustments to the curriculum in that direction. A separate study of 54 universities found that 56% of MBA students admitted to cheating; how many more cheaters lied? In 2005, dozens of applicants to Harvard Business School tried to view acceptance letters before they were mailed by poking around in the school's website after a security hole was reported. HBS denied admission to all 119 net-savvy snoopers.
-This cadre is still young. To define a generation, before they reach 30, by a set of technology artifacts embraced in different ways to various degrees by only some of them feels premature if nothing else. How many of the Paris/Chicago/Prague 1968 generation similarly embraced "fun" or "freedom" as core values back in the age of typewriters? Short of World War II, has any American generation been defined (to the extent that a generation can be defined) before they reach 30?
We're now looking at a global recession (or worse), and the results could well include the first generation in memory, if not American history, whose economic prospects are worse than those of their parents. That is, if the "net generation" experiences widespread downward social mobility, that's considerably more defining than the fact that some of them like to blog or watch funny videos at work.
Don Tapscott, Grown Up Digital: How the Net Generation is Changing Your World (McGraw Hill, 2008)
4) Correction
Regarding last month's assertion about the largest federal government employers, my colleague Russell Barton pointed out that the Department of Veterans Affairs is the largest non-peacekeeping employer. At 278,000 employees (most working at one of 153 medical centers) as of January 2009, it dwarfs Agriculture. Treasury, at 101,000 (lots of those in the IRS), was also bigger than Agriculture.
Here is a complete listing, in rounded 2006 numbers, of federal headcounts courtesy of the Partnership for Public Service's Best Places to Work in the Federal Government 2007:
Agriculture 85,000
Commerce 32,000
Defense (no services) 611,000
Education 3,800
Energy 14,000
Health & Human Services 53,000
Homeland Security 128,000
Housing & Urban Dev. 9,400
Interior 57,000
Justice 102,000
Labor 14,000
Social Security 61,000
State 19,000
Transportation 52,000
Treasury 101,000
Veterans Affairs 205,000
Several recent developments point to the big questions regarding trust in social networks. First, both Facebook and MySpace announced that registered sex offenders were removed from their sites: 90,000 over two years for MySpace, and 5,500 (out of 175 million users) for Facebook, which is still responding to the same subpoena as MySpace. For Facebook especially, those are extremely small percentages. Harvard's Berkman Center published a study that asserts that online threats to teenagers generally mirror real-world issues: bullying and intimidation are the most common problems in both school hallways and on line.
In addition to thinking twice about who the person on the other end of the online interaction might be, Facebook users are uncertain as to the service's policy regarding their data. Over the past few weeks, Facebook updated the terms of service to assert broad claims. According to the San Jose Mercury News, Facebook's current policy is as follows:
"Users retain ownership rights. However, when a person posts content to Facebook, the company is automatically granted 'an irrevocable, perpetual, non-exclusive, transferable, fully paid, worldwide license (with the right to sublicense) to use, copy, publicly perform, publicly display, reformat, translate, excerpt (in whole or in part) and distribute such User Content for any purpose, commercial, advertising, or otherwise.' If a person removes content from Facebook or deletes their account, this license expires but Facebook may retain a copy of the person"s material."
The legalese of even this modified version sounds pretty one-sided. But as Facebook founder Mark Zuckerberg pointed out on the corporate blog, making virtual trust work is a very tricky business:
"People want full ownership and control of their information so they can turn off access to it at any time. At the same time, people also want to be able to bring the information others have shared with them—like email addresses, phone numbers, photos and so on—to other services and grant those services access to those people's information. These two positions are at odds with each other."
Layer Facebook's global constituencies, many litigation environments, and rapid technology change onto the company's core business model problem -- lack of monetization and the implicit pressure from investors -- and one begins to grasp how fragile online trust really is.
2) New Tactics in Wireless Retention
Even though Sprint lost 1.3 million customers in the fourth quarter of 2008, the drop was lower than expected and the company's stock surged. One tactic that will bear watching is a recently-announced customer loyalty program, similar to grocery store loyalty cards or frequent flier miles. Longtime customers and high-value subscribers are targeted: people with 10 years of loyalty, or three months on a $69.99 monthly single-line plan, will be eligible. T-Mobile is rumored to be developing a similar program.
What do the customers get? Better handset upgrade policies (including first access to the Palm Pre), free minutes, and free ringtones comprise the telecommunications benefits. Subscribers' service plans will be evaluated periodically to see if they fit evolving needs. Sprint also plans to more randomly award "Just Because" benefits such as sports or entertainment tickets.
3) Book notes
I recently read a study of innovation at The Economist that illustrated, unintentionally, the difficulty of getting startup-like behavior from employees at established institutions. Amidst the publishing collapse, The Economist has actually grown in the past few years, but in the spirit of looking beyond the headlights, in 2006 the magazine initiated a project (Red Stripe) to generate new Internet-based business models adjacent to the print operation. The ultimate ideas from the team were never formally approved, but several have seeped into deployment. Thus by one definition the team failed, but by others, its members succeeded in spurring change.
The book's subtitle -- "Incubating Innovation and Teamwork" -- hints at a deeper problem. The issue of team performance in an organization of any size or status is critical, and while much has been learned, many issues crop up reliably: people commonly feel confused about mission, view some colleagues as free riders, or are unable to incorporate learning into earlier commitments that were made in the inevitable state of not knowing what you don't know.
Similarly, innovation has been widely studied, yet few durable prescriptions can be cited. Innovation can be open or closed, inside-out or outside-in, capability-driven or requirements-driven, and on and on. The problem in both the book and the project is that the two pursuits get conflated: even if a better-performing team would have generated better or more acceptable ideas to the Economist management team, could it have made them into a profitable business? Doubtful.
That said, there's a lot to be learned about organizational behavior from Project Red Stripe. In facing a problem, for example, one approach is to strengthen your solution -- but, as the book states, "it's often as fruitful to consider how to diminish the forces working against [the team]." [83] The book also features excursions into corporate story-telling, untested assumptions, and the perils and necessity of commitment to a position or idea. On niches, for example, one advisor told the team "although there may be a gap in the market, the key is whether there's a market in the gap." [111]
In the end, the team's ideas were plenty viable: a financial information site for kids, a social networking service for NGOs ("A Facebook for good"), and an Economist video site begin a long list. Each member of the team was a salaried employee with a "home" office and function. None would enjoy the upside potential of the equity shares of a startup. In short, it feels like the term "entrepreneurial committee" might be fatally oxymoronic. But the story contains useful lessons nonetheless.
Andrew Carey, Inside Project Red Stripe: Incubating Innovation and Teamwork at The Economist (Triarchy Press, 2008)
On the same plane flight, I dipped into Don Tapscott's new study of what he calls "the net generation." Seeing samples of said demographic on a daily basis, I compared notes, and there's definitely overlap. Tapscott identifies eight "norms" to describe people born in the 1980s as they diverge from their elders:
1) Freedom and freedom of choice
2) Customization
3) Collaboration
4) Scrutiny of outsiders
5) Integrity
6) Fun, including at school and work
7) Speed
8) Innovation
All of these are readily evident when you spend time with people under 30. To call them a generation, however, overreaches the evidence. Tapscott relied on an online survey instrument that suffers from considerable self-selection bias: active net users found the survey and proceeded to discuss how actively they used and internalized various facets of the net. Based in large measure on the behavior of his admittedly talented, bright, and insightful children and their friends, Tapscott says on page 2 that "I came [in 1996] to the conclusion that the defining characteristic of an entire generation was that they were the first to be 'growing up digital.'" (emphasis added) That statement is problematic for any number of reasons; let's list four:
-Middle-class white and Asian kids, such as those in big-city U.S. and Canadian locales like Tapscott's Toronto, absolutely exhibit some of those eight traits from time to time. They are not, however, a "generation": according to the Pew Hispanic Center in 2007, only 31% of Latinos without a high school degree (that group counts for 57% of the constituency) go on line. Given that the U.S. Latin population is a) big, b) fast-growing, and c) less educated than whites, they cannot be bundled into Tapscott's "generation" without qualification.
-Just as off line, the online world is hardly homogeneous. To connect any two users of various elements of the Internet only on that basis makes as much sense as to say that everybody who drives, or watches television, is a generation. danah boyd's observations on social class differences between Facebook and MySpace users are instructive here (and absent from Tapscott's bibliography). Video-watchers and uploaders are [at least] two different species, as are flame warriors versus lurkers, or Columbine-searchers versus Amazon-shoppers. Web 2.0, Tapscott's pole star, while undeniably a powerful force is not yet universally embraced by members of any broad demographic, not even the 20-somethings.
-As far as "integrity" being a generational attribute, think about the business school students at Duke: 10% of the class of 2008 was caught cheating despite honor code posters prominently posted in the building and multiple adjustments to the curriculum in that direction. A separate study of 54 universities found that 56% of MBA students admitted to cheating; how many more cheaters lied? In 2005, dozens of applicants to Harvard Business School tried to view acceptance letters before they were mailed by poking around in the school's website after a security hole was reported. HBS denied admission to all 119 net-savvy snoopers.
-This cadre is still young. To define a generation, before they reach 30, by a set of technology artifacts embraced in different ways to various degrees by only some of them feels premature if nothing else. How many of the Paris/Chicago/Prague 1968 generation similarly embraced "fun" or "freedom" as core values back in the age of typewriters? Short of World War II, has any American generation been defined (to the extent that a generation can be defined) before they reach 30?
We're now looking at a global recession (or worse), and the results could well include the first generation in memory, if not American history, whose economic prospects are worse than those of their parents. That is, if the "net generation" experiences widespread downward social mobility, that's considerably more defining than the fact that some of them like to blog or watch funny videos at work.
Don Tapscott, Grown Up Digital: How the Net Generation is Changing Your World (McGraw Hill, 2008)
4) Correction
Regarding last month's assertion about the largest federal government employers, my colleague Russell Barton pointed out that the Department of Veterans Affairs is the largest non-peacekeeping employer. At 278,000 employees (most working at one of 153 medical centers) as of January 2009, it dwarfs Agriculture. Treasury, at 101,000 (lots of those in the IRS), was also bigger than Agriculture.
Here is a complete listing, in rounded 2006 numbers, of federal headcounts courtesy of the Partnership for Public Service's Best Places to Work in the Federal Government 2007:
Agriculture 85,000
Commerce 32,000
Defense (no services) 611,000
Education 3,800
Energy 14,000
Health & Human Services 53,000
Homeland Security 128,000
Housing & Urban Dev. 9,400
Interior 57,000
Justice 102,000
Labor 14,000
Social Security 61,000
State 19,000
Transportation 52,000
Treasury 101,000
Veterans Affairs 205,000
Friday, January 30, 2009
January 2009 Early Indications: The Job Issue
Writing just days after roughly 60,000 layoffs were announced, it's difficult to look anywhere else for stories to analyze. Many facets emerge as one studies the employment question, and some historical context provides some surprises.
Scale
It used to be said that the bigger they are the harder they fall. More recently, industry consolidation was partially justified by both "synergy" and economies of scale. The result was companies that may have been too big to manage: Ronald Coase's theory of the firm implies that when the costs of bureaucracy limit market responsiveness, it's time to scale down. While some firms are currently said to be "too big to fail," I think we will see proof to the contrary relatively soon.
Where will all the new jobs come from? Mass hirings are infrequent even in the best of times: "GM adds 4,00 new machinists" wasn't something one saw in the news, regardless of the era. Jobs get added far more slowly and in more dispersed fashion than they get cut, especially when some firms are measuring severance in the tens of thousands. Part of the policy challenge is the asymmetry between the big cuts and the reality that small, growing firms add jobs by the handful or dozen.
The Biggest Employer
One key element of the story is the role of government as a direct employer even before stimulus-related jobs are counted. Ever since World War II, the federal government has been increasing as an employer, either directly or indirectly. For example, seven new cabinet departments (plus the EPA, founded in 1970) are less than 50 years old and reflect the growing scope of government:
Housing and Urban Development (1966)
Transportation (1966)
Energy (1977)
Health and Human Services (1979)*
Education (1979)*
Veterans Affairs (1989)
Homeland Security (2003)
*Broken out of Health Education and Welfare
Headcount at these agencies is significant: the Department of Agriculture employs about 85,000 people, making it a) the biggest federal organization not involved with domestic (DoJ, DHS) or foreign peacekeeping and b) about half as big as Cargill, a $120-billion food processor.
As of Q1 2008, the biggest employer in Pennsylvania was the State of Pennsylvania (no figures were released in the document, compiled by the state Center for Workforce Information & Analysis). #2 was the U.S. government, even after the closing of the Philadelphia naval yard in 1995. As private sector employment and profits drop for the foreseeable future, how will public-sector employers maintain their payrolls? The state of California, ahead of the curve in some matters, may be the bellwether here, and the story looks grim as the shortfall through 2010 reaches $40 billion.
Information-age Stimulus
Borrowing from the title of a recent newsletter, I want to return to the question of how a government stimulates a services-driven, information-centric economy. As a state Pennsylvania is reasonably representative, with a relatively large economy (#6 out of 50 states), and a per capita income almost perfectly at the median, ranking 26th of 50. Agriculture is important but not predominant, and 25 Fortune 500 companies are headquartered here.
To continue that list of Pennsylvania's top employers, note the paucity of private-sector job-generators:
3) Wal-Mart
4) City of Philadelphia
5) University of Pennsylvania (roughly 35,000 jobs, including a big medical center)
6) Philadelphia school district
7) Penn State University (not counting the affiliated medical center)
8) Giant Food Stores
9) UPS
10) University of Pittsburgh Medical Center
11) University of Pittsburgh
12) Weis Supermarkets
13) State System of Higher Education (public colleges and universities excluding Penn State, Pitt, and Temple)
All told, 20 of the top 50 employers in Pennsylvania are not businesses in the traditional sense of the word: that's 40% of the leader board, including six of the top seven. Half of the 30 largest private-sector employers, including eight of the top 12, are retailers, known for relatively low wages and, according to the BLS, the highest turnover among major sectors. As Circuit City demonstrated, they are also sensitive to economic downturns and could themselves be at further risk.
More significantly, Pennsylvania is officially a services economy: only one employer (Merck) in the top 25 and four in the top 50 make something. Many kinds of services are represented, with health care in the lead, followed by education, and grocery, retail, financial services, and fast food/convenience stores.
The contrast to the intermediate past is shocking. Courtesy of researchers at the Pennsylvania Department of Labor and Industry, here are the top 25 employers of 1965 (the earliest year for which they have available records):
1) United States Steel
2) Bethlehem Steel
3) Westinghouse Electric
4) Bell Telephone of Pennsylvania
5) Jones & Laughlin Steel
6) General Electric
7) Sears, Roebuck
8) A&P
9) Acme Markets
10) Western Electric
11) Philco
12) Budd
13) Philadelphia Electric
14) Boeing
15) Crucible Steel
16) Pittsburgh Plate Glass
17) Allegheny Ludlum Steel
18) Sylvania Electric
19) Sun Oil
20) Pittsburgh Steel
21) Armco Steel
22) Aluminum Company of America (Alcoa)
23) RCA
24) Armstrong Cork
25) Rohm and Haas
(Methodology was not made clear: government entities, hospitals, and universities are not listed, but the absence is unexplained.)
Of the 25, services are only represented by retailers and utilities: no banks or health care providers make the top 40. Seven steelmakers dominate the list, joined by Alcoa. The state's heritage in energy was still represented by Atlantic Refining in Philadelphia, Sun Oil, and Gulf Oil. Transportation is more of a factor today, with UPS at 9 and US Airways at 30; in 1965, no railroads made the list, even though their suppliers (Budd, GE, Westinghouse Air Brake) did.
The composition of the 1965 and 2008 lists illustrate several germane points with regard to the current downturn. First, it's hard to stay on top: almost all companies that at one time appeared to be powerfully untouchable sooner or later fall by the wayside. Bell of Pennsylvania, the #4 employer, morphed into Verizon, presently ranked 28th. Among retailers, A&P disappeared, as did Gimbels and G.C. Murphy, while Sears fell from seventh to 32nd. Second, the stimulus packages of the 1930s -- when manufacturing, agriculture, transportation, labor unions, and foreign trade were unrecognizable even from the vantage point of the mid-1960s -- would appear to present few lessons for current policy-makers. Finally, the kinds of firms traditionally targeted by economic development agencies -- addressing dynamic markets, paying high wages, and anchoring a community or region -- are in the Pennsylvania case not particularly large employers:
14) Merck
19) The Vanguard Group (headquartered outside Philadelphia)
25) Comcast (headquartered in downtown Philadelphia)
39) General Electric (which makes railroad locomotives in Erie).
Are We All in the Same Boat?
Given the speed at which the U.S. economy fell into recession (recall that oil prices dropped $100 a barrel in a quarter), the dust is clearly not fully settled. At this juncture, are there some states that might start attracting internal migration given relatively healthier economies?
According to the Bureau of Labor Statistics, December 2008 U.S. unemployment ranged from a low of 3.4% in Wyoming to a high of 10.6% in Michigan. Given that Wyoming is attractive for retirees, miners, and ranchers, it is unlikely to be an employment destination of choice for the kinds of people being displaced elsewhere; North and South Dakota are in a similar situation. Unemployment remains in the 4% range in Iowa, Nebraska, New Hampshire, New Mexico, and Oklahoma -- tellingly, three of those states formed the heart of the Depression-era "Dust Bowl" memorialized in John Steinbeck's The Grapes of Wrath as a place to leave. Unlike the "new South" in the 1970s and '80s, or Arizona and California over the past half-century, these states a) will not serve as a magnet for the unemployed and b) are sufficiently distinctive that they don't serve as a model for other states to emulate.
Those BLS numbers tell a similarly fascinating story: while Rhode Island's December unemployment (10%) is the worst since statistics were standardized in 1976, nine states recorded their record _low_ unemployment month in calendar 2007-2008, including West Virginia, which had its best unemployment month in over 30 years just last August. All told, the unemployment figures have a long way to rise, even in Michigan, which reported 16.9% unemployment less than 10 years ago, in March 2000.
So who's the exemplar, the state others want to emulate on the jobs front? Considerable debate in the literature revolves around a concept associated with Harvard's Michael Porter, that of economic clusters. As the classic formulation puts it, clusters are "Geographic concentrations of interconnected companies, specialized suppliers, service providers, firms in related industries, and associated institutions (for example, universities, standards agencies, and trade associations) in particular fields that compete but also co-operate." Classic examples can be found in and around Detroit, Palo Alto, Los Angeles (aerospace and Hollywood), and New York/Greenwich (hedge funds). Does cluster theory explain the health of the currently healthiest states?
Not so much. At 6% unemployment in December, Texas falls pretty much in the middle of the pack. Its worst month since 1976, however, is only 9.3%, relatively low and surprising in that Texas has been hit hard by economic crises related to real estate (the savings & loan scandal), low oil prices, Enron, and the bursting of the tech bubble in 2001. Texas combines mineral wealth, oilfield-related services, high tech, agriculture, less location-specific service industries (including American Airlines), and tourism to construct a reasonably well-hedged, recession-resistant economy.
With the exception of California, no other state has so successfully balanced natural endowment, knowledge-intensive industries (including military bases and hospitals), ranching and farming (including some ranches spectacularly successful in attracting agricultural subsidies), and cultural distinctiveness: even the state's anti-littering campaign, admonishing "Don't Mess with Texas," was a huge success, one widely emulated elsewhere. Given all these factors, it would not be surprising to see the state attract some decree of internal migration this time around.
Morals of the Story
-Like politics (and closely related thereto), all unemployment is local. Congress could face massive pressure as the mid-term elections are only 21 months away and the economy cannot bounce back that fast everywhere.
-At the state level of job generation, it helps (as in Virginia) to host lots of federal government jobs.
-Exception to the rule above: when a military base closes, the hurt is broad and immediate. Maine's Brunswick Naval Air Station will lose about 5,000 people (including dependents) as it shuts down, with an estimated annual impact of $200 million.
-For all the appeal of brand, brainpower, and other intangible assets in the "new economy" lore, the healthiest states in the Union right now are sitting on mineral or dirt-based wealth for a portion of a balanced economy.
-Cluster theory has failed to be proven as most university-based economic development efforts relate more to quality of life than direct linkage to a given university's academic focus areas. Stanford provides a glaring exception that proves the rule.
-Cluster theory also generates economic monocultures, which tend more to boom-and-bust cycles than do more diversified economic ecosystems. Clusters are also proving difficult to undo, as Michigan's limited success in luring materials science, biotech, software, and other non-automotive firms illustrates.
The rapid shift of the U.S. economy to a services-driven structure with a massive trade imbalance presents the Obama recovery team with many new challenges. Government employment is already high, and will be limited by falling tax revenues. The M&A activity of the previous decade has generated some very large organizations that, along with Detroit's Big Three, are shedding jobs at a rapid rate. Even though a "knowledge economy" sounds intuitively appealing, at some point U.S. manufacturing will need to be redefined for employment and trade to behave more sustainably. Finally, the biggest intangible of all -- consumer and investor confidence -- will play a critical role in a recovery, and the relationship between $819 or however many billion dollars and that elusive quantity remains to be determined.
Scale
It used to be said that the bigger they are the harder they fall. More recently, industry consolidation was partially justified by both "synergy" and economies of scale. The result was companies that may have been too big to manage: Ronald Coase's theory of the firm implies that when the costs of bureaucracy limit market responsiveness, it's time to scale down. While some firms are currently said to be "too big to fail," I think we will see proof to the contrary relatively soon.
Where will all the new jobs come from? Mass hirings are infrequent even in the best of times: "GM adds 4,00 new machinists" wasn't something one saw in the news, regardless of the era. Jobs get added far more slowly and in more dispersed fashion than they get cut, especially when some firms are measuring severance in the tens of thousands. Part of the policy challenge is the asymmetry between the big cuts and the reality that small, growing firms add jobs by the handful or dozen.
The Biggest Employer
One key element of the story is the role of government as a direct employer even before stimulus-related jobs are counted. Ever since World War II, the federal government has been increasing as an employer, either directly or indirectly. For example, seven new cabinet departments (plus the EPA, founded in 1970) are less than 50 years old and reflect the growing scope of government:
Housing and Urban Development (1966)
Transportation (1966)
Energy (1977)
Health and Human Services (1979)*
Education (1979)*
Veterans Affairs (1989)
Homeland Security (2003)
*Broken out of Health Education and Welfare
Headcount at these agencies is significant: the Department of Agriculture employs about 85,000 people, making it a) the biggest federal organization not involved with domestic (DoJ, DHS) or foreign peacekeeping and b) about half as big as Cargill, a $120-billion food processor.
As of Q1 2008, the biggest employer in Pennsylvania was the State of Pennsylvania (no figures were released in the document, compiled by the state Center for Workforce Information & Analysis). #2 was the U.S. government, even after the closing of the Philadelphia naval yard in 1995. As private sector employment and profits drop for the foreseeable future, how will public-sector employers maintain their payrolls? The state of California, ahead of the curve in some matters, may be the bellwether here, and the story looks grim as the shortfall through 2010 reaches $40 billion.
Information-age Stimulus
Borrowing from the title of a recent newsletter, I want to return to the question of how a government stimulates a services-driven, information-centric economy. As a state Pennsylvania is reasonably representative, with a relatively large economy (#6 out of 50 states), and a per capita income almost perfectly at the median, ranking 26th of 50. Agriculture is important but not predominant, and 25 Fortune 500 companies are headquartered here.
To continue that list of Pennsylvania's top employers, note the paucity of private-sector job-generators:
3) Wal-Mart
4) City of Philadelphia
5) University of Pennsylvania (roughly 35,000 jobs, including a big medical center)
6) Philadelphia school district
7) Penn State University (not counting the affiliated medical center)
8) Giant Food Stores
9) UPS
10) University of Pittsburgh Medical Center
11) University of Pittsburgh
12) Weis Supermarkets
13) State System of Higher Education (public colleges and universities excluding Penn State, Pitt, and Temple)
All told, 20 of the top 50 employers in Pennsylvania are not businesses in the traditional sense of the word: that's 40% of the leader board, including six of the top seven. Half of the 30 largest private-sector employers, including eight of the top 12, are retailers, known for relatively low wages and, according to the BLS, the highest turnover among major sectors. As Circuit City demonstrated, they are also sensitive to economic downturns and could themselves be at further risk.
More significantly, Pennsylvania is officially a services economy: only one employer (Merck) in the top 25 and four in the top 50 make something. Many kinds of services are represented, with health care in the lead, followed by education, and grocery, retail, financial services, and fast food/convenience stores.
The contrast to the intermediate past is shocking. Courtesy of researchers at the Pennsylvania Department of Labor and Industry, here are the top 25 employers of 1965 (the earliest year for which they have available records):
1) United States Steel
2) Bethlehem Steel
3) Westinghouse Electric
4) Bell Telephone of Pennsylvania
5) Jones & Laughlin Steel
6) General Electric
7) Sears, Roebuck
8) A&P
9) Acme Markets
10) Western Electric
11) Philco
12) Budd
13) Philadelphia Electric
14) Boeing
15) Crucible Steel
16) Pittsburgh Plate Glass
17) Allegheny Ludlum Steel
18) Sylvania Electric
19) Sun Oil
20) Pittsburgh Steel
21) Armco Steel
22) Aluminum Company of America (Alcoa)
23) RCA
24) Armstrong Cork
25) Rohm and Haas
(Methodology was not made clear: government entities, hospitals, and universities are not listed, but the absence is unexplained.)
Of the 25, services are only represented by retailers and utilities: no banks or health care providers make the top 40. Seven steelmakers dominate the list, joined by Alcoa. The state's heritage in energy was still represented by Atlantic Refining in Philadelphia, Sun Oil, and Gulf Oil. Transportation is more of a factor today, with UPS at 9 and US Airways at 30; in 1965, no railroads made the list, even though their suppliers (Budd, GE, Westinghouse Air Brake) did.
The composition of the 1965 and 2008 lists illustrate several germane points with regard to the current downturn. First, it's hard to stay on top: almost all companies that at one time appeared to be powerfully untouchable sooner or later fall by the wayside. Bell of Pennsylvania, the #4 employer, morphed into Verizon, presently ranked 28th. Among retailers, A&P disappeared, as did Gimbels and G.C. Murphy, while Sears fell from seventh to 32nd. Second, the stimulus packages of the 1930s -- when manufacturing, agriculture, transportation, labor unions, and foreign trade were unrecognizable even from the vantage point of the mid-1960s -- would appear to present few lessons for current policy-makers. Finally, the kinds of firms traditionally targeted by economic development agencies -- addressing dynamic markets, paying high wages, and anchoring a community or region -- are in the Pennsylvania case not particularly large employers:
14) Merck
19) The Vanguard Group (headquartered outside Philadelphia)
25) Comcast (headquartered in downtown Philadelphia)
39) General Electric (which makes railroad locomotives in Erie).
Are We All in the Same Boat?
Given the speed at which the U.S. economy fell into recession (recall that oil prices dropped $100 a barrel in a quarter), the dust is clearly not fully settled. At this juncture, are there some states that might start attracting internal migration given relatively healthier economies?
According to the Bureau of Labor Statistics, December 2008 U.S. unemployment ranged from a low of 3.4% in Wyoming to a high of 10.6% in Michigan. Given that Wyoming is attractive for retirees, miners, and ranchers, it is unlikely to be an employment destination of choice for the kinds of people being displaced elsewhere; North and South Dakota are in a similar situation. Unemployment remains in the 4% range in Iowa, Nebraska, New Hampshire, New Mexico, and Oklahoma -- tellingly, three of those states formed the heart of the Depression-era "Dust Bowl" memorialized in John Steinbeck's The Grapes of Wrath as a place to leave. Unlike the "new South" in the 1970s and '80s, or Arizona and California over the past half-century, these states a) will not serve as a magnet for the unemployed and b) are sufficiently distinctive that they don't serve as a model for other states to emulate.
Those BLS numbers tell a similarly fascinating story: while Rhode Island's December unemployment (10%) is the worst since statistics were standardized in 1976, nine states recorded their record _low_ unemployment month in calendar 2007-2008, including West Virginia, which had its best unemployment month in over 30 years just last August. All told, the unemployment figures have a long way to rise, even in Michigan, which reported 16.9% unemployment less than 10 years ago, in March 2000.
So who's the exemplar, the state others want to emulate on the jobs front? Considerable debate in the literature revolves around a concept associated with Harvard's Michael Porter, that of economic clusters. As the classic formulation puts it, clusters are "Geographic concentrations of interconnected companies, specialized suppliers, service providers, firms in related industries, and associated institutions (for example, universities, standards agencies, and trade associations) in particular fields that compete but also co-operate." Classic examples can be found in and around Detroit, Palo Alto, Los Angeles (aerospace and Hollywood), and New York/Greenwich (hedge funds). Does cluster theory explain the health of the currently healthiest states?
Not so much. At 6% unemployment in December, Texas falls pretty much in the middle of the pack. Its worst month since 1976, however, is only 9.3%, relatively low and surprising in that Texas has been hit hard by economic crises related to real estate (the savings & loan scandal), low oil prices, Enron, and the bursting of the tech bubble in 2001. Texas combines mineral wealth, oilfield-related services, high tech, agriculture, less location-specific service industries (including American Airlines), and tourism to construct a reasonably well-hedged, recession-resistant economy.
With the exception of California, no other state has so successfully balanced natural endowment, knowledge-intensive industries (including military bases and hospitals), ranching and farming (including some ranches spectacularly successful in attracting agricultural subsidies), and cultural distinctiveness: even the state's anti-littering campaign, admonishing "Don't Mess with Texas," was a huge success, one widely emulated elsewhere. Given all these factors, it would not be surprising to see the state attract some decree of internal migration this time around.
Morals of the Story
-Like politics (and closely related thereto), all unemployment is local. Congress could face massive pressure as the mid-term elections are only 21 months away and the economy cannot bounce back that fast everywhere.
-At the state level of job generation, it helps (as in Virginia) to host lots of federal government jobs.
-Exception to the rule above: when a military base closes, the hurt is broad and immediate. Maine's Brunswick Naval Air Station will lose about 5,000 people (including dependents) as it shuts down, with an estimated annual impact of $200 million.
-For all the appeal of brand, brainpower, and other intangible assets in the "new economy" lore, the healthiest states in the Union right now are sitting on mineral or dirt-based wealth for a portion of a balanced economy.
-Cluster theory has failed to be proven as most university-based economic development efforts relate more to quality of life than direct linkage to a given university's academic focus areas. Stanford provides a glaring exception that proves the rule.
-Cluster theory also generates economic monocultures, which tend more to boom-and-bust cycles than do more diversified economic ecosystems. Clusters are also proving difficult to undo, as Michigan's limited success in luring materials science, biotech, software, and other non-automotive firms illustrates.
The rapid shift of the U.S. economy to a services-driven structure with a massive trade imbalance presents the Obama recovery team with many new challenges. Government employment is already high, and will be limited by falling tax revenues. The M&A activity of the previous decade has generated some very large organizations that, along with Detroit's Big Three, are shedding jobs at a rapid rate. Even though a "knowledge economy" sounds intuitively appealing, at some point U.S. manufacturing will need to be redefined for employment and trade to behave more sustainably. Finally, the biggest intangible of all -- consumer and investor confidence -- will play a critical role in a recovery, and the relationship between $819 or however many billion dollars and that elusive quantity remains to be determined.
Tuesday, December 23, 2008
December 2008 Early Indications: The Predictions Issue
Given a year in which oil prices inflicted broad economic pain -- then fell $100 a barrel, a Republican president nationalized key banks, and an African-American first-term U.S. Senator won the presidency, it's pretty tough to predict the encore. Volatility is obviously on everyone's mind, bad people from Wall Street to Mumbai are doing outrageously bad things, and the quality of news we receive about the state of the world is up for grabs. What framework can possibly explain what might happen next?
Despite arguing that interconnectedness of many factors matters a lot, I'm going to start by dividing the world into a domestic sphere (U.S., in this case) and a global sphere, then discuss the latter first.
Externalities of Globalization
An externality, in simplified form, is a spillover cost or benefit that accrues to someone outside an economic transaction. Pollution is a classic negative externality, but positive ones also exist, as when my health prospects improve in proportion to the percentage of the population that get flu shots.
Two main points of view delineate the globalization debates. Thomas Friedman carries the flag for the "flat" (level playing field) school, while the "lumpy" camp, which asserts that places, notably cities, are far from being fungible, is associated with urban theorists like Richard Florida. Wherever one comes down on that spectrum, there's no denying that the world has changed dramatically in the past decade or two. Whether one looks at Russia, or Korea, or Iraq, or India, huge changes are afoot in communications, life style, crime and warfare, ethnic relations, and other important realms.
All that is known; what's the prediction? As we have seen with armed conflict, capital flows, disaster relief, and other phenomena, a globalized world creates a new category of issue that requires multi-lateral response well beyond the scope of traditional definitions of sovereignty. A few examples illustrate the issue:
-Efforts to address the effects of climate change are impossible to restrict by nation-state: it's not as though Canada, let's say, could bear responsibility for some number of square miles of the ozone layer or the Gulf stream. Action and impact are impossible to connect in either time or space, except at a macro level, if then. As environmental concerns lead to the "internalization" of previously external phenomena (end of life disposal for goods with toxic components, cross-border pollution lawsuits, carbon taxes, and other arrangements), the need for both new definitions of sovereignty and new types of multi-lateral institutions will increase.
-Dealing with bad guys proves similarly problematic. The Somali pirates are a case in point: if some were to be caught, where might they be lawfully (and practically) imprisoned and tried? Guantanamo, for all its controversy, does serve a useful purpose, as the "not in my back yard" discussions related to its closure illustrate: at both the state and international level, there are few practical options for relocating the current detainees, many of whom are now men without a country. The international reaction to the Mumbai terror attacks supplies yet another example of the issues: much terror is now a global as well as a regional, tribal, and/or national question, yet we lack the institutions with which to prevent and fight these sorts of actions.
Furthermore, as the case of Mexico illustrates, the line between criminality and terrorism is extremely fuzzy. When narcotics gangs kill law enforcement and judicial officials, invade hospitals to kill survivors of prior attacks or threaten doctors, and shake down schoolteachers to surrender annual bonuses, they systematically undermine conventions of civil society. Conventional police forces are outgunned by such gangs, but as the Italian example shows, soldiers with adequate firepower, when mobilized to reassure tourists and citizens, lack training in even the basics of policing. Extend the conflict across borders, and the need for new kinds of multilateral action and coordination becomes an issue yet again.
Immigration -- whether in China, Greece, Norway, South Africa, or the U.S. -- provides another example of the need to address the externalities of globalization, as do several other new-era problems:
-Information flows matter in intellectual property, news media, or business transactions. These include offshore programming, contracts, or ingredient provenance as in the melamine matter. One could argue that information technology amplified the destructive potential of both the Mumbai terrorists (via satellite phones, GPS, Google Earth imagery, IP telephony, and other tools) as well as the Wall Street catastrophe (in part by enabling risk exposure far greater than models could accommodate).
-The governance and monitoring of global capital flows by nationally-delimited regulators have already been a topic of conversation at the G20 and G8 levels.
-Reporting standards for everything from land mines to life expectancy to laboratory results rarely coordinate or enable effective (and cost-effective) information across continents and often borders.
With so much room between the cracks of law, enforcement, and reporting, expect to see more global equivalents of dropped fly balls in 2009. (Speaking of sports metaphors, the internationalization of professional leagues including soccer, American football, and perhaps most successfully basketball bears watching.)
The Domestic Conundrum
As we noted in the October letter, many of the challenges facing U.S. public- and private-sector leaders, most notably President-elect Obama, are sticky and intertwined: it's hard to reduce the inventory of unsold houses with rising unemployment, no matter what the interest rates, but cheapening the dollar by lowering these rates causes problems of its own (a probable increase in oil prices for starters).
Given the high stakes, and the relative freedom to address the issues (provided by the combination of a friendly but not veto-proof congress and the perception of a honeymoon period with the electorate), expect to see some combination of strong efforts that will have the effect of attacking boundaries between problems. Four key areas in particular are often attached:
-Health care
Can a broadly inclusive appetite for change retie this massive knot into something more manageable? Demographics (see below) is driving unprecedented demand for care as the baby boom generation starts needing stroke care, diabetes treatment, heart surgery, and hip replacements in massive numbers: what will be the de facto or de jure rationing mechanisms? Managed care is historically credited with curbing cost increases but also blamed for unsustainably low morale among primary care providers -- and for today's thin pipeline of internists in medical schools. Defensive medicine, in part attributable to the American litigation climate, is estimated by the McKinsey Global Institute to cost $150-190 billion annually. Pharmaceutical pricing in the U.S. is 50% higher for equivalent molecules compared to other countries, but even concerted pressure on this sector cannot turn the tide without similarly dramatic changes in the status quo elsewhere. One number may be the scariest of all: 45 million Americans lack health insurance, and the number will rise given the trend in unemployment.
-Demographics
Big shifts are underway across groups defined by age, education, and sex. According to the Labor Department as reported in the Boston Globe (Dec 5), 1.1 million fewer men are working than were a year ago; 12,000 more women are now employed. Job losses in financial services and construction, for example, hit men hard, while health care, which is about 80% female, added 400,000 jobs. Intergenerational wealth transfer, often achieved via real estate, may in a rising number of cases be negative for the current generation of adult children. For a slightly younger cadre in their 20s, what Don Tapscott calls the Net Generation is integrating its experiences with technology into work, play, and social interaction -- and one study in the Archives of General Psychiatry controversially found roughly half of the college-age population to suffer from mental health disorders, some of which may relate to the dynamics of online interaction.
The biggest factor in demographics may be the collapse of many people's retirement assets. As one executive noted to me, people who retired two or three years ago made any number of assumptions that have been shattered, and jumping back into the labor market with old skills, contacts, and resumes is extremely tough in this economy. Even without the stock market drop, the shift in retirement funding from defined-benefit pensions (which aren't always defined or beneficial, as Motorola is proving right now) to defined-contribution proceeds always appeared to be a long-term gamble. A professionally managed pension plan costs 20% of salary to fund a full-salary pension. The fact that most 401(k) accounts, almost all run by amateurs, run less than 10% including employer match, should be cause for alarm even before adverse decisions and/or market performance exact their toll. It's not a 2009 prediction, but I believe a bail-out will eventually be required to address a massive shortfall between long lives and small retirement accounts. Unlike health care reform, or bank bail-outs, or wars, demographic change typically takes decades to unfold.
-Seeking consumers
Given high unemployment, what will be the source of customer demand to restart shuttered factories, reduce inventories, and stimulate hiring? The federal government, through a myriad of programs, is on pace to assume responsibility for a World War II-sized proportion -- of a much larger economy. On the private-sector side, growing verticals are hard to locate amidst broad and often deep layoff news. Just two chains of home improvement centers -- Home Depot and Lowe's -- together added over 250,000 jobs between 2000 and 2007 on the strength of the building and renovation boom, but it's hard to see a similarly promising retail (or other) sector on the horizon. Early retirement (see below) is less of an option than it might have been with less damage to retirement portfolios. Cashing out home equity fueled substantial spending earlier in the decade: according to a 2002 paper in the Federal Reserve Bulletin (Canner, Dynan, and Passmore 2002), over 50% of funds liquified in 2001 refinancings went for home improvement and consumer expenditures. The numbers were staggering: according to a paper by researchers at the New York Federal Reserve Bank (McConnell, Peach, and Al-Haschim 2003), the annualized withdrawals of Q2 2003 amounted to $450 billion. Where can similar sums of cash originate in the near future?
-Soft asset markets
Lack of demand for consumer goods is echoed in equity, credit debt, and housing markets as all four suffer from imbalances between supply and demand, and/or uncertainty:
-How will bank balance sheets appear and be analyzed under a TARP model? How will investors react?
-Should people buy cars from a manufacturer in or near chapter 11? Should banks loan them money to do so?
-If an individual of Bernie Madoff's reputation can take down $50 billion, who else is hiding bad news?
-Should people try to improve or even maintain the value of their houses given a) the mortgage is upside-down and/or b) the number of repossessions in the neighborhood may make it impossible to sell my home?
-With 10 years or more of equity gains wiped out, can I ever plan to retire?
Secondary questions
In addition to the four big issues noted above, a number of other questions loom large. With only minor comment, these include the following:
-50 years after the birth of the modern civil rights movement, the election of an African-American to the presidency will shift the terms of the affirmative action debate. At the same time, the status of gay and lesbian couples in the eyes of the state is being framed in terms of both civil rights and religious authority. What will the civil rights movement of 2012 look like?
-The non-profit sector, including private colleges and universities, charities, and religious organizations, has been hit hard by the downturn in financial markets. Given that the end of the calendar year is a traditionally active time for donations, the true impact will be much clearer in January. Schools in the St. Olaf, Colby, and Beloit mold are reporting double-digit drops in the application pool in a year with a huge graduating class of high school seniors. Lower demand poses another challenge apart from the diminished endowments, yet health care, heating, and other fixed costs continue to rise. How many non-profits will add to the unemployment rolls next year?
On the supply side, meanwhile, philanthropy is being reinvented by the Gateses, the Omidyar network, Google.org, Lance Armstrong, and other innovators such as the Multiple Myeloma Research Foundation (profiled in The New Yorker last January). These efforts, running counter to the traditions of the United Way and Rockefeller/Ford/Mellon foundations, bear watching. Can this semi-private sector outperform the NIH in finding a cancer cure, or the WHO in mass inoculations, or big pharma in breakthrough drug discovery?
-For all the concern with jobs lost to overseas locales with lower labor costs, automation (including on-line self-service) remains an important factor in the employment equation. Labor costs at the Big Three automakers, while under scrutiny, disproportionately reflect retiree health care and pension costs: even major wage concessions by active UAW workers would only save about $800 per car -- and would not turn an unsold pickup truck into a Honda Accord/Toyota Camry/VW Jetta competitor. What forces can reinvigorate American manufacturing?
-The timing told a powerful story: on the day that the Chicago Tribune broke the story of Governor Blagojevich's arrest, the paper's parent company declared bankruptcy. In a time and in a world with so much up for grabs and such a pressing need for informed citizenries, the demise of the daily newsprint-driven business model raises critically important questions about accountability, about investment, and about the role of advertising. Meanwhile, Jason Calacanis, a founding father of blogging, quit doing so in July, saying "Today the blogosphere is so charged, so polarized, and so filled with haters hating that it’s simply not worth it." If present-day blogging isn't capable of replacing formerly great newspapers, what comes next? My prediction, not an original one, is that some foundations or other not-for-profits will be organized to fund critical elements of an effective press, potentially including bureaus, archives, and editors.
Why is this time different?
In classes and seminars, I've been asked several times this fall whether this recession is like or unlike the tech slowdown of 2000. The short answer: it's very, very different.
1) More sectors are involved. While Cisco, Intel, et al felt real pain, homebuilding and commercial construction were booming, cheap gas allowed Detroit to sell lots of trucks and SUVs, and the sectors that rely on demand in those areas -- banking, chemicals, steel, for starters -- all could thrive. Job losses in one place -- bank consolidation, let's say -- were partially offset by growth in mortgage lending or real estate.
2) The baby boom generation is farther through the python, demographically speaking, and is about to start drawing down their retirement assets, such as they are. The pace of change in the workplace means that people in their 40s and 50s now being laid off have less chance of re-landing a similar job to the one they lost. Early retirement, geographic relocation, and extended unemployment are all unattractive options for people at this stage of the life cycle. People gearing toward retirement need "less house," making a large component of the population more likely real estate sellers (or downsizers) than upwardly mobile buyers.
3) Many individuals are hit with some combination of a "triple whammy" of equity loss, job loss, and house value loss. In 2001, unemployment hit certain cities hard, but home prices continued to appreciate and extreme liquidity made selling a property reasonably simple for those who wanted to do so. Job losses are far more broadly shared now, and the stock market as a whole fell far less in 2001 than we are witnessing today.
4) Foreign competition is more mature: India's and China's economies have grown significantly, removing a proportional slice of U.S.-based production capacity from the 2001 mix. IBM, for example, has added 70,000 jobs in India in this decade.
All told, it's perfectly likely that next year's big stories come from as-yet unexpected sectors -- natural disasters, say, or mass ethnic violence -- thus making 2009 a completely logical follow-on to one of the wildest years in recent memory.
Despite arguing that interconnectedness of many factors matters a lot, I'm going to start by dividing the world into a domestic sphere (U.S., in this case) and a global sphere, then discuss the latter first.
Externalities of Globalization
An externality, in simplified form, is a spillover cost or benefit that accrues to someone outside an economic transaction. Pollution is a classic negative externality, but positive ones also exist, as when my health prospects improve in proportion to the percentage of the population that get flu shots.
Two main points of view delineate the globalization debates. Thomas Friedman carries the flag for the "flat" (level playing field) school, while the "lumpy" camp, which asserts that places, notably cities, are far from being fungible, is associated with urban theorists like Richard Florida. Wherever one comes down on that spectrum, there's no denying that the world has changed dramatically in the past decade or two. Whether one looks at Russia, or Korea, or Iraq, or India, huge changes are afoot in communications, life style, crime and warfare, ethnic relations, and other important realms.
All that is known; what's the prediction? As we have seen with armed conflict, capital flows, disaster relief, and other phenomena, a globalized world creates a new category of issue that requires multi-lateral response well beyond the scope of traditional definitions of sovereignty. A few examples illustrate the issue:
-Efforts to address the effects of climate change are impossible to restrict by nation-state: it's not as though Canada, let's say, could bear responsibility for some number of square miles of the ozone layer or the Gulf stream. Action and impact are impossible to connect in either time or space, except at a macro level, if then. As environmental concerns lead to the "internalization" of previously external phenomena (end of life disposal for goods with toxic components, cross-border pollution lawsuits, carbon taxes, and other arrangements), the need for both new definitions of sovereignty and new types of multi-lateral institutions will increase.
-Dealing with bad guys proves similarly problematic. The Somali pirates are a case in point: if some were to be caught, where might they be lawfully (and practically) imprisoned and tried? Guantanamo, for all its controversy, does serve a useful purpose, as the "not in my back yard" discussions related to its closure illustrate: at both the state and international level, there are few practical options for relocating the current detainees, many of whom are now men without a country. The international reaction to the Mumbai terror attacks supplies yet another example of the issues: much terror is now a global as well as a regional, tribal, and/or national question, yet we lack the institutions with which to prevent and fight these sorts of actions.
Furthermore, as the case of Mexico illustrates, the line between criminality and terrorism is extremely fuzzy. When narcotics gangs kill law enforcement and judicial officials, invade hospitals to kill survivors of prior attacks or threaten doctors, and shake down schoolteachers to surrender annual bonuses, they systematically undermine conventions of civil society. Conventional police forces are outgunned by such gangs, but as the Italian example shows, soldiers with adequate firepower, when mobilized to reassure tourists and citizens, lack training in even the basics of policing. Extend the conflict across borders, and the need for new kinds of multilateral action and coordination becomes an issue yet again.
Immigration -- whether in China, Greece, Norway, South Africa, or the U.S. -- provides another example of the need to address the externalities of globalization, as do several other new-era problems:
-Information flows matter in intellectual property, news media, or business transactions. These include offshore programming, contracts, or ingredient provenance as in the melamine matter. One could argue that information technology amplified the destructive potential of both the Mumbai terrorists (via satellite phones, GPS, Google Earth imagery, IP telephony, and other tools) as well as the Wall Street catastrophe (in part by enabling risk exposure far greater than models could accommodate).
-The governance and monitoring of global capital flows by nationally-delimited regulators have already been a topic of conversation at the G20 and G8 levels.
-Reporting standards for everything from land mines to life expectancy to laboratory results rarely coordinate or enable effective (and cost-effective) information across continents and often borders.
With so much room between the cracks of law, enforcement, and reporting, expect to see more global equivalents of dropped fly balls in 2009. (Speaking of sports metaphors, the internationalization of professional leagues including soccer, American football, and perhaps most successfully basketball bears watching.)
The Domestic Conundrum
As we noted in the October letter, many of the challenges facing U.S. public- and private-sector leaders, most notably President-elect Obama, are sticky and intertwined: it's hard to reduce the inventory of unsold houses with rising unemployment, no matter what the interest rates, but cheapening the dollar by lowering these rates causes problems of its own (a probable increase in oil prices for starters).
Given the high stakes, and the relative freedom to address the issues (provided by the combination of a friendly but not veto-proof congress and the perception of a honeymoon period with the electorate), expect to see some combination of strong efforts that will have the effect of attacking boundaries between problems. Four key areas in particular are often attached:
-Health care
Can a broadly inclusive appetite for change retie this massive knot into something more manageable? Demographics (see below) is driving unprecedented demand for care as the baby boom generation starts needing stroke care, diabetes treatment, heart surgery, and hip replacements in massive numbers: what will be the de facto or de jure rationing mechanisms? Managed care is historically credited with curbing cost increases but also blamed for unsustainably low morale among primary care providers -- and for today's thin pipeline of internists in medical schools. Defensive medicine, in part attributable to the American litigation climate, is estimated by the McKinsey Global Institute to cost $150-190 billion annually. Pharmaceutical pricing in the U.S. is 50% higher for equivalent molecules compared to other countries, but even concerted pressure on this sector cannot turn the tide without similarly dramatic changes in the status quo elsewhere. One number may be the scariest of all: 45 million Americans lack health insurance, and the number will rise given the trend in unemployment.
-Demographics
Big shifts are underway across groups defined by age, education, and sex. According to the Labor Department as reported in the Boston Globe (Dec 5), 1.1 million fewer men are working than were a year ago; 12,000 more women are now employed. Job losses in financial services and construction, for example, hit men hard, while health care, which is about 80% female, added 400,000 jobs. Intergenerational wealth transfer, often achieved via real estate, may in a rising number of cases be negative for the current generation of adult children. For a slightly younger cadre in their 20s, what Don Tapscott calls the Net Generation is integrating its experiences with technology into work, play, and social interaction -- and one study in the Archives of General Psychiatry controversially found roughly half of the college-age population to suffer from mental health disorders, some of which may relate to the dynamics of online interaction.
The biggest factor in demographics may be the collapse of many people's retirement assets. As one executive noted to me, people who retired two or three years ago made any number of assumptions that have been shattered, and jumping back into the labor market with old skills, contacts, and resumes is extremely tough in this economy. Even without the stock market drop, the shift in retirement funding from defined-benefit pensions (which aren't always defined or beneficial, as Motorola is proving right now) to defined-contribution proceeds always appeared to be a long-term gamble. A professionally managed pension plan costs 20% of salary to fund a full-salary pension. The fact that most 401(k) accounts, almost all run by amateurs, run less than 10% including employer match, should be cause for alarm even before adverse decisions and/or market performance exact their toll. It's not a 2009 prediction, but I believe a bail-out will eventually be required to address a massive shortfall between long lives and small retirement accounts. Unlike health care reform, or bank bail-outs, or wars, demographic change typically takes decades to unfold.
-Seeking consumers
Given high unemployment, what will be the source of customer demand to restart shuttered factories, reduce inventories, and stimulate hiring? The federal government, through a myriad of programs, is on pace to assume responsibility for a World War II-sized proportion -- of a much larger economy. On the private-sector side, growing verticals are hard to locate amidst broad and often deep layoff news. Just two chains of home improvement centers -- Home Depot and Lowe's -- together added over 250,000 jobs between 2000 and 2007 on the strength of the building and renovation boom, but it's hard to see a similarly promising retail (or other) sector on the horizon. Early retirement (see below) is less of an option than it might have been with less damage to retirement portfolios. Cashing out home equity fueled substantial spending earlier in the decade: according to a 2002 paper in the Federal Reserve Bulletin (Canner, Dynan, and Passmore 2002), over 50% of funds liquified in 2001 refinancings went for home improvement and consumer expenditures. The numbers were staggering: according to a paper by researchers at the New York Federal Reserve Bank (McConnell, Peach, and Al-Haschim 2003), the annualized withdrawals of Q2 2003 amounted to $450 billion. Where can similar sums of cash originate in the near future?
-Soft asset markets
Lack of demand for consumer goods is echoed in equity, credit debt, and housing markets as all four suffer from imbalances between supply and demand, and/or uncertainty:
-How will bank balance sheets appear and be analyzed under a TARP model? How will investors react?
-Should people buy cars from a manufacturer in or near chapter 11? Should banks loan them money to do so?
-If an individual of Bernie Madoff's reputation can take down $50 billion, who else is hiding bad news?
-Should people try to improve or even maintain the value of their houses given a) the mortgage is upside-down and/or b) the number of repossessions in the neighborhood may make it impossible to sell my home?
-With 10 years or more of equity gains wiped out, can I ever plan to retire?
Secondary questions
In addition to the four big issues noted above, a number of other questions loom large. With only minor comment, these include the following:
-50 years after the birth of the modern civil rights movement, the election of an African-American to the presidency will shift the terms of the affirmative action debate. At the same time, the status of gay and lesbian couples in the eyes of the state is being framed in terms of both civil rights and religious authority. What will the civil rights movement of 2012 look like?
-The non-profit sector, including private colleges and universities, charities, and religious organizations, has been hit hard by the downturn in financial markets. Given that the end of the calendar year is a traditionally active time for donations, the true impact will be much clearer in January. Schools in the St. Olaf, Colby, and Beloit mold are reporting double-digit drops in the application pool in a year with a huge graduating class of high school seniors. Lower demand poses another challenge apart from the diminished endowments, yet health care, heating, and other fixed costs continue to rise. How many non-profits will add to the unemployment rolls next year?
On the supply side, meanwhile, philanthropy is being reinvented by the Gateses, the Omidyar network, Google.org, Lance Armstrong, and other innovators such as the Multiple Myeloma Research Foundation (profiled in The New Yorker last January). These efforts, running counter to the traditions of the United Way and Rockefeller/Ford/Mellon foundations, bear watching. Can this semi-private sector outperform the NIH in finding a cancer cure, or the WHO in mass inoculations, or big pharma in breakthrough drug discovery?
-For all the concern with jobs lost to overseas locales with lower labor costs, automation (including on-line self-service) remains an important factor in the employment equation. Labor costs at the Big Three automakers, while under scrutiny, disproportionately reflect retiree health care and pension costs: even major wage concessions by active UAW workers would only save about $800 per car -- and would not turn an unsold pickup truck into a Honda Accord/Toyota Camry/VW Jetta competitor. What forces can reinvigorate American manufacturing?
-The timing told a powerful story: on the day that the Chicago Tribune broke the story of Governor Blagojevich's arrest, the paper's parent company declared bankruptcy. In a time and in a world with so much up for grabs and such a pressing need for informed citizenries, the demise of the daily newsprint-driven business model raises critically important questions about accountability, about investment, and about the role of advertising. Meanwhile, Jason Calacanis, a founding father of blogging, quit doing so in July, saying "Today the blogosphere is so charged, so polarized, and so filled with haters hating that it’s simply not worth it." If present-day blogging isn't capable of replacing formerly great newspapers, what comes next? My prediction, not an original one, is that some foundations or other not-for-profits will be organized to fund critical elements of an effective press, potentially including bureaus, archives, and editors.
Why is this time different?
In classes and seminars, I've been asked several times this fall whether this recession is like or unlike the tech slowdown of 2000. The short answer: it's very, very different.
1) More sectors are involved. While Cisco, Intel, et al felt real pain, homebuilding and commercial construction were booming, cheap gas allowed Detroit to sell lots of trucks and SUVs, and the sectors that rely on demand in those areas -- banking, chemicals, steel, for starters -- all could thrive. Job losses in one place -- bank consolidation, let's say -- were partially offset by growth in mortgage lending or real estate.
2) The baby boom generation is farther through the python, demographically speaking, and is about to start drawing down their retirement assets, such as they are. The pace of change in the workplace means that people in their 40s and 50s now being laid off have less chance of re-landing a similar job to the one they lost. Early retirement, geographic relocation, and extended unemployment are all unattractive options for people at this stage of the life cycle. People gearing toward retirement need "less house," making a large component of the population more likely real estate sellers (or downsizers) than upwardly mobile buyers.
3) Many individuals are hit with some combination of a "triple whammy" of equity loss, job loss, and house value loss. In 2001, unemployment hit certain cities hard, but home prices continued to appreciate and extreme liquidity made selling a property reasonably simple for those who wanted to do so. Job losses are far more broadly shared now, and the stock market as a whole fell far less in 2001 than we are witnessing today.
4) Foreign competition is more mature: India's and China's economies have grown significantly, removing a proportional slice of U.S.-based production capacity from the 2001 mix. IBM, for example, has added 70,000 jobs in India in this decade.
All told, it's perfectly likely that next year's big stories come from as-yet unexpected sectors -- natural disasters, say, or mass ethnic violence -- thus making 2009 a completely logical follow-on to one of the wildest years in recent memory.
Monday, November 24, 2008
Early Indications November 2008: Grading the Predictions
In the spirit of accountability, how did this year's reality fit prior predictions?
A) 2008 Predictions
Here's what I said in January: "Somewhere in the next 12 to 18 months, I expect to see major news unfold in some combination of the following five domains."
Domain 1) The Fragility of Democracies
Grade: Miss/incomplete
Apart from a near triumph of a convicted felon in a Senate race, the U.S. election ran smoothly: no major electronic voting irregularities, no hanging chads, no trip to the Supreme Court for vote-counting. Instead, looking back on the election cycle, the Obama campaign's skillful use of social media to raise vast sums of money, mobilize an army of volunteers, and get out the vote proved to be a milestone in the technology curve. Elsewhere, democracies remain fragile, and political instability could surface in the wake of economic turbulence. India and Pakistan both show signals of unrest, as do parts of Africa and South America. Food riots (see below) could precipitate further troubles.
Domain 2) Life in the Food Chain
Grade: Hit
When I said that "overall, U.S. food prices increased dramatically last year, and there's no reason to think the trend will reverse," I was making the same mistake the bond ratings agencies and others made when they assumed U.S. house prices could only go up. Commodity price movement is on the downswing for the moment, but several factors, not least of them global demand, could reverse the trend at any time. Food prices were in fact major news in 2008, as were "slow foods" and "buy local" movements. A big question going forward: as consumer spending responds to rising unemployment and loss of both residential and stock market equity, will people keep paying the premium for organic foods? Early returns (via the research firm Mintel) suggest not: 48% of UK organic shoppers say they will reduce or give up buying organic food in the next year.
Domain 3) Cheap Computing
Grade: Hit
Prediction: "I have no idea how it will play out, but we will see some interesting (both scary and exciting) developments as a result of the increase in low-cost options. This is not to say that paid package software will disappear, but having a growing set of inexpensive options will certainly change the industry, and the market."
Cloud computing became a powerful buzzword, meriting a 14-page special report in The Economist last month. PC demand continues to soften, whereas mobile platform growth has remained vigorous. Last week's launch of the new Blackberry will bear watching, and AT&T continues to see wireless market share movement based on the iPhone. Some U.S. customers are abandoning not only landline voice but also wired broadband, consolidating on the mobile platform now that form factor, usability, and wireless bandwidth have all crossed some threshold for wide adoption.
Domain 4) Organizing Augmentation
Grade: Incomplete
Prediction: "Every year we see more computing done outside 'computers.' . . . The point here is that just as there's a large category of enterprise software that we use to run other software, we'll soon need digital assistance to manage our digital assistance."
This shouldn't have been a one-year prediction. I still think it will pan out, but not in this time horizon.
Domain 5) Consequences of Visible Social Networks
Grade: Hit
Prediction: "As more of us can see and organize who we know, and the people they know, expect to see some unexpected outcomes. . . .we're already seeing changes in demographics. My students have a very different experience of interpersonal connectedness than did their predecessors of just a few years ago."
The Obama campaign capitalized powerfully on viral video, social networking, text messaging, blogging, and online coordination: Internet fund-raising alone allowed the campaign literally to rewrite the electoral playbook. Facebook is becoming a platform in several senses of the word and drives enormous traffic: Alexa ranks it #5, or in other words the #2 non-search site after YouTube. Just behind is Newscorp's MySpace at #7. Hi5, meanwhile, claims to be the #1 social networking site in over 30 countries and supports 37 languages; Alexa rates it as the #17 site overall on the Web, just behind Microsoft's home page. One unexpected consequence of these networks is crime-fighting: to cite a minor but local example, several individuals here in town have been arrested in our version of football hooliganism based on photos and/or videos posted on MySpace et al.
B) Two Older Predictions
1) In September 2005 I wrote a private research report on Microsoft Vista in which I expressed concern that comparisons to Windows 95 were premature. Because Vista failed to give home users new capabilities on par with 95's long filename and CD-ROM support, TCP/IP, modem controls, and other Internet and networking functionality, I predicted that "Vista’s feature set and the competitive environment should ensure that the product represents a single or more likely a double for Microsoft, but more certainly not a home run." I think it's safe to say this has in fact been the case as Microsoft has seen adoption lag predictions.
In the consumer domain, the contrast of four different Vista advertising campaigns this year to the hit-the-ground-running Rolling Stones campaign for 95 could not be more striking. The "Mojave experiment" experiment tried to suggest that Vista was not as bad as people had heard, Jerry Seinfeld lasted less than a month, and the current "I'm a PC" campaign avoids any mention of what Vista actually does. While enterprise purchases drive Microsoft's biggest numbers, even there XP is still controlling disproportionate market share. In addition, Microsoft's own early previews of Windows 7 implicitly acknowledge Vista ranks as less than a world-beater. Finally, the home PC market has changed radically from 13 years ago, as last week's news illustrates: PC Magazine is ceasing print publication after 27 years in business.
2) In April 2007, I hedged my bets on the iPhone, offering reasons for both success or failure. Now that the former outcome can be declared, why did I think the iPhone would succeed in the market?
If the iPhone follows the iPod as a success, it will be because:
-Apple invents a new category of device, learning from previous failures.
Outcome: True
-The user interface transcends anything else in the category not with bells-and-whistles complexity but intuitive simplicity.
Outcome: True
-Apple has once again used superior industrial design, elevated to the level of art, to create unsurpassed "cool" factor in a category.
Outcome: True
-As venture capitalist John Doerr recently noted, Apple has a vast army of users trained to synch their device with a computer. It's an installed base of user behavior that could give the iPhone a jump-start in adoption.
Outcome: True
-The iPhone captures momentum amidst industry disruption. As mobile broadband emerges from competing standards and platforms, the iPhone could dominate a multi-radio niche just at the moment that heterogeneous coverage becomes a reality.
Outcome: True
-The demographics align: the price points, through whatever mechanism, drive adoption in both the niche knowledge-worker and technology-as-jewelry segments along with 20-somethings who replaced landline phones with mobiles and may augment PCs with a tablet-phone-music player.
Outcome: Incomplete
-The beautiful device is powered by a "killer application."
Outcome: False, as the range of applications rather than the power of any one appears to be more compelling.
-The iPhone, rather than being a phone, is treated by enterprise IT shops as a Unix terminal.
Outcome: False. The enterprise market is not driving nearly as much uptake as personal purchases.
C) What I wish I'd have seen:
Although I did say in January that "the world has become more nonlinear: when weird things happen, they affect more people and move faster than such events in the past," the reach of financial mismanagement and shared exposure has stunned essentially everyone. Rather than Avian flu in the physical domain, we're coping with derivative trauma in the financial.
Globalization is leveling some playing fields more than others, but in terms of acquisitions, the sale of first-world assets to non-first-world investors is happening faster than many might have thought. Consider that InBev (Belgium-Brazil) bought Anheuser-Busch in July, Tata Motors (India) bought Jaguar in June, numerous sovereign-wealth funds hold substantial Western equity, Lenovo (China) bought IBM's PC business in 2005, and GE Plastics is now owned by a Saudi Arabian firm. Combine such cross-border M&A with the collapse of U.S. financial-services firms such as Bear Stearns, Merrill Lynch, and Lehman Brothers, and the instability in the auto industry, and we find that very few companies can be said to be acquisition-proof.
While the music industry appears to have stopped suing its customers for downloading music, piracy -- of the high-seas variety -- is back in the news. The impact of the Somali ship-ransom industry (a $150 million effort) will bear watching: the Indian navy recently appeared to sink a pirate vessel, and the Russian navy is sending more warships to the Gulf of Aden. With the U.S. already active, the pirates appear to have mobilized a rare and perhaps unprecedented coalition of protective forces.
The almost instantaneous shift from worries about inflation to concerns about deflation characterizes the wildly unstable year we've witnessed. Consider:
-The Obama campaign promised to levy a windfall profits tax on the oil company, yet in the current climate, investors, employees, and governments would most likely be delighted to see any corporations capable of prospering. Verizon and AT&T appear to be recession-resistant in their mobile and cable units, and HP posted Q3 earnings that reflect 5% year-over-year organic growth, but financial services, manufacturing, most of the tech sector, housing, travel, and retail (outside Walmart and some dollar stores) all range from disastrous to troubled.
-Crude oil prices have fallen nearly $100 per barrel -- $100 per barrel! -- in just over 100 days.
-The U.S. dollar has rapidly strengthened, rising from nearly $1.60 per Euro to under $1.25 in just over 3 months (July 15 to October 27). Historically, dollars and oil have of course moved in close relation to each other, but I could not find any convincing explanation of causation one way or the other, or of a third factor that might be driving both currency appreciation and lower commodity prices as dependent variables.
What could possibly follow this crazy year? Check back next month for 2009 predictions.
A) 2008 Predictions
Here's what I said in January: "Somewhere in the next 12 to 18 months, I expect to see major news unfold in some combination of the following five domains."
Domain 1) The Fragility of Democracies
Grade: Miss/incomplete
Apart from a near triumph of a convicted felon in a Senate race, the U.S. election ran smoothly: no major electronic voting irregularities, no hanging chads, no trip to the Supreme Court for vote-counting. Instead, looking back on the election cycle, the Obama campaign's skillful use of social media to raise vast sums of money, mobilize an army of volunteers, and get out the vote proved to be a milestone in the technology curve. Elsewhere, democracies remain fragile, and political instability could surface in the wake of economic turbulence. India and Pakistan both show signals of unrest, as do parts of Africa and South America. Food riots (see below) could precipitate further troubles.
Domain 2) Life in the Food Chain
Grade: Hit
When I said that "overall, U.S. food prices increased dramatically last year, and there's no reason to think the trend will reverse," I was making the same mistake the bond ratings agencies and others made when they assumed U.S. house prices could only go up. Commodity price movement is on the downswing for the moment, but several factors, not least of them global demand, could reverse the trend at any time. Food prices were in fact major news in 2008, as were "slow foods" and "buy local" movements. A big question going forward: as consumer spending responds to rising unemployment and loss of both residential and stock market equity, will people keep paying the premium for organic foods? Early returns (via the research firm Mintel) suggest not: 48% of UK organic shoppers say they will reduce or give up buying organic food in the next year.
Domain 3) Cheap Computing
Grade: Hit
Prediction: "I have no idea how it will play out, but we will see some interesting (both scary and exciting) developments as a result of the increase in low-cost options. This is not to say that paid package software will disappear, but having a growing set of inexpensive options will certainly change the industry, and the market."
Cloud computing became a powerful buzzword, meriting a 14-page special report in The Economist last month. PC demand continues to soften, whereas mobile platform growth has remained vigorous. Last week's launch of the new Blackberry will bear watching, and AT&T continues to see wireless market share movement based on the iPhone. Some U.S. customers are abandoning not only landline voice but also wired broadband, consolidating on the mobile platform now that form factor, usability, and wireless bandwidth have all crossed some threshold for wide adoption.
Domain 4) Organizing Augmentation
Grade: Incomplete
Prediction: "Every year we see more computing done outside 'computers.' . . . The point here is that just as there's a large category of enterprise software that we use to run other software, we'll soon need digital assistance to manage our digital assistance."
This shouldn't have been a one-year prediction. I still think it will pan out, but not in this time horizon.
Domain 5) Consequences of Visible Social Networks
Grade: Hit
Prediction: "As more of us can see and organize who we know, and the people they know, expect to see some unexpected outcomes. . . .we're already seeing changes in demographics. My students have a very different experience of interpersonal connectedness than did their predecessors of just a few years ago."
The Obama campaign capitalized powerfully on viral video, social networking, text messaging, blogging, and online coordination: Internet fund-raising alone allowed the campaign literally to rewrite the electoral playbook. Facebook is becoming a platform in several senses of the word and drives enormous traffic: Alexa ranks it #5, or in other words the #2 non-search site after YouTube. Just behind is Newscorp's MySpace at #7. Hi5, meanwhile, claims to be the #1 social networking site in over 30 countries and supports 37 languages; Alexa rates it as the #17 site overall on the Web, just behind Microsoft's home page. One unexpected consequence of these networks is crime-fighting: to cite a minor but local example, several individuals here in town have been arrested in our version of football hooliganism based on photos and/or videos posted on MySpace et al.
B) Two Older Predictions
1) In September 2005 I wrote a private research report on Microsoft Vista in which I expressed concern that comparisons to Windows 95 were premature. Because Vista failed to give home users new capabilities on par with 95's long filename and CD-ROM support, TCP/IP, modem controls, and other Internet and networking functionality, I predicted that "Vista’s feature set and the competitive environment should ensure that the product represents a single or more likely a double for Microsoft, but more certainly not a home run." I think it's safe to say this has in fact been the case as Microsoft has seen adoption lag predictions.
In the consumer domain, the contrast of four different Vista advertising campaigns this year to the hit-the-ground-running Rolling Stones campaign for 95 could not be more striking. The "Mojave experiment" experiment tried to suggest that Vista was not as bad as people had heard, Jerry Seinfeld lasted less than a month, and the current "I'm a PC" campaign avoids any mention of what Vista actually does. While enterprise purchases drive Microsoft's biggest numbers, even there XP is still controlling disproportionate market share. In addition, Microsoft's own early previews of Windows 7 implicitly acknowledge Vista ranks as less than a world-beater. Finally, the home PC market has changed radically from 13 years ago, as last week's news illustrates: PC Magazine is ceasing print publication after 27 years in business.
2) In April 2007, I hedged my bets on the iPhone, offering reasons for both success or failure. Now that the former outcome can be declared, why did I think the iPhone would succeed in the market?
If the iPhone follows the iPod as a success, it will be because:
-Apple invents a new category of device, learning from previous failures.
Outcome: True
-The user interface transcends anything else in the category not with bells-and-whistles complexity but intuitive simplicity.
Outcome: True
-Apple has once again used superior industrial design, elevated to the level of art, to create unsurpassed "cool" factor in a category.
Outcome: True
-As venture capitalist John Doerr recently noted, Apple has a vast army of users trained to synch their device with a computer. It's an installed base of user behavior that could give the iPhone a jump-start in adoption.
Outcome: True
-The iPhone captures momentum amidst industry disruption. As mobile broadband emerges from competing standards and platforms, the iPhone could dominate a multi-radio niche just at the moment that heterogeneous coverage becomes a reality.
Outcome: True
-The demographics align: the price points, through whatever mechanism, drive adoption in both the niche knowledge-worker and technology-as-jewelry segments along with 20-somethings who replaced landline phones with mobiles and may augment PCs with a tablet-phone-music player.
Outcome: Incomplete
-The beautiful device is powered by a "killer application."
Outcome: False, as the range of applications rather than the power of any one appears to be more compelling.
-The iPhone, rather than being a phone, is treated by enterprise IT shops as a Unix terminal.
Outcome: False. The enterprise market is not driving nearly as much uptake as personal purchases.
C) What I wish I'd have seen:
Although I did say in January that "the world has become more nonlinear: when weird things happen, they affect more people and move faster than such events in the past," the reach of financial mismanagement and shared exposure has stunned essentially everyone. Rather than Avian flu in the physical domain, we're coping with derivative trauma in the financial.
Globalization is leveling some playing fields more than others, but in terms of acquisitions, the sale of first-world assets to non-first-world investors is happening faster than many might have thought. Consider that InBev (Belgium-Brazil) bought Anheuser-Busch in July, Tata Motors (India) bought Jaguar in June, numerous sovereign-wealth funds hold substantial Western equity, Lenovo (China) bought IBM's PC business in 2005, and GE Plastics is now owned by a Saudi Arabian firm. Combine such cross-border M&A with the collapse of U.S. financial-services firms such as Bear Stearns, Merrill Lynch, and Lehman Brothers, and the instability in the auto industry, and we find that very few companies can be said to be acquisition-proof.
While the music industry appears to have stopped suing its customers for downloading music, piracy -- of the high-seas variety -- is back in the news. The impact of the Somali ship-ransom industry (a $150 million effort) will bear watching: the Indian navy recently appeared to sink a pirate vessel, and the Russian navy is sending more warships to the Gulf of Aden. With the U.S. already active, the pirates appear to have mobilized a rare and perhaps unprecedented coalition of protective forces.
The almost instantaneous shift from worries about inflation to concerns about deflation characterizes the wildly unstable year we've witnessed. Consider:
-The Obama campaign promised to levy a windfall profits tax on the oil company, yet in the current climate, investors, employees, and governments would most likely be delighted to see any corporations capable of prospering. Verizon and AT&T appear to be recession-resistant in their mobile and cable units, and HP posted Q3 earnings that reflect 5% year-over-year organic growth, but financial services, manufacturing, most of the tech sector, housing, travel, and retail (outside Walmart and some dollar stores) all range from disastrous to troubled.
-Crude oil prices have fallen nearly $100 per barrel -- $100 per barrel! -- in just over 100 days.
-The U.S. dollar has rapidly strengthened, rising from nearly $1.60 per Euro to under $1.25 in just over 3 months (July 15 to October 27). Historically, dollars and oil have of course moved in close relation to each other, but I could not find any convincing explanation of causation one way or the other, or of a third factor that might be driving both currency appreciation and lower commodity prices as dependent variables.
What could possibly follow this crazy year? Check back next month for 2009 predictions.
Wednesday, October 29, 2008
Early Indications October 2008: Information-age Stimulus
As economies around the world continue to wobble in the aftermath of the credit crises, the next American president will be faced with competing calls to "do something" both at home and in a global context. With equity, housing, and credit markets showing weakness in concert, the choices of where to intervene are complex indeed. The lack of ready historical precedents complicates the issue further.
Numerous press reports and blog postings raise the question of whether the current situation parallels the Great Depression. In the U.S., the numbers are thus far convincing in the negative: unemployment has (by official measures) risen to 6%, but this number, while concerning, falls far short of the 23% figure reached in 1932. Equity values are low, but even though the S&P 500 is down roughly 40% from its October 2007 high, that's still only half of the percentage decline registered from 1930-1932. In short, even though few are happy with the current picture, it's a far cry from Depression territory.
That news is hardly comforting to job-seekers, investors, or employees. Despite the magnitude of the Troubled Asset Relief Program package passed by Congress earlier this month, it is unlikely to jump-start a global economy that appears to be in a broad-based slowdown. When the American people, and citizens of the other OECD nations, look to the new president for action, what are the realistic options?
Franklin Roosevelt's reaction to the Great Depression is instructive, not for parallels to the current situation, but for the many differences in the two situations. According to the Library of Congress, the New Deal enacted in 1933 and modified thereafter worked across multiple fronts:
"Based on the assumption that the power of the federal government was needed to get the country out of the depression, the first days of Roosevelt's administration saw the passage of banking reform laws, emergency relief programs, work relief programs, and agricultural programs. Later, a second New Deal was to evolve; it included union protection programs, the Social Security Act, and programs to aid tenant farmers and migrant workers."
Threads of continuity are obvious: banking regulation and Social Security will be very much top of mind in 2009. Beyond those two areas, however, the tools that Roosevelt reached for will likely not be high priorities for President McCain or Obama: migrant agricultural workers, factory laborers, and farmers, whatever their current pain, will not play central roles in the eventual economic recovery.
What investments and other actions by the federal government, then, might help increase economic competitiveness, raise the standard of living for broad segments of the population, and restore confidence and therefore asset values? Given the increase in the size of the services sector (including government itself) since 1933, and given the impact of information technology since about 1950, the levers for today's economy are less obvious, but several areas do stand out. Each of the following determines the employment of large numbers of people, is ripe for investment and innovation, and plays a strategic role in the overall economy. What separates our age from Roosevelt's is how the "real" and financial (as well as physical and information) economies have so quickly grown intertwined.
-Food
Not surprisingly, food is important for numerous other economic sectors. The current U.S. agriculture system is premised on cheap and plentiful petroleum and water. Going forward, nether assumption can be taken as given, which raises the importance of biology -- new seed types -- going forward. These in turn call into question the place and reach of intellectual property protections for life forms.
The food and nutritional policy layer -- governing tariffs, labeling regulations, and food safety and nutrition -- merits a thorough revisiting. Current practices, for example, include prophylactic doses of antibiotics to livestock that are implicated in the rise of "superbugs" such as MRSA and other gram-negative antibiotic-resistant bacteria. Similarly, policies regarding sugar and especially high-fructose corn syrup should be examined in light of potential connections to obesity and diabetes.
At the level of economics, encouraging food as fuel (corn ethanol) is having unintended consequences for both farmers and eaters. Indeed, according to the Lancet (May 17-23 2008), the entire investment climate around food commodities is showing signs that speculation is connected to malnutrition. In short, the CBOT and its kin become a public-health issue: "There is compelling evidence that the recently expanded market in food-commodity derivatives has led to large increases in speculative investment, pushing global food prices far higher than predicted by demand-supply effects." (Pace et al, "Food commodity derivatives: a new cause of malnutrition?" pp. 1648-51)
In the process of improving the outcomes of financial markets, health care, international trade and assistance, and energy, a hard look at the food industry is essential.
-Immigration
Near the core of the United States' identity, history, and tradition of innovation lies the nation's role as a destination of immigrants. Andrew Carnegie used to be the archetype of the immigrant-entrepreneur, but we live today among some extraordinary immigrants.
*Steven F. Udvar-Házy (Hungary) co-founded International Lease Finance Corporation, which with a fleet of 824 is the largest owner of aircraft in the U.S.
*Sergey Brin (Soviet Union) co-founded Google.
*Arno Penzias (Germany) won a Nobel Prize for work done at Bell Labs.
*Jerry Yang (Taiwan) co-founded Yahoo.
*Elon Musk (South Africa) co-founded PayPal; last month, his SpaceX company launched the first privately funded liquid-fueled rocket into orbit.
*Vinod Khosla (India) co-founded Sun Microsystems and later helped nurture many other startups in tech, finance, and energy as a venture capitalist.
*Pierre Omidyar (born in France to Iranian parents) founded eBay and continues to innovate, now in philanthropy.
It is safe to say that few, if any, of the above ventures could have launched, much less succeeded, in these individuals' countries of origin. At the same time, illegal immigration from Mexico and Central America stresses education, medical care, and social services in countless localities. The U.S. will suffer if global brainpower and creativity are locked out, but completely open borders are no longer an option in most countries. Striking a better balance will require courage, negotiating skill, and vision.
-Health care
According to the National Coalition on Health Care, overall health care spending increased at twice the rate of inflation in 2007. Employer premiums have doubled since 2000, compared to cumulative inflation of 24%. Total spending -- $2.3 trillion -- represented 16% of GDP, or $7,600 per person, and is expected to double in the next nine years. Health care finance, malpractice law, and payment processing are ripe for innovation and waste reduction: nobody contends that the U.S.'s current ratio of paperwork to patient care is remotely fair, safe, or effective.
At the same time, many towns suffer from physician shortages as medical school loans, managed care reimbursement schedules, and quality of life issues combine to make practice in many areas unattractive. Pharmaceutical companies, meanwhile, act in economically rational fashion to invest in drugs with high payoff. Lifelong maintenance drugs (think cholesterol, obesity, or certain mental health categories) represent annuity streams, while antibiotics, vaccines, and other high-value categories from an outcomes perspective look insufficiently profitable in prospect to capture significant investment.
Any way you look at it, innovation in health care creates substantial leverage, and is essential given demographic trends. Public-private partnerships, such as philanthropies' and NGOs' efforts to create viable vaccine markets, can be much better coordinated. Information, beginning with public health and outcomes statistics, electronic medical records, and improved claims processing arrangements, will be necessary but far from sufficient.
-Energy
The proximity of solar panels to the semiconductor industry represents but the tip of the iceberg in terms of information intensity. Whether it be solar, wind, new drilling techniques for oil and natural gas, or storage technologies such as batteries and fuel cells, information technology will be front and center in the evolution of the industry. Markets for carbon offsets or other financial instruments, increased software content in battery and hybrid automobiles, and an improved power grid will all rely on significant contributions from IT. At the same time, cloud computing is particularly dependent on an adequate power grid -- see below re: infrastructure.
-Manufacturing
Amidst all the calls for "energy independence" on the oil/import side, an important factor in the current U.S. trade imbalance is manufactured exports. Figures are difficult to come by, for defense-related items are not readily broken out. Fully a third of U.S. total exports go to Canada or Mexico, but it is difficult to determine how much they offset $113 billion in oil and related imports from these two countries. In addition, many totals are deceptive: in automobiles, for example, chassis, components, and other sub-assemblies are "exported" to Canada then assembled in Ontario, at which time the U.S. "imports" the car or truck.
For many reasons, increasing U.S. manufacturing exports makes sense, as does improving the balance of trade where possible by reducing imports. For this to occur, investment in such high-value manufacturing areas as advanced materials (for things like windmill blades; lighter and therefore more fuel-efficient automobiles; and medical devices) should pay dividends. Medical electronics, energy-related systems, and heavy equipment have historically done well in world markets as well. As shipping costs rise, making automobiles for fast-growing nearby markets including Mexico and potentially Brazil presents a golden opportunity.
-Communications
The U.S. lags its peers in broadband deployment by many measures. In Japan, KDDI has announced 1-gigabit fiber to the premise service for about US$50 per month. Policy reform and potentially investment -- think of the equivalent of the Interstate Highway system -- could spur development of such economic engines as telemedicine, remote learning and training, and realistic "telecommuting."
-Education
No Child Left Behind has yet to improve American 15-year-olds' poor performance relative to math and science students in most peer countries: the OECD's Programme for International Student Assessment (PISA) was most recently scored for 2006. The U.S. finished 35th of 70 countries in math, just ahead of Croatia and far behind Finland (#1), Korea (2), and Canada (5). Much like communications, the equivalent of a Manhattan Project to reinvent primary and secondary education would rely heavily on, and improve the nation's performance in, information and technology industries.
For all the effort needed in math and science, the outlook in language and cultural understanding may be worse still. High schools persist in teaching German, Spanish, French, and Latin at a time when Arabic, Russian, and Chinese hold great strategic importance. Furthermore, unlike Europe or even South America, where English is often the de facto language of international discussion, no one can assume that the billions of people who speak these languages natively are in a great hurry to learn English.
Whatever the weaknesses at the K-12 level, the U.S. excels at higher education. At the doctoral level, research universities led by Texas, Michigan, and California are educating the world's research scientists and technologists. According to an annual report compiled by the University of Chicago for the National Science Foundation and five other government agencies, of about 7,500 Ph.D.s granted by U.S. institutions in the physical sciences in 2006, over half went to non-U.S. citizens. In engineering, 64% of the 7,200 Ph.D.s went to non-U.S. citizens. Not surprisingly, China and India -- countries competing with us in the development of such strategic projects as blue-water navies, space weapons, and domestic automobile industries -- led the way.
To get people to study these areas and help restock Northrop Grumman, NASA, and Ford, there needs to be incentive. In the recent past, reward has gone to individuals who innovated in financial services: the Enron Special Purpose Entities lead a list of tools (ending in credit default swaps) which made a small number of people rich but failed to generate widespread growth. Brainpower followed the money, potentially to the detriment of more durable fields of innovation. Think of the broad and lasting impact of such American real-economy inventions as the mobile phone, the Internet, the personal computer, MRI and PET scanning, the laser printer (and indeed the laser), the transistor, and the integrated circuit. Only PET is less than 35 years old. As elsewhere, to fix education, other sectors need to be considered.
-Infrastructure
Whatever the ability of information to move rapidly through fiber or ether, people, goods, and food need reliable infrastructure: roads, ports, airports, and pipes. The American Society of Civil Engineers -- not an uninterested party, to be sure -- graded the country's infrastructure in 2001 and 2005, giving the nation a D, with $1.6 trillion deemed necessary for improvements. Bridges (C) and solid waste treatment (C+) were the relative highlights of an otherwise dismal list.
A coalition of state and local officials has recently been formed to highlight the need. According to New York Mayor Michael Bloomberg, "the governors and the mayors of this country every day see at an operational level bridges that are rusting away, and tracks that can't carry high speed trains, and power transmission lines that can't keep up with demand, and airports that need new runways, and water lines that need backup systems, and sewage plants that leak into the rivers and the oceans."
One problem is that infrastructure spending at the federal level has historically been burdened with non-essential earmarks for things like bike paths: a report by the Department of Transportation Inspector General found over 8,00 such provisions, worth $8 billion, in FY07 federal spending -- 13% of the entire spending plan. Leadership to do better is essential: peace gardens won't get the economy back into gear.
Beyond Subsidy to Synergy
In the recent past, lobbying rather than presidential leadership has driven legislation: the AARP got the prescription drug benefit, the corn lobby got ethanol subsidies and tariffs, the financial sector got a light regulatory hand. The list above, however, illustrates how intertwined the key areas of the economy have become. As the credit crisis highlights, commodity markets (currently regulated separately from financial markets) have become part of a complex, tightly coupled global financial system. Immigration has a huge impact on health care. Health care costs affect the competitiveness of manufacturing companies in global markets.
The list goes on, but shows how merely acting one lobby at a time is a recipe for slow progress at best or disaster at worst. As Ray Kurzweil (another U.S. innovator who is a child of immigrants, by the way) and others have argued, change itself is changing:
"Our forebears expected the future to be pretty much like their present, which had been pretty much like their past. . . . Today, in accordance with the common wisdom, everyone expects continuous technological progress and the social repercussions that follow. But the future will be far more surprising than most observers realize: few have truly internalized the implications of the fact that the rate of change itself is accelerating." (quoted from here)
Accordingly, instead of more of the same old governance, one hopes that the next president leads with a vision of a global, information-age future that addresses complex problems with robust, synergistic actions, rather than being satisfied with delivering trophies to K Street.
Numerous press reports and blog postings raise the question of whether the current situation parallels the Great Depression. In the U.S., the numbers are thus far convincing in the negative: unemployment has (by official measures) risen to 6%, but this number, while concerning, falls far short of the 23% figure reached in 1932. Equity values are low, but even though the S&P 500 is down roughly 40% from its October 2007 high, that's still only half of the percentage decline registered from 1930-1932. In short, even though few are happy with the current picture, it's a far cry from Depression territory.
That news is hardly comforting to job-seekers, investors, or employees. Despite the magnitude of the Troubled Asset Relief Program package passed by Congress earlier this month, it is unlikely to jump-start a global economy that appears to be in a broad-based slowdown. When the American people, and citizens of the other OECD nations, look to the new president for action, what are the realistic options?
Franklin Roosevelt's reaction to the Great Depression is instructive, not for parallels to the current situation, but for the many differences in the two situations. According to the Library of Congress, the New Deal enacted in 1933 and modified thereafter worked across multiple fronts:
"Based on the assumption that the power of the federal government was needed to get the country out of the depression, the first days of Roosevelt's administration saw the passage of banking reform laws, emergency relief programs, work relief programs, and agricultural programs. Later, a second New Deal was to evolve; it included union protection programs, the Social Security Act, and programs to aid tenant farmers and migrant workers."
Threads of continuity are obvious: banking regulation and Social Security will be very much top of mind in 2009. Beyond those two areas, however, the tools that Roosevelt reached for will likely not be high priorities for President McCain or Obama: migrant agricultural workers, factory laborers, and farmers, whatever their current pain, will not play central roles in the eventual economic recovery.
What investments and other actions by the federal government, then, might help increase economic competitiveness, raise the standard of living for broad segments of the population, and restore confidence and therefore asset values? Given the increase in the size of the services sector (including government itself) since 1933, and given the impact of information technology since about 1950, the levers for today's economy are less obvious, but several areas do stand out. Each of the following determines the employment of large numbers of people, is ripe for investment and innovation, and plays a strategic role in the overall economy. What separates our age from Roosevelt's is how the "real" and financial (as well as physical and information) economies have so quickly grown intertwined.
-Food
Not surprisingly, food is important for numerous other economic sectors. The current U.S. agriculture system is premised on cheap and plentiful petroleum and water. Going forward, nether assumption can be taken as given, which raises the importance of biology -- new seed types -- going forward. These in turn call into question the place and reach of intellectual property protections for life forms.
The food and nutritional policy layer -- governing tariffs, labeling regulations, and food safety and nutrition -- merits a thorough revisiting. Current practices, for example, include prophylactic doses of antibiotics to livestock that are implicated in the rise of "superbugs" such as MRSA and other gram-negative antibiotic-resistant bacteria. Similarly, policies regarding sugar and especially high-fructose corn syrup should be examined in light of potential connections to obesity and diabetes.
At the level of economics, encouraging food as fuel (corn ethanol) is having unintended consequences for both farmers and eaters. Indeed, according to the Lancet (May 17-23 2008), the entire investment climate around food commodities is showing signs that speculation is connected to malnutrition. In short, the CBOT and its kin become a public-health issue: "There is compelling evidence that the recently expanded market in food-commodity derivatives has led to large increases in speculative investment, pushing global food prices far higher than predicted by demand-supply effects." (Pace et al, "Food commodity derivatives: a new cause of malnutrition?" pp. 1648-51)
In the process of improving the outcomes of financial markets, health care, international trade and assistance, and energy, a hard look at the food industry is essential.
-Immigration
Near the core of the United States' identity, history, and tradition of innovation lies the nation's role as a destination of immigrants. Andrew Carnegie used to be the archetype of the immigrant-entrepreneur, but we live today among some extraordinary immigrants.
*Steven F. Udvar-Házy (Hungary) co-founded International Lease Finance Corporation, which with a fleet of 824 is the largest owner of aircraft in the U.S.
*Sergey Brin (Soviet Union) co-founded Google.
*Arno Penzias (Germany) won a Nobel Prize for work done at Bell Labs.
*Jerry Yang (Taiwan) co-founded Yahoo.
*Elon Musk (South Africa) co-founded PayPal; last month, his SpaceX company launched the first privately funded liquid-fueled rocket into orbit.
*Vinod Khosla (India) co-founded Sun Microsystems and later helped nurture many other startups in tech, finance, and energy as a venture capitalist.
*Pierre Omidyar (born in France to Iranian parents) founded eBay and continues to innovate, now in philanthropy.
It is safe to say that few, if any, of the above ventures could have launched, much less succeeded, in these individuals' countries of origin. At the same time, illegal immigration from Mexico and Central America stresses education, medical care, and social services in countless localities. The U.S. will suffer if global brainpower and creativity are locked out, but completely open borders are no longer an option in most countries. Striking a better balance will require courage, negotiating skill, and vision.
-Health care
According to the National Coalition on Health Care, overall health care spending increased at twice the rate of inflation in 2007. Employer premiums have doubled since 2000, compared to cumulative inflation of 24%. Total spending -- $2.3 trillion -- represented 16% of GDP, or $7,600 per person, and is expected to double in the next nine years. Health care finance, malpractice law, and payment processing are ripe for innovation and waste reduction: nobody contends that the U.S.'s current ratio of paperwork to patient care is remotely fair, safe, or effective.
At the same time, many towns suffer from physician shortages as medical school loans, managed care reimbursement schedules, and quality of life issues combine to make practice in many areas unattractive. Pharmaceutical companies, meanwhile, act in economically rational fashion to invest in drugs with high payoff. Lifelong maintenance drugs (think cholesterol, obesity, or certain mental health categories) represent annuity streams, while antibiotics, vaccines, and other high-value categories from an outcomes perspective look insufficiently profitable in prospect to capture significant investment.
Any way you look at it, innovation in health care creates substantial leverage, and is essential given demographic trends. Public-private partnerships, such as philanthropies' and NGOs' efforts to create viable vaccine markets, can be much better coordinated. Information, beginning with public health and outcomes statistics, electronic medical records, and improved claims processing arrangements, will be necessary but far from sufficient.
-Energy
The proximity of solar panels to the semiconductor industry represents but the tip of the iceberg in terms of information intensity. Whether it be solar, wind, new drilling techniques for oil and natural gas, or storage technologies such as batteries and fuel cells, information technology will be front and center in the evolution of the industry. Markets for carbon offsets or other financial instruments, increased software content in battery and hybrid automobiles, and an improved power grid will all rely on significant contributions from IT. At the same time, cloud computing is particularly dependent on an adequate power grid -- see below re: infrastructure.
-Manufacturing
Amidst all the calls for "energy independence" on the oil/import side, an important factor in the current U.S. trade imbalance is manufactured exports. Figures are difficult to come by, for defense-related items are not readily broken out. Fully a third of U.S. total exports go to Canada or Mexico, but it is difficult to determine how much they offset $113 billion in oil and related imports from these two countries. In addition, many totals are deceptive: in automobiles, for example, chassis, components, and other sub-assemblies are "exported" to Canada then assembled in Ontario, at which time the U.S. "imports" the car or truck.
For many reasons, increasing U.S. manufacturing exports makes sense, as does improving the balance of trade where possible by reducing imports. For this to occur, investment in such high-value manufacturing areas as advanced materials (for things like windmill blades; lighter and therefore more fuel-efficient automobiles; and medical devices) should pay dividends. Medical electronics, energy-related systems, and heavy equipment have historically done well in world markets as well. As shipping costs rise, making automobiles for fast-growing nearby markets including Mexico and potentially Brazil presents a golden opportunity.
-Communications
The U.S. lags its peers in broadband deployment by many measures. In Japan, KDDI has announced 1-gigabit fiber to the premise service for about US$50 per month. Policy reform and potentially investment -- think of the equivalent of the Interstate Highway system -- could spur development of such economic engines as telemedicine, remote learning and training, and realistic "telecommuting."
-Education
No Child Left Behind has yet to improve American 15-year-olds' poor performance relative to math and science students in most peer countries: the OECD's Programme for International Student Assessment (PISA) was most recently scored for 2006. The U.S. finished 35th of 70 countries in math, just ahead of Croatia and far behind Finland (#1), Korea (2), and Canada (5). Much like communications, the equivalent of a Manhattan Project to reinvent primary and secondary education would rely heavily on, and improve the nation's performance in, information and technology industries.
For all the effort needed in math and science, the outlook in language and cultural understanding may be worse still. High schools persist in teaching German, Spanish, French, and Latin at a time when Arabic, Russian, and Chinese hold great strategic importance. Furthermore, unlike Europe or even South America, where English is often the de facto language of international discussion, no one can assume that the billions of people who speak these languages natively are in a great hurry to learn English.
Whatever the weaknesses at the K-12 level, the U.S. excels at higher education. At the doctoral level, research universities led by Texas, Michigan, and California are educating the world's research scientists and technologists. According to an annual report compiled by the University of Chicago for the National Science Foundation and five other government agencies, of about 7,500 Ph.D.s granted by U.S. institutions in the physical sciences in 2006, over half went to non-U.S. citizens. In engineering, 64% of the 7,200 Ph.D.s went to non-U.S. citizens. Not surprisingly, China and India -- countries competing with us in the development of such strategic projects as blue-water navies, space weapons, and domestic automobile industries -- led the way.
To get people to study these areas and help restock Northrop Grumman, NASA, and Ford, there needs to be incentive. In the recent past, reward has gone to individuals who innovated in financial services: the Enron Special Purpose Entities lead a list of tools (ending in credit default swaps) which made a small number of people rich but failed to generate widespread growth. Brainpower followed the money, potentially to the detriment of more durable fields of innovation. Think of the broad and lasting impact of such American real-economy inventions as the mobile phone, the Internet, the personal computer, MRI and PET scanning, the laser printer (and indeed the laser), the transistor, and the integrated circuit. Only PET is less than 35 years old. As elsewhere, to fix education, other sectors need to be considered.
-Infrastructure
Whatever the ability of information to move rapidly through fiber or ether, people, goods, and food need reliable infrastructure: roads, ports, airports, and pipes. The American Society of Civil Engineers -- not an uninterested party, to be sure -- graded the country's infrastructure in 2001 and 2005, giving the nation a D, with $1.6 trillion deemed necessary for improvements. Bridges (C) and solid waste treatment (C+) were the relative highlights of an otherwise dismal list.
A coalition of state and local officials has recently been formed to highlight the need. According to New York Mayor Michael Bloomberg, "the governors and the mayors of this country every day see at an operational level bridges that are rusting away, and tracks that can't carry high speed trains, and power transmission lines that can't keep up with demand, and airports that need new runways, and water lines that need backup systems, and sewage plants that leak into the rivers and the oceans."
One problem is that infrastructure spending at the federal level has historically been burdened with non-essential earmarks for things like bike paths: a report by the Department of Transportation Inspector General found over 8,00 such provisions, worth $8 billion, in FY07 federal spending -- 13% of the entire spending plan. Leadership to do better is essential: peace gardens won't get the economy back into gear.
Beyond Subsidy to Synergy
In the recent past, lobbying rather than presidential leadership has driven legislation: the AARP got the prescription drug benefit, the corn lobby got ethanol subsidies and tariffs, the financial sector got a light regulatory hand. The list above, however, illustrates how intertwined the key areas of the economy have become. As the credit crisis highlights, commodity markets (currently regulated separately from financial markets) have become part of a complex, tightly coupled global financial system. Immigration has a huge impact on health care. Health care costs affect the competitiveness of manufacturing companies in global markets.
The list goes on, but shows how merely acting one lobby at a time is a recipe for slow progress at best or disaster at worst. As Ray Kurzweil (another U.S. innovator who is a child of immigrants, by the way) and others have argued, change itself is changing:
"Our forebears expected the future to be pretty much like their present, which had been pretty much like their past. . . . Today, in accordance with the common wisdom, everyone expects continuous technological progress and the social repercussions that follow. But the future will be far more surprising than most observers realize: few have truly internalized the implications of the fact that the rate of change itself is accelerating." (quoted from here)
Accordingly, instead of more of the same old governance, one hopes that the next president leads with a vision of a global, information-age future that addresses complex problems with robust, synergistic actions, rather than being satisfied with delivering trophies to K Street.
Monday, September 22, 2008
September 2008: Of Crowds, Both Wise and Foolish
The surest sign that a phrase has entered broad usage is to apply the cliche test: if you leave the last word(s) blank and most readers know how to complete it, the phrase is best used carefully, if at all, in good writing. In broad swaths of the online literate, the phrase "wisdom of _____" will not refer to elders, the East, science, or abstinence. Only four years after James Surowiecki's book of the same name, it's an article of Internet faith that groups of people can give better answers than will individuals.
It's timely to revisit the notion given a powerful paradox: many observers -- including yours truly, who raved in this newsletter about the Iowa Electronic Markets (IEM) after trekking to Iowa City nine years ago -- see great potential in idea markets at the same time that financial markets are proving eminently fallible. In concrete terms, the number of businesses built on markets as information processing mechanisms is soaring even as the number of U.S. investment banks, home to tens of thousands of well-supported best and brightest, shrank from five to two in a matter of months after over 150 years in business.
It seems clear that U.S. financial markets are suffering in the aftermath of an inflated mortgage-products market, but it turns out that financial scholars can't agree on what a bubble is. According to Cornell's Maureen O'Hara in The Review of Financial Studies (February 2008), the "less controversial" approach is to follow one scholar's mild assertion that "bubbles are typically associated with dramatic asset price increases, followed by a collapse." Begging the question of what constitutes a collapse, the issue for our purposes concerns the potential for bubble equivalents in information markets.
The fate of the many information market startups, some of which we will discuss, will unfold over the next few years. In under two months we will see whether IEM maintains its record of performance in tracking presidential election results. Come February, traders in the Hollywood Stock Exchange (owned by the finance firm Cantor Fitzgerald) will try improve on its 10-year average of 82% correct picks across the top eight Oscar award categories. Specific companies aside, it's worth discussing some of the larger issues.
1) How do crowds express wisdom?
Several mechanisms come to mind:
-Voting, whether officially in the process of politics, or unofficially with product reviews, Digg or similar feedback ("Was this review helpful?"). All of these actions are voluntary and unsolicited, making statistical significance a moot point.
-Betting, the putting of real (as at IEM) or imagined (at HSX) currency where one's mouth is. Given the right kind of topic and the right kind of crowd, this process can be extremely powerful, albeit with constrained questions.
-Surveys, constructed with elaborate statistical tools and focused on carefully focused questions. Interaction among respondents is usually low, making surveys useful in collecting independent opinions.
-Convened feedback. This catch-all includes tagging, blogs and comments, message boards, trackbacks, wikis, and similar vehicles. Once again, the action is voluntary, but the field of play is unconstrained. Compared to the other three categories, convened feedback can contain substantial noise, but its free form allows topics to emerge from the group rather than from the pollster, market maker, or publisher.
2) What kind of questions best lend themselves to group wisdom?
On this topic Surowieki is direct: "Groups are only smart when there is a balance between the information that everyone in the groups shares and the information that each of the members of the group holds privately." Conversely, "what happens when [a] bubble bursts is that the expectations converge." (pp. 255-6)
A great example of this effect can be found at Metafilter. A year ago the question was posed, "What single book is the best introduction to your field (or specialization within your field) for laypeople?" Hundreds of people replied, in areas from homicide forensics to astrophysics. The results are truly priceless, a distillation of centuries of experience into a modest library.
Cass Sunstein, a University of Chicago law professor, agrees in his book Infotopia (2006). He states that "This is the most fundamental limitation of prediction markets: They cannot work well unless investors have dispersed information that can be aggregated." (pp. 136-7) Elsewhere in a blog post he notes that in an informal experiment with U of C law professors, the crowd came extremely close to the weight of the horse that won the Kentucky Derby, did "pretty badly" on the number of lines in Shakespeare's Antigone, and performed "horrendously" when asked the number of Supreme Court invalidations of state and federal law. He speculates that markets employ some self-selection bias: "participants have strong incentives to be right, and won't participate unless they think they have something to gain."
The best questions for prediction markets, then, involve issues about which people have formed independent judgments and on which they are willing to stake a financial and/or reputational investment. It may be that the topics cannot be too close to one's professional interests, as the financial example would suggest, and in line with the accuracy of the HSX Oscar predictions.
3) Where is error introduced?
The French political philosopher Condorcet (1743-1794) originally formulated the jury theorem that explains the wisdom of groups of people, when each individual is more than 50% likely to be right. Bad things happen when people are less that 50% likely to be right, however, and crowds then amplify error.
Numerous experiments have shown that group averages suffer when participants start listening to outside authorities or to each other. What Sunstein called "dispersed information" and what Surowiecki contrasts to mob behavior -- independence -- is more and more difficult to find. Many of the startups in idea markets include chat features -- they are, after all, often social networking plays -- making for yet another category of echo chamber.
Another kind of error comes when predictions ignore randomness. Particularly in thickly traded markets with many actors, the complexity of a given market can expose participants to phenomena for which there is no logical explanation -- even though many will be offered. As Nassim Nicholas Taleb pointed out in The Black Swan (2007), newswire reports on market movement routinely and fallaciously link events and price changes: it's not uncommon to see the equivalent of both "Dow falls on higher oil prices" and "Dow falls on lower oil prices" during the same day.
Varieties of market experience
The following are just some of many businesses seeking to monetize prediction markets:
-Newsfutures makes a B2B play, building internal prediction markets for the likes of Eli Lilly, the Department of Defense, and Yahoo.
-Spigit sells as enterprise software to support internal innovation and external customer interaction. Communities are formed to collect and evaluate new ideas.
-Intrade is an Irish firm that trades in real money (with a play money sandbox) applied to questions in politics, business (predictions on market share are common), entertainment, and other areas. The business model is built on small transaction fees on every trade.
-Hubdub, from Edinburgh, trades in play money but prominently features leaderboards, which intensify user involvement. Topics under discussion are limited only by users' imaginations and curiosity as any member can propose a question. The current leader, orlin, has done well on European football but also advanced wide ranging predictions, including one regarding the Higgs boson being discovered by the large hadron collider within a year. He or she has made nearly 6,000 predictions.
Apart from social networking plays and predictions, seemingly trivial commitments to intellectual positions work elsewhere. Cass Sunstein's more recent book, called Nudge (2008), was co-authored with the Chicago behavioral economist Richard Thaler. It points to the value of commitment for such personal behaviors as weight loss or project fulfillment. For example, a Ph.D. candidate, already hired as a lecturer at a substantial discount from an assistant professor's salary, was behind on his dissertation. Thaler made him write a $100 check at the beginning of every month a chapter was due. If the chapter came in on time, the check was ripped up. If the work came in late, the $100 went into a fund for a party to which the candidate would not be invited. The incentive worked, notwithstanding the fact that $400 or $500 was a tiny portion of the salary differential at stake. A Yale economics professor who lost weight under a similar game has co-founded stickK.com, an ad-funded online business designed to institutionalize similar "Commitment Contracts."
Futures
It's clear that crowds can in fact be smart when the members don't listen to each other too closely. It's also clear that financial and/or reputational investment is connected to both good predictions and fulfilled commitments. Several other issues are less obvious. Is there a novelty effect with prediction markets? Will clever people and/or software devise ways to game the system, similar to short-selling in finance or sniping on eBay? What do prediction bubbles look like, and what are their implications? When are crowds good at answering questions and when, if ever, are they good at posing them? (Note that on most markets, individuals can ask questions, not groups.) Can we reliably predict whether a given group will predict wisely?
At a larger level, how do online information markets relate to older forms of group expression, particularly voting? The U.S.'s filtration of a state's individual votes through the winner-take-all Electoral College is already controversial (only Maine and Nebraska currently allot their votes proportionately), and so-called National Popular Vote legislation is passed or pending in states with 274 electoral votes - enough to overturn the current process. Will some form of prediction market or other crowd wisdom accelerate or obviate this potential change?
Any process that can, under the right circumstances, deliver such powerful results will surely have unintended consequences. The controversy over John Poindexter's Futures Markets Applied to Prediction (FutureMAP) program, which was canceled by DARPA in July 2003, will certainly not be the last of the tricky issues revolving around this class of tools.
It's timely to revisit the notion given a powerful paradox: many observers -- including yours truly, who raved in this newsletter about the Iowa Electronic Markets (IEM) after trekking to Iowa City nine years ago -- see great potential in idea markets at the same time that financial markets are proving eminently fallible. In concrete terms, the number of businesses built on markets as information processing mechanisms is soaring even as the number of U.S. investment banks, home to tens of thousands of well-supported best and brightest, shrank from five to two in a matter of months after over 150 years in business.
It seems clear that U.S. financial markets are suffering in the aftermath of an inflated mortgage-products market, but it turns out that financial scholars can't agree on what a bubble is. According to Cornell's Maureen O'Hara in The Review of Financial Studies (February 2008), the "less controversial" approach is to follow one scholar's mild assertion that "bubbles are typically associated with dramatic asset price increases, followed by a collapse." Begging the question of what constitutes a collapse, the issue for our purposes concerns the potential for bubble equivalents in information markets.
The fate of the many information market startups, some of which we will discuss, will unfold over the next few years. In under two months we will see whether IEM maintains its record of performance in tracking presidential election results. Come February, traders in the Hollywood Stock Exchange (owned by the finance firm Cantor Fitzgerald) will try improve on its 10-year average of 82% correct picks across the top eight Oscar award categories. Specific companies aside, it's worth discussing some of the larger issues.
1) How do crowds express wisdom?
Several mechanisms come to mind:
-Voting, whether officially in the process of politics, or unofficially with product reviews, Digg or similar feedback ("Was this review helpful?"). All of these actions are voluntary and unsolicited, making statistical significance a moot point.
-Betting, the putting of real (as at IEM) or imagined (at HSX) currency where one's mouth is. Given the right kind of topic and the right kind of crowd, this process can be extremely powerful, albeit with constrained questions.
-Surveys, constructed with elaborate statistical tools and focused on carefully focused questions. Interaction among respondents is usually low, making surveys useful in collecting independent opinions.
-Convened feedback. This catch-all includes tagging, blogs and comments, message boards, trackbacks, wikis, and similar vehicles. Once again, the action is voluntary, but the field of play is unconstrained. Compared to the other three categories, convened feedback can contain substantial noise, but its free form allows topics to emerge from the group rather than from the pollster, market maker, or publisher.
2) What kind of questions best lend themselves to group wisdom?
On this topic Surowieki is direct: "Groups are only smart when there is a balance between the information that everyone in the groups shares and the information that each of the members of the group holds privately." Conversely, "what happens when [a] bubble bursts is that the expectations converge." (pp. 255-6)
A great example of this effect can be found at Metafilter. A year ago the question was posed, "What single book is the best introduction to your field (or specialization within your field) for laypeople?" Hundreds of people replied, in areas from homicide forensics to astrophysics. The results are truly priceless, a distillation of centuries of experience into a modest library.
Cass Sunstein, a University of Chicago law professor, agrees in his book Infotopia (2006). He states that "This is the most fundamental limitation of prediction markets: They cannot work well unless investors have dispersed information that can be aggregated." (pp. 136-7) Elsewhere in a blog post he notes that in an informal experiment with U of C law professors, the crowd came extremely close to the weight of the horse that won the Kentucky Derby, did "pretty badly" on the number of lines in Shakespeare's Antigone, and performed "horrendously" when asked the number of Supreme Court invalidations of state and federal law. He speculates that markets employ some self-selection bias: "participants have strong incentives to be right, and won't participate unless they think they have something to gain."
The best questions for prediction markets, then, involve issues about which people have formed independent judgments and on which they are willing to stake a financial and/or reputational investment. It may be that the topics cannot be too close to one's professional interests, as the financial example would suggest, and in line with the accuracy of the HSX Oscar predictions.
3) Where is error introduced?
The French political philosopher Condorcet (1743-1794) originally formulated the jury theorem that explains the wisdom of groups of people, when each individual is more than 50% likely to be right. Bad things happen when people are less that 50% likely to be right, however, and crowds then amplify error.
Numerous experiments have shown that group averages suffer when participants start listening to outside authorities or to each other. What Sunstein called "dispersed information" and what Surowiecki contrasts to mob behavior -- independence -- is more and more difficult to find. Many of the startups in idea markets include chat features -- they are, after all, often social networking plays -- making for yet another category of echo chamber.
Another kind of error comes when predictions ignore randomness. Particularly in thickly traded markets with many actors, the complexity of a given market can expose participants to phenomena for which there is no logical explanation -- even though many will be offered. As Nassim Nicholas Taleb pointed out in The Black Swan (2007), newswire reports on market movement routinely and fallaciously link events and price changes: it's not uncommon to see the equivalent of both "Dow falls on higher oil prices" and "Dow falls on lower oil prices" during the same day.
Varieties of market experience
The following are just some of many businesses seeking to monetize prediction markets:
-Newsfutures makes a B2B play, building internal prediction markets for the likes of Eli Lilly, the Department of Defense, and Yahoo.
-Spigit sells as enterprise software to support internal innovation and external customer interaction. Communities are formed to collect and evaluate new ideas.
-Intrade is an Irish firm that trades in real money (with a play money sandbox) applied to questions in politics, business (predictions on market share are common), entertainment, and other areas. The business model is built on small transaction fees on every trade.
-Hubdub, from Edinburgh, trades in play money but prominently features leaderboards, which intensify user involvement. Topics under discussion are limited only by users' imaginations and curiosity as any member can propose a question. The current leader, orlin, has done well on European football but also advanced wide ranging predictions, including one regarding the Higgs boson being discovered by the large hadron collider within a year. He or she has made nearly 6,000 predictions.
Apart from social networking plays and predictions, seemingly trivial commitments to intellectual positions work elsewhere. Cass Sunstein's more recent book, called Nudge (2008), was co-authored with the Chicago behavioral economist Richard Thaler. It points to the value of commitment for such personal behaviors as weight loss or project fulfillment. For example, a Ph.D. candidate, already hired as a lecturer at a substantial discount from an assistant professor's salary, was behind on his dissertation. Thaler made him write a $100 check at the beginning of every month a chapter was due. If the chapter came in on time, the check was ripped up. If the work came in late, the $100 went into a fund for a party to which the candidate would not be invited. The incentive worked, notwithstanding the fact that $400 or $500 was a tiny portion of the salary differential at stake. A Yale economics professor who lost weight under a similar game has co-founded stickK.com, an ad-funded online business designed to institutionalize similar "Commitment Contracts."
Futures
It's clear that crowds can in fact be smart when the members don't listen to each other too closely. It's also clear that financial and/or reputational investment is connected to both good predictions and fulfilled commitments. Several other issues are less obvious. Is there a novelty effect with prediction markets? Will clever people and/or software devise ways to game the system, similar to short-selling in finance or sniping on eBay? What do prediction bubbles look like, and what are their implications? When are crowds good at answering questions and when, if ever, are they good at posing them? (Note that on most markets, individuals can ask questions, not groups.) Can we reliably predict whether a given group will predict wisely?
At a larger level, how do online information markets relate to older forms of group expression, particularly voting? The U.S.'s filtration of a state's individual votes through the winner-take-all Electoral College is already controversial (only Maine and Nebraska currently allot their votes proportionately), and so-called National Popular Vote legislation is passed or pending in states with 274 electoral votes - enough to overturn the current process. Will some form of prediction market or other crowd wisdom accelerate or obviate this potential change?
Any process that can, under the right circumstances, deliver such powerful results will surely have unintended consequences. The controversy over John Poindexter's Futures Markets Applied to Prediction (FutureMAP) program, which was canceled by DARPA in July 2003, will certainly not be the last of the tricky issues revolving around this class of tools.
Wednesday, August 20, 2008
The Paradox of Data Visualization
It has been a full quarter-century since the publication of Edward Tufte’s landmark book, The Visual Display of Quantitative Information. In that time, computer screens and other projection tools have emerged as a powerful medium challenging the primacy of paper, previously the default tool of choice. Information visualization is now exploiting new display technologies (think flexible OLED), new computing platforms (iPhones and their kin), and ever-increasing computing power (Playstation 3 et al). For visualization to capitalize on the power of these and other technologies, information architecture must increase in sophistication, usability, and explanatory leverage.
This task is deceptively difficult: on screen, even more than on paper, it is far too simple to use both desktop tools, such as the ubiquitous Excel, and enterprise “business intelligence” packages to create bad information displays. Going forward, the task will get harder even as it becomes more necessary.
Why?
Several factors are responsible. First, data is generated by more sources and available to more users every year. “Data glut” may be a cliche, but tools such as search can intensify it: Google recently announced that a trillion web pages had been indexed. For context, if each of the 32 million books in the Library of Congress averages 300 pages, that’s less than 10 billion physical pages, and these individual units reside in nothing resembling a unified, organized, searchable repository.
More important, the task of data visualization is difficult because good displays must create spatial representations of non-spatial data. This is not new: linear representations have conveyed time for millennia, and pie charts have become handy shorthand for subsets of a whole. Good maps remain the gold standard, but enjoy the advantage of being a spatial representation of, well, space rather than something less tangible. Consult a UK Ordnance Survey map, or a fine 19th-century sample from any number of countries, and compare the quality to the non-spatial representations we encounter every day: USA Today visuals, executive dashboards, or owner’s manuals. In most cases, the antique remains superior to the modern.
Going forward, information architects are challenged to create readable, repeatable conventions for such abstractions as risk, intellectual property (patents are a poor proxy for human capital, for example), and attitudinal information such as customer satisfaction. Semi-arbitrary lists of text-string matches remain hard to make visual: concepts are notoriously difficult to map spatially, in contrast to the elegance of the periodic table of the elements, to take a classic example. Current social network maps, especially those of large social graphs such as Facebook, quickly grow useless, as this example illustrates.
Color presents a further difficulty. Even outside a visual context, meanings are inconsistent: operating a business in the black is good, but a black mark on your record is bad. A person green with envy, or looking slightly green on a cruise ship, lies conceptually opposite from a green-lighted script in Hollywood; an environmentally conscious activity is another matter entirely. In displays, the situation is worse yet as colors seldom hold stable meanings. Color-blindness is a further fact of life overlooked by many applications.
Given all of these challenges, it’s important to get things right. Human powers of pattern recognition remain more formidable than anything powered by Moore’s law: ask a 5-year-old to find objects in her toy box that belong on a dinner table and she’ll likely outperform even laboratory-grade artificial intelligence. In the face of the information volumes noted above, rising at an accelerating rate because of video, and given the need for more decisions in shorter times than ever, humans need the augmentation that good displays can provide.
How?
In his book Envisioning Information, Tufte suggests five tactics for increasing information density and “escaping flatland” – conveying more than two dimensions of meaning on paper. These are:
-Micro/macro readings (relating both wholes and parts as distinct entities)
-Layering and separation (often by use of color and graphic weight, as in a technical drawing)
-Small multiples (to show often subtle differences within elements of a system: a good lunar chart is an example)
-Color and information (sensitivity to the palette as color labels, measures, represents reality, and enlivens)
-Narratives of space and time (compressing the most powerful human dimensions onto flatland).
For all of the wisdom in these suggestions, and the beauty of Tufte’s examples – it’s no accident he’s both a statistician and a working artist – good information visualizations remain rare. For information to convey meaning in standard, predictable ways, we need tools: “tools” as in grammars and lexicons rather than more software widgets. (A noteworthy effort that appears to be directly in line with this need is Leland Wilkinson’s The Grammar of Graphics (New York: Springer, 2005).)
Some precedents may be useful. The history of sailing and shipping is rich with examples of various parties agreeing on conventions (port and starboard do not vary in different countries the way rules for automobiles do) and solving problems of conveying information. Container ships interlock regardless of carrier while being handled at countless global ports. The Beaufort wind scale arose from the need for agreed-upon metrics for measuring wind aboard a ship, a matter of great practical importance. Even today, with satellites and computerized navigation systems, a Beaufort 0 (“Calm; smoke rises vertically”) is the same around the world, while a 12 (“Air filled with foam; sea completely white with driving spray; visibility greatly reduced”) spells disaster no matter how fast the hurricane winds are actually blowing.
Closely related to navigation is weather. From early tabular and graphic representations of temperature and precipitation until 1982, when USA Today made a full-page set of color maps and tables a trademark of the upstart publication, tools for understanding weather and climate have helped lead the state of information visualization. More recently, graphics workstations were overrepresented in television studios as an arms race of weather-casting helped advance the state of the field. The weatherpeople can boast results: compare the number of people who can understand a Doppler radar image to those who can grasp binomial distributions, bid-ask spreads, or treemaps.
Musical notation is another relevant example. Easily transportable, relatively impervious to language, and yet a representation (rather than a reproduction) of a performance, scores have the kinds of conventions that information visualization for the most part still lacks. At this point, good visualizations are featured in “galleries” – as befit works of art. They are created by artists and artisans, not by people who merely have something to say. At the risk of a strained analogy, we are at the stage where latter-day monks painstakingly hand-letter sacred texts, still awaiting both Gutenberg and the typewriter.
As the references suggest, this is a rich field with many fascinating byways and footnotes. For a superb historical overview, see Friendly and Denis, Milestones in the History of Thematic Cartography, Statistical Graphics, and Data Visualization.
Current Directions
There is cause for optimism, however, on several fronts:
1) Hollywood and the gaming market are leading a charge toward effective, practical, and multidimensional visual tools. A quick look at the most recent SIGGRAPH conference program illustrates the overlap as featured speakers come from both computer science powers like Carnegie Mellon and animation houses such as Pixar.
2) 3-D has become a day-to-day reality in architecture, manufacturing, and, again, gaming, and this trickles down to consumer applications such as kitchen design tools. Even state-of-the-art roller coasters are being rendered (how, I don’t know) in CAD for mass enjoyment.
3) Since the release of its Flex version 2 product in 2006 which extended Flash functionality to more programming environments, Adobe has supported the rapid development (in both senses of the term) of visually attractive, data-driven visualizations: search the Flex application showcase and see a wide variety of database-driven shopping, monitoring, configuration, and wayfinding tools. Some are extremely handsome and useful, and even some of the visually “flat” examples possess a high information density.
4) Mapping remains important, and through the release of APIs from the likes of the UK Ordnance Survey, ESRI, Microsoft, and Google, developers can build data-rich geographically-useful tools more easily than ever before. Once again, Flex can accelerate the process.
5) In the labs, more senses are being enlisted in human information processing. Just as force-feedback enhances a driving game, so too can users navigate 3-D data volumes with haptic tools. Sonification is another emerging tool: when two or more elements interact (for example, sensor or observational reports regarding some phenomenon), the user can hear sounds of varying harmony to indicate different kinds of similarity or coherence. If two reports have plausible time stamps but fail to corroborate each other, there may be a) bad information in the system or b) two observed targets rather than one at different times. A dissonant tone warns the user from overlooking the potential inconsistency. (For more see here.)
6) Transparency in real or implied 3D data volumes can allow exceptions to stand out more clearly. These approaches can score well on several of Tufte’s implied indices. In 2-D, transparency preserves the baseline information.
7) Time can be manipulated via sliders and other intuitive tools, effectively creating animations. True data richness, as in this example from the Boston Federal Reserve Bank, is well served by easy comparison across time and county, instantly obvious navigation, subtle but clear use of color for information, and appropriate scale: doing such a tool on a national level would be unfeasible and lose appropriate granularity.
There’s no shortage of activity, samples of which can be experienced at Flex.org, Visual Complexity, or this IBM site - some work is truly stunning, and global centers of design leadership are emerging. Even so, the fundamental tension quickly becomes evident: words like “galleries” suggest that we are viewing works of art, and in many instances the work should be in museums. But art by definition is unique; visualization needs to be brought to the masses of managers, citizens, and students who have something to say but lack the tools, grammar, and training to create the beautiful. In short, the task is to help high levels of information visualization migrate from the artist to the worker.
This task is deceptively difficult: on screen, even more than on paper, it is far too simple to use both desktop tools, such as the ubiquitous Excel, and enterprise “business intelligence” packages to create bad information displays. Going forward, the task will get harder even as it becomes more necessary.
Why?
Several factors are responsible. First, data is generated by more sources and available to more users every year. “Data glut” may be a cliche, but tools such as search can intensify it: Google recently announced that a trillion web pages had been indexed. For context, if each of the 32 million books in the Library of Congress averages 300 pages, that’s less than 10 billion physical pages, and these individual units reside in nothing resembling a unified, organized, searchable repository.
More important, the task of data visualization is difficult because good displays must create spatial representations of non-spatial data. This is not new: linear representations have conveyed time for millennia, and pie charts have become handy shorthand for subsets of a whole. Good maps remain the gold standard, but enjoy the advantage of being a spatial representation of, well, space rather than something less tangible. Consult a UK Ordnance Survey map, or a fine 19th-century sample from any number of countries, and compare the quality to the non-spatial representations we encounter every day: USA Today visuals, executive dashboards, or owner’s manuals. In most cases, the antique remains superior to the modern.
Going forward, information architects are challenged to create readable, repeatable conventions for such abstractions as risk, intellectual property (patents are a poor proxy for human capital, for example), and attitudinal information such as customer satisfaction. Semi-arbitrary lists of text-string matches remain hard to make visual: concepts are notoriously difficult to map spatially, in contrast to the elegance of the periodic table of the elements, to take a classic example. Current social network maps, especially those of large social graphs such as Facebook, quickly grow useless, as this example illustrates.
Color presents a further difficulty. Even outside a visual context, meanings are inconsistent: operating a business in the black is good, but a black mark on your record is bad. A person green with envy, or looking slightly green on a cruise ship, lies conceptually opposite from a green-lighted script in Hollywood; an environmentally conscious activity is another matter entirely. In displays, the situation is worse yet as colors seldom hold stable meanings. Color-blindness is a further fact of life overlooked by many applications.
Given all of these challenges, it’s important to get things right. Human powers of pattern recognition remain more formidable than anything powered by Moore’s law: ask a 5-year-old to find objects in her toy box that belong on a dinner table and she’ll likely outperform even laboratory-grade artificial intelligence. In the face of the information volumes noted above, rising at an accelerating rate because of video, and given the need for more decisions in shorter times than ever, humans need the augmentation that good displays can provide.
How?
In his book Envisioning Information, Tufte suggests five tactics for increasing information density and “escaping flatland” – conveying more than two dimensions of meaning on paper. These are:
-Micro/macro readings (relating both wholes and parts as distinct entities)
-Layering and separation (often by use of color and graphic weight, as in a technical drawing)
-Small multiples (to show often subtle differences within elements of a system: a good lunar chart is an example)
-Color and information (sensitivity to the palette as color labels, measures, represents reality, and enlivens)
-Narratives of space and time (compressing the most powerful human dimensions onto flatland).
For all of the wisdom in these suggestions, and the beauty of Tufte’s examples – it’s no accident he’s both a statistician and a working artist – good information visualizations remain rare. For information to convey meaning in standard, predictable ways, we need tools: “tools” as in grammars and lexicons rather than more software widgets. (A noteworthy effort that appears to be directly in line with this need is Leland Wilkinson’s The Grammar of Graphics (New York: Springer, 2005).)
Some precedents may be useful. The history of sailing and shipping is rich with examples of various parties agreeing on conventions (port and starboard do not vary in different countries the way rules for automobiles do) and solving problems of conveying information. Container ships interlock regardless of carrier while being handled at countless global ports. The Beaufort wind scale arose from the need for agreed-upon metrics for measuring wind aboard a ship, a matter of great practical importance. Even today, with satellites and computerized navigation systems, a Beaufort 0 (“Calm; smoke rises vertically”) is the same around the world, while a 12 (“Air filled with foam; sea completely white with driving spray; visibility greatly reduced”) spells disaster no matter how fast the hurricane winds are actually blowing.
Closely related to navigation is weather. From early tabular and graphic representations of temperature and precipitation until 1982, when USA Today made a full-page set of color maps and tables a trademark of the upstart publication, tools for understanding weather and climate have helped lead the state of information visualization. More recently, graphics workstations were overrepresented in television studios as an arms race of weather-casting helped advance the state of the field. The weatherpeople can boast results: compare the number of people who can understand a Doppler radar image to those who can grasp binomial distributions, bid-ask spreads, or treemaps.
Musical notation is another relevant example. Easily transportable, relatively impervious to language, and yet a representation (rather than a reproduction) of a performance, scores have the kinds of conventions that information visualization for the most part still lacks. At this point, good visualizations are featured in “galleries” – as befit works of art. They are created by artists and artisans, not by people who merely have something to say. At the risk of a strained analogy, we are at the stage where latter-day monks painstakingly hand-letter sacred texts, still awaiting both Gutenberg and the typewriter.
As the references suggest, this is a rich field with many fascinating byways and footnotes. For a superb historical overview, see Friendly and Denis, Milestones in the History of Thematic Cartography, Statistical Graphics, and Data Visualization.
Current Directions
There is cause for optimism, however, on several fronts:
1) Hollywood and the gaming market are leading a charge toward effective, practical, and multidimensional visual tools. A quick look at the most recent SIGGRAPH conference program illustrates the overlap as featured speakers come from both computer science powers like Carnegie Mellon and animation houses such as Pixar.
2) 3-D has become a day-to-day reality in architecture, manufacturing, and, again, gaming, and this trickles down to consumer applications such as kitchen design tools. Even state-of-the-art roller coasters are being rendered (how, I don’t know) in CAD for mass enjoyment.
3) Since the release of its Flex version 2 product in 2006 which extended Flash functionality to more programming environments, Adobe has supported the rapid development (in both senses of the term) of visually attractive, data-driven visualizations: search the Flex application showcase and see a wide variety of database-driven shopping, monitoring, configuration, and wayfinding tools. Some are extremely handsome and useful, and even some of the visually “flat” examples possess a high information density.
4) Mapping remains important, and through the release of APIs from the likes of the UK Ordnance Survey, ESRI, Microsoft, and Google, developers can build data-rich geographically-useful tools more easily than ever before. Once again, Flex can accelerate the process.
5) In the labs, more senses are being enlisted in human information processing. Just as force-feedback enhances a driving game, so too can users navigate 3-D data volumes with haptic tools. Sonification is another emerging tool: when two or more elements interact (for example, sensor or observational reports regarding some phenomenon), the user can hear sounds of varying harmony to indicate different kinds of similarity or coherence. If two reports have plausible time stamps but fail to corroborate each other, there may be a) bad information in the system or b) two observed targets rather than one at different times. A dissonant tone warns the user from overlooking the potential inconsistency. (For more see here.)
6) Transparency in real or implied 3D data volumes can allow exceptions to stand out more clearly. These approaches can score well on several of Tufte’s implied indices. In 2-D, transparency preserves the baseline information.
7) Time can be manipulated via sliders and other intuitive tools, effectively creating animations. True data richness, as in this example from the Boston Federal Reserve Bank, is well served by easy comparison across time and county, instantly obvious navigation, subtle but clear use of color for information, and appropriate scale: doing such a tool on a national level would be unfeasible and lose appropriate granularity.
There’s no shortage of activity, samples of which can be experienced at Flex.org, Visual Complexity, or this IBM site - some work is truly stunning, and global centers of design leadership are emerging. Even so, the fundamental tension quickly becomes evident: words like “galleries” suggest that we are viewing works of art, and in many instances the work should be in museums. But art by definition is unique; visualization needs to be brought to the masses of managers, citizens, and students who have something to say but lack the tools, grammar, and training to create the beautiful. In short, the task is to help high levels of information visualization migrate from the artist to the worker.
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