Is the airline industry an example of excessive competition? Friday, Jun 8 2007

Economics divide businesses into oligopolies, monopolies or those in perfectly competitive markets.  Theory doesn’t address excessive competition – markets so competitive that nobody makes any money.  For an example consider the US domestic airline industry. It seems impossible for a carrier to make money for a sustained period, but players never go out of business. Economics says that companies exit markets if they lose money.  

To the casual observer airlines rarely seem to go out of business, but go into Chapter 11 bankruptcy regularly as clockwork. Why can nobody make any money and why don’t these apparently unsuccessful operators get forced out of business permanently?

In fact, over the years numerous airlines have gone belly-up, if you include those acquired by other airlines. The few successful airlines, such as Southwest, have carefully avoided acquisitions, but mergers are fashionable among the incautious. Wikipedia lists more than 200 defunct airlines, including such notables as PanAm (1927-1991), Braniff (several existences) and TWA which lasted from 1930 until being acquired by American Airlines in 2001.  

Clearly there is excessive competition in the airline industry. I think there are two reasons for this. One is an abundant supply of people just itching to start an airline, none of whom have any experience or knowledge in the business. Some do manage to beat the odds, Virgin being one, although they do not operate in the cutthroat US domestic market.  Numerous others such as Trump, Hooters, ValuJet (now AirTran) and Song (merged back into Delta), have been willing to jump into the sacrificial fire. A new entrant, Skybus, is launching the ultra-low fare model made popular in Europe by Ryanair.  I will be extremely surprised if they are profitable, but I expect they will survive several injection of financing from their hopeful backers.  This regiment of entrants inevitably pulls down potential returns.

The second reason for the excessive competition is the apparent willingness of large lenders to the industry to lose big sums of money.  When airlines are in bankruptcy there seems to be an endless troop of banks willing to advance more cash in the expectation a recovery in the industry is just around the corner.   Additionally airline costs are still very high, and bankruptcy is seen as a model for getting down to a lower-cost model that is thought to be a requirement for survival.

This is a fairly miserable situation for the customer.  Employees have seen their pensions go west, so are generally demotivated and surly.  The airlines have no money to spend on planes so the conditions range from down-at-heel to alarming. Operators, desperate to fill seats, offer very low prices to the casual traveler, subsidized by us business travelers, who pack in despondently. 

I am waiting to see the emergence of small, business-only flights on domestic routes.  If this happens then the big carriers will melt away like summer mist, taking a fortune in frequent flyer miles, but otherwise unmourned.

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The Changing Economics of Atheism Wednesday, Jun 6 2007

The great advantage of an organized church is that it can develop and maintain a reliable income stream. Listen to any evangelical radio station or read the novels of Anthony Trollope and you quickly realize that money is the chief preoccupation of the church leaders. Finance gets a lot of time and attention in churches, managing it and to making sure it continues to flow in. Atheism has no such institutional advantages. The problem with atheism is that there is no money in it.

Several organizations exist for the propagation of atheism, but since the obvious advantage of atheism is that you can stay in bed on a Sunday morning, there is no clear mechanism for raising funds. Atheists don’t gather where they can be exhorted. For the cynical who believe that evangelical organizations are established at least in part because of the power and influence that accrue to the founder, it might seem that the same motivation should inspire a guru of non-belief to start a non-church. This might be a little too obvious and blatant. Even if it were successful in generating cash flow, what would an atheist organization do with the money? All you need is to support a few web developers.

I suggest this is actually a problem for society. Atheists are invisible. There is no organization that a TV station can call upon to defend the interests of atheists when someone like former President Bush says that atheism is incompatible with being an American – something that he would not have considered saying about any other minority. Since nine percent of Americans describe themselves as atheists, this would appear to be a large amount of people to antagonize. Another problem with this invisibility is that the average person can be lead to believe that an atheist is some kind of crazed neo-Marxist hiding in the woods, probably making pipe-bombs.

All this has shown some signs of changing in recent months with the publication of several books by atheists that have received a lot of publicity. Christopher Hitchens’ God is Not Great is the most recent one, hotly following The God Delusion by Richard Dawkins and Letter to a Christian Nation by Sam Harris. Sam Harris is notable for having been catapulted if not into fame at least notoriety by his book.

Suddenly there are some spokesmen for atheism who come across as being reasonable beings, somewhat passionate about their non-beliefs, but otherwise quite normal. In Hitchens, the cause has a formidable, polished and assertive debater, who reduced Sean Hannity to incoherence in a recent discussion.

Society now effectively enriches people solely for their adoption of atheism as a personal creed, which has not happened before, at least not to this extent. Atheists may regret that two of these authors appear to be definitely non-American (which might be viewed in some quarters as bolstering Mr. Bush’s opinion), although Christopher Hitchens has recently become a US citizen.

What happens next? If non-believers are really as much as nine percent of the population, then it would seem that politicians cannot ignore them indefinitely. Historically a minority is ignored as long as there is an unspoken agreement between the two parties to do so. Typically, a politician will break ranks when he or she reckons the advantage to be gained is worth the potential dismay among existing supporters. Eventually the cause of the minority goes mainstream and both parties battle for their vote, with the advantage usually going to the original champion.

There is no sign that atheism will get the nod from anyone, judging by the tone of the presidential nomination debates. But that could change, especially of someone emerges as an articulate spokesman for non-believers at large.

The biggest problem for politicians who might want to court the atheist vote is how to address it. After all, on Sunday morning atheists are all in bed.

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Why do some people resist science? Wednesday, May 30 2007

Here is an interesting article, on a site called Edge that I got to from the excellent Arts & Letters Daily, that explores why some people find scientific ideas so difficult to accept. It is worth reading the entire article, but one conclusion is that on the whole scientists do not enjoy much of a position of authority in modern America. Consequently, when scientists pronouncements go counter to generally held, intuitive, but completely wrong ideas about the role of design in the origins of life, people tend not to give science much credence. The authors demonstrate that this extends to simple misperceptions about how objects move, a field that is subject to a level of objective proof.

An unwillingness to accept blatant appeals to authority sounds somewhat healthy, but this is a selective unwillingness. What puzzles me is that the authority of preachers and politicians seems able to trump that of scientists. This seems to be peculiar to this country and according to the authors, accounts for why the theory of evolution is accepted by only 40% of the adult population in the United States. Of 34 countries sampled only Turkey has a lower percentage.

I wonder has this always been the case. If this is a recent phenomenon, what caused it?

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The Creation Museum – the implications for the rest of us Wednesday, May 30 2007

There has been much commentary about the Creation Museum, an institution which opened recently in southern Ohio, but little has been said about what this implies for economics, science, business and society at large.   

At one level it is all somewhat encouraging.  Clearly a determined person can get almost any enterprise off the ground in this country.  Whether there will be a market for this is less certain, but if there is it is perhaps another small victory for private enterprise. 

Less facetiously, the emergence of this museum and the degree of publicity it has received both nationally and internationally is worrying.  The people who are responsible for this are trying to assume a mantle of scientific respectability, and this is bad for the rest of us, even if, as will surely be the case, their efforts will be entirely fruitless.

If one had any doubt about the desire by the creationist wing to put a scientific stamp on their beliefs, the Creation Museum should settle the question. Behind this costly effort is a desire for acceptance.  Creationists don’t seem to want the recognition and respect of established scientists, on whom they regularly pour scorn.  Instead, they seem to want acceptance from the public as representing legitimate scientific thought. 

Before going any further I should first declare my colors: I am entirely sure that creationism is an essentially religious belief.  The young earth variant of creationism as espoused by the founders of this museum is contradicted completely by a vast body of unconnected scientific evidence.  No reasonable, well-educated and intelligent person doubts this, and no serious scientist gives literal creationism any credence whatsoever. So at one level, the whole thing is a bit of a joke. The museum will have no effect on accepted scientific ideas.  The only people who will emerge convinced by this depiction of the origin of life will be those who know absolutely nothing about the accepted explanations – the scientific illiterates – or those who are familiar with those explanations but dismiss them on religious grounds, i.e. the zealots. 

Nevertheless, what bothers me is the advance of the idea that what one believes is more important than what is actually the case.  This entire venture is the diametric opposite of pragmatism, and pragmatism is what we need much more of if economies and societies are to progress. Given that a majority of people in this country believes that the fairy-story portrayed by the Creation Museum is broadly correct, the picture is quite bleak.  When it comes to issues of what used to be called political economy, where is this majority going to side?   Not with the facts and the data, you can be sure. This is a manifestation of a tendency to abandon real experience and objective data in favor of a system of belief, a system of economics, for example, as the believer wishes it to be, not as it is.  This negates the credibility of the professional who has made a life study of a subject, whether that might be economics, geology, biology or genetics.  In fact, I wonder why someone would really want to go into any demanding technical field if any new ideas that might be developed can be trumped by this faith-based, ideological way of looking at the world. 

All good business people, all great economists and scientists and all effective politicians are pragmatists and empiricists.  The world is the way it is, notwithstanding any theological mindset we bring to trying to understand it.   If we want to affect any useful change we need to accept things as they are, not as we would like them to be.   This is the defining characteristic of reasonable people. 

Down the other way lies chaos, turmoil and ultimately a type of self-destructive individual and collective deceit that will drive civilization back, not forwards.

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Revaluation of the Renminbi – why it won’t happen Saturday, May 26 2007

The recent meeting between China and the US was used as an opportunity to put pressure on China to allow their currency to revalue upwards. The theory is that this will lower the US-China trade deficit, and reduce the US political pressure to impose trade sanctions against China. This is mostly incorrect, and this pressure will not be effective. Indeed, the trade surplus with the US is a by-product of the Chinese currency policy.

If the renminbi were to float upwards there would be some reduction in demand for Chinese-manufactured products, but the cost differential between the US and China is so large that I doubt that this would be significant. Certainly, US goods imported in China would become relatively less expensive. However, the flood of Chinese imports into the US would continue, since there would still be nowhere else that produces a comparable range of products. Since prices would now be higher the deficit could potentially go up.

The Chinese government wants to keep the renminbi low for other reasons. The exchange rate has a big impact on the return on foreign direct investment into China. If a company has made an investment at one currency rate, an uptick in that rate reduces the return. More importantly to the Chinese government the number of companies willing to invest in China may fall if the return on future investments goes down. It’s hard to know what proportion of companies investing in China is making money. Given the flood of investment this is surely the majority, but there some definite losers, and a great many may be profitable but marginally so. If the cost of operating a transplanted facility in China increased significantly then the investment cost in dollars or euros would rise and the return would fall. Given that China has 25 million new entrants to the labor force every year, maintaining direct foreign investment is a huge priority, because indigenous industry is probably still incapable of absorbing this number of new employees. Keeping the flow foreign investment intact is much more important to the Chinese government than keeping Washington happy.

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Nicholas Kristof’s Factory of the World Thursday, May 24 2007

See Nicholas Kristof’s video on the New York Times site today for an interesting slant on manufacturing conditions in Guangzhou province.  He makes a point, related to myone below, that we can no longer even view the garment factories in SE China as being sweatshops.   Conditions, pay and the level of opportunity have risen dramatically.  Much of the concern in the US about worker’s conditions in these places does not rest on entirely pure motives…

 

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Travel segments – Shenzhen Thursday, May 24 2007

I have just walked across the bridge in Shenzhen that separates China from the Hong Kong Special Administrative Region, and boarded a train going south. 

The level of formality required to enter the SAR from China remains surprising.  The  crossing is no longer manned by the military and the officials on both sides are friendlier than in the past, but this place remains very much a national border. The formalities include arrival and departure cards, passport and customs inspection on both sides and a change of currency.  By comparison borders in Europe are invisible.

On my first trip to Shenzhen in 1994 I visited a plant manufacturing outboard motors.  The assembly area was a series of stark, connected rooms. Bare concrete walls streamed with moisture.  Workers in rough overalls hunched over tables assembling the motors using simple tools.  Labor was obviously so cheap that any investment in productivity was clearly pointless.  The factory worker accommodation outside in the courtyard was equally unappetizing.   Back in the city, massive road-building projects were underway, again with an almost total absence of equipment.   Rows of laborers with the iconic straw sun hats, stripped to the waist, were building highways using shovels and manual labor.

Today I was with a medical equipment supplier headquartered in Shenzhen.   This local company produces its own line of high-technology equipment for the global market.  The showroom displayed products clearly designed to modern aesthetic and ergonomic standards. The operation was indistinguishable from any similar enterprise in a western economy. Revenue per employee was just under €100,000, low by western standards, but this is clearly as far from being a sweatshop as you can get.   I suspect a low profile partnership with a major western player in the industry, but the current organization is entirely Chinese.  The customer is buying custom components wanted to talk about quality and technical partnership as well as cost. 

The city is now utterly different.  It has a modern road system, plentiful parks and a crowded skyline. There is something of a sense that everything went up yesterday, perhaps accounted for by generic modern architecture but it is nonetheless impressive.  The change in infrastructure and the quantity and diversity of new buildings is remarkable enough, but the real achievement is to have developed a globally competitive indigenous industrial base in such a short period of time.   This isn’t another gloom and doom whine about China’s rise – concerns that are greatly overblown – more a respectful raising of the hat to a society developing at an almost unimaginable pace.

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China’s Blackstone Investment Monday, May 21 2007

See Jonathan Stempel on Blackstone’s IPO. It is hard to say which part of this deal is the most brilliant. Obviously the IPO is very strongly anticipated but selling a $3bn to China’s state investment company helps the process along. The deal also indicates to Blackstone’s rivals that the firm has tapped into a new source of funds to continue the private equity spree. (A condition of the deal is that China is prevented from making a similar investment in Blackstone’s rivals for a year). For China, this gets them into investments in the global stock markets without having to front deals, a process that has been shown to generate significant backlash. It also recognizes that for China the global markets are now the most attractive investment avenue. Currencies are going to offer a lot of risk, and the bond market is looking at interest rate upticks. This message, that the Chinese trade surplus is going into stocks, is good for the market, which is good for IPOs, which is good for Blackstone’s IPO in particular….

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How often do you think about your personal finances? Sunday, May 20 2007

Here is a little question to ask yourself. How often do you think about your personal finances, income, investments and expenditures? 

I have a colleague who admits to calculating his net worth daily using Quicken, which seems not only a little unhealthy, but frustrating since presumably the daily changes are very small. On the internet we frequently see short money management articles and it is tempting to click on these either in the hope of either learning something useful or demonstrating to oneself that one is now beyond needing this kind of advice. In other times, unless one is a Buddhist monk, (and maybe even then), I suspect that we think about our own wealth, or lack thereof, pretty often during the day, if only in a glancing way. It’s a little materialist stream of consciousness in the background: “Wonder what the raise pool will be this year. Payday tomorrow, FICA deductions should be over soon. There’s Jerry – wonder how much he makes? Can we afford to go to Europe again this year? Be nice. Pity about the dollar, though. Should probably do it again before the kids leave home. That last Visa bill was a nasty one – time for another family conference – I’m not made of money (although I do ok, probably a good deal better than Jerry if the truth were told. I think.)  If the kids get into Cornell it will be another story, though. Belt-tightening all round. The Beemer goes past 50k miles soon, no more free services. Maybe I should get a new one before tuition starts. Probably a bad idea, though. Market’s up today, should look at my portfolio again or did I do that yesterday? Oh, here’s another article on getting to your first million. Wonder what the raise pool will be this year…”

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The Illusion of Abundance Wednesday, May 16 2007

Despite what economists will say, there is an iron law about the provision of goods and services that says there is only so much good stuff to go around. Economics predicts that as demand for a good rises, so will price, causing the supply of the good to increase, bringing more to the market at a higher price. This encapsulates the promise that we can always have more of what we enjoy. For anything that truly matters this is not so.

While we can continue to consume more of anything, the problem is that most goods become inferior as their production and supply is scaled up. To produce a lot of anything, the means of production must become industrialized. In many cases the consequence is a fall in the quality of the good being produced. While we usually can buy more, the value of the experience tends to go down. If you don’t believe this, eat at any chain restaurant. These establishments have perfected the mechanized production, preparation and delivery of food. Portions are massive but the experience is mediocre.

Current house construction is another example. The demolition of a modern house is a revealing sight. It requires shockingly little effort to reduce a contemporary building to rubble. Find a place in a new house where there is no brick – usually not too difficult – and you can drive a car through the exterior wall at modest speed. You probably won’t even get hurt. Building techniques that make houses less vulnerable to hurricanes and tornadoes are well-established; the problem is that they cost too much, so are never applied. More accurately, we are told they cost too much.

Visit a Wal-Mart or K-Mart and marvel at the variety of useless junk on display. Here is an apparent wealth of goods, made in the cheapest manner and displaying the smallest possible amount of good design. Further up the economic chain, in stores furnishing apparently higher-quality goods, the situation changes but doesn’t always improve. Often, one sees equally poor-quality goods, packaged more expertly, and advertised more expensively.

There are occasional islands of excellence in this landscape. Automobiles from Europe and Japan truly show higher quality than was historically the case, while being made on an industrial scale. Target is a mid-priced store that is genuinely trying to offer products that are better designed and manufactured. However, more generally, people continue to expect to be supplied the lowest common denominator at the poorest quality they will accept.

As with products, experiences seldom scale up satisfactorily. If you liked visiting a foreign country, you will enjoy doing so far less when the experience becomes mass-marketed and homogenized. Cable television provides an endless list of channels, but there is a limited number of talented programmers, whose work is now more difficult to locate amidst the dross.

From time to time and in certain arenas, people do rebel against this tyranny, although in small numbers. In many localities one can find more good cheese, decent beer and artisan bread, albeit at a steep price, than ten years ago. The existence of these goods supports my argument and also shows that inflation, corrected for reduction in quality, is much higher than we are led to believe. The market for truly scarce goods such as fine art and prized real estate reflects reality, as prices soar in response to limited supply.

Unfortunately we are unwilling to suspend consumption when faced with products on offer that have made the transition from inexpensive to truly cheap.

How should we respond, as producers and as consumers? As producers, we need to realize that when a good becomes commoditized nobody will make any money producing  it or derive much satisfaction from its consumption. We need to invest in solid brands conveying specific attributes that we adhere to and carrying guarantees of performance. We need to embrace the educated consumer and be willing to participate in third party organizations that furnish objective information to the market. We should accept that progress may mean producing less of our product but making it better and longer-lasting. We need to invest in producing superior products that will require less advertising and marketing inducement to attract buyers.

As consumers, we should ideally be prepared to spend our money only when we see something genuinely good on offer. We should be willing to keep goods we buy for longer periods of time and be prepared to buy fewer of them at higher prices. It isn’t easy to do this, but we have to get in the habit of demanding variety and quality and be prepared consume less. This doesn’t mean that we become self-sufficient small farmers; it simply means that we insist on better goods. We should insist on better-constructed, smaller homes, especially where we must cope with the threat of catastrophic weather conditions. We must put more knowledge and time into the process of buying. Above all, if the market doesn’t provide what we seek at the quality we want, we should buy nothing.

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