Monday, November 12, 2012

“A Skeptic’s Optimism”

Sydney M. Williams

Thought of the Day
“A Skeptic’s Optimism”
November 12, 2012

The election is over, and in less than two months it will be 2013. Of course there is the “fiscal cliff,” but I worry less about it than others. If we go over the top, it will force those on both sides to deal with the consequences. The worst part will be the finger pointing, but actions will then have to be taken. Necessity, as Plato once wrote, is the mother of invention.

Our economy’s anemic growth, which resembles the pace of a tortoise rather than a hare, can be ascribed to a government unable or unwilling to unleash the economy’s innate animal spirits. But, it also reflects society’s focus on immediate satisfaction at the expense of the long term. But beneath all the ‘gotcha’s’ are the rumblings of change – a desire to move forward. There are things happening which causes a skeptic to be skeptical of his pessimism.

An article in the November 2nd issue of Forbes is not only instructional, it is inspirational. Khan Academy founded three years ago by 36-year-old Salman Khan and with 36 employees, is now the largest school in the world, last year serving 10 million students. At a time when our public schools are producing, at best, mediocre results and our universities are graduating students laden with debt, and with degrees unsuited for today’s job market, innovation and competition are welcome in the critical field of education. On-line learning is available through many universities and their offerings are being snapped up. Last spring, for example, a single (and as Forbes describes it “rather difficult”) electrical engineering course from M.I.T. attracted 155,000 students. To put those numbers in perspective, M.I.T. has a total student body of 10,894 on their Cambridge campus.

In a recent New York Times article by Clayton Christensen, the point is made that there is a surplus of capital, but a scarcity of new skills. He cites the levels of corporate cash, the amount of money in money market funds and today’s extraordinary low interest rates. He also notes that, because of perverse investor demands and an antiquated tax policy, time horizons have been shortened. Wall Street analysts are focused on next quarter earnings. Rapid trading strategies have been designed to help small groups of speculators make large amounts of money, but which do nothing to help the economy. Students are provided Pell Grants and subsidized loans, and then graduate with skills and majors that employers cannot use. Capital is cheap; and it should be used toward fields that offer an increasing number of jobs – STEM (science, technology, engineering and mathematics) jobs. Mr. Christensen also argues persuasively that the capital gains tax should be regressive over time. For example, taxes on short-term investments might be taxed at personal income rates, but that “tax rates on investments held for five years might be zero – and rates on investments held for eight years might be negative.” He is right, in that the times demand radical changes in tax policy.

While Washington can either hinder or boost economic growth, the fact remains that the human being is an incredibly adaptable species. Aspiration, the desire to succeed, is a strong component of our makeup and is non-political. In a search for opportunities, there are a few that seem possible, if not probable.

One is the silver lining I have referred to in the past: the fallout from Wall Street’s woes. (It is also a subject of a piece in the October 31st issue of the Financial Times, by Gillian Tett, entitled “Banking may lose its allure for the best and the brightest.”) As the 1980s began, Wall Street was on its back. Stocks had peaked fourteen years earlier; inflation and interest rates were at record highs; confidence had evaporated, both in our political system, as well as in our markets. The problem was resolved when Paul Volker and Ronald Reagan teamed up to kill inflation and jump-start the economy. Sky-high interest rates created a sharp, steep, but short recession; but it laid the ground work for extended economic growth and the longest bull market in U.S. history.

As a consequence of technological advances, Wall Street became increasingly addicted to using computers to model myriad trading-desk scenarios. Their success changed the nature of the securities business from a client-centric business to one with a far greater focus on proprietary trading platforms, using a variety of algorithmic programs. Math graduate students from leading universities went to Wall Street where their trading models produced enormous bonuses for them and huge profits for the firms for which they worked. But they altered the traditional role of Wall Street, which was to provide capital to companies in need and a means by which investors could buy and sell securities. Additionally, the promise of riches seduced a generation of math and engineering students away from what might have been more productive careers.

The consequence was a financial industry that grew far more rapidly than the rest of the economy over the following three decades. In 1980, the finance and insurance industries represented 4% of U.S. GDP; by 2010, that had grown to 8.4%. It is my sense that we are reversing that trend – that more math graduate students will return to industry or academia. Academic studies support that conclusion. Pressure has been put on educational institutions to produce more STEM jobs. There are currently about 2 million such jobs in the U.S. However, the U.S. Bureau of Labor Statistics (BLS) expects there to be 9.2 million such jobs by 2020.

Neil Gershenfeld, a professor at M.I.T. has a fascinating essay in the current issue of Foreign Affairs entitled, “How to Make Almost Anything.” His essay complements a book I have discussed before, The New Industrial Revolution by Peter Marsh. What Professor Gershenfeld discusses is, for the most part, over my head, but, nonetheless, interesting. He writes of digital fabricating machines that have the ability to turn data into things and things into data. As I understand it, designs produced at one location, including one-offs, can be fabricated anywhere. He forecasts: “Integrated personal digital fabricators comparable to the personal computer do not exist, but they will.” The professor notes that the goal of personal fabrication is not to make what you can buy in stores, but to make what you cannot buy. He writes of the launch by the Fab Academy of a fab lab network, which he describes as being somewhat akin to the Internet. It will help bring educational and research facilities to millions of people around the globe, those unable to attend a physical institution.

Just because we cannot envision the future does not mean it will not happen. In 1977, Ken Olsen, founder and CEO of Digital Equipment, made his infamous prediction: “There is no reason for any individual to have a computer in his home.” Things changed. Digital Equipment is no more and, according to Wikipedia, 2010 global shipments of personal computers were 350.9 million. Professor Gershenfeld suggests that the killer “app” in digital fabrication will be personalization – the production of products for a market of one person. There are of course risks, which he enumerates, like the individual who chooses to make weapons. But the possibilities are endless.

Garry Kasparov and Peter Thiel (founder of PayPal) had a cautionary op-ed in last Friday’s Financial Times about technological progress. They write that in the past forty years “the world has retreated from a culture of risk and exploration towards one of safety and regulation.” It is a concern of mine as well. A culture encouraged by a government more interested in protecting consumers than in fostering individual innovation is one that will produce fewer risk takers. Washington should heed their warnings.

Another significant and unexpected development has been the recent discovery of recoverable natural gas in shale rock formations in the United States. That gas, plus the availability of oil from Canada’s Athabasca Tar Sands (and what the U.S. has offshore,) provide the potential of altering our dependency on the Middle East and South America. It is possible that U.S. and Canadian environmentalist groups may nix both programs. But, for the first time in the post-War era, the United States has the potential to become either totally energy self-sufficient or, at least, dependent on North American sources. In fact, the IEA has forecast that the U.S.’s oil production will exceed that of Saudi Arabia by 2020, according to a Bloomberg report this morning. That independency will do wonders for our ability to compete globally. Of course, it is not only environmentalists that prefer we pursue wind and solar; it is also oil producing nations, from Russia to Iran to Venezuela. The oil we buy from them helps keep the price high.

There are other industries that should be recovering and that should help drive economic growth. The peak in the housing industry occurred five and a half years ago. Since then, the country has been absorbing an overbuilt inventory of houses. But population growth adds about 3 million people per year, suggesting the country has grown by a little more than 15 million since mid-2006. A ratio of about three people per household would suggest we have absorbed most of what had been overbuilt, allowing the industry to continue to expand, at least in line with household formations. In July it was reported that the average age of the 245.5 million passenger cars and trucks on U.S. roads reached a record 10.8 years. Anecdotally, it seems to me that cars are better built than they were three or four decades ago, but still ten years is ten years, and fewer cars will be sold in 2012 than in 2000, when there were thirty million fewer Americans. And third, the infrastructure of our roads, bridges and our electric grid (as we on the East Coast know so well) are badly in need of repair and/or replacement. Opportunities abound.

We cannot ignore politics. Restrictive regulation dampens the animal spirits necessary for innovation. And the tax code should be dramatically reformed, as Mr. Christensen notes in his Times article, to encourage long term investing. Tax rates should be lowered, broadened and simplified by limiting deductions, so that the wealthy can no longer take advantages of loopholes. The same should be done for the corporate tax code. Government must recognize and encourage the risk-taking of individuals that drives economic progress. While care for the environment is critical for all of our well-being, we must acknowledge that environmental concerns are a luxury of a wealthy society; so we must be sensible in not permitting progress to be unnaturally impeded. And finally, we must address the sword of Damocles that hangs over our heads, in the form of entitlements. Left unreformed, they will sink our state.

Mr. Obama has a unique opportunity to unleash this latent economic growth, struggling to be free. If he does, we will all benefit, and his position in history will be secure. If he does not, growth will flounder and the poor will become poorer. It will be then left to a future Administration to reap the benefits of economic growth. But growth will reassert itself at some point; it remains to be seen if it occurs on Mr. Obama’s watch.

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