Gill Eapen's Blog, page 80

Invest, not cut

Politicians from all persuasions are on a cutting binge – everyone is trying to out-cut the other as the deficit continues uninterrupted and the debt, spirals out of control. The infamous "credit rating agencies," - the same ones who found nothing wrong with companies who went bankrupt a few months later and rated worthless securities, investment grade - even downgraded the US debt recently. In the panic of debt reduction – some have also proposed a "debt ceiling," something akin to committing suicide when the debt hits an arbitrary preset threshold.

All of these are good theater – for politicians, credit rating agencies and the press. The press loves it as it allows them to take something that sounds simple such as "debt" and create public frenzy around it. "Ratings," after all is highly correlated with such magical analyses. For the politicians, it allows grand standing – in the chambers of the congress and the unemployment ravaged cities around the country. They want to reduce deficit at any cost and they sob at the lack of morals of the present generation, who robs from the next. They provide statistics – how much debt is already present for every individual in the country already and how much more is added every day, week and month. Cutting, is what everybody wants – some want to cut taxes and others spending. Some want to stop military spending and others research and development. Some want to stop "social programs" and others "secret programs." Whatever it is, cutting, appears to be the dominant policy tactic. Cutting is an easy exercise – it is easy to understand and we have already graduated many, who are extremely adept at this activity, from the world's greatest education institutions. However, no country, organization and company has become great by cutting. Reduction of debt can only be accomplished by investing into the future. Selecting, designing and managing investments optimally, however, is more difficult. Unlike hedge fund managers who go in and out of securities every minute or investment bankers with pocket calculators for M&A, these take different skills.

To make matters worse, there is also a question of who should invest on top of what to invest in. Governments have to invest into areas that will create discontinuous innovation – areas that cannot attract private capital due to market failures. These include energy, healthcare and education. Successful investments and resulting innovations in these areas can wipe out the debt in a few years. Governments, however, should step aside from any areas that is already attracting (or can attract) private capital, as such public investments crowd out private investing. Just as the financiers and accountants have led many successful industries to the brink of extinction by cutting costs and people, the debt hawks have sharpened their pencils to do the same to the country. Their fans in the press are fanning public opinion in this direction as well with disastrous consequences.

Today's policy makers and their handlers are ill-equipped to make policies for the future. It is time we replaced them with those from a relevant generation with appropriate education and skills.

Creative content of society

The ratio of the level of effort expended by society on activities such as art, philosophy and cosmology – endeavors with no direct practical benefit - to total effort can be characterized as creative content. Since this is a ratio, it can decrease if either the numerator (effort in creative activities) decreases or the denominator (total effort) increases. It may be interesting to measure this over time as this may be a proxy for the evolution of societies.

Early in their history, there is evidence that humans engaged in creative endeavors such as art and story telling. The capacity of the human brain allowed conceptualization and abstraction. As they settled down through agriculture, an era of practicality and good living, the total effort increased dramatically. Although creative efforts also increased, the net effect may have been a decrease in the ratio. Later, industrial revolution allowed societies to lever up, dramatically increasing total effort resulting in a significant reduction in creative content. This trend continued for the past century with increased productivity from application of technology for practical living.  Associated increase in leisure, however, has not been invested in creative endeavors sufficiently, leading to a continuous decline in creative content.

This basic metric may also be studied in subsets such as the rise and fall of cultures and countries. A decrease is creative content beyond a threshold may trigger a long term decline and eventual death in such human systems. Sustainable cultures and countries may need a stable level of creative content, without which they lose perspective and wither away. Technological progress, as measured by efficiency gain and related increase in total available effort, is not a good measure of advancements or sustainability. A more important measure is how much of the available effort is diverted into creative endeavors that nurture the essential aspects of the human system.

Business education redefined

The US has always led the business education in the world with hundreds of schools across the country providing good enough general education to the masses. In many emerging countries, till recently, business education was considered inferior to most other professions – medicine and engineering, typically taking top spots. Business is something people considered if they cannot become true professionals or scientists. This cultural nuance has held some countries back as they created engineers and doctors in excess supply, while significantly under producing people who can create and run companies to employ the educated.

The process in the US is not without its faults, however. Many business schools in the West take pride in their ability to create leaders, who then go out and change the world. Statistics show this has not been the case. Over 80% of the value in the economy is created by less than 20% of all the companies and most of the high fliers are not created by people who had a traditional business education. Many of them dropped out of school and followed a dream – unconventionally. On the other hand, those from top schools with near perfect grades generally went to work for investment banks or consulting companies, the former has been a destroyer of wealth and the later a minor influence on the economy. This should be a troubling observation for most business schools, especially those rank high in the list.

Why are business schools mostly producing those who are unable to make a significant contribution to society and the economy? Is there something systematically wrong with what has been taught in the class rooms? Are these schools doing a disservice to the next generation of leaders by pumping up their ego and then letting them fail? These are important questions for every school and more importantly for the top dozen, who take exceptional pride in their rankings by various magazines and market research firms. Such rankings and surveys consider extremely tactical metrics such as jobs and starting pay. This is consistent with what may have been taught in the program – how your stock price moves with your quarterly EPS and how to nourish the stars and kill off the dogs. These are archaic notions of business and most schools are caught in a time warp – without themselves noticing it.

The mark of a great institution and exceptional education is the contributions of its graduates to society overall. If their curriculum is producing thieves and liars, just introducing a course on ethics is not going to correct it. They are misdiagnosing the problem as a lack of "ethics education." The real problem here is the overall design of the program – a focus on financials, efficiency and organizational designs from the industrial revolution. These programs create people who can count well and improve efficiency by fine tuning processes. They believe value is created by dressing up financial statements and cutting costs. But these skills are irrelevant for the future – we have moved on. The economy is not driven by oil, automobiles and retailing. The future is shaped by those who can innovate and if business schools do not teach these skills, they might as well close their doors – as they are doing more harm than good.

Ref:  Flexibility : Flexible Companies for the Uncertain World http://www.crcpress.com/product/isbn/9781439816325

ROI of happiness

A recent article 1in Science establishes what has long been known to be true – happiness increases health and longevity. This intuitive and accepted observation may have significant implications for policy and societal design. If an individual's happiness increases her health that has a positive contribution to productivity and aggregate utility of society. On the other hand, longevity may have conflicting effects if the additional time results in a demographic shift toward older people, who are presumably less productive, that may drive down average societal productivity, to the consternation of the young and restless.

Before one can analyze the net effects of individual's happiness on overall society, one has to first define the process by which individuals get happy. Modern religions generally support materialism and power as good attributes – thus providing the foundations of current notions of happiness. Earlier, ancient organizations have attempted differing ideologies – some attempting to optimize societies without consideration for the individual and others defining the objective functions of individuals differently with forecasted beneficial effects on the society. Neither has been robust enough to dominate. On the other hand, systems based on individual's ability to make decisions for her and the society, have not been exceptionally effective either – perhaps because the current examples are not pure or because the individuals' notion of happiness is inefficient. Further work is needed to define the origin of happiness but that should not deter us from thinking about systems that could take us in the right direction.

Past experiments have shown that systems with top-down designs are unstable – as they quickly deteriorate into corrupt autocrats and governance bodies – made up of a small number of individuals optimizing locally. So, the stability of the system that provides the best opportunity for the maximum number of participants to seek and gain happiness, is a minimum requirement for favorable designs. Assuming stability is available, designs that maximize the number of people with non-zero probability of achieving happiness, may be dominant. Finally, systems that maximize each individual's ability to gain happiness are the best.

Societal designs, should, at the very least, consider stability (time available to achieve happiness), engagement (share of participants seeking happiness) and ability (probability of an individual attaining happiness) as building blocks. These designs will take investments  and a return on investment (ROI) can be forecasted and measured – allowing possible comparisons of available choices.

 

1. Warwick Business School, University of Warwick, Coventry CV4 7AL, UK and Department of Economics, University of Zurich, Wilfriedstrasse 6, 8032 Zurich, Switzerland.

Free wisdom

A new career was born when the stock market crashed in 1987 – predicting the next crash. This is a sure bet. There will be another crash in the future – it is as certain as the sun becoming a red giant in about 5 billion years from now. Crashers are brave fellows and they are consistent with their message – the crash is always in the future unless it is now. They predicted the Dow will crash to 2000, when it was 8500, they predicted the market is "dicey," when it was 9800 and "economic meltdown" was near when it was nearing 11000. They sell books helping people avoid the "crash," they sell gold coins on TV, radio and the internet as they "help," people avoid the disaster.



Let's look at it a bit more objectively. The abject forecast of Dow 2000 given out in 2008 by the "bond king" and the many self-professed critics and prognosticators, would have returned their timid disciples who do not know how to leverage, a whopping 40% loss in 2 years (20% loss per year). The "dicey market" forecast given out when the Dow was at 9800 last year would have returned a loss of 20% in one year. And the "nuclear and economic meltdown," forecast doled out just 3 months ago was no less than 10% loss in 3 months – topping all of their previous endeavors.



It is important to keep tabs on the crashers who claim to be kings, critics and forecasters. After all, unlike before, we can now document their wisdom given out free to everybody.

Self-correcting policies

Fiscal and monetary policies with specific forecasted benefits are not affected if the expectations are not delivered. For example, a tax regime change – such as a tax increase with an explicit goal of deficit reduction will stay in place even if the deficits increase as a result of the policy change. Economists and policy makers alike have too high a confidence in their ability to forecast the future precisely. Thus, they embark on policy changes with precise arguments as to why and how the policy change should be effected. As has become clear from many previous experiments, policy changes do not typically deliver what they intended to do. There are two major reasons for this: First, the effects of a policy-change on the macroeconomic system depends on not only its direct influence but also its interactions with attributes that drive the complex system and second, it is impossible to forecast future conditions – such as growth, demand, inflation etc. – which may be dramatically different from the present regime in which the policy is enacted.



A self-correcting policy – one that becomes null and void if its intended effects are not realized is one way to tackle this problem. This may substantially reduce the gaming that goes on in the chambers of the law-makers, where one party or the other rushes to enact policies within favorable time windows. In this case, any policy-change will require a threshold minimum goal of both expected outcomes and the timelines and if the actual observations are lower than the goals within allotted time, the policy is nullified. For example, a minimum expectation of a tax increase in the presence of a spending freeze may be a decrease in deficit within a time window. If the deficit is the same or higher in the window, then the policy becomes void.



A more aggressive mechanism will be a policy reversal in the presence of a goal with a minimum expectation of neutrality. For example, if a tax increase policy is met with an unexpected increase in deficit, it should automatically reverse with a subsequent reduction in taxes. This will keep law-makers from random and poorly thought out policies.

Out-source-in

Labor cost differentials have been the primary motivation for the phenomena of outsourcing – the practice of sending certain aspects of work to another country. Although such tactical cost advantages may be beneficial in dressing up income statements for some companies, it may have long run deleterious effects for both – the outsourcer and the outsourcee. Service companies in the modern era continue to view themselves as similar to the manufacturing enterprises of yesteryear and manage themselves the same way. Accelerating economic growth in the 90s, forced many companies to accept such management fads as business process outsourcing, that continues to be a moneymaker for many consulting companies. The idea was (and still is) to disaggregate a "business process," and take components of it to low cost countries. This, many argue, is similar to steel being manufactured in a low cost country for raws, shipped to another where nuts and bolts are made and ultimately to yet an another where the ultimate manufactured good is made – perhaps an automobile. It is elegantly simple – make the parts of a process where cost advantages exist.

What is forgotten in this process is that we have moved on from the industrial revolution. Components of business processes are not like nuts and bolts. We live in a modern economy in which products are based on information and not on steel and petrol. In this economy, the "processes," cannot be disintegrated the same way as before. In the information economy, knowledge holds sway and that cannot be transported to another country easily. More importantly, value in the products come from integration and not by substitution. Those pushing "outsourcing," account for costs but they do not understand value. Value emanates from the benefits delivered – the top line - and it is not correlated with costs.

Once again, business schools are locked into a time warp, in which they teach their graduates how to measure costs but do not train them on how to innovate and cultivate ideas. The advantage, the US held for many decades in graduate education – where significant innovations of the last century were initiated and nourished, is under a serious threat. We have succumbed into a word of accountants and engineers, trained to measure and not prompted to think. Equally important is the problem that low cost countries are going to face, not too distant into the future. Blinded by cheap work pouring into the country – aided by artificially low currency rates and underemployment – most low cost countries have been pursuing unsustainable policies. Their engineers clam into call centers and their doctors do medical transcriptions – sub-optimizing their talents and skills.

Outsourcing is bad for those pursuing it and those accepting it.

Ref: Flexibility: Flexible Companies for the Uncertain World

http://www.crcpress.com/product/isbn/9781439816325

Past confusion

Politicians and lobbyists love complex policies – those general public cannot analyze to reach clear answers. The "deficit and debt reduction policies," fit into this neatly. Most understand debt to be bad and this is good for some to fan the anger by showcasing it. Social programs and handouts are good for some – compassion after all is what we teach our children - and this is good for some other politicians to win over the voters. Complexity, thus, has been good for politicians to push agendas they themselves do not understand.



Take the debt (stock) and the deficit (flow) of the US for example. Most politicians who seek offices do not understand them. What is a country's debt capacity? It does not depend on its balance sheet – it depends on its ability to innovate. If this were not so, there will be no start-up companies, some carrying infinite debt. Apparently, the credit rating agencies – the same idiots who rated all the failed companies in the last few years with AAA+ – just woke up to the fact that the US is carrying "unsustainable debt," to the merriment of many bean counters who have been "predicting," the same outcome for many years, if not decades. Asset prices did not change any.



Business schools have done a great disservice graduating finance and accounting professionals who count well but have little understanding of the system. They have migrated into policy and the press, spreading panic and confusion. They have created algorithms that trade and rate – companies and countries – based on the past and statistics – that have little relevance for the future.



It is innovation and scientific know-how that determine a country's "debt capacity," and not its debt/GDP ratio, the latter is an accounting metric – that can be calculated by most 3rd graders without any understanding of finance, let alone the heavy compensation commanded by the rating agencies. It's time to throw out incompetence from every financial and policy institution, that understand the past well but they are without any comprehension of the future.

Migration of languages

A recent article1 describes the methodology and data that show the serial founder effect – decreasing diversity from the point of origin – in languages. Over 500 global languages were studied by the author and it points to the origin of languages in Africa. This is further confirmation that both the hardware and the software of humans originated in a singular continent – if not in a singular place. This is important as it confirms that language/culture (software) developed in tandem with the physique (hardware) of humans.  As the human stood up and walked across the savannah, her brain was already in full force – devising languages of communication, replete in abstract thought. This was the only step-function change observed by humanity in the last 50,000 years. It came quickly and early and ever since humans have been deploying most of their endowed brain power to showcasing incremental and irrelevant differences in appearances and pretending that incremental advancements in thought and application are somehow important.

The first language and the abstract constructs that effected it are so magnificent, they make everything else pale in comparison like stars around a supernova. The fact that 500 similar languages exist today – minor variations to the original construct, similar to the color of the skin and eyes of diverse populations that spread across the globe to mine it clean and choke it dry – show that humans have been resourceful but that is far inferior to the beginning. The promise relayed to an external observer of earth by an organism exhibiting abstract thoughts 50000 years ago, would have been momentous. But since then, it has been a boring movie with predictable endings.

The slope of the trend in human psyche is undeniably flat, at best.

1. Phonemic Diversity Supports a Serial Founder Effect Model of Language Expansion from Africa Quentin D. Atkinson, Department of Psychology, University of Auckland, Private Bag 92019, Auckland, New Zealand.

 

Fancy kitten

A recent article mathematically describes how the Schrodinger's cat could be teleported using the principles of entanglement. The S. cat, teleportation and entanglement have tickled the fancy of physicists and those less endowed for many decades. What is fascinating about this is that it combines phenomena that challenge status quo framework. Together, it demonstrates that it is possible to make sensible manipulations of inexplicable phenomena within the present context. This is important as the fact that many inexplicable phenomena challenge the status-quo have not deterred most physicists embarking on fine measurements of irrelevance. It is a bit like accountants and financiers counting money and next quarters earnings while the company's R&D has no products for the future. Counting, after all, is in the genes of humans – evolutionary advantages gained by those who could understand environments by counting and memorizing. Most of the human brain cells are still employed in the same activity they started 50K years ago. They count more now but nothing has really changed from the early years.

Teleportation of the Schrodinger's cat by entanglement is different. It actually takes inexplicable phenomena and combine them to produce yet another. Such thought experiments are much more useful than counting and generating data as they will ask questions and not force fit answers. In every contemporary field, it appears that better counters gain higher premium than those who ask questions before the counting begins.