Thursday 30 December 2010

Why China's trade surplus is a strategic opportunity

The economic growth in China over the last 20 years has been one of the biggest forces for reducing global poverty, as tens of millions of people have gone from subsistence farming to industrialised production jobs. The wealth that has been created from this trend has transformed China, and now cities such as Shanghai and Beijing are catching up with Hong Kong and Singapore in their level of development. The growth in China looks set to continue, with the economy forecast to surpass the USA’s in size within the decade, according to a new interactive tool published by The Economist.

During its period of growth, China has benefitted from being a low cost economy by exporting manufactured products to the rest of the world. Now, its low levels of domestic consumption have been brought into the spotlight by the sovereign debt crisis. “How can developed countries deal with their trade deficits while China runs such a large surplus?” is the question Western politicians and economists are asking. China’s ability to export is propped up by its cheap currency, which results from the Chinese government selling Yuan and buying US-dollar denominated Treasury Bonds.

Some American economists decry this as manipulation of the Chinese currency, at odds with a free-market philosophy of world trade (this is a view I see as rather hypocritical: as long as the Chinese government is buying Treasury bonds on the free market it is up to them how to spend their Yuan). However it is clear that a lot of tension is building up in the system. If the Chinese government stops buying Treasuries, the Renminbi will appreciate against the dollar, which devalues all the bonds the Chinese government already holds. Furthermore, Chinese exports would become less competitive in the global marketplace, potentially damaging its economic growth. And the US will find it harder to finance its budget deficit, likely to cause serious problems for its domestic economy.

The only thing that will sustain China’s growth is a rebalancing of China’s economy toward domestic consumption. This will cause a large shift in the nature of the goods and services most in demand. It presents both local and foreign companies with a great opportunity for growth. Capitalising on this shift in consumption from developed to developing countries should be high on the list of strategic priorities of any multinational corporation.

Thursday 9 December 2010

A few more words on Tuition Fees before I get back to writing about the rest of the World

The passing of the motion to raise the cap on tuition fees came as a massive disappointment today. I was impressed by Labour MP Sharon Hodgson, who made the best speech in the commons on the actual sums involved. She emphasised the fact that graduates on typical salaries will not even be paying the interest on their loans, which will lead to a large proportion of the debt being written off. (as I have discussed here).

I also admire the students who came to London to peacefully engage in a protest on this important issue, and I wished I could have joined them. I heard a number of comments today critical of the protesters, grouping them all together as violent aggressors, but really this label only applies to a small minority of them. The vast majority were only interested in peacefully expressing their discontent at the cuts to education funding. The tactics of the police, in particular the thuggish ‘Territorial Support Group’ were heavy handed, and were responsible for inciting and perpetuating violence rather than stemming it. The latest figures – 9 police officers* injured compared to 15 protesters – underlines which group was the more violent.

I am sure we have not heard the last word on the tuition fees debate, and as the details are ironed out in a white paper next year I am hopeful that more politicians will see sense and will make amendments to the current proposals. I expect that I will have more to write on the matter later. But the tuition fees debate has distracted me from my intention to write more about China, following my visit there in October. The aim of this blog is to take a ‘worldview’ and I have become wrapped up in the problems of the UK, which significant though they are, pale in comparison to the challenges faced by most countries in the developing world.

As an example, one of the most memorable features of my trip to China was living with the air pollution. I am not especially prone to respiratory problems, but even so my lungs felt weak and I had frequent bouts of coughing due to the air pollution, and I was only there for two weeks. The pollution in China is something that hundreds of millions of people have to live with daily. In time it is bound to cause serious chronic health problems.

The pollution is directly related to China’s rapid economic growth, which has spurred the building of a large number of coal-fired power plants. It is an example of the ‘tragedy of the commons’ where a common resource – in this case clean air – is depleted through over-use. The only solution to this kind of market failure is government intervention, which has been slow as the government prizes economic growth so highly.

Reminding myself of the scale of problems like this helps me to feel a little less angry about the UK’s University funding debate.

*At least one police officer was injured when he was ‘forced off his horse.’ Perhaps the use of horses in crowd control is a little outdated nowadays?

Wednesday 1 December 2010

J.K Rowling, JJ Abrams and Claudio Sanchez: Epic visions, brilliantly realised

I caught Harry Potter and the Deathly Hallows Part One this weekend, which brought back to me how much I enjoyed reading J.K.Rowling’s novels.

J.K Rowling clearly has a fantastic imagination, and a gift with words. This was clear from the first novel, The Philosopher’s Stone, which was enough by itself to get many people (adults and children alike) hooked on the Harry Potter series. However I think it was only when the whole series was released that her greatest achievement became clear: the creation of a narrative that spans seven books, while each book is in itself a compelling self-contained story. Few authors, even the amongst world’s most celebrated, have attempted such a feat.

The process of producing an uber-narrative that is told in multiple parts has many challenges, but has in recent years lead to some brilliant creations. In television, the first series of 24 was ground-breaking not just in its real-time photography, but in the way the 24 consecutive episodes fitted together to tell a seamless story. JJ Abrams’ Lost has taken the epic-television-series even further, with six series (121 episodes) interweaving one major story arc with emotive details from each character’s back-story. The blend of genres - fantasy / sci-fi in the major arc and drama / tragedy in the back-stories - creates a powerful and suspenseful masterpiece.

In music, one of my favourite bands, Coheed and Cambria, have used the multi-part narrative to great effect. The multi-talented Claudio Sanchez used Coheed and Cambria the band to tell the story of “The Amory Wars” a science-fiction story that he originally conceived as a comic book. Each chapter of the Amory Wars corresponds to a Coheed and Cambria album, creating a five-album rock epic. Furthermore, after four albums were released the band famously played a four-day concert series, performing one album each day, an event called The Neverender.

I have gained much enjoyment from these works, but by their nature they have all come to an end. I look forward to discovering new epic sagas in the future, ones that are perhaps being written as I write these words now...

Tuesday 23 November 2010

Follow-up on tuition fees: What politicians need is a new frame of reference

Over the past few weeks I have had a number of conversations with people coming from various viewpoints on the issue of HE financing. When I have criticised the proposed system I have been challenged in two key areas: How would I propose universities be funded, and Why should taxpayers subsidise universities anyway?

On the question of how to fund higher education, I believe it is a matter of priorities. The government undoubtedly needs to cut expenditure, but has a number of options for doing so. For example, we should prioritise funding universities ahead of replacing the Trident missile system. I would favour full funding for a smaller number of University places, awarded on the basis of merit, over arbitrary targets for the percentage of people starting degrees. Many school-leavers may be better off getting vocational work experience than learning an abstract academic discipline.

There is a broader, more philosophical, question about whether it is fair that taxpayers support a student’s education. One strong argument in response to this is that graduates who benefit financially from their degree (e.g. going into banking, law or medicine) pay higher tax through the existing income tax regime, thereby giving back to the Treasury. This does not apply, however, to graduates whose earnings are in line with or less than non-graduates. In this case, they may be seen to have enjoyed a few years of relative leisure being subsidised by hard-working taxpayers. When described in this way, I realise that this scenario looks unfair. But only with the benefit of hindsight can we know which graduates go on to be financially successful (and pay loads of tax) and which go on to earn relatively little.

The fundamental problem with an increase in tuition fees is that it will affect people’s decisions in a negative way. The tuition fees question is being approached purely from the perspective of economics, when what policy makers need to consider is the psychological effects tuition fees will have. People who ought to go to university won’t. Graduates who ought to explore career paths based on their passions will instead go into low-paying but safe jobs. I sincerely hope that politicians realise this before voting on the issue.

Correction: Debt free aged fifty-three (with underfunded universities the result)

Having found out more details about the proposed system of student loans, some of the conclusions I made in my last post are incorrect. Most importantly, student debts will be written off 30 years after graduation. The majority of students, who graduate in their early twenties, will therefore be paying off debt until their early fifties, rather than into their sixties or seventies as I suggested. This makes things look marginally less bad from the students’ point-of-view. However it is counteracted by the fact that interest is planned to be charged at 3% per annum while a graduate is making re-payments, worse than I had modelled.

From the perspective of Universities, looking for sustainable financing, the fact that a large chunk of student debt will get written-off is not such good news. In my simple financial model a typical graduate still owes c.£15,000 (more than a half of their original loan) when it gets written off at the age of 51.

Saturday 6 November 2010

Debt free aged 73: How £9,000 tuition fees could be with you for life

I have plenty more to write about China, but I couldn’t let this week pass without commenting on the government’s proposal to cap University tuition fees at £9,000 instead of the current £3,290.

I have previously expressed concern that student loans create a damaging cycle of graduate debt, forcing graduates into steady, low-risk jobs. Many graduates are full of entrepreneurial ideas, but the weight of thousands of pounds of debt stifles their ability to take risks by starting their own businesses. It is precisely these kinds of small high-growth companies that the economy requires for long-term growth, as the majority of net new jobs are created by such companies. The existing student loans system has already discouraged one generation from founding innovative start-ups, and the proposed increase tuition fees will make this many times worse.

There is no easy solution to the funding crisis facing Universities. But what struck me this week is just how far the government has got it wrong. I wonder if they have done the sums:

1.) If we take the average graduate starting salary as £25,000 (the figure in c.2009)
2.) Assume a moderate salary upon reaching retirement of £50,000 (in today’s money)
3.) Assume for simplicity that progress between starting and finishing salary is in a straight line

‘Back of the envelope’ method
The average salary over this person’s career is £37,500. They would pay 9% of their earnings above £21,000, which is an average of £1,485 per year. At this rate they would need 18 years to pay off their debt, not including interest, and not accounting for the change in repayments over time.

More detailed calculation
In order to better understand the proposed fee system I have created a simple financial model of the repayments individuals will need to make over time. With the three assumptions above the more accurate ‘time to pay off’ is 27 years, so a 21 year-old graduate would be paying off student debt until they are 48.

If you add a real interest element to the loan, this has a substantial effect on time to pay off, as for several years the repayments do not even cover the interest. Under a 2% real interest scenario, a graduate on a four year course would not be debt free until they are (about) 73...

Note: A correction to the method, though not the message, of this post can be found here

Wednesday 3 November 2010

How China reminded me: it's not long till we're history

I wrote no blog posts in the month of October on account of taking a holiday in China. It was a great place to be to think about the world and how it’s changing, and it triggered a few ideas.

One of the most remarkable sights in China is the Terracotta Army, which can be found near Xi’an in the centre of the country. Over 8000 sculpted warriors are thought to have been buried alongside the body of Emperor Qin Shi Huang, over 2000 year ago. They were discovered by accident in 1974 by a group of farmers digging a well and have since become one of the most feted tourist attractions in China.

The fact they were discovered so recently is remarkable. It suggests that there could well be other equally amazing archaeological sites still buried underground. Our current technology and resources do not permit an exhaustive search of the planet’s surface – and until they do, we can always look forward to the prospect of amazing discoveries still being out there.

Nowadays our societies are not building anything as grand as the Terracotta Army or the Great Wall of China. But we are leaving behind a wealth of evidence of our existence in warehouses of data, in both physical and electronic form. Future generations will have the (exciting?) task of sifting through the data in order to form a view of what life was like in the 20th and 21st centuries. It is easy for us to assume that the databases and digitally encoded images will still be accessible to future generations, but hard drives corrode and file formats change. The archaeologists in the future could well find themselves dealing as much in microchips as in fossils – and they might unearth some truths about the present day that we ourselves are not aware of!

Thursday 30 September 2010

Everyone's talking about ACS Law (and it's not a new TV series)

By far the most interesting story in the headlines this week has been the release of personal information about alleged file-sharers, acquired from the now-notorious ACS Law. The combination of porn, lawyers , hackers and money seems to have captured the public’s imagination. But for me, the most interest lies in the ISPs, the encryption of personal data, and the implications for the UK’s copyright law.

A very good discussion of the attitudes of ISPs appears on ‘dot.Rory’. In the GQ article on music piracy (which I discussed a few weeks ago), McGuinness complains that ISPs have made billions from the illegal sharing of content. However I firmly disagree with the scatter-gun approach companies like ACS Law take to try and remunerate copyright holders. I was impressed to learn that two ISPs (Virgin Media and TalkTalk) have refused to hand over personal data to law firms. My new-found respect for these companies may well influence my future buying patterns.

The episode has brought the importance of encrypting data prior to sending it into the spotlight. Given that most people assume that their email accounts are secure, I expect a lot of files are currently sent unencrypted. Further, it raises the question of the level of encryption required, as many forms of encryption can be broken by a skilled and determined hacker. The story, this week, of a group of internet fraudsters who stole millions from online bank accounts has shown just how vulnerable our information security can be, even when we think we are taking all the right precautions.

And finally, the ACS Law episode has stimulated discussion about the Digital Economy Act and the practicalities of implementing it. The public anger against ACS Law, Sky and Plusnet is going to make ISPs more reluctant to take sanctions against file sharers. Furthermore, the online community 4chan has proved it has the will and the resources to put up a guerrilla fight against organisations trying to fight file sharing. The need to come up with a viable solution to support content-owners rights in a digital world is now stronger than ever. And a war that has had a relatively low profile until now, has become front page news.

Tuesday 21 September 2010

Disruptive Innovation requires Interdisciplinary Thinking

I was recently leafing through a psychology blog, and a post about The Perils of Interdisciplinarity caught my attention. I very much agree with the statement, “Some of the most engaging research topics today lie firmly on the boundaries between two or more distinct subjects.”

Intersection between two subjects previously thought of as distinct is a ripe ground for coming up with new ideas. In business school terminology, pursuing single discipline research can lead to ‘incremental’ innovations, i.e. steady improvements on existing technologies. Interdisciplinary research, on the other hand, is where you are likely to find ‘disruptive’ innovations, which completely transform whole industries.

A few examples of interdisciplinary technologies that came to mind:
  • Nanotechnology, at the intersection of quantum physics, materials science and engineering. Nanomaterials are already used in some suncreams and cosmetics, and could potentially revolutionise medicine, computing, and the energy industry.

  • Biotechnology: at the crossroads between genetics and manufacturing, biotech has long been touted as a boom industry. Growth has not been as rapid as once predicted, but that is not to say it won’t happen. A lot of interesting work is going on around using artificial photosynthesis on an industrial scale to solve the world’s energy problems.

  • Photonics: the use of light instead of electrical signals in computing is another area that breaks boundaries between quantum physics, information engineering and materials science. A breakthrough was announced this week in the form of the world’s first ‘photonic’ chip capable of complex calculations. It seems that quantum computing may not be far off, which could render today’s information security systems obsolete.
I found it interesting to speculate which combinations of research areas I would like to see more of in the future. Combining some of the process-flow analysis techniques from chemical engineering with macroeconomics could lead to some interesting modelling of monetary / wealth flows; research in mathematical modelling of non-linear systems (chaos theory) might improve the design of manufacturing systems, and (to lead things back to psychology) the study of hallucination and dreaming might help us to understand the scientific basis of ‘time.’ All just wild speculation – but interdisciplinary thinking has to start somewhere...

Monday 6 September 2010

Digital piracy could end up hurting you, too

Music piracy is a controversial and divisive issue, with both copyright holders and supporters of free media vocal for their cause. I recently read an insightful article by on the issue by Paul McGuiness, manager of U2, in August’s issue of GQ. McGuiness argues for copyright protection through legislation that forces internet service providers (ISPs) to issue warnings to persistent file-sharers, and ultimately to then throttle or cut off their internet access. Known as the “Graduated Approach,” this has been adopted in the UK as part of the Digital Economy Act.

A big part of the debate on music piracy is whether or not it actually harms anyone. After all, the reasoning goes, once a piece of music has been recorded all the costs to the creator of that music have already been incurred. Having one more person listen to the music doesn’t cost the originator so why not just let it happen?

Paul McGuiness responds that treating music as a free good causes longer-term damage to the music industry. Without paying listeners, the industry lacks sustainability

“Indigenous music industries from Spain to Brazil are collapsing. An independent study endorsed by trade unions says Europe’s creative industries could lose more than a million jobs in the next five years... this isn’t just about fewer limos for rich rock stars.”

Unfortunately confusion around the issue results from the fact that both lines of reasoning are at least part way correct. Imagine a Venn diagram, where one circle represents people who want an album enough they are willing to pay for it, and the other circle represents people who download the album without paying. The artist is losing out on revenue where the two circles overlap, representing people who would be willing to pay for the album but download it for free anyway*. If someone who would not be willing to pay for the album downloads it, then the artist is not losing out on a potential sale (although they could still raise a moral objection). One of the greatest difficulties from the perspective of music industry is that it is impossible to tell whether someone who downloads something illegally would have been willing to pay for the content.

As previously noted on this blog, the web allows for a wide variety of amateur producers of content to share their material. However the expectation of free content has also been detrimental to some of those on the lower rungs of the professional ladder, and so far a satisfactory solution has not been found.

*The relative size of boxes and degree of overlap in the Venn diagram varies according to the price of the content – a realisation that has lead to the proliferation of cheap downloads and subscriber services for music and TV

Wednesday 25 August 2010

What does 'Reputation' mean in a world of instant knowledge?

Eric Schmidt, CEO of Google, has made the headlines this week for suggesting people will need to change their names to hide embarrassing material from their past. Indeed, for each cautious person who monitors carefully what they post about themselves online, there are several more who put little thought into it. And we cannot control what other people post about ourselves.

However I believe that in liberal-minded societies (such as the majority of Europe and parts of America), it is more likely that people’s standards will adjust. Having a spotless record in your past will not be a requirement for a responsible job, because enough people will recognise that a few wild years is actually the norm. This has already become the case, to an extent, with the public’s acceptance of politicians who have smoked cannabis. I expect that in future generations, people will be judged on their merits and not on their social faux-pas, recorded forever in the social media archives.

There may be a rather more serious problem in societies which are less accepting of the rebellious behaviours of the young. Super-conservative religious communities come to mind, such as the Christians of ‘Bible-Belt’ America, or Muslims living under Sharia law. Standards of acceptable behaviour are much more restrictive and the consequences of straying from the straight and narrow can be serious. And while these societies are just as exposed to new technologies as the rest of the world, their cultural norms may adapt more slowly.

In this sense, the ease of accessing information, that Eric Schmidt’s comments have highlighted, may have a polarising effect on culture. In liberal cultures, behaviour will become more open; in conservative cultures a paranoia about tainting one’s record could reinforce the restrictions. It’ll be interesting to see how it plays out...

Wednesday 18 August 2010

An Immigration Cap? Bad for the UK; Good for everywhere else

There is a lot of debate at the moment over whether the UK should put a cap on the number of migrant workers allowed into the country. Even the two coalition party leaders are at odds over this issue. With visa restrictions already tightening, it looks as though the conservatives are bowing to populist demand for an immigration cap, to the detriment of British business.

There are convincing theoretical arguments for why limiting immigration of skilled workers is a bad thing for the country. Workers coming to the UK from overseas are benefitting the economy by expanding the supply of goods and services while also increasing consumption. Working adults generally pay more in tax than they receive in public services, thus helping the public finances. And by working in the UK they are increasing the country’s capacity to export goods, which improves the long term sustainability of the economy.

To back up the theory, there is empirical and anecdotal evidence that demonstrates the benefits immigrants bring to an economy. In his book “Outliers”, Malcolm Gladwell describes the entrepreneurial success of Jewish immigrants in New York in the early 20th century. He argues that migrants are at an advantage when it comes to starting new businesses, as they can apply knowledge from their home country to a new environment (more of my own views on this at a later time!) Looking at the 21st century, Thomas Friedman writes in “The World is Flat” about the large number of Indian entrepreneurs who studied for degrees in the USA, but started their businesses in India as the visa restrictions made it so difficult to settle in The States.

These should serve as a lesson to UK politicians as they consider the UK’s immigration policy. It seems the main argument in favour of capping immigration is so that more jobs are available for British workers. While this may be true on a timescale of 3 to 12 months, in the longer term businesses will simply choose to expand in other countries.

This would be bad for the UK. However I did not start this blog just to write about the UK. Taking a “World View” instead of a country-centric one, I actually believe that transferring the economic benefit that skilled workers produce from developed countries to developing ones is a good thing for the world as a whole. All those Indian entrepreneurs who left the US to start outsourcing companies in Bombay, Bangalore and Hyderabad have helped rebalance the wealth and power in the world; if more of the same happens because of the UK government’s short-sightedness, I won’t hold it against David Cameron.

Sunday 1 August 2010

The Trouble with Healthcare

Both the US and the UK are preparing dramatic reforms to their respective healthcare systems. In the US, the role of the government is set to increase; in the UK the role of the free-market is being expanded.

Why is it so hard to design a healthcare system that works? Last week’s Economist ran thoughtful articles on both the UK and US reforms which highlight some of the problems. In a sentence...

“The demand for healthcare is always greater than the resources available.”

This problem applies to (almost) every industry, but is particularly troublesome for healthcare because rationing access to health services causes pain and mortality. Healthcare resources must be allocated somehow, and the main issue is whether free markets or government intervention is better. Unfortunately both of these paradigms lead to some perverse incentives.

Under the free market system, as exemplified by the US, there is an incentive for health insurers to try to minimise provision of treatments. The consequences of this are emotively depicted in Michael Moore’s superb film ‘Sicko’. Where treatment is provided, the patients typically demand the latest available procedures and medicines, which leads to extremely high expenditure. In addition, the paperwork and bureaucracy involved, not to mention the lawsuits, impose another heavy cost. Healthcare expenditure per capita in the USA is the highest in the OECD – but in international league tables the health outcomes are mediocre at best.

Compare this, then, to a government-run system such as the NHS. Centrally planned health care brings its own set of problems. Some are ethical, such as the rationing of expensive treatments and drugs, which is essential to keep costs down. This is one source of resistance to government planning in the US. Other problems are to do with incentives – as public sector employees, healthcare providers do not have the ‘profit motive’ to help stimulate efficiency. The government must design its own set of incentives that aim to maximise patient care at minimum cost, and then monitor performance; a set of tasks the government is not typically very good at.

Despite these pitfalls, the benefits of government-run medicine is borne out in the statistics: European countries have better health indicators and lower health expenditure than the US.

There is clearly some way to go before we find an optimal method of healthcare management. The reforms in the UK and the US are both trying to find some middle ground that gets ‘the best of both’ of the market based and publicly run systems. I can’t help feeling that some more fundamental paradigm-shift is required before we find a truly effective healthcare system.

Thursday 22 July 2010

How long until there is "A Smartphone for Everyone?"

The Product Lifecycle (PLC) is one of the pieces of business theory that is most clearly visible in the world around us. A new product is take up by a small group* of “lead users” initially before being gradually adopted by the rest of the population once (or if) the benefits of the given product are well demonstrated.

Smartphones appear to have now gone well beyond the lead users, and the take up by amongst the majority of the population is well underway. Since Spring this year, T-mobile has focussed its marketing on offering “A smartphone for everyone” with Blackberries and other top-name brands on contracts for £20 per month. And Tesco mobile has begun offering iPhones at prices that undercut the mainstream networks.

Although society is just beginning to see the effects, the widespread availability of data communications literally “at our fingertips” is bound to cause some dramatic changes throughout whole segments of business. The impact may eventually prove even more dramatic than the growth of the (wired) internet. Present-day applications like paid-parking-by-telephone, mobile-phone boarding passes and setting your video recorder from your phone are already making our lives easier, but there is infinitely more scope out there.

If phones were integrated with shopping then personalised recommendations and vouchers could be sent to you as you walk around the store; you could photograph barcodes of things as they go into your basket and bypass the need for a checkout (barcode photography already allows you to price-check against online sites!) In clothes stores, precise data about your body dimensions could be downloaded from your phone to a store’s computers to direct you straight to the best fitting clothes. With advances in 3-D printing, bespoke items could one day be rapidly-manufactured while you wait. At a bar, you could order on your phone and get drinks and food brought directly to your table, paid for automatically from your bank account. And I have already written elsewhere about the integration of smartphones within everyday conversation.

At the moment smartphone apps are designed to be used in parallel with existing pre-smartphone business models. The fundamental shift that we haven’t seen yet is the re-design of business models on the premise that the vast majority of customers have smartphones. The potential benefits are so great that I doubt this shift is far off.

*Small in this sense is proportional, it is a few percent of the population so still numbers in several million people

Sunday 18 July 2010

Government debt? Out-of-sight, Out-of-mind

It’s been clear for a while now that the UK’s public finances are in a mess, but this week’s ONS report on “off-balance sheet” liabilities really rubs it in. Although it made the front page of the Independent, and a small article in the FT, it hasn’t yet had the attention it deserves.

The Office for National Statistics has attempted to quantify some of the future payments the government is locked into, but that are not accounted for in the figure quoted as “the national debt.” Some of the liabilities it has included, related to guarantees on financial instruments and the government’s stake in the banks, are not likely to materialise into real losses. In that sense, the upper estimate of the liabilities of £3,000,000,000,000 (Three trillion) pounds is a bit alarmist.

However some of the future payments are inescapable – most notably the Private Finance Initiative (PFI) obligations. PFI is a mechanism almost solely designed to allow governments to put off expenditure. Instead of paying up front for buildings and infrastructure, such as new roads, hospitals or landfill sites, the government signs a contract to pay a fixed fee at a future point in time for the services delivered in that infrastructure. The private sector then finances the capital investment in property and equipment, and aims to get a reasonable return on its capital when the services are delivered.

In the private sector it is akin to a “leasing” model where you are replacing a capital cost with an operational cost. However in the private sector, the assets being leased are generally being used to generate revenue. The cost of one year’s lease can be straightforwardly compared to one year’s revenue. In this context, then, the lease makes the accounting simpler. When applied to the public sector, however, there is no income to offset the cost, and the effect of the PFI is often to complicate the accounting. Furthermore, the need to draw up large, long-term contracts is a costly process. And flaws in the contract can leave the government with major costs incurred, without seeing the benefit expected (as happened with the London Underground expenditure, which used the related “PPP” mechanism).

Fundamentally, the move towards PFI has allowed the government to hide its liabilities. It is similar to the “Off-balance sheet liabilities” that contributed to the bankruptcy of Enron, and to the 2008 financial crisis (most of the CDOs held by banks were off-balance sheet).

On the bright side, the fact that the ONS is beginning to pay more attention to the obligations that will fall on future generations is most certainly a good thing.

Saturday 10 July 2010

Are indebted graduates good for the country?

Last week I read an article in the Evening Standard that neatly summarizes some of the growing problems surrounding higher education in the UK.

Firstly the problem of debt. Teaching needs to be funded and as the government cannot afford it themselves, they introduced ‘top-up fees’ in 2006, which most students pay for with student loans. Given that most students also take out loans to cover living costs, this means many who graduated in 2009 onwards will have debts of c.£20,000. That is a massive debt for someone in their early twenties. To pay back the debts, 9% of what a graduate earns over £15,000 is taken directly from their pay check. So someone earning an average of £30k p.a. would take 15 years to pay their student loan. That is one long hangover.

The second, related problem, then is employment. Young people are given statistics like “on average, graduates earn £100,000 more over their lifetime than non-graduates.” This makes a degree sound like a great investment, and sadly many people don’t look at these statistics critically. For one thing, this “average” figure hides a lot of variability, from artists at one end to bankers at the other. Even more fundamentally, this figure does not tell you the marginal benefit gained by going to university. The number of graduates that end up in non-graduate-level jobs seems to be proof that doing a degree is not a good investment for everyone.

As the government prepares to re-examine top-up fees and consider whether to lift the tuition fee cap, what we need is a more critical look at the effect student loans will have on future generations. With the Universities and Lord Browne clearly intent on raising the cap, we need to hear the other side of the story. Luckily, the mainstream media appear to be picking up the story of graduate unemployment in a big way. I will be watching closely to see whether a fair solution can be found.

Monday 28 June 2010

Advertisers' originality still manages to impress

It’s the World Cup and the summer movie season, so the advertising companies are bringing out the big guns. There are a couple of adverts out there at the moment that really stand out.

The Vodafone ad with a businessman’s dinner being interrupted by his daughter-in-distress is particularly powerful. I saw this one up on the big screen and it was not obvious at first that it was an advert at all. It builds up a deep feeling of sadness in the audience as we empathise with the recently-dumped woman. And we admire the man for sacrificing what it clearly an important moment without any hesitation.

Mobile-phone companies have long been at the forefront of marketing psychology – they brought minimalist music into the mainstream with their abstract adverts in the 2000s – but this one really stuck with me for the simple reason that it induced a strong emotional response. It doesn’t especially make me want me to buy Vodafone products, but it’s memorable – which is most of the battle.

Another prominent ad campaign at the moment is the iPad posters up around the London underground. In fairly typical Apple style, they are simple images of the product in question. But the screen of the iPad is filled with different things on different posters, and the screens’ contents are a window on the ‘type’ of person who might like one. Predictably, one of the images is of Facebook, so we can assume that our archetypal iPad user is a social networker (who holidays in Biarritz). To illustrate its use as a newspaper device, some posters have shots of The Guardian; as an example of an eBook, the posters show a page from The Picture of Dorian Gray; and as for music videos they have Juliette Lewis; for movies they have “Up” by Disney. These portray the iPad user as liberal, arty and fun, all of which are quite appealing characteristics.

What’s more, walking around London and noticing an iPad poster I haven’t seen before has become one of the summer’s simple pleasures. And recognising the references to popular culture that they contain lets me feel like I am in on the ‘inside joke.’ Another very clever piece of marketing (though, again, I don’t actually own an iPad – yet).

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Sunday 20 June 2010

Financial innovation is on the menu at Hotel Chocolat

On the playing-field of UK start-up businesses, one that I particularly admire is Hotel Chocolat. Started in 1993 by Angus Thirlwell and Peter Harris, it has grown to open 44 stores worldwide by providing a product of superb quality and developing a brand that is modern, decadent and personal. Their products are innovative (I particularly like the super-thick shelled Easter Eggs); their marketing is democratic (customers can submit ratings of each chocolate); and thanks to free samples and a friendly team of sales assistants the shopping experience at their stores is always a pleasure.

When it came time to raise finance, then, is was only natural that the Hotel Chocolat entrepreneurs would find a novel way to do it. Conventional options would include selling equity in the company, which would dilute the owners’ stakes, or taking out a long-term bank loan, which could have a high, variable rate of interest. Instead HC gave their customers a chance to invest in the business. In exchange for a lump sum of £2000 or £4000, the customers will receive “interest” paid in regular deliveries of boxes of chocolates.

A £4000 “chocolate bond” yields 13 boxes of chocolate each year, with a retail value of £18 a box, equating to £234 p.a., or 5.83% net interest (7.29% gross). For customers who are already paying cash for the monthly boxes of chocolates, this is a potentially attractive investment opportunity: to swap capital expense for reduced cash outflows in future. For HC they are locking in the value of those future sales as capital – which they can then earn a further return on.

Looking, for a moment, with a critical eye, I expect the transaction costs of this deal are fairly high (although partly offset by free publicity received). And there is no guarantee that the target customers will take up the offer. Furthermore, the investors are putting their capital at risk, as unsecured creditors, and would be left with a big loss if HC went into liquidation. So as with most forms of innovation, it comes with a certain set of hard-to-quantify risks.

Perhaps the most exciting message from the Chocolate Bonds project is that financial innovation is not dead. Financial innovation has taken a beating in recent years due to the mis-selling of complex mortgage instruments and derivatives, which allowed one party to exploit another. This looks like something refreshingly different: a genuine win-win scenario for HC and their customers.

Thursday 10 June 2010

The 80:20 Principle and the Long Tail

I’m a big fan of the “80:20 Principle.” The principle basically suggests that a small proportion of causes are responsible for a large proportion of consequences; e.g. 80% of a company’s profits could be derived from 20% of its customers. In his book, Richard Koch writes about the 80:20 principle in both a business context and a lifestyle context, and encourages people to use the principle to maximise their effectiveness. He suggests that by concentrating on the few things that you are especially good at (where you fall into the top 20%) you can multiply your productivity (collectively the top 20% deliver 80% of the results, putting them a factor of 16 ahead of the rest).

When the topic came up in the book I am presently reading, it caught my attention. In The Long Tail, Chris Anderson writes about the growing importance of very niche forms of media. The Internet, due to sites like iTunes and YouTube, has become a platform for distributing media with zero marginal cost. This allows a much wider selection of books / songs / movies than is possible in conventional retail, so the “Long Tail” of the market demand curve can now be addressed.

As Anderson points out, this suddenly makes the 80% of books / songs / movies that would previously have been ignored by mainstream business channels really rather important. Entire livelihoods and subcultures have grown up around the niche content that can now be profitable. The global sharing of ideas has created new hybrid styles of art and music. Most importantly: the mass transfer of information is not acting as a homogenising force – rather it is allowing an immense level of diversity to flourish.

Tuesday 1 June 2010

Digital Voyeurism

This weekend I went to the newly opened exhibition “Exposed” at the Tate Modern. The collection of images explores the invasion of privacy through photography – at what point does artistic licence decay into dangerous voyeurism? Is the viewer of a photograph implicated in the act of taking it?

Most of the exhibition looks at the invasion of privacy in a historical context, but it prompted me to think more deeply about the present (and the very imminent) technological advances that could take voyeurism to a whole new level.

For example, online photo sharing means that most of us are already leaving publicly available records of our movements through time. It is easy to imagine a scenario in which an organisation trawls the web for photographs, downloading them to an archive and running them through face-recognition software. With the time, date and location stored with each photograph they could create a searchable database that could re-produce the historical location, through time, of just about anybody, based on the photos that they appear in. It would not surprise me if national intelligence services already have such a system. Nor would it surprise me if a privately-run commercial system is available soon.

On the subject of digital voyeurism, Google managed to open up a new frontier when they recorded masses of data being passed over unsecured wi-fi networks. I, like millions of others, already entrust Google with my personal data (emails and search histories and such). As such, I think it is probably a good thing they were behind the data collection and not a company that might be tempted to exploit what they found.

But overall the pace of technological advancement seems to be outstripping the pace at which we adjust our behaviour, our laws and our cultural norms. The Tate Modern’s exhibition focuses on the extreme, but in doing so it acts as a useful prompt for us to re-think our concept of privacy for a digitally-connected world.

Tuesday 25 May 2010

Studio Execs, Please don’t kill 3D cinema

These weekend I went to the cinema not once, but twice (to see Robin Hood and Prince of Persia, both good films.) One thing that struck me was the number of adverts for 3D movies. It seems that after the success of Avatar, all the film studios want a piece of the 3D pie.

So far the investments in 3D seem to be paying off: not only can cinemas charge more for tickets but 3D cannot be replicated (yet) in a pirated version downloaded for free from the internet. Consumers can benefit from an improved movie experience and cinemas are doing better revenue-wise.

Having been extremely impressed by the visual effects in Avatar, I was recently very disappointed by the 3D effects in Clash of the Titans. From conversations with a friend in the film industry, I learned that Avatar was originally filmed stereoscopically, using two cameras to capture video, one for each eye. In contrast, Clash was not originally intended to be a 3D movie. It was shot with a single perspective, and the ‘depth’ effect was added later with a digital overlay. This created an unconvincing picture, it interfered with the other computer graphics, and generally made it a worse visual experience.

Unfortunately many of the “3D” films that I have seen advertised are apparently being made the same way. This is quite alarming to me: 3D technology has the potential to create a revolution throughout our visual media, but if it is implemented badly consumers will be put off. I hope that movie studios realise that by taking short cuts for fast money this year, they could lose out significantly in the longer term.

Tuesday 18 May 2010

Its time for a public sector recession

The UK’s budget deficit has received a lot of attention recently. However up to now, politicians have only spoken openly about what they will ring-fence, and not about what they will cut. The scale of the declines in public spending about to happen will probably take most of the country by surprise. The Financial Times has a superb budget balancing tool that brings home how difficult the decisions that have to be made really are.

In the run up to the election, the Labour party was right about one thing: the cuts will be a setback to the UK’s economic recovery. (They were wrong about something else: the cuts are not optional and cannot be put off.) The UK’s private sector has already had its recession: from 2008 to 2010 companies cut back on capital expenditure and stopped recruiting, causing a drop in the country’s output and a hike in unemployment (especially amongst the young). Throughout this period, though, the public sector kept spending and kept recruiting. Furthermore, a substantial chunk of the debt in the private sector was transferred to the public sector through the bank bailouts / nationalisations.

This action prevented a deeper recession. Unfortunately, the flip side is that we have a lot of pain to come. Rather than the “V shaped” recession we were hoping for, we are very much destined for a W-shaped one. Only this time round it will be the public sector that has to freeze its capital expenditure, and its new hiring, and, of course, its “unemployee” expenses.

Wednesday 12 May 2010

Facebook: the Big New Story that was overlooked?

May has been a busy month for news what with volcanic ash, the election, and the oil leak. But for me, one of the biggest stories has been overlooked by the mainstream media. For me, Facebook’s decision to link any Interests or Favourite things that we mention on our profile pages directly to “Community Pages” is a watershed moment. Not only is privacy being eroded - nothing new there – but this major change was undertaken without any consultation, without any choice to opt out and without any regard for the widespread criticism that has followed. In my opinion it could signal the beginning of the end for the Facebook phenomenon.

What’s so bad about the changes? For me, my profile feels like my personal space. What people see on my profile will shape their image of me, so I want to control what goes on there. In a similar way to clothes, hair styles and body language, our online presence is something that people see and make judgements about. This extends, in my opinion, to the things that we link to on our profile, in our status updates, and in wall posts. By forcing us to link our profiles to these bland and invasive ‘Community Pages,’ Facebook has put me off listing any Interests or Favourites*. Which removes one of the more interesting aspects of the social networking medium.

Why the dramatic talk of the ‘beginning of the end’ for Facebook? Because in order to sustain its dominance in social networking in the long term, Facebook will have to consistently make itself better. Judging by the outcry every time Facebook makes a change, a lot of people find that it is consistently getting worse. Facebook started out by being adopted by small but influential communities then spreading out more widely; there is no reason this success couldn’t be emulated if someone came out with a social networking platform that is a step change better.

* This also means the adverts now displayed to me are less relevant, which means I click on them less and Facebook loses advertising revenue

Wednesday 5 May 2010

Election week – the bet I can’t lose

I like the Liberal Democrats. I don’t like all of their policies. Some of them are rubbish. But I like the fact that they care about civil liberties, that they are willing to consider an alternative to Trident and that their immigration policy is not idiotic. From my perspective, the more power they gain on Thursday May 6th, the better.

Which is why I have placed a bet against them. I have bet a relatively modest sum against a ‘hung parliament’ outcome in the election. With a Labour majority, I am £15 richer; with a Tory majority I am £15 richer. With a hung parliament, I am £10 poorer but feel a lot better about the future of the country. It may not be a perfect hedge – my feelings about the future of the country are probably stronger than that*. But at least I will have something to smile and feel smug about on Friday.

*For a ‘perfect hedge’ I would also have to factor in the net present value of the cash flows determined by the future government’s tax policy on my income, which could be an interesting project in its own right

Thursday 29 April 2010

Liquidity – at what cost?

Last week I read an interesting definition of arbitrage: "making money by buying and selling something without adding value." Those last three words began a train of thought that led to a conversation that led me to conclude that the world probably has too many arbitrageurs, and too many financial traders in general. Probably.

The primary purpose of financial instruments used to be for large companies to raise finance (through debt or through equity) and to hedge risk (through derivatives). Now it seems like their main purpose is to allow hedge fund managers and bank’s proprietary traders to make large profits.

In most industries, making a profit is achieved by adding value to some product or service and selling it at more than the cost of delivering it. The value added usually corresponds to a direct benefit for society – think of a baker turning flour into bread or a bike mechanic making a broken bicycle usable. One person’s effort allows them to earn a living while benefitting another person.

With the trading industry it is much harder to see who are the net beneficiaries - but they do exist. Speculators and arbitrageurs create liquid markets for financial instruments, which are important for companies to be able to raise finance with which to grow. Growth allows economies of scale, and public listings create a certain level of discipline amongst corporate management.

Having said this, I would argue that there are probably more people working in speculation and arbitrage than are required to make the financial markets liquid. The cost to society of the additional liquidity is that the people working as traders could have otherwise been adding value to society through industry or entrepreneurship. In this trade-off of the allocation of talent, there must be an optimal level of trading activity – enough to make financial markets work, without damaging other industries by sucking up too much brainpower – and I don’t think we are there.

Tuesday 20 April 2010

Planes go down; Cars go up?

Following up on the Enron post, the ash cloud currently over Europe reminds of a great moment in that play when they explain the financial concept of hedging.

The character explains that if you invest only in airlines, then you put yourself at serious risk that planes might start falling out of the sky. So you would ‘hedge’ your investment by buying shares in car hire firms. “Planes go down; car hire goes up.” At least so the theory goes.

The irony is quite acute. Of course no one expects planes to start falling out of the sky, but the nearest equivalent (that all planes are grounded) has taken place, for a completely unexpected reason. So does “The Enron Theory of Hedging” stand up to empirical testing? Here’s how the share prices look:

British Airways – down 4% Friday pm to Monday am
EasyJet – down 7% Friday pm to Monday am
Ryanair – down 4% Friday pm to Monday am

Avis Europe (car rental) – up 9% Friday pm to Monday pm
Hertz (car rental) – down 1% Friday pm to Monday pm
Go-Ahead (public transport and airport parking) – up 3% Friday pm to Monday pm

So the car rental hedge would have partly but not entirely worked. I should add that in calculating the airline percentages I have taken the Monday am price because they rallied later in the day, presumably on the back of expectations of either the flight ban lifting or even the possibility of a government bail-out.

In the longer term, the effect of a flight ban on Europe’s economies will be scrutinised in some detail. For now I would just like to congratulate the script writer of Enron (the play) for their prescience...

Sunday 18 April 2010

Augmented conversations: the future is here

It seems like recently iPhones and iPads have become a staple of any conversation. First comes ‘How are you?’ then comes ‘How’s the weather?’ then comes ‘How’s your iPhone?’

Almost as a matter of protest, I do not own an iPhone myself. However, this weekend I had an experience that left me deeply impressed. For the first time, with the aid of an iPhone, I had what I would call an ‘Augmented Conversation.’

My friend, whom I had not seen for some time, had his iPhone out on the table. Fair enough, I thought, as long as you don’t start checking your texts instead of talking to me (my past experiences of phones interacting with face-to-face conversation have generally been negative). It wasn’t long, though, before the topic of conversation moved onto areas that were greatly enhanced by the use of the iPhone. While talking about his new job he could bring up the company website and show me some photos of his workplace. Chatting about running routes, I could bring up googlemaps to help describe the routes I recommended. Upon passing on the news about Demetri Martin’s 224-word palindrome poem, instead of just passing on a vague description of it, I could read it and feel truly awed.

And at the end, when it was time to go home, we could check what time the last tube was.

This ‘augmented conversation’ is a use of a smartphone I had not even considered, and it makes me a little less sceptical about iPhones and their merits. It also lead myself and my friend to an even more profound conclusion: we are living in the future. The advances in telecoms and computing that have made the iPhone have been gradual but their impact is unquestionable, and things that seemed like science fiction a few years ago are now, at this moment, reality.

Sunday 21 March 2010

Enron: Bad Business at its Worst

For anyone who cares deeply about both business and ethics, the modern world can be a confusing place. When is secrecy dishonesty? At what point does hospitality border on bribery? How low can pay be without being exploitative? These kinds of issues play out every day in boardrooms, lecture theatres and people’s minds. Although they underlie most of what is reported in the business news, they are rarely tackled head on in the mainstream media.

Last weekend I went to see the theatrical production of Enron. The play was great. The case of corporate fraud on which it is based is truly shocking.

“When Jeffrey Skilling was hired [as Enron’s CEO], he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives were able to mislead Enron's board of directors and audit committee of high-risk accounting issues as well as pressure Andersen [their auditor] to ignore the issues.”
-from the Wikipedia article on the Enron Scandal

The bottom line? Twenty thousand jobs were lost and many employees lost their life savings, which they had invested in company stock (they also lost their pensions plans and health insurance). Enron is a case study in bad business on a breath-taking scale...

Wednesday 3 March 2010

I aim to get this blog up and running by the end of March. It's still in the planning stage as I explore ideas for content, but progress is being made (slowly)