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Alibaba: not just the Forty Thieves. China at the Cutting Edge

In the whole of the 20th century, only a few countries managed to transform themselves and join the club of rich economies. Japan is the most prominent example. The key question for the first half of the 21st century is whether or not China will manage to do the same. It is a difficult and elusive feat, and the number of failures, of countries who nearly made it but then fell back, is as great as the successes.

It is only a few decades ago that there were serious doubts about Japan’s capacity. They were stereotyped as producing cheap, shoddy manufactured products, and at best managing to copy in an inferior way goods made in the West.

Last week, I was in Hangzhou, a Chinese city of millions of people which most people have never heard of. There was prolific evidence of poor copying in the many slogans translated into English which adorned massive development sites, billboards and shops. The graphic phrases were somehow not quite right. The undoubted winner was a clothes shop which proudly styled itself ‘Fashion Fuck All’.

I had been invited to speak at a conference celebrating the launch of the Alibaba Complex Systems Research Center. ‘Alibaba?’ I hear many people ask. It is an internet company which does both business to business and business to consumer transactions. When Facebook was floated, it was valued at $16 billion. There is terrific excitement and speculation about the public offering of Twitter at a possible $20 billion. Alibaba is in the final stages of negotiations over its own IPO. The current estimate is that this will be valued at $70 – seventy! – billion.

Japan rose to economic prominence by making complex and sophisticated products at least as well as, and often better than, the West. Now, the Western economies are dominated by the services sector. The key point about Alibaba is that it is not just in the services sector, but in the fastest growing, cutting-edge technology part of the whole sector. In a city which most people in the West could not place on a map, a company unknown to many is planning a public offering which will make it worth twice that of Facebook and Twitter combined. The company in terms of revenue is already easily the number one in e-commerce in the world, and the IPO will give it the appropriate capital value.

Retaining the top spot in any businesses based on the internet is far from easy. As recently as 2008, MySpace, a precursor of Facebook, was the world’s most visited website, and until 2009, America’s, pulling in 70 million unique US users a month. And then all of a sudden, it died. Alibaba may find challenges in replicating in America and Europe its stupendous success in East Asia if Western consumers take time to trust what is for them a relatively unknown offering. But even so, the company shows that China is able to leapfrog the process of development and compete effectively in the leading sectors of the world economy.

As published in City Am on Wednesday 18th September 2013

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Always Look on the Bright Side

The American economic recovery carries on apace, with a net rise in employment of almost half a million over the past three months. The Office for National Statistics has decided that the UK never had a double dip recession, and the texture of the economic news has turned positive.

But economics is not called the dismal science for nothing. What of the longer-term? Here, there is no shortage of doom and gloom. Stephen King, chief economist at HSBC, has just published an interesting and well-written book ‘When the Money Runs Out’. Pessimism infects the high command of the American academic economics establishment.

The source of these melancholy views is an influential paper by Robert Gordon published by the National Bureau of Economic Research in August 2012. The title poses a stark question: ‘Is US Economic Growth Over?’ Gordon’s answer is basically ‘yes’. There are a few nuances to this in his paper, but he takes a bleak view of the prospects for the American economy during the rest of the 21st century.

For Gordon, the basic problem is that all the major technological innovations are behind us.  The period 1750-1850 saw the steam engine and the railways. In the closing decades of the 19th century, the foundations of our modern way of life were laid down with the internal combustion engine and electricity. He argues that in 1960 we entered the information age, and although this has brought benefits, the boost to growth which it provided is now fading.

A key question is whether this is true. Predicting how new technologies will be used is fraught with difficulty, and their full potential can take many decades to realise. The statement made by Thomas Watson, chairman of IBM, in 1943 is notorious: ‘I think there is a world market for five computers’.

Even after the event, their impact can be difficult to identify. There is still a powerful school of thought amongst economic historians that the railway made little difference to the growth of the American economy in the 19th century, a proposition which strikes the layperson as absurd but which is nevertheless believed.

But it is not just in the information technology and communications sector where dramatic advances are already taking place. Major breakthroughs in energy use and extractions have been made, with 300 mpg cars, shale gas, and the huge potential of both renewable energy and energy storage. Biotechnology is even more exciting. Humans may soon have the ability to live healthy lives to the age of 200 and beyond.  Sociobiology may give us deep new insights into how to deal with major social issues such as drug addiction and crime.

Capitalism has been incredibly inventive during the 250 years of its history, and there is no reason to believe that this will not continue. The crucial requirement is not technological but political. The basic institutional structures of the rule of law and private property must be maintained, so that innovators can reap the fruits of their labours.

As published in City AM on Wednesday 3rd July 2013

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Car crash on the Office for National Statistics website… Is it cos I is Welsh?

The website of the Office for National Statistics (ONS) has recently been re-designed. A perfectly functional, low tech website has been transformed into a really cool delivery platform. It looks great. The only drawback is that it is very difficult to find any useful data on it.

The ONS is the basic source of information not just about economic data in the UK, but a lot of social data as well. The institution has recently been the subject of widespread criticism about the reliability of its estimates of GDP data. Its move of more functions to Newport in South Wales, has raised doubts about the quality of the staff willing to work there.

Although the ONS has been revising upwards its initial view of the state of the economy during 2012, this is not a new phenomenon. As more information comes in over time, a more accurate estimate can be made. Revisions to the past have been a feature of preliminary GDP estimates for many years now, and there is no clear evidence that the ONS is suddenly performing worse than it used to in this respect.

But finding data about the past on the website, even data from just a few years ago, now presents a major challenge. For example, it is interesting to compare how the economy performed during the recent recession with what happened in previous downturns in the mid-1970s, early 1980s and early 1990s. So, we type ‘GDP’ into the search box on the ONS website. This returns no fewer than 2828 results. Mercifully, only the first 1000 are displayed. Prior knowledge is required to realise that the first potentially relevant result appears in third place in the list, under the title ‘second estimate of GDP data tables, Q1 2013’. Not a lot of people know that, as Michael Caine allegedly used to say.

Once the Excel file is downloaded and opened, it becomes apparent that it is in fact useless for the immediate purpose. There is indeed data for the past, but only as far back as 1997, Year Zero of the Great Helmsman Brown.

Even real nerds struggle. Data does exist from 1948, but how to find it? Each series in the national accounts has its own four letter identifier. For real GDP (expenditure based, of course!) it is ‘ABMI’ – try it as a question in your next pub quiz. But even if you know this, a search will no longer give you the data itself, but merely the name of the publication in which it appears.

The ONS has abandoned paper publications, so its ‘improved’ website is now the only source of its data. This expensive shambles is nothing to do with the move to Newport. It is yet another example of the fact that the public sector really struggles with the new technology. Governments exhort us that we live in the technology-driven information age. Physician, heal thyself!

As published in City Am on Wednesday 19th June 2013

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Trouble at Co-op Bank raises questions about fitness of the mutual model

IT’S not all fun and games at the Co-op Bank. Just over a month ago, the bank was serious about acquiring 632 branches from Lloyds. Now its debt has been downgraded six notches to junk status, and veteran HSBC banker Niall Booker has been brought in as replacement chief executive after Barry Tootell resigned.

Inquests have begun, and it is only human nature to look for a scapegoat other than the large amount lost on the bank’s new IT system. Management has delved into its hat, and, hey presto, here is the old Britannia Building Society, merged with the Co-op in 2009. It is, we are solemnly told, the bad debts on the Britannia’s commercial property portfolio which are the problem.

But is there more to this than meets the eye? At a time when other UK banks are rebuilding their balance sheets, the Co-op’s has worsened. In 2009, in the depths of the recession, the bank made a profit. Its write-off of bad debt was only £112m compared to the £24bn impairment figure at Lloyds. This comparatively excellent result was claimed to be due to the “cautious approach taken by both heritage businesses”. Now, instead of being described as cautious, Britannia’s portfolio is portrayed as being very risky indeed.

It is hard to see, on the face of it, how a loan portfolio can survive 2009 in good shape and now be seen as a wreck. It does seem as if the Co-op has relatively recently taken a particularly gloomy view of UK economic prospects over the next five years or so. Commercial property values are sensitive to the state of the economy and, on a sufficiently pessimistic view of the next few years, almost every bank in the UK would be in serious trouble. Of course, the official Co-op view of this crisis could be completely correct. Only time will tell.

But the bank’s current predicament does raise the wider issue about the evolutionary fitness, as it were, of the co-operative structure as way of doing business. Co-ops have been with us since at least 1844, when the Rochdale Pioneers were founded, but have never come close to being the dominant species in the corporate environment. For well over a century, the shareholder-based organisation has reigned supreme.

Organisational structures do not spring fully formed into the world. Like almost everything, they evolve over time by a process of natural selection. In principle, any variant or any mutation might be thought to have a chance, however small, of becoming dominant. The weird and wonderful variety of things that have become Top Boy at some point suggests that this is true.

But a recent scientific paper in the august journal Nature on 16 May provides evidence against this idea. Some variants can indeed become successful and survive, but there may be inherent limits on how much fitness they can develop. The co-operative form of organisation may fit this bill.

As published in City Am on Wednesday 29th May 2013

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Bankers, Greens and the Barking Mad: When Prophesy Fails

Forecasts of the end of the world have an even worse track record than predictions in economics.  Some followers of the Mayan calendar believe the world will end next week.

But we have been here before.  In 1956, an American group, led by a suburban housewife, believed that a catastrophic flood would destroy the world on a specific date. Concealing his true identity, a leading American social psychologist, Leon Festinger, had joined them several months previously. When the flood failed to happen, he noted that, far from abandoning their beliefs, the members became even fervent in their view that the world was about to end.

Festinger used this evidence to develop a key concept in psychology, that of cognitive dissonance. He identified a number of factors which need to be present in order for people to intensify their belief following its empirical disconfirmation. For example, the belief must be deeply held and has to have led to actions which are difficult to undo. In addition, the individuals in the group need to give each other support across their social network.

The concept of cognitive dissonance sprang to mind listening to Lord Dennis Stevenson, former chairman of HBOS, giving evidence to the House of Lords committee on the performance of his bank last week. Prior to the actual collapse of his bank, it seems that nothing could persuade him that there were problems.  The freezing of the interbank loan market in the late summer of 2007, for example, was easy to reconcile with the belief that everything was fine. HBOS had already made large numbers of risky loans, which were difficult to call in.  And, of course, his views were sustained by the group-think which dominated the banking sector as a whole.

Another example is the blind fury with which some environmentalists have greeted the increasing realisation that shale gas completely alters the future path for energy and emissions. We no longer need to wear hair shirts and abandon capitalism.  But far from reappraising their views in the light of the empirical evidence of what has happened in America, they become ever more vociferous and shrill.

Most bankers and greens are not barking mad in the way in which many of Festinger’s flood believers were. But even high intelligence could not prevent the emergence of cognitive dissonance in the banking community.

Groupthink, with its potentially negative consequences, is in fact a common problem in the corporate world.  It is not usually as lethal as full-scale cognitive dissonance. If a company plans to make a profit but actually makes a loss, behaviour tends to alter.  But the lack of a challenge to the consensus can lead to very bad decisions.  We may need to revive the concept of the Court Jester, a small, highly paid unsackable group of individuals, whose sole function is to constantly challenge the prevailing beliefs in a company. They would certainly get up people’s noses, but better that than a banking crisis or disastrous acquisition.

As published in City AM Wednesday 12th December

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International Airlines Group: a ‘fantastic object’? The psychology of mergers and acquisitions

International Airlines Group (IAG), formed in January 2011 by a merger of British Airways and Iberia, is in the news. Operating losses at Iberia in the first nine months of the financial year are believed to be in excess of £200 million.

Since the start of last year, IAG’s shares are down by nearly 40 per cent. Shareholders have a right to feel disgruntled. They might, for example, reasonably raise queries about the revenue forecasting methodology of IAG, just how far out were the projections? Or they may ask how much ‘revenue synergy’ – his task specified on the IAG website – has actually been achieved by Robert Boyle, the Director of Strategy. The list can go on.

Such details of the problems are specific to the BA/Iberia merger. But the principles are general across a whole range of merger and acquisition activity amongst publicly listed companies. Twenty years ago, three American business school academics carried out a studied which transformed the approach to analysing mergers and acquisitions.  There was a lot of work about the impact on share prices of an announcement of a merger, and on the value to the shareholders of the company being acquired.  Julian Franks, Robert Harris and Sheridan Titman looked instead at the long-run impact on the share price of the company in the driving seat.

What they found was not good news. Their results gave rise to a whole new area of academic activity, the so-called ‘post-merger performance puzzle’.  Most of the time, the shareholders of the acquiring company lose out. Each individual case has its own particular reasons, but initiating a merger or acquisition is usually bad news for your shareholders.

For believers in economic rationality and efficient markets, this is a puzzle of the first magnitude. On this view of the world, people are allowed to make mistakes. But they are not permitted to do so consistently. For every merger which underperforms, there should be one which delivers unexpectedly large benefits to the shareholders. And there have been such a large number of mergers and acquisitions that executives ought to be able to learn from previous mistakes. Instead, we observe that there is a persistent downside for shareholders of the acquiring company. Occasionally they gain, usually they lose.

IAG is just one more example of this phenomenon. It is one more nail in the coffin of the concept of economic rationality. To understand why very experienced managers still pursue mergers and acquisitions, despite the track record of such activity, we need to turn less to economics and more to psychology.

George Soros in a speech in June this year borrowed a phrase from University College London psychoanalyst David Tuckett, when he described the boom phase in the EU as being a ‘fantastic object’, unreal but immensely attractive. Executives may create such objects when they think of mergers and acquisitions. BA remains a vital part of the British economy. Let’s hope that Willie Walsh brings IAG back to Earth and sorts out the mess.

As published in City AM on Wednesday 14th November 2012

 

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