Thursday, August 31, 2017

Assume the worst about people and you get the worst by Dr. Ha-Joon Chang

Assume the worst about people 
and you get the worst
by Economist

(Book Excerpt from 23 Things They Don't Tell You About Capitalism, Thing 5) 

What they tell you
Adam Smith famously said: ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.’ The market beautifully harnesses the energy of selfish individuals thinking only of themselves (and, at most, their families) to produce social harmony. Communism failed because it denied this human instinct and ran the economy assuming everyone to be selfless, or at least largely altruistic. We have to assume the worst about people (that is, they only think about themselves) if we are to construct a durable economic system.

What they don’t tell you
Self-interest is a most powerful trait in most human beings. However, it’s not our only drive. It is very often not even our primary motivation. Indeed, if the world were full of the self-seeking individuals found in economics textbooks, it would grind to a halt because we would be spending most of our time cheating, trying to catch the cheaters, and punishing the caught. The world works as it does only because people are not the totally self-seeking agents that free-market economics believes them to be. We need to design an economic system that, while acknowledging that people are often selfish, exploits other human motives to the full and gets the best out of people. The likelihood is that, if we assume the worst about people, we will get the worst out of them.

How (not) to run a company
In the mid-1990s, I was attending a conference in Japan on the ‘East Asian growth miracle’, organized by the World Bank. On one side of the debate were people like myself, arguing that government intervention had played a positive role in the East Asian growth story by going against market signals and protecting and subsidizing industries such as automobiles and electronics. On the other side, there were economists supporting the World Bank, who argued that government intervention had at best been an irrelevant sideshow or at worst done more harm than good in East Asia. More importantly, they added, even if it were true that the East Asian miracle owed something to government intervention, that does not mean that policies used by the East Asian countries can be recommended to other countries. Government officials who make policies are (like all of us) self-seeking agents, it was pointed out, more interested in expanding their own power and prestige rather than promoting national interests. They argued that government intervention worked in East Asia only because they had exceptionally selfless and capable bureaucrats for historical reasons (which we need not go into here). Even some of the economists who were supporting an active role for government conceded this point.

Listening to this debate, a distinguished-looking Japanese gentleman in the audience raised his hand. Introducing himself as one of the top managers of Kobe Steel, the then fourth-largest steel producer in Japan, the gentleman chided the economists for misunderstanding the nature of modern bureaucracy, be it in the government or in the private sector. The Kobe Steel manager said (I am, of course, paraphrasing him): ‘I am sorry to say this, but you economists don’t understand how the real world works. I have a Ph.D. in metallurgy and have been working in Kobe Steel for nearly three decades, so I know a thing or two about steelmaking. However, my company is now so large and complex that even I do not understand more than half the things that are going on within it. As for the other managers – with backgrounds in accounting and marketing – they really haven’t much of a clue. Despite this, our board of directors routinely approves the majority of projects submitted by our employees, because we believe that our employees work for the good of the company. If we assumed that everyone is out to promote his own interests and questioned the motivations of our employees all the time, the company would grind to a halt, as we would spend all our time going through proposals that we really don’t understand. You simply cannot run a large bureaucratic organization, be it Kobe Steel or your government, if you assume that everyone is out for himself.’ This is merely an anecdote, but it is a powerful testimony to the limitations of standard economic theory, which assumes that self-interest is the only human motivation that counts. Let me elaborate.

Selfish butchers and bakers
Free-market economics starts from the assumption that all economic agents are selfish, as summed up in Adam Smith’s assessment of the butcher, the brewer, and the baker. The beauty of the market system, they contend, is that it channels what seems to be the worst aspect of human nature – self-seeking, or greed, if you like – into something productive and socially beneficial.

Given their selfish nature, shopkeepers will try to over-charge you, workers will try their best to goof off from work, and professional managers will try to maximize their own salaries and prestige rather than profits, which go to the shareholders rather than themselves. However, the power of the market will put strict limits to, if not completely eliminate, these behaviours: shopkeepers won’t cheat you if they have a competitor around the corner; workers would not dare to slack off if they know they can be easily replaced; hired managers will not be able to fleece the shareholders if they operate in a vibrant stock market, which will ensure that managers who generate lower profits, and thus lower share prices, risk losing their jobs through takeover.

To free-market economists, public officials – politicians and government bureaucrats – pose a unique challenge in this regard. Their pursuit of self-interest cannot be restrained to any meaningful degree because they are not subject to market discipline. Politicians do face some competition from each other, but elections happen so infrequently that their disciplinary effects are limited. Consequently, there is plenty of scope for them to pursue policies that heighten their power and wealth, at the cost of national welfare. When it comes to the career bureaucrats, the scope for self-seeking is even greater. Even if their political masters, the politicians, try to make them implement policies that cater to electoral demands, they can always obfuscate and manipulate the politicians, as was so brilliantly depicted in the BBC comedy series Yes, Minister and its sequel, Yes, Prime Minister. Moreover, unlike the politicians, these career bureaucrats have high job security, if not lifetime tenure, so they can wait out their political masters by simply delaying things. This is the crux of the concerns that the World Bank economists were expressing in the meeting in Japan that I mentioned at the beginning of this Thing.

Therefore, free-market economists recommend, the portion of the economy controlled by politicians and bureaucrats should be minimized. Deregulation and privatization, in this view, are not only economically efficient but also politically sensible in that they minimize the very possibility that public officials can use the state as a vehicle to promote their own self-interests, at the cost of the general public. Some – the so-called ‘New Public Management’ school – go even further and recommend that the management of the government itself should be exposed to greater market forces: a more aggressive use of performance-related pay and short-term contracts for bureaucrats; more frequent contracting-out of government services; a more active exchange of personnel between the public and the private sectors.

We may not be angels, but . . .
The assumption of self-seeking individualism, which is at the foundation of free-market economics, has a lot of resonance with our personal experiences. We have all been cheated by unscrupulous traders, be it the fruit seller who put some rotten plums at the bottom of the paper bag or the yogurt company that vastly exaggerated the health benefits of its products. We know too many corrupt politicians and lazy bureaucrats to believe that all public servants are solely serving the public. Most of us, myself included, have goofed off from work ourselves and some of us have been frustrated by junior colleagues and assistants who find all kinds of excuses not to put in serious work. Moreover, what we read in the news media these days tells us that professional managers, even the supposed champions of shareholder interest such as Jack Welch of GE and Rick Wagoner of GM, have not really been serving the best interests of the shareholders.

This is all true. However, we also have a lot of evidence – not just anecdotes but systematic evidence – showing that self-interest is not the only human motivation that matters even in our economic life. Self-interest, to be sure, is one of the most important, but we have many other motives – honesty, self respect, altruism, love, sympathy, faith, sense of duty, solidarity, loyalty, public-spiritedness, patriotism, and so on – that are sometimes even more important than self-seeking as the driver of our behaviours.

Our earlier example of Kobe Steel shows how successful companies are run on trust and loyalty, rather than suspicion and self-seeking. If you think this is a peculiar example from a country of ‘worker ants’ that suppresses individuality against human nature, pick up any book on business leadership or any autobiography by a successful businessman published in the West and see what they say. Do they say that you have to suspect people and watch them all the time for slacking and cheating? No, they probably talk mostly about how to ‘connect’ with the employees, change the way they see things, inspire them, and promote teamwork among them. Good managers know that people are not tunnel-visioned self-seeking robots. They know that people have ‘good’ sides and ‘bad’ sides and that the secret of good management is in magnifying the former and toning down the latter.

Another good example to illustrate the complexity of human motivation is the practice of ‘work to rule’, where workers slow down output by strictly following the rules that govern their tasks. You may wonder how workers can hurt their employer by working according to the rule. However, this semi-strike method – known also as ‘Italian strike’ (and as ‘sciopero bianco’, or ‘white strike’, by Italians themselves) – is known to reduce output by 30 –50 per cent. This is because not everything can be specified in employment contracts (rules) and therefore all production processes rely heavily on the workers’ goodwill to do extra things that are not required by their contracts or exercise initiatives and take shortcuts in order to expedite things, when the rules are too cumbersome. The motivations behind such non-selfish behaviours by workers are varied – fondness of their jobs, pride in their workmanship, self respect, solidarity with their colleagues, trust in their top managers or loyalty to the company. But the bottom line is that companies, and thus our economy, would grind to a halt if people acted in a totally selfish way, as they are assumed to do in free-market economics.

Not realizing the complex nature of worker motivation, the capitalists of the early mass-production era thought that, by totally depriving workers of discretion over the speed and the intensity of their work and thus their ability to shirk, the conveyor belt would maximize their productivity. However, as those capitalists soon found out, the workers reacted by becoming passive, unthinking and even uncooperative, when they were deprived of their autonomy and dignity. So, starting with the Human Relations School that emerged in the 1930s, which highlighted the need for good communications with, and among, workers, many managerial approaches have emerged that emphasize the complexity of human motivation and suggest ways to bring the best out of workers. The pinnacle of such an approach is the so-called ‘Japanese production system’ (sometimes known as the ‘Toyota production system’), which exploits the goodwill and creativity of the workers by giving them responsibilities and trusting them as moral agents. In the Japanese system, workers are given a considerable degree of control over the production line. They are also encouraged to make suggestions for improving the production process. This approach has enabled Japanese firms to achieve such production efficiency and quality that now many non-Japanese companies are imitating them. By not assuming the worst about their workers, the Japanese companies have got the best out of them.

Moral behavior as an optical illusion?
So, if you look around and think about it, the world seems to be full of moral behaviours that go against the assumptions of free-market economists. When they are confronted with these behaviours, free-market economists often dismiss them as ‘optical illusions’. If people look as if they are behaving morally, they argue, it is only because the observers do not see the hidden rewards and sanctions that they are responding to.

According to this line of reasoning, people always remain self-seekers. If they behave morally, it is not because they believe in the moral code itself but because behaving in that way maximises rewards and minimizes punishments for them personally. For example, if traders refrain from cheating even when there is no legal compulsion or when there are no competitors ready to take away their businesses, it does not mean that they believe in honesty. It is because they know that having a reputation as an honest trader brings in more customers. Or many tourists who behave badly would not do the same at home, not because they suddenly become decent people when they go back home but because they do not have the anonymity of a tourist and therefore are afraid of being criticized or shunned by people they know and care about.

There is some truth in this. There are subtle rewards and sanctions that are not immediately visible and people do respond to them. However, this line of reasoning does not work in the end. The fact is that, even when there are no hidden reward-and-sanction mechanisms at work, many of us behave honestly. For example, why do we – or at least those of us who are good runners – not run away without paying after a taxi ride? The taxi driver cannot really chase us far, as he cannot abandon his car for too long. If you are living in a big city, there is virtually no chance that you will meet the same driver again, so you need not even be afraid of the taxi driver retaliating in some way in the future. Given all this, it is quite remarkable that so few people run away without paying after a taxi ride. To take another example, on a foreign holiday some of you may have come across a garage mechanic or a street vendor who did not cheat you, even when there really was no way for you to reward her by spreading her reputation for honest dealings – particularly difficult when you cannot even spell the Turkish garage’s name or when your Cambodian noodle lady, whose name you cannot remember anyway, may not even trade in the same place every day. More importantly, in a world populated by selfish individuals, the invisible reward/sanction mechanism cannot exist. The problem is that rewarding and punishing others for their behaviors costs time and energy only to the individuals taking the action, while their benefits from improved behavioral standards accrue to everyone. Going back to our examples above, if you, as a taxi driver, want to chase and beat up a runaway customer, you may have to risk getting fined for illegal parking or even having your taxi broken into. But what is the chance of you benefiting from an improved standard of behavior by that passenger, who you may not meet ever again? It would cost you time and energy to spread the good word about that Turkish garage, but why should you do that if you will probably never visit that part of the world ever again? So, as a self-seeking individual, you wait for someone foolish enough to spend his time and energy in administering private justice to wayward taxi passengers or honest out-of-the-way garages, rather than paying the costs yourself. However, if everyone were a self-interested individual like you, everyone would do as you do. As a result, no one would reward and punish others for their good or bad behavior. In other words, those invisible reward/sanction mechanisms that free-market economists say create the optical illusion of morality can exist only because we are not the selfish, amoral agents that those economists say we are.

Morality is not an optical illusion. When people act in a non-selfish way – be it not cheating their customers, working hard despite no one watching them, or resisting bribes as an underpaid public official – many, if not all, of them do so because they genuinely believe that that is the right thing to do. Invisible rewards and sanctions mechanisms do matter, but they cannot explain all – or, in my view, even the majority of – non-selfish behaviours, if only for the simple reason that they would not exist if we were entirely selfish. Contrary to Mrs Thatcher’s assertion that ‘there is no such thing as society. There are individual men and women, and there are families’, human beings have never existed as atomistic selfish agents unbound by any society. We are born into societies with certain moral codes and are socialized into ‘internalizing’ those moral codes.

Of course, all this is not to deny that self-seeking is one of the most important human motivations. However, if everyone were really only out to advance his own interest, the world would have already ground to a halt, as there would be so much cheating in trading and slacking in production. More importantly, if we design our economic system based on such an assumption, the result is likely to be lower, rather than higher, efficiency. If we did that, people would feel that they are not trusted as moral agents and refuse to act in moral ways, making it necessary for us to spend a huge amount of resources monitoring, judging and punishing people. If we assume the worst about people, we will get the worst out of them.

Saturday, August 26, 2017

Unions, Pensions, Social Security, and Legacy Costs

Unions, Pensions, Social Security, and Legacy Costs
by Allen Laudenslager & Bryan Neva

In the 1987 film Wall Street, the antagonist Gordon Gekko (played by Michael Douglas) didn't want to buy the airline that Bud Fox’s father, Carl Fox, worked for (played by Charlie and Martin Sheen) in order to run it; rather, he wanted to close out the pension fund, distribute the cash and arrange to pay future pensions from future earnings.  Now Gekko knew full well there wouldn't be any money left when those pensions came due so his plan was to sell the company long before then.

Back in the mid-1960s, the government started “borrowing” from the social security fund (America’s pension fund) to pay for the war in Vietnam and the social programs of the Great Society.  They expected to pay the money back later from future tax revenues. This mixing of funds worked so well for the government that business lobbied for the same privilege and they got it. 

The American automakers then proceeded to do the same thing the government did, they collected money for future pensions and benefits as each car was sold, but they didn't put that money in a separate account, instead, they used it to cover current expenses and show bigger profits.  Now, as the bill is coming due and the automakers have to actually pay the pensions and benefits, they are bemoaning their union employee’s "legacy costs."  It's not the actual cost of the pensions and benefits that are the problem, it’s years of poor money management by the automakers that are the problem.  So when you hear pundits bemoan the huge “legacy cost” of autoworkers’ pensions and benefits, they either don’t know what they’re talking about or they’re purposefully lying to you because those costs have already been paid.  Any accountant could tell you this.

Economic theory posits that within an ideal free market, property rights are voluntarily exchanged at a price arranged solely by the mutual consent of sellers and buyers. They engage in trade simply because they both believe that what they are getting is worth as much or more than what they give up.  Market prices are the result of buying and selling decisions en masse as described by the theory of supply and demand.  The wages the labor unions in the United States were able to negotiate with companies were either “free market” agreements or were the result of the union’s coercing the companies into unsupportable wage agreements.  But if (and this is a big if) the unions created unrealistic wage scales, how come the companies were still able to make huge profits during the heydays of unionism in the 60s, 70, and 80s?

According to Fortune Magazine, GM made $873 million dollars in profits for 1960, $14,820 million in 1970, $32,215 million in 1980, $173,297 million in 1990, and $273,921 million in 2000.  If the unions were really behind the demise of GM in 2009, as some pundits claim, we should have seen a downward trend in GM’s profits over the preceding 40 years, but the reverse is actually true as profits went up not down!

If you factor in the “legacy costs” of employee’s pensions and retiree’s health care benefits, these didn’t actually cost GM anything because employee’s benefits are calculated into their hourly labor costs, which GM writes off on their taxes each year.  If an employee earns “x” dollars per hour and his benefits are “y” dollars an hour, then GM’s hourly labor costs are “x + y” dollars an hour.  The employee’s hourly benefits of “y” dollars are deferred compensation, and GM ideally should invest those tax-free dollars in a retirement fund so that the investment returns will lower GM’s benefits costs.

And when companies calculate the costs of making their product, they also include all the production costs for the product or service as well as raw materials, manufacturing equipment, and factory space. The production costs includes an employee’s "burden rate" which is the cost of the employee’s hourly salary plus the cost of their benefits, the cost of their share of heat, lights, their desk, computer, and any other tools or factory space, divided by the actual number of hours the employee works (usually about 1800 hours when you subtract out vacation, holidays, and sick leave).  (The burden rate = (((employees salary + employees benefits) + employee’s share of infrastructural costs) / 1800 annual work hours.)  And do you think GM actually pays those costs…of course not?  The customer pays those costs in the price of the vehicle they purchase.

By following the current fashion in corporate management, far too many companies are focusing on squeezing every last penny of profits out of each sale.  And in far too many cases, that has led to short-sighted decision making such as not saving for the retirement of their employees despite making huge profits.  The government is facing the same conundrum.  After over fifty years of “borrowing” from the social security fund, the bill is coming due as all the baby-boomers are retiring and there’s no money left to pay them.  Now lawmakers and pundits are bemoaning the cost of their citizen’s “legacy costs.”

Wednesday, August 9, 2017

Pride & Riches

Pride & Riches
by Bryan Neva

“Get rid of Pride and Riches will do no harm!”
—St. Augustine of Hippo

Sometime around the year 400, there was a monk named Pelagius who, while living in the city of Rome, became concerned about poverty and the oppression of the poor by the rich.  And he conceived a simple solution: “Get rid of the rich and you will find no poor!”  In other words, he believed that the rich were the cause of poverty because they oppressed the poor, so if they just outlawed being rich then that would solve the problem of poverty. 

In response to Pelagius’ idea, St. Augustine of Hippo said, “Get rid of pride and riches will do no harm!”  In other words, Augustine believed that it was the pride of the rich that was the real cause of poverty and oppression of the poor.  Augustine didn’t buy into Pelagius’ argument that the divisions in the world were between the rich and the poor, but rather it was between the proud and the humble.  He believed that the inequality of wealth and power was a fact of life.  But if the rich stopped abusing their power and practiced humility instead then that would solve the problems of poverty and the oppression of the poor.

In ancient Roman culture, there was a belief that the rich could rule the city provided they treated those below them well and showed “civic love” by spending money to maintain the economy and provide work for the poor.  Augustine added to this belief by saying that the rich should also abandon their pride (instead of their wealth) and give alms to the poor.  There were “good rich people” and there were “bad rich people.”  The “good rich people” treated those below them well, practiced humility and did not abuse their power, and they shared their wealth with society through their spending and alms giving.  The “bad rich people” did none of these.

Over time, Augustine’s view on riches proved to be exactly right.  When communism reared its ugly head in the early 20th century they did exactly what Pelagius proposed: they outlawed being rich.  But it didn’t solve the problems of poverty as those in power abused their authority and oppressed the poor.  The communist leaders weren't rich but they were still full of pride.  The failure of communism proved that the divisions in the world were not between the rich and the poor, but rather between the proud and the humble as Augustine said.  Wealth is not the problem in and of itself; the real problem is pride!

Nowhere in the Bible does it ever condemn being rich…what it condemns is the love of riches.  St. Paul in his first letter to the Bishop Timothy (6:10) wrote, “For the love of money is the root of all evil.”  Jesus said in Matthew 19:24, “It’s easier for a camel to go through the eye of a needle, than for a rich man to enter into the kingdom of God.”  Why is it so difficult for a rich person to go to heaven because they love riches more than God and their fellow man?  

Jesus also said in Matthew 6:24, “No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other. You cannot serve both God and money."  Jesus was talking about keeping our priorities straight.  Obviously, we all need money to live.  Jesus needed money too, but interestingly he gave the coin purse to the man who would betray him for thirty pieces of silver.  When we keep our priorities straight, we put God first, others second, and ourselves third.  And money should be really low on our priority list.

Friday, July 21, 2017

Go With Your Gut Feeling | Magnus Walker | TEDxUCLA

Go With Your Gut Feeling
by Magnus Walker | TEDxUCLA

Do what you love and you'll never have to work a day in your life.

Monday, July 17, 2017

Should American Homes Be Disposable? by Allen Laudenslager & Bryan Neva

Should American Homes Be Disposable?
by Allen Laudenslager & Bryan Neva

In a February 27, 2014 blog posted on entitled, “Why Are Japanese Homes Disposable?”, it discussed the reasons why the Japanese think of their homes as disposable.  In Japan, homes actually depreciate in value because when they’re sold the new owners just demolish them and build new homes in their place.  Consequently, there’s a huge demand for new homes in Japan.

In the west when you hear of “a huge demand for new homes,” you’d naturally think the economy in that place is booming and the population is increasing.  But that’s not the case in Japan.  The economy in Japan has been stagnating for over twenty years, and the Japanese population has been declining due to low birth rates and a cultural resistance to immigration.  Furthermore, the housing vacancy rate in Japan is close to 20%.  So Japan defies common sense economics.  Why is this?

One possibility discussed in the blog is that after World War II the country’s homes were demolished and the replacement homes built were very shoddy construction unable to withstand the weather and Japan’s frequent, catastrophic earthquakes.  With more stringent building codes it was understandable those homes would be demolished and replaced with better-built, earthquake resistant homes.  But all those homes were replaced by 1980.

Another possibility discussed is that the Japanese culture highly values “newness,” so they’ve come to view housing as a perishable item like a car.  Unlike in the west where people maintain and improve their homes, the Japanese just let their homes deteriorate like their cars.  And this seems to be the most likely reason why the Japanese view homes as disposable.

Maybe this comes from the Japanese recognition that a house is a machine that they live in just as a car is a machine that they travel in.  All machines wear out with use and houses are no exception.  Yes, that lifespan can be extended with proper maintenance, but a used car is still worth less than the same new car no matter the level of maintenance.  A used house is worth less than a new house, but not as much as the maintenance costs after 20, 30, or 40 years.  Most houses need major renovations in 10 to 20 years.  In the U.S., the bursting of the housing bubble in 2008 actually reset home values to their real value after years of everyone failing to understand that houses naturally wear out.

In Japan, there are more architects and construction workers than in any other developed country because of the high demand for new homes. Whereas in America, there’s a huge demand for home improvement, which is why there are so many big box home improvements stores like Lowes and Home Depot.  Americans believe they can add value to their homes and eventually sell them for a profit if they’re properly maintained and improved. The huge home improvement industry in the U.S. is just a way for people to slow down the depreciation of their homes so they can eventually sell for a profit.  And if they’ve purchased a home in a good location, then the land value will appreciate and they could eventually make a bigger profit.

The markets do not entirely set home values, rather the banks indirectly set home values based on how much they’ll loan someone to buy a house.  If you want to buy a home, the only things that matter are how much the bank will loan you and how much money you can put down on the house.  After all, before a bank will approve a loan they’ll have an appraisal done, and if the bank says, “no we don’t think the house is worth that much,” you’d either have to put more money down on the house or the seller would have to be willing to accept less for the house.  (This is a standard clause written into most home selling agreements that the sale is contingent on the appraised value.)  So if the banks used the actual cost to build a new house minus the cost to renovate the old house to like-new condition then home values would be more realistically priced.  In fact, this is exactly what they do for commercial properties like warehouses and office buildings.

Slavishly misapplying the concept of “the market sets the value” leads to silly bidding wars similar to the silly bidding wars on the television show Storage Wars where the actors end up bidding against each other rather than the expected value of the storage unit’s contents.  Remember, those actors can afford to overbid since the bidders are getting paid as actors on the show, meaning that the producers of the show are in effect subsidizing them in order to create more drama.  Similarly, if the bank wasn’t subsidizing you, you’d need to compare the cost of that house in that location to a brand new house built in the same location!  One reason there’s so much resistance to new construction in some localities (especially in California) is that homeowners know that new construction drives down the values of existing homes.  The only reason to pay more for an existing home is that too many people want to live in a particular area and there’s no competing new home construction.  In other words, the land value is greater than the value of the home; which is why in real estate the mantra is “location, location, location.”  In the small island city of Coronado, California, a suburb of San Diego, you literally can’t buy a “dog house” on a "postage stamp sized lot" for less than a million dollars!

Most Americans, including bankers, don’t realize that the real reason home values go up is that the value of the land is increasing faster than the value that the wood, brick, and mortar is decreasing. They are in fact paying a premium for the location.  It’s OK to pay that premium as long as you understand that’s what you’re doing.  Whenever you pay a premium for something you are hoping to resell it in a few years for a profit. (On average, most Americans only live in a house for 7 years; whereas, in Japan, it’s for decades.) So you have to keep in mind that the next person who wants to buy that house may not be willing to pay a premium which is why there are so many declining cities like Detroit, MI.

So should American homes be disposable?  Well, in fact, they already are.  The only difference between Japan and the U.S. is that homes depreciate much faster in Japan than they do in the U.S.  In Japan, homes depreciate close to zero within 30 years (in about one generation); whereas, in the U.S., it’s closer to 100 years (in about four generations).  In Europe where the homes are typically built with stone and concrete rather than with wood like in Japan and the U.S., homes depreciate over 200 years (about eight generations).

Most experts believe that the Japanese culture of thinking their homes are disposable is very wasteful and shortsighted.  They’re giving up a huge store of wealth they could be accumulating in the form of their homes.  No other developed or semi-developed country in the world treats real estate like the Japanese do: as disposable in one generation.  And in the long run, by changing the attitudes of the Japanese they could potentially become more prosperous and pull their economy out of its slump. 

On the other hand, we could take a lesson from the Japanese by changing our attitudes about homes.  If homes were discounted proportionately to the cost of getting them back into like-new condition, then homes would be more reasonably priced and more Americans could afford to buy homes.  

Thursday, July 13, 2017

GE Needs A New Strategy And A New CEO by Adam Hartung, Forbes

My Thoughts: I've never been a fan of GE as I believe the company represents everything that's wrong with Corporate America today with it's profit-at-any-price, throw-the-baby-out-with-the-bathwater mentality. I post this article from Forbes more as an example of how NOT to run a company where profits come before people. Also, GE is a good example of why bigger is not always better; historically, smaller, more agile companies outperform huge conglomerates. GE under the leadership of Jack Welch and Jeff Immelt shows that eventually, you'll reap what you sow. As of this writing, GE announced Immelt will be retiring on August 1st, and John Flannery will be assuming the role. Personally, I'm rooting for the vultures that want to come in and tear GE up into smaller, more bite-sized pieces.  - Bryan Neva 7/13/17

GE Needs A New Strategy And A New CEO

I cover business growth & overcoming organizational obstacles. 

I'm an expert on business growth and overcoming organizational obstacles to success. I do keynote speaking at conferences and management meetings, and a workshop leader for companies wanting to find their next growth engine. I am the author of "Create Marketplace Disruption: How to Stay Ahead of the Competition," a contributing editor for International Journal of Innovation Science and a leadership columnist for CIOMagazine and ComputerWorld. I currently serve as audit chair for 6D Global, and am CEO of Soparfilm Energy E&P company as well as Content Laboratory. I previously headed business development for Pepsico and Dupont, and was a consultant with The Boston Consulting Group. I have a Harvard MBA and live in Chicago.

General Electric CEO Jeffrey Immelt (ERIC PIERMONT/AFP/Getty Images)
General Electric stock had a small pop recently when investors thought CEO Jeffrey Immelt might be pushed out. Obviously more investors hope the CEO leaves than stays. And it appears clear that activist investor Nelson Peltz of Trian Partners thinks it is time for a change in CEO atop the longest running member of the Dow Jones Industrial Average (DJIA.)
You can't blame investors, however. Since he took over the top job at General Electric in 2001 (16 years ago) GE's stock value has dropped 38%. Meanwhile, the DJIA has almost doubled. Over that time, GE has been the greatest drag on the DJIA, otherwise the index would be valued even higher! That is terrible performance  especially as CEO of one of America's largest companies.
But, after 16 years of Immelt's leadership, there's a lot more wrong than just the CEO at General Electric these days. As the JPMorgan Chase analyst Stephen Tusa revealed in his analysis, these days GE is actually overvalued, "cash is weak, margins/share of customer wallet are already at entitlement, the sum of the parts valuation points to a low 20s stock price." He goes on to share his pessimism in GE's ability to sell additional businesses, or create cost lowering synergies or tax strategies.

Former Chairman and CEO of General Electric Jack Welch. (AP Photo/Richard Drew)
What went so wrong under Immelt? Go back to 1981. GE installed Jack Welch as its new CEO.  Over the next 20 years there wasn't a business Neutron Jack wouldn't buy, sell or trade. CEO Welch understood the importance of growth. He bought business after business, in markets far removed from traditional manufacturing, building large positions in media and financial services. He expanded globally, into all developing markets. After businesses were  acquired the pressure was relentless to keep growing. All had to be no. 1 or no. 2 in their markets or risk being sold off. It was growth, growth and more growth.
Welch's focus on growth led to a bigger, more successful GE. Adjusted for splits, GE stock rose from $1.30 per share to $46.75 per share during the 20 year Welch leadership. That is an improvement of 35 times - or 3,500%. And it wasn't just due to a great overall stock market.  Yes, the DJIA grew from 973 to 10,887  or about 10.1 times. But GE outperformed the DJIA by 3.5 times (350%).  Not everything went right in the Welch era, but growth hid all sins  and investors did very, very, very well.
Under Welch, GE was in the rapids of growth. Welch understood that good operating performance was not enough. GE had to grow. Investors needed to see a path to higher revenues in order to believe in long term value creation. Immediate profits were necessary but insufficient to create value, because they could be dissipated quickly by new competitors. So Welch kept the headquarters team busy evaluating opportunities, including making some 600 acquisitions. They invested in things that would grow, whether part of historical GE, or not.
Jeff Immelt as CEO took a decidedly different approach to leadership. During his 16 year leadership GE has become a significantly smaller company. He sold off the plastics, appliances and media businesses  once good growth providers  in the name of "refocusing the company." Plans currently exist to sell off the electrical distribution/grid business (Industrial Solutions) and water businesses, eliminating another $5 billion in annual revenue. He has dismantled the entire financial services and real estate businesses that created tremendous GE value, because he could not figure out how to operate in a more regulated environment. And cost cutting continues. In the GE Transportation business, which is supposed to remain, plans have been announced to double down on cost cutting, eliminating another 2,900 jobs.
Under Immelt GE has focused on profits. Strategy turned from looking outside, for new growth markets and opportunities, to looking inside for ways to optimize the company via business sales, asset sales, layoffs and other cost cutting. Optimizing the business against some sense of an historical "core" caused nearsighted  and shortsighted  quarterly actions, financial gyrations and transactions rather than building a sustainable, growing revenue stream. Under Immelt sales did not just stagnate, sales actually declined while leadership pursued higher margins.
By focusing on the "core" GE business (as defined by Immelt) and pursuing short term profit maximization, leadership significantly damaged GE. Nobody would have ever imagined an activist investor taking a position in Welch's GE in an effort to restructure the company. Its sales growth was so good, its prospects so bright, that its P/E (price to earnings) multiple kept it out of activist range.
But now the vultures see the opportunity to do an even bigger, better job of whacking up GE  of tearing it into small bits while killing off all R&D and innovation — like they did at DuPont. Over 16 years Immelt has weakened GE's business what was the most omnipresent industrial company in America, if not the world - to the point that it can be attacked by outsiders ready to chop it up and sell it off in pieces to make a quick buck.
Thomas Edison, one of the world's great inventors, innovators and founder of GE ,would be appalled. That GE needs now, more than ever, is a leader who understands you cannot save your way to prosperity, you have to invest in growth to create future value and increase your equity valuation.
In May, 2012 (five years ago) I warned investors that Immelt was the wrong CEO. I listed him as the fourth worst CEO of a publicly traded company in America. While he steered GE out of trouble during the financial crisis, he also simply steered the company in circles as it used up its resources. Then was the time to change CEOs, and put in place someone with the fortitude to develop a growth strategy that would leverage the resources, and brand, of GE. But, instead, Immelt remained in place, and GE became a lot smaller, and weaker.
At this point, it is probably too late to save GE. By losing sight of the need to grow, and instead focusing on optimizing the old business while selling assets to raise cash for reorganizations, Immelt has destroyed what was once a great innovation engine. Now that the activists have GE in their sites it is unlikely they will let it ever return to the company it once was - creating whole new markets by developing new technologies that people never before imagined. The future looks a lot more like figuring out how to maximize the value of each piece of meat as it's carved off the GE carcass.

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