Drones

I’m mostly copying this from an email conversation, just to put it here where I might be able to find it again someday.

On Father's day my son Gage called me partly to reference the fact that I am his father, but also to  offload some troubled contemplation on the issue of drones in United States airspace and modern loss of privacy in general.  There have been rumors along the political edges, and in radical places like Kansas, that various government agencies were spying on pretty much everyone from unmanned drones.  Within cities there are fears, apparently, that the police are using drones to spy on public places, and maybe even within your home, somehow, with thermal imaging.  In the Midwest the rumor was that the FDA was using drones to try to catch farmers doing something the FDA might not approve. 

It turns out that this last rumor was a paranoid fantasy, much like the old fear among militia fanatics that black United Nations helicopters were poised to swoop down and impose military law on North Dakota, or wherever.  Those older rumors also took the fear-of-surveillance form: federal agents were supposedly using them to enforce wildlife laws. 

The FDA doesn't use drones.  It uses manned aircraft to perform that task, if that helps us feel any better. 

The rumors about police departments have some truth to them, but not much...yet.   They have been used for border surveillance since 2005, and there has been some limited police use of drones in special situations.  But they aren’t in general use by police departments yet.  And the police departments who want to use them point out that the same cameras and much more can be loaded on piloted aircraft, which are already in use everywhere and have been for a very long time, and that cell phones can take videos on any city street at any time.   That’s all true.  We can be recorded at any time in any public place; and not just by the police, or by government, and not just by drones.  Google may be mapping your house this very minute.

But drones seem a bit more intrusive, don't they?  A manned aircraft has to be at least big enough, and visible enough, to contain a human form, and powerful enough to lift one.  Drones can be very small, and very quiet.   So in theory the privacy concerns are valid, and the issue is real.  And privacy concerns over drone use are getting attention, from both the right and the left.  The ACLU is on this, and see here for a report in the National Journal on concern from the Congressional Privacy Caucus (now, honestly, did you know there was one??).  The Electronic Privacy Information Center has a page on drones in the United States.

There are, apparently,  63 sites in the United States that are permitted by the FAA to launch drones, (click here for an interactive map of where they are and who they are: most of those are pretty benign.) 

The picture may change a lot in the near future, though.  There are all kinds of legitimate uses, including scientific research, traffic control, and so on, and the FAA, as required by legislation earlier this year, recently modified the rules with respect to drones, making it easier to get permission to use them.  

So what do you think?  Is this an four-alarm privacy holocaust, or is it just the next step in a privacy erosion process that has already gone so far we can't stop it?  Or do you think that the uses of drones will be generally contained within reasonable bounds?

I don't think this is a major issue yet.  But Gage is right to raise it.  It could become a major issue sometime soon.  And it was one that was completely (ahem...) off my radar until Gage pointed it out.

Still a Greecy Mess

My first petulant post-Greek-election comment: this is a triumph of wishful thinking.  Actually, there was no good option in this election.  At the moment Greece is out of good options.  This declaration of faith in European unity and the power of austerity does nothing but prolong and deepen the anguish, and in the end Greece may still default and exit the Euro.  The terms of trade between the GIPSIs and the rest of Europe, but primarily with Germany, must change, and within the Euro that can happen only by inflation in Germany or deflation in the GIPSIs.  Of these two, inflation is the best choice; it's easy and and the discomfort is fairly mild.  Deflation takes a very long time, and creates tangle of bankruptcies and broken contracts, a generation---or more---of lost potential, and masses of human pain.

Still, no one knows the future for certain.  I hope this works for them.  

PS: I just read Krugman's response, which contained this line: 

                    "So they will now have the ability to continue pursuing an 

                      unworkable policy. Yay!"  

It's good to have my petulance seconded at the higher and more dignified levels of economic debate.

Sunday Stories from the Washington Post

Wow.  I can't believe it's been a week since I visited here.  Well, I should report, so that those few who visit this blog can take note for posterity; tonight's post is induced by a Murphy-Goode Souvignon Blanc ("The Fume").  It was great with dinner, but we'll see.  We have a different standard here.  Here we judge wines by the quality of the blog posts they provide.

There were two items in the Post this morning that deserved a comment, or at least there were two that prodded me on economic grounds.  One was in the Fact Checker, the column by Glen Kessler, and the other---probably the one that will get the most press in the next few months of political fantasy---was in the Dana Milbank column on the Opinion page.  

I have mixed reactions to Kessler.  Sometimes I think the gets things as close to right as he can be expected to be, and other times I think he's just expressing his own politics.  But in this case it wasn't either of those, it was just a throw-away end to a fairly good storyline.  Here's the paragraph from the Kessler column that prodded me: 

“Richard Kogan, a budget expert at the Center on Budget and Policy Priorities, said that while federal outlays in 2011 amounted to 24.1 percent of GDP, transfer payments were 15.7 percent and interest payments were 1.5 percent of GDP, leaving just 6.9 percent of GDP ‘that can reasonably be thought of as federal consumption (purchases of goods and services) in 2011.’”

All of Mr. Kogan’s facts are right.  But the last fact seems incomplete to me, and even misleading.  But it’s misleading by omission, and by that omission it’s misleading people into continuing a belief that is almost universal: that a government, at any level, “consumes” some large part of the economy.

What is omitted is that all spending has two sides.  Always.  No matter who is spending, whether it’s government, households, or businesses, someone else is earning.   When I spend money at the grocery store, the grocer is making a living.  And when the federal government buys something, some good or service, someone else receives the money that the government spends.  The government purchases computers: some computer manufacturer sells and ships them to a retailer, and the retailer sells them to the government.  Without the government’s purchases that business would never have happened; that part of the economy, that part of GDP, would never have happened.  So when Mr. Kogan says that the federal government purchases goods and services, he is saying that the federal government has purchased something from the private sector, on the open market.  Federal civilian salaries are bit over 1% of GDP, as a rough measure, so that part is not payment to a private business.  But even when the federal government employs people directly, it is buying that labor from the civilian workforce, and those same people are available for employment in the private sector; that is, they are members of households who are selling their labor for income, and just as General Dynamics sells ships to the federal government or Oshkosh sells trucks, households sell labor to the federal government.  In return, GD and Oshkosh get money to pay the salaries of their employees and their suppliers, and households get income to pay their bills.  The idea that government expenditures are somehow lost to the economy, that is, that the government “consumes” some share of GDP, and that the act of government consuming is just a drain on the taxpayers, is just wrong. The government’s act of consuming is also income to taxpayers.

Ok.  On to Dana Milbank.  Mr. Milbank says that “Obama has made no serious proposal to fix the runaway entitlement programs that threaten to swamp the government’s finances”.  I don’t want to attack or defend the programs that Obama has proposed.  The issue I have with this statement is the presumption, from the outset, that we must adopt some radical restructuring of Social Security and Medicare, because they will overwhelm the budget if we don’t.  I’ve said before in this blog that Social Security and Medicare are totally different programs, that Social Security is a comparatively easy fix---if it even needs fixing---and that the problem with Medicare is that health care costs are rising in the private sector, and that is what will overwhelm budgets everywhere in the next few decades.   Let me repeat that: it is rising private health care prices that are the problem, not the structure of the government program that has to pay some of them.  If we radically change Medicare to relieve the government of the expense of paying for those health care costs for the elderly, that only means that the elderly themselves will have to pay them---or their children will.  Or the elderly could simply do without health care: they could suffer, or die. 

Caring for our elderly might be a national responsibility; I believe it is.  There are those who disagree with me, and they surely have that right; this is a personal sense, a personal judgment, not a matter that is subject to scientific test or proof.  But whether it is a national responsibility or not, simply abandoning that responsibility by radically restructuring the government program that supports it may solve the government’s budget problem, but it does not solve the national budget problem, the budget problem that includes the budgets of all businesses and households.  If we don’t solve the underlying problem of rising health care costs, the nation will be broke, whether that budgetary catastrophe falls on the government or falls on others.

Private equity stories; gains, losses, heros and villains..

Wow.  What a title.  

Several days ago I linked to this blog post and this one, by Noah Smith in Noahpinion, which in general is one of my favorite economic blogs.  It’s a fun blog to read, and Smith sometimes grazes in the higher meadows, which is also fun.
  

 I talked about the argument presented in the first of these as an example of the kind of economic storytelling, or of economics as a kind of storytelling, that the second of these references criticized.  If economics is only storytelling, then we can all select the story we like and cling to that.
  

His post was all about Private Equity (PE) firms like Bain Capital, which is already a controversy in the presidential campaign.  The story he tells about PE (private equity capital, and primarily hostile takeovers) is that they increase efficiency, both in the firm that is taken over and in the general economy in which it operates.   Dr. Smith argues that Japan is filled with the kind of ossified, highly inefficient firms that would benefit from a big dose of hostile takeovers.  Here’s his description of a typical Japanese company:
  

“Employees sit idly in front of their computers waiting for the boss to leave so they can go home, or make busy-work for themselves, copying electronic records onto paper (yes, this is real!). Unproductive workers are kept on the payrolls because of lifetime employment, with high salaries guaranteed by the system of seniority pay. To this, add endless meetings, each of which must be exhaustively prepared for in advance. Layer upon layer of bureaucracy with poorly defined accountability. Pay based entirely on tenure rather than merit.”
  

This Japanese work culture, he argues, could be cured by the application of PE managers with their cold-eyed focus on efficiency and on getting rid of deadwood in the pursuit of company profits.  But even apart from the issue of any possible salutary impact of private equity capital firms like Bain, I find this description of Japanese management fascinating; I remember a couple of decades back when the business world was awash in books like this or this or this, about how we should all emulate the superior Japanese management methods.
  

This vision of private equity as a kind of stimulant to economic efficiency, and a kind of recycling agent restoring life to run-down firms, is one story about how PE operates, but it isn’t the only one.  I’ll tell three stories here.  The first is the most like the Noahpinion version, although I think Noah Smith is far too smart to accept this classical version in its pure state as I tell it here.
  

But here goes.
  

The first PE story sees private equity managers as risk-takers very like the venture capitalists who fund startups, except that the ventures they embark on and invest in are established companies that need to be refreshed, renewed, or redirected.  They are the story’s good guys---admittedly greedy good guys who make huge profits, but still good guys.   These good guys take over a (possibly wobbly) existing business and improve its operations enough to stabilize it by finding and ending inefficiencies, by making better product and publicity decisions, by replacing a complacent, overpaid and uninspired management, and so on.   The value of the company rises, both the company’s shareholders and the deserving private equity managers reap their justified and hard-won rewards, and the latter move on to save other companies.  It’s true, even in this version of the PE story, that often the process of improving efficiency is full of “hard choices” (in quotes because the choices aren’t necessarily hard for those who make them; it’s a word used to describe decisions that impose losses on others).  Sometimes people must be fired, plants must be closed, wage or pension contracts must be renegotiated, but PE managers sometimes argue that the alternative is to have the company bumble along until it is bankrupt, which would mean that all of its employees would be unemployed rather than only some of them, and all would suffer reduced income, and loss of pensions.   Or, at a minimum, they argue that the efficiency they gain more than compensates for the costs they impose, meaning that the gainers gain more than the losers lose.  They, the PE managers, are making tough but necessary choices.   The surgery is hard but they are saving what they can so that the patient can live and prosper in the future.  And if the employees really are worth the wages they were being paid before the takeover, then they will not have to accept a wage cut because other companies will offer them the wage they are worth, and they will simply move to other jobs instead of accepting lower income.
  

There are other things to say about the impact of this process on its participants.  Let’s tell the other stories first, but I do want to come back to the impacts on those who lose, and on those who gain.  You may have noticed, for example, that it’s the employees and suppliers who lose, and the existing and new shareholders who gain.  There’s a lot to talk about there.  Maybe I’ll do that another day, though.
  

The second story I want to tell is the very opposite of the PE manager as a good guy: in this version he’s the bad guy.  This is the story Rick Perry and Newt Gingrich tried to tell about “vulture capitalists”.  In this story the private equity investor isn’t looking for a company to save; he really doesn’t care much about what happens to the company in the long run.  Instead, he looks for a company that has good credit, or large amounts of retained earnings, and when he finds one he raises money using junk bonds to buy it---and then uses the company’s own credit or retained earnngs to pay the junk bonds off, so the transaction costs him little or nothing, and he ends up owning the company!  And the story goes on from there: the equity capitalist can use what remains of the company’s retained earning or credit to borrow large amounts of money which he keeps for himself, or for his investors, as a “management fee”.  And now the company, which was healthy before the PE firm discovered and attacked it, is in debt and in trouble. In this story, the PE manager is not looking for a company to save; he’s looking for a company to loot.  But what will he do with this company that he owns, now that he has used up its retained earnings and its credit?  Well, he can then try preserve some value by making all those “hard choices” we talked about in the first story, by renegotiating pension contracts or just capturing and using the retirement fund, or by firing workers or lowering their wages.  But now the shareholders of the original company are among the losers: they had a good investment, and their employees had good, secure jobs, all of which is wealth.  The private equity firm invests very little of its own money, ends up pocketing huge management fees, and extracting a large part of the wealth of the firm, before it sells its shares and leaves the company to wither under the burden of its new debts.
  

Sounds pretty aweful.  But here’s the third story: it’s the one that is told by Andrei Schleifer and Larry Summers in the paper, or book chapter, referenced in the Noahpinion blog post I linked to above.  I looked it up and read it.  This paper remarks that “corporations represent a nexus of contracts, some implicit, between shareholders and stakeholders”.  This sounds a bit like the way I described households a few blog posts back, and it is: any organized collection of people, like households and businesses, and also like clubs and churches and charities, represent a nexus of contracts, and the truth is that most of those contracts are implicit because drawing up signed paper contracts for every last thing would be exhausting and prohibitively expensive.  The contracts Schleifer and Summers are considering are embedded in culture, both national culture and corporate culture.  The idea is that when, for example, a company hires a new employee, and keeps the employee through some conditional period, there is---or was, when I was young---an expectation of sorts on both sides.  The employee expects that his job will have at least some job security, that the company will do its best to survive over the long run, if there is a retirement system he or she will get a share of it, and so on; and the company expects some loyalty and personal investment from the employee.  This is an implicit contract, an item of trust, which binds the employee and the employer together, and based on that trust, based on the sense of security and continuity the company has implied is valid, the employee may “put down roots” in the company’s vicinity and in its goals and culture.  He or she may buy a house and enroll children in costly local schools, he may make friends and join churches or other groups, he may take training that is valuable specifically to that company or that area, and so on.  All of these things take an investment of time and money, and all of it is wealth of a sort, non-financial wealth, to the employee.  Similarly, a supplier of resources to the company may make specialized capacity investments that increase their capacity to produce the resources the company needs in the area in which the company needs it, based on an expectation that the company will be a continued customer for a substantial time, at least for enough time to make the investment worthwhile.  These implicit contracts all provide value, or wealth, to both sides, and they are part of the reason that people who have choices choose the way they do; without these implicit handshake contracts companies might have to pay higher wages or higher prices for inputs to compensate employees and suppliers for having to endure higher risks.  The story Schleifer and Summers tell about hostile takeovers is this: the wealth that is gained by the private equity firm’s shareholders when a hostile takeover happens is not necessarily due to improved efficiency or better management.  That wealth may be a pure transfer of value from stakeholders (employees and suppliers, for example) to shareholders that is gained simply by violating all of those implicit contracts that looked good when they were made, and may still be good for the company in the long run, but which can generate short run visible improvements in profits.    For example, the new management can drastically reduce investment in R&D, or can eliminate jobs in areas that may be important but don’t show up quickly in the bottom line.  They may “raid” retirement funds, if there is any legal way they can get at them, because at least some of the expectation that retirement fund management will be honest and that the funds will be used entirely to secure the retirements it is supposed to provide, can be an implicit contract, a contract that binds the company’s existing management but which does not bind the new management under the new PE owners. The pre-takeover shareholders of the company, if they are smart insiders who see this entire process happening, may sell their shares, and take home a profit.  But suppliers and employees suffer outright losses, and those losses may become the shareholders gains.  In this story the PE managers are not greedy good guys or psychopathically greedy bad guys, they are just ruthless business people whose profits come from transferring wealth from trusting workers and suppliers who had foolishly depended on the good word of the company’s prior management.  The PE managers transfer value to themselves and to other shareholders by raiding the value contained in implicit contracts.  They are not exactly robbing the poor to pay the rich, since it can be argued that the wealth the suppliers and employees felt was all a mirage based on naïve trust.  But they are mining the value that can be extracted from trust relationships, and they are taking that value from people who are powerless to prevent it.   And in the long run, since they have completely spent all the trust the company had, the new management may have to pay more for inputs of all kinds, and spend much more on creating costly but explicit, legally binding contracts.  For this company, under this new management, a handshake won’t work anymore, and that is actually a true loss of wealth: but that loss won’t show up in the bottom line for several years.
  

Which of these stories about private equity is true?  I think the answer to that is “yes”.  Yes, at one time or another, in one deal or another, private equity firms have behaved in all of these ways, sometimes even in all of these ways at once.  And the fact that each of these stories is true at one time or another, with one firm or another, may have some implications about the impact of PE on the general economy.  Because if either of the latter two stories is even partly true then the economy as a whole has lost something when a takeover happens.  In the first story the PE firm can argue that there are those who lose and those who gain, but the gainers dominate, and the economy improves on the whole.  They can even claim, as Dr. Smith was claiming, that the presence of takeover companies will induce increased efficiency in firms that are never threatened with takeovers, simply because they know they could be subjected to a takeover bid if they relax too much.  But in the middle story the economy as a whole has lost a healthy company that simply failed to defend itself sufficiently from wolves.  In the last story, the company has lost the trust of its suppliers and employees, but these same suppliers and employees will be slow to trust any other company too.  And Schleiffer and Summers paper presents some evidence that this has happened.
  

At the end of the Noahpinion post, as a postscript, Dr. Smith links to this post in Paul Krugman’s blog, which has a good discussion of whether the relaxation of business rules in roughly 1980 that allowed much wider scope for hostile takeovers increased or decreased the efficiency of the U.S. economy. Krugman offered this chart:

Krugman’s comment in looking at the graph above was this:
  

"Let’s look at how trends changed after 1980 or so, when the underlying rules of American business (and politics) shifted. Start with productivity – I use a log scale, so that the slope of the trend represents the rate of growth. See the big acceleration? Neither do I – productivity growth has actually been slower since the rise of Bain-type operators.”
  

For the record, I don’t see any big acceleration around 1980 either.  This doesn’t prove that the PE has failed to instill greater efficiency in the economy as a whole.  But it certainly does not provide any evidence of success.
  

Long week, but a preview

It's been a long week, full of business, so I've neglected the blog.  And tomorrow I'm going sailing!!  But I'll try to get back down to blogging on Sunday.  I think I need to look at the various visions of private equity capital---not Bain in particular, but the concept in general. 

But I'm totally worn out tonight.  I'll do that Sunday.

Another Long Lonely Month Waiting for the Confidence Fairy...

I haven't really read the recent employment report---it was too discouraging.  But I was interested in this response.  And not just because the title is brilliant.  I was interested because of the flavor of magic the author believes in.

Paul Krugman makes fun of European Austerians' faith in the "confidence fairy", which seems to be the belief that somehow if they make enough sacrifices---or if they, the prosperous policy makers who have no personal risk to consider, make the poor and the old sacrifice enough---that international bankers will gain confidence, and will be willing to lend money at low rates to cover their government debt.   At least I guess that's what they think.

um....ok.  I have so many problems with this I don't know where to start.  It's not clear to me why an international banker would gain any confidence in them by watching them drive their economies into double dip recessions (England) or even real no-baloney depressions (Spain, Portugal, Greece).  But what puzzles me is this: why did they choose international bankers as their savior of choice?  Why do they think that confidence from those people in particular will save them, and cause an economic renaissance?

This author of the piece I linked to above has a different group he wants to reassure, or at least that's my impression from reading this piece.  He seems to believe that the U.S. economy is waiting breathlessly for the confidence of business investors to return, of CEOs of companies, who can hire people if only they believe the future is good.

Well, that's closer, I think.  It's true that businessmen are often  driven by their personal beliefs in a future they can't really predict with confidence, driven by what Keynes called "animal spirits", the urge to act even when the future can't be predicted, when you only have your own gut feeling to go on.  We're all driven by that, because for most of our lives our own feeling about the future really is all we have to go on.  There is a lot about the future that we can't predict in any rigorous way: we simply don't have and can't have the data we would need to make a forecast.  Who will win the Presidential election?  How about the election in 2016?  We can't have the information we need to predict that.  It just isn't available.

So I approve, mostly, of his choice.  At least it makes more sense to me than waiting for international bankers, who show no signs of being impressed by governments who beat themselves in a morality-driven budget-balancing frenzy.  But he sees these businessmen acquiring their confidence, or lack of confidence, by observing some pretty abstract events.  He sees them as all being driven by the kinds of events and concerns, and even the kinds of data, that fascinate economists:  by the economic conditions in China, and in Europe, by the slowdown in emerging markets, by the price of oil futures.  All of these matter, without any doubt.  But I don't think the local tire store or supermarket is driven to hire by events as distant as these.  Local businesses hire because they think they must hire someone to service expected local sales.  And big businesses, international businesses, don't hire large numbers of workers here, in the United States, to service sales in distant emerging markets: they hire workers in China or India to make the new product, and salespeople in the country where they expect to sell their products.  They don't hire workers in Spain to serve customers in Sri Lanka. 

That doesn't mean that the news has no impact on the mood of businessmen.  Of course there is.  We are all moved by the front pages.  And as I said, I like the choice of economic savior: business people certainly fit that role better than international bankers. 

But I'll stick with my faith in my own version of magical creatures.  I believe the economy will improve when potential customers, meaning ordinary people, have renewed confidence in their own futures.  When they have replenished their wealth, and driven down their debts, when their retirements seem more secure, and when their jobs seem more secure, they will return as customers.  And when they do, businesses will gain confidence, and will hire.  And when that happens, the economy will improve, and international bankers will gain confidence from that fact.  But it is the customers that start it all---not the bankers.

What makes my version of the magical confidence fairy, the version that thrives on the confidence of ordinary people, of potential customers, instead of on the confidence of international bankers, what makes that version better and more true? 

Well, because it's mine.  Because it's the confidence fairy I believe in.