Um, Which Way is Downstream?

Posted on by David Wright

My boss sometimes laments that we’re in a declining industry and, to be honest, the statistics do show the absolute level of employment in Reinsurance on a steady downward trend.

That doesn’t mean the industry is declining, though. Quite the opposite: it grows with the economy.  Insurance is a business that passes the ‘grandmother test’ because “there will always be insurance”.

So what’s happening?

Here’s Paul Krugman, commenting on an old article of his:

[I argued that] information technology would end up reducing, not increasing, the demand for highly educated workers, because a lot of what highly educated workers do could actually be replaced by sophisticated information processing

And again, citing the work of Autor:

[they] argued that the crucial difference in terms of possible replacement of humans by machines was one of routine versus non-routine, rather than white-collar versus blue-collar

So, to the degree that the insurance business is a collection of routine processes, folks get replaced by flops and the balance slowly moves from labour to capital.

I’m rather obsessed by this macro trend, as a quick flick through this blog would plainly show.

But it’s bigger than insurance, of course. And ain’t no recent thing.

I like to think of economic progress as the decline of the share of our income spent on food, water, shelter and other ‘necessities’. As they get cheaper, we get richer.

Here’s Arnold Kling:

As the cost of food and durable goods falls, what are you going to do? You only consume more health care services if you think you are sick and that the doctor can do something for you. So you either consume more education or more leisure.

These trends matter. The strongest businesses don’t fight the current, they ride the crest.

So, at the margin I expect three types of businesses to grow in the near term. The first is the medical industry (easy).

The second supply things people do in for leisure and/or education. The Silicon Valley social media types are all over this, along with self-help gurus and tv producers.

The third business joins the chorus crushing the costs out of the the rest of life’s pursuits. Think commodity producers (insurance!) and the news media. Over time, their quantities supplied grow with the (world) economy, but their share must fall.

To my boss, then, I say: “watch your margins, insurers grow by adding capital in innovative ways”.

If he’s still worried, I say: “write a book and go on CNBC: become a media darling and guru”.

Still upset? Go to med school.

Taxassination

Posted on by David Wright

In my emerging view, Americans have a high standard of living because things are cheap here. Putting sin goods (alcohol and tobacco) and rent to one side, NYC is cheaper than Toronto, London, Sydney and Hong Kong.

Economists, bless them, would destroy this.

You see, taxes are distorting. And any increase in a particular tax is more distorting than the last. Since taxes are necessary, how does one minimize the distortion?

Keep the rates low but have lots of taxes is the answer. Low rate, broad base.

Now, I’m not sure why things are cheap here, but let’s say I’m convinced it’s due to low consumption taxes (fuel, VAT, etc). Add in high income taxes and the quick answer for most efficient tax at this margin is: ‘on stuff we buy’

The prospect of this worries me a bit:

There’s an amazing swarm of low-paid workers who get paid in cash and can live cheaply (in apartments with a dozen other people, probably). These workers supply inexpensive services to everyone here: delivery, shoe-shines, restaurant service. Luxuries for the well off, to be sure. Is that so bad?

The services in New York are incredibly diverse. And I worry that a consumption tax will destroy this part of the economy. In econ-speak, I’d say that economists are horribly underestimating the deadweight loss.

I’d also say that this underground economy breathes life into a city that, in my opinion, is shockingly controlled and regulated.

Perhaps taxes must be raised, as they all say. If so, I’ll get fewer shoe shines and no more deliveries. Goodness knows what happens to those who once supplied those services. As I said: deadweight loss.

Maybe the kind of low-level service economy I’m witnessing here is a relic. If so, I’m thrilled to have seen it.

As we move toward a mild socialism (I don’t mean that in the pejorative), this kind of fly-by-night service economy will be crushed.

Making Waves

Posted on by David Wright

I like having pet ‘theories’ that I find useful for thinking about the world but are exaggerations or ‘caricatures’, as I typically call them. Reading Arnold Kling and Robin Hanson freed me from the need to feel like people should ‘kinda agree with me all around‘ about things.

Here comes another one: “people and politics never matter”

Barry Cunliffe’s Europe Between the Oceans discusses Fernand Braudel‘s division of history into three concepts of time:

(oh, yes, I’m using the french!)

1. l’histoire evenmentielle (“events insitgated by individuals”);

2. conjontures (“collective forces, impersonal and restricted in time to no more than a century”); and,

3. the longue duree (“geographical time”).

Ok, some examples to help explain.

Scott Sumner’s had what I’m sure he would say was a provocative idea:

I seem to be the only person in the world who thinks Al Gore would have led us into Iraq.

I’d rephrase what Scott’s saying as: everyone thinks that the invasion of Iraq was a #1 event (attributable to GWB or Rumsfeld or something), but it was really a #2 event (driven by the will of the people in reaction to 9/11).

Controversial example, to be sure. But it helps illustrate the point that humans have a deep need to attribute actions and consequences to individuals. We aren’t built to think on a societal scale, we’re built to think in terms of tribal units, a mental model that evolved waaaay before societies were of any size.

Now, my caricature of this idea is that NO heroic historical figure is relevant for understanding any historical process: Plato, Aristotle, Alexander the Great, Jesus, Charlemagne, Copernicus, Martin Luther, Newton, Geroge Washington, Napoleon, Abe Lincoln, Darwin, Einstein, Hitler, Stalin, Martin Luther King Jr, Jackie Robinson, Ronald Regan, Bill Clinton, George W Bush, Sarah Palin or Joe the Plumber.

All extraordinary individuals, to be sure. But I’d say that all of their acts (good or bad) were fundamentally products of their culture. The WHO affects the WHEN (barely), but not the WHY.

The next lesson I take from this is that we attribute #3 effects to #2. Geography builds societies, not culture.

Why did Western Europe develop faster than North America, Africa or Australia? Geography. Why did the Middle East develop first and not Europe? Geography. Why was the Industrial Revolution in England? Geography.

GG&S was the first exposure I had to this idea and it blew me away. Cunliffe’s book is very much in this tradition.

When I hear some grand even attributed to a person, I think about the culture. When I hear something attributed to culture, I think about the geography.

Why Does Berkshire Hathaway Hold Any Debt At All?

Posted on by David Wright

You could be forgiven for not noticing with pages of self congratulatory pagentry like this:

Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor…

But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces  zeroes, even when it is employed by very smart people…

On the facing page you can read a letter sent in 1939 by Ernest to his youngest son, my Uncle Fred. Similar letters went to his other four children. I still have the letter sent to my Aunt Alice, which I found – along with $1,000 of cash – when, as executor of her estate, I opened her safe deposit box in 1970. Ernest never went to business school – he never in fact finished high school – but he understood the importance of liquidity as a condition for assured survival. At Berkshire, we have taken his $1,000 solution a bit further and have pledged that we will hold at least $10 billion of cash…

Flip over a few pages. Now, what do you see on the balance sheet?

Cash and cash equivalents:

(2010) $ 34,767

(2009) $ 28,223

yep, that looks right. But wait a sec, what’s THIS?!

Notes payable and other borrowings:

(2010) 14,477

(2009) 13,769

Growing every year. Why oh why?

Here’s David Merkel:

What I am saying is that once the discipline against debt is breached, it becomes easy to justify more debt.  I think we are seeing that now, and Buffett is compromising his principles.

Hey, Greenberg eschewed debt for two decades, and then piled it on for two decades.  Is Buffett doing the same thing?  Personally, I think he is, though I don’t think he has thought it through.  Warren, if you are reading me, pull back on the debt.  It killed Hank.

Inmates Run the Asylum

Posted on by David Wright

Just finished Russ’ podcast with Daron Acemoglu on inequality and the financial crisis. There’s a lot of interesting stuff here.

The genesis of the podcast is a book by Ragu Rajan that I haven’t read. The ideas (as discussed in the podcast) are familiar, though: measured inequality goes up, everyone freaks out, politicians figure subsidizing housing is a good response, a housing bubble emerges and every special interest under the sun (the poor, Wall Street, Real Estate, etc) makes a killing.

Acemoglu has a great stat about how politicians’ voting records correlate most highly with the surveyed priorities of the top third of the income distribution, somewhat well with the middle third and not at all with the bottom third. Lots of interpretations here:

My caricature of Bryan Caplan would say that the top third are the informed voters and the rest don’t matter because their desires are nonsensical and they don’t vote anyway.

Super lefties immediately go for the corruption angle.

Who knows.

Tyler Cowen’s awesome essay on financial regulation and inequality screams for a mention here. It taught me that bailouts are impossible to a avoid, really.

The only people who know enough to figure out how to engineer a non-bailout system or command enough authority to convince the polity that bailouts aren’t necessary are in the system!

Depressing stuff.

Destroying Jobs [not the guy!]

Posted on by David Wright

I’m obsessed with this idea that I work in a commodity business. That statement breezes through quite a lot of legitimate criticism, but I don’t care. I’m convinced.

And since I am in a commodity business, success at the margin requires developing a more efficient system for delivering that commodity. Exogenous price fluctuations are irrelevant.

Money tells us that sales are the second most important part of an insurance policy after claims. Brokers take a cut of between 10% and 20% of the premium.

Until the singularity comes along, our ability to extract the cost of salesmen from the system will be extremely limited, so that’s fixed.

Claims, the point of all this, are the biggest part, and cost about 60-70% of the premium, but they’re exogenous (commodity!), so forget them.

That leaves something between 10%-30% for corporate expenses, profits and other things under control.

Labour and capital. Salaries and systems and overhead. Capital + scale is no new idea. But applying capital to new areas is ripe for innovation.

Now, here’s my philosophy: new ideas do not exist. Certainly not in my head and almost certainly not in my business.

I take a cue from Fabrice Zinga. This guy made a fortune exporting the ebay model to non-US countries. I think that’s a bit of a naked wholesale swipe of a business model, but it worked.

I’m not quite so bold, but my plan is to spend as much time learning about innovation in OTHER businesses, particularly recent innovation, and figuring out if it will work in mine. I’d guess the implementation delay of a solid idea from Silicon Valley to insurance is about a year.

-=-=-

Edit: and google is telling me that this post has gotten a pile of traffic, no doubt because of the word “jobs” in the title. I bet that the only better traffic bait would be the name of a certain former Alaska governor.

*shudder*

People of the world: I regretted writing this stupid post!

Stop the Thoughts! I Need to WORK!

Posted on by David Wright

Ok, Cringely has a post that I need to get out of my head.

He says that he approves of Nokia’s move of ditching their in-house operating system by “Trading Symbian for Windows Phone 7 with a $100 bill attached”  because Symbian is “crap”.

Never used it, but it doesn’t surprise me. I expect the mobile phone universe is going follow the PC and migrate from a hardware-driven market to a software-driven one with the old guard mostly screwing it up.

I love his advice, though:

Hire a Bob Lee (or heck, hire Bob Lee), set up a small development office somewhere in the USA, and spend $5 million per year aiming at mobile life after Microsoft.

I’m going to write more about Tyler Cowen’s awesome The Great Stagnation (really want to solidify the concepts in my mind), but I can’t resist parroting a point here: software is a revolutionary industry in the midst of its revolution.

Unlike other ‘industrial’ revolutions, though, this one isn’t going to require millions of retrained workers.

Software teams work best when they’re manageable. And that means small. Big scale does not mean big staff.

*SMACK*

Posted on by David Wright

That’s the sound of my hand hitting my head.

Nick Rowe makes some interesting points (followed by Krugman) on economics education, which I’m slowly realizing did me a unforgivable disservice when I went through mine (formally).

Firms supply goods and people buy them. Economics is concerned with the problem of increasing total output, which is the quantity of good traded.

The constraint here isn’t demand, you can only push how much people can buy so far (it’s related to how much they can produce!). The constraint is supply: what we need are more firms/competition to drive down prices to sell more stuff.

So policies that aim to increase the amount of demand for products are doomed to very mediocre results. These are things like tax cuts, tax increases (ie government spending) and inflationary monetary policy.

Except now is different.

The idea is that, during this past recession, people/firms were holding onto money for some reason. Because they have to repay debt? Because they expect things to get worse in the future and so are saving against that outcome? Maybe…

Scott Sumner is awesome here.

Debts are paid in nominal dollars. Salaries are paid in nominal dollars. If firms start worrying they’ll have fewer nominal dollars next year than this, they’ll cut back. If they fear this because their business just sucks, so be it, they deserve to go out of business. But that kind of thing doesn’t happen to EVERYONE at ONCE.

That’s the difference.

The New Manufacturing

Posted on by David Wright

I think of the insurance business (and banking for that matter) as a process-driven technology industry, like manufacturing.

We have a very similar value chain, with engineers pulling costs out of the system and slowly tailoring products to peoples’ uses. Over time, the systems employ fewer, more skilled people and the products become ever more commoditized.

Value and innovation are not revolutionary in these businesses, but incremental, and brands are a key differentiator among the otherwise indistinguishable elite few operators.

The most powerful in the business are those most gifted salesmen that can make a commodity feel less like one, all while quietly making it more so.

Collaborarion Networks (and Entrepreneurship)

Posted on by David Wright

Just read Michael Nielsen’s article on the “Future of Science“, which is really about how the Culture of  The Science Profession is proving incompatible with the Culture on Online Collaboration. Shame.

Add science to the list of professions requiring collaboration, networking and communication skills to succeed. You know, like every other human pursuit in the world.

It seems ironic to me that the people dedicating their lives to the progress of knowledge struggle to adopt the latest products of human ingenuity. As Michael says in the article, the scientific journal process is a rigid institution that is proving tough to crack.

Culture drives technology, not vice versa.

(The thought struck me that companies are simply collections of collaboration networks. A new company, to succeed, needs to be an outstanding collaboration network, perhaps a novel one. Want to start a company? Well, figure out a new or interesting combination of people to work on a problem. Or find a common set of team skills doing the same work cheaper.)

Also, collective success is much more easily dispensed shared in companies. In the aggregate, stock options have produced more happiness than Nobel Prizes (the prizes themselves, I mean; obviously the ideas that win the prizes are a pretty big deal).

But I think that we tend to overestimate the impact that social media can have on the professional world. It’s great for sharing photos or mocking your friends, but is it really (like, really) going to change how we interact professionally?