Friday, November 30, 2012

Developing Economies: Will They Ever Catch Up?

Economists enjoy taking recent data and projecting it far into the future in order to draw grand conclusions. Such exercises lead to warnings that the doddering western countries will be economically overwhelmed in an Asian future, for example. Ruchir Sharma is the latest to take offense at this type of forecasting in an article in Foreign Affairs: Broken BRICs: Why the Rest Stopped Rising. Sharma addresses the prospects of the BRICs (Brazil, Russia, India, and China), but also looks at the broader issue of whether or not the class of emerging economies are gaining ground on the developed economies.

Sharma points out that it is a mistake to take the rapid growth rates from the past decade and assume that they can be projected into the future.

" is hard to sustain rapid growth for more than a decade. The unusual circumstances of the last decade made it look easy: coming off the crisis-ridden 1990s and fueled by a global flood of easy money, the emerging markets took off in a mass upward swing that made virtually every economy a winner. By 2007, when only three countries in the world suffered negative growth, recessions had all but disappeared from the international scene. But now, there is a lot less foreign money flowing into emerging markets. The global economy is returning to its normal state of churn, with many laggards and just a few winners rising in unexpected places."

The data supports the notion that the last decade was an outlier and fails to support the assumption that a convergence between developed and developed countries has been taking place.

"The notion of wide-ranging convergence between the developing and the developed worlds is a myth. Of the roughly 180 countries in the world tracked by the International Monetary Fund, only 35 are developed. The markets of the rest are emerging-and most of them have been emerging for many decades and will continue to do so for many more. The Harvard economist Dani Rodrik captures this reality well. He has shown that before 2000, the performance of the emerging markets as a whole did not converge with that of the developed world at all. In fact, the per capita income gap between the advanced and the developing economies steadily widened from 1950 until 2000....It was only after 2000 that the emerging markets as a whole started to catch up; nevertheless, as of 2011, the difference in per capita incomes between the rich and the developing nations was back to where it was in the 1950s."

The BRICs were to be the countries in line to overtake the western economies.

"As with previous straight-line projections of economic trends, however-such as forecasts in the 1980s that Japan would soon be number one economically-later returns are throwing cold water on the extravagant predictions. With the world economy heading for its worst year since 2009, Chinese growth is slowing sharply, from double digits down to seven percent or even less. And the rest of the BRICs are tumbling, too: since 2008, Brazil's annual growth has dropped from 4.5 percent to two percent; Russia's, from seven percent to 3.5 percent; and India's, from nine percent to six percent."

This source provides the most recent data on GDP growth: China 7.4%, India 5.5%, Russia 2.9%, and Brazil 0.5%.

Historically, high rates of growth have been difficult to maintain.

"Over the course of any given decade since 1950, on average, only a third of the emerging markets have been able to grow at an annual rate of five percent or more. Less than one-fourth have kept up that pace for two decades, and one-tenth, for three decades. Only Malaysia, Singapore, South Korea, Taiwan, Thailand, and Hong Kong have maintained this growth rate for four decades. So even before the current signs of a slowdown in the BRICs, the odds were against Brazil experiencing a full decade of growth above five percent, or Russia, its second in a row."

Sharma concludes that it is foolish to project more than two business cycles into the future (five years per cycle). That allows him to make some of his own predictions.

"Among countries with per capita incomes in the $20,000 to $25,000 range, only two have a good chance of matching or exceeding three percent annual growth over the next decade: the Czech Republic and South Korea. Among the large group with average incomes in the $10,000 to $15,000 range, only one country -- Turkey -- has a good shot at matching or exceeding four to five percent growth, although Poland also has a chance. In the $5,000 to $10,000 income class, Thailand seems to be the only country with a real shot at outperforming significantly."

Finally, there is this somewhat gloomy conclusion.

"Although the world can expect more breakout nations to emerge from the bottom income tier, at the top and the middle, the new global economic order will probably look more like the old one than most observers predict. The rest may continue to rise, but they will rise more slowly and unevenly than many experts are anticipating. And precious few will ever reach the income levels of the developed world."

The OECD is one organization that is prone to making the projections that Sharma was warning us about. It has produced a report that projects economic growth out to the year 2060. It has assumed that in the 2011-2030 period the BRIC countries will have the following GDP (PPP (purchasing power parity)) growth rates: China 6.6%, India 6.7%, Russia 3.0%, Brazil 4.1%. These are numbers that Sharma would find puzzling. Growth rates drop off considerably in the 2030-2060 interval with the rate of drop off seemingly dependent on the working-age demographics in each country.

An article in The Economist provided an interesting synthesis of the conclusions in the report. It produced a plot of per capita GDP (PPP) for a range of countries as a fraction of US per capita GDP. Data was provided for 2011 and the projected numbers for 2060.

It is perhaps not too surprising that there is little relative change predicted for the developed countries because the same economic and demographic models probably apply closely to all. What is a bit surprising is the lack of progress that the developing countries make over the 50 year period, given the rather optimistic growth assumptions.

Perhaps 50 years is just a small period in terms of economic growth. Growth will have phases and transitions that must occur in order to get to the next phase. These steps can be difficult and require the development of new technical and social infrastructure to support them.

The developed countries had centuries to reach their current status so a little patience may be required.

RUCHIR SHARMA is head of Emerging Markets and Global Macro at Morgan Stanley Investment Management and the author of Breakout Nations: In Pursuit of the Next Economic Miracles.

Wednesday, November 28, 2012

Moving to a National Retirement Plan

The nation seems to be lumbering into a retirement crisis. Social Security is intended to provide a significant fraction of preretirement earnings for only the lowest income seniors. Others require additional funds if they are to maintain anything like their preretirement standard of living. The 401(k) fund was intended to provide a mechanism by which a wage earner could manage a savings plan to provide for retirement. The 401(k) (403(b) for nonprofit organizations) was used to replace defined-benefit pension plans. It is referred to as a defined-contribution plan on the assumption that employees and employers would both contribute to it. In reality, many companies have not chosen to institute such a plan, and those that have contribute very little. The burden falls on the employee, assuming he/she has access to one, to manage it wisely and maintain a high level of contributions over the working career. A combination of unwise investment decisions, a dreadful economic environment, and stagnant or falling wages have made it difficult for saving to occur at an appropriate level. We have large numbers of young workers struggling to gain entry into the work force, while we have large numbers of senior citizens who can’t afford to retire and leave the work force.

A New York Times article by Steven Greenhouse provides an excellent summary of the situation and describes a number of proposed corrective measures in Should the 401(k) Be Reformed or Replaced?.

"But many investment experts and economists give the 401(k) system low marks. They note that fewer than half of the nation’s private sector workers are in 401(k) plans and that nearly a quarter of businesses with more than 100 employees do not offer 401(k)’s. Moreover, many Americans put only 3 percent of their earnings into 401(k)’s when investment experts often recommend saving 10 or even 12 percent."

"The typical worker age 55 to 64 had just $54,000 in a 401(k) in 2010, according to a new report by the Center for Retirement Research at Boston College, and households with workers in that age group had $120,000 in retirement savings on average, if the money rolled into I.R.A.’s was included. That $120,000 is less than one-fourth the savings recommended by many retirement experts. Moreover, the center calculated, that $120,000 would provide an annuity of a paltry $7,000 a year."

The current system has many defects that seem fixable. An improved approach would make a plan available to all, remove the need for individuals to make investment decisions, encourage people to invest more, and provide some sort of guarantee that there will be a return on their investment and that income will be maintained until end of life.

One of the financial experts queried about ways to improve the 401(k) system was John C. Bogle. He provides a lengthy discussion of his suggested approach in his book The Clash of the Cultures: Investment vs. Speculation. His proposed plan addresses most of these issues in a compellingly straightforward manner.

Bogle would keep Social Security as is except for modest changes to increase revenue. His idea is to replace the 401(k) and all other retirement savings options encouraged by the tax code with a single, national plan managed by a federal commission. This commission would delegate management of the assets to a non-profit entity to avoid the exorbitant fees that financial firms now charge when they control investors’ funds. Bogle would set up two indexed funds in which to invest. One would be a broad market stock fund and one would be a broad market bond fund. The use of indexed funds that follow the entire market simplifies management and guarantees that investors will do as well as the markets do. An investor’s funds would be invested mainly in equities when young and gradually emphasize bonds more as he/she ages. This would all be automatic based on an algorithm. Bogle addresses the issue of longevity by suggesting prospective retirees switch at least a portion of their accrued savings to an annuity.

Bogle’s idea provides a healthy core for a viable national plan, but there are modifications that would make it more effective.

Teresa Ghilarducci has been promoting what she refers to as a "Guaranteed Retirement Account." Her notion would add a federally provided guarantee that funds would earn at least 3% above inflation, a number chosen to correspond to the anticipated growth in GDP over the years. She would offset this potential fiscal burden on the government by eliminating the various tax breaks that shelter retirement savings now. She indicates that would provide almost $200 billion in new revenue. Ghilarducci also recommends converting funds to an annuity on retirement, perhaps through integrating with Social Security.

The addition of a guarantee that there will be a return on their investment might be critical in encouraging people to save more for their retirement.  Ghilarducci's 3% above inflation seems excessive, but guaranteeing a return equivalent to the return on investments in treasury bills could be a reasonable approach.

The most contentious issues would be the degree to which the program is voluntary for the employee and for the employer. Bogle would make all contributions voluntary; Ghilarducci prefers a plan where both employer and employee contribute 2.5% of income automatically. A 5% contribution is minimal in terms of covering preretirement earnings so, presumably, employees could contribute more and employers would match the first 2.5%. A limit on how much could be contributed would also limit the potential fiscal burden of the earnings guarantee.

Asking employers to contribute a few percent of income to a retirement plan does not seem an unreasonable burden. Many that are now offering 401(k) plans are already making similar contributions plus suffering the administrative burden of carrying the plan. The simplicity of the proposed retirement system should be attractive to those with current plans and not unduly burdensome on those who do not.

Combining Bogle’s investment ideas with Ghilarducci’s concept of a guaranteed return would provide the core of an effective retirement plan. There are many details that would have to be worked out. For example, since it is a savings plan, should people be allowed to extract funds? And under what circumstances?

There do not seem to be any issues that can’t be resolved, other than dealing with the inertia built into out legislative system. The only way to overcome inertia is to start pushing. The time to begin is now.

Monday, November 26, 2012

Mutual Funds: Investors Beware

There was a time when an investor would purchase a share in a publicly traded company and assume that share’s price was a reasonable representation of its actual value. The investor could expect the value to increase or decrease as the business fortunes of the company increased or decreased as it used the funds from that share creation to further its interests. The situation today is much more complex. John C. Bogle provides insight into what the world of investing has become in his book The Clash of the Cultures: Investment vs. Speculation. Most investors enter the markets via mutual funds and pension plans. Mutual funds will be the principle topic here.

Investment has long been beset by agency issues. The rise of public corporations meant that an agent had to be hired to manage the enterprise. These agents could have agenda’s that were not in alignment with the best interests of the corporation and could use their positions to enhance their own wealth at the expense of the corporation and its investors. This agency problem was supposed to be controlled by holding directors responsible by means of tying compensation to performance. Influential economists created the notion that the best indicator of performance should be maximizing the wealth of the corporation. Given perfect markets, that wealth would be represented by the share price. Executives had marching orders to maximize the share price, and it was assumed that shareholders would keep them and their Boards of Directors honest. The use of potentially volatile share prices as a measure of wealth, and as a determinant of executive compensation, forced attention on meeting short-term market expectations. This could be accomplished by financial engineering if necessary, even if at the long-term expense of the company.

In the days when shares were mostly owned by individual investors, the assumption was that the investors were in for the long haul and expected the company to be focused on long-term growth and prosperity. The ability of these individuals to impact company policy was always minimal, but the rise of institutional investing created another agency issue. About 70% of corporate shares are now owned by institutional investors, mainly mutual funds and pension plans.

Bogle describes how the mutual fund industry evolved from one focused on investing for long-term gains, to one more interested in attaining short-term gains. He describes developments over the 60 years of his experience in the business:

"During that long span, fund assets increased by nearly 5,000-fold—from $2.5 billion to $12 trillion. A profession once focused largely on investing became a business largely focused on marketing. Of course such growth makes change inevitable. But the counterproductive form of change that developed was fostered by a sea-change in the industry’s culture, from private ownership to largely public ownership and the near pervasive control of fund managers by financial conglomerates. For fund shareholders it was a tragic change."

The new mutual fund environment also focused on short-term gains, and as principal "owners" of corporations, this view supported the short-term focus of company executives.

"Together, these two sets of agents came to an apparent, if tacit, understanding that the principle focus of corporate accomplishment is ‘creating shareholder value.’ That’s a fine goal, of course, but their shared definition of value focused on the short-term, evanescent, emotion-driven price of the stock, rather than the long-term, solid, reality-driven intrinsic value of the corporation."

Bogle refers to this conspiracy between corporate management and institutional investors as a "double agency" problem. Indeed, his description of the mutual fund industry as it exists today suggests that there is a third agency issue, one critical to fund investors.

"Today, among the 50 largest mutual fund complexes, 41 are publicly held, including 33 held by conglomerates. Only eight remain private....All of the public fund management companies have external owners, and thus a second master to serve."

If fund managers were compensated based on a metric dominated by fund performance, then a long-term approach to investment for consistent gains could be appropriate. But that is not the way the system works. Fund managers are paid according to how much money they control. A typical fee is about 1.5% annually on all funds under management; and that is independent of performance. The focus of managers then is to use fund performance as a marketing tool to attract more money. Fund performance is the bait for attracting more investors, but it drives the funds into a highly speculative mode in order to better the competition. This doesn’t, and can’t work in the long term, and investors suffer the consequences.

Fund managers require money to pay themselves lofty salaries, to cover the transaction costs involved in churning stocks in order to try to gain that extra advantage, and money to pay for the marketing required to attract more money. If publicly owned, the fund manager must also extract funds from its investor-clients to provide profit for its investor-owners. How about that for a conflict of interest?

As mentioned, fees have grown to average about 1.5%. A fund portfolio that actually increases in value by 5% annually, would deliver only 3.5% annually to the investor. The difference between 5% compounded annually and 3.5% compounded annually becomes enormous over the years.

To Bogle, the system is not only wasteful, but also shameful.

"But do these costs enhance returns to shareholders? It’s simply not possible. Since fund managers, in essence are the market, how could they—as a group—beat the market? (Or, for that matter, lose to it?) But when they are the market, the gross returns of investors must match those of the market, but net returns after fund expenses must inevitably fall short."

"Such enormous costs seriously undermine the odds in favor of success for citizens who are accumulating savings for retirement. Alas, the investor feeds at the bottom of the costly food chain of investing, paid only after all the agency costs of investing are deducted from the markets’ returns...."

Bogle is famous for having invented the index fund which tries to track an entire market or market segment, thus avoiding speculation and guaranteeing gains equal to the market. Such a construct has no justification for high fees and can be found in the range of 0.25% or less. As an exercise try compounding money at 4.75% rather than at 3.5% over an investment lifetime.

More on Bogle’s book and his investment advice can be found in Investing in Wall Street’s Casino: The House’s Take.

Tuesday, November 20, 2012

Life Expectancies and Social Security and Medicare Eligibilities

Paul Krugman has never been one to shy away from making bold expository statements. And his track record seems to be excellent in terms of accuracy. He recently took on what he referred to as the misleading conclusion that since life expectancies have been rising, then it is advisable to raise the eligibility age for Social Security retirement and Medicare in response.
"America’s political landscape is infested with many zombie ideas — beliefs about policy that have been repeatedly refuted with evidence and analysis but refuse to die. The most prominent zombie is the insistence that low taxes on rich people are the key to prosperity. But there are others."

"And right now the most dangerous zombie is probably the claim that rising life expectancy justifies a rise in both the Social Security retirement age and the age of eligibility for Medicare. Even some Democrats — including, according to reports, the president — have seemed susceptible to this argument. But it’s a cruel, foolish idea — cruel in the case of Social Security, foolish in the case of Medicare — and we shouldn’t let it eat our brains."

Krugman justified his argument about Social security by pointing out that while life expectancy at birth has risen considerably, the more relevant number is life expectancy at age 65. This number has increased much less over the years. Let us look at some numbers to justify Krugman’s conclusion. This source provides us with data.

 The numbers chosen are for the total population. The gain in life expectancy at age 65 (5.3 years) was about half that at birth (10.3 years) since 1950. Which number one chooses makes a significant difference when the fiscal ramifications are considered.

Different values exist for men, women, blacks, Hispanics, and Native Americans. Consequently, it can be misleading to apply a single set of numbers to an entire population. Krugman suggested that the most significant discrepancy hidden by the overall numbers are the differences between the wealthy and the poor. This source provides us with an indication of how great that effect can be.

These numbers are based on Social Security Administration data. It is rather startling to realize that there is a difference in life expectancy at age 65 of over 5 years that has developed, depending on whether a person is in the top or bottom half of the income distribution. And that is a rather crude delineation. One has to wonder what the distribution would look like if it was broken down into finer groups such as quintiles.

There is another set of data that takes a different approach in delineating life expectancy. Data exists at the county level that would indicate regional effects, and, indirectly, illuminate effects of poverty. This source provides more startling data by plotting life expectancy at age 50 by county for both women and men.

Life expectancies at age 50 can vary by over ten years depending on the location. There are undoubtedly multiple factors at play in determining these numbers, but it is hard to avoid the conclusion that much lower life expectancy is associated with the lower-income southern states where poverty is often endemic.

One can find locations where the life expectancy at birth does not even attain the current Social Security retirement age. This source tells us that in Quitman and Tunica Counties in Mississippi the life expectancy at birth is a mere 66.1 years. Raising the retirement age or the Medicare eligibility age in locations such as these would have a devastating effect.

We are a diverse population. Attempts to capture the reality of our condition in averages and other global representations can produce false impressions and lead to bad policy decisions.

The data presented here supports Krugman’s statements and suggests that he may have been uncharacteristically timid in formulating them.

"This means that any further rise in the retirement age would be a harsh blow to Americans in the bottom half of the income distribution, who aren’t living much longer, and who, in many cases, have jobs requiring physical effort that’s difficult even for healthy seniors. And these are precisely the people who depend most on Social Security."

"What would happen if we raised the Medicare eligibility age? The federal government would save only a small amount of money, because younger seniors are relatively healthy and hence low-cost. Meanwhile, however, those seniors would face sharply higher out-of-pocket costs. How could this trade-off be considered good policy?"

"The bottom line is that raising the age of eligibility for either Social Security benefits or Medicare would be destructive, making Americans’ lives worse without contributing in any significant way to deficit reduction. Democrats, in particular, who even consider either alternative need to ask themselves what on earth they think they’re doing."

Sunday, November 18, 2012

Evolution in the South: Slave...Sharecropper...Walmart Associate...

Elizabeth Dwoskin supplied an interesting article in Bloomberg Businessweek indicating that Walmart’s workers are finally fed up and beginning to resist the work conditions imposed by one of the most exploitive organizations on the face of the earth.
"America’s biggest retailer may be in for an unexpectedly painful holiday season. Protesting low wages, spiking health care premiums, and alleged retaliation from management, Wal-Mart Stores workers have started to walk off the job this week. First, on Wednesday, about a dozen workers in Wal-Mart’s distribution warehouses in Southern California walked out, followed the next day by 30 more from six stores in the Seattle area."

"The workers, who are part of a union-backed employee coalition called Making Change at Wal-Mart, say this is the beginning of a wave of protests and strikes leading up to next week’s Black Friday. A thousand store protests are planned in Chicago, Dallas, Miami, Oklahoma, Louisiana, Milwaukee, Los Angeles, Minnesota, and Washington, D.C., the group says."

"In a conference call with reporters on Thursday, workers who were either planning to strike or already striking explained their situation. ‘We have to borrow money from each other just to make it to work,’ said Colby Harris, who earns $8.90 an hour after having worked at a Wal-Mart in Lancaster, Tex., for three years. ‘I’m on my lunch break right now, and I have two dollars in my pocket. I’m deciding whether to use it to buy lunch or to hold on to it for next week.’ He said the deduction from his bimonthly pay check for health-care costs is scheduled to triple in January. In 2013, Wal-Mart plans to scale back its contributions to workers’ health-care premiums, which are expected to rise between 8 percent and 36 percent. Many employees will forgo coverage, Reuters reports."

"Sara Gilbert, a manager who was striking in Seattle, called in on her cell phone: ‘I work full-time for one of the richest companies in the world, and my kids get state health insurance and are on food stamps,’ she said."

It is a little surprising that it has taken this long for serious push-back to begin, but it was inevitable that as the shadow of Walmart spread from the South and across the nation that it would eventually have a problem when it had to recruit workers (called associates) who hadn’t been conditioned by generations of abuse by southern oligarchs. I have been highly critical of Walmart and its practices in the past: Wal-Mart: How it Mistreats Its Employees, and Wal-Mart: The Damage It Has Done to Society. (Wal-Mart officially became Walmart a few years ago.) But it was Colin Woodard, in his book American Nations: A History of the Eleven Rival Regional Cultures of North America, who provided the proper perspective in which to view Walmart and its methods.

Woodard claims that the Southern states, and the Republican Party, have accepted the philosophical leadership of what he refers to as the "Deep South."

"The Deep South was founded by Barbados slave lords as a West Indies-style slave society, a system so cruel and despotic that it shocked even its seventeenth-century English contemporaries. For most of American history, the region has been the bastion of white supremacy, aristocratic privilege, and a version of classical Republicanism modeled on the slave states of the ancient world, where democracy was a privilege of the few and enslavement the natural lot of the many."

"The goal of the Deep south oligarchy has been consistent for over four centuries: to control and maintain a one-party-state with a colonial-style economy based on large-scale agriculture and the extraction of primary resources by a compliant, poorly educated, low-wage workforce with as few labor, workplace, safety, health care, and environmental regulations as possible."

Woodard tells us that the Republican Party agenda is identical to that of the historic Deep South approach, and suggests that the treatment accorded southern workers is just of modern version of the sharecropping system put in place as the next best business practice after slavery.

"...they focused on cutting taxes for the wealthy, funneling massive subsidies to the oligarchs’ agribusinesses and oil companies, eliminating labor and environmental regulations, creating ‘guest worker programs’ to secure cheap farm labor from the developing world, and poaching manufacturing jobs from higher-wage unionized industries in Yankeedom, New Netherland, or the Midlands. It’s a strategy financial analyst Stephen Cummings has likened to ‘a high technology version of the plantation economy of the Old South,’ with the working and middle class playing the role of sharecroppers."

This reference reminds us what it meant to be a sharecropper in the Old South.

"Sharecropping became widespread as a response to economic upheaval caused by the emancipation of slaves and disenfranchisement of poor whites in the agricultural South during Reconstruction. Plantations had first relied on slaves for cheap labor. Prior to emancipation, sharecropping was limited to poor landless whites, usually working marginal lands for absentee landlords. Following emancipation, sharecropping came to be an economic arrangement that largely maintained the status quo between black and white through legal means."

"....many sharecroppers (both black and white) were economically confined to serf-like conditions of poverty. To work the land, sharecroppers had to buy seed and implements, sometimes from the plantation owner who often charged exorbitant prices against the sharecropper's next season. Arrangements also typically gave half or less of the crop to the sharecropper, and the sale price in some cases was set by the landowner. Lacking the resources to market his crops independently, the sharecropper was sometimes compensated in scrip redeemable only at the plantation."

"Thus the cost of production and price of sale were both largely controlled by the land owner, with the sharecropper having little, if any, margin for profit. These factors made sharecroppers dependent on the plantation owners in a way that perpetuated some of the aspects of slavery, and in the late 19th century maintained a stable, low-cost work force that replaced slave labor..."

The sharecropping system persisted in the South until the middle of the twentieth century.

For the sharecropper analogy with the Walmart system to apply, Walmart would have to be in the position to exercise complete control over workers’ wages and working conditions, and be guilty of excessive greed in extracting profits from its workers’ labor. A Walmart employee would be paid at a sufficiently low rate that saving money in order to better her condition would not be possible. The comments from the workers quoted above indicate that the case will not be hard to make.

In Wal-Mart: How it Mistreats Its Employees the ways in which Walmart imposes policies that are hurtful to the employee and occasionally cross the line into illegality are described. Consider, for example:

"Full-time employment at Wal-Mart is considered to 34 hours per week. That is so they can work you extra hours and legally not pay you overtime. What it means immediately is that your effective wage is actually 15 percent lower than the quoted hourly figure. And there is no guarantee of your hours. If your hours are low enough they do not have to provide you with any benefits. Wal-Mart’s policy is that if business slows down, the loss in income comes first from its employees in terms of shorter hours and less pay. That is the Wal-Mart way. If you end up working more than 40 hours in a week and expect to earn some overtime—well, watch what you wish for. Any number of law suits have proven that Wal-Mart encourages its managers to cheat the employees by modifying time cards or by instructing them to punch out and then continue working. This is referred to as working "off-the-clock." If one is foolish enough to complain she can easily be rewarded with shortened hours or enough variable shifts to force her to quit."

And from The Retail Revolution: How Wal-Mart Created a Brave New World of Business by Nelson Lichtenstein:

"Indeed, Wal-Mart is an outlaw. ‘We’re going to quit breaking the law,’ Regional Vice-President Larry Williams told a Tulsa meeting of store managers in 1994. The OSHA laws we have, the wage and hour laws that we have, the federal firearms law, we’re going to quit breaking the law.’ But without a radical shift in the corporate work culture, such top-down admonitions were but futile wishes, ignored by Wal-Mart’s army of hard-pressed managers. Although both K-Mart and Target proscribe overtime pay and squeeze their managers and workers to keep labor costs in line, neither has been the subject of a class-action ‘off-the-clock’ suit. Wal-Mart, on the other hand, was defending itself against seventy-five such suits as of December 2008 when the company announced a settlement, perhaps costing as much as $640 million, in sixty-three of those wage and hour lawsuits covering hundreds of thousands of workers in some forty-two states."

I finished that post with this statement. I see no reason to modify it.

"Wal-Mart tries to cloak itself in a mantle of righteousness, but it has spent its life careening along that fine line between mean-spiritedness and criminality. It deserves the same rapid termination that it provides its employees. Let’s try to avoid supporting this company in any way."

Saturday, November 17, 2012

Oklahoma Leads the Way in Preschool Education

The education of a child begins at birth. How the child matures depends on the nurturing and nourishment provided by whoever cares for it. Obviously, children will receive a vast range of experiences depending on their particular environment, and by the time they are ready to enter kindergarten and begin formal schooling some will be much more advanced than others. There is evidence that these initial advantages can create a bias in favor of the better prepared that persists throughout their schooling, and produces inequality in educational outcomes. To counter this effect many nations provide universal preschool for all four-year-olds, and some for three-year-olds as well. This approach more nearly provides similar starting points for the children as they enter formal schooling.

How does the United States perform in providing preschool care? An OECD report provides a summary and compares us with other wealthy OECD nations. In terms of the fraction of four-year-old children participating in a preschool program, we fall at number 28 out of 38 countries. Not only are we behind comparable countries, the way we approach the issue seems intended to enhance inequality rather than damp it out. Instead of the majority of children being enrolled in a common program, nearly half of our children are enrolled in private programs. Also, the quality of instruction provided, both public and private, is very uneven since there are no universal standards. As in so many other areas, those who can afford the best get the best.

Providing quality instruction to all preschool children would be a desirable goal. It was interesting to come across a report that indicated that the state of Oklahoma actually had the best and most universal program for four-year-olds. Sharon Lerner provided an article titled Pre-K on the Range in The American Prospect. She begins with this lede:

"Rural, conservative, impoverished Oklahoma has built the nation’s brightest model for early education."

Oklahoma is definitely conservative and rural, but the term impoverished deserves some elaboration. While many people qualify as living in poverty, there is a lot of wealth in the state. The issue is being able to share wealth in a productive manner.

Lerner attributes the guiding philosophy for Oklahoma’s program to Ramona Paul who worked in the state Department of Education, and the implementation to a Democratic legislator named Joe Eddins.

"It wasn’t until 1998 that a legislator named Joe Eddins quietly pushed through a law that provided the funding to expand Paul’s vision into a mostly full-day program that would be offered throughout the state."

Eddins was successful because the most important constituency of all was convinced that such a program was in their best interests.

"Eddins allies included not just child-development experts and educational policy makers but also a handful of business leaders who had come to see early education as the state’s economic salvation. Getting young Oklahomans into school earlier was not only in the kid’s interest, they argued; it was important for businesses, which were facing a dwindling pool of potential workers and customers."

Lerner ascribes some cleverness and subtlety to Eddins’s means of getting this most progressive of bills passed in this most conservative of legislatures. What he accomplished was both simple in concept and powerful in execution, and can serve as an example of how other states could address the initiation of a universal program.

"By building its cost into the larger public-school funding formula, rather than funding early education separately in the state budget, it also protected pre-K from fiscal conservatives who might object to it as part of a ‘nanny state’."

"This seemingly small detail may be the key difference separating Oklahoma from other states, such as Arizona and Illinois, where pre-K funding was slashed during the recent recession. Indeed, in Oklahoma, pre-K is essentially just another grade—as unlikely to be singled out as [any other]."

Another advantage of putting pre-K on the same footing as other grades is that comparably qualified teachers can be recruited for pre-K and be paid on the same scale as teachers in the higher grades. And funding for pre-K students is not subject to lower standards. Lerner tells us that Oklahoma spends about $7400 on each of its preschoolers, a level that allows it to attract quality teachers, keep class sizes low, and provide a healthy learning environment.

Part of Eddins’s strategy in getting his legislation passed was to make participation voluntary. Oklahoma’s experience with participation indicates the degree to which there is demand for quality and affordable preschools.

"...’people started camping out that first night before we began enrolling,’ says Cathy Burden, the superintendent of Union Public Schools in Tulsa. That was in 1998, when Union enrolled less than half of its four-year-olds and pre-K was only half-day. Today, about 75 percent of the district’s four-year-olds are enrolled, all are in school for full days, and demand continues to grow. ‘If anyone tried to get rid of pre-K now,’ Burden says, ‘they’d get run out of town’."

The thought of starting from scratch in a state and organizing a universal preschool program at this point in time seems foolhardy. But what about the approach taken by Oklahoma: just add another grade? The educational, administrative, and legislative simplifications that ensue are rather startling.

Could this be the best way to approach the problem? It seems worth the try.

Thursday, November 15, 2012

Election 2012: Polarization Grows and The Big Sort Continues

In an earlier post, Politics in the USA: The Big Sort—1976-2008, we discussed Bill Bishop’s book The Big Sort: Why the Clustering of Like-Minded America Is Tearing Us Apart. Bishop presented rather compelling data from presidential elections in 1976, 2004, and 2008 that supported his contention that our nation was dividing itself into "tribes" of like-minded individuals. This like-mindedness, of course, extended to voting patterns. Bishop produced county level voting results that indicated those counties where one candidate won the county in a "landslide"—meaning by more than 20 percentage points. There was a clear progression over the years as the numbers of such landslide counties grew and spread over significant portions of the country map. The Republicans were accumulating large majorities of the votes in rural areas and the Democrats were doing the same in the more urban areas.

There seemed to be two major reasons for this tribalism. When people did have occasion to change location, they often had a choice of nearby regions and picked the one in which they felt most comfortable—the one in which the people were most like themselves. If a new job was to be filled in Denver, for example, a Republican-leaner might tend to live outside of town and commute in; a Democrat-leaner would more likely head for the heart of town. There is also a group dynamic taking place. Those who vote Democratic or Republican don’t just represent different political philosophies; they represent cultures with different lifestyles and different worldviews. People who migrate into a culture tend to assimilate into that culture. There will be subtle but definite pressures in urban areas, for example, to think and vote like the majority

I was quite interested in learning how this process has proceeded since the last election in 2008. I haven’t found data accumulated in exactly the form presented by Bishop, but Mark Newman of the University of Michigan has posted data that is perhaps even more informative. Newman provides this chart of the winning party in each county. Red is Romney/Republican and blue is Obama/Democrat.

The predominance of one party in specific geographic areas is clear, but the degree of dominance is not. It was startling to watch the election results being reported as they came in and see counties in which one party was winning not just by Bishop’s definition of a landslide, but by much larger margins.

Newman also provides a chart in which the color of the county varies between red and blue according to a scale in which a Republican vote of 70% or more is pure red, and a Democratic vote of 70% or more is pure blue.

Clearly, in the regions where one party dominates, there are significant areas in which the vote is reaching the 70% saturation point. That is rather incredible.

Where does this end? There was a report that there were a number of precincts in an Ohio city in which Romney received not a single vote.  Undiluted partisanship will breed more intense partisanship.  Who would want to be the last Democrat in a Republican precinct?

 Perhaps demographics will come to our rescue and define one party/culture to be dominant and temper this polarization, or realign us so that we fight over different issues.  Something better come to our rescue—and quickly.

Monday, November 12, 2012

India Struggles with Democracy

It is inevitable that India is compared with China as an economic and social entity. In all such comparisons China is perceived as being more efficient in addressing economic and societal needs, with the obvious exception of political freedom. Discourse emanating from the Western nations usually concludes that India, with its democratic system, will ultimately make better decisions than China and, inevitably, produce a better nation. Is this nothing more than wishful thinking? Is it possible for a democracy to be so dysfunctional that it is unable to address critical issues effectively? Could a democracy be so flawed that it is destined to fail? These are the questions raised by Sadanande Dhume in an article in The Wilson Quarterly: India’s Feckless Elite.

Dhume begins by reminding us that India has fallen into rather difficult economic times.

"Economic growth slowed to an annual rate of 5.5 percent in the first quarter of the current fiscal year, and few independent analysts expected it to top six percent in the rest of the year. For a country still at an early stage of development—in dollar terms, the average Indian earns about as much as the average Chinese did in 2004—this augurs ill. Most economists believe that India needs to grow by more than seven percent annually merely to keep pace with the 13 million new entrants into the job market each year."

"Flagging growth isn’t the only cause for concern. Foreign direct investment plummeted 67 percent in the first quarter of the current fiscal year, to $4.4 billion. The rupee has spent much of 2012 touching historic new lows. (By mid-September, it had lost 20 percent against the dollar over the past 12 months.) Though arguably a one-off event, the massive power outage in July that left 600 million people without electricity dramatized the parlous state of Indian infrastructure to the world."

Dhume illustrates the difficulty any government faces in trying to initiate reforms.

"In September, the government raised the price of diesel fuel and announced a rash of long-awaited economic reforms in the retail, aviation, and power sectors. For the first time, big-box retailers such as Walmart will be allowed to own a majority stake in their Indian operations. But it remains to be seen if even these limited reforms, eight years in the making, will take hold amid a firestorm of protest by both the opposition and allies within the ruling coalition. As protestors take to the streets and coalition partners threaten to bring down the government, they highlight the unpredictability of Indian democracy and foreshadow a chaotic alternative to the smooth arc of progress assumed by many."

Dhume defines his concerns:

"Are the country’s ruling elites up to the task of piloting a staggeringly diverse nation of 1.2 billion people, half of them under the age of 25, out of poverty and toward prosperity? Can economic reforms be pushed through in an era of dynastic politics, fragile coalitions, and powerful regional satraps? Can India’s institutions rein in resource grabbing of the sort once associated with postcommunist Russia or Suharto’s crony-ridden Indonesia? Can politicians rise above appeals to caste, religion, and language and begin to debate the country’s future in terms of ideas? In short, will politics, in the broadest sense of the word, enable India to achieve its potential, or choke it?"

While India’s democracy has been remarkably stable, in the sense of assured peaceful transfers of power based on elections, it has unique characteristics that are not healthy. When the British left, the country was in the hands of highly educated leaders. As the political system has evolved, competent, dedicated people who might wish to devote their lives to public service find it almost impossible to gain entry.

"Over time, the odds of an idealistic young man or woman acquiring a world-class education and aspiring to public life in India have become vanishingly small. Many of the most talented instead look toward the private sector or emigrate to the West. Indian elections are usually decided by an electorate that votes primarily on the basis of identity—caste or religion. Moreover, most political parties in India have morphed into family fiefdoms handed down from parent to child like an heirloom. In many ways, the parties resemble personality cults more than organizations of individuals motivated by similar ideals and policy prescriptions."

Such a political structure inevitably leads to the corruption that is now so wide spread.

"Lacking a culture of transparency, virtually all parties use slush funds for campaigns, which in many parts of the country consist of promising voters free kitchen appliances or laptops, or delivering cash-filled envelopes to them the night before voting. In the absence of intraparty competition, the party leader effectively controls both campaign cash and, when in power, the state’s goody bag of handouts. It’s hardly a surprise, then, that politicians have developed a symbiotic relationship with crony capitalists in mining and real estate, fields in which access to decision makers is the single most important element of business success."

"Today, nearly a third of state and national legislators have criminal charges pending against them, including serious ones such as murder, kidnapping, and extortion."

The influence of family on politics is best exemplified by the longevity of the "Nehru-Gandhi dynasty"

"Sonia Gandhi, the daughter-in-law of Indira Gandhi, is president of the ruling Congress Party and is India’s most powerful politician. Manmohan Singh, her mild-mannered and technocratic prime minister, is widely seen as a seat warmer for Gandhi’s 42-year-old son, Rahul. Should he become prime minister, Rahul Gandhi will follow in the footsteps of his father, grandmother, and great-grandfather. Should he fail to ascend to the top post, the party, conditioned by decades of loyalty to bloodline rather than ideas, will almost certainly turn to his 40-year-old sister, Priyanka."

"Two-thirds of members of Parliament under the age of 40 are ‘hereditary MPs’ from political families. In short, while the right name gives a politician a leg up in other countries, in India it’s more like two legs and an arm. Fifty-odd families effectively run much of the country."

India is developing growing middle and upper classes of relatively affluent and well-educated individuals. One would assume that such people would become the core participants in a healthy democratic system. Whether from despair over the low probability of making a difference, or from self-interest, these people seem to have chosen to withdraw from the political system, and, as much as possible, from the nation that surrounds them.

"Unlike in America, in India, the richer you are, the less likely you are to vote. In the richer neighborhoods in Delhi, Mumbai, and Bangalore, and in the gated apartment complexes springing up in satellite towns such as Gurgaon, outside the capital, people have chosen to secede from Indian democracy rather than to fix it. On-site generators provide power. Private guards take care of security. The kids study in private schools and visit private doctors. For the most part, politics belongs to a distant world, glimpsed on television news, gossiped about at parties, and, at best, participated in only when national elections come around every five years."

It is this retreat of the affluent that Dhume finds most disturbing. These are the people from which one would expect competent political leaders to emerge. It is not happening—at least not yet. Dhume’s one hope seems to be that the economy will recover and the affluent classes will grow to the point where sheer numbers will grant them political entry and power. Otherwise, the future is not promising.

Dhume concludes:

"If more politicians could think beyond the inherited template of identity politics and government handouts, they would see the enormous potential—for their parties and for India—of locking in the support of the middle class. In a properly functioning democracy, political arguments are won in newspapers and on television, and through orderly grassroots expressions of dissent. For India to join the developed world, it needs to drag its politicians into the 21st century. Or else, they may just drag India down with themselves instead."

Sunday, November 11, 2012

India: Demographic Dividend or Demographic Catastrophe?

Economists love to project current rates of economic growth into the distant future and draw weighty conclusions. Such thinking leads to predictions that China will dominate the world decades hence. Some conclude that since India will eventually have a larger population than China, it will ultimately be even more powerful. It is often assumed that India will overtake China because its economy will benefit from a demographic dividend as its large numbers of young people enter the work force, while China, because it has limited births, will become a less efficient and aging society. Does this make sense?

The concept of a demographic dividend seems to have been invented to explain China’s successful expansion of its economy. One acquires this dividend by achieving a state in which a country has a large number of employed workers who can save, invest, consume, and pay taxes with their earnings because they are relatively unencumbered by nonworking dependents such as children and the elderly. The United Nations provides a population database containing much useful information. Here are data on dependencies for some relevant countries.


Traditionally, a child dependency is defined as the number aged 0-20 divided by the number between 20 and 65 and then multiplied by 100. Similarly, the dependency for the aged would consider the population over age 65. The sum of these two ratios would be the total dependency. The table includes an entry labeled "Equilibrium." This is arrived at by taking the projected age distribution of the world at 2100, when presumably, if we are still around, we will have achieved a steady-state solution.

China does possess a low total dependency, but Russia’s is even lower. Does that mean that Russia has an economy that is primed to grow as fast as China’s? Not likely. Having a society in which people don’t live long, and they also don’t wish to bring children into it, is not a sign of a vibrant state. Thus, having a low dependency ratio is not necessarily indicative of a healthy economy.

How did China achieve its low dependency number? Consider this data from a report by David E. Bloom.

China arrived at its demographic dividend by drastically—some might say brutally—decreasing the number of children that would be born. India is following a much different path and allowed its population to continue to grow at a healthy rate.

India has the highest total dependency of any of the countries in the table presented above. It is almost entirely due to its large number of children and ever-growing population. If India is ever to turn these children into tax-paying, saving, investing, and consuming engines of the economy, it will have to educate them, keep them healthy, and provide them with jobs when they become adults. What are the odds of that happening?

India is a large and extremely heterogeneous country. Average statistics for the nation tell a misleading story. Nicholas Eberstadt provides some perspective in an article from Foreign Affairs.

"But India has striking regional disparities in population profiles. India is bisected by a great north-south fertility divide: in much of the north, including parts of the Ganges river belt and some of the country's westernmost districts, fertility levels remain quite high, at four, five, or more children per woman; in much of the Indian south, however, fertility levels are at, or already below, the replacement level. In effect, this means that two very different Indias are being born today -- a youthful, rapidly growing northern India whose future population structure will be akin to that of a traditional Third World society and a southern India whose population growth will be slowing or ceasing, where manpower growth will be coming to an end, and where pronounced population aging will be taking hold."

The Bloom report corroborates Eberstadt’s claim;

The states listed from left to right are roughly consistent with a south to north progression.

Eberstadt elaborates further:

"India's engines of economic growth are mainly its sub-replacement-fertility areas, which include much of the south and practically all its major urban centers: Bangalore, Chennai, Kolkata, and Mumbai. But its demographics mean that the country's future workers will increasingly come from the high-fertility areas of the north. This reveals a fundamental mismatch: India's continued economic growth requires workers who are relatively well educated, but India's mostly rural high-fertility areas are producing a rising generation with woefully low levels of schooling."

"India, it is true, can boast of a cadre of millions of highly trained engineers, scientists, researchers, and professionals. But in a country of well over a billion people, these specialists compose only a tiny fraction of its overall manpower. In the country as a whole, educational levels are still remarkably limited, and remedial efforts will take generations to achieve substantial improvement. Currently, about a third of India's working-age population has no education at all; 20 years from now, a sixth of the country's work force may still be totally unschooled. These educational shortfalls place material constraints on the prospects for sustaining rapid rates of economic growth."

These children who are to be depended upon for economic growth in the future are not only under-educated, but nearly half of the children can be considered undernourished—not a healthy combination.

What are the prospects that India will be able to provide enough jobs to satisfy these growing youths? Sadanand Dhume provides this perspective from an article in The Wilson Quarterly: India’s Feckless Elite.

"Economic growth slowed to an annual rate of 5.5 percent in the first quarter of the current fiscal year, and few independent analysts expected it to top six percent in the rest of the year. For a country still at an early stage of development—in dollar terms, the average Indian earns about as much as the average Chinese did in 2004—this augurs ill. Most economists believe that India needs to grow by more than seven percent annually merely to keep pace with the 13 million new entrants into the job market each year."

Recently, the Asian Development Bank forecast growth in India’s economy of 5.6% in the coming year. Here is some perspective on the implications of a 5% growth rate.

"Given India’s demographics and the need to absorb labour, 5 per cent is flirting with social catastrophe."

China and India both have serious problems to deal with as their economies mature. China has been remarkably effective at identifying issues and coming up with plans to address them. They have in place just such a plan to bring the remaining hundreds of millions who are merely subsisting into a more secure place in society and in the economy.

India has been much less successful. When it comes to a plan to address wide-spread and persistent poverty, someone once said something along the lines of: "Our problem is not that we don’t have a plan; our problem is that we have hundreds of plans."

India projects an image of political dysfunction. Let us hope for the best. India is so huge that its failures become worldwide issues.

A few hundred million poorly-fed and uneducated people looking for work is a reality closer to catastrophe than economic dividend.

Wednesday, November 7, 2012

Where the Jobs Are Coming From: Midsized Private Companies

Politicians love to extol the virtues of small businesses, referring to them as engines of job creation. Such statements have been repeated so often that they seem to have become political dogma. Unfortunately, data does not support this contention. Most small businesses create few net jobs because the failure rate is high, and most small businesses do not scale in size. Most small business owners seek the satisfaction of running their own business rather than the hassle of becoming some more complex entity. It seems the "small" businesses that generate jobs are those who begin with a concept that is scalable, but start small by necessity. Apple might have been considered a small business at one point, but it never belonged in the same category as restaurants, gas stations, and beauty salons.

An article in The Economist points out that the discussion of job creation might be missing an important ingredient if we are only considering small businesses and large corporations.

"America has around 197,000 medium-sized firms, defined as those with annual revenues between $10m and $1 billion, according to data from the National Centre for the Middle Market at Ohio State University. Together, they employ over 40m people in the country and account for around one-third of private-sector GDP (equivalent to the economies of India and Russia combined)."

The interest in companies of this size is because they seem to have performed better in the difficult recent period in terms of job creation.

"Some 82% of medium-sized firms survived the dark years of 2007-10, compared with 57% of small firms. And although the survival rate among the 2,100 big firms (with revenue over $1 billion) was 97%, these giants shed 3.7m jobs during those years. Mid-sized companies, by contrast, added 2.2m jobs. This trend has continued as the economy has struggled back to its feet."

This intermediate class of companies is compared to Germany’s Mittelstand businesses.

"America’s mid-sized firms have much in common with the Mittelstand businesses that are the engine of Germany’s economy. They are concentrated in the industrial heartland, rather as Mittelstand firms are in southern Germany. They have typically been around a while; the average age is 31 years."

One interesting characteristic of these companies is that they are mostly privately owned.

"....they tend to be privately owned: 31% by a family, and a further 40% by some combination of private equity and family. Only 14% are traded on a stockmarket. By contrast, two-thirds of big firms are publicly owned."

Benefits from private ownership are suggested.

"The freedom from short-term stockmarket pressures is one reason why middling firms have been more willing to invest for the long term despite the tough economy, says Anil Makhija, who runs the National Centre for the Middle Market."

The fact that these midsized firms continued to add jobs across the recession suggests that they had a business posture that kept product output and the number of employees growing.

"Mr Makhija has studied the fastest-growing mid-sized firms, to see what they were doing differently. They turn out to be more focused on what their customers want (those with social-media strategies did especially well) and to use more state-of-the-art management methods. They also tend to be remarkably globalised, again like Mittelstand firms."

An article from Forbes provides some additional insight into private versus public companies.

"Private U.S. companies’ profitability has lagged that of public companies in the Standard & Poor’s 500-Stock Index through the recession and recovery, according to data from Sageworks Inc., a financial information company. At the same time, private companies took a less drastic hit to sales, on a percentage basis, than did S&P 500 companies between late 2008 and mid-2010, according to Sageworks."

This suggests that private companies are more recession-proof than public companies, and public companies respond to recessions by laying-off workers and cutting spending. It would seem that private companies respond to recessions by trying to maintain their business plans, while public companies respond by trying to maintain their profit levels. Or in simpler terms: private companies try to do something helpful, while public companies try to do something harmful.

These midsized companies and their private nature deserve further consideration. It seems that many public corporations are going private if the possibility presents itself—presumably because they recognize advantages to being private. Is it possible that public corporations have evolved to a state where their focus on short-term profitability and stock price has rendered them economically deficient? In other words, are they becoming obsolete? Should they become obsolete?

Tuesday, November 6, 2012

Birth Date, Education, Ability Grouping, and Accomplishment

There was a recent blog entry by Melissa Korn in the Wall Street Journal that commented briefly on a study of CEOs that showed that CEOs were born preferentially in certain times of the year.
"According to the report, just 6.1% of a sampling of S&P 500 CEOs was born in June, and 5.9% had July birthdays. That’s well below the number born in March (12.5%) and April (10.7%). The researchers looked at 375 CEOs who held the job title between 1992 and 2009."

Cutoff dates for school entry are generally in the September through December time period. If one assumes a September 1 cutoff, then those entering the first year of school and born in September will be up to a year older than a child born in August—a large difference at age five.

"Older children – the March and April babies – tend to perform better than younger ones in a class. At age four or five, just a few months can make a big difference in intellectual development. They do well in kindergarten, may learn to read sooner, thus are funneled into advanced courses, and voila: Executive material in the making."

Parents are concerned about this age effect and often hold back their younger children for a year so that they will enter as the oldest children. The authors of the referenced study apparently needed to move their months for comparison far enough away from the transition months in order to draw a conclusion.

One might be tempted to write off this conclusion as a statistical fluke, but that would be a mistake. The existence of a birth-date effect is well known in academia. The British attempted to survey all that was know about the subject and issued a report in 2009 that is commonly referred to as The Cambridge Assessment. Most attention was placed on British schools, but data from other countries was reviewed as well.

The data seems to vary from school system to school system and from country to country, but there is no doubt that such an effect exists and that it persists throughout the educational careers of the students. Some summary findings:

"There is robust evidence from around the world that, on average, the youngest children in their year group at school perform at a lower level than their older classmates (the ‘birthdate effect’). This is a general effect found across large groups of pupils. Specific Summer-born pupils may be progressing well, but the strength of the effect for the group as a whole is an issue of very significant concern."

"In the UK, where the school year starts on September 1, the disadvantage is greatest for children born during the summer months (June, July, August). "

"The effect of being the youngest in the year group holds in other countries where the school year begins at other times in the calendar year."

This effect of birth date on achievement is most pronounced in competitive sports where age grouping is done. In his book, Outliers, Malcolm Gladwell described the effect in the context of Canadian hockey players where the high performers are generally born in the first three months after the age cutoff. Gladwell explained the effect as being caused by older, stronger, more mature children being able to perform better than their younger counterparts in the early years of competition. This enhanced performance earned them more attention, better coaching, more practice time, and more intense competition. Once players were sorted by ability, the differences in ability would propagate and persist throughout the children’s playing careers.

Gladwell warned us that sorting young children into ability groups at an early age and providing better education to the faster learners would cause a similar effect in educational accomplishment. The size of the effect would be smaller than in sports, but it would persist. The Cambridge Assessment agrees.

"....September-born students are 20% more likely to go to university than their August-born peers."

This is a statistically significant effect. It convinces us that the effect persists throughout education, but it doesn’t tell us how it relates to ultimate accomplishment or how it is propagated.

If one believes the sports analogy, then one would expect the effect to depend on whether or not children are subjected to ability grouping at an early age. Some countries also delay formal education until age seven. Both actions might be likely to lessen age-related effects.

The Cambridge Assessment finds evidence to support the contention that early ability grouping contributes to the performance differences.

Finland begins formal education at age seven; Denmark begins at age six. At age 13 there is no discernible birth-date effect in the children of either country. This would suggest that starting school at a greater age lessens disparities. But then there is Sweden. Sweden begins school at age seven, but it groups by ability in the early grades. Its children do demonstrate a birth-date effect. Denmark forbids ability grouping before the age of 16. Finland has a similar policy. The data from these three countries seems to indicate that separating students into groups based on perceived notions of ability can be a harmful practice.

If the birth-date effect is large enough to effect the probability of attempting a university education, that is a significant effect. If it can affect the probability that a child can become a professional hockey player, that is a significant effect. If one chooses to take the study of CEO birth dates at face value, then that is the business equivalent to making it as a professional athlete.

The CEO data then is telling us that we are doing something terribly wrong in our educational system. The Cambridge Assessment data suggests that the problem can be fixed.

So why not fix it! We have enough sources of inequality. We shouldn’t have to worry about the month in which our child was born.

Saturday, November 3, 2012

Investing in Wall Street’s Casino: The House’s Take

There is certainly nothing new in comparing Wall Street to a gambling operation, but there is more to be learned about the actual operations and about what our encounters with financial types are actually costing us. John C. Bogle has produced a new book that provides us with some necessary background: The Clash of the Cultures: Investment vs. Speculation

Bogle views stock market speculation as debilitating for investors and the economy as a whole. Unnecessary short-term trading does nothing for the value of the market except to siphon off transaction costs to the financial intermediaries. As in a casino, there are winners and losers, but the house always gets its share.

" need only understand the tautological nature of the markets: Investors, as a group, inevitably earn the gross return of, say, the stock market, but only before the deduction of the costs of financial intermediation are taken into account. If beating the market is a zero-sum game before costs, it is a loser’s game after costs are deducted."

While technology and competition have forced down individual transaction costs, the response has been to encourage more trading in order to keep the dollars flowing in.

"While unit-trading costs have plummeted, trading volumes have soared, and total costs of the financial system continue to rise. Too many innovations have served Wall Street at the expense of its client/investors."

Wall Street has a function to perform in allocating capital to those who need it, and in providing liquidity, but those roles have been overwhelmed by speculation.

"In recent years, annual trading in stocks—necessarily creating, by reason of the transaction costs involved, negative value for traders—averaged some $33 trillion. But capital formation—that is, directing fresh investment capital to its highest and best uses, such as new businesses, new technology, medical breakthroughs, and modern plant and equipment for existing business—averaged some $250 billion. Put another way, speculation represented about 99.2 percent of the activities of our equity market system, with capital formation accounting for 0.8 percent."

Transaction costs can be enormous, and their effect is often unrecognized by most investors who place their money in the hands of mutual funds. This source provides a good summary of the cost structure.

"The expense ratio represents the percentage of the fund's assets that go purely toward the expense of running the fund."

"Currently the typical expense ratio for an actively managed mutual fund is about 1.5%, and that number has been going up lately. With an expense ratio of 1.5%, a mutual fund is cutting itself in on 1.5% of the total money in the fund every year."

The expense ratio has the following components:

"The investment advisory fee or management fee is the money necessary to pay the manager(s) of the mutual fund. On average, this fee is about 0.50% to 1.0% annually of the fund's assets, and is necessary to make sure that the manager of the fund can be very well-dressed at all times and is able to go on good vacations."

  "Administrative costs are the costs of record keeping, mailings, maintaining a customer service line, etc. These are all necessary costs, though they vary in size from fund to fund. The thriftiest funds can keep these costs below 0.20% of fund assets, while the ones who use engraved paper, colorful graphics, and phone answers with highfalutin' accents might fail to keep administrative costs below 0.40% of fund assets."

"Surely the fee that you as a mutual fund investor should be most outraged by is the 12b-1 distribution fee. This fee ranges from 0.25% of a fund's assets all the way up to 1.0% of the fund's assets. This fee is used for marketing, advertising, and distribution services. Yup, that's right. If you're in a fund with a 12b-1 fee, you're paying every year for the fund to run commercials and try to sell itself."

Bogle reminds us that while earnings compound, so do costs. Let’s look at a simple example to see how this works. Say your favorite aunt died when you were young and left you $10,000. You wisely invested it in a well-regarded equity fund and left it there for 40 years so that it would be available to you in your retirement. Say you chose well and your investment earned 7 percent annually over the 40 years. You could then expect to have about $150,000 dollars available. However, you hadn’t reckoned on the fund fees. Say your fund took out the typical 1.5 percent each year; that would mean the actual rate of return was 5.5 percent annually. A return of 5.5 percent over 40 years means you would only have about $85,000. That seemingly small fee took away over 40 percent of your earnings and cost you about $65,000. And remember, 1.5 percent is the typical fee, yours could be higher.

Bogle believes it is absurd to pay these fees, and he thought that many years ago. His recognition that a speculatively traded fund, with its fees, cannot match the market as a whole in the long run, led him to create the index fund. Vogel is most famous for founding the Vanguard 500 Fund. Tying a portfolio to an index that tracks the market as a whole limits the need for transactions and minimizes costs. And it guarantees that you will do as well as the market—at least to the degree that the market is represented by the chosen index.

Our source on fund expense ratios provides this information:

"Meanwhile, in the wonderful world of index funds, the expense ratio is typically around 0.25% and gets as low as 0.18% for the king of all index funds -- the Vanguard 500 Index."

Returning to our example, if one had invested in a fund with an expense ratio of 0.18 percent, and had realized the same 7 percent annual gain, the amount available after 40 years would have been about $140,000 rather than $85,000.

Recent studies have indicated that most people who invest in a 401K are not even aware that there are costs associated with their plan. Estimates indicate that for the average investor, about a third of the potential value of a 401K account is consumed by fees levied by fund managers. There are new regulations forcing plans and managers to be explicit about what fees are in place. Hopefully, this will instill some shame and some competition and drive the fees down. It really does make a big difference.

Finally, Bogle provides us with this perspective:

"Pressed to identify useful financial innovations created during the past quarter century, Paul A. Volker, former Federal Reserve Chairman and recent chairman of President Obama’s Economic Recovery Board, could single out only one: ‘The ATM’."

Thursday, November 1, 2012

Final Thoughts on Occupy Wall Street

A bit of satisfaction was experienced as the seemingly spontaneous displays of outrage began to appear from what would be termed "Occupy Wall Street." Clearly, the financial abuses that caused so much suffering were worthy of some outrage. As time went on and a sense of where the protests were heading, and what the protestors intended to accomplish were not forthcoming, satisfaction was replaced by a sense of foreboding, and finally by dismay and a bit of shame. As a dedicated liberal/progressive I see many things in our society that should be corrected. I also believe that action to correct any of them requires dedicated people focusing on a defined objective; one that is capable of marshaling support from a large segment of the nation. What I feared I was seeing was an undisciplined bunch of activists who would, in the end, offend most citizens and make the left once again look confused, disorganized, and out of touch.

Michael Greenberg wrote two articles for the New York Review of Books discussing Occupy Wall Street. He spent a lot of time visiting with the protestors in an attempt to understand who they were and what they wanted. The second article sheds light on the protestors and confirms my concerns. He summarizes the situation:

" Occupy Wall Street enters its fifth month, dislodged from most of the public spaces it had staked out around the country last fall, the movement seems weakened, its future uncertain. It sometimes appears to be driven by a series of tactics designed to maintain its public presence with no discernible strategy or goal—a kind of muddled, loose-themed ubiquity. The movement has proven adept at provoking media attention, but one may wonder what it amounts to, apart from its ability to reaffirm its status as a kind of protest brand name."

The people Greenberg quotes seem to be interested in something bigger than reform, something more akin to revolution; but, a revolution leading where? The most succinct expression of a goal Greenberg could quote seemed to be this:

"A government accountable to the people, freed up from corporate influence."

That is an admirable goal, and some of the protestors actually believed it was time to specify demands that would generate movement towards such a goal.

"In October, a "Demands Group" did spring up among the protesters. When members of the group went public with a few suggestions, the General Assembly attempted to vote them out of existence and by some accounts succeeded."

Why the resistance to explicit demands? Greenberg received this explanation:

"Any such demand would turn them into supplicants; its very utterance implied a surrender to the state that went against Occupy Wall Street’s principles."

One supposes that if a revolution is what is desired, then it makes no sense to try to make incremental changes because that would always mean working within the system that you wish to overthrow. But if revolution is the goal, then the nation has to be convinced to support it. The protestors seemed to want to generate public support for goals that they refused to specify. They also seemed to wish to generate a revolution without generating an organization—as if pure motives by themselves could generate momentum.

David Runciman writes a well-deserved dismissal of the Occupy "movement." His article appears ostensibly as a review of The Occupy Handbook. It appeared in the London Review of Books under the title: Stiffed.

Runciman begins by disposing of the notion that Occupy could have any practical relationship to its slogan proclaiming "We are the 99 percent."

"It relies on a wishful view of the 99 per cent and an absurd caricature of the 1 per cent, who are described as having been revealed ‘as a band of feckless, greedy narcissists, and possibly sociopaths’. What, all of them? Many of the 1 per cent think of themselves as members of the 99 per cent, precisely because they do not feel they belong with the monsters and sociopaths. Many of them are right: the 1 per cent starts at a household income level of around $350,000, so it includes a wide mix of people, including plenty of liberal professionals. Really, as Paul Krugman likes to point out, it’s the 0.1 per cent or even the 0.01 per cent who have been getting away with it on the grandest scale. But ‘We are the 99.9 per cent’ or ‘We are the 99.99 per cent’ seem like increasingly pointless slogans. You can’t play the victim when there’s ten thousand of you to every one of them."

Runciman then estimates the actual number of Occupy protestors as being about 0.1 percent of the population. So it could be said that the 0.1 percent were contending against the 0.1 percent. As we have seen, this 0.1 percent itself was not particularly well organized or focused, so how could it claim that the 99 percent was with them?

"What the 99 per cent have in common is that they don’t have enough in common to make a difference politically, compared to the very rich, who are a well-organised bunch. The 99 per cent are a lot more numerous than the 1 per cent; they are also a lot more divided, and it’s the second fact that counts."

Although the notion of the 99 percent as an abused majority was destined to fail, getting a large fraction of the population motivated to support an abused minority is definitely possible.

"Amid all the grandstanding and parading of manifestos in the Occupy Handbook, one essay that stands out is an old-fashioned piece of historical reportage by Michael Hiltzik. It’s called ‘The 5 per cent’, and it tells the story of the campaign during the 1930s to secure a decent social security programme for the elderly."

In the 1930s, the number of people over 65 consisted of about 5 percent of the population. These people were in the greatest need, but had the least political clout and were being overlooked as New Deal legislation was being proposed. A doctor named Francis Townsend organized a grass roots campaign to obtain a national pension plan.

"Though he didn’t get the scheme he wanted, he drew the nation’s attention to a group of people who were the clear losers in a crisis that had left the rich relatively unscathed."

"By focusing on the 5 per cent, the Townsend campaign made effective political use of the idea of victimhood. ‘Reduced to its essentials,’ Hiltzik writes, ‘the Townsend movement was a quest for justice for an oppressed and abused segment of the population. From this simplicity it drew its political potency’."

Runciman has a suggestion of a new 5 percent group that could use some help.

"Who are the 5 per cent today? It’s definitely not the old, who are now far more numerous and far wealthier than ever before....The losers are the young, especially those aged 25 and under who are not in education but are looking for work. In the US the unemployment rate for those aged 16-24 is 17.1 per cent; for black workers in that age-group it is 29 per cent. But the truly scary picture is the one emerging from Europe. In countries like Greece and Spain the youth unemployment rate is around 50 per cent. In these countries too, the old are better protected than the young, who are often being abandoned. Add to this the fact that the old are the ones who have enjoyed the benefits of years of relative prosperity and security across the Western world, whereas the young are facing a future in which the money has run out, and it is clear who the real victims are."

We must thank Runciman for reminding us that we can produce solutions when we have a specific problem to address, and for providing an appropriate target for our efforts. Addressing the needs of our youth will not require a revolution, but it will require dedicated people to come up with a proposed plan of action that makes sense within the context of the world and the economy in which we exist. And it will require these people to set up an organization to drum up support for the concept.

Goals, plans, and organization were all things that failed to emerge from Occupy. What a frustrating waste of energy and opportunity.
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