Archive for the ‘Economy’ Category

Initial Impressions of the European Bailout

Monday, May 10th, 2010

At this point it should come as no surprise to anyone that the European Union has committed to a large rescue package with a headline number of around $1 trillion (see EU Rescue Package for details).

With the caveat that I am not a macro-economic specialist (my specialty is in firm behavior), I share with you my initial thoughts on the bailout.

First, the good:

  1. Wow! The EU countries were able to overcome their differences and react with a unified voice and purpose. They did so in a swift manner and committed an extraordinary sum of money to try to address a problem whose gravity they had, until this point, largely chosen to ignore, …or at least treat with benign neglect.
  2. The capital committed, in my opinion, is large enough to help meet the short-term funding needs of the countries that might need to draw upon it (think Greece, Portugal, Spain). Greece had been largely shut out of external capital markets, and Portugal and Spain were following not too far behind. The weaker peripheral countries can now turn to the EU/ECB and IMF to raise funds that they might have trouble otherwise raising on their own.
  3. The rescue package not only bails out the peripheral (PIIGS) European countries, but it also bails out the banks. For example, if you were a European bank sitting on a helping of Greek debt, imagine how your balance sheet looked on Friday given the market’s expectation for Greek default and how it looks today now that the ECB has announced that it will buy debt issued by the weaker European nations in the secondary market. Whether the banks deserve such a bailout is certainly open to debate, but the actions taken by the ECB will keep credit markets from freezing in the near term.

Now, the bad (or at least the part that gives me pause):

  1. The obvious: Moral Hazard (see Go Hog Wild). How long will the richer European nations continue to allow their debt-addicted poorer brethren to behave badly?
  2. Aside from the guarantees and the liquidity provisions, I am not seeing any meaningful change in the debt burdens facing Greece and the other PIIGS nations. There is no debt restructuring from what I can tell. Given that there is no debt relief for the PIIGS, it is likely that several of the PIIGS will be forced to tap the rescue packages.
  3. My understanding from the rescue program is that if a country taps into the funds, it will be subject to mandated fiscal austerity programs. As we have seen in Greece, additional (and forced) fiscal austerity is likely to be poorly received, …so get ready for additional social unrest and political turmoil.
  4. Assuming that the countries that agree to the mandated fiscal austerity programs are able to do so with minimal social unrest and political turmoil, the fiscal adjustments will come with negative shocks to the real economy. It will result in, at the least, lower economic growth in those countries that are forced to tap into the rescue funds, and at the worst, a severe recession that could have spillover effects even on the stronger European nations.
  5. All this aid, and there’s still no guarantee that the weaker PIIGS nations will not ultimately default. So for all its benefits, all that the rescue package might achieve is to push the day of reckoning for many of these nations further into the future.

Taking stock therefore, the rescue seems to me like an attempt to buy some time for the struggling European economies while hoping that economic growth (or inflation) can emerge that will help those nations escape their debt problems.

Again, these are just my initial impressions. It will take some time for the dust to settle to see how the bailout plays out. For those of you looking for a deeper analysis from scholars whose specific interests and expertise lie in the analysis of macro-economic issues, I refer you to Simon Johnson, Paul Krugman, and Nouriel Roubini.

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More on this topic (What's this?)
Eichengreen: It is not too late for Europe
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Read more on European Union, 2008 Financial Crisis at Wikinvest

Greek CDS Exposure

Tuesday, April 27th, 2010

The Economist provided a very nice chart last week (see Still in a Spin) breaking down the foreign bank exposure to Greek sovereign debt (as compiled and reported by the BIS).

From the table, it seems that French, German, and Swiss banks have the greatest overall exposure to Greek government debt. But there is much more to it than that…

The figures presumably capture the nominal amount that foreign banks hold in Greek government debt expressed as a percentage of Greece’s total outstanding debt. However, to the extent that foreign banks have hedged their exposure through insurance purchased in the CDS market, the table will not reflect the true exposure of those banks.

We can’t quite know the extent of the exposure to Greek sovereign debt without knowing the exposure of banks (and non-bank financial institutions) to CDS positions on Greek sovereign debt. Since the CDS market is opaque and unregulated, my fear is that, aside from the obvious threat of contagion to the other PIIGS economies, the lack of transparency regarding exposure to Greek CDS contracts might result in a “credit crunch” redux. Might there be a sovereign equivalent to AIG or AMBAC out there?

With the global economy in the midst of a still fragile recovery, I certainly hope not…

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The Horn of Plenty

Thursday, April 15th, 2010

It’s been a whirlwind few weeks of travel for me – beginning in Holland, then on to Paris, followed by a trip to DC. But I am now back in New York, looking forward to getting back to a more regular, regimented schedule.

In the meantime, I thought I’d share some articles that I’ve enjoyed reading over the past few weeks.

  1. Canadian Pension Organization to Buy UK Lottery – Details how a Canadian Teacher’s Pension organization is trying to acquire a British lottery operator. Can someone please explain to me the logic of a pension fund running a lottery company, …in a foreign country no less? This defies just about all corporate strategy logic regarding M&A activity. What do pension funds know about running lottery companies?? And if they’re simply a financial buyer, what business discipline will they be able to impose, especially since the owners get only a small portion of the profit? Also, I can’t help but wonder how Canadian teachers will feel about owning a gambling operation.
  2. The Celebrity Effect – Details research on the financial impact of appointing celebrities to a company’s Board of Directors (e.g., Evander Holyfield at Coca Cola; Michael Jordan at Oakley; Billie Jean King at Philip Morris; Gerald Ford at American Express). Although the research suggests that firms benefit from announcing celebrity directors, I remain skeptical. I have brought board members from various large public corporations to speak in my class, and they have expressed disappointment with the celebrity members of their boards, sharing stories about celebrities who typically do not pull their weight. I can understand if a celebrity has a particular expertise that lends itself to the business or if a former politician joins the board of a firm that operates in the government sector and/or for which political connections are especially important. However, by and large, I think that many of these appointments are ceremonial, and likely do not create value.
  3. The Panda has Two Faces – A story from the Economist on the perils of doing business in China. They stress the political, economic, and cultural quandary facing foreign entrants (see also So You Want to Do Business in a Developing Country). A choice quote from the Economist article, “[China] regards foreign investment as a mechanism for acquiring foreign know-how rather than just jobs and capital; hence the insistence on joint ventures…political difficulties are piled on top of cultural difficulties. The Chinese emphasis on personal connections (guanxi) makes it hard to distinguish between business-as-usual and corruption. And the weakness of the legal system means that companies operate in a confusing half-light. Transparency International’s most recent Corruption Perceptions Index ranks China 79th out of 180 countries…”
  4. Relax, We’re Fine – The future of the US economy according to David Brooks. Although the title of the article might be viewed as insensitive to the plight of the millions of Americans who are currently unemployed, I think that David is rightly optimistic about the long-term prospects of the US economy. And it’s nice to remind ourselves of that sometimes, …especially when things don’t feel so great at the moment. A choice quote, “…the U.S. remains a magnet for immigrants…the U.S. is among the best at assimilating them (while China is exceptionally poor). As a result, half the world’s skilled immigrants come to the U.S. As Kotkin notes, between 1990 and 2005, immigrants started a quarter of the new venture-backed public companies. The United States already measures at the top or close to the top of nearly every global measure of economic competitiveness. A comprehensive 2008 Rand Corporation study found that the U.S. leads the world in scientific and technological development. The U.S. now accounts for a third of the world’s research-and-development spending. Partly as a result, the average American worker is nearly 10 times more productive than the average Chinese worker, a gap that will close but not go away in our lifetimes.” This is exactly why I find it hard to believe some of the predictions that China will soon overtake the US as a technological super-power (see also China Attracting High-Tech Research).
  5. The Return of History – A David Brooks two-fer. This Op-Ed is his critique of the field of economics. These are not necessarily new arguments (see Future of Financial Economics, Future of Financial Economics Part Deux, and Krugman on the Future of Economics). Moreover, I am not so sure I agree with David’s prediction with respect to Act V. Nevertheless, it was thought-provoking and provided an entertaining read.

Anyhow, I hope you find these articles well worth your time to read. Enjoy!

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EU’s Message to the PIS Nations: Go Hog Wild!

Tuesday, February 9th, 2010

If the accounts I’ve been reading are true (see Growing Prospects for Bailout for Greece), Greece might be the beneficiary of an imminent bailout. As reported by Bloomberg:

Olli Rehn, who takes over as European Union economic affairs commissioner tomorrow, said support for Greece will be discussed in coming days. Michael Meister, a German legislator from Chancellor Angela Merkel’s Christian Democrats, said lawmakers in that country are considering financial assistance.

The EU (in particular France and Germany) ought to be very careful in how it approaches the bailout so as to prevent moral hazard. And in this case I am not referring to moral hazard in the sense that the bailout provides Greece an incentive to behave badly again in the future, but moral hazard in the sense that Portugal, Ireland (maybe Italy too), and Spain now have the incentive to continue to behave badly. After all, if France and Germany come to the rescue of Greece, it sends a signal to other fiscally troubled European nations that they are likely to receive similar treatment, …and especially for the more consequential economies of Spain and Italy (see Euro Perspective).

If the EU comes to the aid of Greece, what incentive does Spain, Portugal, Italy, or Ireland have to bring their fiscal house in order. In fact, what’s to prevent them from going on a bigger fiscal bender? For after all, although Greece represents only a small fraction of European GDP, allowing Spain and Italy to falter could be disastrous for the Union.

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Is China a Bubble Economy?

Saturday, January 16th, 2010

Interesting cover story this week from The Economist about the Chinese economy (see China’s Economy: Not Just Another Fake). In that article, The Economist questions whether asset prices in China are becoming unsustainable, and if China resembles Japan circa the 1980′s. To be a bit of a spoiler (if you have no interest in reading on), their take-away is NO.

The similarities between China today and Japan in the 1980′s may look ominous. But China’s boom is unlikely to give way to a prolonged slump.

CHINA rebounded more swiftly from the global downturn than any other big economy, thanks largely to its enormous monetary and fiscal stimulus. In the year to the fourth quarter of 2009, its real GDP is estimated to have grown by more than 10%. But many sceptics claim that its recovery is built on wobbly foundations. Indeed, they say, China now looks ominously like Japan in the late 1980s before its bubble burst and two lost decades of sluggish growth began.

On the face of it, the similarities between China today and bubble-era Japan are worrying. Extraordinarily high saving and an undervalued exchange rate have fuelled rapid export-led growth and the world’s biggest current-account surplus. Chronic overinvestment has, it is argued, resulted in vast excess capacity and falling returns on capital. A flood of bank lending threatens a future surge in bad loans, while markets for shares and property look dangerously frothy.

Just as in the late 1980s, when Japan’s economy was tipped to overtake America’s, China’s strong rebound has led many to proclaim that it will become number one sooner than expected. In contrast, a recent flurry of bearish reports warn that China’s economy could soon implode. James Chanos, a hedge-fund investor (and one of the first analysts to spot that Enron’s profits were pure fiction), says that China is “Dubai times 1,000, or worse”. Another hedge fund, Pivot Capital Management, argues that the chances of a hard landing, with a slump in capital spending and a banking crisis, are increasing.

Scary stuff. However, a close inspection of pessimists’ three main concerns—overvalued asset prices, overinvestment and excessive bank lending—suggests that China’s economy is more robust than they think.

Start with asset markets. Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37.

China’s property market is certainly hot. Prices of new apartments in Beijing and Shanghai leapt by 50-60% during 2009.

Average home prices nationally, however, cannot yet be called a bubble. On January 14th the National Development and Reform Commission reported that average prices in 70 cities had climbed by 8% in the year to December, the fastest pace for 18 months; other measures suggest a bigger rise. But this followed a fall in prices in 2008. By most measures average prices have fallen relative to incomes in the past decade (see chart 1).

The most cited evidence of a bubble—and hence of impending collapse—is the ratio of average home prices to average annual household incomes. This is almost ten in China; in most developed economies it is only four or five. However, Tao Wang, an economist at UBS, argues that this rich-world yardstick is misleading.

Furthermore, Chinese homes carry much less debt than Japanese properties did 20 years ago. One-quarter of Chinese buyers pay cash…China’s property boom is being financed mainly by saving, not bank lending.

Although I agree that there are some important differences between China today and Japan in the 1980′s (see my recent interview in the Effective Executive), I remain skeptical about whether China’s recovery is legit and that it is, in fact, not experiencing another bubble. For the flip side of the argument I point interested readers to the work of Andy Xie (see China has become a Giant Ponzi Scheme or Trapped Inside a Property Bubble):

Many would argue that China isn’t experiencing a bubble. The high asset prices just reflect China’s high growth potential…

I want to make myself perfectly clear on China’s asset markets today. They are a big bubble. Its bursting will bring very bad consequences for the country.

The most basic approach in studying bubbles is to look at valuation. For property the most important measures are price to income ratio and rental yield. China’s average price per square meter nationwide is quite close to the average in the US. The US’s per capita income is seven times China’s urban per capita income. The nationwide average price is about three months of salary per square meter, probably the highest in the world. As far as I can tell, a lot of properties can’t be rented out at all.

The stock market is in a final frenzy again. The most ignorant retail investors are being sucked in by the rising momentum. They again dream of getting rich overnight. As in the past, retail investors usually lose, especially like the ones jumping in now. The final frenzy usually doesn’t last.

from Trapped Inside a Property Bubble:

The biggest risk to China’s economy is the desire to maintain past economic growth rates by maximizing investments in property — an unproductive asset. It supports short-term growth by sacrificing long-term growth as capital’s average productivity declines over time.

Bubbles exaggerate reality but are not formed out of thin air. Cheap money and strong growth are the usual ingredients for bubble-making. Both existed over the past five years. But now, China depends entirely on cheap money to support overvalued assets. Cheap money came from past exports and was warehoused in banks. Cash also came from hot money inflows due to the yuan’s peg to the dollar and weak Fed dollar policy.

Neither money source is sustainable.

So there you have it – two opposing views on China. Funny thing. These arguments sound vaguely familiar to me. They seem to parallel the ongoing debate as to whether the U.S. is experiencing a sustained recovery or whether its asset prices are similarly over-inflated. Nevertheless, when it comes to China, I think that asset prices are currently overheated and will likely experience a near-term correction. But there is no question in my mind that China is on a long-term growth path toward prosperity, …provided it can avoid political calamity.

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U.S. National Debt Clock

Wednesday, January 13th, 2010

I remember passing the National Debt Clock on frequent visits to New York City in the late 80′s and early 90′s. At that time, the National Debt Clock was located in Times Square. I also vividly remember when it was shut down — with rousing fanfare during the Clinton administration — because the U.S. started running a surplus and the national debt declined. Unfortunately, the National Debt Clock was reinstated once we began running fiscal deficits again in 2004. Although it is it now longer located in Times Square, you can now find it on the corner of 44th St. and 6th Ave.

But the Times Square National Debt Clock is so yesterday. Move over physical National Debt Clock, the digital National Debt Clock is available for all to behold (ht Matt). How fitting that the clock is now available on-line, and the timing with which the link arrived in my inbox could not have been more appropriate. Now that the financial crisis has largely abated, we can all watch, in real time, whether the banking crisis will morph into a sovereign debt crisis as Rogoff suggested (see Rogoff, Ferguson Say Financial Crisis Not Yet Over). To see the online National Debt Clock, click on the image below (or on the link underneath). And enjoy, …or not.

US National Debt Clock Online

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U.S National Debt Statistics
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Read more on National Debt at Wikinvest

Notable Corporate Bankruptcies of 2009

Thursday, January 7th, 2010

In January of last year I predicted (see Notable Bankruptcies of 2009: Q1) that “major” corporate bankruptcies in 2009 would challenge the 383 mark set in 2001 (the high-water mark after the dotcom bubble). I even suggested that it was possible that we could exceed 400 “major” corporate bankruptcies in 2009.

It looked good for awhile, …but what a difference a year makes!!

Although corporate bankruptcies in 2009 were the greatest since 2002, we finished well shy of my predicted mark, and the pace of corporate bankruptcies, in fact, decreased as the year progressed. According to Bankruptcydata.com, “major” filings reached 249 in 2009, more than 100 bankruptcies shy of my prediction.

As I mentioned in a previous post (see Notable Bankruptcies of 2009: Q3), the stylized fact that the pace of corporate bankruptcies decreased through Q2, Q3, and Q4 begs the question of whether the underlying cause was a structurally improved economy or the massive Fed/Treasury liquidity programs keeping weaker firms on artificial life support. My sense is that it had more to do with the latter than the former, but we will find out for certain once the Fed/Treasury start to unwind their extraordinary liquidity programs.

With that in mind, it is my expectation that corporate bankruptcy filings will increase in 2010, for a couple of reasons. First, bankruptcies are a lagging economic indicator. As with employment, bankruptcies typically peak well after the economic trough. As an example, although the dotcom bubble burst in March of 2000, bankruptcies did not peak until 2001, and were elevated into 2002. Second, if fundamentally weak companies are being propped up by the provision of credit/liquidity to an economy that cannot structurally support them, it is only a matter of time before bankruptcies begin to reflect the true underlying economic fundamentals.

So my baseline (over/under) call for 2010 stands at 300 corporate bankruptcies.

Anyhow, below you can find an updated list of what I see as the “noteworthy” corporate bankruptcies of 2009 (as reported by Bankrupctydata.com). New additions since October appear in RED (please note that this is not an exhaustive list):

  • 1st Centennial Bancorp (Banking)
  • AbitibiBowater Inc. (Paper)
  • Accuride Corporation (Trucking)
  • Adamar Inc. dba Tropicana Casino & Resort (Gambling)
  • Advanta Corp. (Banking/Finance)
  • Altus Pharmaceuticals (Pharma)
  • American Community Newspapers Inc. & LLC (Newspapers)
  • ARG Enterprises, Inc. (Restaurants)
  • Aurora Oil & Gas Corporation (Energy)
  • Aventine Renewable Energy Holdings, Inc. (Energy)
  • BankUnited Financial Corporation (Banking)
  • Barzel Industries, Inc. (Manufacturing)
  • Baseline Oil & Gas Corp. (Energy)
  • Bearingpoint, Inc. (Consulting)
  • BI-LO, LLC (Supermarkets)
  • Bruno’s Supermarkets, LLC (Supermarkets)
  • Butler International, Inc. (IT Services)
  • California Coastal Communities, Inc. (Real Estate)
  • Cape Fear Bank Corporation (Banking)
  • Capital Corp of the West (Banking)
  • Capmark Financial (Banking)
  • CCS Medical, Inc. (Medical)
  • Champion Enterprises, Inc. (Real Estate)
  • Charter Communications, Inc. (Telecom)
  • Chemtura Corporation (Chemicals)
  • Chrysler LLC (Automobiles)
  • CIB Marine Bancshares, Inc. (Banking)
  • CIT Group (Banking)
  • Citadel Broadcasting (Media)
  • Colonial BancGroup, Inc. (Banking)
  • Cooperative Bankshares, Inc. (Banking)
  • Cooper-Standard Holdings (Automobile)
  • Crescent Resources, LLC (Real Estate)
  • Cynergy Data, LLC (Banking)
  • deCODE Genetics, Inc. (Biotech)
  • Eddie Bauer Holdings, Inc. (Retail)
  • Edge Petroleum Corporation (Oil & Gas)
  • Ennis Homes, Inc. (Real Estate)
  • Extended Stay Inc. (Hotels)
  • Fairpoint Communications (Telecom)
  • Filene’s Basement, Inc. (Retail)
  • Finlay Enterprises, Inc. (Jewerly)
  • Fleetwood Enterprises, Inc. (Recreational Vehicles)
  • Fortunoff Holdings, LLC (Retail)
  • Fountainbleu Las Vegas, LLC, (Hotels)
  • Freedom Communications Holdings, Inc. (Media)
  • Fulton Homes Corporation (Real Estate)
  • General Growth Properties, Inc. (Real Estate)
  • General Motors Corporation (Automobiles)
  • G.I. Joe’s, Inc. (Retail)
  • Goody’s LLC (Retail)
  • Gottschalks Inc. (Retail)
  • GSI Group, Inc. (Semiconductors)
  • Guaranty Financial Group Inc. (Banking)
  • Herbst Gaming, Inc. (Gambling)
  • Holley Performance Products, Inc. (Automotive)
  • ION Media Networks, Inc. (Television)
  • Idearc (Publishing)
  • Imperial Capital Bancorp (Banking)
  • Irwin Financial Corporation (Banking)
  • JL French Automotive Castings, Inc. (Automotive)
  • Journal Register Companies (Newspapers)
  • Lazy Days RV Center, Inc. (Recreational Vehicles)
  • Lear Corporation (Automobile)
  • Lyondell Chemical Company (Chemicals)
  • MagnaChip Semiconductor LLC (Semiconductors)
  • Magna Entertainment (Gambling)
  • Majestic Star Casino, LLC (Gambling)
  • Masonite Corporation (Real Estate Manufacturing)
  • Metromedia International Group, Inc. (Media)
  • Midway Games, Inc. (Entertainment Software)
  • Monaco Coach Corporation (Recreational Vehicles)
  • Muzak Holdings LLC (Entertainment)
  • Nortel Networks, Inc. (Telecom)
  • NTK Holdings – Nortek, Inc. (Construction)
  • NutraCea (Health/Nutrition)
  • Oscient Pharmaceuticals Corporation (Pharma)
  • Pacific Energy (Oil & Gas)
  • Penn Traffic Company (Supermarkets)
  • Philadelphia Newspapers, LLC (Newspapers)
  • Proliance International, Inc. (Manufacturing)
  • RathGibson, Inc. (Manufacturing)
  • Reader’s Digest, Inc. (Media)
  • Recycled Paper Greetings, Inc. (Greeting Cards)
  • R.H. Donnelley Corporation (Marketing)
  • Ritz Camera Centers, Inc. (Retail)
  • Samsonite Company Stores, LLC (Retail)
  • Security Bank Corporation (Banking)
  • Shane Company (Jewelry)
  • Silicon Graphics, Inc. (IT/Computing)
  • Silver State Bancorp (Banking)
  • Simmons Company (Bedding)
  • Six Flags, Inc. (Entertainment)
  • Smurfit-Stone Container Corporation (Paper Manufacturing)
  • Source Interlink Companies, Inc. (Marketing)
  • Southern Community Bancshares, Inc. (Banking)
  • Spectrum Brands (Consumer Products)
  • Star Tribune Companies (Newspapers)
  • Station Casinos, Inc. (Gambling)
  • Sun-Times Media Group, Inc. (Newspapers)
  • Tarragon Corporation (Real Estate)
  • Team Financial, Inc. (Banking)
  • Temecula Valley Bancorp (Banking)
  • Teton Energy Corporation (Oil & Gas)
  • Thornburg Mortgage, Inc. (Banking)
  • TLC Vision Corporation (Vision/Eye Care)
  • Trump Entertainment (Gambling)
  • UCBH Holdings (Banking)
  • U.S. Shipping Partners L.P. (Marine Transportation)
  • Velocity Express Corporation (Delivery)
  • Vineyard National Bancorp (Banking)
  • Visteon Corporation (Auto Supplies)
  • Walking Company Holdings, Inc. (Footwear)
  • Wall Homes, Inc. (Real Estate)
  • WL Homes, LLC (Real Estate)
  • Young Broadcasting, Inc. (Television)

In addition to “major” corporate bankruptcies (e.g., those firms with assets greater than $50M) tracked by Bankruptcydata, the U.S. government tracks all bankruptcy filings by type (e.g., Chapter 7, Chapter 11, Chapter 13). You can find detailed bankruptcy statistics at the U.S. Courts website. I will update the charts that I presented earlier in the year when the final 2009 numbers are released, which should be sometime in March (see Notable Bankruptcies of 2009: Q1).

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The Folly of the Publicly-Backed Private Company

Tuesday, December 15th, 2009

In the aftermath of Dubai World’s near default, The Economist magazine ran an interesting article that examines the so-called “Hybrid” organization (see The Rise of the Hybrid Company). According to the Economist:

The travails of Dubai Inc have left commentators struggling for the right phrase to describe Dubai World and its various siblings. They have come up with various formulations—state-controlled, state-supported, quasi-state, parastatal—without ever quite capturing what they are talking about. And Dubai is not the only place that is challenging the business vocabulary in this way.

Wherever you look you can see the proliferation of hybrid organisations that blur the line between the public and private sector. These are neither old-fashioned nationalised companies, designed to manage chunks of the economy, nor classic private-sector firms that sink or swim according to their own strength. Instead they are confusing entities that seem to flit between one world and another to suit their own purposes.

MY COMMENT: For examples from the U.S., see Fannie and Freddie, pre-nationalization. France, in the form of their national champions, also engages in the practice. So do many emerging economies: China (and their SOE’s), Russia, Malaysia, Vietnam, Brazil, etc.

What should we make of these hybrid organisations? Their supporters have long argued that they enjoy the best of both worlds: the security of the public sector and the derring-do of the private sector. They can use their global reach to provide their home countries with the pick of the world’s resources. They can borrow money at a favourable rate thanks to “implicit” government guarantees. They can use their political muscle to outperform their less well-connected rivals.

MY COMMENT: I have never been a fan of Publicly-Backed Private Companies (PBPC’s). Although they may be able to borrow at lower rates because they are “implicitly” backed by their home governments, they often grow too large, become too bureaucratic, and eventually crater under their own inefficiency (thereby costing home-country taxpayers dearly in the process). In addition, their objective function is not always clear. Are they meant to profit-maximize for shareholders/bondholders, or are they meant to serve a larger social purpose?

The most interesting part of the Dubai World saga (in contrast with Freddie and Fannie) is that the government of Dubai has seemingly repudiated Dubai World’s debt. So much for that “implicit” guarantee. If this becomes the norm rather than the exception, you can soon say goodbye to the last remaining benefit of Public-Private hybrid companies – the ability to borrow at favorable rates.

I have nothing, in principle, against government-backed companies. Although they are generally inefficient and often do not make sense, there are instances in which they might be appropriate — e.g., in instances of severe market failure. However, if there is severe market failure such that the government must become involved to prevent perverse societal outcomes, my intuition is that private companies operating in a system of more stringent governmental oversight and regulation perform better than a system comprised of public-private hybrids.

In this sense then, I agree with the conclusion of the Economist:

The clearer the line between the state and the private sector, the better it is for those on both sides.

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The Horn of Plenty

Friday, October 16th, 2009

Below are some links and teasers to articles that I found interesting:

Selling Foreign Goods in China (The Economist)

Every year, says Paul French, head of Access Asia, a research firm based in Shanghai, the same company buys the same report from him on the market for a particular product in China. That is because each year the company in question sends a new executive to China with instructions to break into the local market, who soon departs in despair—having failed to find an opening given the (brief) time and (insufficient) resources allotted.

The promise—and frequent disappointment—of doing business in China has been a common theme since at least the 19th century, when weavers in Manchester were said to dream of adding a few inches to every shirttail in China.

It is incredibly difficult to do business in developing markets (see So You Want to Do Business in a Developing Country), and China is no exception. The interesting thing to me about entry into developed markets is how managers systematically overestimate the benefits and underestimate the costs. And sadly, I am not aware of any evidence that suggests that we are becoming better at making these entry decisions over time.

———————————————–

Shazam, Maker of Phone App, Draws Investment (New York Times)

Cellphone applications can turn your phone into a mobile dictionary, help you find your way when you are lost on a hiking trail and identify mystery songs on the radio. But can they make significant money?

That question has been hounding the entrepreneurs and venture capitalists behind the start-up companies that create the software programs.

An interesting ditty about how making apps may actually be a commercially viable business. Be sure to look for their IPOs in an equity market near you…

———————————————–

Schumpeter Centenary (The Economist)

The centenary of Joseph Schumpeter’s birth has not brought forth an avalanche of academic tributes and retrospectives. There is no Schumpeter industry to compare with the one on Keynes. No pop biographies. No “Schumpeter and the Post-Schumpeterians”. Yet his academic reputation at the height of his powers was of the same order, and the impact of his analysis continues to be strongly felt.

An interesting look at the history of an influential economist. He certainly left his mark on the fields of innovation and entrepreneurship.

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Wall Street Smarts (New York Times, ht Neysa)

“IF you really want to know why the financial system nearly collapsed in the fall of 2008, I can tell you in one simple sentence.”

The statement came from a man sitting three or four stools away from me in a sparsely populated Midtown bar, where I was waiting for a friend.

“O.K.,” I said. “Let’s hear it.”

“The financial system nearly collapsed,” he said, “because smart guys had started working on Wall Street.”

Hysterical anecdote (with more than a grain of truth) about the near-collapse of the financial system (see Krugman’s post on same)

Happy weekend everyone!!

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Andy Xie on China’s Empty Apartments
What the Heck Is Going on in China?
Read more on Investing in China at Wikinvest

Interview in The Effective Executive

Tuesday, October 6th, 2009

The folks at the Effective Executive magazine asked to interview me last month for an upcoming issue of the magazine. I was asked to share my thoughts about the global economy, the financial crisis, and the growth of developing countries.

Below are excerpts from that interview.

[Y]our current research centers on the management and economics of international expansion. However, with the US financial crisis hitting the world economy hard, even the developed countries seem to be contemplating on going very slow on globalization. And in fact, there is a wide rhetoric about developed world (including most of the G-15 countries) embracing protectionist attitudes. Do you think such a move would indeed undo all the progress that has been made in the last decade?

The benefits of globalization are many. Not only does globalization allow countries to specialize in the productive activities in which they have an advantage, but it also provides an important conduit for the exchange of ideas across countries. As my research points out, the exchange of ideas across countries is critical to innovation and growth.

Therefore, I think it would not only be a mistake for countries to enact protectionist policies, but in the extreme, such policies could threaten the currently fragile economic recovery. Economies have become so intertwined that restricting the cross-border flow of goods and services (and capital) could lead to severe disruptions for developed and developing countries alike. For students of history, a refresher on the impact of the Smoot-Hawley Tariff Act (and protectionist policies adopted by other world economies) during the Great Depression might serve as a guide for the potential deleterious consequences of protectionism.

That said however, I think we are a far stretch from undoing all the progress brought about by globalization over the past decade. I would like to believe that most interested parties (politicians, lawyers, managers, etc.) recognize how important globalization is to economic growth and prosperity. But certainly, the emerging level of protectionist rhetoric bears some monitoring.

What are the best practices that you have, over your distinguished research and teaching career, noticed regarding market entry strategies and international expansion strategies? Any interesting observations that you have noticed either from American companies, European Companies or Asian companies?

One of the things that I have noticed both in my research, and in my interactions with managers, is that managers often exaggerate the benefits and underestimate the difficulty of foreign expansion. Managers are quite good at identifying the demand-side benefits (the ability to tap into additional demand in the foreign market) and supply-side benefits (decreasing input and labor costs) associated with expansion, but systematically underestimate the additional costs imposed by operating businesses across differing institutional environments. Cultural, political, and economic environments vary greatly across countries. These differences manifest as real costs to firms, as research demonstrates that foreign entrants take a longer to set up operations in foreign countries, are forced to pay higher wages than local domestic competitors, run afoul of the law more frequently, and are generally less likely to succeed than similar domestic businesses.

All of this makes it critical for companies to have a sound understanding of how the cultural, political, and economic differences that they face across countries are likely to affect their business. Firms should first see if their business (and business model) is appropriate to the environment, understanding that it might be better, in some cases, not to enter a country. However, once they’ve decided which countries are appropriate targets for entry, they should choose an entry mode appropriate to the environment.

In my experience, I have found that those firms that perform best in this respect pay special attention to the cultural, political, and economic risk factors present in the host country.

Did you find any interesting insights from Chinese companies’ market entry strategies and their international expansion strategies as opposed to let’s say either South Korean or Japanese companies? Do you think Chinese companies are taking the same route as South Korean or Japanese companies followed several years ago or are they chalking out their unique strategies?

This is an interesting question. When I think about China, Japan, and South Korea, certainly some similarities can be drawn. All three followed an export-led growth path to prosperity. However, once a certain level of prosperity had been achieved through trade, the three countries diverged with respect to international investment. South Korean firms have generally followed a more organic growth strategy – eschewing acquisitions of foreign targets in favor of building businesses from scratch. Japanese firms followed a similar strategy up to a point. While many of Japan’s industrial firms preferred organic growth, Japanese firms acquired a vast portfolio of real estate holdings in the late 1980’s and early 1990’s. Insofar as China is concerned, although we are in the early stages of China’s international expansion, it seems so far that Chinese firms are following a more growth-through-acquisition type of strategy, acquiring foreign firms in both basic materials and high-tech industries.

My sense is that this has a lot to do with the capabilities of the firms from these countries. That is, by the time Japanese and South Korean firms began to expand, they did so from a position of technological strength. For this reason, they were able to organically extend existing advantages to other countries. China, by contrast, is expanding from a relatively weak technological position not only vis-à-vis Japan and South Korea, but also vis-à-vis the rest of the developed world. In this sense then, Chinese firms are embarking on a strategy of acquisition in order to acquire the technological capabilities their firms currently lack.

There was more to the interview. The soft copy is currently in newsstands (mostly in India). I am assuming they will post the interview on-line in a few months time. I will update when a link to the on-line version becomes available.

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