The casino economy
October 17, 2007
The New York Times technology blog features some interesting comments from Carlota Perez, author of the superb book Technological Revolutions and Financial Capital. Perez places the current technology "bubble" into a broader context. She distinguishes between two current phenomena: stock-market speculation, which is "an echo of the previous tech bubble," and the acquisitions of smaller tech companies by larger ones at very high valuations:
Historically, what has happened after the collapse of the major technology bubbles is that the new industries establish stable structures (tending to oligopoly) by absorbing the weaker players and defining the competitive boundaries through mergers, acquisitions and divestitures. The current battles for industrial leadership and restructuring in each sector are being fought like the auctions at Sotheby’s. Nobody knows how much each company is really worth (or going to be worth in the future), but if that little company defines who the winner will be in this potential trillion dollar industry, then “we must get it at whatever price.” With no flood of money, this would have happened at bargain prices rather than inflated ones.
We are seeing, in other words, an unusual twist to the normal pattern of bubble-collapse-consolidation that Perez documents in her book. The post-bubble consolidation phase, which would normally play out against a backdrop of depressed prices, is this time, thanks to a new burst of financial speculation, playing out against a backdrop of inflated prices. What's mysterious is "why the NASDAQ bubble didn’t play the usual role of these major technology bubbles, of clearing the decks and going back to fundamentals."
She ends on a dark note. Normally, after a bubble, we shift from wild competition and financial speculation to a more stable economic situation, dominated by a handful of larger companies that operate in an "intelligently regulated" market. It's at this point that wealth spreads out to the population as a whole rather than being concentrated in the hands of the lucky, aggressive, or powerful few:
That is when each revolution produces its “Golden Age.” During the roaring twenties and the brilliant nineties the rich got richer and the poor poorer. The second half of diffusion of each technological revolution spreads its benefits much more widely. But, if it continues to be finance and not production that calls the shots, that golden age may never arrive and the current “gilded age” may continue indefinitely.
That's not a happy thought.
It's at this point that wealth spreads out to the population as a whole rather than being concentrated in the hands of the lucky, aggressive, or powerful few:
I would suggest that the above is not a law of nature, but one path among many, dependent on the existing political system. The 20's and Great Depression begat the New Deal; the 90's created ... what? The Great Globalization/Outsourcing/Offshoring? But there doesn't seem to be a New Deal analog (quite a few unhappy people, yes, but virtually completely politically disempowered).
Posted by: Seth Finkelstein at October 17, 2007 06:36 PM
Nick, it seems I'm doomed to following you around today! Good post, but Perez has got this one wrong from at least two standpoints.
First, she views that bubble pricing is okay when it focuses investment towards valuable innovation. If you read her original quote in the Times, she thinks that in the 90's, we tested, "every imaginable dot.com idea." Clearly she feels there has been no innovation in the years that followed.
But I know from reading your blog that you have to disagree with her. There's been a huge amount of innovation on many fronts since that time that this bubble has helped to fund.
The second quarrel I have with Perez is that while she talks about relative pricing (how many cups of Starbucks will buy a laptop), she misses a huge relative pricing concept that every homeowner understands. When you buy or sell a house, the market often doesn't matter much. If it's up, you can pay more for the new house because you sell your old house for less. In a down market, you sell your old house for less, but you can buy a new house more cheaply. The key thing there is not to move to a new market!
So it is with these acquisitions. Companies like Microsoft, Yahoo, and Google have wonderfully inflated currencies. They can afford to spend a lot more on a key acquisition. Look at it from several standpoints:
Yahoo has a higher PE than Microsoft, about 2x. So when they bought Zimbra, if they can make it profitable, each dollar is worth 2x more to Yahoo than Microsoft. Google is even more inflated on that scale.
Microsoft can pay for a $500M investment in Facebook with a little over a week of cash flow. Ford Motor Company, in it's current state, would take almost 2 years to lay off a $500M bet.
Quite aside from a "gilded age", we have an age where the folks who live in markets that aren't so inflated, namely ordinary investors, aren't betting at these inflated prices on IPO's. Instead, it's just the pros paying with "funny money." That's much healthier in my book.
More detail in my blog:
Posted by: BobWarfield at October 17, 2007 06:40 PM
Seth, Unless I'm misreading you, you seem to be saying the same thing that Perez is: that the current situation does not seem to be following the past pattern. Nick
I'm just saying maybe it's more "path" than "pattern". That is, is there a standard sequence where this seems to be an exception, as opposed to a bunch of datapoints depending on a few other variables (e.g strength of unions, anti-corporate press, etc.)?
Posted by: Seth Finkelstein at October 17, 2007 07:20 PM
Sorry to say, but I don't seem to grasp the whole idea. Are you (she) linking speculation as explained through liquidity by Keynes in the General theory with the increased modularity, and therefore liquidity of the apps, and the company developing them?
I'm not sure there was a “bubble” per se: most of the money spend was found back after, although not in traded companies, but a handful of unique, clear leaders (Amazon, eBay, Google; Facebook?); sounds like the extreme version of venture, and the banks played without understanding that the law of large numbers wouldn't apply in a such a Sierra Madre context — and lost.
The fact that the current economy is not following the former pattern is called “New Economy”: it wasn't trendy for long enough, or by people old enough for Nick or Seth to support it, neither is the buzzword recent enough for anyone else to like it too. It appears rather obvious afterwards though: scarcity and distance are not relevant for a major part of the economic activity.
PE? Price earning ratio?
Posted by: Bertil at October 18, 2007 05:10 AM
I count on the market, in the long run (which may be years), will get things right.
Currently the market is irrational in many aspects. Housing has just started to correct itself, tech sector is still wacky, but the market will eventually be rational in these areas. How long it will take depends on the people and how involved the government wants to be in "correcting" things (actually making them worse).
Hah! It works this way:
Booms happen when there isn't enough innovation. Innovation becomes scarce, and thus very dearly priced. At the margins of trading in dearly priced commodities are lots of opportunities for profit taking -- thus a boom dominated by the financial industry.
Innovation is "scarce" when it is producing nothing but incremental improvements in productivity in mature markets. Unpacking that:
"Incremental improvements" to productivity trade small, short-time-horizon investments for slightly larger returns in profits on the basis of reducing the costs of inputs and processing. Buy a new machine (or outsource), lay off 10 workers, and come out ahead.
"Mature markets" means markets where multiple competitors are competing mostly on price. In this kind of market, productivity improvements are the only way to increase profits. (If instead you invent a new kind of product, you're no longer competing in a mature market.)
If there isn't enough innovation, all firms are trapped in mature or rapidly maturing markets. Worse, they are on a treadmill with their competitors: each has to keep making incremental productivity improvements at no less than the rate that others do, and at least some of them have to make such improvements to maintain barriers to entry.
So, firms get slimmer and more profitable (or go away) -- input consumption (especially labor) is trimmed -- all because of insufficient innovation: boom market. It's a boom because the profit takers are getting more and more cash (profits) and so the things they shop for with that money become inflated. And booms are always against a back-drop of under-employment (trimmed "inputs") -- labor *doesn't* inflate (in real dollars) during a boom because its demand reduction is a key trick for productivity improvement (although some labor can win the stock option lottery).
You can see all of this very clearly in the railroad boom in the U.S.: Trains were a big-step innovation, sure. But the first round of investment was a mess: lots of over-priced spending to create an over-supply and overly fractured market of the infrastructure for trains. Why did all of that money recklessly pursue what all of the other money was chasing? Because of a lack of innovation: While people could have been getting an early start investing in railroad-enabled businesses like catalog shopping, they were instead, for lack of imagination, all trying to own the most right-of-ways for tracks, or the biggest rail plant, or the best engine manufacturing plant or whatever.
I'm somewhat forgiving of the eccentrities of the financial markets and the distortions they create. I see it as "garbage in, garbage out." If engineers and innovators can't get through to investors with big-step innovations, the financiers become the only game in town and everyone is locked in to that game, like it or not. You inevitably wind up with inflation-unto-demand-collapse.
The cure for a boom is a blossoming field of innovation -- breakthroughs where there are so many possible product opportunities that there is little incentive at all to crowd around just a few.
It's up to the alpha-geeks. We need smarter investment in practical research.
Posted by: Tom Lord at October 18, 2007 01:14 PM
Just a humble guess how prices in the 2.0 world are made.
See my small cartoon.
For a good perspective look at this article. http://members.forbes.com/asap/2001/0910/044.html Check the date (i.e. what happened the next day). This has it nailed, why this is a real boom. Another key is a few more hundred million people joining the consumer economy in "the countries formerly known as emerging".
Posted by: bernard lunn at October 19, 2007 08:38 PM
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