China's Innovative Policies

I recently came across a Jul 28, 2010 report by the US Chamber of Commerce, China’s Drive for 'Indigenous Innovation' - A Web of Industrial Policies.  While conceptually it might be easy to understand the idea that unconnected foreign businesses are at a disadvantage in China, this report spells out many of the more specific ways that outside companies are put at a disadvantage when doing business in China and how this ties into China's drive for indigenous innovation.  

In the report, it is pointed out that it is clear to everyone that China's see a large part of its growth path through acquiring foreign technology. They show that China's  “The National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020) defines indigenous innovation as “enhancing original innovation through co-innovation and re-innovation based on the assimilation of imported technologies.”

A lot of these regulations target multinationals who are trying to compete with domestic brands.  The Chinese Compulsory Certification system often delays foreign companies from getting to market before domestic Chinese competitors have had a chance.  Companies that make products with encryption are reluctant to get the certification at all, as the process requires that they trust the Chinese government with proprietary trade secrets.  China also enacted an "Anti-Monopoly Law" in 2008 which some officials are trying to use to justify compulsory technology transfers from foreign companies dominating specific markets to domestic Chinese companies.  The general implementation of IP law is also said to be rather biased towards local companies, either because those enforcing the law have ties to local companies or because the punishment for stolen IP is still rather low unless it happens to be a ruling in favor of a domestic company against a foreign company.

One of the main ways they get this technology is through foreign companies looking for access to the Chinese market.  In return for partnering with a local Chinese company, the foreign company is given access to the large Chinese market with less regulatory hassle and lower tax rates.  

"The indigenous innovation drive is forcing foreign technology companies to anguish over balancing today’s profits with tomorrow’s survival. With its extraordinary infrastructure plans and a continental-sized consumer market that has just begun to really develop, China is a market no multinational can ignore. But the price of admission is getting more expensive by the day as China opens its policy toolbox to ensure that foreign technology allowed into China is accessible for “co-innovation” and “re-innovation” by Chinese companies."
- China's Drive for 'Indigenous Innovation, Page 31

The report then goes on to detail many different industries, from trains to green energy to airplanes where the foreign multinational enters joint partnerships to gain access to China's market and eventually gets supplanted by their former Chinese domestic partners.

The anecdotal evidence in favor of China's rise to technological prominence is just that - anecdotal.  Many of these anecdotes arise from specific mega projects targeted and funded by the Chinese government, so impressive progress is likely to be contained to major areas of interest. Still, there is no denying that domestic Chinese companies are able to copy ideas efficiently from their western competitors/partners.  When companies decide to do business in China, they better be thinking past the next quarterly earnings time period even if the stock market isn't. For some technology companies, it can make sense to move production to China if the other option is going out of business, but companies that have a sustainable business plan should think twice about who they will be competing with in 5 years time.

How this competition impacts the future is open to interpretation. If the low hanging fruit of innovation* has been picked, then it makes sense for the west to become much more protective of giving away any existing technological superiority. If China became as rich as the west in a world without significant innovation occurring, then while China's citizens would be much better off there would also be a major rise in the cost of resources that would lower the standard of living for most people in the west. However, if innovation is occurring on a normal historical course in these and other areas then while companies should protect their trade secrets China's attempts to catch up should not be a problem for anyone but their direct competitors.

Hat Tip: Mish's Global Economic Trend Analysis

*Much more on this later!

Unintentional Irony in the State of the Union

While pointing out what a great country America is and implicitly comparing us to our competitors such as China, Obama made the following remark in his most recent State of the Union Address:

China is building faster trains and newer airports. Meanwhile, when our own engineers graded our nation's infrastructure, they gave us a "D."
We have to do better. America is the nation that built the transcontinental railroad, brought electricity to rural communities, constructed the Interstate Highway System.

The irony comes in using the transcontinental railroad as way to highlight how capable Americans are.  The toughest part of building the transcontinental railroad was laying track across the Sierra Nevada's.  The American workers were unreliable, so Chinese workers were brought in to do the job.

These workers quickly earned a reputation as tireless and extraordinarily reliable workers--"quiet, peaceable, patient, industrious, and economical." Within two years, 12,000 of the Central Pacific railroad's 13,500 employees were Chinese immigrants.

Almost 150 years ago Chinese workers were brought in to do a job that Americans weren't willing or able to do*. Obama's speech writers were trying to make a more general point about the value of infrastructure in general while touching on the feel good notion that Americans can accomplish anything. It is amusing to contrast this message with the idea that 145 years ago the Chinese work ethic, technological expertise and cheap labor were what drove this particular American success.

*This isn't the only way history seems to be rhyming if not repeating. In response to the Chinese competition there was rampant protectionism of white labor with the passage of the Chinese Exclusion Act to prevent Chinese immigration along with many local laws attempting to prevent Chinese labor competition from impacting white Americans.  These discriminatory laws ultimately led to a Chinese boycott of American goods in 1905-1906.
Edit: There is more. Chinese laborers in the US were also known as better savers back then, as many of them were able to refrain from spending a large portion of their paycheck on alcohol.

Trying to set a dangerous precedent

Lawyers and NGOs smell blood. They are trying to use the court system to get damages for climate related disasters from companies responsible for emitting carbon dioxide.  So far, no damages have been paid out by the courts.  That's a good thing, because it seems like lawyers and NGOs want to be able to sue any company emitting greenhouse gasses for any negative weather event.  There would a giant swooshing sound as more resources in the economy flowed out of productive enterprises into the hands of lawyers.

Fixing Broken Government - A Reaction

I just saw a speech given by Philip J. Howard on the topic of Fixing Broken Government.  The LongNow introduces Philip J. Howard as "a conservative who inspires standing ovations from liberal audiences."  They fail to mention that he does this primarily by making fun of Sarah Palin and the Tea Party.

In a very convincing speech, he highlighted how there are many problems that originate from overly complicated rules that are more effective at creating paperwork than in getting the job done. A lot of more of these rules exist today because old laws stay on the books while new ones are added on by a congress who doesn't feel like its job is to fix older laws and regulations.

While he has been involved in attempts to fix regulation on a micro level, Philip has three main reforms that he believes would help solve many of these issues on a systematic level.

1. Laws need to sunset automatically.  This would stop laws from piling up and make the special interests actively fight to protect their favored laws rather than let them target any lawmaker who decides to do anything about their laws.

2. Government officials need to be able to use more discretion in the performance of their jobs.  This would allow for simpler laws and prevent bureaucratic disasters. It will also allow the government to hire more competent employees, the kind who can get the job done without being bogged down by paperwork or always having to follow a poorly planned checklist of procedures.  There also needs to be someone who can green-light a project once a reasonable amount of background research has been done. The interstate highway system was built in 15 years, but today it takes 10 years of feasibility studies and environment assessment before they are even thinking of building windmill off the coast of Massachusetts. 

3. Government officials need to be more accountable for their performance.  This basically means that they need to be able to be fired.  This makes it so the government officials who aren't handling the responsibility they are given can be gotten rid of.

Unfortunately, I became even more pessimistic about fixing broken government after hearing this part of the speech.  The problems that were outlined were much more salient than the solutions that were offered.  When more and more laws sunset automatically, special interests will become more adept at getting them renewed. If a reform that automatically sunsets old laws is ever passed it will hopefully be in conjunction with a congress who is willing to do something about the problem of old laws cluttering the books at the same time. However, once congress grows complacent about this issue and the special interests remain vigilant, it is hard to see how even a large procedural change will do much good in the long term. 

The next two steps go hand in hand. Workers who cannot be fired cannot be given very much leeway in their jobs. In China, local bureaucrats who have discretion with their jobs but are not accountable to anyone but party elders have made millions of dollars selling the land of villagers to large corporations. 

But even if government workers can be fired (by their superiors for lower ranked workers or the higher ranked ones by voters), there are many other problems with giving government workers too much discretion.  In many cases, the government is deciding on whether to award permits that could be worth millions of dollars to businesses who can easily afford to buy the decision maker.  The corruption can happen either directly or indirectly. In Japan, the indirect corruption is subtle: regulators get appointed to the boards of private corporations after they retire. Giving government workers more leeway and accountability might still be better than the status quo, but it will open up a whole new can of worms.

While expanding the three solutions to all of government might take some work, the school system is one area where these types of changes could create an immediate positive impact. One scary statistic is that it cost the Los Angeles School Distract $3.5 million dollars when it tried to fire 7 teachers over the last 10 years. This means that teachers are not by any means accountable once they get their tenure. Another statistic comes from a study which finds that the US would be on top of international math and science educational rankings if we replaced the bottom 5 to 8% of teachers with average teachers.  If the reforms that Philip is pushing were applied only in schools then there could be real progress.

While the chance of a larger fix to the problem of bad governance happening anytime soon doesn't look too likely, it is good to know that there are people identifying and coming up with potential solutions to these types of problems.

Krugman to his commenters

Krugman is a little upset with some of his commenter's insults.

Get your insults right. There is, I believe, a fair bit of evidence against the hypothesis that I’m stupid. What you mean to say is that I’m evil.

I think what his commenters are trying to say is that he often makes stupid arguments because he is evil (which in internet discourse means they have different ideologies) or because he is too obsessed with his clever models that he underestimates the real world consequences of some of his arguments.

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Time Preferences in Different Countries

 

Garret Jones, via twitter, links to a very interesting paper by the Swiss Finance Institutue. Mei Wang, Marc Oliver Rieger and Thorseten Hens did a study titled How Time Preferences Differ: Evidence from 45 Countries.  In this study, they found that not all countries are equal. Richer countries were more likely to contain more patient citizens*.  Countries with more punctuality and a higher working speed and more innovation also had more patient people.

The chart below measured what percent of the respondents decided to wait for $3800 next month rather than taking $3400 this month. If you look at the top of the chart where more people would wait for a monthly return of over 11%, you will generally find countries with less severe financial crises. At the bottom of the chart are countries who are either undeveloped or particuarly at risk of financial crisis.  While it is possible that the current situation of countries like Greece and Spain make people very short term oriented, the different perspectives that these cultures have on time has been noted previous to the crisis so it is more likely that the shorter term perspective of their population is what helped get them into their current financial mess in the first place.

The US comes in slightly less patient than Ireland and more patient than Turkey.  It is distinctly less patient than the German-Nordic countries.  The paper notes that a larger sample done in a previous survey gave the US a score of only 40%, which is below even Greece in this sample.  If the US is anything like Greece, this implies that it that people won't want to suffer through fiscal tightening now to make the future better, so spending without taxing is going to continue until it is stopped by a market crisis. 

*It should be noted that their data was only on university students rather than the population as a whole

Terrorist worries in the US

The FAA is worried about getting data on the owners of planes due to what terrorists might potentially plan with these planes. The TSA is spending 2.4 billion dollars to see people naked or grope those who opt out in the name of stopping terrorists.

This is all ridiculous, of course. If there were a significant amount of dedicated terrorists in this country, we would know. Just ask Israel. Think about what 10 or 20 coordinated people can do.  They don't have to hit the targets they hit before. Two people with a gun and modified car shut down an entire metropolitan area.  Multiple this by 5 or 10 and you have a very large population living in even more of a police state.  The lives lost will be nothing in comparison to the damage done to society during the response to the crisis.  The airport security isn't making anyone safer either, and if there were suicide bombers in the US then they could buy a ticket (or print out a fake ticket) and walk into any packed airline security line and be sure that they are in a crown of people when they go off.  Thankfully, none of these or any other number of simple ideas for terrorists to implement has occurred. When something did happen outside the US in Sweden, the terrorist was apparently so incompetent that they barely manage to kill more than a few people other than themselves in a completely unsuspecting population.

The lack of US terrorist events means that the dedicated terrorists in the US are either planning something really big, have been effectively shutdown by intelligence agents more times than we know or they are in no way organized or motivated enough to give their lives.  Sadly, terrorists don't even have to be organized or even successful to make an impact.  As we've seen, even one or two failed attacks causes billions of dollars of damages by causing money to be sunk into security theater spending that wastes people's time and offends their dignity.  

When we hear that something is being done mainly for our safety, we need to keep Benjamin Franklin's words in mind.

Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.

I would extend this thought to specifically cover those people trying to take away essential liberties. That is the bright side of wikileaks. It may have hurt the US by revealing key people who were helping them, but reminding government workers that their reasons behind their actions might see the light of day sooner than they think will hopefully remove a safety blanket and make them think twice about what they are doing.

The tax cut compromise as a sign of broken politics

So in order to avert a middle class tax hike, Obama agreed to revert tax cuts for everyone and a cut to the payroll tax. In order to give Obama and his party what they wanted, Republicans agreed to extend unemployment benefits.  Everyone wins, just as long as the government can spend money that it doesn't have.

When people worry about inflation or deflation, they are wrong as long as politics are functional. However, events like the recent compromise demonstrate that politics are not really functional.  If more compromises of this nature are expected, then that means that it might take a crisis to fix the deficit.  If the crisis is about dollar confidence, then the crisis will be inflationary. If the government is able to react with austerity to head off the crisis then the crisis will be deflationary.

It is hard to know which way the economy will break, but with each compromise of this nature the probability of a long term goldilocks goes down.

Shorting the VIX

Eric Falkenstein has a post up highlighting another area where there seems to be money on the sidewalk: Shorting the Vix.  He notes that the VXX has underperformed a hypothetical outright short VIX position by a large margin due to the contango in the curve.   

It seems like the people selling lottery tickets are making money, but it is unfortunate that his sample analysis period doesn't go back to the crisis of late 2008.  Any trading strategy that was short volatility over a 10 year period and didn't blow up completely in that time period would probably have made a lot of money overall, but the "not blowing up completely" part is not trivial without utilizing future information.

He links a post from VIX and More where the author of that blog highlights new VIX Exchange Traded Notes (ETNs) and reveals that they are short VXX, one of the front month VIX ETNs.  

One conclusion that can be drawn from this is that if someone wanted to go long volatility to protect their portfolio, front month VIX at this level of contango is one of the most expensive and therefore worst ways to do so.  Now, there are probably good traders who are long the VIX at the short end, but these would be people who are either trading at small enough holding periods that the annual drift doesn't impact them or traders who have found something even better to be short and need to be long the VIX to protect their portfolio.

QE, the deficit and the TSA: Links

1. Scott Sumner Has an open letter to conservatives about monetary policy.  A lot of it is pretty reasonable, but he makes the mistake of thinking that conservatives care about nominal GDP when in reality they care more about real GDP.

2. My solution to the deficit, according to choices offered by the NYT.  It's nice how they let you cap spending on medicare at GDP rates without explaining how this is going to happen.  But it does show how the budget deficit can be balanced without tax increases. I chose to remove the employer tax break on healthcare (which for some reason the NYT doesn't treat as a tax increase), since the connection between employment and healthcare has been one of the reasons the healthcare system costs have gotten out of control.

3. The quantitative easing debate, in video format. Against QEII. For QEII.

4. Orlando is trying to opt out of the TSA, but the TSA points out that their regulation for private screeners requires them to be just as invasive. Ron Paul proposed a law that would remove the immunity of TSA screeners.  Hopefully this issue will get fixed soon, but preventing is people who think the only thing worse than everyone getting seen naked or groped is a little bit of racial profiling.