Elon Musk, Tesla Motors’ Founder, Came to America Because He Believed That This Country Would Offer Opportunity

By Paolo von Schirach

Related story:

http://schirachreport.com/index.php/2013/08/07/electric-cars-are-not-selling-well-but-quality-will-improve-for-heavy-trucks-though-the-future-fuel-is-natural-gas-not-electricity/

August 12, 2013

WASHINGTON – I wrote recently that it is going to be a while before electric vehicle (EV) maker Tesla Motors and others like it will be able to radically transform the US automotive industry. (See link above to related story). Indeed, while Tesla’s model S is doing very well, it is on track to sell at most 21,000 vehicles this year. This is obviously very good for a company that sells very expensive, high performance EVs; but it is hardly transformative.

The value of new ideas

Still, having said that, it is really important to reflect on the incredible value of entrepreneurs like Elon Musk, Tesla’s founder. What needs to be stressed here is that Musk is a true, modern trail blazer. Musk ventured into practically virgin territory with what appeared to most analysts a really crazy idea: making a high performance, high price, sporty EV. Remember that many years ago when Musk got started people thought that EVs should be designed for young or middle aged tree-huggers, people focused on saving the planet. Whereas Musk focused on an entirely different market: quality conscious wealthy people interested in a brand new experience: a high performance (and consequently high price) EV.

Well, this is beginning to work. Of course, when it comes to market expansion, much will depend on Tesla’s ability to roll out equally interesting but much more affordable electric cars. We shall see.

Enterprise is our future

But this is not the point today. The point today is to celebrate Elon Musk and many others like him. These are the people willing to take huge chances in order to see if they can indeed push the envelope. It is obvious that when it comes to innovation many “Grand Ideas” are destined to fail. But some will not. And the record shows how, failures notwithstanding, many determined entrepreneurs will keep going at it. May be on their second or third try they will come up with something really important.

Focus on stagnant sectors

And we should be grateful for all these efforts. Indeed, it is mostly because of people like Musk that America can keep its position as technology leader. In a recent TV appearance Musk  indicated that innovators should really focus on sectors that have been stagnant, sectors that no longer deliver any special value. Real entrepreneurs should really look at ways in which they can introduce disruptive innovation that will cause a real paradigm shift. He talked for instance about the “Hyperloop”. This is really science fiction stuff. A totally new idea for an ultra fast inter city transportation system that is light years ahead of even the best super fast trains that still rely on tracks and locomotives, however advanced.

The “Hyperloop” is on the drawing boards, and most likely it will not happen any time soon. Still, this is just an example of Musk’s ability to think big and think boldly, even when some of his ideas may invite jokes.

Once again, many “Bold Ideas” that promise huge technological transformation will be failures. Sometimes costly failures. But it does not matter. Hopefully, those who tried and failed will not be discouraged. They will learn from their  lessons and try something else.

Policy makers have to keep America’s unique pro-business environment

That said, US policy makers must realize that they need to put in place every possible incentive for innovators. Indeed, for America to keep its coveted position as the world’s premiere “Innovation Hub”, it needs to attract people like Elon Musk who are willing to think big and take big chances. To this end, we need to do our best to reaffirm America’s credentials as the best place for true innovators. Do keep in mind that Tesla’s Elon Musk was born in South Africa. He came to America because he thought that the US would be an ideal home base. If people around the world stop believing this, if we lose this edge, the smart innovators will go somewhere else. 

 




Can China Fix Its Environmental Disaster?

By Paolo von Schirach

August 11, 2013

WASHINGTON – China is indeed “The World’s Worst Polluter“, as The Economist newsmagazine put it in its cover story (August 10th-16th, 2013). The implications are bone chilling for the Chinese people who are forced to breathe foul air and who cannot drink their water. But the rest of the world will also pay a huge price, given the enormous impact of China’s massive emissions on the planet. Indeed, the earth is getting close to a tipping point. Scientists indicate that we humans should do our best to keep carbon dioxide levels below 450 part per million. Well, we are now at 400 part per million. And most of the increase is due to China’s emissions. Put it differently, unless China reverses its course, even the combined efforts of the rest of the world may be not enough to avoid climate change Armageddon.  

Growth now, at any cost

Of course, we do know what happened. Over the last 30 years China pursued relentless industrialization, with total disregard as to how it was doing it. In other words: zero environmental protection standards. The goal was growth, fast growth, whatever the cost. Environmental protection measures costs money. This would slow us down. Therefore, no protection.

China’s apologists say that, in its noble pursuit of higher standards of living for hundreds of million of poor people, China was no different from Britain, the USA or Japan: “High growth now, stricter environmental standards later”. So, what’s the big deal about China’s behavior?

Lessons of experience were ignored

This exculpation is totally disingenuous. The truth is that when older manufacturing economies in the West were pursuing higher growth, the extent of the environmental damage their industries were causing was not well understood. But, beginning in the 1960s, policy makers in America, Europe and Japan began to understand it. And they started taking remedial action, while setting new standards that industries would have to abide by. 

Therefore, given  more than 40 years of Western environmental protection studies, enactment of new policies and consequent appreciation of the actual cost of cleaning polluted soil, air and water, China’s policy-makers cannot seriously claim that they had no idea that what they were doing in the 1980s and 1990s would cause serious, in fact horrible, damage.

Because of the well documented and analyzed Western experience, they knew about pollution, its consequences, the high cost of fixing it, and therefore the importance of preventing it. But they simply did not  care. And when it comes to the scale of the damage the Chinese caused, what they have done does not even remotely compare with what Europe or Japan did in the 1960s or 1970s, simply because of size. China is an enormous country of 1.3 billion. Just to cite one factor, most of its electricity comes from dirty, coal-fired plants. In order to provide electricity to all these people, not to mention hundreds of thousands of industrial plants that fueled the export-led economy, China became the largest user of high polluting coal in the world. As a result, beyond the Chinese people, now the entire world suffers the consequences of China’s emissions. 

Serious clean up efforts?

That said, what are China’s leaders going to do? Now that pollution has become a front burner public policy issue, the Government is trying to show that is really working on it. As the cited The Economist story explains, massive clean up investments have been announced, along with new regulations, strict enforcement standards, etc.

Obviously all this new activism is as much about politics as it is about caring for the environment. The Chinese people, especially the new and better educated middle class, understand that higher standards of living are of no value when the city dwellers are forced to breathe the most polluted air on earth. At some point, China’s scattered but vocal grass-roots environmental movements may morph into organized political resistance. And this is a huge worry for the Beijing leadership.     

Powerful resistance

But, while we have literally tens of million Chinese clamoring for clean air and clean water, while worrying about contaminated food, there are equally powerful interests that will resist meaningful change. The big manufacturers, the big utilities, all the super polluters have no intention to spend fabulous sums of money to clean up their mess. And, even assuming that will be forced to do this, the Communist Party leadership understands that making environmental clean up a top investment priority at least in the short and medium terms will result in slower growth. And this awareness clearly creates another political problem. The very legitimacy of China’s  leadership rests on its ability to deliver consistent high growth. If China’s economy slows down substantially, this is likely to create discontent and disillusionment.

Unpleasant political outcomes

So, there you have it. This is a classic “damned if you do, damned if you don’t” most unenviable situation.  Whichever way you look at it, China’s growth will be less potent, while its dreadfully damaged environment will improve only a little bit, and at a very high cost.

Frankly, my hunch is that the environmental damage already caused is so huge that it is probably irreversible. At best, provided sustained efforts and fabulous amounts of money, China may be able to stabilize  a very bad situation. But the price of any improvement will be lower economic growth. And that carries negative political consequences.

Indeed, as this massive clean up effort will unfold, millions of Chinese will have reasons to complain about persistent pollution and/or the impact of permanent damage, while at the same time complaining about slower economic growth and diminished opportunities.

I really have no idea how Beijing plans to manage all this.




Cost Competitive Solar Power? Coming Soon, But Not Here Yet

By Paolo von Schirach

August 9, 2013

WASHINGTON – The FT published a big spread on solar power, (A rising power, August 9, 2013), accompanied by this intriguing subtitle: “Plunging prices are finally making solar power competitive with conventional sources of energy…” Now, if it were really so, this would be the announcement of a major breakthrough, both technological and economic. This would mean that finally a key component of the renewable energy sector can actually make it on its own, without mandates, rebates or other subsidies, that is.

Mostly subsidized

Well, reading the long article was rather disappointing. True enough, the cost of solar panels has gone down, in fact it has plummeted in the last decade –by 80% in the last five years alone. This is truly remarkable. And certainly, in specific markets where there is a lot of sun and high electricity prices, solar power is becoming a viable alternative. But while this may be the case here and there, it is not true worldwide. Most of the installed solar power in place today is there only thanks to subsidies or mandates.

In fact, the very same FT story tells us that only 0.1% of total solar installations are unsubsidized. So what happened to the headline of solar power having finally become competitive? Well, we are moving in that direction; but we are not quite there, yet.

Solar technology will improve

Look, solar technology has improved and I have confidence that it will keep getting better. Costs have come down rapidly. And soon enough we shall get to a point in which people will place inexpensive solar panels  on their roofs in order to generate their own low-cost electricity, because it is the smart thing to do. I am looking forward to this new era.

But we are not quite there yet. For the moment, amidst overcapacity, bankruptcies, industry consolidation, Chinese dumping, murky regulations, political pressures and what not, renewable energy is still not capable of making it on its own.




The State Is Not A Competent Entrepreneur – Huge Distinction Between Awarding Grants And Running Companies

By Paolo von Schirach

August 5, 2013

WASHINGTON – “The state is the real engine of innovation“. Under this strange FT headline (August 5, 2013) we read a review by economics commentator Martin Wolf extolling the brilliance of a book by Sussex University economist Marianna Mazzucato titled “The Entrepreneurial State“. Wolf tells us that, while it might sound preposterous, it is in fact true that public –as opposed to private–  investments are at the foundation of major technological revolutions that have transformed our world. Think of jet engines, teflon, the internet, and so on.

The critical role of the state in funding R&D

Indeed, contrary to what free market capitalism dogma would like you to believe, the state does good things. In fact, the state performs a role that the private sector would routinely shun: investing in open-ended basic science projects that do not have a compelling economic rationale.

Fine. This is all true. We know that most of the electronics and IT discoveries were made through the aid of government grants. And, yes, there was and there still is an irreplaceable role for open-ended basic R&D that is not tied to a marketable product that will bring in a cash return for the investors.

Entrepreneurial State?

But, while Martin Wolf  does not say so, some readers may inadvertently confuse the quite separate roles of grant making and running an enterprise. I have not  read the book. However, the title “The Entrepreneurial State” conveys the notion of enterprises run by public bodies. I believe that it is important to draw a sharp distinction between “funding” and “managing”. Funding research is one thing. Running an enterprise quite another.

Washington is not running GM

In the US experience, the Federal Government played and still plays a critical role in funding R&D. But Washington, with very few and limited exceptions, has no record in running anything. Even in the most extraordinary case of the recent, (and truly gigantic), General Motors bail out, while providing the massive liquidity injection that saved GM, Washington  did  not send Department of Commerce and Transportation bureaucrats to run the company. It left management in the hands of professionals.

The Soviet Union should have been a real leader

More broadly, think of this. If the state were a natural entrepreneur, then the Soviet Union should have been the most successful economy. During Communism the state run everything, from car factories to barber shops. And surely the Soviet Government ability to direct scarce resources into mostly military R&D was in some measure quite successful. Russia did build impressive tanks, jet fighters and ICBMs.

But, overall, despite its technological successes the state proved to be a lousy entrepreneur and a horrible manager. In the end, the whole country collapsed under the weight of colossal inefficiencies.

And even in mixed Western economies, like France or Italy, on balance the state proved to be a mediocre to bad entrepreneur. Otherwise, exploiting the advantages of abundant state funding for R&D, all state-run conglomerates should be world-class sector leaders. 

Awarding Grants and Enterprise: not the same

I fully agree with Wolf that it is important to debunk the ideologically biased and false notion whereby the state is by definition  incompetent, and therefore it should stay out of any and all economic activities. We know that the state did and still does perform an invaluable function by funding research in areas that the private sector would not touch.

But there is a huge distinction between awarding grants and being an entrepreneur.




Americans Have Discovered Hummus – Growing Sales For The Sabra Brand

By Paolo von Schirach

August 4, 2013

WASHINGTON – For once there seems to be  a positive connection between healthier eating habits practiced by a growing number of Americans, increased sales of  chickpeas based hummus, and the opportunity for Virginia farmers  to start growing a new variety of chickpeas instead of tobacco. It all started with the successful marketing of Sabra products (a joint venture between Israel’s Sabra and Pepsico) in the US market.

Hummus for America

As a result, more and more Americans have discovered hummus, a delicious Middle Eastern dip made with chickpeas. Sabra dips, along with other varieties produced by different brands such as Tribe, are becoming quite popular in America. While hummus sales volumes are still way behind salsa and other dips and snack foods, Sabra products are doing better, year after year. 

 Chickpeas will replace tobacco in Virginia

Well, now Sabra has established a new production plant in Virginia. The problem is that US chickpeas are grown mostly in the North West, creating thus a supply chain uncertainty. Indeed, it may be a problem for East Coast based Sabra to depend entirely on the reliable delivery from the West Coast of  its most essential ingredient.  

For this reason, the firm, (that now runs its main processing plant in Chesterfield County, Virginia),  turned to crop specialists at the Virginia State University for help. There they connected with India born Dr. Harbans Bhardwaj. He started experimenting with different varieties of chickpeas that would grow well in Virginia’s more humid climate. Most importantly, he has to select a variety that will develop resistance against a nasty fungus that attacks chickpeas plants, potentially destroying entire crops.

If Dr. Bhardway will succeed, then many Virginia farmers will have a good opportunity to start planting chickpeas instead of tobacco, in order to supply the Sabra processing facility.

Health dietary habits spur good business

And here is the real story. Tobacco is bad for you, as it is the basic ingredient to make cigarettes. And cigarettes may kill you. Chickpeas instead are really good for you. This humble legume is packed with proteins, several phytonutrients and fiber. 

The fact that Americans like hummus made with chickpeas represents a positive dietary change for a population that is in general addicted to unhealthy stuff. So, here is the happy picture. Americans develop a healthy eating habit. Sabra makes money selling hummus, and Virginia farmers will also make good money growing chickpeas, (instead of nasty tobacco), this way ensuring a reliable supply for the Sabra processing plant.

 




Mediocre July Jobs Report Points To Lower Standards Of Living In The US

By Paolo von Schirach

August 3, 2013

WASHINGTON – The latest US jobs figures are alarming. Sure, we added 162,000 ne jobs in July. While these numbers are not wonderful, more people working is progress. On the surface this growth looks at least decent. The unemployment rate actually went down a bit, from 7.6% to 7.4%. Even though this is largely due to people who stopped looking for work and dropped out, this is the lowest jobless rate we have had since 2008.

Lousy jobs

So, why the unhappiness? Very simple: we are not creating great or at least decent jobs. We are creating mostly lousy, low paying jobs, mostly in retail and in the hospitality industry. On top of that, the percentage of part-time jobs for people who would really like to have full-time employment is growing, while the average worker has shorter work days.

Look, if you were jobless, getting something is surely better than having nothing. Still, these new jobs figures are part of a trend that indicates at best economic stagnation, (we know the economy grows at a mediocre 2% a year), and at worst downward mobility. And this is a problem.

Education, education

Here are the hard facts. In America, if you have a very good education and a super degree from a super university you have good chances to get into a vibrant sector, perhaps a into an industry leader, a GE or an IBM perfectly at ease in the globalized economy. If you are really smart, you will move up and do very well financially. You will have the money to give your kids the same excellent education that gave you a major advantage in life. The problem  is that there are very few of you. Very, very few who are doing and will be doing well.

Mundane jobs

Indeed, if you only have  a so-so degree, then you will be competing for mundane administrative jobs that now pay far less than they used to. Without top qualifications, your chances to move up are small. And if you only have a high school degree, then your chances of getting anything decent, let alone climbing the socio-economic ladder, are really poor. You get part-time jobs in bad times. In good times you get a low paying  job in retail, health care or equivalent. And that’s about it.

Good-bye to the American Dream?

If you do not even have a high school degree, then your chances of ending up in jail are much higher than you having any kind of career.  This is what the July jobs numbers indicate. Unless we shake up our truly mediocre public education system, while at the same time creating a more robust pro-growth policy environment, it is good-bye to the American Dream.

America used to be the land where everything was possible. In large part this was due to affordable, quality public education. Now the rich get their own high quality private education and the opportunities that it opens up . The uneducated get little, often times just the crumbs. 

Given these trends, the already horrendous income gap between the rich and a somewhat impoverished middle class is going to get wider; and we shall live in an overall poorer country marked by even deeper socio-economic divisions. This is not a good prospect for what used to be the most dynamic and optimistic society on earth.




The Bad “Lesson” of The EU Debt Crisis Is That There Will Always Be A Bailout

By Paolo von Schirach

July 31, 2013

WASHINGTON – The situation in Europe turned from really dramatic into just chronic. No more talk of a “Greece Exit”. There are no defaults on the horizon. Still, there has been no qualitative change. Therefore it would be highly deceptive to call this calmer state of affairs a real improvement. The reality is that Southern Europe cannot travel at the same speed of its better organized Northern counterparts relying on its own means. This means that Club Med will have to receive aid and/or special treatment for a long, long time. Who knows, may be in perpetuity.

Bailout does not affect the fundamentals

Mostly for political reasons, wealthier Northern Europe (read: Germany) decided that it was and still is in its own self-interest to bail out its Southern poor, and perennially disorganized, cousins. Better to pay now, then to face the headwinds and possible chaos that may result from a sovereign debt default.

Still, nobody believes at this juncture that the bailout money and/or the indirect fiscal support via ECB bond buying programs or easy credit to battered banks will cause a real qualitative transformation within the South. While economic conditions may improve somewhat, the fundamentals remain bad. For example, Sergio Marchionne, the CEO of FIAT, still the largest Italian industrial conglomerate, in a call with analysts indicated that “Italy continues to have an impossible environment for industry”.

Now, consider this rosy assessment on the economic fundamentals within the third largest Eurozone economy, coming as it does from a pretty seasoned practitioner. How is a profoundly uncompetitive country that continues to have impossible conditions for industry (i.e. growth) going to produce the extra wealth that will allow it to get out of its impossibly high national debt? The simple answer is: “Never”. Italy will probably limp along, supported by ECB bond buying and some other half measures. It may not drown, but it will never become an energetic, competitive economy. In other words, thanks to extra help it will not go under, even though the best it can hope for is survival.

Everybody gets a rescue package 

And here comes the real point. If you are a policy maker in Slovenia, Poland or Hungary, having noted that Germany decided that Greece and the others are indeed “too big to fail”, you will conclude that, if your country gets into serious trouble, it will be considered too big to fail,  just like all the others. Help will come. You will not be allowed to go under. This “message” unfortunately has a perverse effect, because it diminishes the pressure on other mediocre economies to get busy in order to jump-start serious growth.

Michigan allowed Detroit to go under, a lesson for all other troubled municipalities

In a different, but somehow related, context the State of Michigan allowed battered Detroit to go under. Michigan decided that its own domestic “Greece” was not “too big to fail”. It did not bail it out. It forced it into bankruptcy. The just initiated bankruptcy process in turn allowed the rest of America to see and evaluate the compounded effects of unfavorable economics and bad public administration, combined with over generous pensions to public employees.

As a result, local administrators in Chicago, Oakland and other challenged cities now have a strong extra incentive to get their own house in order. If Detroit is not “too big to fail”, chances are that their own municipalities, all of them headed Detroit’s way, may also go under. Therefore some at least may conclude that it is time to get busy and make changes, (renegotiating unsustainable pension benefits would be a good start), before it is too late.

Rescue packages are a disincentive to implement reforms

In contrast, policy-makers in Europe get essentially the opposite message. “Your countries are perennial economic under achievers. Your public accounts are headed the wrong way. But not to worry. Just as they did with Greece, the wealthy Northern partners will bail you out”. If this is indeed the “lesson” of the catastrophic debt crisis that began back in 2009, then you can bet that with the exception of a more solid North most of Europe will lack the incentive to do better and therefore will continue to underperform.




Global Warming Is Real – Still, Do Not Force The Adoption Of Imperfect Renewable Energy, Put More Money into R&D

WASHINGTON – If we knew for sure that man-made global warming were accelerating at a dramatic pace, threatening an imminent global catastrophe and the very survival of the world, then the most desperate counter measures would be appropriate. But we are not there. We have a major problem that is progressively getting worse; but not a catastrophe. The environmentalists of course believe the opposite, and therefore believe that in order to save the earth it is appropriate to impose punitive taxes against carbon based energy, while at the same time forcing the immediate adoption of still imperfect renewable energy technologies.

Green tech not quite mature

The fact is, as Biorn Lomborg, Director of the Copenhagen Consensus Center, argues in a compelling FT piece (Only cheaper “green” fuels will force changes in energy use, July 30, 2013), that: A) while global warming is real and is a serious problem, we do not have an impending catastrophe; B) the early adoption of green technologies as they exist today would not do much to reverse global warming; C) this “solution” amounts to imposing an enormous cost on consumers forced to use electricity that is much more expensive, because it is produced by as yet immature renewable energy technologies.

To be clear, Lomborg does not dismiss global warming as a fantasy, nor does he believe that the pursuit of renewable energy is wasteful.  He has no “pro-carbon” bias. His argument is against the early adoption of green technologies that, while promising, are still not cost-effective. His simple point is that when wind, solar or whatever else will be really cost competitive, they will replace carbon based energy sources, as a matter of course, without any subsidies, special taxes or other ad hoc policy mandates.

Better technologies always displace older ones

As he points out, we did not get the world to adopt personal computers by subsidizing rudimentary electronics and by taxing typewriters, so that people would be forced to buy ineffective, primitive personal computers. Indeed, we had to wait for a certain level of technological development to allow innovators to come up with viable PCs that people really wanted to buy. When they became available and proved to be reliable, then typewriters became immediately obsolete.

By the same token, as soon as renewable energy will become truly competitive, it will not take much for the market to abandon fossil fuels, no matter how plentiful. If state of the art solar panels can provide reliable cheaper electricity, then it is good-bye to coal, natural gas and whatever else we have been using. As history demonstrates, when technologies become obsolete, they are tossed away, without even a second thought.

Promote green tech by spending a lot more on R&D

In order to get faster to our coveted “green tech” future, Lomborg proposed to subsidize R&D, as opposed to forcing the early adoption of the still imperfect technologies we have today. Of course spending a lot more on R&D is no guarantee of success. But it will create more opportunities for innovators to come up with real qualitative changes that may indeed create a new energy technology environment.

If we can produce electricity through solar at a fraction of what it costs to do so by using natural gas, you can bet that, just as the new cost-effective solar panels are rolled out, the gas wells will be closed down in no time. But to force people to abandon gas today, and use still imperfect wind or solar is bad policy and bad economics. And it gets even worse if you need to convince reluctant taxpayers that they really have to swallow this –today–because we are cooking up the planet and soon enough there will be gigantic floods and other man-made catastrophes.

Global warming is a serious matter. But it is best addressed by producing something truly viable that will replace carbon based energy sources. Therefore let’s redouble our research efforts in “green tech”. Forcing the adoption of  half backed technologies ahead of time translates into additional costs, political resistance and negligible improvements. All in all, a bad idea.




Detroit’s Bankruptcy Is About Unaffordable Pension Obligations

By Paolo von Schirach

July 22, 2013

WASHINGTON – The convenient narrative about the Detroit bankruptcy is that the city is the main (and quite innocent) victim of the auto sector crisis. As GM and Chrysler went under, Detroit was sunk by the gigantic downdraft created by this epic collapse. Convenient story. Except that it is mostly untrue. In fact, the auto sector (however diminished) is back, while Detroit got worse. Of course Detroit was going to feel the negative impact of the auto sector crisis. But the real truth is that Detroit is the victim of the ill effects of racial and social conflicts coupled with decades of poor administration.

The 1967 Detroit riots

Detroit’s problems started after the gigantic 1967 riots, among the worst in US history. Sparked by police action that seemed unwarranted, Detroit’s Blacks went on a rampage that lasted five long days. There was so much violence that Governor George W. Romney (Mitt  Romney’s father) called the National Guard and President Johnson sent in the US Army. A curfew was ordered. At the end, there were 43 dead, 1189 injured, 7, 200 arrests and 2,000 building destroyed.

Seeing all that destruction, Whites felt unsafe and started leaving the city, this way causing a progressive shrinking of its tax base. How did the municipality cope? Poorly. Over many years, the city administration, caught between a shrinking revenue base and mounting pension obligations, quite foolishly decided not to renegotiate pensions, going instead for more tax hikes in order make ends meet.  

Making it worse

Well, not surprisingly, higher taxes going to pay for outstanding pension obligations, as opposed to funding new city projects, encouraged even more people to leave the city, therefore making the lack of revenue problem worse, year after year. Short of cash, Detroit did what other cities did and do: it issued bonds. Investors believed that those high interest bonds would be “safe”, because it seemed unthinkable to anybody that one of America’s largest cities, even though in bad shape, would be allowed to go belly up.

High pension costs, no money to pay for them

And this is Detroit’s story: Too many costly obligations towards large number of retirees, high taxes but not enough revenue, (after having lost most of the tax base due to tax hikes), and growing debt issued for the sole purpose of paying for pensions.

The only way to rebalance the fiscal outlook would have been a combination of renegotiated (meaning lower) pension benefits and measures aimed at encouraging economic growth and thus a larger and healthier revenue base. But the city did neither. The pension agreements stayed, while taxed remained too high to encourage new business. And so, year after year, things got a bit worse.

Bankruptcy

And now, here we are: bankruptcy. This is of course a tragedy for all those who trusted the word of city administrators. And this includes retirees who will see cuts in benefits and bond holders who will not see their money back.

That said, as painful as this is, it is welcome news that Detroit is not “too big to fail“. Detroit failed because it had unwisely created massive obligations, (due to the political deals between public services unions and public officials), that it could not meet. Its attempts to raise more revenue while city services were deteriorating made matters worse. It lost its tax base, while it created an army of (now) angry bondholders.

Other cities headed the same way

The cautionary tale in all this is that Detroit is only the tip of the iceberg. Many other large US municipalities, (like Chicago), are headed exactly in the same direction: too many unfunded liabilities to retirees. Trying to make up the difference through a combination of higher taxes and more borrowing is both suicidal and not enough, as Detroit’s story demonstrated. Tax payers will vote with their feet. They will simply move somewhere else in order ta avoid paying higher taxes.

Just like Greece

Ultimately, Detroit’s problems are not that different from Greece’s problems: too much spending on over generous social programs, without a growing economy that will generate the necessary revenue. While this bankruptcy is a mess, it is a good thing that Detroit is not “too big to fail”. Numbers should mean something, and when something is unsustainable it is wise to put an end to it. In the case of Greece, for the moment numbers do not count. Greece’s future is about political calculations on the part of its EU partners willing to keep the bail out going, despite all. Indeed, notwithstanding its stubborn inability to embrace serious reforms, Greece’s EU partners decided to support this virtually bankrupt country. This would be the equivalent of Detroit, whatever its financial outlook, seeking and getting more credit. 

US Federal Government has the same problem

Long term the US Federal Government faces a similar scenario. Even though the short term fiscal picture, thanks to the impact of the dreaded “sequester” has improved somewhat, long term America is faced with growing debt. And why? Yes, you guessed it, it is mostly about social spending obligations (mostly health care to seniors) completely out of line with Federal revenue. For the time being, the world is eager to lend money to Uncle Sam, trusting America’s creditworthiness. But what if global credit markets stop believing that America will pay back? As a minimum they will demand higher interest rates, this way making the fiscal outlook a lot worse.

Of course, Detroit is much, much smaller than the entire United States. And yet, until recently all creditors were comforted by the notion that such a large city would never go into bankruptcy.




Egypt’s Tragedy Is In The Mix Of Impossible Politics And Total Economic Collapse

By Paolo von Schirach

July 16, 2013

WASHINGTON – The unfolding Egyptian drama sadly tells us that the Arab Spring was no Spring at all. It was a convulsion affecting populations made miserable by amazingly obtuse tyrants who failed in all respects. They believed that autocracy was the best and only political option for the Arabs, while they did not promote any meaningful economic modernization, allowing their countries to be left way behind by a rapidly advancing global economy. 

New politics?

In Egypt’s case, getting rid of shop worn Hosni Mubarak, as difficult as it seemed at the time, was in fact the easy part. After that, the Egyptians would have needed pragmatic, middle of the road and mostly secular reformers to lead the country into the mostly unknown territory of democracy and rule of law, while at the same time breaking a new path leading to economic modernization, something that should have included the emancipation of women.

Morsi: arrogant and incompetent 

Well, Egypt got none of the above. The majority of the population (mistakenly) believed that the Muslim Brotherhood could provide stability. Well, they were profoundly wrong. President Morsi proved to be arrogant, stupid and incompetent to the very end. A more pragmatic leader could have salvaged something by compromising with the opposition once the military issued its ultimatum. If Morsi had been more conciliatory, today he would still be President, albeit with far less power and latitude. Whereas he made thing worse by doggedly refusing to acknowledge that more than half the country was vehemently against him and his semi-autocratic aspirations.

Political rebellion in the midst of economic chaos

And now? Now it is a lot worse. The military is in control. Their claim that they only want to steer Egypt towards a more inclusive democracy may very well be genuine. But the country is in a terrible political mess, while teetering towards bankruptcy. And here a dreadful situation becomes truly awful. It is pretty clear that the anti-Morsi crowds were protesting against both the politics of the Muslim Brotherhood and the deteriorating economy. Now there is a totally unrealistic expectation that a new government will bring economic relief. If this expectation is not met, expect more turmoil. So, here is the mix at the root of this new chapter in Egypt’s crisis: political rebellion in large part driven by genuine hunger. 

Turning a page on the political front will be an incredible challenge. Morsi does have genuine followers who believe that he should be reinstated and who are therefore refusing to participate in any new political arrangement sponsored by the military who ousted him. But if finding a new political equilibrium is a daunting task, recreating economic stability in Egypt is almost impossible, at least for several years. 

Egypt’s economic collapse

If you want a detailed picture of the depth of systemic economic management, please read the excellent analysis provided in a WSJ op-ed piece by David P. Goldman, President of Macrostrategy LLC, (The Economic Blunders Behind the Arab Revolutions, July 13-14, 2013).

Here is an excerpt:

“Egyptians are ill-prepared for the world economy. Forty-five percent are illiterate. Nearly all married Egyptian women suffer genital mutilation. One-third of marriages are between cousins, a hallmark of tribal society. Only half of the 51 million Egyptians between the ages of 15 and 64 are counted in the government’ measure of the labor force. If Egypt counted its people the way the U.S. does, its unemployment rate would be well over 40% instead of the official 13% rate. Nearly one-third of college-age Egyptians register for university but only half graduate, and few who do are qualified for employment in the 21st century.”

Got that? 40% unemployment. And then there is the daily bleeding of state coffers due to the established practice of government subsidies for staple food and more.

Saudi Arabia will give cash

For the moment it looks as if this exhausted country of almost 90 million will get some emergency cash from Saudi Arabia, Kuwait and the UAE. But this welcome relief is not a substitute for new economic policies.

And so, here is the picture. The Egyptians will have to find the wisdom to elect a coalition government that will be able to navigate the treacherous waters of a society deeply divided between fundamentalists and urban secularists, while at the same path charting a course leading to meaningful economic improvements.

While we should wish the Egyptians best of luck, realistically we should acknowledge that this is te closest thing to  “Mission Impossible”.

America has become irrelevant

One last note. In case you haven’t noticed, America has become essentially irrelevant in this whole process. Until yesterday Cairo’s strongest ally, now Washington is routinely vilified by everybody in Egypt, liberals and conservatives.

Sure enough, it would be good for America to retain and in fact strengthen its historic ties with the Egyptian military. Therefore, by all means, do not suspend the US assistance package. But let us also recognize that the $ 1.3 billion we give to the Egyptian armed forces is not that much, considering what the country needs just to stay afloat.

The Obama administration wanted to create a new era with the Muslim World. (Remember the Cairo Speech?) But it was caught completely off guard by the Arab Spring. As the profound upheaval was taking place, a mix of timidity and lack of money proved that Washington today is at best a spectator in a Region in which it used to exert an enormous amount of influence.