Friday, August 29, 2008

Lowering the Cost Structure of the U.S. Economy

Despite the Nobel prizes and the thousands of econometric academic papers, economics remains a pseudo-science anxiously grasping for the lustrous numerical certitude of physics and the hard sciences.

Science is based on supporting a theory of how something works with real-world data drawn from experimentation which can be replicated by others. The theory can then be used to predict real-world interactions (how much electrical energy is required to split water into its constituent hydrogen and oxygen, for instance.)

Economics predicts nothing of the future with any certitude or precision. It is a cliche that economists never correctly predict recession, or indeed any other sea change in the economy.
While it may seem harsh or unfair to categorize economics as a pseudo-science, science is clear-cut: can your results be replicated by others? can your results be used to accurately predict real-world interactions? If your results fail these two tests, then you're not doing science.

Economics is a "social science," which is less an expression of science and more an insecurity seeking confirmation ("we have numbers! We have data! We're worthy!") of value in a world dominated by the hard sciences.

Amidst all the nonsense published under the rubric of "post-modernism," the key point remains: the "hidden" structures of one's language, culture, class and era influence one's interpretation of "facts" and "data."

The assembly of "data points" is supposed to be objective, but of course data can be massaged and edited to support one's preselected position or unconscious bias. Data thus becomes manipulative, not enlightening--witness today's announcement that the U.S. GDP grew at a rate of 3.3% in the 2nd quarter.

Hmm. This is quite expansive for a large economy like the U.S., and if this were reported about Japan or the E.U. then the superlatives would be flowing. A 3.3% expansion is just about as good as it gets for a large diversified economy.

Yet those of us who walk or ride bicycles here in one of the most prosperous, wealthy enclaves in the world, home to Silicon Valley, tourist meccas San Francisco and Napa Valley, and a handful of the greatest research universities on the planet (Stanford, UCSF, UC Berkeley) see abundant "data points" in the real world with our own eyes that the economy is in decline.

If economics were truly a science, this kind of dramatic disconnect between "official" macro-statistics and the data gathered in the field would not require some sort of magical reconciliation to make sense.

Hence the inescapable conclusion: economics is a pseudo-science and not to be entrusted with any credibility. It is closer to "political science" in the sense that practitioners weave all sorts of statistical webs that ultimately support what their hidden cultural/academic structures and personal biases have already ordained.

Another similar field is marketing, which also relies on the illusions woven by "hard data." You bought one of the first iPods? Ha, data point! You're an "early adopter," and based on this "hard data" I will now try to sell you a Kindle reader.

The only problem with this data-driven marketing structure is that it no longer works. As I suggest in my new little book, Weblogs & New Media: Marketing in Crisis , the Marketing Emperor truly has no clothing, yet his enthralled and desperate subjects continue to rave about the finery of the lace on his sleeves.

Which brings me to cost structures. Here we enter the thicket of academic structure, which demands that aspirants to the golden glories of tenure write numerous narrow-focus papers which get published and thus "advance" knowledge.

"Big Picture" papers are frowned upon because they are difficult to back up with data. Or even worse, some fundamental trend might not lend itself to "data." If so, academic success requires researchers stay away from such trends or risk academic "death" i.e. denial of tenure.

For instance, when did the U.S. populace and government on all levels trend away from fiscal responsibility? When did borrowing vast sums of money or refinancing to pull out all of one's equity become "the norm" and unworthy of comment? What triggered this convergence of irresponsibility?

If economics cannot shed some light on this fundamental trend, then exactly what good is it?
It seems abundantly clear that the cost structure of the U.S. economy has ballooned to unsustainable levels. By cost structure I mean all the fundamental inputs: energy, healthcare, etc.

For instance: the budget of every city, every county, every agency and every department of every government in the U.S. is under pressure from two basic sources: pension costs and the inexorable rise in mandated healthcare employee costs. What was once a relatively modest share of total employee compensation--healthcare insurance, drug coverage, and eye care--has swollen into a huge percentage of total employee compensation.

If you wonder why building permits now cost more, and parking tickets have tripled, and why garbage fees are skyrocketed, look no further than the crushing burden of ever-rising pension and healthcare costs on every level of government.

These skyrocketing costs act as a huge economy-wide tax, raising the input costs of every good and service in every nook and cranny of the economy. Healthcare (what I call "sick-care" because our collective health continues to slide despite ever-larger sums spent on "curing" us) consumes $2.7 trillion of the $14 trillion U.S. economy--almost 20%. That's equivalent to a 20% VAT (value-added tax) on every purchase.

The bubble mentality of the past decade has also constructed an economy-wide tax. Here is an example. A famed local independent bookstore which once had 3 outlets in the SF Bay Area recently closed its last store. The local newspaper reported it owed two months rent of about $6,600.

How many books would the store have to sell to net $3,300 for basic rent? Add in utlities, employee wages and benefits, cash flow needed to maintain inventory, etc. and you come up with a stupendous number of books which would have to be sold.

Compare that to a cost structure in which rent was $500 per month.

Virtually any crummy retail space is asking $2/sq. ft. and up, regardless of how many empty storefronts there already are in the block. A famous local bakery just announced it's closing due to a rent increase. We have to wonder: just how greedy and stupid is the landlord? As the economy sinks into a death spiral, who is going to rent that vacant space?

Though greed undoubtedly plays a part, we should also look at the cost structure of the building. Let's say a commercial building which was once valued at $1 million sold at the bubble top for $3 million. The new owners now have huge built-in costs: sky-high property taxes and a massive mortgage, not to mention their own health insurance is skyrocketing. From the point of view of the owners, he/she needs to raise rents just to keep up with rising costs.

Too bad nobody noticed that small business can no longer afford bubble-era rents.

So how long can these high-cost-structure owners cling on as the recession takes down more and more of their small-business tenants? How can the cost structure be realigned with what the economy can support?

By all high-cost owners going bankrupt and their assets being sold for cash.

Eventually this may well seep into the heavily protected healthcare industry as hospitals, clinics and emergency rooms close due to rising costs.

Correspondent Paul M. recently made this cogent comment:

You are closing in on a health care solution when you write: (Income Inequality in the U.S. August 22, 2008)
"I have long suggested that the only real driver for lowering the cost structure of healthcare in the U.S. will be 100+ major state-of-the-art hospitals across the border in Mexico which cater exclusively to Americans with cash, clinics which provide the same level of care for 25%-30% of the cost of the care in the U.S.

The choice for U.S. healthcare will then be, adapt or die. Creative destruction is the core of capitalism. Fear-based moat-building and the garrisoning of fiefdoms protected from global competition can only stave off the destructive forces of bloated cost structures and inequality for so long."

Another alternative, suggested by progressive economist Dean Baker, is simply to admit into the U.S. as many foreign upper echelon healthcare providers as will fill the need for inexpensive, readily available care:
Rising Wages for Nurses? Nanny State to the Rescue
Professional Protectionists: The Gains From Free Trade in Highly Paid Professional Services (PDF format)

Thank you, Paul, for this provocative commentary. If we trace back the high cost of educating doctors in the U.S., we stumble upon the huge student-loan debt many would-be doctors must carry forward. Hmm. Then we notice the $250 textbooks (used, of course--new are slightly higher.) Does it cost more than $20 to print even a thick heavily illustrated volume in Asia? Let's say a fair royalty would be $10 to publisher and author. Is there any justification for a price above $40?

A thorough cost-structure analysis would turn up seemingly endless numbers of these bloated inputs throughout the U.S. economy. Yes, most are "protected" by regulations, tariffs, union contracts and the like.

If we ponder the closure of hospitals and emergency rooms, then we have to wonder: what if the hospital that just closed was bought for $1 by a non-U.S. firm and opened with a much lower cost structure (salaries included)? What if pharmaceuticals were purchased at global market prices? Could the hospital then "afford" to offer care which was paid for in cash, thus dispensing with all the 50% added "overhead" costs of insurance, counterclaims, etc.?

In the current climate and economy, no--that's not allowed. Hence my suggestion that the firm acquire the hospital across the border in Mexico where the forces against lower cost structures are not so thick and well-defended by inertia and moated fiefdoms.

Lower healthcare costs by 80%? "It can't be done!" True--not with the current mindset and cost inputs. But can it be done elsewhere? It already is.

The U.S. economy will only thrive when a bookstore can rent a space for $500 rather than $3,300, and anyone can get basic healthcare and even outpatient operations for a modest amount of cash on the barrelhead. Until the entire cost structure is lowered via insolvency, bankruptcy, the contraction of credit and the tearing down of entrenched fiefdoms, then the inefficiencies and inertia of bubble-era valuations and legacy/fiefdom costs will continue strangling the U.S. economy.

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