According to the paper, corporatization of hospitals — also called “system ownership” — has delivered higher profitability with higher prices and reduced operational expenses. Titled “The Corporatization of Independent Hospitals,” the paper is authored by Wharton professor of health care management Atul Gupta; Texas A&M School of Public Health professors Elena Andreyeva and Benjamin Ukert; Malgorzata Sylwestrzak, associate vice president at Humana Healthcare Research; and Catherine Ishitani, a doctoral student of health care management and economics at Wharton.

Hospital ownership in the US has seen “a rapid corporatization” over the past two decades. Total bed capacity owned by hospital chains — or systems — has raced from 58% in 2000 to 81% by 2020. Driving that trend is not just a desire for greater market power, but also increased profitability when corporate chains buy independent hospitals.

Taking off from that trend, the paper’s authors studied 101 independent hospital acquisitions by systems from 2013 to 2017, and prices for hospital inpatient services in 20 large states. The paper’s data sources included large commercial insurers, Medicare claims and patient discharges across all hospitals in New York State. The study also covered 135 acquisitions of system-owned hospitals by other systems.

The new corporate owners of formerly independent hospitals achieve high profitability by raising prices and cutting operating costs, mainly through staff cuts and lower financing costs, Gupta explained on the Wharton Business Daily radio show that airs on SiriusXM. (Listen to the podcast.) “The average acquired hospital increases its operating margin by about $14 million a year,” he said.

Staff reductions make up 60% of those cost savings, while another 20% comes from lower capital and financing costs. Since most of the savings come from reducing headcount, acquirers may be able to predict those savings with more certainty and plan to pass a portion of these savings to insurers, the paper stated.

The staff cuts are primarily in maintenance and support functions. “That makes sense because they can rely on support staff at the system level, and they don’t need to duplicate those functions, [such as in accounting or IT],” Gupta noted.

Quality of Care May Worsen after Corporatization

But corporatization — or system ownership — of independent hospitals has an underwhelming performance in patient outcomes. “We find no evidence that the quality of care improves [following system ownership of a hospital],” Gupta said. In fact, the quality of care may worsen in some cases — a pointer to that is an increase in short-term readmission rates on average after those acquisition deals. The readmissions were evident across different patient samples spanning multiple payers and disease groups. The study found “no detectable changes in short-term mortality or patient satisfaction.”

Although system ownership of hospitals may improve operating efficiency, the authors advised caution in interpreting reduced costs as improved productivity. That is because the increase in readmissions as the size of the firm grows may be an indicator of declining quality.

Gupta explained why the quality of care may suffer after corporatization. “While cutting back on staff creates some efficiencies, it might also disrupt the protocols that were already in place at a hospital,” he said. Cutbacks in nursing staff, social workers and case managers could affect the ability of the hospital to follow up on patients after they discharge from the hospital, he added. They could also adversely impact “some of those smaller things that play a big role in keeping people out of the hospital,” he noted. “That could be a reason why we see an increase in readmissions after these deals take place.”

Key Findings

• After an independent hospital is acquired by a corporate chain, it sees a 6% increase in the reimbursement per inpatient stay for commercially insured patients, the study estimated.
• That price increase varies from “negligible to 11%” across the top seven specialties by volume. Hospitalization for respiratory, central nervous system and cardiac diseases saw the largest increases.
• After corporatization, inpatient hospital revenue increases by an estimated $11,700 per bed.
• Total operating expenses decline by about $48,300 per bed at the acquired hospital following system ownership, not including any offsetting price increases.
• Based on those changes in revenue and expenses, the acquired hospital sees an average estimated increase in hospital operating profit of about $60,000 per bed per year.
• Acquired system-owned hospitals are less likely to be rural and non-profit, and more likely to be located in urban markets.
• System-owned hospitals enjoyed a much higher profit margin than independent hospitals, on average, perhaps reflecting their higher price levels.

How Cost Savings Are Shared for Hospital Expenses

The savings in operational costs are passed on to insurers in varying degrees. “In the deals where hospitals achieve larger cost savings, the price increases for insurers are smaller in magnitude,” Gupta said. “This is consistent with some passing through of efficiencies to insurers.” How much of that is then passed on to consumers through lower insurance premiums is an open question; the scope of the study did not include data on premiums.

“Notwithstanding such large cost savings, average prices for [privately insured] patients increase following system acquisitions, prompting the question of whether consumers benefit from cost savings at all,” the paper noted.

The increase in prices primarily affects people with private insurance; Medicaid and Medicare set prices unilaterally, which are not affected by changes in hospital ownership, Gupta said.

Medicare and Medicaid (and therefore taxpayers) may not share these gains immediately since they set reimbursement rates based on market-level average costs, the paper noted. However, in the long run, the authors expected greater corporatization to reduce market-level costs and growth in reimbursement rates for public payers as well.

From One Hospital System to Another

While the main focus of the paper is on corporatization of independent hospitals, a companion exercise looked at ownership transfers between two hospital systems, or from one corporate ownership to another. In those cases, the authors found a similar magnitude of price increases and suggested that those increases may be driven more by changes in market power.

However, the authors found “insignificant effects on operating costs, including no effect on employment or personnel spending” after deals between hospital systems. The reason for that is meaningful cost savings are available and extracted when an independent hospital is bought by a system for the first time, and not necessarily after subsequent ownership changes. Such system-to-system deals also have no effect on readmission rates.

Broader Significance of the Findings

The authors set the backdrop for the significance of their study: Hospital care accounts for $1.3 trillion in annual spending, and it is the largest segment in the $4.3 trillion US healthcare sector. Consumer prices for hospital care grew nearly 60% faster than those for prescription drugs and twice as fast as those for physician services. The paper also fills a research gap on the performance of chain ownership in health care – the last study to quantify the effects of hospital system ownership on prices, costs and quality covered deals ending in 2000.

With the corporatization of independent hospitals, “at least in theory, there’s the possibility that efficiencies are generated, and they might be passed on to insurers or consumers ultimately in the form of lower costs and therefore lower insurance premiums,” Gupta said. Those savings are not evident on a matching scale in ownership changes between hospital systems.

Justifications for Hospital Corporatization

The paper included a summary of the arguments by industry participants in favor of corporatization:

• First, independent hospitals expect that they will obtain easier access to capital for capacity, service expansions and upgrades after they are part of a larger corporate entity.
• Second, they anticipate reducing operating costs by leveraging the system’s scale, such as in procuring medical supplies and devices.
• Third is access to a larger and potentially better pool of managerial and clinical talent in the system.

Not all of those promises materialize in hospital corporatization deals. In fact, some deals have produced underwhelming outcomes. As an example, the paper cited the 2015 acquisition of Northern Westchester hospital in New York by Northwell, the largest hospital system and private employer in the state. It noted that “the anticipated capital infusions from Northwell did not materialize in a significant way, although Northern Westchester gained access to expert physicians at Northwell’s academic medical cHospitalReimbursement rates increased, “but the effects on quality and efficiency are not obvious,” the authors added. “This type of ambiguous evidence has led to a debate over the role of hospital systems, and more generally of corporatization, in health care.”

Room for Regulators

Hospital acquisition deals come under the regulatory purview of the Federal Trade Commission and the Department of Justice. But “their hands are tied” because the statutes they have to follow “narrowly define” the conditions that reduce competition, Gupta said. “[For instance], just the fact that prices go up is unfortunately not enough for them to take action,” he added.

“But regulators have become more vigilant,” Gupta continued. “The FTC has been more active [than earlier] in scrutinizing deals and potentially blocking them.”

Gupta pointed to Thomas Jefferson University’s 2018 plan to buy Einstein Health Care Network. The deal faced significant antitrust scrutiny from both the FTC and Pennsylvania’s attorney-general before it was cleared in 2021 after a court ruled against the FTC and Jefferson agreed to invest $200 million over seven years in Einstein’s North Philadelphia facilities, the Philadelphia Inquirer reported.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Why Are US Hospitals So Expensive? appeared first on Fair Observer.

Given the centrality of trust in the crypto-economy (see Kevin Werbach’s outstanding book and this podcast), understanding the drivers of confidence from a consumer perspective in this sector is critical. To do this, Wharton marketing professors David Reibstein, Cait Lamberton and Z. John Zhang and visiting scholar Martin P. Fritze began collecting data from online panelists in January 2023, trying to build a baseline understanding of confidence in cryptocurrency. More importantly, they wanted to understand what drives that confidence, and how it might change over time.

These online panelists look much more typical than Hilton and Laurie: On average, they have an age of 42.14 years (SD=14.05) and have a 47.4% female/50.9% male (rest “other/prefer not to declare”) gender split. Though much remains to be learned, after more than 1.5 years of data and over 25,000 responses have been analyzed, the researchers have some insights into how political conviction tints individuals’ confidence in crypto — and more importantly, why.

They find that as political conservatism increases, so does confidence in cryptocurrency. Specifically, individuals who rate themselves as more conservative on a seven-point scale — where 1 represents extremely liberal and 7 represents extremely conservative — tend to show greater optimism about statements like, “Do you think cryptocurrencies will become more important or less important in business over the next 12 months?” (with 1 meaning definitely less important and 7 meaning definitely more important).

Moreover, the more conservative they are, the more likely consumers were to indicate current cryptocurrency holdings. A total of 41% of Republicans, compared to 32.4% of Democrats, reported owning cryptocurrencies. With an overall average of about one-third of the sample holding cryptocurrencies, Republicans significantly exceed the general trend.

A key factor: distributed trust

The researchers also have some initial insights about why self-described conservatives are confident in crypto and how they think about it. Rather than feeling that trust is best placed in institutions like the Federal Reserve, conservatives tend to place more stock in distributed trust. In contrast to trust that relates to a 1:1 relation to a person or institution, distributed trust can be defined as a decentralized form of trust that spans multiple entities and where no single entity alone can dictate the outcome.

In their data, the researchers captured belief in distributed trust by asking questions like, “In general, who do you trust more (1 — Individuals; 7 — Institutions),” “In general, what type of system would you feel more comfortable in? (1 — A system with CENTRALIZED power; 7 — A system with DECENTRALIZED power).” They find that as conservatism rises, so does trust in individuals (vs. institutions) and trust in decentralized (vs. centralized) power.

While only time will tell if current crypto-confident consumers will fare well riding out long-term vacillations, the researchers anticipate that ongoing changes in regulation and the political landscape will continue to shift perceptions at a macro level. In this sense, they believe that research on consumer confidence in cryptocurrencies will also provide important insights, allowing us not only to consider the way that this emerging form of currency evolves from a technical perspective, but also the way in which it both shapes and responds to consumers’ everyday experiences, fears and aspirations.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Crypto Politics: Liberals’ and Conservatives’ Confidence in Cryptocurrencies appeared first on Fair Observer.

The first panel of the series, held on October 23, 2024, focused on the federal debt, trade policies and the future of the US economy. Sharing their insights were Jeremy Siegel, professor emeritus of finance and Kent Smetters, professor of business economics and public policy and faculty director of the Penn Wharton Budget Model (PWBM), with session moderator Joao Gomes, professor of finance and senior vice dean of research, centers and academic initiatives.

Watch the full panel or read some key takeaways below:

Containing the federal debt

Both Trump, a Republican, and Harris, a Democrat, have promised tax incentives such as scrapping taxes on tips and Social Security payments and expanded child tax credits, even as the US federal debt is at record levels. “We can’t afford it. Even without either candidate, we are on an explosive path in terms of the debt,” Smetters said. Going that route in the present times would mean contraction in the economy and lower wages, which then would warrant tough corrective action, he warned. “While our fiscal house is burning down, both candidates are moving in more furniture.”

If raising taxes is the solution to fund those tax breaks, it would mean an “immediate and permanent” increase of 33% on all federal taxes. If spending cuts is the option, that would mean a 25% scythe across the board, including Social Security benefits. Those two scenarios are based on the current debt trajectory “and if we acted today. The longer we wait, the harder it becomes,” he said.

Siegel said excessive debt offerings by the government will raise the interest rate on long-term treasury bonds, which then would make everything more expensive, such as buying a home or financing for firms. At that point, the government will be forced to either cut spending and/or increase taxes, he added.

Outlook for interest rates

A Republican sweep where the party leads the House, the Senate and the presidency will enable “a free reign for goodies,” Siegel said. That could trigger a spike in interest rates, but rates may come down after “some soothing words” by those elected, he added. He did not foresee any big increase in interest rates in three to five years, or to levels that would hurt the economy.

Interest rates will have to respond when the federal debt grows to 175% of GDP, said Smetters. A Penn Wharton Budget Model brief noted that under current policy, the debt-to-GDP ratio would grow from 98% in 2023 to 150% by 2045; the debt becomes unsustainable beyond 200% of GDP, PWBM warned. “[Those high debt levels are] not mathematically possible, either without explicitly defaulting or implicitly defaulting,” Smetters said. Implicit default could occur either through monetization, which would result in higher inflation, or by pruning liabilities like Social Security and Medicare, he explained.

Siegel sees some light on that front. Foreigners own a third of U.S. debt, and the U.S.-owned portion is the remaining two-thirds, he pointed out. “The debt-to-world GDP ratio or the U.S. portion of [the debt-to-GDP] doesn’t look as scary. I see an ability to absorb the deficit that we have.”

Tax cuts and tarrifs

“Trump is way more expensive, and Harris is a lot cheaper,” Smetters said. “Nonetheless, neither candidate has proposed anything that both reduces debt and grows the economy.”

Trump wants to extend tax cuts to higher-income households and corporate income tax. Harris proposes to increase taxes on higher marginal payers and the corporate income tax. Many provisions of the 2018 Tax Cuts and Jobs Act, including individual income tax rate cuts, are temporary and will expire on December 21, 2025; the corporate tax cut from 35% to 21% is permanent.

If there is a split in control of Congress, there will be “huge negotiation on taxes,” Siegel said. “Everything will be on the table.” If the Republicans sweep Congress, they could extend all the tax cuts if the bond markets signal approval with interest rates, he predicted. “The long bond market tells politicians whether they have to act.”

Trump wants to impose stiff tariffs on imports (60% on Chinese goods and 20% on all others). A 20% tariff increase would cause the dollar to rise by about 10%, offsetting the price impact on goods to that extent, Siegel said. But higher import tariffs might provoke exporting countries to retaliate, he added. “If everyone retreats to barriers by taxes, that’s not going to help anyone.”

Such retaliation could cause a contraction of the economy, which in turn would lead to lower taxes than the higher revenues from tariff increases, Siegel continued. But the biggest cost of those tariffs will be felt more on the capital account than the current account, Smetters said. “When you have more debt, that also lowers capital flows across countries, which makes it harder for our government to sell debt,” he added.

Reading market expectations

“The stock market would prefer a Trump victory,” cheering his plan to extend tax cuts, including to long-term capital gains, Siegel said. But the bond market may not relish that (because of the impact on the federal debt and interest rates), he added. At the same time, “the market likes a legislative split; they like Congress to keep tabs on [the parties], he added. Smetters agreed: “The market wants gridlock. That would be the perfect outcome for them.”

“The other market that really matters for the average American is the housing market,” Gomes pointed out. Here, Harris’s proposed tax credits of up to $25,000 for first-time homebuyers is unrealistic because of supply shortages, Smetters said.

What would really help younger homebuyers is lower interest rates, made possible with a sustainable debt policy. “Think about doubling your house bill as you go from a 3% borrowing rate to a 6% or 7% borrowing rate. That is way more important than a $25,000 credit,” Smetters said. Home prices are up 45% since the COVID pandemic began, but along with the cost of an 80% mortgage, they have risen almost 150%, Siegel added.

Missing the math

• Harris’s proposal to avoid raising taxes for households that earn less than $400,000 annually is “mathematically impossible,” Smetters said. “There’s just not enough money at the high-income [levels].”
• Both parties have pledged not to touch Social Security, Medicare and Medicaid, including increasing the retirement age. “It’s not mathematically possible either,” said Smetters.
• Higher minimum wages also don’t evenly spread the gains. Both Smetters and Siegel said the earned income-tax credit (EITC) is far more effective in redistribution than higher minimum wages.
• Proposals by both parties to create more manufacturing jobs also seem to be overambitious. The idea is to “bring back the halcyon days of the 1960s, when manufacturing jobs were among the highest paying jobs,” Siegel said. “That’s just not the world today.”

“Both parties are so disconnected from reality that the stakes in the ground don’t make any sense,” Smetters said.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What Lies Ahead for the Federal Debt and the US Economy appeared first on Fair Observer.

“Both countries are focused very much on trying to be self-sufficient in science and less international, and this is the opposite of what the trends have been for a long time,” Glennon said. “There’s more of a nationalist shift. We think there hasn’t been as much consideration of what some of the side effects of that might be [on innovation].”

Glennon spoke to Wharton Business Daily about the working paper titled, “Building a Wall around Science: The Effect of US–China Tensions on International Scientific Research,” which was published by the National Bureau of Economic Research. (Listen to the podcast.) Her co-authors are Robert Flynn, doctoral candidate at Boston University’s Questrom School of Business; Raviv Murciano-Goroff, strategy and innovation professor also at BU Questrom; and Jiusi Xiao, doctoral candidate at Claremont Graduate University.

The downturn in US–China relations

When countries are actively at war, the wounds to science are clear: collaboration stops, less money is spent, foreign scientists are often deported and some are even killed. But the effect of a cold war on science is less understood. That’s what the research team wanted to explore.

The scholars analyzed resumes of more than 800,000 American and ethnically Chinese STEM graduates to determine how their careers fared since 2016, when there was a marked downturn in US–China relations with the election of President Donald Trump and the ramp-up of prosecutions of Chinese researchers under what was later known as the China Initiative program. They also examined the amount of published research coming from both groups since then. The results were threefold:

• Mobility — Between 2016 and 2019, ethnically Chinese graduate students became 16% less likely to attend a US-based PhD program, and those who did were 4% less likely to stay in the US after graduation. In both instances, these students were more likely to move to a non-US anglophone country, such as Canada or Australia.
• Building on Research — There was a sharp decline in Chinese usage of American science, as measured by citations. But there was no such decline in the propensity of US scientists to cite Chinese research.
• Productivity — A decline in Chinese usage of US science does not appear to affect the productivity of China-based researchers, as measured by publications. But heightened anti-Chinese sentiment in the US appears to have reduced the productivity of ethnically Chinese scientists in the US by 2% to 6%.

“There’s a huge increase in anti-Chinese sentiment during this time frame. We think that’s really impacting the ability of these scientists to continue to be productive,” Glennon said, noting a Pew Research Center report that found American adults with unfavorable views about the Chinese rose from 55% in 2015 to 66% in 2020.

Connecting science and politics

According to the paper, Trump stoked anti-Chinese hostility during his presidential campaign through consistent rhetoric that China’s rise came at the expense of the US. After taking office, he followed up with a trade war to reduce the US–China deficit and the theft of intellectual property. At the same time, the US Department of Justice launched the China Initiative, investigating Chinese and Chinese-American scientists suspected of stealing IP for the Chinese government. Chinese President Xi Jinping countered with retaliatory moves of his own.

Anti-Asian hate worsened during the COVID-19 pandemic, which is outside the time period of study for the paper. But Glennon said she expects to find a widening gap if the research is updated.

“The tensions are very much mutual. It’s not a one-sided thing,” she said.

The scholars said they understand that national security and economic prosperity are primary objectives for the United States. However, they are concerned about the chilling effect that current policies have on the kind of scientific collaboration that leads to broader benefits for America and beyond.

“There’s a lot of research showing a strong link between immigrants and innovation,” she said. “When you have more immigration, innovation increases quite a lot. It’s not just immigrants doing more patenting and more publishing and startups, but also their effect on Americans.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post How Hostile US–China Relations Are Hurting Science appeared first on Fair Observer.

Nearly two decades and many recommendation algorithm tweaks later, this discourse continues, now laser-focused on whether social media recommendation algorithms are primarily responsible for exposure to online misinformation and extremist content.

Researchers at the Computational Social Science Lab (CSSLab) at the University of Pennsylvania led by Stevens University Professor Duncan Watts study Americans’ news consumption. In a new article in Nature, Watts, along with David Rothschild of Microsoft Research, Ceren Budak of the University of Michigan, Brendan Nyhan of Dartmouth College and Emily Thorson of Syracuse University, review years of behavioral science research on exposure to false and radical content online and find that exposure to harmful and false information on social media is minimal to all but the most extreme people, despite a media narrative that claims the opposite.

A broad claim like “it is well known that social media amplifies misinformation and other harmful content,” recently published in The New York Times, might catch people’s attention, but it isn’t supported by empirical evidence, the researchers say.

“The research shows that only a small fraction of people are exposed to false and radical content online,” says Rothschild, “and that it’s personal preferences, not algorithms that lead people to this content. The people who are exposed to false and radical content are those who seek it out.”

Misleading statistics

Articles debating the pros and cons of social media platforms often use eye-catching statistics to claim that these platforms expose Americans to extraordinary amounts of false and extremist content and subsequently cause societal harm, from polarization to political violence.

However, these statistics are usually presented without context, the researchers say.

For example, in 2017, Facebook reported that content made by Russian trolls from the Internet Research Agency reached as many as 126 million U.S. citizens on the platform before the 2016 presidential election. This number sounds substantial, but in reality, this content accounted for only about 0.004% of what U.S. citizens saw in their Facebook news feeds.

“It’s true that even if misinformation is rare, its impact is large,” Rothschild says. “But we don’t want people to jump to larger conclusions than what the data seems to indicate. Citing these absolute numbers may contribute to misunderstandings about how much of the content on social media is misinformation.”

Another popular narrative in discourse about social media is that platforms’ recommendation algorithms push harmful content onto users who wouldn’t otherwise seek out this type of content.

But researchers have found that recommendation algorithms tend to push users toward more moderate content and that exposure to problematic content is heavily concentrated among a small minority of people who already have extreme views.

“It’s easy to assume that algorithms are the key culprit in amplifying fake news or extremist content,” says Rothschild, “but when we looked at the research, we saw time and time again that algorithms reflect demand and that demand appears to be a bigger issue than algorithms. Algorithms are designed to keep things as simple and safe as possible.”

Social harms

There has been a recent trend of articles suggesting exposure to false content or extremist content on social media is the cause of major societal ills, from polarization to political violence.

“Social media is still relatively new and it’s easy to correlate social media usage levels with negative social trends of the past two decades,” Rothschild says, “but empirical evidence does not show that social media is to blame for political incivility or polarization.”

The researchers stress that social media is a complex, understudied communication tool and that there is still a lot to learn about its role in society.

“Social media use can be harmful and that is something that needs to be further studied,” Rothschild says. “If we want to understand the true impact of social media on everyday life, we need more data and cooperation from social media platforms.”

To encourage better discourse about social media, the researchers offer four recommendations:

1. Measure exposure and mobilization among extremist fringes.

Platforms and academic researchers should identify metrics that capture exposure to false and extremist content not just for the typical news consumer or social media user but also in the fringes of the distribution. Focusing on tail exposure metrics would help to hold platforms accountable for creating tools that allow providers of potentially harmful content to engage with and profit from their audience, including monetization, subscriptions and the ability to add members and group followers.

2. Reduce demand for false and extremist content and amplification of it by the media and political elites.

Audience demand, not algorithms, is the most important factor in exposure to false and extremist content. It is therefore essential to determine how to reduce, for instance, the negative gender- and race-related attitudes that are associated with the consumption of content from alternative and extremist YouTube channels. We likewise must consider how to discourage the mainstream press and political elites from amplifying misinformation about topics such as COVID-19 and voter fraud in the 2020 U.S. elections.

3. Increase transparency and conduct experiments to identify causal relationships and mitigate harms.

Social media platforms are increasingly limiting data access even as increased researcher data and API access is needed to enable researchers outside the platforms to more effectively detect and study problematic content. Platform-scale data are particularly necessary to study the small groups of extremists who are responsible for both the production and consumption of much of this content. When public data cannot be shared due to privacy concerns, the social media platforms could follow the ‘clean room’ model used to allow approved researchers to examine, for example, confidential U.S. Census microdata data in secure environments. These initiatives should be complemented by academic–industry collaborations on field experiments, which remain the best way to estimate the causal effects of social media, with protections including review by independent institutional review boards and preregistration to ensure that research is conducted ethically and transparently.

4. Fund and engage research around the world.

It is critical to measure exposure to potentially harmful content in the Global South and in authoritarian countries where content moderation may be more limited and exposure to false and extremist content on social media correspondingly more frequent. Until better data is available to outside researchers, we can only guess at how best to reduce the harms of social media outside the West. Such data can, in turn, be used to enrich fact-checking and content moderation resources and to design experiments testing platform interventions.

[Annenberg School of Communications first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What Public Discourse Gets Wrong About Social Media Misinformation appeared first on Fair Observer.

Recent research by Mustafa Dogan, Alexandre Jacquillat and Wharton’s Pinar Yildirim, published in the Journal of Economics & Management Strategy, also touches on this recent phenomenon. Using theoretical modeling, the study explores how automation impacts the structure of decision-making within organizations, specifically examining the trade-offs between centralization and decentralization. It challenges the conventional wisdom that technology will democratize organizations and empower lower-level managers by decentralizing authority.

The research shows, firstly, that automation can change how decisions are made in companies. Centralized firms, typically characterized by top-down decision-making, are more likely to automate tasks within divisions that face uncertainty, such as new product development groups. Doing so reduces a top manager’s reliance on the knowledge of mid-level managers in situations facing uncertainty, streamlines processes and enhances top-level control. “Automating divisions that involve uncertainty can diminish the need for managers’ localized expertise, empowering executives to break free from their dependencies,” Yildirim explained.

In contrast, decentralized firms, where decision-making is more distributed across the managerial hierarchy, tend to allocate automation resources to more stable, business-as-usual tasks. For these firms, it is better to use automation to support stable, ongoing operations in existing product divisions. This helps to shield these operations from the negative effects of biased decision-making by mid-managers of other, uncertain divisions, helping to improve the overall financial performance of the firm.

Moreover, if companies can allocate more resources to automation, over time, they tend to centralize decision-making. Automation reduces the variability in operations, so lower-level managers don’t need to make as many decisions. This shifts more control to top executives, making the firm’s structure more centralized, regardless of their original setup. Yildirim noted: “This is reducing the strategic role of mid-level managers, who shift towards more operational tasks because lower-level ones are automated.”

Impact on innovation

A second finding from the paper suggests that, as automation resources become more available over time, the gap between the innovative potential of centralized and decentralized firms could widen. Centralized firms may become increasingly resistant to change, while decentralized firms may become more agile or better able to adapt to new market conditions. “For decentralized firms, automating routine tasks in stable divisions allows managers to focus on adapting to changes and innovating, enhancing the firm’s agility and responsiveness,” Yildirim added. This divergence could have significant implications for the competitive dynamics in various industries.

Thirdly, automation deployment, as it changes the role of mid-managers, will also change the communication and the degree of disagreements in firms. As more tasks are automated in divisions facing uncertainty, the quality of communication between executives and managers may deteriorate. This can lead to a less informed decision-making process, ironically undermining the very efficiency gains that automation is supposed to deliver. Yildirim noted: “Automation makes communication from managers to top executives less informative. This means managing people can become harder when using technology strategically.”

Maintaining alignment

The final insight from the study is that the strategic use of automation can also substitute for something else — traditional financial contracts used to manage conflicts within organizations. As automation reduces the need for managerial input, firms may find less need to align managers’ incentives with those of the organization through financial means. Instead, automation can standardize processes and reduce opportunities for bias or misalignment. “It’s a cost-effective way to maintain alignment and reduce internal conflicts,” said Yildirim.

The implications of the findings from the study are profound. The authors suggest that, as firms find it easier to access automation resources, they should also anticipate changes to their managerial hierarchy: top-down decision-making becomes more pronounced. This shift can reduce the role of mid-level managers, relegating them to more operational tasks and diminishing their strategic influence in the organization. In essence, the authors propose that automation is not only a tool used for efficiency; it can also become a strategic asset that can reshape the power dynamics within an organization.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post The Impact of Automation on Corporate Decision-Making appeared first on Fair Observer.

Early on, most enterprise leaders failed to grasp the magnitude of the Mobile Wave on their customers and employees. They focused only on “building an app” rather than transforming their operating and business models to fully unlock the mobile opportunity. Despite their massive investment, users abandoned two-thirds of mobile apps after the first 30 days. Companies that were slow to see mobile as an innovation opportunity versus simply as another communication channel became laggards or roadkill in their respective industries.

Fast forward to 2021, when OpenAI CEO Sam Altman made a similarly audacious statement about AI: “This technological revolution is unstoppable. This revolution will create phenomenal wealth. The price of many kinds of labor (which drives the costs of goods and services) will fall toward zero once sufficiently powerful AI joins the workforce.”

The AI Wave is growing fast. Billions of people globally are using foundation models like ChatGPT, Claude, Gemini and Llama, along with a sprawling number of vertical generative AI (GenAI) applications. Many enterprises have leaned into this new wave, with over 70% using GenAI in their enterprises; however, just 15% are achieving real business impact at scale. Sound familiar?

What can enterprises learn from the Mobile Wave that might help them avoid the same challenges in achieving real transformation in the AI Wave? Let’s start by looking at the similarities and differences between the two waves.

What do the AI and Mobile waves have in common?

Apple blew away its goal by selling 13 million phones in 2008. It has since sold 2.3 billion iPhones, created the app store model to democratize app innovation and completely transformed how we communicate, interact and consume content. Its intuitive interface, coupled with a powerful computing platform, captivated users across the globe.

Likewise, GenAI, the latest AI technology, offers unprecedented new capabilities that can create content, conduct analyses and allow humans to interact with machines in more natural ways. Ultimately, the technology could make machines as intelligent, or even more so, than humans. Similar to mobile, GenAI will:

Change what is possible. Mobile technology initially changed how consumers and employees did everyday tasks. Eventually, entrepreneurs tapped into the “always on” connectivity to deliver new services (e.g., real-time fitness feedback) and change business models. AI companies like Humane and Rabbit are creating personal AI devices (PADs) that are helping us envision a future of virtual assistants and agents accessed via natural language. Just like with mobile, innovative products and business models will follow.

Challenge the status quo. Smartphones displaced many consumer devices, including home phones and cameras, undermining seemingly strong competitive advantages in other industries. GenAI could be even more disruptive as it takes on advice- or language-based services, content creation and analysis. Google is already disrupting its own business model as it replaces search results with AI-generated answers. A single virtual assistant (e.g., Apple Intelligence) may replace many apps.

Devour data to create relevant and extraordinary experiences. With user permission, smartphones gave brands (or apps) users’ location, elevation, movement and more. Smart algorithms enabled them to teach people to dance or detect the early onset of Alzheimer’s. GenAI’s massive computing power will make these examples seem rudimentary. GenAI can already understand users’ digital behaviors. Ultimately, the models will build a more holistic understanding of users by observing them in the physical world (speech, movement, consumption, etc.). GenAI-fueled services will use these learnings to mimic us, assist us and offer insights that both reduce costs and create new sources of revenue for businesses.

Depend on and exploit infrastructure owned and operated by third parties. The evolution of mobile services depended on massive and ongoing investments in advanced device technology, cloud computing, developer platforms, data centers and cellular networks. Since the iPhone launched, AT&T’s market cap has declined nearly $100 billion to $139 billion while Alphabet’s, Apple’s and Meta’s have grown by hundreds of millions to $2 trillion, $3 trillion and $1 trillion, respectively. So, too, will GenAI. With $200 billion expected to be invested in GenAI by 2025, the major infrastructure and platform players will be under pressure to recover their investment under similar pricing pressure that comes with assets perceived as commodities.

Create new business opportunities and revenue for third parties. Apple has paid out more than $320 billion to third-party developers since the launch of its app store. In 2023, Uber generated more than $38 billion in annual revenue. IDC forecasts that enterprises invested more than $19.4 billion in GenAI solutions in 2023 and expect it to double in 2024, focused on both efficiency gains and new revenue streams. Questions still remain about the uptake speed of GenAI solutions and what existing services they will ultimately displace.

How do the AI and Mobile waves differ?

AI’s innate ability to improve itself, along with growing regulatory scrutiny, will create a non-linear, unpredictable trajectory unlike mobile’s steady rise. GenAI’s impact will be different because:

AI consumer adoption will be faster as consumers don’t need to buy new devices. Mobile’s growth initially depended on consumers upgrading their smartphones every 18 to 24 months as well as the build-out of progressively more capable networks or infrastructure. No one was ready for the Internet to be everywhere. Today, they are. Most services are fundamentally digital — if they weren’t pre-2020, they are now. While hardware manufacturers are building their next generation of devices with local large language models (LLMs), most of the massive computing will be done in the cloud, which means consumers can start with the devices they already own.

Data is essential, but users have more privacy concerns, as do regulators. Crafting relevant, convenient and personalized experiences depends heavily on user data. Tech giants burned proverbial bridges with consumers and regulators while failing to respect consumer privacy. While Europe’s General Data Protection Regulation (GDPR) did not come into effect until 2018 (Google was founded in 1998 and Facebook in 2004), Europe’s AI Act went into effect on August 1 of this year, setting a high bar for new and existing models. Meanwhile, large media companies such as The New York Times are suing the LLM creators (e.g., OpenAI) for training their models on their content without permission. Enterprises are also beginning to protect their own data and content by opting out of sharing it for training or quality purposes with those AI model owners.

The pace of change will be even faster as AI will operate autonomously. Humans have built mobile and digital experiences to date. As AI capabilities evolve towards general artificial intelligence or AGI (matches human intelligence) and Super AI (exceeds human intelligence), these “tools” will start to generate their own experiences and no longer depend on human labor. Agents are beginning to self-correct and work together. Capabilities are progressing quickly despite the need for resources like GPUs, power, data and human training, as well as ethical, safety and regulatory concerns.

Customer and enterprise acquisition costs will be higher for new app entrants. Customer acquisition is difficult. An existing installed base or billing relationship gives companies a head start for at least two reasons. First, GenAI will initially augment existing services. Think of Siri (i.e., Apple Intelligence) or Microsoft Copilot for employees. Second, applications will need history and data (i.e., long-term relationships) about individuals to evolve into true virtual assistants. The more an entity or AI-based service knows about a human, the more it can anticipate needs and deliver contextual or personalized experiences. Doing so ultimately increases switching costs.

Factors outside of the control of LLM makers will constrain growth. Brands building mobile experiences have always faced business model or capability constraints of the mobile ecosystem. LLMs face even more hurdles. First, advancing models requires more training data or content. While LLMs can generate synthetic data, the next leaps forward depend on content (e.g., video) and physical world data (e.g., chemistry or nature) that isn’t available. Next, there are physical limitations, including access to GPUs for training or the electricity, water and human talent required to train the models. Finally, government regulators are already nervous about not only the use of consumer data but also the ethical, controllable or known outcomes of these models.

Five steps for leaders to navigate the AI wave

Reflecting on the lessons of the past from the Mobile Wave, what can enterprises do differently to avoid the pitfalls of the AI Wave? Here are five key steps leaders can act on today.

• Don’t underestimate the amount of change required in your organization, business and operating model. Just as winners in the Mobile Wave were those that innovated well beyond “building an app,” winners in the AI Wave will be those that focus on transforming products, services, experiences and ways of working. Don’t bring yesterday’s thinking into your future AI-first business.
• Empower your employees, or they will innovate around you. Chief information officers battled to keep iPhones from popping up in their businesses until they realized they could no longer fend off a better experience. “Bring your own device” (BYOD) became the new enterprise model as BlackBerrys waned and security and controls improved for managing employees’ personal devices. Companies must now embrace “Bring your own AI” (BYOAI) with the appropriate controls to allow employees to use the latest GenAI tools for productivity and innovation while protecting enterprise data.
• Get your data strategy and infrastructure ready to move at the same speed as AI. Data will be the oxygen that powers new AI-driven experiences and operations. This will include both structured and unstructured data or content to train and optimize new GenAI-based solutions. The ability to collect, clean, transform and expose data to innovators across your business with the right security, privacy and controls will be fundamental to staying ahead of this next wave. This includes setting clear data-sharing policies for employees and third parties vital for improving GenAI models; for example, Figma gives users the option to share or not share their data when using its new GenAI features.
• Build a culture of accountability around AI solutions to innovate responsibly. Your customers and employees will depend upon accurate and ethical outputs of GenAI applications. Creating and communicating a responsible AI policy that fits your company’s strategy and values is an essential first step. Building a sense of co-creation and ownership for employees involved in AI innovation will also be critical. Everyone working with AI needs to understand the immense benefits along with the real risks (hallucinations, data security, copyright infringement, etc.) in creating new AI solutions for internal and external users. If you create it using AI, you are accountable for the results.
• Define your own metrics for “ROAI” and use them early. Too many companies are plunging into GenAI experimentation with little to no sense of how they expect to measure real business impact. While it’s important to do pilots to learn, you should invest with an eye toward real business impact. Having your own definition of “Return on AI” (ROAI) will help you better direct your investments across the vast number of AI opportunities.

Like mobile, GenAI brings new superpowers to the end-user and has the potential to drastically transform how companies operate and deliver value to customers. Capitalizing on lessons from the Mobile Wave can only make us more prepared for what’s to come.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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An edited transcript of the conversation follows.

China’s Strategic Economic Zones in Africa

China Knowledge at Wharton: At the African Summit in February, Robert Zoellick, the head of the World Bank, briefly mentioned the Oriental China Ethiopia Industrial Zone, which China is setting up to promote various industries and serve as a trading hub. Is this indicative of how China is forging a greater presence in Africa and if you could summarize in one point what it is that China is doing in Africa, what would it be?

Shinn: I would hesitate to narrow it down to such a small point. It’s done four major things in Africa, but if you want only one, the way I would summarize it as increasing economic and business collaboration with Africa. That is a huge topic in and of itself, but as I said, that is only one of four major objectives that China has in Africa.

The economic zones you identified … actually began in China, and over the last several years China has decided to expand the concept to Africa and maybe beyond Africa. I don’t try to suppose China’s activities in the rest of the world, but I wouldn’t be surprised if they are doing this elsewhere.

At the Forum on China–African Cooperation in Beijing in 2006, they agreed to create six of these zones in Africa. They have already done or committed to doing eight in Africa, and one of these is in Ethiopia. That one is further along than several others, with the one in Zambia being the furthest along … This is certainly a unique Chinese approach to Africa. No Western donors do this sort of thing.

If you wanted to use this as a microcosm of what they are doing in Africa, it could be illustrative. But if you narrowed it down to that, you would sort of miss 90% of what they are doing in Africa.

Four Pillars of China–Africa Relations

China Knowledge at Wharton: Could you elaborate on the other areas?

Shinn: There are four interests that China has in Africa. The first one, which in my view is the most important, is to develop and retain access to Africa’s raw materials, such as oil and minerals. Agricultural products are also becoming more important.

Number two is a political goal. That is to develop or maintain relations with as many of Africa’s 53 nations as possible, so that China can draw upon their support in international settings, such as the United Nations or World Trade Organization, or some of the specialized agencies of the UN where numbers count and China might occasionally run into difficulties. If China has the support of most of the 53 countries, it has a big block of votes for defending its position, particularly in a place like the UN’s Human Rights Council.

Interest number three is getting Taiwan out of Africa, at least politically and diplomatically. They don’t care if Taiwan has trade offices or is involved economically on the continent. In fact, there are even instances in which Beijing and Taipei collaborate in Africa on some economic issues.

Four African countries still recognize Taiwan — Sao Tome, Swaziland, Burkina Faso and Gambia. These are not important countries, but they don’t care … it’s four votes, it’s four countries. Now it flies in the face of the whole “One-China” policy [in which China forbids countries that want to maintain diplomatic ties with it to not have official relations with Taiwan].

Economic Interests and Trade Growth

The fourth interest relates to the business component of developing Africa for China’s export market. Today, Africa trade is only 4% of China’s global trade, which is not very much. But it was only 2% five years ago, so it’s growing exponentially. If it gets up to double digits, which it probably will in the not too distant future, it starts to be big trade. 10% or more is fairly big even for China. Of course, it’s far more important for Africa. I don’t know what the global percentage of African trade with China is, but it is far above 4%. 

Looking at it from the African perspective, it is like one of these horns that you use at a football game where China has the small end and Africa has the big end. Africa is very interested in increasing its exports to China and it is becoming a very important market. But since we are looking at China’s interests, we are looking at only 4% of its global trade at the moment, but it is looking to the day I’m sure when that is in the double digits.

China’s Aid and Development Strategy in Africa

China Knowledge at Wharton: How would you define China’s aid to Africa? And in what ways is it providing sustainability and preventing future problems rather than being reactive?

Shinn: Defining aid is difficult for any country. In the West, at least you have the OECD Development Assistance Committee definition of aid, which the West agrees to. But it is not really used by China and it’s one of the explanations why you cannot get aid figures out of China. They don’t announce global figures. They’re just not available. One of the concerns is that the Chinese haven’t quite ascertained what constitutes aid.

Take the huge loans to Angola. They are loans. Normally, you don’t think of a commercial loan as aid because you’re making money. However, most of these loans are concessionary. When I was in Angola, I was told by the minister of finance that some of the loans had interest rates as low as 0.75% to about 1%. You can probably legitimately say the concessionary component of that loan is aid. I’ve looked at this issue pretty closely and [American University professor] Deborah Brautigam has just written a book on this [The Dragon’s Gift: The Real Story of China in Africa]. She and I agree on the amount of aid [from China], in the OECD context, is about$1.5 billion per year to Africa.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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University of Pennsylvania Wharton School experts Valery Yakubovich, Peter Cappelli and Prasanna Tambe believe it isn’t going to happen as drastically as many predict. In an essay published in The Wall Street Journal, the professors contend that AI will most likely create more jobs for people because it needs intensive human oversight to produce useable results.

“The big claims about AI assume that if something is possible in theory, then it will happen in practice. That is a big leap,” they wrote. “Modern work is complex, and most jobs involve much more than the kind of things AI is good at — mainly summarizing text and generating output based on prompts.”

Yakubovich recently spoke to Wharton Business Daily, offering several key facts he hopes will allay people’s fears of robotic replacement. First, while generative AI has advanced rapidly, it still has a long way to go before it can function autonomously and predictably.

Second, large language models (LLMs) like ChatGPT are capable of processing vast amounts of data, but they cannot parse it accurately and are prone to misleading information, known as AI hallucinations. “You get this output summary — how accurate is it? Who is going to adjudicate among alternative outputs on the same topic? Remember, it’s a black box,” said Yakubovich.

Third, companies are risk-averse and need to maintain a high degree of efficiency and control to be successful. So, they won’t be rushing to lay off all their people in exchange for technology that still has a lot of bugs to work out. “If we are thinking 40, 50 years ahead, that’s wide-open ended,” Yakubovich said. “The issue we are discussing now is very the specific [needs] for business. The risk for companies is very high, and they are not going to move very fast.”

LLMs are not even replacing humans in communication tasks

Despite its shortcomings, generative AI has been touted for its ability to handle what many consider to be mundane communication at work — interacting with customers online, producing reports and writing marketing copy such as press releases. But the professors point out that many of those tasks have already been taken from workers. For example, chatbots handle customer complaints, and client-facing employees are often given scripted language vetted by lawyers.

Yakubovich said most office interaction is informal communication, and a lot of useful organizational knowledge is tacit. While digital tools are increasingly capable of capturing both, nobody wants their emails, Slack chats or Zoom transcripts freely parsed by an LLM, and the quality of extracted information is hard to verify.

“I haven’t seen any company yet that dared to feed their emails into the models, because you can learn a lot about the company from that. Who wants to give open access?” he said. “It’s very hard to control what the model will produce and for whom. That’s why the models are very hard to use within the organization.”

Companies also don’t want AI involved in politically sensitive matters, especially if there are legal concerns. “What I see so far in talking to senior leaders of companies is that they try to avoid completely using models in politically charged cases because they know they will have more work to do adjudicating among the different parties,” he said.

Data science has been around for years, Yakubovich said, yet many companies still lack good infrastructure to organize the tremendous information that the technology is capable of collecting. Even if they built it, humans are still an indispensable part of making sense of it all.

“If you want to curate everything, it’s a lot of work, and this is where more jobs will emerge,” he said.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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This acute sense of loneliness and anxiety is contributing to more physical and mental ailments, particularly in high-income countries, and dampening the most basic of human desires — procreation. The US birth rate has declined by an average 2% a year for the last decade. The global fertility rate has plunged to 2.3 live births per person and is expected to continue decreasing below the 2.1 rate needed for population replacement.

“My co-author and I are just kind of gobsmacked by this because this is not what species do. They don’t decline in numbers, because reproduction is the driver of evolution,” Platt said during an interview with Wharton Business Daily on SiriusXM.

The paper, “Declining Human Fertility and the Epidemic of Despair,” appears in the journal Nature Mental Health.

Declining fertility rates are bad for business

A declining population may be beneficial for a planet already scarred by the effects of climate change and resource scarcity, but it could have profound effects on economies and labor markets, the professors said. Without enough young people, it will be difficult to staff work that requires “young muscle,” such as construction and the military, or find new recruits for fields such as medicine and engineering. There will be fewer consumers overall, and an overall reduction in the wages that generate taxes for programs like Social Security.

“Knowledge work may be a little bit less [affected] because of the rise of AI and tech. But that in and of itself is probably accelerating the conditions that we think are actually driving part of this fertility decline,” Platt said.

The professor pointed to a catastrophic rise in anxiety, depression and obesity-related diseases such as diabetes that corresponds with the rise of digital culture, where people are interacting with screens more than with each other. The problems are worst among teen girls, who are reporting record high rates of sadness and suicidal thoughts.

Government interventions have yet to slow fertility rate decline

All these factors coalesce to create a “negative momentum,” which the professors explain as a drop in the dopamine-inducing rewards that usually come from material gains and deep social bonds.

“If you’re spending more time on your phone or in front of a screen, you’re not out experiencing real life and making real connections, making real friends,” Platt said. “And you’re potentially limiting your ability to find the person you’re going to fall in love with and start a family.”

The professors argue that government interventions to encourage having babies, like subsidizing child care, have had little effect on the downward fertility trend. More foundational changes are needed, they said. Countries that have banned smartphones at school, for example, have reported improved mental health and less bullying among students.

“I think, unfortunately, what we’re looking at is something more like a restructuring of our economic and social lives,” Platt said. “That’s a big task, but we can start small.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The 2023 banking crisis, headlined by the collapse of Silicon Valley Bank, exposed the challenges banks face with their large and growing share of uninsured deposits. Uninsured depositors could trigger runs on banks when they perceive unmanageable risks, the paper noted. The paper was discussed at a recent conference co-hosted by the Wharton Initiative on Financial Policy and Regulation (WIFPR) with Yale’s Tobin Center for Economic Policy.

Goldstein and Davila provide a framework to determine the optimal level of deposit insurance to stave off bank runs. The framework allows ways to measure the welfare impact of changes in deposit insurance coverage limits, and the costs it will entail. The authors demonstrate the efficacy of the framework by applying it to the 2008 financial crisis. As it happens, that crisis triggered the most recent change in deposit insurance to $250,000 per account; the previous limit had been $100,000, since 1980.

“The deposit insurance limit is updated every once in a while, but not very rigorously or not with much data or science behind it,” Goldstein said. “What we wanted to ask is, can we have a framework that will guide policymakers on what that limit should be?”

The pros and cons of deposit insurance

Optimal deposit insurance limit would essentially have to be “socially optimal” in a way that maximizes the welfare or utility among economic agents or people, Goldstein continued. “It entails a cost-benefit analysis to see whether the benefit of changing the limit is significant enough relative to the cost.”

The benefits are clearly in helping create a more stable banking environment. “When you have more deposit insurance, it reduces the probability of a run and a bank failure,” Goldstein said. “Depositors might run on a bank when they think that their money is at risk. But if you insure them, their money is not at risk.” Governments will typically meet the costs of providing that insurance through taxation.

The paper noted that after the introduction of the federal deposit insurance in 1934 (with a limit of $2,500 per account), the number of bank failures dramatically reduced. More than 13,000 US banks failed between 1921 and 1933 in the midst of the Great Depression, but only 4,057 banks failed between 1934 and 2014.

While deposit insurance helps reduce bank failures, it involves a moral hazard, where market participants could, for instance, go lax in running the banking system. That possibility underscores the need to design optimal levels of deposit insurance coverage.

Designing the deposit insurance framework

The framework in the paper incorporates the tradeoffs that policymakers would have to consider in determining the optimal deposit insurance limit. It visualizes an environment with uncertainty about the profitability of banks’ investments, where both fundamental-based and panic-based failures are possible. It then mimics deposit insurance arrangements and weighs the implications for social welfare with varying degrees of coverage.

Essentially, the tradeoffs boil down to two possible scenarios: On the one hand, a marginal change in deposit insurance coverage may substantially reduce the likelihood of bank failure with significant gains from avoiding that failure. In such a situation, it is optimal to increase the level of coverage, the paper stated. On the other hand, when bank failures are frequent and when the social cost of subsequent interventions is high, the optimal route would be to decrease the level of coverage, it added. It might be unwise to incur the social cost of intervention, for instance, when it is very costly to raise resources through distortionary taxation, the authors wrote.

Goldstein said the framework incorporates four ingredients: One is the likelihood of a bank failure. The second is the cost of funds for the government to provide deposit insurance. The third is the relationship between the benefit from deposit insurance and the probability of a crisis, such as bank run. The fourth is the likely damage from a run.

Determining the right insurance coverage

When the authors applied their framework to the change in the deposit insurance limit in early 2008, they came up with an optimal level of coverage of $381,000 per account. That is substantially higher than the decision back then to raise the coverage limit to $250,000 in October 2008. Even so, the welfare gains are “very large” from increasing the coverage from the earlier limit of $100,000, they stated in their paper. They also qualify their choice of $381,000 as the coverage limit by noting that it is “perhaps more aligned with the extended guarantees that were implemented soon after” the 2008 financial crisis.

Incidentally, in March 2023, after Silicon Valley Bank and Signature Bank collapsed, the Treasury, the Federal Reserve and the FDIC extended to them a “systemic risk exception,” where it made whole all of the bank’s depositors. Taxpayers will not bear the losses from the two banks, they announced in their joint statement.

That one-time exception was widely seen as an attempt to prevent a contagion effect where depositors across the banking industry might feel vulnerable. Silicon Valley Bank’s assets were eventually moved to a bridge bank the FDIC set up, and New York Community Bancorp took over select parts of Signature Bank. The episode prodded policymakers and regulators into exploring ways to strengthen the banking system from bank failures.

Pointers for bank regulators

Goldstein recalled that after the 2023 crisis, many policymakers and legal scholars called for unlimited deposit insurance. “Our paper exactly goes against that. There is a benefit. There is a cost. You want to find the optimal balance between the cost and the benefit.”

Goldstein said that while it would be prudent to revisit deposit insurance limits from time to time, it would be unwise to change it too often. “It would be good to have a dynamic adjustment of the deposit insurance limit, but it might be infeasible because you can’t readjust it every month.”

Their paper also looks at how emerging economies should set their insured limits. In most European countries, the current deposit insurance coverage limit is 100,000 euros ($108,000 at the current exchange rate).

Goldstein and Davila do not, of course, provide a fail-safe way to prevent bank failures, but stated that their analysis provides the tools to build a “theory of measurement for financial regulation that can be applied to a wide variety of environments.” The ability to measure aspects such as “the sensitivity of bank failures to changes in the level of coverage and the relevant fiscal externalities associated with such a policy change” can potentially guide regulators, they added.

Goldstein said that their framework may end up capturing too many moving pieces that may be seen as “noisy,” but argued that it is still a step forward. “It’s better to have a noisy framework than have no framework at all. The way that this policy has been set over the years was very arbitrary.”

Deposit insurance helps minimize or prevent bank runs, but it must be accompanied by other actions to strengthen the banking system, Goldstein said. Among his suggestions: increased scrutiny of mid-sized banks, more imaginative stress tests and more effective capital and liquidity regulation.

In the first quarter of 2024, the US banking industry showed growth in net income, along with favorable asset quality, according to an FDIC report. But it continues to face “significant downside risks” from inflation, interest rates and geopolitical uncertainty, it noted. It specifically mentioned a deterioration in certain loan portfolios such as commercial real estate and credit cards.

[Knowledge at Wharton first published this piece.]
[Lee Thompson-Kolar edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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“What’s going on with electrification transition and the demand for electric vehicles … is a reset that’s almost like the starting up of a new industry,” MacDuffie said on the Wharton Business Daily radio show that airs on SiriusXM. (Listen to the podcast.) He pointed to predictions of a shakeout and consolidation within China’s EV industry, and said, “I’m sure we’ll see it here [in the US], too.”

For sure, any new industry will see many casualties as it evolves. “One out of ten is considered a decent success ratio for entrepreneurial ventures of any kind,” especially in industries such as EVs that call for large capital requirements, MacDuffie said.

Vertical integration is key to success

According to MacDuffie, vertically integrated EV makers like Tesla and China’s BYD can ride out a shakeout because they control large parts of their supply chains. Tesla, for instance, makes EV batteries and has invested in battery storage. It also coped with the recent global semiconductor shortage by redesigning its software to support alternative chips, as a Forbes report pointed out. “You have more control, you can present a more coherent product and a more coherent brand and identity if you control the whole [manufacturing chain],” MacDuffie said.

Among the likely EV casualties that MacDuffie pointed to is Fisker, which appears to be on the verge of bankruptcy. But he expected Rivian, another startup that is also facing challenges, to survive, because it has an “appealing product that’s been well received,” which will help it continue to draw investment.

Legacy automakers have an advantage

Established automakers with EV products have another advantage over EV startups in that they can ride out the current demand slowdown by shifting to hybrid vehicles, MacDuffie noted. Several legacy automakers such as General Motors, Honda, Toyota and Ford have taken such a portfolio approach to increase their hybrid offerings.

Established automakers have another advantage over EV startups. “They already know how to do the design, the build, the supply chain, and the distribution,” MacDuffie continued. They also have the wherewithal to cross-subsidize their forays into new technology such as EVs, he added. “They can keep selling their existing product line and use those profits to cross-subsidize. That advantage is not available to a startup.” Such an advantage is especially useful when technology transitions get complicated or when demand growth slows down, he noted.

The demand slowdown hasn’t deterred new EV startups, especially those based on autonomous vehicle technology. MacDuffie pointed to Amazon subsidiary Zoox, an autonomous electric vehicle firm that is aiming for the robotaxi market. Another well-heeled EV startup is Aurora, an autonomous trucking company with backing from both Amazon and Toyota. “Where there’s a deep-pocketed investor that has a stake in you continuing, then you’re more likely to make it through this period of ferment than if you’re simply relying on the public markets,” MacDuffie said.

Building supply chains from scratch

Unlike with consumer electronics where an Apple could tap into an existing supply chain, the EV industry didn’t have “a bunch of contract manufacturing capacity sitting around just waiting for a great car design” that somebody comes up with, MacDuffie noted. The EV industry has faced hurdles in building out that supply chain from scratch. It has been hard for EV companies to obtain debt financing or venture capital financing because of the long wait before they can roll out their products and make profits, he explained.

As a consequence, companies like Tesla and Rivian have had to rely on the public capital markets to finance those investments, but that has made them particularly sensitive to the expectations of equity investors, MacDuffie noted. “Investors and everyone watching the stock market are hanging on every announcement about your sales. Anytime you don’t meet a sales projection, the stock tanks.” Not surprisingly, the drop in demand for EVs has hurt the stock prices of Tesla, Rivian and Nio.

Policy support vital for EV makers

Government support has been crucial for the EV industry in these trying times. “If there were not government subsidies and priorities to advance the electrification transition, then I don’t think you would see all of the world’s automakers making big strategic bets on electrification, and you wouldn’t see as many startups either,” MacDuffie said. “They have the confidence that this transition will happen with so much government push behind it.”

At the same time, EV makers in the U.S. face a degree of policy uncertainty unlike their counterparts in China which has a “unidirectional government,” MacDuffie noted. “In the U.S., if there’s a change in political party, and a change in who’s in the White House, then we may see policy swings much more,” he said. “It makes American EV companies subject to more volatility and more risk because, what if all the subsidies are taken away all of a sudden in a few years?”

On a recent trip to Germany, MacDuffie found that EV makers there are confident that their policymakers are committed to supporting the electrification of transportation; they are therefore surer of making their investments.

MacDuffie said the impending consolidation among EV makers is a familiar theme for the auto industry. He recalled that after the birth of the auto industry in the early 1900s, there were hundreds of auto companies, but they consolidated into five or six companies in the 1920s and 1930s, and eventually into the Big Three of General Motors, Ford and Chrysler (now part of Stellantis).

As the EV industry braces for a shakeout, financial staying power will make the difference. “Anybody who succeeds in persuading the various sources of capital to come together, as Elon Musk did very well from lots of sources [for Tesla], you have more chance to survive,” he continued. “But any time you lose one of those incoming streams of capital, boy, you’re much more on the edge.”

[Knowledge at Wharton first published this piece.]

[Lee Thompson-Kolar edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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“It’s the kind of thing you never expect from such an industry that’s often closely aligned with its regulators and that isn’t inclined to make such a big deal out of some regulatory initiative,” David Zaring, Wharton professor of legal studies and business ethics, said recently on the Wharton Business Daily radio show that airs on SiriusXM. Also unusually, the proposed rules have drawn opposition from both sides of the political aisle.

“Basel III Endgame” is the name of the final round of capital adequacy proposals from the Bank for International Settlements in Switzerland, which is owned by member central banks and acts as their banker. The latest rules are part of a series aimed at keeping the banking industry safer after the 2008 global financial crisis and the March 2023 regional banking crisis set off by the collapse of Silicon Valley Bank (SVB) and First Republic Bank.

The proposed rules will require large US banks (those with $100 billion or more in total assets) to increase their capital by an aggregate 16%, varying across banks based on their activities and risk profiles. “Most banks currently would have enough capital to meet the proposed requirements,” the Federal Reserve said when it unveiled the proposals last July. The new rules will also standardize the capital framework related to credit risk, market risk, operational risk and financial derivative risk. Banks would have a window between July 2025 and July 2028 to comply with the new framework.

So why the pushback from banks?

The affected banks do not see a need for that extra capital. The Bank Policy Institute is running a campaign called “Stop Basel Endgame.” It says the rules would limit banks’ capacity for mortgages, car loans, credit cards and small-business loans.

“Ironically, a proposal meant to mitigate risk will actually increase risk,” JPMorgan Chase chair and CEO Jamie Dimon argued in a congressional testimony. He said Basel III Endgame will increase borrowing costs for governments and businesses and that “regulators will be unable to see the next crisis brewing.” CEOs of other big banks echoed those sentiments in their testimonies.

Zaring pointed to some aspects of the proposals that could misfire. “While the overall goal is to make the largest US banks safe and sound, there’s some concern that the way it’s being implemented will impose such stringent requirements on these large banks that they’ll have a hard time lending in certain areas that we are accustomed to seeing them lend in,” he said.

Zaring pointed out, for instance, that the new rules will bring constraints on residential mortgage lending. “That makes it a little bit likely that banks will continue to exit from the residential mortgage space, and nonbanks will be the companies underwriting most of the home mortgages in the US,” as has been the case since 2016. In fact, bank lending to the real estate industry could contract in the fallout from the regional banking crisis, as Wharton professor of real estate and finance Susan M. Wachter warned soon after that crisis broke out last year.

The story on either side

Zaring described how banks and central banks might argue over the proposals.

“The big banks will tell you that the US banking industry has never been safer,” he said. “They came through the COVID disruptions to the economy with flying colors. They haven’t had problems dealing with inflation in the way that midsize banks have, and they haven’t been troubled by [the March 2023] mini-banking crisis. If anything, many of those people who left First Republic and SVB went to JPMorgan Chase, our largest American bank. So, the big banks have a story that is, ‘We’re doing great. What on Earth are you doing imposing these onerous new capital requirements on us when we’ve already established that we can make it through lots of different crises?’”

In a rebuttal to those claims by the large banks, the regulators would point to the bailouts of SVB and First Republic Bank at taxpayer expense, Zaring noted. “The regulatory story is, ‘Maybe the largest banks are doing okay, but we have a banking sector that can run into problems, and it can cost the [Federal Deposit Insurance Corporation] money. And so, we need to tweak capital requirements to be ready for that.’”

Another sore point with Basel III Endgame is its effort to standardize the capital framework related to different types of risks such as credit risk and operational risk. Managing risk at banks often involves a tradeoff, Zaring said. Regulators could either require banks to set aside more capital buffers against potential risks, or they could more closely monitor how banks manage their risks, he explained. “Basel III Endgame doesn’t ignore risk management, but it focuses on making capital really high so that banks make their own choices and if those choices go badly, they will make it through.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Why Banks Are Worried About the “Basel III Endgame” appeared first on Fair Observer.

Driving that “depositor alertness” is faster bank processing of transactions made possible with more efficient payment technology, according to a new paper by experts at Wharton and elsewhere titled “The Making of an Alert Depositor: How Payment and Interest Drive Deposit Dynamics.”

The paper traced the evolution of bank depositors from a sleepy state to becoming more alert. Banks rely on low-cost and stable deposits; they make up more than 80% of the liabilities of an average US bank. Most depositors were unresponsive to changes in the value of the bank assets. But the 2023 regional banking crisis was a wake-up call: Silicon Valley Bank went belly up and the ripple effects were felt across regional banks.

In fact, depositors were shown to be more sensitive to the financial health of their banks, interest rates, ease in transferring money with technology aids, and service quality. The paper described “a new portrait of depositors: depositors may become ‘flighty,’ particularly for banks with better service quality and during times of increased interest rate risk.”

Depositor inertia and the market power of banks

Depositor inertia, or inattentiveness, and the market power of banks are the main reasons why people have traditionally stuck with their banks, according to Wharton finance professor Yao Zeng, who co-authored the paper with Xu Lu and Yang Song at the University of Washington.

“Most retail depositors don’t keep a huge amount of money in their banks and are covered by deposit insurance, so they are not super worried about their bank’s financial health,” Zeng said. That is especially true with depositors in rural areas where large banks do not have as many branches, and the only options are local community banks, he noted.

Most large banks also derive market power with their branch network and online banking facilities, which they can use to offer low interest rates on deposits, Zeng continued. “Even if your bank offers you a zero-interest rate on your deposits, you’re not that unhappy, and you’re probably fine parking your money there.”

Traits of the newly alert depositor

But now, depositors move their money across bank accounts more actively when the payment technology linked to their accounts is more efficient and when they face higher interest rate risk, the paper stated. Specifically, their alertness is “particularly pronounced during periods of rate hikes but diminishes when rates fall.” Faster payment technologies reduce transfer frictions, which in turn heightens depositor alertness.

Payment frictions, such as delays in transferring money, have long been a sore point with depositors. But the growth of fintech firms in recent years has changed that and made people less dependent on their banks. Payment apps like Zelle, Venmo, PayPal and Cash App have made it easier for depositors to send money to family and friends or pay for purchases, Zeng explained. “Fast payment technology has specifically led to higher depositor awareness.”

Banks, however, face a paradox when they embrace those new payment technologies, Zeng pointed out. “If a bank offers faster payment technologies, that will make its depositors happier. But that also means that thanks to the higher payment convenience depositors tend to move money more actively between your bank and other banks.”

Scope of the study and key findings

In their study, Zeng and his co-authors delved into questions like how alert have depositors become, which economic factors command depositors’ alertness and how that alertness might influence their financial outcomes.

The authors analyzed novel transaction-level data from over a million US depositors at 1,400 banks and credit unions between 2013 and 2022. Zeng shared specific insights into their findings:

• One fewer day of delay is associated with $239–$321 more inter-bank deposit transfers in a month. That accounts for 20%–30% of the total monthly deposit transfers by the median American depositor.
• One fewer day of transfer delay is associated with roughly $89 more monthly consumptions for an average American depositor. “This effect is economically important because it is solely driven by depositors’ banks processing payments and transfers faster; these depositors effectively become ‘richer’ despite their income not changing at all,” Zeng said.
• When bank deposits become a worse store of value in the sense that interest rate risk is higher, depositors move money more actively across their bank accounts. When the MOVE index, an index that measures the volatility of the bond market, increases by one standard deviation, inter-bank deposit transfers tend to increase by $15–$20 more, suggesting that depositors have become more alert.

Contours of depositor alertness

The study tracked patterns in changing depositor behavior on several fronts. One is a new metric it designed called “deposit turnover,” which measures the total dollar amount that a depositor transfers across her bank accounts within a given period. Another metric captures transfer delays in conventional banking channels, while a third measure looks at how sensitive depositors are to changing interest rates. “Higher interest rate fluctuations lower the appeal of deposits as secure value storage,” the paper noted.

Efficient payment technology which enables faster transfers is a big factor that encourages depositors to shift their deposits more actively between accounts. Faster payment technologies also help boost economic activity. Depositors who use debit cards or bank accounts for more than 90% of their spending increase their consumption when transfer delays are reduced.

Depositor alertness is high also when facing heightened interest rate risk. In order to mitigate that interest rate risk, depositors tend to move their deposits more actively between accounts instead of keeping them in one place. They get more restive when they face delays in transferring funds between banks because delays mean higher risks in experiencing late fees and overdraft fees when managing their own floating-rate mortgages or auto loans.

These findings have significant policy implications, especially as they relate to the impact of changing depositor behavior on bank funding costs and risks. Those changes are set against the backdrop of rapid developments in new payment technologies and during times of monetary tightening. “The temptation of offering better payment technologies to compete for depositors versus improving liquidity management to handle interest rate risks presents a tough choice to bankers,” said Zeng.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Closely held companies — those whose shares are mostly owned by a small number of individuals — worry about volatility in their share prices and tend to conserve cash. They consequently cut back on new investments and R&D outlays, according to a new research paper by experts at Wharton and elsewhere titled “Corporate Responses to Stock Price Fragility.”

Such companies accumulate cash because they are apprehensive that “stock price fragility,” or volatility of their share prices, could hinder their ability to raise fresh capital in the public markets, according to Wharton finance professor Itay Goldstein. His co-authors are Stockholm School of Economics professor Richard Friberg and University of Kentucky finance professor Kristine W. Hankins.

“When companies think that their ownership base has changed in a way that their stock prices can be subject to volatility, they will take precautionary measures to avoid the potential for downside risk,” said Goldstein. “If such firms do not have sufficient cash for their future investments, they conserve cash in anticipation of a drop in their share price.” Such stock price fragility has a negative impact on capital expenditures, R&D, repurchases, and short-term debt, the paper stated.

The paper covers new ground in exploring whether firms change their financial behavior when they anticipate that their exposure to non-fundamental price movements, such as their stock price fragility, has increased. This can happen when firms’ ownership base changes in a way that makes large flows and price fluctuations more likely.

Closely held firms are exposed to a variety of shocks to their share prices, such as rapid unwinding of positions by large institutional investors, or “meme stock” trading fueled by social media, the paper stated. Against that backdrop, the authors contended that their paper is “the first to provide evidence that managers identify increasing stock fragility — and the resulting potential exposure to non-fundamental shocks — as a salient risk.”

How the volatility of a stock drives capital allocation

The paper’s authors have developed a model that illustrates the economic mechanism of stock price fragility; they tested that model in two different empirical settings. One empirical setting is the long-sample evidence using a fragility measure fleshed out in a 2011 paper by Robin Greenwood and David Thesmar. The second setting is the merger of financial institutions, and particularly that of Blackrock and Barclays Global Investors (BGI) in 2009.

In the first setting, the paper analyzed quarterly corporate data from 2001 to 2017. It showed that companies exposed to stock price fragility decide on how much cash they must keep as a buffer for future financing needs. “While all firms face some risk that equity misvaluation increases their cost of raising capital in the future, changes in the degree of misvaluation risk should affect the benefit of precautionary cash holding. This implies that firms exposed to greater stock fragility will hold more cash and invest less in capital expenditure,” the paper stated.

In the second setting, the paper focused on the BlackRock-BGI merger, where the combined entity controlled $2.8 trillion worth of assets under management. The merger led to “a substantial change in ownership concentration” for many stocks in their portfolios. The study found  “a causal effect” between stock price fragility caused by ownership concentration and the capital investment and the R&D outlays of portfolio companies. The authors found similar patterns following other smaller financial institution mergers.

Capital allocation, interrupted

Goldstein summarized the main takeaways from the analysis in the two settings: “In the first one with long-sample evidence, we show how stock fragility affects firms’ financial policies. When the stock price fragility goes up, firms tend to take precautionary measures and hold more cash, which at the end of the day also affect their investments, R&D, and so on.

“In the second experiment of the BlackRock-BGI merger, we show that when firms see that their ownership concentration has gone up, they react by increasing their cash, and reducing their investment and R&D outlay. It interrupts the process of capital allocation.”

The paper pointed out that stock price fragility does not rely on any asymmetry between underpricing and overpricing. “A fragile stock price implies a higher probability of bigger overpricing just like it does for bigger underpricing,” the authors wrote. Overpricing does not impact a firm’s choice on how much cash it must have as a buffer, but the higher likelihood of underpricing will drive a firm to build its cash reserves.

Goldstein said the findings are significant especially because of the increase in stock ownership concentration, with more and more stock holdings moving from retail investors to institutional investors. Institutional investors account for 80% of the U.S. stock market capitalization, according to one report.

Investors who do not want to be exposed to the resulting stock price fragility may want to reduce their exposure to firms with concentrated ownership, Goldstein advised.

Regulators should also take into account the implications of ownership concentration of firms, he added. “The Securities and Exchange Commission, for instance, tries to regulate financial markets to allow for smooth allocation of capital. When stock ownership becomes too concentrated, the allocation of capital might be interrupted.”

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The study, penned with co-authors Arthur Acolin from University of Washington and Desen Lin at California State University, Fullerton, found that about one-quarter of the nine-percentage-point increase between 2000 and 2021 can be explained by the decline in housing affordability, along with higher unemployment and delays in people getting married and rearing children.

Recent census data underscores the magnitude of this trend, with almost half of those aged 18–29 currently dwelling with their parents, marking the highest level observed since the Great Depression era (1929–1941). After the economic boom following the end of World War II, the number of young adults living with their parents dropped to a low of 27% in 1960. Since then, this figure has been steadily increasing, reaching 40% in 2000, 47% in 2019, and 49% in 2021.

Despite increasing salaries, Gen Z and Millennials can’t afford houses

“This is a resilient response to the very dramatic increase in rental burden. The average proportion of a person’s income that goes to rent was 25% in 2000, and it’s now 40%. That’s really a striking increase,” Wachter said.

Overall, the paper found that delays in getting married and having kids account for most of the increase in Gen Z and Millennials living with their parents. But the study focused on the period from 2000 to 2021, during which housing affordability significantly deteriorated. Since 2021, both household income and housing costs have risen, but rent and housing prices have outpaced wage growth. The study’s estimates suggest that the worsening affordability explains one-fourth of the increase in the share of young adults living with their parents in the aggregate and as much as twice that for minorities.

Notably, the connection between soaring housing prices and young adults residing with their parents is particularly strong in areas where housing costs are highest. “This reflects the deepening affordability crisis in the US,” Wachter said. “There would be two million more households occupying housing units but for this alternative solution of seeking financial shelter with one’s parents. So the excess demand for housing is lessened, which is a good thing in the current housing affordability crisis where there’s high demand and lack of supply.”

Broader economic conditions also affecting trends

From 1960 to 2000, the increase in young adults living with their parents was primarily due to fewer young men participating in the workforce. However, the decline in housing affordability has driven an even more rapid increase in co-residence in the past two decades, reaching 49% in March 2021 from 39.9% in 2000, according to the study. 

Moreover, this may explain why, despite a surge in co-residence during the Great Recession, the number of individuals living with their parents did not significantly decrease during the subsequent economic recovery period. “This is happening due to housing costs outpacing income growth,” said Wachter.

Looking into specific time periods, the study finds that both housing affordability and job market conditions played a key role in more people living together — both during the COVID-19 outbreak and earlier in the 2000s. For instance, during the pandemic when unemployment rates surged, more individuals resorted to living with their parents, akin to trends observed during the 2009 global financial crisis.

Affordable housing issues disproportionately impact minority groups

Moreover, the study highlights the disproportionate impact of housing affordability on minority populations, particularly Asian, Black and Hispanic young adults, who are more likely to live at home with their parents. “These groups tend to start off with fewer people living with parents but then see a quicker increase, surpassing the average for white non-Hispanic people,” said Wachter.

The findings further suggest that the increasing trend of young adults living with their parents might be influenced by factors related to wealth and limitations on borrowing money — a subject warranting further research. “Previous studies have shown that when housing becomes less affordable, fewer people can afford to buy homes. An alternative for those who can’t afford high rents or home prices is to live with their parents,” said Wachter.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Gen Z Doesn’t Have the Money to Move Out appeared first on Fair Observer.

The authors found that EVs, compared to non-electric models in the same car family, are financed with higher interest rates, lower loan-to-value ratios and shorter loan durations. That “financing gap” occurs because lenders price in the risks they perceive in obsolescence caused by rapid advances in EV technology, the paper explained.

“Our paper is the first step towards understanding financing barriers to EV adoption,” said Wharton finance professor Huan Tang, who co-authored the paper with University of British Columbia finance professors Jan Bena and Bo Bian. The paper noted that in discussions around the global transition to electric mobility, there is a lack of emphasis on the significance of consumer financing in EV adoption.

What causes the EV financing gap

The study showed that the primary driver of the “EV financing gap” is the technological risk associated with EVs. Lenders charge higher interest rates on EV loans because “the rapid and uncertain evolution of EV technologies accelerates technology obsolescence, diminishing the resale value of EVs,” the paper pointed out. The tighter financing terms for EVs have little to do with consumer demographics, lenders’ market power, or macroeconomic factors, it added.

EVs are an important part of the transition from traditional fossil fuels to clean energy, Tang noted. “However, during this transition period, the battery technology associated with EV innovation has not matured yet, which means the current generation of battery may become obsolete very quickly, maybe in one or two years,” she said. “Existing batteries have insufficient capacity and charge slowly, leading to unprecedented amounts of public and private funding being allocated to advancing battery technology research and development,” the paper pointed out.

The residual value of EVs is an important aspect of understanding lenders’ behavior. Lenders would get possession of the cars they finance either in the event of repossession if borrowers default, or at the end of a lease term. But the rapid development of EV battery technology could lower the market value of their EV loan portfolio.

“There’s also a lot of uncertainty in how much lower that market value could be, because we don’t know when the next generation of better technology will be born and commercialized,” Tang said. “So, to price in that risk or to cope with that risk, lenders charge a higher interest rate. They are passing through that risk to the household.” In vehicle leases, the study found that lenders attribute lower residual value estimates to EVs at the commencement of a lease.

In addition to technology risks, the paper listed other factors that might contribute to the high financing costs of EVs. Those include the potential of a default risk for EV loans; a relatively lower demand sensitivity with respect to price where buyers are willing to pay a higher price for their loans; and possible differences in lenders’ market power in the EV vs. non-EV loan market segments. “[But] these alternative explanations account for either little or only a small fraction of the EV spread,” the paper stated.

Key findings: EV vs. non-EV financing

The study used data covering 15 million car loans in 11 European countries, between January 2010 and August 2021 and securitized by European lenders. It focused on 10 brands of manufacturers that make both EVs and non-EVs: BMW, Ford, Honda, Hyundai, Lexus, Mercedes, Peugeot, Toyota, Volkswagen and Volvo.

Analysis of that data revealed “a systematic gap” in the financing terms between EV and non-EV models within the same car family, across different lenders, different car makes and different countries. Specifically, the gaps were as follows:

• The interest rate on EV loans was 0.29 percentage points higher than that for non-EV loans, representing 6.5% of the average interest rate of 4.5% in the study’s sample.

• The loan-to-value (LTV) ratio for EV loans was 4.7 percentage points lower than that for non-EV loans, which meant that EV buyers had to make higher down payments than non-EV buyers. The loan component in EV loans was 6.7% lower than the sample average of 70%.

• The third difference was a 2.5-month shorter loan maturity for EV loans than that for non-EV loans. It was also 5.4% lower than the sample average of a little over 46 months. The average loan size was 13,890 euros (approx. $15,000).

Citing prior research, the paper noted that consumers are “highly sensitive” to both the prices of vehicles and the financing terms offered by auto loans. “[Notably], consumers mention a lack of affordability as the primary concern when considering the adoption of EVs,” the researchers added.

The authors measured the risks associated with EV-related technologies in terms of both “intensity” and “dispersion” of innovations by analyzing trends in patent awards and venture capital investments. They gauged the “intensity” of relevant battery technology innovations, based on the number of patents granted, the importance of those patents and the dollar value of VC investments in EV-related startups. The “dispersion” aspect captures the uncertainties about the directions of future advancements in EV and battery technologies.

Next, they devised a metric they called the “EV spread” to measure how innovations in battery technology impact interest rates. They found that a higher level of their measures of the intensity and dispersion of innovations in EV-related technologies is associated with a larger EV spread. A one-quartile increase in the intensity of clean patenting widens the EV spread by 0.148 percentage points, the paper stated. Similarly, a one-quartile increase in the dispersion of battery-related technological directions widens the EV spread by 0.136 percentage points.

Conducive policy environment

The policy push for EVs is unambiguously encouraging in both the European Union and the US, as the paper noted. The EU in 2023 adopted a law that requires carmakers to achieve a 100% reduction in CO2 emissions from new cars sold by 2035. That would effectively prohibit the sale of new fossil fuel-powered vehicles in the 27-country EU bloc. The law also calls for a 55% reduction in CO2 emissions for new cars sold from 2030 compared to 2021 levels.

In the US, the Biden administration has set a goal of EVs accounting for at least 50% of all new vehicle sales by 2030. Toward that end, through its EV Acceleration Challenge initiative, it has issued a “call to action” to support that goal to the private and public sectors, including advocacy and community groups.

The Biden administration has attempted to ease the financing burden for EV buyers. Taxpayers who buy an eligible vehicle may qualify for a federal tax credit of up to $7,500, according to a Department of Energy note. That breaks up into two credits of $3,750 each for vehicles that meet the critical mineral requirements and those that meet the battery component requirements; vehicles meeting both conditions are eligible for the total tax credit of $7,500. Various states also offer their own incentives to boost EV adoption; the DoE periodically publishes updates on state-level incentives for EVs.

The paper noted that while most policy discussions focus on the affordability of EVs in terms of their purchase price, less attention is paid to the role of consumer financing of EVs. “Our research fills this gap and can inform public policies that aim at making EV financing more accessible,” the authors wrote.

“Along the whole supply chain, we have subsidies for the production and purchase of EV cars, but we have not seen any intervention related to the financing part,” Tang said.

[Knowledge at Wharton first published this piece and is a partner of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The role that the greenback plays in international portfolios is studied in a paper titled “Dollar Asset Holding and Hedging Around the Globe” by Wharton finance professor Amy Wang Huber and Columbia Business School financial institutions professor Wenxin Du. (Du was finance professor at Chicago University’s Booth School of Business when she wrote the paper.) The study scores a first in that it sheds light on the composition of dollar asset holdings and hedging patterns.

“There are various reasons why investors want to hold dollar assets. Our framework in this paper is that of a very rational investor,” said Huber. “When a foreign investor buys a U.S. security, that investor gets two returns: one on the security itself, and one from holding U.S. dollars instead of his local currency. A smart international investor who cares about the overall return as well as the overall risk in a portfolio would hold increasingly more dollar-denominated assets but would also hedge quite a bit of the exchange rate fluctuation.” The study focused on institutional investors, who as “rational investors” would want their portfolios to have the lowest risk and highest return.

Trends in dollar asset holdings

The paper identified three trends in foreign investors’ ownership of dollar assets. First, foreign investors increased their holdings of US dollar (USD) bonds and equities by six-fold from $5.5 billion in 2002 to about $33.4 billion in 2021. Significantly, a big driver of those increased holdings was a higher portfolio allocation for dollar assets, in addition to growth in the overall size of those portfolios.

Second, after the financial crisis of 2007–2009, foreign investors increased their USD hedge ratio by an average of 15 percentage points, despite higher hedging costs. (The USD hedge ratio is the share of USD assets whose returns are guaranteed to convert to foreign investors’ local currency at pre-determined exchange rates.) The hedge ratios for insurance companies, pension funds, and mutual funds were 44%, 35% and 21%, respectively, as of 2020. The total hedging demand from those three sectors was nearly $2 trillion annually.

The study’s third finding is the existence of “considerable heterogeneity,” or wide variations, in the hedging practices across countries and sectors, or in the costs for investors in managing those holdings. That heterogeneity is seen across geographies and between security types. Significantly, foreign investors tend to hedge USD bonds at higher ratios than they hedge their USD equity holdings, the paper noted.

Why foreign investors want dollar assets, but not necessarily the dollar

Huber offered an overarching reason why investors like dollar assets: “Dollar assets have been performing really well.” She noted that “realized returns” for U.S. equity over a five-year rolling basis after the 2007 Global Financial Crisis (GFC) have been “very attractive.”

As to why investors may want to hedge away some of the dollar exposure in their dollar asset holdings, Huber says that “it’s all about the risk-return trade-off.” The return of having dollar exposure is that the dollar tends to appreciate in value, but the risk is that fluctuations in exchange rates can increase the overall risk of the portfolio.

In their study, Huber and Du analyzed “the empirical covariance,” or correlation, between the return from holding the dollar as currency, and the return that a foreign investor would get by holding their domestic asset, such as local bonds or equity in their specific country. They found that often, the covariance in returns is positive between holding dollars as currency and holding local bonds, such as a German bund. “That is why a European investor will like investing in dollar assets, but they hedge a significant fraction of their dollar exposure,” Huber said.

Huber explained how their covariance analysis supported investors’ preference for holding dollar assets. “You don’t like assets that have positive covariance because when one asset does badly, the other asset also does badly. Similarly, when one asset does well, the other asset also does well,” Huber said. “You want negative covariance. When investors construct their portfolio, they like assets that are negatively correlated with each other.”

In fact, it is not always critical to have negative covariance; it is sufficient to have less positive correlation. “When investors have three types of assets, it doesn’t even matter if they are negatively correlated, as long as two of those assets are less positively correlated than the other. That is because relative to the third asset, the first two are a natural hedge in some sense; they have lower correlation.”

The covariance trends were mostly consistent over the two decades that the study covered. “Typically, this correlation structure tends to be slow-moving; we academics tend to think of it as a stable property,” Huber said. The correlation structure was estimated over the sample period that also included the Great Financial Crisis as well as COVID. “It survived all of those periods,” Huber noted. Her guess is that trend was true also of the years before 2000.

As for how international investors would be affected by Fitch’s downgrading the US from AAA to AA+ last year, “very little” was Huber’s answer. “Investors react to information. Fitch’s downgrade did not give investors much new information.” She added: “Although foreign demand for U.S. Treasury securities has flatlined in recent years, when looking across other assets, including corporate bonds, dollar-bonds issued abroad, and U.S. equity, international demand for dollar-denominated securities as a whole is robust and growing.”

Scope of the study and takeaways

The paper cited 2022 data from the US flow of funds, which showed that the “Rest of the World” category accounts for about 30% of US Treasury securities and 25% of US corporate bonds. At last count on June 30, 2022, the value of foreign portfolio holdings of US securities was $24.893 trillion, according to a press release from the US Treasury Department. The next survey, covering holdings as of June 2023, will be released in February 2024.

The authors analyzed data for foreign holdings of USD assets across seven major sectors: the official sector (comprising central banks, sovereign wealth funds, and other public financial agencies), banks, insurance companies, pension funds, mutual funds, the non-financial sector and hedge funds. In the absence of standardized data sources on investors’ dollar holding and hedging, the authors relied on company filings and industry statistics. The combined foreign holdings across those seven sectors amounted to 75% of foreign holdings of U.S. assets, and about 60% of total foreign holdings of USD securities.

The study does not include real estate and infrastructure funds since it is sharply focused on foreign holdings of USD securities. It also does not specifically include Chinese investors in its data set “because it is hard to get data on their holdings,” Huber said. But it does cover Chinese state-owned enterprises and state-owned sovereign wealth funds. “If you believe that most of the Chinese holdings are part of their official sector, they are in our data; we just can’t see that separately,” she continued. The reason for that is the data source that the study used for the official sector does not provide disaggregation. Other investments that fly below the radar are separately managed accounts of ultra-high net-worth individuals, she added.

According to Huber, the paper offered two main takeaways: First, between the pre-GFC and post-GFC periods, on average, the active investors in the sample (mutual funds, pension funds and insurance companies) increased their portfolio allocation to dollar holding by seven percentage points.

Second, foreign investors have been hedging “quite a bit” of their dollar exposure. At first sight, that “could be intriguing,” especially since the dollar appreciates during times of crisis. But “what they’re doing [with their hedging] is actually right,” Huber said. The hedge ratio would increase along with the increase of USD assets in investor portfolios, she explained. “Investors don’t want to either leave their hedge ratio to be same as before, nor would they hedge completely. What they’re doing is directionally consistent with a focus on risk and growth.”

One “hedging puzzle” persisted, which is the hedging by investors in countries with low interest-rate currencies, such as Japan or Taiwan. Considering that their expected return from holding dollars as currency would be higher compared to those from high interest-rate countries, “these countries should not hedge too much, but they actually hedge a lot,” Huber said. “That is a puzzle we raise. [But] there might be many other considerations that investors have in mind when they decide whether or not they should hedge.”

[Knowledge at Wharton first published this piece and is a partner of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Wharton marketing professor Thomas S. Robertson studies the runaway growth of resale and has an urgent message for companies reluctant to get on the bandwagon: If they don’t sell their own used products, somebody else will.

“This is a large market, and it is evolving fast,” he said. “There will be more profits to be made in this market, and there certainly are sustainability credentials to be gained in this market.”

Robertson wrote about the “resale revolution” in an article published by Harvard Business Review late last year. He recently spoke to Knowledge at Wharton about why consumers are gravitating toward secondhand items and how retailers can carve their own niche in the resale space, which is getting crowded. Retail giants Amazon and Walmart are already selling used products, along with Apple, Lululemon, Dick’s Sporting Goods and many others. “Gently pre-loved” sections are turning up in department stores such as Dillard’s. And Neiman Marcus has partnered with luxury reseller Fashionphile, letting customers drop off pre-owned luxury handbags and accessories in select stores.

“I don’t know what the future holds, but there are going to be new, omnichannel business models around resale,” said Robertson, who is also director of the Baker Retailing Center. “We’re already seeing an integration of new and used on sites like Amazon, and you see it more and more in fashion.”

Gen Z and sustainability

Robertson said the resale revolution is being driven by younger consumers, like the sophomores and juniors in his classes who tell him that sustainability is an important core value for them. The crises of climate change, plastic pollution, energy transition and food insecurity have heightened their commitment to living sustainably and wasting less.

There’s also no longer a stigma associated with used goods. On the contrary, Gen Z consumers use sustainability as a virtue signal to others that they are thrifty, conscientious and care about the environment. Robertson said his undergraduate research assistant Anoushka Ambavanekar, who helped with the HBR article, is also a strong advocate for sustainability.

“This is reverse conspicuous consumption, in a sense. It’s another form,” Robertson said. “Social media channels have a lot to do with this. Young consumers may go thrifting and then display their finds to friends on Instagram and TikTok and YouTube.”

Older consumers still matter, but younger ones wield “disproportionate influence” in retail, the professor said. They are spreading the sustainability ethos to others, making it “move up the ranks” in the factors people consider when purchasing.

For companies, reselling items helps them build a solid sustainability reputation, especially in high-waste industries such as fashion. Some fashion brands have suffered from negative publicity over wasteful practices, and resale can help them prove to fickle customers that they are committed to change.

“They do it for the long-run sales and profits, but in the short run they may not make money. So, many of them are doing it to establish their sustainability credentials,” he said.

The professor said companies needn’t be so concerned that resale encourages consumers to “trade down,” which means buying lower-priced used items instead of new, full-priced versions. He said resale can expand the customer base by giving shoppers a first rung to step onto the brand ladder.

“If you can get them on that ladder through resale, you hope to make them long-term customers who aspire to buy original merchandise,” he said. “Some of them will and some of them won’t, but the real result is that you are bringing in new customers by introducing them to products they may not have been able to buy before.”

Guidelines for success in reselling

Robertson offered some guiding principles for reselling items that he’s learned from years of research and in-depth conversations with numerous retail executives. They are:

— Make the process frictionless for customers. Retailers can do this in a number of ways, such as certifying pre-owned products for authenticity or offering store credit for trade-ins.

— Work with a third party. While it’s often better for brands to exercise total control over their resale, not every retailer has the bandwidth to create the best strategy. Enlist the help of a vendor that can manage the inventory, create a website and integrate resale into the business model.

— Appeal to the Gen Z consumer. Young shoppers are smart, so brands need to give them more than just resale opportunities. Brands need to prove that their values are aligned with their Gen Z customer.

— Build an integrated portfolio. The line between new and used may blur over time, so consider incorporating returns into resale. A vast majority of returned items are sold to discount outlets, discarded or sent abroad. Recapture some of that lost revenue by selling returned items in house.

— Start brand loyalty initiatives. Examples include credit for trade-ins or rewards programs. This practice creates lifetime customer value by keeping them with the brand.

[Knowledge at Wharton first published this piece and is a partner of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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“In terms of a grade, I would give it an A-plus for what it’s trying to do, but obviously an incomplete because they’re just starting. So, the devil will be in the execution details,” Fisher said during an interview with Wharton Business Daily on SiriusXM.

The new White House Council on Supply Chain Resilience was announced last month as part of nearly 30 new actions to strengthen supply chains described as critical to economic and national security. The actions include using the Defense Production Act to increase domestic manufacturing of essential medicines, along with a number of administrative measures to share data and develop a better strategy to deal with the types of disruptions that left store shelves bare during the worst of the COVID-19 pandemic.

The pandemic has subsided, yet the shortages persist, raising concerns about offshoring and higher prices amid dwindling supplies. From 2021 to 2022, retail food prices rose by 11%, the largest increase in 40 years, according to government data.

Fisher, a professor in the department of operations, information and decisions, said Biden’s plan is a bit of a “novel approach” to attacking inflation. Typically, the Federal Reserve takes the lead on combating inflation by raising interest rates to temper demand. The Fed has raised the benchmark rate 11 times since 2022.

“What is inflation? It’s an imbalance between supply and demand,” he said. “So far, we’ve focused on reducing demand. But this gives us a second approach: Let’s make sure also that we improve supply by avoiding disruptions to supply chains.”

What production is essential?

Offshoring has always been around, but it became widespread across industries in the late 1970s when China began investing in low-cost manufacturing, Fisher said.

“Instead of getting something from 100 miles away, you’re getting it from halfway around the world. And that’s when you realize that it’s low-cost, but it’s also very vulnerable,” he said. Factories can shutter for a host of reasons — natural and man-made disasters, war, political instability, the list goes on.

Bringing more production back to the US would help with shortages, but Fisher said the new council will have a tough time figuring out what products are so essential that they should be made on American soil. He described himself as a “skeptic” on domestic manufacturing and pointed out the many advantages of participating in the global economy. Trading with other nations creates allies and builds influence. In that context, Fisher said, the US has more to gain from being friends with China than enemies. The same goes for many Central and South American nations from which immigrants come seeking greater economic opportunity.

“There’s a saying that when trade crosses country boundaries, armies don’t,” he said. “A critique I have of generally bringing manufacturing home to the US is there are also advantages to sourcing from other countries and having strong relationships with as many countries as we can.”

Fisher is also critical of what’s missing in Biden’s plan: specific mention of the less developed nations that make much of the world’s goods, such as Bangladesh. Instead, Canada, Mexico, the European Union, the United Kingdom, Japan and several other developed economies are named.

“When I look at the list of countries involved in this initiative, I would add to that list less developed nations, which are important to developed nations as a source of low-cost supply,” he said.

Supply resilience is in vogue

Fisher has spent more than 35 years studying supply chains, examining industries as diverse as transportation and fashion. Before joining Wharton in 1975, Fisher was a systems engineer in the Boston Manufacturing and Distribution Sales office of IBM and on the faculty of the University of Chicago Graduate School of Business. He doesn’t recall a time during his experience when supply chains were part of daily conversations among Americans as they are now. Recent product shortages of antibiotics, baby formula, computer chips that power most electronics, and other everyday items have people talking.

“Be careful what you wish for,” he said with a chuckle. “All my career, I’ve pretty much labored in obscurity, studying supply chains. Suddenly, it became front-page news, but not exactly good news.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Over the past decade, mobile money has emerged as a dominant force, particularly in regions like sub-Saharan Africa, Latin America and South Asia grappling with inadequate infrastructure in credit markets, commonly referred to as “institutional voids.” These voids impede access to financial products and services, hindering the growth of businesses and limiting economic productivity. The study by Agarwal and Assenova shows how mobile money platforms, through unique features and mechanisms, effectively fill these institutional voids, fostering financial inclusion and economic development.

“Mobile money platforms help out in places where credit information is missing and infrastructure isn’t well developed,” said Agarwal, the paper’s lead author. “Mobile money platforms provide alternative data and fill for the infrastructure gap, causing positive spill-over effects on economic activity for various players in the market.”

Mobile money boosts financial inclusion in three critical ways

Named after the Swahili word for “money,” M-Pesa’s expansion into Ethiopia signifies a transformation in the financial landscape. These platforms stand out by not only capturing economic value but also creating it, disrupting existing industries and expanding market transactions. The distinctive features of mobile money platforms include data-driven business models, distributed value creation and “network effects,” where the value of the service increases for both users and service providers on the platform as more people use it.

The authors argue that these features empower mobile money platforms to address institutional voids in credit markets in three critical ways.

1. Creating a digital record of financial activities.

First, they verify users by assessing digital data on the platform. Mobile money operators play a pivotal role in providing alternative means for lenders to assess creditworthiness, especially for people lacking established credit history. By creating a digital record of users’ financial activities, platforms like M-Pesa enable lenders to make informed decisions on loan approvals. “These platforms create a digital record of users’ financial activity, such as their recent transactions — data that can help lenders make decisions on whether someone is able to pay back a loan,” Agarwal explained.

2. Simplifying access to financial services.

Second, they offer simplified access to financial services. Through their decentralized networks, mobile money platforms connect various financial services and products from partners like banks. This one-stop-shop approach fills gaps caused by limited access points, such as bank branches, in emerging economies, facilitating the distribution of financial products. “Mobile money is providing a one-stop-shop to access a whole range of financial services,” Agarwal said.

3. Establishing a massive network of users.

Third, these platforms leverage network effects to speed up their growth, allowing them to quickly expand and reach millions of new users who previously didn’t have access to banking services. M-Pesa has more than 51 million customers across seven African countries. This not only enhances financial access but also serves as a bridge to established financial groups like banks, credit unions and microfinance institutions, facilitating credit access for individuals and businesses alike.

“These loans help individuals and small businesses expand their growth and enhance their productivity. In the absence of credit, small businesses cannot grow,” Agarwal said, highlighting the deficiencies in traditional financial systems.

Policy reforms can broaden financial inclusion and sustain growth

To reach these conclusions, the study delved into the impact of regulatory changes that allowed non-banking entities, including mobile network operators and fintech start-ups, to introduce mobile money platforms. Analyzing data from more than 71,000 adults before the reforms in 2014 and some 80,000 adults after the reforms in 2017 across 78 countries, the authors discovered that initially, only 11% had access to formal financial services. Post-regulatory changes, mobile money usage increased and access to credit from formal financial institutions rose significantly, with the reforms leading to a 22% rise in the likelihood of borrowing.

“The increase was even more significant for women, the poorest individuals and those with limited education,” said Agarwal, indicating that mobile money platforms have played a crucial role in broadening financial service access in emerging and developing economies.

The research carries significant implications for policymakers and regulators. The findings suggest that regulatory reforms welcoming new entrants into the financial services sector can potentially boost financial access. “By enabling the launching of these platforms, governments can promote more collaborations between mobile money platforms and traditional financial institutions, thereby fostering innovation and co-creation in the financial sector,” said Assenova. “This provides more products and services on the rail of mobile money, so policymakers can contribute to sustainable growth and development.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The authors focused on Apple’s App Tracking Transparency (ATT) policy, which by default opts out users on Apple’s iOS platform from sharing their data. They found that a 10% increase in the number of iOS users in a given zip code results in a 3.21% drop in financial fraud complaints from that location. The study also found that “the effects are concentrated in complaints related to lax data security and privacy.”

The drop in financial fraud complaints could grow tenfold if tight privacy laws are universally applied. “If the whole population of [cell phone] users on both the iOS and Android platforms were subject to a policy like the ATT, then the number of financial fraud complaints should drop to 32%, assuming the effect scales up linearly,” Tang said.

Apple’s ATT policy, which was launched in April 2021, required all app providers to obtain explicit user permission before tracking them across apps or websites owned by other companies. Consequently, without a user’s permission, Apple would not provide those apps and websites with so-called “mobile identifiers.”

Although the ATT policy only applies to mobile users, it has implications for commercial surveillance and fraud among the general population due to the prevalence of smartphones, the paper pointed out. After the ATT policy, companies with an app are 42% less likely to experience cyber incidents, compared to firms without an app, it added. The paper described the implementation of ATT as “an event that enhances data security and privacy standards.”

A shock to the data industry

The ATT policy dealt “a major shock to the data industry,” especially providers of mobile apps that are available on the Apple App Store or the Google Play store, the paper stated. As of February 2022, 82% of users refused to grant permission to track them, or only 18% of app users allowed tracking among those who were asked for such permission, according to Flurry, a mobile advertising company.

According to Tang, Meta’s Facebook tops the list of ATT casualties. “Facebook is the largest victim of Apple’s privacy campaign, because 98% of Facebook’s revenue comes from targeted ads,” she said. In February 2022, Facebook’s share price plunged a record 26% after it announced its 2021 fourth-quarter results, where it blamed Apple’s privacy laws and macroeconomic challenges for its forecast of lower revenues in the subsequent quarter. Apple’s privacy policy would cost the company $10 billion in 2022, Facebook had warned. The implementation of ATT also caused sharp falls in the stock prices of other firms that own active iOS apps, the paper noted, citing a companion paper on data privacy in mobile apps that Tang co-authored.

Tang explained how exactly the ATT hurt Facebook. In order to target consumers for advertising, Facebook needs to link different pieces of data from various sources about the same individual using a mobile identifier that links all of the individual’s mobile devices and that links all user choices from different websites, she explained. But after ATT, Facebook couldn’t use mobile identifiers unless iOS users explicitly agreed to share their data with a third party, she added.

Facebook’s loss, Apple’s gain

Apple, in contrast, benefited because its users were happy that it was taking steps to protect their privacy, Tang said. “Apple’s privacy campaign is self-serving because it allows the tech giant to tap into the targeted ad industry,” she continued. “And its largest opponent besides Google is Facebook. By taking down Facebook, there’s a void to be filled.” Incidentally, France’s competition authority and Italy’s antitrust agency accused Apple of abusing its dominance in the market to set unfair conditions.

Apple stepped in later with crowd-level targeting, where it could use aggregated information of specific communities of users it created, Tang added. Other platforms that wanted to target Apple users had to adopt that approach, which allows “less refined targeting,” she explained. As Apple’s guide to search ads states, “targeting specific audiences will prevent ads from appearing to users who have turned off the Personalized Ads setting.”

Apple had begun tightening the screws on data privacy more than a year before it launched the ATT policy, the paper noted. In December 2020, Apple introduced “nutrition” privacy labels, which required all developers to provide information about their data practices in a standardized and user-friendly format. Developers who failed to comply with that policy faced the risk of having their future app updates rejected by Apple’s app store.

In July 2022, Google too launched data safety forms on its Google Play platform, which also required firms to disclose the types of data they collected from users and how they would use that. Google’s data safety form also required disclosure of data security practices, including whether the user data is encrypted during transit.

How the study tracked financial fraud

The authors began with detailed foot traffic data from Safegraph (a provider of datasets on global places) to calculate zip-code-level shares of iPhone users out of all smartphone users. Next, they analyzed data from the Consumer Fraud Prevention Bureau (CFPB) and the Federal Trade Commission (FTC) on the number of financial fraud complaints and the amount of money lost due to fraud. They then applied the 82% opt-out rate of ATT to arrive at their finding of a 3.21% reduction in financial fraud complaints.

Significantly, the study found that trends in the likelihood and number of financial fraud complaints were more pronounced among minorities, women, and younger people, suggesting that these groups are more vulnerable to surveillance and fraud. Those findings contribute to the process of creating new regulations and rules to enhance consumer data protection and privacy, the paper stated.

To isolate CFPB complaints that relate to financial fraud originating from lax data security, the authors used keyword searches to look for indicators such as fraud, scam, or identity theft. They used that in combination with a machine learning method that generates a likelihood of complaints being related to financial fraud caused by data security issues.

Main findings of the study

— A 10% increase in the number of iOS users in a given zip code results in a 3.21% drop in financial fraud complaints from that location.

— About 26% of financial companies listed in the CFPB complaints database own an app, and 11% of them collect and share user data with third parties, such as data brokers, other websites, and advertising networks. The effect of ATT on consumer complaints is more pronounced for companies that are active in the app market, share user data with third parties, or do not encrypt user data in transit.

— Complaints of financial fraud are more likely in categories like credit reporting and debt collection than in others like student loans and mortgages. Specifically, the ATT policy reduced the number of financial fraud complaints about credit reporting and debt collection in a zip code by 2.48% and 0.61%, respectively, when it has 10% more iOS users.

— The ATT policy helped reduce money lost in all complaints by 4.7%. Of that, the money lost as reported in internet and data security complaints would be about 40% less with the ATT policy.

Regulatory reforms

“Our results provide compelling evidence in favor of industry-led regulations aimed at constraining consumer surveillance practices,” the paper stated. Tang recently presented her findings to the FTC, which she said is eager to use her paper’s findings in its efforts to frame future regulation on data privacy and security.

“For their cost and benefit analysis, the FTC was interested in the cost to consumers when firms collect excessive amount of data, but it is very hard to find empirical evidence of that,” she said. “This is where our paper comes in. We provide a point estimate.”

According to Tang, Apple’s efforts at strengthening data privacy for cell phone users have advantages over the European Union’s General Data Protection Regulation (GDPR) that was launched in 2018. She said users have found it cumbersome to navigate the privacy notices of firms that pop up on their screens, especially because they are not standardized and require multiple clicks before they can understand how their data might be used. A CNBC report referred to that experience of users as “consent fatigue.”

The paper pointed to other efforts that are underway to limit data transfers across firms, including Google’s plan to phase out third-party cookies in Chrome by 2024. Similar to the GDPR, laws in Virginia and Connecticut require opt-in consent for sharing sensitive personal information, according to a report by OneTrust, a firm that advises companies on issues including privacy standards. Other privacy laws in California, Colorado, and Utah follow an opt-out mechanism for consent in most areas, it added.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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“Informed AI traders can collude and generate substantial profits by strategically manipulating low order flows, even without explicit coordination that violates antitrust regulations,” warned a research paper, titled “AI-Powered Trading, Algorithmic Collusion, and Price Efficiency,” by Wharton finance professors Winston Wei Dou and Itay Goldstein and Yan Ji, professor of finance at the Hong Kong University of Science and Technology.

Quantitative hedge funds and leading investment firms like BlackRock and JP Morgan are already using AI, and that trend is gathering momentum across the financial markets. The SEC recently gave the green light to Nasdaq’s AI trading system, which utilizes reinforcement learning (RL) algorithms for making real-time adjustments. Wall Street has been clear so far of a scandal over AI-powered abuses, but the threat of that is palpable, according to Dou.

Red flags on AI in retailing, manufacturing

Dou pointed to the Federal Trade Commission’s recent lawsuit accusing Amazon of using a secret algorithm to manipulate prices. “AI collusion in retail markets could drive prices to super-competitive levels as the algorithms learn to achieve and maintain coordination without any form of agreement, communication or even intention,” he said. “Retailers and manufacturers have an incentive to gain market power without improving their product qualities. That’s why antitrust regulators are very nervous about this.”

Dou said their paper addresses those very concerns. “We have seen the rise of adoption of AI trading in financial markets, so naturally we would ask similar questions — whether AI collusion will arise in the financial markets,” he said. “If that’s the case, the question is whether we will see important adverse real consequences. If there’s AI collusion in the financial markets, market liquidity and price informativeness may be hurt.” Put another way, he said the worry is whether the markets will effectively facilitate liquidity and if market prices will reflect “real fundamental information.”

Goldstein noted that, the Amazon case apart, there is an increasing worry about AI collusion in several other markets. “Our main question is whether something like that might be happening or could happen in financial markets. Financial markets generate another type of environment with their own nuances and complications.”

The broad reach of financial markets

Goldstein said he and his co-authors focused on financial markets for potential bad outcomes of AI-powered collusion because of the broader impact they have. “The way prices are formed in financial markets ends up having a real effect,” he said. “Firms rely on financial markets to a large extent (such as to raise capital), and so we need to understand the price formation process.”

Another reason the paper’s authors picked the financial markets is because of a paucity of research on their specific concerns. “There’s no scientific study on the outcomes and how AI trading would affect the market efficiency, including factors like price informativeness, market liquidity, and mispricing,” Dou said. The authors stated: “Our paper is one of the first few that study how the widespread adoption of AI-powered trading strategies would affect capital markets.”

The paper noted that the “integration of algorithmic trading and reinforcement learning, known as AI-powered trading, has significantly impacted capital markets.” Drawing from that observation, the authors created a virtual laboratory where they could study the effects of collusion between autonomous, self-interested AI trading algorithms. They developed “a model of imperfect competition among informed speculators with asymmetric information to explore the implications of AI-powered trading strategies on informed traders’ market power and price informativeness.”

A lab to study AI behavior

Dou said their laboratory captures in a transparent manner the important features of the real financial market such as information asymmetry, price impact and price efficiency. Within this laboratory, they ran trading algorithms to study their behavior and assess their influence on market liquidity and the informativeness of prices.

According to the paper, algorithmic collusion arises from two mechanisms: collusion through homogenized learning biases and collusion through punishment threat as in a price-trigger strategy. Biased learning, also known as “artificial stupidity,” arises because of insufficient learning about play at off-the-equilibrium-path information sets. Such learning biases are homogenized among AI traders due to the shared foundational models upon which they are developed. The collusion through the threat of punishment occurs to deter members of a cartel from breaking away, or “deviate from tacitly agreed upon behavior,” Dou explained.

In product markets such as the OPEC oil cartel, members can monitor deviations from agreed-upon behavior by tracking prices and volumes, and then hand out punishments to cartel-breakers such as blocking them from profitable deals. But high-frequency trading in the financial markets makes it difficult to monitor cartel-breakers. That is where AI-powered trading algorithms can learn to automatically trigger penalties for deviant behavior that market prices may reveal, Dou said. “Such collusion will incentivize all AI algorithms to stay within well-behaved trading strategies. No one will trade too aggressively relative to others.”

The upshot of that is that price informativeness will be hurt, due to market manipulation. “In a market with prevalent AI-powered trading, price efficiency and informativeness can be compromised due to both artificial intelligence and stupidity,” the paper noted.

Understanding the psychology of machines

In the lab they created, the paper’s authors became detectives looking for ways in which AI-powered trading algorithms might learn to collude without being detected. “What we were looking for is implicit collusion that occurs between machines,” Goldstein said. “They come to behave in a way that is difficult to detect. And that’s what we tried to figure out through this paper.” Added Dou: “The collusion automatically happens, even when each machine is 100% autonomous without any communication or intention of coordination.”

The lab studies showed the conditions under which collusion thrives. “Collusion through punishment threat (artificial intelligence) only exists when price efficiency and information asymmetry are not very high. However, collusion through homogenized learning biases (artificial stupidity) exists even when efficient prices prevail or when information asymmetry is severe,” the paper stated.

In order to study the way collusion among AI-powered trading algorithms can occur, the authors have to understand how machines think, so to speak. “Comprehending the dynamics of capital markets with the prevalence of AI-powered trading algorithms requires insights into algorithmic behavior akin to the ‘psychology’ of machines,” the paper stated.

What the study found

The study’s main findings included:

profits by strategically manipulating excessively low order flows,
even in the absence of agreement or communication that would
constitute an antitrust infringement.

— In scenarios where so-called “preferred-habitat investors play a
substantial role in price formation, resulting in prices that are
not highly efficient, tacit collusion among informed AI-
powered speculators can be sustained through the use of price-
trigger strategies.” (Preferred-habitat investors are typically
long-term and insensitive to new short-run information.)

— How effective AI collusion is depends on the level of information
asymmetry in the market: To maintain collusion via a price-
trigger punishment threat mechanism (artificial intelligence), the
level of information asymmetry must not be too extreme, and
there should not be an excessive number of informed
speculators, conditions that mirror real-world scenarios.

— In the scenario with high price efficiency or high information
asymmetry, tacit collusion between AI-powered speculators can
still be achieved through homogenized learning biases,
reflecting artificial stupidity.

Regulators on a vigil

Regulators are on high alert. Security and Exchange Commission chair Gary Gensler recently cautioned against “the possibility of AI destabilizing the global financial market if big tech-based trading companies monopolize AI development and applications within the financial sector,” the paper noted. “[Regulators] have repeatedly highlighted the potential for AI to inadvertently amplify biases that could lurk in their designers, further jeopardizing competition and market efficiency.”

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The findings of the paper serve as an early warning signal to both investors and regulators who want to prevent price distortions — and the broader implications of such distortions on the capital markets. But more research is required to draw insights that weigh both the good and bad outcomes of AI power, Goldstein said. “If you want to think about whether overall, AI technologies are helping or hurting the discovery of information through prices, broader investigation is needed for that. Our study brings to light one potential adverse effect.”

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The purchase checks off several boxes at once that make it a “remarkable deal,” as Singh put it. With Activision in its portfolio, Microsoft can leapfrog from its modest Xbox platform to one that is severalfold bigger, he said. It can also gain a “time-to-market” advantage that organic growth cannot provide like an acquisition can.

Microsoft will provide Activision Blizzard with both access to capital from its deep pockets and its “ecosystem” that includes gaming enthusiasts across platforms such as those built around the Android operating system, Singh said. The deal also helps Microsoft gain a foothold in markets that have grown around mobility, cloud, and streaming. Microsoft overcame challenges from regulators in multiple countries who worried about potential anti-competitive outcomes, The New York Times reported.

Singh noted that investors revealed how they expected the deal to weaken the outlook for Microsoft’s rivals: Sony’s stock dived 13% on January 13, 2022, when Microsoft announced its bid for Activision Blizzard; it has since lost 28% to last week’s close of $80. “It was a significant impact on what people saw as [Sony’s] PlayStation oriented gaming business.”

What Microsoft gains with Activision

As Singh put it, in one shot, the Activision purchase enables Microsoft to shorten time-to-market with new gaming products, expand its reach and deepen its penetration in those markets. Microsoft had tried some of those with offerings around its Xbox video game console system, he noted; it recently marked 40 years in the gaming business.

“Activision Blizzard gave [Microsoft] large numbers of users with Candy Crush and Call of Duty and other such games, and also multiple platforms including the mobile, the cloud, and many others,” Singh said. In a note after the purchase, Microsoft Gaming CEO Phil Spencer was effusive about welcoming Activision into his company’s fold.

With Activision Blizzard in its fold, Microsoft can also hope to change the way gaming enthusiasts perceive it. Singh noted that Microsoft “never really had enough of a strength in the entertainment area.” While Apple demonstrated how it can offer users a seamless experience on mobile devices, Microsoft’s Xbox was seen as “a hardware-based second platform” that had its primary focus on its MS Office platform, he added.

“When Satya [Nadella] came in [as CEO in 2014], he had to reset back to the mobile business.” That meant providing its community of software developers “the visibility and the resources” to create apps for entertainment products, he added. “[For developers], it’s also no longer a desktop – it’s the mobile platform, it’s the cloud, it’s streaming. It’s all those possibilities.”

Organic growth not an option

In closing the Activision Blizzard deal, Microsoft is also falling in step with “the remarkable pace” at which tech companies have been growing, Singh said. “Just a few years ago, [tech companies] were relatively skittish about making acquisitions because they worried about loss of talent, which is a real issue, and also about differences in organizational culture. But Microsoft has gone into this with both feet.”

In the fast-moving gaming market, acquisitions bring both new sources of revenue and opportunities to sell across platforms. But there is also a sense of urgency about acquisitions: “Firms are recognizing that internal development is a bit slow,” he said. Sure, firms don’t have to worry about overcoming cultural differences that acquisitions bring up, “but sometimes you don’t win with your internal products,” he added. “Partnerships are useful, alliances are useful.”

For companies that are getting disrupted by startups, the options are to either “buy the startups or partner with a startup that’s winning in their space,” Singh continued. “You’re going to make some mistakes, but then those mistakes are small in relation to the payoff if you get some of these [acquisitions] right.”

In settings where time-to-market is a crucial differentiator, another driver for acquisitions is the tradeoff between “market value versus replacement value,” Singh said. He considered the questions a company like Microsoft would likely face: “What would it take to replace Activision through Microsoft’s own activities, whether it’s internal [development] or through partnerships? These are not tradable assets. You have to buy them. If they don’t want to partner with you, there’s no other choice.”

Acquiring a firm like Activision Blizzard is a persuasive option for Microsoft, which already has its Xbox ecosystem, he said. “You realize you’re not winning a particular race, but you have complementary assets. There’s value on both sides here.”

Making the deal work with a culture fit

Now that Microsoft has bagged Activision Blizzard, it must avoid the familiar trap of a clash of cultures. “This is where tech firms have had a long history of failures,” Singh said. Acquiring companies try to enforce their systems or their way of doing things or impose their bureaucracy on the acquired firm, he explained. “That is a real danger that [Microsoft faces].”

Having said that, Microsoft “seems to have done well with many of their more recent acquisitions; this is something that they have to continue to follow,” Singh continued. “Luckily Microsoft’s image is positive and that can be helpful. But that’s not enough. You know you need to ensure that the innovation engine remains intact.”

Microsoft demonstrated its comfort with a hands-off approach after it bought LinkedIn in 2016, disproving naysayers, he recalled. “They left LinkedIn largely alone.” His advice for Microsoft was to follow that template with Activision Blizzard, giving it both autonomy and the resources to innovate and grow.

In addition to access to capital, Activision Blizzard gets “the scale of Microsoft,” and it could tap into “a menu of complementary resources” from Microsoft, such as connecting to its cloud platforms, he added.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Envisioning a solution for Portugal’s drug addiction problem

In 1999, Lisbon carried the moniker of the “heroin capital of Europe.” Consequential diseases such as HIV infection reached an all-time high in 2000, with 104.2 new cases per million people. A multi-partisan party coalition backed sweeping and coordinated change. Portugal redefined the problem of addiction and correspondingly envisioned a very different approach to addressing it compared to other countries, an approach that de facto followed the change model presented in Leading Successful Change.

First and foremost: Portugal defined addiction as an illness. Second, Portugal eliminated the distinction between hard and soft drugs. Third, Portugal concentrated on an individual’s unhealthy relationship with drugs and the likely accompanying frayed connections between the addict, others and the world at large.

To quote João Goulão, architect of the program, physician and head of the General-Directorate for Intervention on Addictive Behaviors and Dependencies within Portugal’s Ministry of Health: “Our first goal is to help people to resume their dignity [and the first task is getting them] the citizenship tools that they need — an identification card and a health card. … [After stabilizing their drug use] I can ask more from them, but always with them being assisted with those new focuses.”

Decriminalization: one part of Portugal’s eight-part change strategy

Portugal, in effect, set out to alter the environment around drug addicts in order to alter their behavior and, thereby, to reduce addiction and its toll on individuals and on society overall.

The Work System Model (WSM) presented in the book Leading Successful Change: 8 Keys to Making Change Work offers a way to understand Portugal’s approach, namely addressing eight aspects of the work environment that shape individual behavior — eight aspects that can become eight levers of change.

1. Organization: Move from the court system for incarceration to the Commissions for the Dissuasions from Drug Abuse (CDTs) made up of professional, technical experts.

2. Workplace Design: Construct mobile teams to provide care to addicts on the street.

3. People: Staff mobile teams with professional experts.

4. Task: Implement work processes to test, administer treatment (including often first-time primary care) and exchange syringes.

5. Rewards: Decriminalize possession of small amounts of drugs (i.e., not legalization) and encourage addicts to seek treatment or to face penalties (such as fines, just not jail). Assist addicts with finding employment. Drug traffickers still go to jail.

6. Measurement: Track the various costs of drug addiction, e.g., public health, addiction levels, unemployment, crime and total cost to society.

7. Information Distribution: Educate the public (especially addicts) about this disease, its treatment as well as their healthcare and overall life options in the service of an enhanced sense of agency.

8. Decision Allocation: Give treatment officials the power to make decisions about drug users instead of police officers.

These eight aligned aspects produced recurring and desired scenes covering the cycle of recovery and reentering society as a functioning member, e.g., finding employment or receiving ongoing medical care, including screening for HIV, methadone treatment and syringe exchange. As an illustration of these aspects applied, consider the following scene for a person identified as possessing illegal drugs:

Police take the person to a police station and weigh the drugs. If the weight exceeds amounts specified for personal use, then the person is charged and tried as a drug trafficker and can receive prison sentences of 1–14 years. Otherwise, the next day, the person appears at the Commission for the Dissuasion of Drug Addiction for an interview by a psychologist or social worker. Next comes an appearance before a three-person panel that will provide guidance about how to stop drug use.

A fast track leads the person to any accepted services. Refusal of such services can lead to required community service, a fine and confiscation of belongings to pay the fine.

In summary, drug possession remains illegal, drug possession for personal use is decriminalized and comprehensive treatment and recovery options become available as a viable next step for the identified user of illegal drugs.

Initial results of Portugal’s new drug policies

By 2018, Portugal’s number of heroin addicts had dropped from 100,000 to 25,000. Portugal had the lowest drug-related death rate in Western Europe, one-tenth of Britain and one-fiftieth of the U.S. HIV infections from drug use injection had declined 90%. The cost per citizen of the program amounted to less than $10/citizen/year while the U.S. had spent over $1 trillion over the same amount of time. Over the first decade, total societal cost savings (e.g., health costs, legal costs, lost individual income) came to 12% and then to 18%.

International acclaim for Portugal’s originally maligned “experiment” came from sources as varied as the American Psychological Association, Vancouver Sun and The Guardian. Still, in 2017, The Guardian reported local frustration with inaction regarding supervised injection sites, overdose treatment and needle exchange programs in prisons. In short, some feared insufficient recognition of the ongoing need to maintain “a web of health and social rehabilitation services.”

The unraveling of a system — decriminalization is still just a part of a larger issue

Two forces have led to the at least partial unraveling of Portugal’s efforts over the last few years and, predictably, to less favorable results. First, global drug traffickers continued to use Portugal as an entry point for access to Europe’s illegal drug market dealers. They battered the entry points of this coastal country, hence a supply of illegal drugs continued. Second, Portugal reduced resourcing of its programs as the country faced multiple difficult economic years.

The financial crisis of 2007–2008 led to program cuts, held to 10% due to continued bipartisan support, initial successes and demonstrated long-term benefits. Still, significant program (system aspects/levers) compromises occurred, e.g., the extent of research and measurement of results. Ongoing ripple effects followed from cost-cutting through the elimination of government assistance for employing recovering users (often in smaller businesses), which hamstrung efforts to reintegrate users into society (and contributed to the closing of numerous small companies.)

Funding ebbed still more recently due to new national budget pressures, which undercut efforts encouraging addicts into rehabilitation programs. The results of “disinvestment” and “a freezing in [their] response” led Goulão to state that “what we have today no longer serves as an example to anyone.”

Speaking more quantitatively, drug users in treatment declined from 1,150 to 352 (from 2015 to 2021) as funding dropped in 2012 from $82.7 million to $17.4 million. Budget pressures and the apparent desire to cut immediate program costs of drug addiction (distinct from the total societal cost of drug addiction) led to program decentralization and the use of NGOs. Anecdotal evidence of a fragmenting, even breaking, system abounds: Demoralized police no longer cite addicts to get them into treatment and at least some NGOs view the effort as less about treatment and more about framing lifetime drug use as a right.

The number of Portuguese adults who reported prior use of illicit adult drugs rose from 7.8% in 2001 to 12.8% in 2022 — still below European averages but a significant rise nonetheless. Overdose rates now stand at a 12-year high and have doubled in Lisbon since 2019. Crime, often seen as at least loosely related to illegal drug addiction, rose 14% just from 2021 to 2022. Sewage samples of cocaine and ketamine rank among the highest in Europe (with weekend spikes) and drug encampments have appeared along with a European rarity: private security forces.

A few lessons from the rise and decline of Portugal’s drug policy

1. Design a system by working backward from what you want it to deliver, i.e., the behaviors desired.

Implication: Carefully construct the desired stories and then carefully consider which system aspects, if changed, might deliver those stories or outcomes. Keep all of that in full view and, like the Portuguese, change everything — or at least everything that you can. Francisco Rodriguez, president of the Order of Portuguese Psychologists, demonstrated this by noting, “You cannot work with people when they’re afraid of being caught and going to prison … It’s not possible to have an effective health program if people are hiding the problem.”

2. “If you want truly to understand something, try to change it,” said Kurt Lewin, often called the father of social psychology. Restated: Changing enables learning … if you’re paying attention.

Implication: Carefully monitor which coordinated system changes most affected outcomes. Beware, even amidst financial hardship, to cut back on measurement and research, i.e., key ingredients to ongoing learning and program improvement.

3. Altering a system that produces desired behavioral outcomes necessitates careful monitoring.

Implication: Systems generate outcomes and altering aspects of those systems, especially multiple aspects of them, can easily lead to unanticipated and undesired changes in outcomes. Systems require maintenance. Sustaining change does not just happen. Changing enough aspects of a system changes the system and, therefore, the behavior it generates.

4. To code the case of Portugal’s illegal drug initiative (as with many attempts at change) as a binary choice — in this case, to decriminalize drugs or not — misrepresents the change effort required and, consequently, how to sustain it.

Implication: To paraphrase an aphorism often attributed to Einstein, “Everything should be made as simple as possible, but no simpler,” i.e., Beware of silver bullets and binary choices when envisioning, designing, implementing and sustaining change. Think systems. As Goulão said, “Decriminalization is not a silver bullet … If you decriminalize and do nothing else, things will get worse.

The model presented in Leading Successful Change will help you act in accord with these lessons and succeed in changing your organization and in sustaining that change.

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post No Simple Answers For Portugal’s Drug Decriminalization Policy appeared first on Fair Observer.

It’s the sixth time that the Central European nation has grabbed the top spot in the eight years the rankings have been around, including last year.

“Switzerland has been a perennial and a winner in this particular assessment,” Wharton marketing professor David Reibstein, who helped create the rankings, told Wharton Business Daily. “They are economically stable, they’ve got great education, and it’s one of the top countries people say they would like to live in.”

Canada comes in as a close second, moving up from third place last year. Sweden, Australia and the United States round out the top five, respectively. Despite the high marks of these countries, it’s hard to beat Switzerland, which also landed perfect scores for being “open for business” and offering “a comfortable retirement.”

“Switzerland is very high in terms of quality of life and entrepreneurship. It’s just a really stable and safe country,” Reibstein said.

The professor produces the rankings in partnership with U.S. News & World Report and WPP, a global marketing and communications services company. The 2023 list measures perceptions about 87 nations chosen because they contribute most to the world’s GDP. More than 17,000 people around the world were asked to evaluate the countries based on 73 attributes ranging from political stability to racial equity to health consciousness. One third of the survey respondents were business leaders, one third were college-educated individuals who were middle class or higher and one-third were from the general population.

More than just interesting trivia, the list has become a sort of competition for many countries because it relies on scientific data analysis. Reibstein said he’s frequently contacted by country representatives who ask what their nations can do to improve their overall rank.

“This has an impact on tourism, on foreign direct investment and on foreign trade,” said Reibstein. “Those are the three major components of the GDP of a country, and these factors are indicative of how much people are willing to visit a country or how much they are willing to do business with a country.”

The nations of North America

The United States dropped from fourth to fifth place this year and has been hovering around the same spot since the rankings began in 2016. The exception was its low point of eighth place in 2018. Reibstein attributed that slide to fallout from the contentious presidential election of Donald Trump, which changed global perceptions about the US.

This year, the US hit the highest marks for agility, entrepreneurship and power, but it ranked 23rd for quality of life and a shockingly low 59th for being open for business. “That’s primarily based on the cost of labor,” Reibstein said. “People don’t want to move their manufacturing to the United States because the cost of labor is really high.”

Canada fared much better on those sub-rankings and achieved an overall score of 99.3, which is very close to Switzerland’s perfect 100. “Canada is No. 2 for totally different reasons than the United States,” Reibstein said. “They’re perceived to have a great quality of life and also a very strong social purpose. Even though the countries are right next to each other and located in North America, they are perceived as very, very different, and what they bring to the table is obviously very different.”

Mexico ranked 33rd overall, the same as last year. While it received high numbers for adventure, heritage and cultural influence, it fared poorly along business rankings.

France, Germany and the UK

Reibstein noted two European nations that have been struggling to climb up the list: the United Kingdom and France.

The UK ranked third when the list premiered, and it has steadily gone down. It’s No. 9 this year. Reibstein pinpointed the likely cause as the turmoil around Brexit and political leadership. The country is on its fourth prime minister, Rishi Sunak, in eight years.

France has fallen out of the top 10 for the first time. It landed this year at No. 12, behind Norway. “France has really taken a dive downward,” Reibstein said. “Some of that is because of all the [political] strife that’s been happening in the country and terrorist acts that have happened there over the years.”

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The professor also noted Germany, which was No. 1 when the rankings premiered and has bounced around the top 10 since then. “Some of that has been changing leadership, some of that has been taking in [immigrants],” he said. “They’re down right now at No. 7, which is the lowest they have been in the eight years of the study.”

China’s power

China slipped from No. 17 last year to No. 20 this year, but it ranked second behind the US in power, a reflection of its strong political and economic influence in the world.

“There’s probably no country for which there is greater divergence of perceptions than China,” Reibstein said. “There are some people that totally admire China, some that detest some of the practices of China and almost universally there’s fear of China. Part of that fear is the power that they have.”

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But China’s massive economy is slowing, with capital investments generating more debt than growth and a slump in the property sector. “I’m really interested to see what happens in next year’s rankings, when we see some of the downturn in the economy and how that affects things,” he said.

India Is a “Rising Star”

India is inching up slowly, from No. 31 last year to No. 30 this year. Even though it hasn’t cracked the top 10, Reibstein said he’s keeping an eye on the country. India doesn’t score well on social purpose, but it ranked fifth as a mover.

“People believe India is a country to invest in, and a country they believe is going to be a rising star,” he said. “If you want to bet on development in any country, India is the one that a lot of people put their money behind.”

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The top 10 were, in order, Switzerland, Canada, Sweden, Australia, the United States, Japan, Germany, New Zealand, the United Kingdom and the Netherlands

[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What Is The Best Country In The World? Here Are The Rankings appeared first on Fair Observer.

Typically in the US, a homeowner with a mortgage can move to a different home only after paying off the existing mortgage and refinancing their home with a new mortgage. But homeowners who find themselves in a mortgage lock-in cannot move to a different location unless they buy a cheaper home or earn more, in addition to covering the costs of moving and refinancing. In such conditions, Liu said “the housing market is gridlocked,” where homeowners have a “strong incentive to stay put” in their current homes.

The paper’s authors build their case around the metric of the mortgage rate differential (or “mortgage rate delta”) which is the difference between the mortgage rate locked in at purchase and the current market rate. Their study covered the period between 2010 and 2018, with about four million observations (or households) of data on consumer credit records. The average mortgage loan balance was $205,480, the average remaining loan term was 21 years, and the average mortgage rate was 5.1%. The moving rate was measured as a change in a homeowner’s primary residence that has been reported to a credit bureau or bank.

How Rising Mortgage Rates Impact Moving

The paper has three main sets of findings. First, it studied interest rate increases over the past few years and projected rates and predicted a worsening mortgage rate differential (the gap between the rate at which a homeowner financed a mortgage and the current market rate). It estimated the average mortgage rate delta would decline by 1.9% since 2018.

“As interest rates go up, the [mortgage rate] differential becomes more negative, meaning people are getting more locked-in.”

— Lu Liu

Liu explained the impact of that declining mortgage rate differentials on moving rates: A one percentage point decline in mortgage rate deltas reduces moving rates by 0.68 percentage points, or 9%. “As interest rates go up, the [mortgage rate] differential becomes more negative, meaning people are getting more locked in,” she said. Considering rate increases over the last few years and projected rates, this can explain a decline in moving by around 25% between 2018 and the next 10 years, she added.

Lock-in Can Happen Even When Mortgage Rates Don’t Rise

The second main finding is the discovery of a non-linear effect between mortgage rate differentials and moving. If households didn’t have a mortgage, moving would only be driven by moving considerations such as a better-paid job opportunity. Once households have a mortgage, they need to remortgage and hence pay the mortgage rate differential as well as a remortgaging cost to move. But once the mortgage differential is sufficiently positive, and it is higher than the cost of refinancing, “the probability of moving no longer depends on the mortgage rate delta,” Liu said.

One surprising finding of their study, Liu continued, was that mortgage lock-in occurs before the mortgage delta turns zero and heads into negative territory, meaning even if rates don’t rise. “That is because refinancing is costly; if you want to move, you have to pay that cost,” she explained. “You’re only going to move once that net difference is big enough.”

The third finding is that mortgage lock-in discourages labor mobility. “This is important from a welfare perspective and from a real economy perspective,” Liu said. The study used a “moving shock” like higher-wage employment opportunities as a proxy to gauge the effects on labor mobility.

“A shock to wage increases within the broader metropolitan area where you live means that you have better employment opportunities and so you should move,” Liu said. The study found that people who find higher-wage jobs do move, but those with a high delta are much more sensitive to these moving shocks than those with a low delta.

“You would move if you had a fantastic job opportunity that pays you 50% more than your current job, and that’s enough to cover the cost of a more expensive mortgage.”

— Lu Liu

“You would move if you had a fantastic job opportunity that pays you 50% more than your current job, and that’s enough to cover the cost of a more expensive mortgage,” Liu said. “That would be an example where the moving shock was large enough to overcome the cost of mortgage lock-in.”

Takeaways for Policymakers

According to Liu, their paper offered some takeaways for policymakers. She pointed out that when homeowners in the US want to move, they have to settle their existing mortgage and take out a fresh mortgage for their new home. In that, they have less flexibility in moving home than those in the U.K. or Canada, which allow portability (taking your mortgage to a new house) or assumability of mortgages (taking over the mortgage on an existing house), respectively. (Some mortgages in the US are assumable, such as those insured by the Federal Housing Administration for low-income people, she clarified.)

“When policymakers raise interest rates, we need to think about mortgage market policies that alleviate lock-in, otherwise there will be knock-on effects on mobility and labor reallocation,” Liu continued. It would be helpful if homeowners can keep their existing mortgages and take it to their new houses; policymakers should evaluate these policies with mortgage lenders, she added.
[Knowledge at Wharton first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Mortgages at Locked-In Rates Lower Labor Mobility Now appeared first on Fair Observer.

A recent paper led by Wharton management professor Michael Parke reveals that some of the highest-performing employees intentionally withhold information, ideas, or concerns until the time is right to speak up. Their “strategic silence” is often rewarded by managers who view their voices as more valuable to the organization and the task at hand.

The scholars say their research findings challenge the predominant view that silence at work is inherently harmful.

“People don’t just engage in silence when they are afraid or when they think there’s no point, which is what the literature had suggested and assumed,” Parke said to Wharton Business Daily on SiriusXM. “They actually do it for strategic reasons, for performance reasons, to make their voice come out and be received much better when it does.”

The paper, “How Strategic Silence Enables Employee Voice to Be Valued and Rewarded,” was co-authored by Subrahmaniam Tangirala, management professor at the University of Maryland’s Robert H. Smith School of Business, and Apurva Sanaria and Srinivas Ekkirala, both organizational behavior and human resources management professors at the Indian Institute of Management Bangalore.

Knowing when to speak

Conducting a qualitative study and two field studies, the professors found that employees who use strategic silence most effectively consider three factors in deciding when and how to speak up: issue relevance, issue readiness, and target responsiveness. First, they determine whether speaking up would align with the goals of the recipient or the current situation (i.e., relevance). Second, they determine whether they are ready to talk or need to hold off until they collect more data, find a solution, or think through some other aspect of the problem or idea (i.e., readiness). Third, they wait until the recipient — usually a manager — is in the right cognitive (not too busy) or emotional state (not in a bad mood) to hear the message (i.e., responsiveness).

When strategically silent employees finally present their case, it’s not surprising to find their managers value it. That’s because what they share is now perceived as deliberate, thoughtful, and well-timed. Ultimately, the study found these employees get higher performance evaluations and are rated more favorably by their managers.

“There is not only team value for doing this, but individual value as well,” Parke said.

Parke acknowledged that knowing when to speak can be complicated for employees trying to navigate the social and professional norms of their workplace, or even the mood of a mercurial boss. Nobody wants to be the person who hijacks a meeting by bringing up a half-baked idea or non sequitur, yet most managers don’t want employees to stay mum on what could be a looming problem.

Parke said building trust will enable more meaningful conversations, and he encouraged leaders to “check in” with their employees more frequently to establish open lines of communication.

“If leaders in teams had more explicit conversations about the avenues for which people communicate different ideas and concerns and issues, they could navigate that in a much more efficient way. But I don’t think that happens,” he said, adding that employees often hold back because they are trying to “read the room.”

Managers must create the right environment

Parke also warned managers to be careful about creating an environment where only expert voices are allowed. He said quality and expertise are correlated, but not perfectly. Experts’ ideas should be challenged, and there should be room for healthy debate.

“The other thing to bring up is that even though we want high-quality voice, there has to be patience for low-quality voice,” he said. “By people understanding why their voice is low quality, they can improve and learn.”

In addition, Parke pointed out the limitations of their research — it focused on task-related strategic silence as opposed to silence on social issues, such as concerns related to diversity, equity, and inclusion (DEI). He noted that organizations must ensure that employees feel confident and free to discuss DEI without fear of backlash or retaliation.

Scholars are still learning new things about workplace communication. Parke said he is studying the impact of what is known as faking voice, where someone offers a little bit of input without full feedback or disclosure, and voice leakage, where employees talk to each other about a problem rather than directly to the managers capable of addressing it.

Parke said he and his colleagues want to take their study on strategic silence a step further to show the costs and benefits. If strategic silence is good for individual employees, is it also good for teams and organizations? Or does it delay solutions, costing a company more in the long run?

“There’s still a lot to uncover and unpack in this area,” Parke said. He hopes the insights gained from the research can be used to “advise leaders and employees on how to navigate these conversations effectively and efficiently, because voice is so critical to the success and the well-being of the organization.”

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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That psychology drives homeowners to list their homes at higher-than-market prices and produces two outcomes, according to a paper titled “Reference Dependence in the Housing Market” by Wharton finance professor Lu Liu along with other experts. One outcome is that the psychological dependence on the original purchase price generates an aversion to losses that is 2.5 times larger than the prospect of gains. Two, homes that list above market prices stay longer on the market before they get sold. The findings help explain why home prices typically move in tandem with sales volumes, and why a period of decreasing house prices (increasing the number of households experiencing losses) can lead to reduced turnover and market illiquidity.

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Liu co-authored the paper with Copenhagen Business School finance professors Steffen Andersen and Julie Marx, National University of Singapore real estate professor Cristian Badarinza, and Imperial College London professor of financial economics Tarun Ramadorai.

The study analyzed data on the Danish housing market between 1992 and 2016. The researchers gathered comprehensive data on ownership and transactions covering all registered housing properties in Denmark, along with property listings data and mortgage data, and owner/seller demographic data such as aggregated household income and wealth data.

The Psychological Factor in Home Prices

Essentially, Liu and her co-authors quantified the concepts of “reference dependence” and “loss aversion” in the Prospect Theory, a behavioral model that was propounded in 1979 by Daniel Kahneman, an Israeli-American psychologist and economist who won the 2002 Nobel for economic sciences, and Amos Nathan Tversky, an Israeli cognitive and mathematical psychologist.

Households are so attached — or “reference dependent” — on what they originally paid for their homes that they want a profit on top of that when they sell their homes. That desire for profit shows up as a “listing premium,” or the difference between the price at which they list their homes and the “fair market value” or the prevailing market value. The study found that when households putting up their homes for sale face the prospect of not making a profit on their original purchase prices, they raise their listing prices. The listing premiums get higher as the potential losses get bigger. When plotted on a chart, in many cases the prices at which the homes are eventually sold are bunched exactly at their original house purchase prices. The listing premiums then drop as the potential losses get smaller. That pattern shows up in a “hockey stick” shape, which captures the degree of households’ desire to avoid losses.

Liu offered an example of a house that was originally bought for $150,000 and has a current market value of $145,000, implying a $5,000 loss if the homeowner puts it up for sale. “According to pure rational logic, the past sales price should not affect how you set your current list price,” she said. “We see that homeowners try to push the list price higher, just so they can offset that potential loss. We think of this as a psychological preference.” That aversion to losses has an “asymmetry” in that it is greater than the prospect of a gain, the study found.

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“They care more about the losses than the gain,” Liu said. The study estimated the loss aversion as 2.5 times more than the potential gains. This psychological preference, however, comes at a cost: Setting a list price that is 20% higher than the current market value reduces the probability of a swift sale by 20% to 30%, the paper pointed out.

Those traits of dependence on the original purchase price and loss aversion were equally pronounced when the household selling a home faced a down payment for its next home. “A lot of people selling homes are repeat buyers; they’re sellers in one market and buyers in another market,” Liu noted. The down payment, which the paper described as a “home equity constraint,” is 20% in Denmark. So, households also set higher listing prices when they are squeezed to make a down payment on their next home — a financial, rather than a psychological, factor.

Modeling Pricing Behavior

The authors designed a model to capture the various parameters influenced by market conditions that are involved in selling a house. Starting with the persona of a “rational” seller, who simply derives utility from the final sale price of the house, the study weighed the options for reference-dependent sellers who either make a gain or suffer a loss. The model also factors in the effect of financial constraints on sellers who pay off an outstanding mortgage when selling a house, and must make a down payment to finance a new house purchase; it also incorporates a “penalty parameter” for any shortfall if the home equity realized after a sale falls below the required down payment.

Typically, the higher the sale price a seller expects, the greater the incentive to lower the listing price and increase the likelihood of a sale. Similarly, sellers who expect a lower sale price will be encouraged to raise the listing price and thus achieve a higher final price. But that linear relationship between the listing price and sellers’ potential gains changes when sellers are affected more by the prospect of a loss, or loss averse, than they are by the likelihood of a gain. The listing premium reflects that asymmetry, “sloping up more sharply when sellers face losses than when they face gains,” it added.

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Sellers have a disproportionate impact in setting housing prices, Liu said. The study found that the down payment constraint can account for about 60% of the correlation between house prices and sales volumes, and 40% is accounted for by their psychological preference to make a gain over their original purchase price.

“When prices go down, sellers who are loss-averse and constrained by a down payment set higher listing premiums, which makes the market illiquid because fewer people are willing to pay a big premium,” she said. “So, quantities go down just at the time when you need them. When you need the market to be liquid, there’s an exacerbating effect that may reduce prices further.”

Research Takeaways

According to Liu, the main contributions of the paper are threefold. One is in modeling the relationship between listing premia and reference dependence on the original purchase price of a home and the asymmetry between loss aversion and potential gains. Second, it quantified the degree of loss aversion to show that households are approximately 2.5 times more sensitive to losses than gains, supporting previous evidence from lab experiments in an important real-world market where households have high financial stakes. Third, it used its estimate of loss aversion to explain the movement of housing supply and prices.

The study’s findings help “pin down the sources of the asymmetric effects of house price changes on house selling decisions,” and also explain why property owners appear “locked in” to their houses during market downturns, the paper noted. Those insights will help in gaining “a better understanding of labor mobility, and informing housing and mortgage policy.” Illiquid housing markets where homes take longer to sell make it more difficult for people to move jobs, Liu explained.

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One important takeaway for regulators is that “in general, a more homogeneous housing stock, with more transparent pricing may make housing markets more liquid,” said Liu, as it disincentivizes sellers to set high listing premia. She noted that the hockey stick slope was flatter in more homogeneous markets, or those where homes have similar characteristics. Also, “the psychological effect is stronger in markets that are less transparently priced,” she added. 

Interestingly, the authors also find that households who are not down-payment constrained seem to set higher listing premiums with respect to their expected losses and vice versa. In other words, “the luxury of being unconstrained appears to allow more psychological motivations such as loss aversion to come to the fore,” the paper stated.

Liu said their paper builds “a detailed and careful model” of how households make home sales decisions, and then maps that to the data to provide “a rounded view of why people seem to set certain prices.” Those effects may play a larger role again in an environment of decreasing house prices in the near future, she noted.

[Knowledge@Wharton first published this piece.]

[Shaurya Singhi edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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In two forthcoming papers, Low, a professor of business economics and public policy, takes a revealing look at “reproductive capital,” a term she uses to describe the economic value of fertility, and thus the trade-offs that women make when they make time-consuming educational and career investments.

In her first paper, “Pricing the Biological Clock: The Marriage Market Costs of Aging to Women,” forthcoming at the Journal of Labor Economics, Low designed a unique online dating experiment to determine how both men and women fare in the marriage market as they get older and fertility declines.

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“You always hear people talking about the biological clock and how influential it is in women’s lives. But what’s been missing from the literature is this idea that if men also want to have kids, then it isn’t just a personal trade-off for women, it’s an economic trade-off,” she said. “Who you marry is one of the most significant financial decisions you can make. It’s a big deal for your financial well-being whether you marry someone who is going to make $50,000 a year or $500,000 a year.”

The experiment recruited real online daters who were asked to rate hypothetical profiles in which the photo was the same, but the age and income varied. The participants were incentivized to be honest in their answers; as compensation, they received customized advice from a dating coach on how to attract the type of partner they rated highest.

The results found that both male and female participants valued a high income in a potential romantic partner, but there was a sharp contrast when it came to age preferences. Men were rated higher as they aged, while women were rated lower as they aged. However, the preference for younger women was only found among male daters who had no children and who were knowledgeable about when female fertility declines. Based on their ratings, for every year past 30, women had to make $7,000 a year more to stay in the romantic running for them.

“These findings indicate that men also hear the ticking of the biological clock. Seeking to marry and have children, they naturally prefer more fertile partners,” Low wrote in the paper.

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More Equitable Policies

Low said she hopes business and political leaders will use her findings to craft more equitable policies that take into consideration this economic trade-off for women. Although women’s education levels have been rising rapidly in the last 50 years, women still make up just 8.8% of Fortune 500 CEOs. Keeping talented women in the workforce isn’t just important in closing the gender pay gap, it’s a key component to a thriving economy, she said.

“You might be paying her more money to stay in this high-pressure job, but she’s losing out on the marriage market, which puts it in different economic terms,” Low said, noting that women’s fertility begins to decline in the 30s, which is the same age that most careers ascend. “Firms need to think about how to alleviate that trade-off and recognize it as the equivalent of costing her money.”

She said change could come in the form of redesigning career timelines so that women can get the full value of both their human and reproductive capital. In law and medicine, for example, women often delay marriage and children as they attain graduate degrees and pursue residency or partnership.

“There’s no reason you shouldn’t be able to finish law school, take a fellowship that’s a slower pace for a few years, and then start the partner track when your kids are in kindergarten,” Low said. “People are working into their 70s these days. Why can’t they make intensive investments starting when they are 35?”

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Human vs. Reproductive Capital

While Low’s first study finds a $7,000 price tag on each year marriage is delayed, her second study, “The Human Capital – ‘Reproductive Capital’ Tradeoff in Marriage Market Matching,” forthcoming at the Journal of Political Economy, models the real trade offs this consideration creates in women’s school and career investments.

People who are higher income or higher education typically marry partners who are also higher income or higher education. This is a phenomenon economists refer to as “assortative matching.” Low documents a key deviation from this pattern: Throughout the 20^thcentury, graduate-educated women have married poorer spouses than college-educated women, despite being higher earning themselves. Every other education level yields richer spouses.

Why? Education may increase “human capital,” but because it takes time, it decreases “reproductive capital,” especially for educational investments that take longer and are later in life.

Low shows that when you acknowledge this duality in women’s school investments, you can predict that education will be viewed as a positive thing in the marriage market, up to a point, but will start to detract from women’s marriage market “value” when it interferes with fertile years.

Low said her research illuminates how women pay for investing in their careers and education with a “tax on the marriage market.” This makes entering careers requiring lengthy investments, which also tend to be the highest paying, less appealing for women, and may help explain the persistent gap in representation for women at the top of the corporate ladder.

It’s not all bad news, though. Recently, graduate-educated women have started marrying richer men than college-educated women, and also marrying at higher rates and divorcing less.

Low’s explanation: the shrinking American family. Because everyone is having fewer children, graduate women aren’t facing quite the same disadvantage. The preference for smaller families seems to be a bit of an equalizer for women across the board.

“People have documented this phenomenon of a reversal of fortune for educated women on the marriage market — that they used to marry less, get divorced more, have fewer children. And now, things are improving. But I show this has not been driven by college-educated women at all, but rather graduate-educated women, and that’s because of reproductive capital,” Low said. “A graduate degree and the subsequent career investment really do cut into those reproductive years when you want a large family.”

Low’s work further suggests that this marriage market improvement could be leading to a greater willingness for women to pursue educational investments, with women’s graduate school enrollments now outpacing men’s.

Women as ‘Economic Agents’

When asked if she found these studies to be a disappointing indictment about gender in society, Low said it was simply honest.

“There are some real difficulties, and we can build a better society that lets us be more equal by taking account of those differences,” she said. “But we don’t get there by ignoring those differences and gaslighting women that they can just try harder.”

Low, whose research focuses more broadly on diversity, equity, and inclusion, said the two papers are part of her larger agenda to change how women are studied in economics and beyond. She wants society to value women as “economic agents” and treat women’s issues with the same weight as other serious topics. Whether or not to have children — and when to have children — is a fundamental decision.

“If you look around the world, you see not everybody consumes cars or designer clothes, but most people get value in their lives by either having or connecting to children in some way,” she said. “Children are of fundamental economic importance, and I want to treat that with the full seriousness of the economic tools that we have. In doing so, it takes women’s decisions out of this dismissive context and puts it back in the domain of economic optimization, where there are two very important sources of value creation that she’s trading off between.”

[Knowledge@Wharton first published this piece.]

[Shaurya Singhi edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The details of the new plan

Income-based repayment plans have long existed within the US Department of Education, but the new plan will be “much more generous than existing programs,” Smetters noted. The new rule would require borrowers to pay no more than 5% of their discretionary income monthly on undergraduate loans, compared to 10% available under the most recent income-driven repayment plan.

It would also raise the amount of income that is considered non-discretionary income and therefore is protected from repayment. It aims to guarantee that no borrower earning under 225% of the federal poverty level — about the annual equivalent of a $15 minimum wage for a single borrower — will have to make a monthly payment, according to a White House note on the plan. Furthermore, it would cover the borrower’s unpaid monthly interest so that no borrower’s loan balance will grow as long as they make their monthly payments — even when that monthly payment is zero because their income is low.

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Federal student loan repayments have been paused since March 2020 as part of COVID-19 relief measures, and the new plan extends that pause “a final time” through December 31, 2022, with payments resuming in January 2023. In order to smooth that transition to repayment, the new plan will offer debt cancellation of up to $20,000 to Pell Grant recipients and up to $10,000 to non-Pell Grant recipients, so long as their income is less than $125,000 (for individuals) or $250,000 (for households). Another feature of the new plan is to forgive loan balances after 10 years of payments, instead of 20 years, for borrowers with loan balances of $12,000 or less.

Invitation to Max Out Loans?

Smetters highlighted the dimensions of the new income-driven repayment plan that are generous: capping monthly payments to 5% of discretionary income; redefining discretionary income to make it much smaller than it was under current law; and the government will “essentially make payments on your behalf so that your loan balances never grow, even if you’re making payments less than the interest rate.”

Under existing programs, a student borrower’s debt would increase if a borrower does not make full interest payments; it would be forgiven later after reaching the time limit – usually 20 years, Smetters continued. “The idea was simple: suppose that your income increased a lot later, then you would be expected to pay off that debt. One reason for the low sign-ups might be because of this feature — i.e., you are accumulating a lot of debt at higher interest rate that you would eventually have to pay off.”

Under the new IDR program, that effect would disappear, Smetters pointed out. “So, even if you thought your income might increase, you would still want to take advantage of the new IDR in the meantime. That is the reason why there is essentially no downside to signing up.”

“I’ve already had people tell me why even set up a 529 plan anymore,” Smetters noted. (A 529 plan is a tax-advantaged plan to encourage saving for higher education). “Lots of students have even mentioned to me [that they] should take out as much debt as possible, because payments are going to be severely capped under the new income-driven repayment program.”

“If people are really rational, and if they really believe that this program would stick around, it should fundamentally transform how college financing is done, because a lot of students would have the incentive to max out loans for paying for college,” said Smetters. “Why work that summer job? Why have your parents or grandparents contribute?”

Costs Could Cross $1 Trillion

Smetters said he did not expect the White House to release data on the costs of such a generous program. But the analysis that PWBM economist Junlei Chen produced under the guidance of Smetters estimated the costs of the program over its 10-year budget window: Student loan debt cancellation will cost between $469 billion to $519 billion, depending on whether existing and new students are included; about 75% of that benefit will go to households making $88,000 or less per year. Loan forbearance for 2022 will cost an additional $16 billion.

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Under strict “static” assumptions about student borrowing behavior and using take-up rates within existing income-based repayment programs, the proposed new IDR program will cost an additional $70 billion, increasing total package costs to $605 billion, the study estimated. But based on how the IDR program plays out and changes in student borrowing behavior, it could add another $450 billion or more, thereby raising total plan costs to over $1 trillion, the study added.

The features in the new IDR proposal could sharply increase take-up rates, the PWBM study noted. PWBM’s current calculations do not even account for this effect yet, Smetters said. “They only account for the higher take-up rates in the income-based program, assuming existing financing done by students. Our cost numbers will get large once we account for the shifting toward more borrowing.”

A majority of qualified borrowers do not enroll in existing programs, a previous PWBM brief had found. PWBM plans to study the distributional effects of the new IDR program and related aspects in future reports.

The federal student loan portfolio currently totals more than $1.6 trillion, owed by about 43 million borrowers, according to a Forbes report. Federal student loans make up the vast majority of American education debt — about 92% of all outstanding student loans is federal debt. About 5% of student debt was at least 90 days delinquent or in default in the fourth quarter of 2021, the report added. That number is artificially low because federal student loans are currently in forbearance, it pointed out.

(Knowledge at Wharton first published this article.)

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Bornstein defined consumer inertia as “the tendency of consumers to choose the same products over time for reasons other than the fundamental attributes of those products.” His hypothesis is that a rise in consumer inertia leads to higher profits of large incumbent firms while discouraging the entry of newer firms. His study estimated that young households are almost twice as likely to switch their consumption products relative to older ones.

The Big Firms Have Become Bigger

According to the paper, over the past four decades, the share of young firms in the US has declined while the share of aggregate profits in GDP has increased. Using a model, Bornstein contended that “the aging-induced rise in consumer inertia accounts for about 10%–30% of the twin phenomena between the late 1980s and late 2010s.” The model analyzed the effects of the rise in consumer inertia to make the case that “more consumer inertia leads to higher aggregate profits, higher incumbent markups, and less entry.”

Furthermore, Bornstein found that between the late 1980s and 2019, the share of young businesses in the economy, defined as businesses that are five years old or younger, fell from 50% to 30%, and the share of workers employed by young businesses fell from 20% to 10%. Over the same period, the share of aggregate profits in GDP rose by 12%.

“What I showed in the paper is that older individuals tend to stick to the products that they buy, while young households are more likely to switch the firm from which they’re buying their goods,” said Bornstein. “I argue that through this channel, the aging of the population has contributed to both the decline in business formation and to the rise in profitability that we’ve been seeing.”

“In economics, when profits go up, we think that more firms should enter to take a part of that pie,” said Bornstein. “We’ve been seeing that pie getting larger, and yet fewer and fewer firms are entering the economy. I explain in my model that these large established firms have these loyal customers with inertia whom they can charge high prices and therefore get high profits. It takes a long time to establish such a customer base, and that’s why it’s so hard for new entrants to claim a share of that pie of profits.”

The study offered some granular insights as well. It found that US states which experienced a larger increase in consumer inertia also experienced a larger decline in the share of young firms. Further, product categories with “a relatively more inertial consumer base” display lower entry rates of new firms. “For example, the carbonated beverages category has a high degree of consumer inertia, where consumers stick to Coke or Pepsi,” said Bornstein. “Also, older households have high inertia with respect to their breakfast food, but young households may change it more often.”

Fresh Insights on Aging Effects

Earlier research has studied the impact of population aging on the decline in firm formation, but Bornstein said his paper is the first to focus on the impact of population aging due to demand forces, or consumer inertia. “It is challenging for traditional models of firm dynamics to account for the twin phenomena of declining entry and rising profits. Other things equal, higher profits should stimulate firm entry,” the paper noted.

Bornstein overcame that challenge with a four-step process: First, he built a model of firm dynamics with consumer inertia. Second, he used detailed microdata to identify how consumer inertia varies with household age. Third, he used his model to study the implications of a rise in consumer inertia. Finally, he provided empirical evidence on a causal negative link between consumer inertia and firm formation.Bornstein used Nielsen’s Consumer Panel dataset, which provides information on the purchases of 160,000 households in the US between 2004 and 2015; and the GS1 US dataset. He distributed the households in his dataset across four age groups: 20–34, 35–49, 50–64, and older than 64. He found that younger households (age 20–34) display significantly less consumer inertia than any other age group across more than 95% of the product groups. A young household is, on average, about 20 percentage points more likely “to re-optimize its product choice” relative to older age groups, he found. “Product categories which face high consumer inertia are also ones where we see lower entry rates,” he said.

For sure, aging and consumer inertia do not drive all of the decline in new business formation, which would have many other contributing factors, said Bornstein. But those trends are worth watching closely, he added. “We expect the economy to be even older in the future decades, so that phenomenon will continue in allowing the big firms in the economy that have a large share of locked-in consumers to charge high markups,” he said. Americans aged 65 and above will account for 21.6% by 2040, up from 16% in 2019, according to a report by the US Department of Health and Human Services.

Bornstein said his paper may have some takeaways for consumers to consider. “If there were a way to nudge some consumers and say, ‘Here are the options that you have — you can actually get a better deal,’ it could potentially increase the degree of competition, and it can have implications for pricing by firms and for the efficiency of the market,” he added.

(Knowledge at Wharton first published this article.)

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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The findings of the project are explained in a paper titled “Deploying an Artificial Intelligence System for COVID-19 Testing at the Greek Border,” authored by Hamsa Bastani, a Wharton professor of operations, information and decisions and affiliated faculty at Analytics at Wharton; Kimon Drakopoulos and Vishal Gupta from the University of Southern California; Jon Vlachogiannis from investment advisory firm Agent Risk; Christos Hadjicristodoulou from the University of Thessaly; and Pagona Lagiou, Gkikas Magiorkinis, Dimitrios Paraskevis and Sotirios Tsiodras from the University of Athens.

The analysis showed that Eva on average identified 1.85 times more asymptomatic, infected travelers than what conventional, random surveillance testing would have achieved. During the peak travel season of August and September, the detection of infection rates was up to two to four times higher than random testing.

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“Our work paves the way for leveraging [artificial intelligence] and real-time data for public health goals, such as border control during a pandemic,” the paper stated. With the rapid spread of a new coronavirus strain, Eva also holds the promise of maximizing the already overburdened testing infrastructure in most countries.

“The main issue was, given the fixed budget for tests, whether we could conduct the tests in a smarter way with dynamic surveillance to identify more infected travelers,” said Bastani. One of the biggest challenges governments face in dealing with COVID-19 is the inability of the testing infrastructure at their national borders to realistically check every arriving passenger. Such comprehensive testing would be both costly and time-consuming, which is why most countries screen either arriving passengers from specific countries or conduct random testing for COVID-19.

Eva also allowed Greece to identify when a country was exhibiting a spike in COVID-19 infections a median of nine days earlier than what would have been possible with machine learning-based algorithms using only publicly available data.

The underlying technology of Eva is a “contextual bandit algorithm,” a machine-learning framework built for “sequential decision-making,” taking into account various practical challenges like time-varying information and port-specific testing budgets, Bastani explained. The algorithm balances the need to maintain high-quality surveillance estimates of COVID-19 prevalence across countries and the allocation of limited testing results to catch likely infected travelers. Eva is the first instance of that technology being applied to address a public health challenge, although such algorithms have found use in online advertising and A/B testing, she added.

Overcoming Data Challenges

Eva is an advancement over conventional border control policies because it does not rely on publicly reported data, which has a number of issues.

Publicly reported data is of “poor quality” chiefly because different countries follow different reporting protocols and testing strategies. It is common to focus testing resources on symptomatic patients, but the resulting prevalence rate may not be reflective of the asymptomatic population that is likely to travel. There is often also a reporting delay due to poor infrastructure, said Bastani. “We can tell, based on the data we’re actively collecting at borders, that a country’s COVID cases are spiking typically nine days before you will see that reflected in the public data.”

“Testing is usually targeted towards symptomatic individuals rather than asymptomatic individuals,” Bastani said in an interview with the Wharton Business Daily radio show on SiriusXM last July, as the Greek deployment was getting underway. “You can imagine tourists who are coming in are probably asymptomatic.” That underscores the criticality of not relying on publicly reported data, but using data that accurately reflects the prevalence of asymptomatic COVID-19 travelers across countries.

Eva’s algorithm overcomes the poor quality of public data by dynamically collecting testing results at the Greek border, thereby maintaining high-quality surveillance estimates of the prevalence in each country. “By adaptively adjusting border policies nine days earlier, Eva prevented additional infected travelers from arriving,” the paper noted, referring to the Greece deployment. “That is a long period of time in which a lot of high-risk people would probably have come in and infected other citizens,” said Bastani.

It is common for border control policies to use publicly reported data, but such data is often unreliable and inconsistent across countries, said Bastani. The inconsistencies arise from censorship of testing data by some countries, and even varying definitions of a COVID-19 death, she added. She pointed to the recent discovery of undercounting of COVID-19 deaths in nursing homes in New York City as an example of flawed data. “That issue is exacerbated when you compare death counts in different countries because in some places they’re accounting very accurately and in other places they’re not.”

Greece is the first country to design border controls based on the dynamic random surveillance testing approach that Eva uses. The model specifies the infrastructure required to collect COVID-19 test results, using those to form estimates and to inform future testing decisions in a dynamic feedback loop.

In using the Eva model, Greece required every individual or family planning to enter the country to fill out 24 hours before arrival a digitized “passenger locator form,” where they provided some basic information about themselves such as other countries they have visited in the past year. All those who submitted those forms received a QR code that allowed tracking. Eva’s algorithm processes the information in the forms to identify those who need to get tested for COVID-19. Greece’s border control authorities processed an average of 38,500 forms each day; some 18% of those who submitted the forms did not eventually show up.

Keeping COVID-19 at Bay

Eva’s targeted testing that allowed for adaptive border control policies helped Greece keep its case count “very low pretty much all of the summer,” said Bastani. The country was able to maintain some economic activity, unlike many others that had to completely shut down, she noted. Greece imposed a second lockdown and travel restrictions in November after a spike in COVID-19 cases.

The Greek government acknowledged Eva’s accomplishments in a press conference last July. “The AI system developed by Bastani, Drakopoulos, Gupta, and Vlachogiannis has been an asset both for preparing the opening of the country to visitors from all over the world, as well as for allowing flexibility in decision-making regarding our COVID-19 strategy,” said Nikos Hardalias, Greece’s civil protection and deputy minister for crisis management, who heads the COVID-19 Response Taskforce for the country.

Free-to-use Technology

Eva is an open-source technology, which means Bastani and her team will provide it free of cost to any country that might want it. They have made presentations to COVID task forces in several countries in the European Union. Adapting it to other countries would involve designing passenger locator forms that are appropriate for different immigration processes and dovetailing back-end resources such as testing labs.

Bastani made a strong pitch for governments to capture private data such as that generated by the passenger locator forms used in the Greece deployment, and customize them to suit their specific situations. “No country should just be relying on public data; they should be actively monitoring who is coming to their borders, testing at least a subset of them, and using that to make informed decisions about border control,” she said. “That said, if a country doesn’t have the resources to do that, it’s probably better to use a policy that mimics another country that is doing that rather than relying only on public data.”

Bastani and her colleagues are working on refining Eva to incorporate more passenger-specific information than they used in the Greece deployment. Europe’s General Data Protection Regulation limited the scope of data they could use with Eva; they used only anonymized and aggregated data with limited demographic information. Other countries with less stringent data protection regulations could gather a wider range of data, such as on occupation, Bastani said. “We know that certain occupations carry a much higher COVID-19 risk than others.”

Eva could also be trained to incorporate pooling to mitigate constraints faced by testing labs, she added. Overloaded labs could share their samples with other labs that may have spare capacity at any given point in time, she explained. In much the same way, Eva could also use dynamic data to help determine optimal staffing levels at labs and other locations in the testing infrastructure, she added.

*[This article was originally published by Knowledge@Wharton.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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Businesses dependent on global sourcing are facing hard choices in crisis management amid the supply chain disruptions. But in planning to mitigate the risks of similar disruptions in the future, they confront other questions that have no easy answers: Should they broaden their supplier choices, or do more local or near-shore sourcing? How much inventory of raw materials, sub-assemblies and finished products should they stock to tide over the crisis?

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The impact of the coronavirus pandemic on global supply chains is “a major disruption, along the lines of having an earthquake or a tsunami,” said Morris Cohen, Wharton professor of operations, information and decisions. “This is an unprecedented type of disruption. I don’t think we’ve ever seen anything quite like this.” Cohen is also co-director of the Fishman-Davidson Center for Service and Operations Management at the school.

The uncertainties ahead swing between extremes. As the shortages worsen before they get resolved, prices of many products could go up for consumers even if laws exist against price-gouging, said Cohen. At the same time, constrained supplies could cause declines in demand, which in turn may end up weakening prices. “All those things will happen and have already happened. There’s no magic answer here.”

Medical Supplies Are the Priority

The choking of supply chains is “a second-order problem,” and the foremost priority is to ensure the availability of medical supplies, Senthil Veeraraghavan, Wharton professor of operations, information and decisions, said in an interview with the Wharton Business Daily radio show on SiriusXM. “The first-order problems have to do with medical devices, medical products, productive equipment, masks, screeners, disinfectants [and so on], which are critically necessary for providing care for people we are going to see getting infected over the next few months,” he said.

Veeraraghavan noted that the US alone needs a “supply chain ramped up for about 100 million people to get tested and taken care of,” based on predictions for the number of infections. With social distancing, the peak demand in the US for testing kits is an estimated 5 million or 6 million, he added.

Getting those testing kits to the right locations across the country is the next big challenge. “This is why a lot of epidemiologists and supply chain [professionals] are suddenly talking about what we call flattening the curve, to help with production smoothing,” said Veeraraghavan. (Production smoothing, or production leveling, refers to removing unevenness in the supply of intermediate goods in manufacturing processes.)

Parallels from the Past

The 2011 earthquake and the tsunami it unleashed on Japan is probably the closest comparison to the coronavirus outbreak in terms of the extent of disruption to supply chains, said Cohen. “It was also unprecedented, had a global impact and it had multiple dimensions. Coronavirus is also a natural disaster. This is not something caused by the actions of governments or policies or economic actors.” Marshall Fisher, Wharton professor of operations, information and decisions, also pointed to the 2011 tsunami as a watershed period for supply chains, and included the 9/11 terrorist attacks, the 2008 Great Recession and the health scares around the Ebola virus in 2013-16 and SARS in 2002-03 among key disruptive events.

Although the 2011 earthquake and tsunami were short-lived, “we’re living with the consequences to this day,” Cohen continued. The tsunami caused a cooling failure and a meltdown at the Fukushima Daiichi Nuclear Power Plant, triggering the release of radioactive waste that continues to this day, he noted. “Many factories in that part of the country were closed and they were suppliers of key parts to supply chains all over the world. And it took weeks and weeks for companies to recover.”

The northeastern region of Japan that the earthquake hit was home to many factories manufacturing semiconductors, auto parts and other components for export, and crippled manufacturing in China, for instance, according to a Knowledge@Wharton report at the time.

Honing Risk Mitigation Strategies

Businesses have sharpened their risk mitigation tools after each successive disruption to supply chains. For example, after the 2011 tsunami, “companies like Cisco and Boeing have invested substantially in supply chain risk management policies, strategies and infrastructure so that they can be aware of [such] an event and understand its consequences,” Cohen said. “Now, there’s a fairly well-understood methodology, and most major companies have some kind of supply chain risk management process in place.”

However, those risk management processes are not robust enough to cope with the fallout of the coronavirus pandemic, Cohen said. “This is unprecedented in its scale and in the extent of it. We’ve never seen a disruption like this where … a large number of countries are telling their populations to stay home, to not work — there are lockdowns all over the world.”

Businesses would surely revisit their strategies on sourcing raw materials, sub-assemblies or finished products. Over the past two decades, the concept of supply diversification has focused on continually driving down costs, said Veeraraghavan. Companies such as General Motors, which have sizable demand for their products in both the US and China, benefit from locating production capacities in both countries to be close to their customers, he noted. Consistent with that strategy, it would benefit US businesses to have “some amount of supply capability” that they can ramp up to deal with the outcome of a pandemic like a coronavirus, he added.

“It is a prudent idea for companies to invest in the resilience of their supply chains — and this has become more important than ever before,” Veeraraghavan continued. “Given that we are living in a global economy with a lot of people traveling all over the world, we’re going to have such public health crises — hopefully infrequently — for sure in the future.”

Companies could “stabilize their supply chains” in multiple ways such as enlisting new suppliers, boosting inventories or invest in omnichannel distribution that includes online sales, according to a McKinsey report on the implications of the pandemic for businesses.

The Benefits of Timely Action

“All those are great ideas of ways to mitigate the risk and they can be effective, but unfortunately, most of those are based on decisions that you have to make before the event occurs,” said Cohen. “It’s hard after the event occurs to go find alternative suppliers or redesign your product or your process or introduce new technologies. Those are all great things to do in the long run.”

“There’s always been pressure or incentives for companies to maximize efficiency and reduce costs, finding the lowest-cost supplier and the most efficient producer or distributor in the world and to go after that,” said Cohen. “On the other hand, if you end up with a single source, you’re vulnerable to risk. And that’s what is playing out now.”

There’s always a fundamental trade-off between costs or return, and risk, Cohen noted.

“This will tip the balance more towards trying to mitigate risk, which means going to the low-cost producer and giving them 100% of your demand may look very risky now. Companies may start to want to hedge their bets and have alternative suppliers more than they would have in the past.”

Another possibility is that businesses could be persuaded to source more of their needs locally. Cohen pointed out that the pharmaceutical industry is particularly challenged now, since “the vast majority of the active ingredients are manufactured in China.”

Mitigating risk by adding new suppliers is not an easy solution, though. “There will be more pressure [on businesses] to make those investments and perhaps absorb a higher cost of sourcing things so that they have a higher insurance against these disruptions,” said Cohen. “It comes at a price. If you want to mitigate risk and absorb uncertainty, you have to make investments and pay a price.”

There are two schools of thought regarding how businesses could plan for those unforeseen risks, said Fisher. “One is you try to identify the risks that might happen.” However, “had anybody been making up a list of potential risks, I’m not sure this [COVID-19 pandemic] would have even been on the list. The other school of thought is to identify all the different things that might disrupt supply.”

But companies don’t need to go through that exercise, said Fisher. “Just take it as a given that something could disrupt your supply. The prevention is either keep a buffer stock in inventory or have multiple sources of supply, geographically separated. Or you could do both.”

However, the disruption in supply chains caused by COVID-19 is “the mother of all disruptions,” said Fisher. “How do you do geographic mitigation of supply when the whole world is involved?”

Be Proactive and Agile

Being proactive is critical, according to Cohen. “If you want to be prepared for the occurrence of a random risk, then you have to make investments and decisions upfront, before the event,” he said. “You have to buy that insurance by making those investments. But once the event has occurred, as in this case, many of those strategies take a long time to implement; they may not be feasible at this point. It’s hard for a company that has its main supply coming from China to go find an alternative supplier. Maybe there isn’t one. Maybe the alternative supplier is also disrupted. The problem is they’re not going to find enough capacity to replace what was lost in many cases. It’s just not feasible.”

For sure, there are exceptions that have demonstrated superior supply chain agility. Fisher recalls how a fire in 2000 at a Philips Electronics semiconductor plant in Albuquerque, NM, disrupted the supply of chips for Nokia of Finland and Ericsson of Sweden, who needed them for the mobile phones they manufactured. Philips needed weeks to get the plant back up to capacity, as The Wall Street Journal reported, but Nokia deployed a crash plan to cope with the crisis.

Within two weeks of the fire disrupting chip supplies from Philips, Nokia “redesigned chips on the fly, sped up a project to boost production, and flexed the company’s muscle to squeeze more out of other suppliers in a hurry,” according to the Journal. Ericsson lost nearly $400 million in potential revenue that year, and eventually became part of Sony of Japan.  Like that episode, “there have been lots of events in the past that have been wake-up calls for companies that disruptions can be a big deal in your supply chain,” Fisher added.

In the current situation, in order to overcome capacity shortages, more capital is needed for production planning and equipment delivery, Veeraraghavan said. The transportation industry, for instance, will need that additional capital as it faces both supply and demand constraints, he pointed out. “I’m not sure every company that’s facing a crisis right now has enough capital to last them for the next few months. I do see governments having to play a role [here] at some point, for sure.”

In addition to governments, multiple other actors would have to come aboard to address shortages of various products, almost like “a war effort,” said Veeraraghavan. He noted, for instance, that LVMH, the French maker of Dior and Givenchy perfumes and cosmetics, has decided to repurpose its production lines to make hand sanitizers to cope with shortages in that country.

The fallout of the coronavirus pandemic on supply chains will also likely strengthen the hands of critics of globalization. “Absolutely; it’s going to have an impact on that whole debate,” said Cohen. A March 2019 paper Cohen co-authored with Stanford University professor Hau L. Lee examines the impact of changing government policies on designing supply chain networks. Those changing government policies have taken the form of trade wars, such as those between the US and China, protectionism and efforts to bring back American manufacturing jobs lost to China and Mexico.

“Are people going to hit the pause button on globalization?” Fisher asked. “That was already happening for a number of reasons, including the tariffs and trade wars with China and other regions, and Brexit. Trade disruptions are already causing companies to have to rethink how they approach globalization and basically do less of it.”

Long Road to Recovery

The pandemic’s disruption to global supply chains will have a long tail. “Supply chains are a problem so sticky that they take time to resolve,” said Veeraraghavan. Even if production “comes back to 100% levels, let’s say as about six months back,” there will be delays of up to a few months in getting products to consumers, and that situation will continue until fall 2020, he added. It is precisely because these disruptions take a long time to wear off that it is important for companies “to have [sufficient] capital to last this period of lull,” he said. Meanwhile, China seems to be on the rebound, according to Veeraraghavan. “[We are] seeing some life for production and consumption coming back in China,” he said. Apple, for instance, reopened all its 42 stores in China on March 13, he noted.

Businesses that have already invested in supply chain risk mitigation will be able to bounce back faster than others. “The reason that companies maintain these networks of locations around the world and have multiple factories and multiple suppliers is precisely to respond as events occur by shifting production and shifting sourcing,” said Cohen. Redundancy is built into that diversified supplier base, which enables a quicker rebound, he added. “This is like buying a real financial option, and you either exercise that option or not.”

According to Cohen, “the capability of global supply chains to recover [from the COVID-19 fallout] is fairly strong.” Many businesses have already invested in redundancies to absorb the risks of supply chain shocks, he said. “I think they’ll respond quickly. I’m going to be an optimist here.”

Signs of optimism are available also in the progress in select regions in containing the pandemic. Fisher pointed to data on the global spread of COVID-19 as tracked by the Center for Systems Science and Engineering at Johns Hopkins University, which shows a sharp drop in the number of new cases after reaching a peak in China’s Hubei province and its capital, Wuhan, where the outbreak first began.

Fisher noted that the number of new cases in Hubei peaked on February 13 at 14,840 cases, but by March 13, that number had fallen to 5, according to the Johns Hopkins data. That extent of containment shows how effective social distancing, self-quarantine and testing could be, he added.

So, is the end of the coronavirus pandemic within sight? “If everybody enacts identification of who has [the infection] and isolates them, and [with] all the aggressive [measures that are] going on now, it has the potential to be over in a month or two,” said Fisher. However, if people just go back to life as normal, and don’t change the way they live or practice hygiene, it could blow up all over again.”

The repercussions of COVID-19 could extend far beyond supply chains. “This is almost an issue that we all face as individuals, thinking about how this will change our lives,” said Fisher. “Maybe the world will become less materialistic or consumers will be less materialistic. Many of us have multiples more of material goods than we actually need to lead a happy life.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Coronavirus and Supply Chain Disruption: What Firms Can Learn appeared first on Fair Observer.

These factors whiplashed US markets this week, even as global stocks took a beating for similar reasons. Monday, March 9, saw a worldwide rout across markets, with values dropping in a precipitous one-day plunge reminiscent of the financial crisis a decade ago. By March 10, as the Financial Times noted, “Global markets stabilized from heavy losses as investors welcomed signs that policymakers would launch significant stimulus measures to soften the economic blow from the coronavirus outbreak.” Though European markets recovered slightly that day, investors were still nervous about the nationwide lockdown in Italy, as that country sought to contain its COVID-19 crisis.

What Stock Market Awaits Gen Z in the 2020s?

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So what lies in store for US and global markets in the weeks and months ahead? Will the world economy sink into a recession? If so, will it be short and sharp — as some economists have predicted — or will we have to contend with a deeper, more protracted downturn? Under either scenario, how should investors respond? Should they “buy the dip,” as investment gurus often recommend? Or should they batten down the hatches and lie low until the storms have passed?

Wharton finance professor Jeremy Siegel and Moody’s Analytics chief economist Mark Zandi discussed these issues and more on the Wharton Business Daily show on Sirius XM. The key takeaways: First, Siegel and Zandi believe the US will probably be unable to avoid a recession. Second, more stock market price corrections may occur, possibly heading into bear-market territory, where prices fall by 20% or more. Third, more interest rate cuts are likely from the Federal Reserve. Fourth, stalled hiring and layoffs could worsen unemployment to a point where the recession could grow severe. Siegel and Zandi also offered advice to investors on how they could respond.

Major stock indices — the Dow, Nasdaq and the S&P 500 — have shed some 18% in value since mid-February. Investors chasing safety thronged 10-year Treasuries, dragging yields down as they expected more interest rate cuts and offloaded corporate bonds, especially those of companies in travel and energy. Earlier last week, the Federal Reserve tried to boost the morale of investors with an interest rate cut of a half a percentage point, but that brought limited cheer to the stock markets, as did the results of the Super Tuesday Democratic primaries. Central banks in Canada, Australia and elsewhere also cut interest rates, and G-7 finance leaders explored possibilities of coordinated actions in a conference call.

In order to contain the impact of the coronavirus crisis, Siegel and Zandi believe that governments should offer bridge loans and other forms of aid to small businesses; widen the unemployment insurance safety net; and maybe temporarily cut payroll taxes to give consumers more spending power. President Donald Trump said on March 9 that he would work with Congress on tax cuts and other measures.

Looming Recession?

According to Siegel, “earnings [at companies will] be dramatically affected this year” as they grapple with declines in revenues and cost pressures. “We could have a 20% decline in earnings this year, which would be dramatic, and of a recession magnitude.” A recession is informally defined as two consecutive quarters of declining real economic activity, he noted. However, equity analysts “are always slow to put down earnings because they concentrate on micro factors,” Siegel noted. “They concentrate on firms. They are not really geared to try to project what’s going to happen [to the broader economy].”

Zandi said the stock markets “haven’t fully discounted … the possibility of a recession. But they’re on their way. You can see that in the equity market, and even more clearly in the bond market. Now 10-year Treasury yields are at record lows and falling. That’s a pretty clear window to what investors are thinking. If the pandemic is comparable to what the CDC [Centers for Disease Control and Prevention] seems to be suggesting will happen, it will be tough to avoid a recession.” The epidemic has resulted in closures of establishments such as schools and daycare centers, disrupted businesses and adversely affected their travel plans, he said.

Positive Sign

The good news is that if a recession were to occur, the US economy will enter it from a position of strength, said Siegel. As a case in point, he pointed to the latest employment report, which revealed a gain of 273,000 jobs in February, with the unemployment rate holding steady at 3.5%. “If a patient is going to get sick, what the doctors say is the most important thing is he goes into that sickness being healthy,” Siegel noted. “That will mean that he or she will recover the fastest. That is exactly what we see in the US economy. The US economy is going to receive bad bumps. There’s no question about it. But the fact that we are going into that as healthy as we can be is a very strong positive.”

Employment gains have been strong in the past two months — 225,000 jobs were added in January — but they have been “juiced” by mild weather and hiring by the Census Bureau, Zandi said. The jobs gains were disappointing in December at 125,000, to put that in perspective. “If you abstract from the vagaries of the data, they were probably running around 125,000-150,000 per month,” he said. Job gains have ranged from 128,000 to 145,000 in the previous months, barring a jump to 164,000 jobs in November, according to Bureau of Labor Statistics data. “An employment gain of 125,000-150,000 isn’t bad … and that’s consistent with stable unemployment,” he said.

Still, if monthly employment gains fall below 100,000 on a consistent basis, unemployment will start to rise, Zandi warned. “Once unemployment starts to rise, even from a very low level, that’s the fodder for recession. People can sense that and they will pull back. Businesses will see that and they [too] will pull back. That’s how you get into a vicious cycle known as a recession. So, I don’t think we’re too far away from an environment where a recession becomes a real threat.”

Stock Market Outlook

According to Siegel, whenever investors consider long-term assets, they need to realize that “more than 90% of the value of stocks is dependent on profits more than 12 months out into the future.” He added that earnings reports may be “very bad” in this year’s second quarter and also perhaps in the remaining two quarters of the year, but they could change for the better after that. He noted that according to experts, viruses are self-limiting. “I’m looking at a pretty bad 2020, but I’m [also] looking for a bounce-back in 2021.”

According to Siegel, stock prices were “already too high” in the weeks before the coronavirus outbreak began spreading worldwide. “We were riding too high in that momentum-driven market.” Estimates he made earlier this year about corporate earnings growing 5% in 2020 are no longer valid, he explained. “That was without the virus. Right now we could get minus 20%. We could get minus 30%. We have not had a bear market since the crash of 1929, which is defined as a 20% [decline from recent highs]. We could definitely have that. Would that shock me? Not in the least.”

To counter the impact of the coronavirus crisis, the Fed’s rate cut was “the right thing to do,” said Seigel. “Hundreds of billions of dollars of loans are pegged to the Fed’s prime rates, Libor rates, [and also] all sorts of business rates.” He noted that the rate cut of 50 basis points would translate into a proportionate fall in interest payments for small businesses such as restaurants. “It will help. It’ll give them a few thousand dollars more in these months.” He expects more interest rate cuts from the Fed in the future.

Zandi agreed that the rate cut was an appropriate step. “[But] I’m not sure about the execution,” he said. In hindsight, it wasn’t as effective as expected, he noted. The stock markets seemed to give it fleeting attention, and then they continued their free fall. “[It didn’t] go as well as I’m sure Fed officials had hoped. The market sold off significantly. The Fed’s intent was to shore up confidence in the US and it did the opposite. They kind of spooked investors, so if they had it to do it over again, maybe they do it a little bit differently.” Still, “the Fed doesn’t have a whole lot of room to maneuver here, given where rates are,” said Zandi. The low rates give the Fed little wiggle room to exert more influence with rate cuts.

Fiscal Stimulus

Given those limitations of monetary policy, the Trump administration should use fiscal policy to prime the pump, according to Zandi and Siegel. “[For instance], stepping up Small Business Administration bridge loans to small businesses that might have cash flow problems could very well happen,” said Siegel. Added Zandi: “It’s about cash flow. Many small businesses don’t have those resources to weather a storm that lasts for more than a week or two.”

Siegel also called for “an emergency step [of] a tax cut.” That would leave more cash in the hands of small businesses and workers who may not get paid or get tips or be laid off. “I think despite the politics of the situation, both Democrats and Republicans are ready to do that,” he said. “We already have some sort of a fiscal stimulus package that the Senate is looking at from the House. They’ve stopped this bickering back and forth. We may have to look for an emergency tax cut that that’ll give more cash to consumers.”

Zandi agreed. “A temporary payroll tax holiday is a tried and true fiscal stimulus,” he said. “It gets money to lower-middle-income households so quickly. It shows up right in their paychecks.” Among the other measures he suggested was to expand unemployment insurance benefits, since many people may not be able to get to work.

Companies that need the most support include those in transportation and distribution, because “they are on the front lines of the hit to global trade” that the coronavirus epidemic is creating, said Zandi. Next in line would be the travel, hospitality and leisure industries, he added. Beyond that, almost every industry in areas where communities are shut down through quarantine or declared as disaster areas will be affected, he noted.

What Should Investors Do?

As stock prices seem low now, should investors try and pick up some on the cheap? Zandi and Siegel had different perspectives on that question. “Most people shouldn’t look [at the market now],” said Zandi. “They should have a long-term investment horizon of five or 10 years. These ups and downs are not relevant. They should just ignore it.”

Investors who are in their 50s and 60s, who are approaching retirement, should wait until the volatility settles down, said Zandi. “Then, it would be a good time to evaluate how invested you are in the stock market, given the volatility that exists there, because you’ll need that money for retirement sooner rather than later. Your horizon isn’t long enough to be investing a large share of your portfolio in stocks.” Zandi also advised investors to avoid trying to re-allocate their portfolios, trying to balance equities with safer asset classes. “[Do not do that] at a time like this,” he said. “The markets are very volatile, and the S&P is already down almost 20%. I would caution [investors] not to do anything rash. This is a wake-up call for those who don’t like this kind of volatility and can’t live through it. When the dust settles, you can find investments that are more suited to your willingness to take risks.”

According to Siegel, “We all know which industries are going to suffer. I do want to warn people [to] get out of those in the stock market. Even though [those industries are] going to be hit, a lot of that hit has already been discounted in the prices.” He didn’t rule out stock prices in those industries declining another 5% or 6%. If people invest now in those industries, they will “most likely be rewarded a year from now with decent returns,” he added.

To be sure, uncertainty clouds the investment outlook. “Nobody knows how much earnings will be affected in 2020,” Siegel said. But beyond that, one might “assume that 2021 earnings will rebound to the same levels we saw in 2019. But virtually no one can buy at the bottom. Buying stocks at reasonable levels relative to history has always paid off for the long-term investor.”

The long-term prospects may well be why Chinese stock markets seem to be shrugging off the coronavirus impact and moving towards higher prices. Siegel noted that the Shanghai Composite Index is now higher than it was last November before China had had a single case of coronavirus. “How can that be? They’ve been in lockdown. They’re going to have a recession,” he said. But even as China may be staring at a contraction in its GDP, the investors driving up the Shanghai index may have decided they are going “to look further out,” he said. “The experts say, and we know through experience that these viruses – they have their big impact, and then they’re self-limiting. And we bounce back in 2021.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Stock Shock: What Lies Ahead for Global Markets? appeared first on Fair Observer.

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Elizabeth Warren’s Grudging Acceptance of Billionaires

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In November, Warren announced a revision of her earlier wealth tax proposal of January 2019, doubling the levy on households with more than a billion dollars in net worth. Under her plan, households would pay an annual 2% tax on every dollar of net worth exceeding $50 million and a 6% tax on net worth more than $1 billion. The tax would impact some 75,000 households who comprise the top 0.1% of US households, according to analysis by economists Emmanuel Saez and Gabriel Zucman of the University of California-Berkeley.

“A small group of families has taken a massive amount of the wealth American workers have produced, while America’s middle class has been hollowed out,” Warren said in the introduction to her latest plan. “It’s time for the rich to pay their fair share.” She cited findings by Saez and Zucman that the 400 richest Americans now own more wealth than all black households and a quarter of Latino households combined.

Revised Estimates

Kent Smetters, Wharton professor of business economics and public policy and faculty director of the PWBM, explained why the PWBM estimate is less optimistic than Warren’s. Speaking on the Wharton Business Daily show on Sirius XM, he said, “We assume that people will change their behavior to try to avoid some of the tax.” Some of this could be “legal behavior” on the part of the ultra-millionaires, such as setting up foundations that have less than a billion dollars or other devices “to escape at least the high threshold of the tax, especially if they are planning on giving some of their money away,” he added.

In trying to model “a reasonable avoidance mechanism,” the PWBM gathered international evidence on how taxpayers responded to wealth taxes and conducted interviews with tax experts. The study also drew upon the experience of its own team, which includes former Treasury officials who have worked on tax avoidance in the past.

The PWBM estimated the revenues the wealth tax could generate under two scenarios. If there were no avoidance of the wealth tax, the measure would raise $4.8 trillion from fiscal years 2021 to 2030. With “extreme avoidance,” that revenue estimate would drop to $1.4 trillion. Somewhere between those two extreme scenarios lies the PWBM’s best estimate of a total revenue increase of $2.7 trillion from fiscal years 2021 to 2030.

Impacts on GDP and Wages

The PWBM projected that the wealth tax would cause the US gross domestic product to fall by 0.9% in 2050 under the “standard budget scoring convention” that new tax revenues would be used to reduce the federal budget deficit. However, if those revenues were instead spent on public investments, it projected GDP in 2050 to fall between 1.1% and 2.1%, depending on the productivity of the investment. The tax would also cause average pre-tax hourly wages in 2050 to fall between 0.8% and 2.3% because it would reduce private capital formation, the PWBM study stated.

“If this [revenue] is all just coming from billionaires having fewer yachts to buy, that’s one thing,” said Smetters. “No one is going to have too many tears shed over that. But where it really comes in for everybody else, where the rubber hits the road, is in wages. Billionaires are billionaires because they’re invested in companies that aren’t being worked by billionaires. They’re being worked by you and me, who get wages and so forth.”

The PWBM’s projections of the wealth tax’s potential impact on GDP and wages are not particularly large, “but often people focus on the sign — whether it’s positive or negative — and it is, in fact, in a negative direction,” said Smetters. The estimates are in a range because much depends on how the money is ultimately spent, he added.

In a video explainer, Diane Lim, senior advisor at PWBM, and Richard Prisinzano, PWBM’s director of policy analysis, discussed the highlights of the Warren wealth tax proposal.

Great Expectations

Warren has focused on programs such as pre-K education, which generate returns of 7% to 10% on spending, but her campaign has not matched the money sought to be raised with government spending programs, Smetters noted. So, the PWBM study looked at a broad basket of productivity-boosting public spending programs, using the current distribution of public spending including on pre-K education and roads and infrastructure. In its calculations, it has assumed “pretty high” annual returns of 12% on money spent, he said. “If anything, we’ve given a pretty nice return to that spending,” said Smetters. “But even with that, you still have some economic activity that has been reduced, even with positive spending returns.”

Smetters said the PWBM estimate of returns is “aggressive” because it takes a long time for the benefits of programs like pre-K education or road construction to filter through. If, for instance, the public spending has to offset the negative effects of the wealth tax on the GDP, it has to earn returns of 15%, according to the PWBM. He also pointed to some “secondary effects” of such public spending. “For example, if some lower-income females suddenly had access to childcare, maybe they could go to work,” he said, noting that the Warren campaign has discussed that possibility.

Any of those scenarios involves “a fundamental tradeoff,” Smetters said. “If you believe that you’re going to get more revenue than what we’re suggesting, then you also have to believe that the tax actually has more bite to it. So there’s a fundamental, classic tradeoff between equity and efficiency.”

Unattractive Option

Wealth taxes are not new internationally, but over time, fewer governments have taken that route, the PWBM report noted. In 1990, 12 of the 36 member countries in the Organization for Economic Cooperation and Development (OECD) imposed wealth taxes, but by 2019, only four of them continued with that approach (Norway, Belgium, Spain and Switzerland). The report cited an OECD review, which concluded that “administrative difficulties, modest revenues, and failure to adequately address wealth inequality are among the main reasons why most member countries have abandoned wealth taxes.”

Smetters said the debate comes down to how net worth is defined. “How do we count that? That has been the struggle a lot of countries have had,” he noted. Unlike the value of a publicly-traded stock, it becomes “more challenging” to value privately-held businesses, he said. “[For instance], if you’re talking about a pension plan that’s giving you a stream of income over time, should that value be capitalized into its present value and treated as an asset? All those things are very challenging to figure out, and that’s where a lot of countries have found that very hard to administer.”

Families or other entities could own businesses with a net worth of $50 million or more — and the wealth tax could have a significant impact on them. Some countries like Spain, which still has a wealth tax, have exempted privately-held businesses precisely for that reason, since they are worried that it might compel the families that own them to sell their businesses, Smetters said. He dismissed suggestions from some economists that those wealthy businesses could give some shares to the government instead of paying the wealth tax. “That creates a lot of challenges because ultimately the government doesn’t want shares, it wants money,” he said.

Enforcement Matters

Smetters pointed out that while the PWBM does not take advocacy positions, “taxing wealth is challenging.” He said taxing high-income or wealthy people and enforcing it is much easier with, say, an estate tax, which kicks in at the end of a person’s life.

In the same way, capital gains taxes could be increased in order to get more revenue. Plugging loopholes that allow much wealth to remain untaxed upon death could also help raise tax revenues, Smetters said. “There are lots of ways that you can hit at this wealth, but they are much easier to administer if they focus on the income from the wealth, rather than the wealth itself.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Is Elizabeth Warren’s Wealth Tax Proposal Too Optimistic? appeared first on Fair Observer.

To be sure, Americans shopped in record numbers this year. The National Retail Federation (NRF) reported nearly 190 million consumers made purchases in the five days from Thanksgiving to Cyber Monday, an increase of 14% from last year. But more of them abandoned physical stores for the ease and limitless choices of online shopping. The biggest draw to digital was free shipping, according to NRF. Nearly half of shoppers surveyed said free shipping was the push they needed to make purchases they were otherwise hesitant about. A fifth of shoppers cited the option of buying online and picking up in-store as another factor in favor of virtual retail.

“The growth in online retail sales is a tide that lifts everybody,” said Phil Rist, executive vice president of strategy for Prosper Insight & Analytics, which conducted the survey for NRF. “When consumers are buying from retailers online but picking up or making returns in-store, it is more and more difficult to distinguish between the sales retailers make in their stores and the ones they make on their websites.”

Even with in-store pickup, the surge in online shopping means millions of packages need shipping. And free shipping, which is increasingly becoming the norm, is a significant cost to retailers. Amazon, for example, has spent more money year over year on shipping. Global shipping cost the company a whopping $9.6 billion in the third quarter of 2019, and this year’s total is expected to surpass the 2018 total of $27.7 billion. Overall, US firms spent a record $1.5 trillion on shipping, warehousing and logistics in 2017, according to the Council of Supply Chain Management Professionals.

“I think almost every retailer online offers free shipping,” said Wharton marketing Professor Ron Berman in an interview with Wharton Business Daily on Sirius XM. “It costs more to the retailer, of course. But the other thing is it makes people feel much more comfortable in buying, but also much more comfortable in returning.”

Berman and Wharton marketing Professor Barbara Kahn said there’s a certain psychology behind free shipping that makes it almost compulsory for retailers. Kahn calls it the “pain tax.”

“We know from psychology that people like to segregate gains — in other words, take pleasure individually in each positive benefit. But [they like] to integrate costs — in other words, they rather take pain in one lump sum than to experience the painful pricks each time,” she said. “If the shipping price is incorporated in the price of the good, and customers don’t have to think about that pain tax, they would definitely prefer it.”

According to Berman, shoppers simply don’t like to be charged extra for a service such as shipping when they have already paid for a product. Companies are forced into a trade-off between receipt transparency and consumer desire, so they mark up the product to absorb the shipping cost.

“One thing we know is people really, really do not like taxes. They do not like seeing taxes as itemized on their receipts. Shipping sounds like a tax,” he said. “When you have shipping kind of disappear from the receipt or the invoice, people are saying, “Oh, we love that. We don’t see that tax.”

Winning Customer Loyalty

A subscription service is one way to mitigate shipping costs, and Amazon Prime is the leading example of that. Prime members spend $119 a year in exchange for free shipping on more than 100 million items, according to the company. Many items are available with free one-day or two-day shipping. Although Prime doesn’t recoup all the shipping costs for Amazon, the company is willing to take losses in exchange for customer loyalty, which Kahn said is a winning strategy.

“Maximizing lifetime value of the customer can be highly related to overall profitability,” she said. “Amazon Prime customers are very loyal to Amazon, not only in retention rates (i.e., once a Prime member they tend to renew easily and stay Prime members for a long time), but also because Prime members stay on the Amazon website longer and purchase more. So, they are loyal over the long term and continue to be more profitable.”

Another approach is to offer in-store pickup and returns, which is feasible for retailers that have physical locations. It’s especially effective for smaller companies that can’t absorb shipping costs as easily as mega-retailers.

“This strategy gets the consumers to take on the costs of the ‘last mile delivery,’ which significantly reduces costs,” Kahn said. “Walmart is doing this very successfully, but smaller retailers have also started embracing this strategy as well, sometimes in very creative ways. For example, Urban Outfitters has allowed consumers to pick up purchases in Walgreen’s stores.”

Berman said retailers that can use their stores as “logistical centers” have an advantage over those that don’t, which is ironic because physical stores have become a financial liability for a lot of chains. Retailers are also experimenting with third-party shipping subscriptions and bundling items as ways to further mitigate costs.

While studies show that free shipping entices more customers to click the “order” button, it is also associated with a high volume of returns. The return rate can be as high as 40% or 50%, Berman said. It’s easy for shoppers to buy multiple sizes to try on at home knowing they can return what doesn’t fit, or take a chance on a product they aren’t completely committed to, knowing they can send it back for free or at a nominal cost.

Peer Pressure

One thing is clear: It’s hard for firms to shrink from the pressure to offer free shipping. “I’m not sure they can do too much, right?” Berman said. “Once you have enough retailers offering free shipping, you have to compete, and you need to stay on top of it and offer roughly the same level of service.”

Aside from following the Amazon model and charging a subscription, retailers could bundle smaller shipments together so they are not, say, sending out a tube of toothpaste one day and then laundry detergent the next, Berman said. Some are also requiring minimum purchases for shoppers to get free shipping. Berman noted that on Black Friday, he saw minimums ranging from $30 to $50.

“If the amounts are going to be too low or the shipping is going to be too over-dispersed, they’re going to start maybe offering more customized things, saying, ‘Well, we can offer you free shipping, but it’s going to be slow or you need to pick it up at the store,’ or something like that in order to somehow get the cost back,” he said.

Kahn said the future of free shipping is unclear. “I’m not sure what will happen,” she said. “The hyper-competitive nature of the retailing world, exacerbated by Amazon tactics, has definitely made this the norm. But operating margins are much lower nowadays for retailers than they used to be, and that is definitely a problem.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Is Free Shipping Sustainable for Retailers? appeared first on Fair Observer.

Uber has attempted to retain customer trust under Dara Khosrowshahi, who took charge as CEO in August 2017 to overhaul a flawed culture that developed under its former CEO and cofounder, Travis Kalanick. It also has grown at a scorching pace to now command a worldwide customer base of 110 million and a 68% market share in its industry in the US. Khosrowshahi has also taken steps to improve passenger safety and work with regulators.

If it could fix its processes, strive to be profitable and act less like an experimenting startup, Uber could potentially not just regain its London license, but also help shape the next phase of its industry, Wharton experts say.

What a Repeat Offense Means

The second denial of Uber’s license in London is “definitely a bad sign” for the ride-hailing pioneer, said Wharton Management Professor John Paul MacDuffie, who is also director of the Program on Vehicle and Mobility Innovation at Wharton’s Mack Institute for Innovation Management. “It shows that new CEO Dara Khosrowshahi’s efforts to bring about change at Uber in order to regain trust with customers, drivers, regulators and the public have not yet been successful,” said MacDuffie. “Not dealing more seriously with public concerns about safety appears to fall into the larger category of Uber’s resistance to any conditions placed upon it by regulators in cities, regions and countries.”

Uber had been denied a license renewal in September 2017, but it won a court reprieve to secure a provisional license for 15 months. TfL granted Uber a two-month probation in September 2019 to allow it to submit information on its actions to meet the 20 conditions it had set for the ride-hailing company to ensure that passenger safety was protected. Uber has said it would appeal the decision; it has 21 days to do so. Khosrowshahi tweeted that the TfL decision “was wrong,” but he pledged to “keep going, for the millions of drivers and riders who rely on us.”

In its latest action, TfL had identified a loophole in Uber’s systems called “account sharing,” which allowed unauthorized and unidentified drivers to upload their photos onto other drivers’ accounts. This allowed those drivers to pick up passengers as though they were the booked driver, which occurred in at least 14,000 trips, “putting passenger safety and security at risk,” the regulator stated.

Uber may have been able to prevent such a practice from creeping into its systems, MacDuffie suggested. “[The loophole] is something one imagines Uber, with its technological sophistication and skilled staff, could solve if it wished.”

Testing Technology’s Reach

For a company that touts its technology platform as its core strength, Uber ought to do “a better job,” according to Gad Allon, Wharton professor of operations, information and decisions, who is also director of the Jerome Fisher Program in Management & Technology. If Uber falls short on providing guardrails for its customers, that has to do with its culture, Allon noted during a recent interview on the Wharton Business Daily radio show on Sirius XM. “Their culture has been: ‘We’ll do things and then we’ll see the best way to do them and potentially ask for forgiveness.” He noted that Uber has already once asked for forgiveness in London. “Now they’re going to ask for the second time and we’ll see what happens.”

But Uber has also brandished its technology platform to keep regulators at bay. “There appears to be a deep belief that, as a technology platform that simply brings drivers and customers together, Uber and its business model exist outside all past transportation business models and rules,” said MacDuffie. He noted that Uber has taken such a stance taken toward attempts to regulate its business model in New York City and in California.

Two months ago, when California passed a bill that could have forced Uber to classify its drivers as employees, the company was defiant. The company’s “drivers’ work is outside the usual course of Uber’s business, which is serving as a technology platform for several different types of digital marketplaces,” Tony West, Uber’s chief legal officer, said at the time. “We will continue to defend the innovation that makes that kind of choice, flexibility and independence a reality for over 200,000 drivers in California.”

Challenges to the Business Model

According to MacDuffie, Uber’s regulatory face-off in California regarding whether drivers should be regarded as employees rather than independent contractors represents the most fundamental challenge to the company’s business model. While that issue is not at the center of the London dispute, it may play out first in the US, in states like California and New Jersey or in cities like New York, he said.

Uber’s approach to regulators is also significantly different from those of others in its industry. Uber’s competitors often differentiate by working more closely with cities, sharing more information and negotiating rather than defying conditions, said MacDuffie. “Uber, as the original ‘move-fast-and-break-things’ provocateur, still has that reputation,” he added. “Perhaps that tendency is embedded deep in its culture. It will have to work harder to win back trust of its various constituencies.”

Uber chiefly has to fix two issues to straighten out its culture, said Allon. One is for it to become profitable. “They’re not profitable yet. It’s very clear that to be able to sustain themselves they will need to be profitable,” he said. The second aspect has to do with its “culture of being a startup,” which has to change. “You want to keep an entrepreneurial culture as much as you can, but this notion that you can get into a city, just do things and then see how they evolve later on, in terms of also having casualties, potentially, and having issues around harassment of [individuals], definitely cannot be sustained.”

Further, with diversifications such as Uber Freight, Uber Eats and Uber Works, “it’s not clear that they’re actually investing heavily in making this market more efficient,” said Allon. “The feeling is that Uber is playing a catch-up game with regulation, and making sure they appease regulators, rather than innovate on the safety side.”

Regulators, too, are playing catch-up with evolving technologies such as those used by Uber, and that situation could unfold over the next two decades, or maybe longer, said Allon. Ride-hailing firms, for instance, “are playing a waiting game until we see what happens with autonomous cars,” he added. The advent of autonomous cars would raise multiple issues for regulators such as validating algorithms or ascertaining that driver attention is not sacrificed, he noted. “I don’t think the types of regulations we have are ready to [handle that].”

How the Market Would Readjust

Even as London’s regulator has turned off Uber’s ignition key, the setback “is not fatal to the future of ride-hailing services” in the city, said MacDuffie. He noted that several ride-hailing firms are active in London, including Bolt, ViaVan (a pooled service from the US company), and Kapten (a French firm with funding from BMW and Daimler); Ola from India is weeks away from launching its service in London after it recently secured a license. “This is the story in many parts of the world — Grab in Singapore, Didi in China, Lyft in the US – challenging the idea that ride-hailing is a winner-take-all market,” he added.

MacDuffie offered a glimpse into how the ride-hailing market could change in the foreseeable future as Uber appeals the TfL ruling. It could continue to operate in London until a decision is available on its appeal, which could take several months. “During that time, Uber has the opportunity to make further reforms to address public fears that it is not sufficiently careful about safety,” he said. “Its competitors will attempt to gain ground, and they may or may not succeed because they face the same daunting economics that have kept Uber and all the other ride-hailing services unprofitable since their founding. Meanwhile, additional challenges to Uber and other ride-hailing services will continue to mount around the world.”

According to a report in CityAM, on the day of TfL’s Uber suspension, Bolt’s daily downloads nearly doubled from 5,778 to 10,894 and have stayed around that mark since. French ride-hailing app Kapten saw a similar increase in daily downloads, going from 3,274 to 8,901 on November 25.

In any event, Allon expected to see Uber back on London roads at some point in time. “I cannot see a solution where [Uber’s license] is not going to be renegotiated,” he said. “I think it will be renegotiated in a way where Uber will have to strengthen its processes, and will potentially have to give up something in terms of controlling hours [that drivers work], maybe like in New York.” (Under new rules that took effect last April in New York City, Uber is not permitted to dispatch trips to drivers who have completed 10 hours of “passenger time” in a 24-hour period or 60 hours a week.)

According to Allon, the regulator’s action is not aimed at banishing Uber from London, but more at ensuring that it improves its safety processes. “The solution is not going to be to take Uber out of the city. I don’t think that’s what’s going to be at stake here,” he said. “It’s just another point in negotiation requiring Uber to demonstrate that their drivers are, indeed, safer — that they’re doing a better job on background checks. That they’re doing a better job in moderating some of that. And maybe potentially some of that will also be about taking care of their drivers better.” He noted that Khosrowshahi has steered Uber to improve its safety processes with its safety toolkit and a “bike lane alerts” feature that lets its drivers know if their passengers are exiting on a bike lane.

In London, specifically, Uber has to carefully manage the improvement of its safety processes in order to avoid collateral damage, Allon said. “There is a constant balance between people and processes. At the initial stage, you rely a lot on people. And as you start growing, you need to start adding more processes,” he added. “But you don’t want these additional processes to become a bureaucracy where you start alienating people. And since they are competing on drivers, if you’re going to make it hard for any driver to join by creating a lot of red tape, ultimately, you’re going to stifle the market that you’re building on.”

What Works in Uber’s Favor?

While the London debacle may have affected the safety perception of Uber, it still enjoys a fair amount of consumer trust, said Allon. “Think about how much trust Uber managed to garner in a very short amount of time,” he noted. “I go to a random city, anywhere in the world, and I take out my phone and get into a random stranger’s car — all because the name Uber is associated with it.”

In fact, Uber could use improved safety processes as an entry barrier to stave off competition. “Once you set up [a process where] every driver will have a background check run by the firm with a process that has, say, 15 different steps, you’ve basically solidified Uber as the monopoly in this market,” said Allon. “There is no way that a new entrant could then withstand this type of regulation.”

Customers themselves would like to see Uber continue to grow, Allon noted. “Uber solved a problem in most cities,” he said. “In New York City, for example, if you went to take a cab during rush hour, good luck. And so, we like their presence.”

The Road Ahead for Uber

MacDuffie offered several scenarios that could unfold over the long run: “Will Uber only fight these challenges, in court and by expensive campaigns to influence public opinion? Or will it engage its critics, stop seeing governments and regulators as enemies, and seek compromise? Will Uber’s critics seek to punish it for past sins, possibly removing an important source of transportation in locations and at times of days when many people have no good alternatives and eliminating a flexible-hours job that many have found helpful when extra income is needed? Or will they work towards a multi-mode mobility system in which Uber and ride-hailing make up an important piece but just one piece – of solving the puzzle of moving people and goods around?”

Those factors could either leave the ride-hailing industry permanently shackled or bring solutions to recurring problems it faces. “The next few years will be a time when a growing backlash against ride-hailing could become politically powerful and lead to lasting constraints for its business model,” said MacDuffie. “Or, instead, it could be a time when skillful strategizing and abundant communication between parties on both sides of the dispute lead to creative solutions and a better process for moving forward on the crucial mobility challenges of the early-to-mid 21st century.”

*[This article was originally published Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Can Uber Overcome Its Regulatory Obstacles? appeared first on Fair Observer.

Even though the boss in question actually ended up being thrown out of ABC for embezzlement, “when your boss tells you you’re unpromotable, when you’re 23, it’s hard to dismiss that,” Iger said. “I just didn’t want to believe it, and fortunately I ended up getting another job at the company that he had no hand in.”

Over his more than 40 years in the entertainment business, Iger has proved himself to be anything but unpromotable — he rose through the ranks at ABC and then at Disney after the entertainment giant purchased the television network in the 1990s. Since taking the helm at Disney, a $236-billion empire that encompasses television, movies, theme parks and more, he has overseen lucrative acquisitions such as the Pixar animation studio, Marvel Entertainment, Lucasfilm and, last summer, a $71.3-billion deal to purchase 21st Century Fox.

The content and brand equity associated with those properties, along with Disney’s vault of classic films, are the cornerstone of Iger’s latest big move – the November 12 launch of Disney+, which aims to take on Netflix for the No. 1 spot among streaming services.

From Weatherman to the C-Suite

Iger started his career with aspirations of becoming a network television anchorman. He initially got a job as a TV weatherman, an experience that taught him he was better suited to working behind the camera.

On July 1, 1974, Iger took a job as a production assistant at ABC. He worked at ABC Sports for 13 years, including covering six Olympic Games. He was head of ABC’s entertainment division when the network was home to popular sitcoms like “Home Improvement” and “Roseanne,” and the TGIF programming block that included “Full House” and “Family Matters.” In 1994, he was named president and COO of the network’s parent company, Capital Cities/ABC.

“I worked my way from job to job,” he said. “I got in this position through a combination of applying myself, really working hard and never being fearful of the next opportunity that came my way, getting lucky, and having great mentors.”

Disney bought ABC in 1996 and Iger was named president of the business unit that oversaw Disney’s international operations in 1999. In 2000, he became COO of Disney, making him the No. 2 executive after then-chairman and CEO Michael Eisner.

Iger said he wasn’t sure that he would one day run Disney “until I was being told by the board I was getting the job 10 years later. It’s not something I dreamed of being, it’s not something I set my sights on early,” he noted. “I’ve always been the kind of person who did the job that was given to me, tried to apply myself and … [was then] given another opportunity. And that was the case — I never really looked beyond what might be the next opportunity until I was really close.”

It took 15 interviews before Iger was offered the CEO job at Disney. At the time, Eisner had held the job for more than 20 years — and for much of that time, he had great success, including reviving Disney’s slumping animation division with hits like “The Little Mermaid” and “The Lion King,” acquiring ABC and ESPN, and becoming something of a celebrity in his own right as host of “The Wonderful World of Disney” TV series.

By the early 2000s, however, Disney had fallen on tough times creatively and commercially and Eisner had lost the confidence of the company’s board, including Roy E. Disney, nephew of founder Walt Disney. During Iger’s interview process, he faced significant pressure to criticize Eisner.

“I refused to do that — I was still working for him and he had been a mentor to me,” Iger said. “Making the case for myself by comparing me to him was beneath me, disrespectful and irrelevant. … I told the board that I can’t do anything about the past, but I’m glad to talk about where I want to take the company and where the company needs to go.”

Why Streaming?

Where the company needs to go next, Iger said, is into direct-to-consumer platforms — namely streaming. According to a recent profile in The Hollywood Reporter, in addition to the Fox deal, Iger has invested $2.6 billion in technology for Disney+ and left $150 million in revenue on the table after ending the studio’s deal to stream its content on Netflix.

Disney+ customers can pay $7 a month to access almost 500 Disney movies and more than 7,500 classic episodes of television, The Hollywood Reporter story noted. Disney+ will also be home to original series that expand the worlds of Marvel and Star Wars, along with a live-action “Lady and the Tramp” reboot and a series spin-off of the popular “High School Musical” TV movies.

“When I got my job … I saw a world where technology has enabled storytelling to proliferate much more and there is much more consumer choice,” Iger said. “Quality and brands matter more than ever. That essentially means don’t let the economy get in the way of making something great, don’t let time get in the way of making something great. Don’t be limited by the amount of time it takes or the amount of money. Greatness is a necessity and an imperative.”

As the service was poised to launch a few weeks ago, Disney stock gained 5% as it announced fourth-quarter earnings that were in line with Wall Street’s expectations, including a 34% increase in revenue to $19.1 billion.

Disney+ faces tough competition in the streaming space from current leader Netflix, along with new entrants Apple+, HBO Max and Peacock, all of which are expected to roll out in the next year. (As part of the Fox deal, Disney became the full owner of Hulu, which was previously a joint venture between Disney, NBCUniversal and 21st Century Fox.)

Disney is projecting between 60 million and 90 million subscribers to its streaming service by 2024 — by comparison, Hulu reported 28 million subscribers last spring and Netflix reported 60.6 million subscribers in the US and 97.7 million internationally earlier this month.

The acquisition of Pixar, Marvel, Lucasfilm, National Geographic and other household names are key to the future success of Disney+, Iger told the audience at Wharton.

“Consumers have a habit of going right to brands that you know because that brand has values. It creates almost a chemical reaction inside you if I say Nike, or Apple or Mercedes Benz or Pixar or Star Wars,” Iger said. “There’s a comfort level because you know you’re going to be buying something that you know and trust.”

The existence of such a large library of existing content, plus those brand names, are why Disney is hoping its streaming service will be a different kind of value proposition to subscribers who are already being inundated with streaming options.

“As we see it, we’re not competing as directly because of the brand proposition of the service,” Iger noted. “That’s one reason we’re doing it, and that’s one reason we’re confident about it. From a consumer perspective, it’s a very, very different product than what you’re buying from Netflix and Amazon and what you’ll buy from Apple.”

Segmentation and the Creative Process

While many observers see Disney+ as a slam dunk for families with children or dedicated fans of Star Wars or Marvel’s Avengers, some wonder whether Disney+ will have enough content to attract other key demographics. On the earnings call, Iger said Disney+ had a successful test run in the Netherlands and that the demographics of people using the service was broader than expected.

During his talk at Wharton, Iger said the company’s acquisition strategy in recent years makes it easy to offer content for a variety of different audiences, even if it isn’t overtly branded as Disney content.

“FX is one of the networks we bought from 21st Century Fox and it’s known for edgier programming,” Iger said. “We have no problem owning that because we didn’t think the edginess put into the programming was gratuitous; we thought it had a purpose in terms of the storytelling.”

However, consumers shouldn’t expect to see FX shows like “American Horror Story” or “The Americans” streaming on Disney+, Iger said. “Disney+ will be Marvel, Pixar, Star Wars, Disney and National Geographic,” he said. “It’s not FX, not the other Fox brands, not [Fox] Searchlight [movies]. We’ll deliver those separately to the consumer.”

During Disney’s earnings call, Iger said FX programming will have a larger presence on Hulu going forward, including current and former shows and original content created exclusively for the streaming service.

Like his predecessor, Iger is also credited with reigniting Disney’s animation division, which had once again fallen on tough times at the end Eisner’s tenure. Fixing a souring relationship with, and then acquiring, Pixar was a major part of that strategy, Iger said, but equally important was giving creative power back to directors.

“We turned what had become a producer’s medium back into a director’s medium, where the stories we’re telling typically emanate from directors’ hearts and minds,” he said. “We ask people to tell us what [resources] do you need to make it great: how much time, how much money do you need, and if we really believe in you and your idea we’re going to give you the support to execute it.”

While Iger still has to pay a lot of attention to Disney’s bottom line, he noted that no one has ever complained about a creatively and commercially successful movie or television show costing too much money or coming out later than it was expected.

And what if the endeavor is ultimately a failure? “Failure in creativity is inevitable; there are no guarantees, it doesn’t reduce to a math or a science. You can believe in the creator, believe in the idea, believe in the executive, but you don’t know 100% whether something will succeed,” he said. “You have to figure out how to process that; you don’t want to wallow in failure. You have to say this is a business and move on.”

Using His Voice

Iger said he’s careful to use a targeted approach to giving input on creative projects – as CEO, he sees his role as weighing in on the big issues, like a story’s pacing or clarity, rather than smaller details.

He takes a similar approach to deciding when and how to use the power that comes with being in his position. For example, director Martin Scorsese was recently in the news for making critical comments about the Marvel movies, telling Empire magazine that they aren’t “cinema.”

Rather than debating Scorsese publicly, Iger — a big fan of the director who counts “Raging Bull” as one of his all-time favorite movies – instead sent a note via Scorsese’s producing partner and manager, complimenting the director’s new film, “The Irishman,” but also noting that the team in front of and behind the camera of the Marvel movies, “are putting their heart and soul into them creatively and really believe in what they’re doing. When a guy like Martin Scorsese criticizes them, that hurts. I have no idea what his motivation was, but on their behalf, I felt I needed to say what he said was hurtful.”

Although Iger doesn’t see himself as much different than the 20-something PA who started at ABC making $150 a week, he acknowledged that “the power of my voice is much greater than it ever was and sometimes I expect it to be. It affects my interpersonal relationships with the people who work with me, creative people and even the people I interact with in my personal life. … Because of that, I’m more aware of my voice and the effect it can have on people. I’m much more careful of how I use it, when I say something, what I say or, especially, how I say it.”

Iger has also been clear that his time at Disney is nearing its end — he plans to step down as CEO in 2021.

“I have a great job – who wouldn’t want to run Disney? It’s a lot of fun and no two days are the same. I’m working in a business that touches the world and the impact we have on the world is incredible,” Iger noted. “But I think there’s a time to make a change at the top, and my time is about right. I said I’m leaving in 2021, and I’m leaving in 2021.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Why Disney Is Betting Big on Streaming appeared first on Fair Observer.

The company announced the dismissal on November 3 after Easterbrook sent an email to employees expressing regret over the relationship with the unidentified subordinate and calling it “a mistake.” McDonald’s confirmed that its board of directors determined Easterbrook violated company policy, which prohibits employees from “dating or having a sexual relationship” with direct or indirect reports.

McDonald’s decision to fire Easterbrook was the right call, according to Wharton Management Professor Stephanie Creary, whose research focuses on identity and diversity in the workplace. “There’s a policy [at McDonald’s] that said that people who are in a reporting relationship … should not be in a position to control the rewards or punishment of somebody else who’s in a subordinate role in that relationship. And that policy was broken,” Creary said during a segment on the Wharton Business Daily radio show on SiriusXM.

According to Creary, workplace liaisons between employees who are not peers create “asymmetric power relationships” that raise serious concerns about subjectivity, ambiguity and fairness. “You think of that from a top-down perspective, but we can also think about it from the perspective of that person who is in this relationship,” she said. “What is their clarity around what they can and cannot say about their workplace experience when, in actuality, anything that they’re saying is in direct relationship to the CEO’s position? There are a lot of complications here.”

The larger societal context around sexual harassment and misconduct, brought to the forefront by the #MeToo movement, is another reason why McDonald’s was correct in parting ways with Easterbrook, according to Creary. The company’s action mirrors those taken by several others in recent years, including Intel, Best Buy and Boeing.

In 2018, Intel CEO Brian Krzanich resigned after the company discovered that he violated its managers’ nonfraternization policy by having a relationship with an employee. In 2012, Best Buy CEO Brian Dunn stepped down after engaging in what was described as an “extremely close personal relationship” with a female employee. And in 2005, Boeing chief executive Harry Stonecipher was forced to resign over a relationship with an employee.

Executives Are Part of the Brand

According to Wharton Marketing Professor Americus Reed, corporate branding is one reason why inappropriate behavior is no longer tolerated. In the past, executives were largely unknown to customers. But in the digital era, much of what they do is public, and their actions reflect the values of the company.

“You can’t hide in the C-suite anymore,” Reed said during a separate radio interview on Wharton Business Daily. “All the C-suite individuals are on blast now because consumers want to know how are you running your company? What are your morals? What are your ethics? How are you appropriately treating your customers, your employees, the people around you? Those questions didn’t often get asked, and you never knew who the person in the C-suite was. Now, you know the person, they have a brand themselves and they represent that company.

“If the CEO is representative of the brand,” Reed continued, “then they cannot allow things that may have nothing to do with making hamburgers affect or compromise the overall perception of what the brand is trying to do.”

Reed noted that he was shocked by news of the firing and thinks it sends a strong message to middle managers to fall in line with the company’s code of conduct. “As middle management, I’m probably under more scrutiny in terms of my ability to be doing things that may not be consistent with what I’d like to portray as my brand,” he said.

Compensating Bad Behavior?

Easterbrook joined McDonald’s as CEO in 2015 and was widely credited for revamping the iconic fast-food chain, leading the company to historic high stock prices. Company financials listed his salary as $15.9 million in 2018. He will receive a severance package worth a reported $42 million, in addition to $23.8 million in stock options.

Creary thinks the longstanding practice of giving hefty compensation to CEOs who are shown the door over misconduct will change in the future. The first step is for companies to include explicit language in contracts that would require CEOs to forfeit money and other benefits in such cases. “I think as boards are accepting their responsibility more around issues of sexual misconduct and personal misconduct, this is going to be something that they continue to raise,” she said.

Rebecca Thornley-Gibson, partner at the London-based law firm DMH Stallard who joined Creary on the radio segment, pointed out that workplace relationships are unavoidable, so companies should have clear policies regarding them. In the US, such relationships are banned or frowned upon. However, in the UK, employees are expected to disclose any sort of relationship — romantic, friendship, familial, etc. — in order to be transparent and avoid conflicts of interest, she noted.

“There’s more of an understanding that it’s going to occur, and there’s more of an understanding that it’s inevitable, so practical measures should be put in place to ensure that the risks of that workplace relationship impacting on others and on the organization are reduced,” she said.

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Workplace Romance: Did McDonald’s Make the Right Call? appeared first on Fair Observer.

South Korean immigrants Jin Sook and Do Wan Chang started the chain in 1984 with $11,000 that they saved from working in low-paying service jobs. Their first store was a 900-square-foot space in Northeast Los Angeles that offered cheap and trendy clothing to a young, mostly Korean-American clientele.

But the couple had a plan. Their fast-fashion business model, which was based on quick-turnaround designs that could be inexpensively mass-produced, proved wildly popular with young customers who didn’t have much money to spend but wanted the latest looks. By 2015, global sales peaked at $4.4 billion, with 480 stores occupying enormous spaces in malls across America, according to Business Insider. Sook and Chang became wealthy, with a combined estimated net worth of nearly $6 billion.

However, the couple didn’t anticipate the so-called retail apocalypse, which began in 2017 and continues to threaten virtually every retail chain. More than 8,200 stores in the US have closed this year, according to Coresight Research. The firm anticipates 12,000 closures by year’s end, eclipsing the 5,844 closures in 2018.

The rapidly changing retail sector put too much pressure on Forever 21, and the privately-held company filed for Chapter 11 bankruptcy in late September. It announced that it will cease operations in 40 countries, including Canada and Japan, and close 350 of its 800 stores, including 178 in the US.

The dramatic rise and fall of Forever 21 is a story that repeats in similar fashion across the retail landscape, but there are some factors specific to the chain’s troubles. Wharton marketing Professor Barbara Kahn and Ludovica Cesareo, a marketing professor at Lehigh University, analyzed the case on the Knowledge@Wharton radio show and outlined three distinct reasons why Forever 21 failed to stay on top.

Too Many Stores, Too Much Space

Forever 21 expanded rapidly in a short period of time, going from outlets in seven countries to 47 in just six years. Even as other chains were downsizing amid the retail apocalypse, Forever 21 was opening new stores as late as 2016.

“It’s kind of like the Gap, where they overbuilt the stores, too,” said Kahn, who also hosts “Marketing Matters” on Sirius XM. “They weren’t seeing the trends, and instead of slowing down on physical space, they were building up physical space. That was a tactical mistake.”

It isn’t just the number of stores that is problematic, it’s also their size. Forever 21 stores are huge, with the average size at 38,000 square feet, according to the company’s website. The largest store is multiple stories and takes up 162,000 square feet. The Times Square store in New York City is 91,000 square feet, and a mall store in Las Vegas spans 127,000 square feet.

All that space is expensive, the experts said. Sales reportedly dropped by 20% to 25% last year, which means the company likely struggled to pay the high rents demanded by premier spots while facing increased competition from Zara and H&M, the other big players in the fast-fashion segment.

“A lot of [Forever 21] stores were big footprints — almost as big as department stores in some of the malls,” Kahn said. “When they close down, it’s kind of like an anchor closing down. It doesn’t bode well for those malls, either.”

The company’s rapid expansion in recent years is opposite to the business strategy currently being deployed by retailers trying to save themselves from extinction. Many chains are closing their big stores and moving to smaller footprints and mini-shops as a way to shrink costs while maintaining consumer access to their brands. Even big-box retailers like Target are opening smaller stores in metropolitan areas, where big retail space is hard to find.

Meanwhile, “digital native brands — think of the Warby Parkers or the Caspers of the world – they’re opening stores,” said Cesareo, whose research specialty includes consumer behavior. “You would say it almost wouldn’t make sense, but they are opening these small pop-up shops and flagship stores where consumers can actually experience the brands firsthand. There’s more of a shakeout in retail than a full apocalypse right now. Retail is just repositioning itself.”

A Weak Focus on E-Commerce

Another big failure for Forever 21 is particularly baffling to Cesareo. She said the company didn’t bolster its e-commerce platform, even though its core customers are young people who prefer to shop online.

“It’s fascinating that they couldn’t predict that shift, so now they’re forced to restructure their entire company and really put pressure on their online commerce platform to try to make up for the lost sales,” she said.

Digital has become such an important component to retail that most stores cannot survive without it. For brands that target younger consumers, digital drives their business. Forever 21 has stated that 16% of sales come from online, and Cesareo praised the site for being user-friendly. In fact, she said, it’s highly rated in surveys by Generation Z shoppers — defined as those born after the year 2000. The company also has good customer interaction, reposting a lot of social media content from their customers that showcases the store’s products.

“So they’re good at doing it, except they didn’t realize that’s where consumers wanted to buy most of their clothing, and they also didn’t realize the amount of competition coming from other online retailers was skyrocketing,” she said. “Think of brands like ASOS or Fashion Nova, whose entire business model is online. They have understood that the customer of the future is a digital-savvy one who wants to buy online, who prefers to buy something online and return if they don’t like it or don’t have a need for it, rather than going into the store to try it on.”

Kahn argued that customers still like the experience of shopping in physical stores, and she and Cesareo agreed that stores have to reinvent themselves.

“Bad, out-of-date retail that’s not paying attention to the trends, those are the ones that are closing. But to say physical stores don’t have a purpose, I just don’t think that’s right,” Kahn said. “I think you just have to pay attention to what’s going on and what people want.”

The Move Toward Sustainability

Perhaps the biggest mistake made by Forever 21 was its leadership’s inability to read the tea leaves and see a significant shift in consumer attitudes about fast fashion. That business model worked well until the world woke up to the pressing problems of climate change.

According to the United Nations, the fashion industry produces 20% of the world’s wastewater and 10% of global carbon emissions — more than all international flights and maritime shipping. With its focus on synthetic fabrics and quick manufacturing time, fast fashion has been shouldering much of the blame for those statistics because it produces tremendous waste.

Young people are leading the charge for sustainability, demanding that businesses reduce their devastating impact on the environment. Customers that once flocked to fast-fashion stores like Forever 21 are abandoning them in favor of clothing that isn’t disposable.

“I think fast fashion as we know it is not going to exist for much longer, meaning they’re going to have to completely rethink their business model because the younger consumer is so attentive to sustainability issues,” Cesareo said. “The younger consumer wants to spend more money on higher-quality clothes, so they’re less likely to go to Zara 17 times a year as they did in the past because they just care more about the environment, and they know that these companies don’t really have sustainability at the heart of what they do.”

Gen Zers are demanding change and want to see their values reflected in their favorite brands. Companies including Forever 21 must show their sustainability efforts not just through their products but also in their marketing, messaging and online engagement with customers, Cesareo said.

She and Kahn credited Zara and H&M for rolling out sustainable collections this fall, and they highlighted the growing trend toward upcycling, recycling and renting clothes.

Forever 21 built its model on “trying to have this fashion come in, and in style, very, very quickly. The clothes aren’t necessarily supposed to hold up for a while. They’re only a couple of wears because they’re so trendy,” Kahn said. “At the same time they’re doing that, there’s a lot of headwind for sustainability efforts and renting and sharing and not making clothes that get thrown away.”

Kahn does cut the company some slack. After all, she said, predicting what young consumers want is difficult because they change their minds so quickly that it’s hard to keep up.

“They’re fickle. That’s the point,” she said. “They’re revolting about what’s there, they want to do something new, and it’s kind of hard to figure out what their trends will be.”

Still, the professors believe the sustainability movement is here to stay. The company will have to get on board as part of its survival — if it can survive.

In a letter posted to customers on its site, Forever 21 emphasized that it is not shutting down. “We are confident this is the right path for the long-term health of our business. Once we complete a reorganization, Forever 21 will be a stronger, more viable company that is better positioned to prosper for years to come,” the letter states.

The professors remain skeptical. Cesareo said she’s waiting to see whether Forever 21 takes on some of the strategies that are helping other retailers succeed, including smaller stores, ship-to-store options and sustainable products. Kahn said it’s imperative that they restructure properly.

“One can only hope,” she said. “We see a lot of these brands that come back and they just don’t seem to get it, so I hope they do.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Fashion Fail: Where Did Forever 21 Go Wrong? appeared first on Fair Observer.

Today, these four players have been overshadowed by Amazon, Google, Apple and Facebook. Fueled by a leap in broadband adoption in households and the advent of smartphones, tablets and other devices, the digital living room is no longer a TV-centric area in the home. Amazon’s Alexa digital assistant and connected devices are changing the way people search for and consume content. Google is doing the same thing with Google TV, Google Home and YouTube, as is Apple with its HomePod, Apple TV and Siri. Meanwhile, Facebook has become a source of content for people as they interact within the social media site’s platform.

But while the digital living room may look vastly different now, it still isn’t the unified and open ecosystem consumers want. “We’re certainly much further along, but there still isn’t true integration of all the different devices and services,” said Kevin Werbach, Wharton professor of legal studies and business ethics. True integration, he said, is a digital environment where consumers can link “every device and every piece of content on every service and be able to experience them together.”

This quasi-utopia remains out of reach because of competing business interests, Werbach said. Companies race to become the main provider of video and music in the home but also seek to dominate in digital services more broadly to corral consumers into their ecosystem. “The economics make it difficult,” he explained. “For the foreseeable future, it’s going to be this co-opetition (cooperative competition) landscape where it’s never quite in anyone’s interest to give consumers what they want, which is one subscription and one set of devices that give them everything.”

Streaming Video Frenzy

Back in the mid-2000s, Werbach recalled, the challenge in the digital living room was “hardware systems not talking to each other.” These days, the issue is less about technical ability but rather content fragmentation. For example, he said that while he has access to plenty of good content through his cable provider’s ecosystem, it doesn’t offer everything he wants to watch. “Now that we have all these streaming services, we increasingly have the problem of content not being available across different platforms — and that’s getting worse,” Werbach noted.

As more streaming services popped up, content became further siloed. “For a while, if you paid for Netflix, you got most of the stuff you wanted to get. Now there’s Netflix, there’s Amazon, [there’s the upcoming] new Disney service and AT&T/Time Warner [service] and so forth,” Werbach said. “These companies are strategically withholding content from each other to get people to pay for their subscription service.” (Disney and Comcast’s NBC are pulling their most popular content from Netflix to put into their own new video services.) But this move will backfire: “No one wants to pay for six different video services.”

That means among the dozens of streaming services, many won’t make it. “At some point, some of the streaming services that are available today will exit the space,” said Wharton marketing professor Josh Eliashberg. He cited several reasons that could lead to their departure, which include the need for big investments in new content development, constraints in capitalizing on other entertainment consumption outlets such as movie theaters, and consumer dissatisfaction with subscriptions to multiple service providers. “These trends are likely to lead to an increase in M&A activities and decrease in the number of major players,” he said.

While it’s tough to forecast how many streaming services the market can sustain, Eliashberg believes the major studios — such as Disney, Comcast and AT&T/Time Warner — will stay. These are the studios that have been generating entertainment content for a long time and for which streaming video services represent just “a fraction of their business,” he added. In particular, he sees Disney dominating along with Netflix. “Disney owns and will capitalize, through Disney+, on its franchises and potential for remakes.” As for Netflix, “they don’t only collect useful data on consumers’ preferences and content with global appeal, they also analyze the data effectively and use them to drive creativity.”

What Eliashberg sees continuing are the popularity of streaming services, the use of smartphones for entertainment and the decline of pay-TV providers (cable, satellite and telecom TV companies). He also noted that “the increased number of options and payments available for consumers is likely to lead media content providers to aggregate their services.” For example, Comcast customers can access Netflix, YouTube and Pandora without leaving the cable system. He also expects there to be more consumption of augmented and virtual reality content in the home, voice-assistant platforms playing a major role and “active consumers” sharing reactions to content in real-time online.

(User-Generated) Content Is King

The flip side of content fragmentation is that the digital living room is now more decentralized and fluid. “So much of the digital living room was centered around the television and how we could use technology to interact with the [TV] program,” said Wharton marketing professor Peter Fader. “What we’re seeing now is you go into the living room, there’s plenty of digital, but there’s no [crowding around the] TV. Everyone’s sitting around watching what might pass as TV, just consuming content on their laptops. Very often, you’ll have four different people watching four different programs with their headphones on.” He calls this phenomenon “fragmentation desocialization.”

Increased broadband speeds were a major factor in fueling this trend. “Everybody in the household kind of streams content at a rate and quality that’s unthinkable even half a generation ago,” Fader said. “We really can just pump so much content at the same time that there’s no reason why we have to sit around and argue about which channel all of us are going to watch.” He said this ability to watch what one wants brings “greater overall satisfaction,” punctuated by periods of “intermittent sharing” of content worthy of attention before going back to solo viewing.

When 5G arrives, which promises wired broadband speeds for mobile, it could “create just all kinds of untethered flexibility [leading] to content forms and distribution mechanisms that we just can’t even imagine right now,” Fader added. But he acknowledged that the promise of true 5G remains “years and years and years away.” (More spectrum needs to be cleared for 5G and extensive infrastructure has to be built for this next-generation wireless protocol to work robustly.)

Werbach has a different view. “5G for consumer applications in the home just means more bandwidth, but we already have, generally speaking for most people, enough bandwidth” for current use cases. If virtual and augmented reality applications take off, then 5G will be a major enabler. “But in the near term, 5G is not a game changer for consumer entertainment applications in the home,” he said. “It’s about mobile and ultimately, it’s going to be about the Internet of Things.”

Looking ahead, Fader sees user-generated content and activities as a big game changer for the digital living room. “This to me is the biggest unspoken trend,” he said. People are increasingly using video game systems not to play games, but for their avatars to interact in a reality TV show-type of way. For example, Fader said, around 20 to 30 people are using the video game Grand Theft Auto as a “stage. They’re not necessarily playing the game, but they’re using it as a place to meet … and almost have their own reality show.” But it’s more real since the dialogue is unscripted and no production company is behind it.

Millions of people watch these players — and choose to do so from any viewpoint, Fader said. As they watch, people are donating money. There are also sidebar chats going on among the viewers. “This is an example of how these technologies and use cases are blending together in ways that we either wouldn’t have anticipated, or where media giants don’t exactly have control over it,” he said. “The main thing is people are just getting control, doing what they want to do and being less beholden to what the content-producing behemoths are telling them to do.”

Winner Take All?

Will any one company ever win the digital living room wars? “One view is that this will be a ‘winner-take-all’ contest in which one firm will dominate the home infrastructure, controlling almost everything from entertainment, communication and shopping,” said Shiri Melumad, Wharton marketing professor. For now, she said, Amazon and Google are vying to be the main provider. But she also said growing concerns over data privacy could result in a more democratic scenario where the market is shared by several companies — some of which might not even currently exist.

“Google and Amazon seem to be doing a decent job in this,” added Wharton marketing professor Pinar Yildirim. “Amazon is figuring out the whole ecosystem of connected devices, from bulbs to plugs to other things. When it comes to the connectivity of small devices, and their sale, they have an edge.” However, when it comes to “what controls them, or how to control them at home or via mobile phones, that is more Google or Apple.”

Facebook also is a contender. It is developing a cozier virtual place for people to gather, including a real-time group video chat. The social network is “putting greater emphasis on private messaging,” Melumad said. “Interpersonal communication may end up increasingly occurring over smaller networks of close friends rather than being broadcast to one’s wider network.” She said CEO Mark Zuckerberg described it as people communicating more in the “living room than the town square.”

Fader, for one, is excited about the current “wild west” of content services. “I think it’s terrific because we’re really letting business models arise and either flourish or die, based on [whether] customers want it and are they willing to pay for it, instead of cramming stuff down our throats, and [laying down] onerous terms for the content creators and the talent behind them. So it’s really great to see just so much diversity of content production and distribution — that’s the real golden age that we’re in.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What’s Next for the Digital Living Room? appeared first on Fair Observer.

A 2008 report on social determinants of health from the World Health Organization said it plainly. It might not be surprising that the poor have higher levels of illness and mortality. However, the report said, “in countries at all levels of income, health and illness follow a social gradient: the lower the socioeconomic position, the worse the health.”

“Every single session I have in my clinic I see the downstream effects of social factors,” says Dave A. Chokshi, chief population health officer for NYC Health + Hospitals — New York’s public health care system — and an attending physician at Bellevue Hospital. “I think about my patient with diabetes whose blood glucose levels I haven’t been able to get under control because he can’t take the insulin I prescribe because he lives in a homeless shelter and has no place to refrigerate it. Or the person with advanced liver disease related to alcohol use exacerbated by his sporadic employment. When you trace back to the causes of the causes of illness, in so many cases you see how our social fabric itself is in need of mending.”

But broad changes are taking shape. Payers of health care are increasingly incorporating the concepts of social determinants of health into the way they think about reimbursing for health care services and providing incentives for health care delivery organizations, says Risa Lavizzo-Mourey, senior fellow at Penn’s Leonard Davis Institute of Health Economics, population health and health equity professor at Penn Nursing and the Perelman School of Medicine and Wharton professor of health care management.

That, she says, “is a new development and one that obviously creates a lot of questions and opportunities for good research to really figure out how to best incorporate social determinants of health into reimbursement plans, how to make them focused on populations and not solely on the individual, and then to look at what kinds of bundles of social determinants are going to lead to the best outcomes. It’s a very interesting and exciting time.”

For the most part in the US, there has been a separation between public health, which focuses more on prevention and the environmental factors that influence health, and health care, which focuses more on diagnoses and illness, says Kathleen Noonan, adjunct senior fellow at Penn’s Leonard Davis Institute of Health Economics and CEO of the New Jersey-based Camden Coalition of Healthcare Providers. “It’s not that the health care side hasn’t known for a long time that social determinants influence what they see, but health systems are not structured to respond to them,” she says. “We have a public health system that is run largely by government and smaller nonprofits that operate in parallel to larger private non-profit and for-profit health systems.”

Historically, health systems were paid on a fee-for-service model, “which did not incentivize them to think holistically at the individual or population-health level,” says Noonan. “The managed care organization (MCO) concept of a bundled payment ‘per-member, per-month’ does, at least conceptually, introduce the idea of payment for total health.”

“If the goal is to improve health in America at a lower cost, there is only so much we can do by waiting for people to get sick and then treating them,” says Shreya Kangovi, a senior fellow at Penn’s Leonard Davis Institute of Health Economics and associate professor of medicine at the Perelman School of Medicine. “It’s far more efficient both in terms of cost to human life and dollars to go upstream.”

Many are calling for the stitching together of partnerships from the health care and public health realms — a prospect Kangovi calls “the greatest opportunity to advance health in our country in a generation.”

Seeing Pathologies Through a Different Lens

Initiatives that aim to address social determinants of health are proliferating. In Coal Township, in central Pennsylvania, Geisinger Shamokin Area Community Hospital started a fresh-food “farmacy” in 2016 to bring not just nutrition counseling to diabetic patients, but also recipes and the fresh food itself. CareMore Health in Cerritos, California, launched its Togetherness Program in 2017 to “address senior loneliness as a treatable condition by focusing on patients’ psychological, social and physical health,” as the company describes it.

UnitedHealthcare in April announced that since 2011, it has put more than $400 million into affordable housing across the US to help reduce social barriers to better health in underserved communities.

The concept of social determinants of health has come to the attention of Congress with the introduction of a bipartisan bill in July. The Social Determinants Accelerator Act would provide “planning grants and technical assistance to state, local and Tribal governments to help them devise innovative, evidence-based approaches to coordinate services and improve outcomes and cost effectiveness” for Medicaid participants, according to a fact sheet from Democratic Representative Cheri Bustos of Illinois.

Increasingly, looking at health in the US through the lens of role of social determinants of health is considered just as useful as viewing it through traditional measures, such as how many people live and die with heart disease or cancer.

One study found that in 2000, about 245,000 deaths in the US could be traced to low education, 176,000 to racial segregation, 162,000 to low social support, 133,000 to individual-level poverty, 119,000 to income inequality and 39,000 to area-level poverty. “The estimated number of deaths attributable to social factors in the United States is comparable to the number attributed to pathophysiological and behavioral causes,” wrote the authors of “Estimated Deaths Attributable to Social Factors in the United States,” published in 2011 in the American Journal of Public Health.

In fact, the number of deaths in 2000 stemming from low education was comparable to the number from heart attacks (192,898) — the leading cause of death in the US that year.

Programmatic innovations that address social determinants of health are increasingly popular, but these innovations should not distract from major policy decisions that may threaten gains, says Chokshi, also a clinical associate professor at New York University’s School of Medicine. A rule change proposed by the federal government, for instance, could eliminate food stamps for millions by instituting work requirements and putting up other barriers to the SNAP program.

“We can’t in the same breath talk about programs that might help dozens with food insecurity and not heed these larger dynamics on the policy side that are setting back the conversation around social determinants of health. We have to have a sense of scale in these conversations,” says Chokshi.

The reasons to care about social determinants of health go well beyond altruism or empathy. “The circumstances that our most vulnerable citizens are in have implications for the cost of health care systems and implications for the fabric of society,” says Atheendar Venkataramani, a Leonard Davis Institute senior fellow and assistant professor of medical ethics and health policy at the Perelman School of Medicine. “Where people are not flourishing and there is inequality, those environments are a challenge for people across the income distribution. If you are in close proximity to illness that affects other people, that does affect you through how it challenges the health care system that you have and how it might redirect resources within your community. Those spillovers come to your front door.”

One animating factor behind the current discussion over social determinants of health is the rise of US health care costs — projected to increase an average of 5.5% per year from 2018 to 2027, or 0.8 percentage points faster than the gross domestic product, according to the Centers for Medicare and Medicaid Services. Another was the introduction of millions more insured under the Affordable Care Act.

“For decades, the big policy push was to increase the number of people who had insurance and access to care, because it was hard to imagine the impact of being able to improve health care outcomes for the population if there were so many people uninsured,” says Lavizzo-Mourey, who was president and CEO of the Robert Wood Johnson Foundation from 2003 to 2017. “And while we still have millions uninsured, it’s less than it once was.”

Increasing attention to social determinants of health now, she says, also has to do with the state of the overall health of our population. “We’ve long had the dubious distinction of paying more for care than anyone else and fair to middling health status when you compare the US to similar countries in terms of wealth. And then more recently we see health care status is going down in some populations. When you put those trends together, the logical mind says: Where else do we need to look to make progress in these trends that are not going in the right direction?”

Getting to the Heart of Intervention

Progress has come in the much-praised program for which Kangovi is founding executive director. The IMPaCT program at the Penn Center for Community Health Workers hires from within local communities to provide social support, advocacy and navigation of services to high-risk patients. In operation since 2011, IMPaCT (Individualized Management for Patient-Centered Targets) has been shown through several randomized clinical trials to provide consistent improvements in quality while reducing hospital days by 65%.

In serving more than 10,000 Philadelphia-area patients to date, it boasts two dollars in return for every dollar invested annually and has become a model for other programs around the country. Woven into its design was an initial interview process that asked 1,500 low-income patients to describe the hurdles to staying healthy and what could help.

Kangovi says she often sees a fragmented approach to assessing patients’ needs — looking in a compartmentalized way at depression, food insecurity or smoking — rather than a holistic, patient-dictated approach. As part of their ongoing contact with patients, community health workers use an interview guide developed by the IMPaCT program that allows them to “have a real conversation to learn life stories and ask the patient, ‘Mrs. Jones, what do you need to improve your health?’ It is a very logical question that is at heart of intervention,” says Kangovi. “She can say, ‘I need a reason to get out of bed in the morning,’ because her son was murdered,” rather than imposing on her a domain-centered intervention.

“It is always about what people need in their lives,” says Kangovi. “It will straddle disease types and come up with tailored action plans, and then provide hands-on support to help them achieve that. It may be that a community health worker will go with her to a crochet class to get her out of bed in the morning, and others may accompany Mrs. Smith to talk to her landlord to help get her housing. People are actually the experts of their own lives. You are a lot more cost-effective because you are not doing a cookie-cutter approach.”

It is also important who is doing the asking. Kangovi says: “One basic premise is that the program is delivered by community health workers who come from a similar cultural and social background, so they can relate to patients. In the IMPaCT model, they are specifically engaged for their empathy and traits like being good listeners and being non-judgmental, so starting with the right workforce has been critical.”

Often, programs use a screen-and-refer protocol for identifying social determinants of health in patients. But that tool comes with significant pitfalls, says Kangovi.

“We’ve all been asked while a nurse is typing, ‘Are you safe at home?’ And what does that even really mean? People are being asked that over and over again, and that inures them — patients don’t trust them as much as they did before, and patients have legitimate fears of consequences like losing child custody, deportation, or stigma. And what are we doing when someone tells us they have struggles? The most common thing is nothing, or we are just going to refer them to some resource, like a food pantry or housing authority. The reality is there have been studies recently suggesting that screen-and-refer approaches do not work. They have low rates of uptake and do nothing for patient outcomes.”

Good Intentions, Good Outcomes?

The number of social determinants of health programs rolled out by health systems grew ten-fold in a decade, according to a 2017 study published in the American Journal of Preventive Medicine. But do they work? Which social determinants have the greatest impact on health, and which needs, when addressed, can lower costs?

Certain programs might make sense intuitively, but that doesn’t mean they will lead to breakthroughs on lower costs or better patient care. One could suspect, for instance, that providing transportation to Medicaid patients for primary care appointments would help lower missed-appointment rates. But in a 2016-2017 clinical trial conducted at two West Philadelphia clinics, complimentary ride-share services were provided for clients.

“Surprisingly, it made no difference,” said Krisda Chaiyachati, a Leonard Davis Institute senior fellow, assistant professor of medicine at the Perelman School of Medicine and clinical innovation manager for Penn’s Center for Health Care Innovation. The uptake of free rides was low, and rates of missed appointments remained unchanged at 37%, according to the research study.

“We simultaneously interviewed 45 patients, and really what we learned is that a lot of patients have pretty chaotic lives,” said Chaiyachati, the trial’s lead author. “It’s not like they missed an appointment because they didn’t know. It was because the person taking them to the appointment was sick, or they didn’t have someone to take care of an ill grandparent or didn’t have childcare. For some, missing three or four hours of work meant a meaningful dollar amount, or they were under a lot of pressure to be at work, or some patients were so sick they couldn’t leave home.”

Chaiyachati — who hasn’t given up on the idea of exploring what transportation could do to bring better health to patients and improve efficiency — notes that patients in the Penn health system on Medicaid have a nearly 50% no-show rate to primary care dates, and every missed appointment represents costs to Penn.

It also represents potentially lost lives. He is working with Penn’s Abramson Cancer Center to create screening tools to catch patients now falling between the cracks. Preliminary results of a study in progress show that one in seven uninsured cancer patients misses at least one chemotherapy or radiation treatment, while the insured miss virtually zero.

“From an equity perspective, the challenge here is that we can have two individuals who walk in our clinic doors who have the same exact diagnosis and get the same treatment, but because they have a different skin color or a different income level, one person will do much worse,” says Chaiyachati.

The disparities are just as startling for behavioral health issues as physical ones. Persons with the lowest socioeconomic status are two to three times more likely to have mental health disorders than those at the highest levels, according to the US Department of Health and Human Services. At the same time, minority and rural populations in the US have less access to mental health services than others.

But behavioral health attention remains inadequate generally. “At this point, our medical model is more adept at identifying risks for diabetes than mental health risks,” says Noonan. “The American model assumes children and young adults are healthy. After age three, you might see a doctor once a year. But for the most part, our health systems largely ignore the developmental periods when we know early signs of mental health and addiction issues begin to manifest. Figuring out how to address this gap in our health system is really important, instead of waiting until we have young adults who show up in our ERs with significant mental health and/or addiction issues.”

Indeed, comprehensive thinking about the entire system is critical. “We need cross-sector thinking that considers regional partnerships, and new ways for local public health departments, social service agencies and health care systems to work together to create more prevention-oriented systems,” says Noonan. “We don’t have enough affordable housing in this country, and I’m glad hospitals are thinking about the connection between health and housing, but hospitals alone can’t solve the housing crisis in our country. We also need state governors, public agencies and legislatures to use their authority to incentivize or require different types of partnerships with flexibility from the federal government around how and what is paid for in the pursuit of total health.”

It will also take some hard evidence to advance the cause of social determinants of health. “My great worry is that there is this huge hype-to-evidence ratio in the field,” says Kangovi. A lot of data now being cited, for instance, comes from simple pre-post studies, “and if you’re measuring something, it’s not a straight line — blood sugar, rates of hospitalization, they are going to vary. And if you do a study where you take a group of people at their highest point, people who have been to the hospital a lot in the past year, and you even do nothing, their rates will go down.

“There are very good and ethical ways of using study design and to answer ‘does this work?’ You are trying to disprove your intervention. If something can really stand up in that light, then it is worth being disseminated.”

Kangovi says: “This is a big deal, and if we don’t get it right we’re going to get the money pulled away. There are not many chances to do good for people living in poverty or address these wide-ranging issues, and I think patience is going to run out in a few years if a lot of the investments we’re making now don’t result in true outcomes.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post Why Addressing Social Factors Could Improve US Health Care appeared first on Fair Observer.

Revenue rose by 14% to $3.2 billion, the slowest quarterly gain in its history. It has reported slowing growth over the past four quarters — from 58% to 12%. In the second quarter, gross bookings decelerated to 31% to $15.8 billion from 49% in the 2018 quarter. Meanwhile, Uber continues to burn through cash, with net cash used in operating activities jumping six-fold to $922 million from $153 million in the same quarter a year earlier.

“You can get away with these large losses when the growth rates are quite high, because many of your expenses, of course, are investments in the future,” said David Wessels, adjunct professor of finance at Wharton. “But in this particular case, it’s just bad news when the numbers are so low.” He noted that rival Lyft posted “some pretty nice growth numbers” — up 72% in revenue and 41% in active riders in the second quarter of 2019.

Leonard Sherman, adjunct professor of business at Columbia Business School, said what’s more troubling than the big loss is Uber’s difficulty in becoming profitable on an ongoing basis. “That number per se is not a worry,” he said, noting that it doesn’t even come close to making it to the top 10 worst quarterly losses in history. “The big number was their quarterly cash burn.” Uber’s profitability problem “continues to exist, with the added pressure that we now have essentially diluted current stockholders in a money-losing enterprise. And it’s not a pretty picture.”

Wessels and Sherman discussed Uber’s latest earnings report and business model on the Knowledge@Wharton radio show on SiriusXM.

“The main theme of Uber’s business model is the positive network effects. With more drivers, the value for riders go up — lower wait times, cheaper prices,” said Gad Allon, Wharton professor of operations, information and decisions. “The more riders, the higher the value for drivers — or more work, and less wait time. The combination of the two can result in a powerful cycle, in which the firm’s costs goes down and the revenue goes higher.”

However, “Uber’s growth is slowing down, and the costs are not slowing down,” Allon continued. “There are many reasons, but fundamentally, the issue is that Uber competes in both markets: riders and drivers. So, they can’t pay drivers less and they cannot charge riders more, basically breaking the main assumptions that underline its growth strategy. In that light, working on other verticals of mobility (such as Uber Eats) is a viable strategy, as it waits for either … self-driving cars [to reduce driver costs] or a merger with Lyft [to consolidate operations].”

Uber CEO Dara Khosrowshahi described the $5.2 billion loss as a “once-in-a-lifetime” hit in an interview with CNBC. “We think we can not only survive, but we can really thrive in this business,” he said. In his earnings call with analysts, he pointed out that Uber’s adjusted net revenue this past quarter was $2.9 billion, representing a 26% year-on-year growth, and that it is set “to accelerate beyond 30%” in the second half of this year.

Warning Signs Ahead

In the meantime, Uber’s cash trough has limits. “The clock is ticking,” said Wessels. He noted that Uber has about $15 billion in cash, and that gives it about 15 quarters to get its business right and become profitable. (Those cash resources include about $8 billion in net proceeds from its IPO; $500,000 from its PayPal investment; $1 billion from investments by Toyota, Denso and SoftBank; and other cash and cash equivalents, according to a company statement.) Uber’s cash burn is a persistent problem.

While stock-based compensation expenses did inflate Uber’s second-quarter loss, this charge is “not something that can be completely overlooked in a broader scale,” Wessels contended. Investors would be concerned about its dilutive impact on earnings per share, he noted. Moreover, while it won’t drain any cash, over the long run it still means “giving away ownership in the company,” he said. “It’s sort of a stealth way of giving benefits out without hurting from a cash flow perspective.”

While Wall Street did expect Uber’s second-quarter earnings to be walloped by a big stock compensation charge related to its IPO, the company still fell short of expectations for revenue and earnings per share. The stock plunged, hitting an all-time low of $32.92 intraday before rebounding to $34.61 on August 19. Its valuation has fallen to $58 billion from the $75 billion at the time of its IPO.

In the meantime, Wall Street is bracing for another possible sell-off in the stock once early investors can dump their holdings after the lockup expires on November 6. “Until we get past that lockup, it would be very problematic for investors with a lot of money at stake to say, ‘We’re going to scale back operations; we’ve got to raise prices; we’re going to consciously trade-off growth with profitability and all those other things,’” said Sherman.

An Alternative to the Growth Narrative?

Since inception, Uber has pushed its growth narrative, but that may no longer be acceptable, Sherman noted. “When you don’t have a profit story to tell, the only possible offset is [to say that] we’re growing like weeds,” he said. “The only possible future is to accept what should have been the way they approached this business from the beginning, which is to perfect [the business model] and then grow responsibly from there.”

Sherman recalled that in the days of the internet bubble, grocery delivery startup Webvan and pet supplies firm Pets.com failed because they had a flawed business model. “[Uber] made the same mistake here with too much money being thrown too fast at the business that scaled before they understood what they were getting themselves into.”

Wessels added that while Uber “wants to be in everything related to vehicles,” it has to “pare back” to focus on those businesses it does best. He said it ought to focus on the core business of ferrying customers and then choose one or two other businesses it is particularly excited about. Also, Uber has to reassess whether it makes sense for the company to be in electric bike rentals, especially when it faces competition from firms such as Bird.

In two years, Bird has grown rapidly to gain a presence in 60 cities across Europe, North America and the Middle East, and clocked 10 million rides in its first year. Uber entered this market last year buying bike-sharing service JUMP, and it now has a presence in 28 cities in the US and elsewhere. In 2018, Uber also launched its ‘Transit’ app that integrates with public transportation systems to help users plan their journeys.

Finding the Right Business Model

However, Uber could very well get its act right if it is resolute about it, said Wessels. “It’s not like there are 40 competitors out there; it has one or two competitors nipping at their heels, who have their own problems to deal with,” he added. “So, this could be a successful business, but at some point, they’re going to have to get serious.” Reining in its billion-dollar quarterly burn should be a high priority, he said.

Sherman wasn’t hopeful. “Unfortunately, I don’t see the right response coming from Dara Khosrowshahi,” he said. “The company continues to promote this idea that it is growth at all costs, which is, of course, what Travis did. (Travis Kalanick, Uber’s founder, stepped aside in June 2017 amid controversies over the company’s corporate culture.) Travis did an amazing job scaling this company. Unfortunately, he was replicating a fairly broken business model around the world rather than taking the steps necessary to strengthen the foundation of the business.”

Both Kalanick and Khosrowshahi have promised that Uber will start making money after some big market play or market exit, but failed to do so, Sherman pointed out. Those promised turning points were its exit from China two years ago; its launch of Uber Eats five years ago (initially called UberFresh); or its migration to self-driving vehicles. Two months ago, Uber unveiled a self-driving car that will be built by Volvo in Sweden; it hasn’t set a date for its launch, but said it could be in the next few years.

However, “most folks who stay close to the sector realize that it’s going to be a decade and probably a lot more before autonomous vehicles are widely commercially deployed,” said Sherman. He said their launches have to be programmed city by city, and it also needs “continued massive breakthroughs in technology.”

Even within its core business of ride-hailing, Uber faces tough challenges in deciding which cities it wants to stay in and which it should exit because they are unprofitable, Sherman said. “Everyone’s waiting for Uber to blink or Lyft to blink,” he said. If Uber does decide to exit a market, it would have to cede the area’s business to Lyft, “and Lyft is probably sitting there and thinking the same thing,” he added.

Urban Transportation: A “Crappy” Business

Sherman pointed to what he called an “inconvenient truth” with urban transportation. “As an economic sector of activity, urban transportation services is a crappy business,” he said. “Not a single major rideshare company around the world is making money. That includes Didi in China, which after Uber pulled out in 2016 had “a near-monopoly control of by far the largest ride-share market in the world” and still incurred losses of $1.6 billion in 2018, he noted. Also, Singapore-based Grab, to which Uber sold its Southeast Asia business last year, “continues to be unprofitable,” he said, adding that Lyft is also unprofitable.

Urban transportation is an unprofitable business as governments want those services to be subsidized to spur economic growth and welfare, Sherman explained. “Unfortunately, Uber has no way to take advantage of the positive externalities it creates — all those happy drunken passengers who go to bars on Friday night and make lots of business for bars.” At the same time, Uber will continue “to be punished for the negative externalities,” such as regulatory barriers erected in cities such as New York and restrictions pending in Los Angeles.

On the other hand, taxis are profitable in cities where they’ve been allowed to grow without regulation and caps are imposed on the number of taxi permits, Sherman noted. “That almost guarantees that Uber can’t make money” because the company and its competitors keep adding drivers, it is “ultimately is a race to the bottom.” Added Wessels: “At some point, Uber has to focus and show us that the business model does make sense because taxis have never been a very good business.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What Will It Take for Uber to Become Profitable? appeared first on Fair Observer.

The yuan-dollar rate of 7-to-1 was at its lowest since 2008. “[The] trade war has now become a currency war, which raises the potential economic harm to another level,” The Wall Street Journal noted in an editorial. On August 5, the Dow Jones and the S&P indices fell 3% and stock markets and currencies in emerging markets weakened, and an economic downturn seemed closer than before. The spread between the 3-month and 10-year Treasury yields — an indicator of recessions — inverted to its widest level since 2007.

On August 1, Trump said the US would impose 10% tariffs on $300 billion worth of imports from China effective September 1, amid signs that talks between the two countries over the past year or so were yielding little progress. That tariff move would be in addition to the higher tariffs already in place for $250 billion worth of imports from China, thereby covering all US imports from that country. Trump reportedly overruled resistance from within his administration in announcing the latest tariff move.

Worries are over the larger and longer-term implications of China allowing the renminbi (RMB) to drop below “the psychological barrier” of 7 to a dollar, said Marshall W. Meyer, Wharton emeritus professor of management. “People are wondering whether China will repeat what it did in 1993-1994 when it devalued the RMB sharply to turn around a recession, and the knock-on effect perhaps was the Asian financial crisis.” Back then, China devalued the yuan by 33% overnight to 8.7 to the dollar as it unified its dual exchange rates, hoping it would help its state-owned enterprises embrace a market-based economy.

The Penn Wharton Budget Model (PWBM), which analyzes the longer-term implications of policy moves, has identified two primary effects of the trade war with China. One is lower output for the US economy, and the other is a shift toward households in the financing of US debt, said Efraim Berkovich, director of computational dynamics at PWBM.

As the escalation in the trade war reduces foreign capital inflows into the US, it would provide a short-term boost to GDP as domestic households would pick up the slack and provide more labor, but GDP will fall the long-run, Berkovich said in an article with Zheli He, an economist at PWBM.

US companies will also see their global competitiveness eroding with the tariff war. “The rest of the world will continue to enjoy lower-priced inputs, and our companies are going to have to compete with them,” said Mary E. Lovely, professor of economics at Syracuse University’s Maxwell School of Citizenship and Public Affairs; she is also a senior fellow at the Peterson Institute for International Affairs. “That really ties one of their hands behind their back. This is doing permanent damage to the US economy.

“It’s [all] pain, no gain,” said Lovely. “For example, we went into this [trade war] ostensibly to get some relief for American corporations in terms of intellectual property rights protection. China hasn’t changed on that yet. What about disciplining their state-owned enterprises? We’re zero on that one.”

Meyer, Berkovich and Lovely discussed the longer-term implications of the trade war with China on the Knowledge@Wharton radio show on SiriusXM.

Impact on Electronics, Farm Produce

The threatened tariff increases “will fall much more heavily than in previous rounds on consumer goods, clothes, shoes and baby products,” said Lovely. “Almost half of it will fall on computers and electronic devices, because of the way our trade with China is structured.”

Lovely predicted “a big hit” to prices of cell phones, laptops and anything electronic, affecting businesses, households and universities. The consequences could be worse if Trump persists and takes the next round of tariffs from the proposed 10% to 25%, she added.

China has also suspended purchases of US agricultural products, and an official statement through its state-run media outlet Xinhua said it is up to the US to set right trade conditions. “We stand to lose all of what was a $9.1 billion market in 2018, which was down sharply from the $19.5 billion U.S. farmers exported to China in 2017,” said American Farm Bureau Federation President Zippy Duvall.

“The consequence is the entire economic system becomes less efficient; that is the long-term cost to all of us,” said Meyer.

US Debt Will Grow

Of the two likely outcomes of the tariff war Berkovich identified, the implications for the financing of the US debt is more significant in the long run. Thus far, trade with China has helped finance US debt, and a reduction in the volume of that trade means others have to pick up the tab. “When we shut down the trade channel by which dollars are sent out to broaden and come back as purchases of assets, we are actually forcing the debt in the US to grow,” he said. “We’re forcing US households to buy the debt, and that’s going to long term drive the economy down.”

According to Berkovich, “Right now, 40 cents out of every new dollar that’s issued is purchased by foreigners. That is quite substantial, and you’re being subsidized to that level now. Otherwise, you and I would have to buy it.” As the trade war escalates, “the Chinese are going to hoard their dollars,” he added.

Foreign Capital Inflows Will Fall

A decrease in US imports resulting from higher tariffs reduces foreign investment flows into the US, Berkovich said, attributing that to a phenomenon he called “effective openness.” “As the average tariff rates rises, the openness goes down,” he noted. “And that means less capital flowing in, and less purchases of US debt by foreigners.”

Berkovich explained that when US households pay for imports with dollars, foreign exporters typically use that to buy US exports or dollar-denominated assets. But “effective openness” of the US to such foreign investments is reduced because they would tend to invest in their home countries, even at the expense of forgoing higher returns elsewhere. He called that a “home bias,” a concept identified by Martin Feldstein and Charles Horioka in 1979 paper.

“Even a country with relatively few laws that directly limit the flow of capital may not be fully effectively open due to various non-legal frictions on capital flows, including a preference to invest in one’s own country,” Berkovich and He wrote in their article.

The reduced foreign investment will also hurt the U.S. labor market, Berkovich warned. “You are going to see that wages are going to drop. With purchasing power and wages lower, we’re not in a good place.”

Even if the trade war ends, the U.S. will be in a worse place than now, Berkovich predicted. “When foreign capital actually starts flooding back in, we will be in a situation where foreigners own a greater share of U.S. capital than they did prior to the trade war.”

Berkovich and He elaborated on that in a blog post. “Although a trade war initially lowers the share of U.S. capital owned by foreigners, it will actually increase the amount of American business capital owned by foreigners, by almost $1 trillion by 2028,” they wrote. “Over time, the foreign-owned share of business capital rises from about 29% today to over 34% in 2049.”

Brace for Permanently Higher Costs

The US tariff move would also upset existing global supply chains by forcing both countries to look for alternative sources for their imports. While the US may not be selling soybeans to China now, Brazil and Canada will continue to export agricultural products to China, Meyer said. “But guess what? We may be selling soybeans to Brazil or to Canada. Our farmers are getting a lower price for it. The middlemen are extracting a tax, to work around the tariffs.”

Lovely warned that an escalating trade war with China will mean US households must brace for higher prices that won’t come down. “We’re going to see permanently higher prices because the system as a whole will be less efficient,” she said. “President Trump’s actions are cementing firms’ view that this is going to go on for a long time.”

Already, US importers are moving away from sourcing from China and increasing their investments in other countries, Lovely noted. “But the fact is, that other place is a higher cost option, and [that’s] the reason we weren’t using it in the first place,” she pointed out. “And that becomes a permanent tax on US firms and US consumers, reducing the consumer’s buying power and reducing American firms competitiveness on the global market.”

In addition to a readjustment in global supply chains, the trade war would drive US importers to prepare by stockpiling, said Berkovich. “The natural thing for you to do if you think that the economy is going down the toilet is that you want to prepare,” he said. “It’s like a squirrel before winter hoarding the nuts. The longer you drag out the trade war, the more nuts you start to hoard.”

Finding a Way Out

Politics is behind the tariffs, and the two countries are on “a collision course” on that front, Meyer noted. Within the US, there appears to be bipartisan consensus on a tough approach to China. However, the US seems to be playing right into the hands of Chinese President Xi Jinping with its tariff moves, he said. “Xi Jinping has effectively had his position bolstered by what appears to be peremptory US action on tariffs.”

At the same time, the US is trying to find a better foothold in Asia and in Europe, where it may have antagonized some of its allies not just with the China tariffs, but also by “repudiating” some of its multilateral agreements, Meyer continued. In the process, the US seems to have lost more ground than has gained, and needs to “rethink this very, very carefully.”

As the US seems set to end up losing more than it set out to gain from the trade war, it needs to urgently do some course correction, according to Meyer. “We are on the horns of a terrific dilemma here,” he said. “Unless the US takes some action at this point,” China will extend its economy to the Belt and Road Initiative and other initiatives such as its Made in China 2025 program, which will further reduce US influence in world trade, he added. “The consequence is the entire economic system becomes less efficient; that is the long-term cost to all of us,” said Meyer.

Faced with those headwinds, the US has to focus on what it wants to achieve in the long run, Meyer said. “What is our vision of the future? What’s the role of the US economy in the global economy 10, 15 or 20 years from now? Until we have answers, we’re stuck with tariffs or other defensive moves.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What Are the Long-Term Costs of the China-US Trade War? appeared first on Fair Observer.

And while some analysts were connecting the sluggish growth figure directly to the current trade spat with the US, that’s not the central problem, according to experts from Wharton and Stanford University. Rather, the challenges to China’s economy are deeper, structural, longer-term, and have been building for years. They include over-investment, high savings and modest, if growing, consumer spending, high debt and low industrial productivity.

Those are the views of Wharton Emeritus Management Professor Marshall W. Meyer, a longtime China expert, and Richard Dasher, director of the US-Asia Technology Management Center at Stanford. Overcoming those problems requires big shifts in how the country’s economy is organized, an overhaul the government is attempting to execute.

“The tariffs and trade friction with the US is a relatively small part of what is going on,” notes Dasher.

Less Export-Dependent

One reason the current head-butting on trade issues between US President Donald Trump and Chinese President Xi Jinping is not deeply affecting China: Net exports as a percentage of China’s economy have shrunk sharply for years and now are under 1% of total GDP. And Dasher says that China’s exports to the US make up just 5% of total exports. So while China’s US exports fell 7.8% in June, the result is not exactly a death blow to the nation’s $13.6 trillion economy.

More generally, the graph of China’s economic growth has sloped downward since 2009, Meyer notes. The last quarter’s number was related to internal problems. Three of the most important in his view are the following: (1) demographics, “China is getting older” and the workforce is beginning to shrink; (2) “regression to the mean” — countries that grow quickly “almost always encounter … very rapid deceleration in growth at some point;” and (3) “excessive reliance on capital investment,” particularly in infrastructure.

Added to overspending on infrastructure, China also is boosting consumer and industrial spending by expanding available credit, Dasher says. “They are really very debt-ridden.” He found it interesting that financial markets did not react “too unfavorably” to the very low GDP growth rate “because consumer spending is up over 9% (in part due to recent tax cuts). And industrial investments are higher than GDP growth. The only way you can do that is through extending more credit.” And officials have done that by giving banks a lot of funds to lend out. 

Dasher and Meyer offered their comments on the Knowledge@Wharton radio show on SiriusXM.

But the most fundamental — and crucial — issue for China’s economic future is lagging productivity, according to Meyer. Productivity — “the amount of output we get per level of input” — is the most important driver of GDP in the long run for every economy and it has been low in China. In most industrial sectors, “some economists say it has been negative since as early as 2007. And certainly, I would say with a little more certainty since, say, 2012, 2013.”

In the meantime, the country has been piling up debt — by consumers and local governments in particular. “Who’s going to repay that debt? No one knows,” Meyer says. To repay it China will have to increase productivity, which almost certainly means moving up the value chain into “leading-edge industries.” Related to that, China analysts have long said that the nation must move from investment-led growth to consumption-led growth as a way to avoid the so-called middle-income trap.

Racing Toward Innovation

And China has to try to do this rapidly. The list of industries it is hotly pursuing and that fit the bill run from “green energy to artificial intelligence to 5G and beyond,” Meyer explained. China is in a race to get a foothold in industries “where productivity will increase” in time to pay off its mountain of accumulating debt.

While China is pushing hard to restructure its economy, pressures are mounting. There is an increasing gap between the rich and the poor, just as there is in the US. “Wages in East Coast Chinese cities are going up drastically while the wage gap between the coast and interior is [becoming] greater and greater,” notes Dasher. “You really have tension inside the country.” Chinese officials may not have to worry about getting re-elected, but they do “have to worry about people seeing them as legitimately improving the quality of life for people.”

This Financial Times article agrees that China’s chief economic problems are domestic and creating social pressure. “Asset prices, particularly housing, have risen so high that many young professionals find themselves priced out of the market in China’s booming cities.”

Taking trade out of the picture for a moment creates more clarity around what are the central differences between the US and China. Some argue that the real competition between China and the US ultimately is not over trade, but rather about who will lead the future in innovation and technology. That idea also helps to explain the related disputes involving US tech sales to Huawei and objections to accepting Huawei into the 5G space in the US.

In the US, meanwhile, “we complain about our productivity levels which seem to be a 0% to 1% increase a year — my gosh, that’s low,” says Meyer. “Why aren’t we seeing the benefits of automation, etc.? But in China, in most industrial sectors, productivity has been going down.”

Despite the productivity advantage, the US does not have a company that can compete with Huawei, Meyer points out, noting that the “strongest Western competitors are Nokia and Ericsson,” both small compared to Huawei. “So the question is why aren’t we in this space? Why are we complaining that the Chinese are unfair, which they may be by US standards but probably not by their standards. Why aren’t we competing?”

The US has to grow “its fundamental industrial capacity” just as China needs to build a more balanced economy. But another key question for Meyer, given that Huawei enjoys significant government aid, is this: How much should the US government help guide the effort for US companies? “There’s a lot of evidence out there that government support has been critical in many of our technologies, even today in Silicon Valley.”

Meyer also thinks the US should realize the risky game it is playing with the trade war. The US should “worry a little more — maybe a lot more — about what would happen if Xi were precipitously pushed out of power. Is this going to be a good thing or not a good thing? And use that to calibrate the amount of pressure we put on China.”

As for the tariffs themselves, Meyer calls them “a blind alley…. They often end in economic downturns.” And it is worth noting that US exports to China were down 31.4% in June.

A Blunt Instrument

Dasher, meantime, finds the tariffs a “blunt instrument” that are ineffective in solving the problems the US faces with China. “We really need to move back towards a rule-based kind of international system. We need to worry about IT. We need to try to encourage China to join the club of other advanced nations that have intellectual property to protect, and recognize each other’s need to protect intellectual property.”

President Trump, meanwhile, recently said that US tariffs “are having a major effect on companies wanting to leave China for non-tariffed countries.” There appears to be some truth in the claim. Some countries are benefiting from shifts in sourcing as result of the 25% tariffs imposed on many Chinese goods. Those countries range from Vietnam – the biggest winner — to Taiwan, Malaysia, Chile and Argentina, according to a report by Nomura, the Japanese investment bank.

Other reports suggest that Mexico and even France and Germany have benefited. On balance, however, the impact on third-party countries from the trade disputes will likely be negative, the report noted. Certainly if the disputes slow China’s economy, others will feel the effects because China remains the world’s largest generator of economic growth.

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post What’s Really Behind China’s Falling GDP? appeared first on Fair Observer.

Countries that have invested in human capital, infrastructure and decent systems of social protection have made more progress than others in reducing extreme poverty, according to Mahmoud Mohieldin, the World Bank Group’s senior vice president for the 2030 Development Agenda, United Nations Relations, and Partnerships.

At the same time, entrepreneurs and corporations must accept responsibility for shaping their business environments, notes Djordjija Petkoski, a senior fellow at Wharton’s Zicklin Center for Business Ethics.

In this video, Mohieldin and Petkoski discuss these and other ways to meet the United Nations’ Sustainable Development Goals, or SDGs.

*[This feature was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

The post How Localization Can Help Overcome Extreme Poverty appeared first on Fair Observer.