Wednesday, February 16, 2011

Things That Go Bump in the Night

Two swallows make a summer.   I've read essentially the same story in the last few days from two different sources with no reference and, so far as I can tell, no direct relationship, to each other. I think the common heading might be "a collection of devices whereby we live more and more in our heads."   First, here's Steven Randy Waldman at Interfluidity (critiquing Tyler Cowen):
 ... In spheres such as health care and education ... are difficult to evaluate relative to alternative uses of resources. Cowen reminds us that health care and education are widely viewed as “growth” sectors, but to the degree we collectively overpay for them, “revenue” overstates economic value. A substantial portion of these expenditures should probably be accounted for as transfers and excluded from measures of aggregate production. But of course, we have no means of estimating the size of the appropriate haircut.

I’d add another important industry to government, health care, and education: financial services. Like with health care and education, we simply are unable to evaluate the degree to which payments to financial service providers represent wise use of resources and to what degree they represent transfers to financial industry stakeholders. Inherent informational problems associated with investment quality, combined with the temptation by service providers to exploit these difficulties to extract transfers, renders financial sector revenue highly suspect as a marker of value. Also, financial services are intimately involved in the other problematic sectors: One thing that binds government, health-care, and education is that all are financed in roundabout and sometimes opaque ways that soften near-term budget constraints and that shift costs and risks, both across time and onto people other than the purchasing decisionmaker. The means by which government, health-care, and education are financed help keep them vulnerable to agency and information problems.

I think of government, education, health care, and finance collectively as the “information asymmetry industry”, and I find it terrifying that many people presume that they are the future growth industries for the United States. Dani Rodrik has pointed out that tradable goods are special, in terms of engendering development in often corrupt emerging markets. Cowen offers an astute explanation: tradables that compete in international markets are usually low-information-asymmetry goods. Apparent value (revenue from trade) and real value are likely to be closely aligned and hard to fake. I worry that specialization in the information asymmetry industry could be an antidevelopment strategy for developed countries.
And here is Richard Bookstaber on the evolution of accounting:
The orientation that accounting took for railroads was, not surprisingly, focused on the assets of the company--the track and rolling stock, along with the depreciation of capital--rather than earnings.  Value was defined simply as the cost of assets less the depreciation of the assets over time.  This orientation carried through smoothly to other industries of that era, principally manufacturing and transportation, where cost could be used as an index of value.

For real assets such as physical plant, assembly lines, machinery, and real estate, valuation in terms of costs is logical: a business can reproduce the enterprise by simply going out and buying each of the component parts that constitute the production process. But the relationship between the cost of assets and the value of the enterprise does not work as well for companies with intangible assets, and these increasingly form the basis of economic value today. Intangible assets--ideas, patents, proprietary software, brand names, trade secrets, trademarks, and copyrights--have values that cannot be extracted from their costs.

The reach of intangibles is extensive; as Charles Leadbetter has said, "modern corn is 80 percent science and 20 percent corn," alluding to the extensive lab development behind hybrid corn seed.   By some estimates, intangible assets now make up 80 percent of the value of the S&P 500,  They are what provide companies with their franchise value, sometimes bordering on monopolistic market position.  Intangible assets are the product of imaginative people who walk out the door every night; others are formulas locked in a vault.  And in many cases, once they have been created and intellectual property has been claimed, they cannot be reproduced at any price.
These guys are telling the same story, not so?  About how more and more of our life is taking place inside our head?  And correspondingly, less and less consists of things that go bump in the night?   But while we are on the subject of living in one's head, does one do Second Life any more, or is that just too 2001? 

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