Monday, January 24, 2011

Skills and Value Concentration

Many of my colleagues and peers complain about "wealth concentration" and the "superstar effect" without realizing these are natural trends in any group, regardless of size. As a community expands, the effect I am going to explain is magnified. The end result approximates a "natural monopoly." Seldom is there a nefarious plot to control products or knowledge -- it just happens to be more efficient to concentrate skills and products.

I'm going to use a large-scale, modern example to explain how skills concentration (specialization) leads to wealth concentration and the superstar effect. Afterwards, I'll offer other examples to help clarify the concept further.

For nearly 40 years, from the 1960s through the mid-1990s, when a company wanted to use computers to automate and improve a task's accuracy the firm would hire a team of programmers. As a result, companies of every size and type had customized software. This was great for programmers, but not so great for the companies.

Most early computer applications were financial in nature. This is one reason information technology departments within large companies traditionally report to Chief Financial Officers. The programmers worked on software for everything from basic payroll to client billing. Even departmental budgets were crunched by custom software.

The first big beneficiaries of skills concentration were small businesses. Because these smaller companies didn't have programming departments, they were either paying accounting firms (that used custom software) or dealing with finances by hand.

Along came VisiCalc, followed by Lotus 1-2-3, and a dozen other spreadsheet applications. Small businesses noticed. The owners and department managers purchased Apple II computers and the first IBM PCs specifically to use spreadsheet software. Over a decade, Lotus 1-2-3 emerged as a favorite because it was flexible, fast, and relatively easy to learn. It also didn't take long before large companies were arming everyone from accountants to sales representatives with spreadsheet software.

Programmers complained that Lotus 1-2-3 wasn't specialized. It wasn't optimized for each user, or at least not for each purpose. But, the reality was that one team of centralized programmers could and did displace thousands and thousands of developers.

This happened with databases, too. Databases are the core of almost any business. In the early years, these had to be custom. But, along came dBase and then FoxPro. Again, programmers were displaced.

In both of these cases, some displaced programmers became experts in customizing spreadsheets or databases. Other displaced programmers created new, groundbreaking applications. This is the process of "creative destruction" in any economy and it is not unique to capitalism.

Jumping to the middle of this story (where we are now, I believe), Microsoft is the dominant supplier of general-purpose business applications. Microsoft Office is a single suite of "everything you need" for many small businesses and corporate departments.

The benefits are many, from the perspective of businesses and individuals. But, this does mean programmers have to consider developing other types of software or specializing in "value-added" services.

Some of the benefits include:
  • Reduced software budgets, since the costs of software development are "shared" by all buyers of MS Office.
  • Reduced training budgets, since employees are generally familiar with Microsoft products while custom software requires extra training and documentation.
  • Improved responsiveness to business needs, since you can buy software instead of waiting for it to be developed and customized.
  • Increased efficiency, since data can be shared by individuals, departments, and even between companies and their customers.

Because one company provides this software, the employees of Microsoft are the "superstars." The company has the same "potential value" in economic models as all the programmers its software has displaced. Imagine all the custom software no longer necessary because of Microsoft Office. All that "value" is then shifted to one company. To that value, we have to add all the software now in use at smaller businesses that previously couldn't afford to hire programmers.

A company no longer has to worry about retaining one or two programmers with all the knowledge of a system or application. Microsoft developers might come and go from their employer, but as far as companies using their software are concerned Office is from "Microsoft" not "Bob" or "Sally" the programmer.

A significant portion of the handful of specialists in spreadsheet, word processing, and database development work at a few large companies, like Microsoft or Google. Together, they accomplish great things.

The results are:
  • Skills are concentrated among a few better providers as consumers select them over other providers.
  • Value is, therefore, concentrated at these same providers.
  • Wealth accumulates among these experts.
  • Investments are made by the wealthy in research and development, increasing their value.
  • Average (and below average) providers are displaced.

These trends leave us with superstars who earn a lot of money (or whatever represents "worth" in a culture). Once at the top of a field, an individual or company has to invest constantly in research and development. Failure to remain a leader is normal, though. One set of superstars will eventually be replaced by another set. These new stars might have an entirely different set of skills, providing a different product or service that displaces the previous leaders.

The superstars do not, in reality, earn every penny the displaced programmers would have earned. In fact, they earn much, much less than what the sum total would be if companies still had to pay programmers for basic tasks. However, the sheer volume of sales translates into individual wealth.

No company could have Word or Excel developed for $150. But, that's the price most people now pay for Microsoft Office. Microsoft doesn't earn the $100,000 or more I would have to pay someone to develop a decent financial application. I pay a retailer $150, the retailer pays a distributor, the distributor pays Microsoft… and in the end, Microsoft likely collects $70. I "saved" thousands of dollars. Microsoft made far less than individual programmers might have, but it concentrates the value in one provider.

There was a time when superstars were regional. This limited their potential value to whatever their community could support. Now, though, the community is global and the value potentials are astonishing. Even the limits of shipping have been eliminated. Microsoft doesn't even need to ship physical media to provide MS Office applications to businesses anywhere and everywhere on earth.

Let us consider a more basic example: music.

Until recorded music came along, if I wanted the best performance it meant hiring the best local musicians. These musicians might be great, or they might merely be the best in my small town. Once I could buy a recording, I could replace the local talent with music matching my tastes.

With the ability to choose between mediocre live music and outstanding, but recorded, music, it was certain that the recorded would win.

Recorded music replaced thousands of musicians. It also allowed us to enjoy music in places where live musicians wouldn't be, well, desirable. I can't imagine driving around with a pianist in the backseat of my car.

In time, the value of musicians and composers was concentrated among the superstars. The result was that groups like the Beatles were able to invest in technologies that gave them yet more advantages over local, live musicians. The Beatles moved from dual-track, to four-track, to eight-track recordings in their studio work. The recordings were better than live music, technically. Each success allowed more investment, and that created yet more value concentration.

This concentration of skills is impractical in some fields, at least for now. However, any field that is technology-intensive and prone to automation will eventually have superstars. The end result of skills concentration is value concentration, leading to wealth concentration.

The financial industry is a highly automated, technology-intense field. As a result, a few individuals can and do manage immense sums of money. Fewer and fewer people are needed to move capital. The result is that the most successful firms invest in technology and training to become even more efficient. You can see where this is heading: a few superstars are astonishingly wealthy.

Even chefs are experiencing the superstar effect. Cooking is as mundane a skill as you might imagine, but the best of the best are concentrating the wealth of restaurant menu design. Executive chefs were once limited by space and time to single locations. Today, a chef can fly from city to city every week or month to test menus and train head chefs. With the same technologies altering other industries, a chef can send recipe changes and even training videos to remote locations in an instant.

At the turn of the twenty-first century there were 1000 "leading" executive chefs world-wide. Today, there are fewer than 150 "leading" chefs, according to Indeed.com. There are fewer top-tier posts for chefs because one executive chef is expected to oversee managing chefs and head chefs at dozens, or even hundreds, of restaurants. The best chefs are truly the best at creating new recipes, so other chefs are reduced to implementing menus — at lower pay.

We can argue that the superstar trend isn't fair — but what is or isn't fair? If I am the best chef, best musician, or the best programmer, shouldn't my services be available to as many people as possible? And if people choose my services or products over those of others, shouldn't I be compensated?

Skill and value concentration should be understood and then discussed, but it isn't reasonable to condemn something we all do. Yes, we all seek to concentrate skills and value, even within our families.

Every family has a "best" cook, a "best" mechanic, a "best" whatever. We turn to that person for those tasks, which in turn means that person is gaining yet more experience and expertise. The best cook prepares meal after meal, and because we prefer that individual's cooking, he or she gets more practice. Other members of the family do not develop the same skills in the kitchen, but they are called upon for other tasks. Specialization is not, therefore, unique to business.

Another example to consider: the best youth athletes end up getting the most "game time" as children. This increased time on the field or court means these "better" athletes get even more practice. Eventually, these young people become great, while those getting less game time lose skills but turn to other activities.

We can complain about skills concentration, but in an advanced civilization you cannot be an expert in everything. Someone is bound to be better than you at something, and that will enable him or her to work towards being the best. You will specialize, too. That's how advanced societies are.

The only alternative to skills concentration would be living independently on rural farms. Even isolated farms are connected by technology today, so even that idealistic alternative is fanciful. We could adopt Amish customs, but even they have specialists in their communities. What's different is that their specialists are rewarded in ways that are not financial, but even Amish "stars" are recognized within a culture that demands humility.

Instead of complaining about superstars, maybe we should focus on how to improve opportunities to become stars in a wider variety of fields. Also, we might ask why we value some fields more than others, so that a superstar in music is paid so much more than a superstar in science research. Cultural judgments of value/worth are important in determining what children decide to do later in life. If youth perceive superstar athletes are worth more than scientists, you can expect more hours spent developing athletic skills than math skills.

The superstar effect is not going to vanish. How we manage it is the real question.

Note: This blog entry is the first in a series I plan to write on basic economics and daily life. My goal is to explain how things work -- not how I wish they worked or how anyone else wishes they worked.

Friday, January 14, 2011

Extreme Budget Illogic At the CBO

I've noted this issue repeatedly: health care reform will not and cannot reduce federal spending. Only in the absurd world of Congress can you pretend "The cuts are coming!" year after year, always delaying them, and yet count those "cuts" as savings. Do you really believe Congress is going to cut payments to doctors by 20% or more? Do you really believe Congress is going to increase taxes on union health plans 20-50% in four years?

But, as long as Congress claims it is going to cut, the CBO has to pretend the cuts will happen. Viola! Health care reform cuts the deficit! No, it does not. It will not, it cannot.

Read this at Real Clear Politics:

Extreme Budget Illogic At the CBO

It's simple: the CBO has to use the fake numbers provided by Congress. If the Congress claimed taxes will be 100% and no jobs will be lost, the CBO would have to use those assumptions. That's how the CBO functions — lots of garbage in, tons of garbage out. Sadly, the CBO knows this, so every report from the CBO includes warnings that the estimates are unlikely to be accurate. Those admissions are what the press should report.

We could reform the health care and insurance markets. We could, but we won't.

Some quick cost control measures:

1. End direct employer-provided insurance, making employees pay for insurance. This would make insurance both portable and a real expense to employees.

2. Allow insurance purchases and transfers across state lines. This does mean national insurance standards instead of the state-by-state patchwork of mandates and compliance rules. One set of rules, one large insurance market. Insurance would be interstate commerce, definitely, and therefore a federal concern. Yes, it's a compromise of libertarian ideals, but the trade is a competitive market.

3. Tort reform! I wouldn't mind banning the commercials for lawsuits against drug companies, device manufacturers, and doctors, too. In return, let's also end direct advertising of most drugs. I'll make the compromise, even though it goes against my libertarian impulses. Drugs are regulated as interstate commerce, so tell the medical companies: we'll improve safety and testing standards, but you'll have less advertising in return for legal liability limits.

The list could be much longer, but I wouldn't need 2000 pages to develop real health care reform.

Study Downplays Outside Groups' Power

This story from Politico.com indicates the real problem isn't money in politics.
Over the course of the campaign, the report found, Democratic committees and candidates outspent their GOP foes $159 million to $112 million – more than enough to compensate for the money outside GOP-leaning groups contributed toward airtime.
Democrats spent more, and lost a lot more at local, state, and national levels. What happened to the huge affect we were told to expect from Citizens United? It didn't happen. The U.S. Supreme Court’s Citizens United decision didn't seem to change spending by more than two, yes two percent. Of course, we also had several multi-millionaires wasting their own fortunes running for offices that pay under $250,000 a year.

My personal theory is that problem of "revolving doors" — politicians go into lobbying, business executives go into politics, media consultants become reporters, and every now and then they rotate positions on the chess board.
Study downplays outside groups' power
http://www.politico.com/news/stories/0111/47589.html
By: Alex Isenstadt
January 13, 2011 06:24 PM EST

For all the ink spilled on moneyed outside groups’ prominent role in the 2010 campaign, their influence might have been overstated.

A new study from the Wesleyan Media Project found that while outside groups spent slightly more on ads in House and Senate races in the 2010 cycle proportionately to the total amount invested in the campaign, their contributions represented only a small increase from 2000.
The one part of the election spending study mentioned can be found at:
http://election-ad.research.wesleyan.edu/files/2011/01/Forum_EFF_TNR.pdf
Despite the heightened attention on independent groups over the course of the campaign, according to the study, candidates and campaign committees actually drove most of the spending. By the time the final campaign ad aired, candidates and parties paid for 85 percent of all ads in Senate races and 88 percent of ads in House races.
This particular report does point out that 54% of advertisements were negative, an increase over previous election cycles. Outside groups do tend to spend more on negative ads because they are restricted to "issue ads" instead of straight endorsements. Also, it still remains illegal for outside groups to coordinated with campaigns. So, what changed if anything?
The report also rebuts the widely held belief that Republicans vastly outspent Democrats on the airwaves.

While Democratic officials –including the Obama White House and House and Senate campaign leaders – complained about the wave of conservative outside activity, Franz noted that well-funded Democratic committees and candidates held their own.
Democrats "held their own" according to this. They actually spend more than Republicans (slightly) and the results certainly didn't reflect "holding their own" in terms of the election results.
Republican-leaning outside groups spent $30 million more than their Democratic counterparts, the study determined.

“If anything, pro-Republican groups helped keep Republican challengers competitive with the incumbent Democratic class,” the report says.
Now, I've heard people claim that this and similar studies fail to measure Fox News, talk radio, and the Internet chatter. I'm sorry, but MSNBC and DailyKos exist. If they aren't effective, that's not something the Supreme Court or anyone else can "fix" for Democrats.

As I wrote at the intro of this blog entry, the real problem is that politicians, lobbying firms, corporations, unions, et al, are nothing more than elites playing musical chairs or some other game. A politician like John Corzine (D) moves from Goldman Sachs to being governor of New Jersey and back to being a business "consultant." A former governor becomes a television pundit. A pundit runs for office… and around it goes.

Monday, January 10, 2011

Tit-for-Tat: Extreme Rhetoric of Progressives

I'm not a fan of Michelle Malkin, but she has performed an important service.

The left and right have serious problems. They are busy vilifying each other, only able to see "the other" as wicked and guilty of heated, nonsensical rhetoric. Truth is, our history is littered with left-wing assassins, right-wing sociopaths, left-wing political terrorists, and so on. Even our founding was a series of violent acts. I'm not sure what this says about American politics.

I don't know what to make of this inventory list, but it is depressing…

http://michellemalkin.com/2011/01/10/the-progressive-climate-of-hate-an-illustrated-primer-2000-2010/

There are pages and pages on the Web now listing the horrible statements, images, and so on from both political sides.

Friday, January 7, 2011

Will Repeal of Obamacare Increase the Deficit?

This response to various news stories on the repeal of healthcare reform is one of several interesting responses.

Will Repeal of Obamacare Increase the Deficit?

One of the problems with any estimates from the CBO is that such estimates can only use numbers and assumptions provided by Congress. Usually, the assumptions of Congress are incorrect, assuming cuts that are never enacted and revenues that never materialize.

The CBO states in its analysis of H.R. 2, the heath care repeal act:
As with all of CBO’s cost estimates, these estimates—both for the first 10 years and beyond—reflect an assumption that the provisions of current law would otherwise remain unchanged throughout the projection period and that the legislation being considered would be enacted and implemented in its current form. CBO’s responsibility to the Congress is to estimate the effects of proposals as written and not to forecast future legislation. However, current law now includes a number of policies that might be difficult to sustain over a long period of time. If those policies or other key aspects of the original legislation would have subsequently been modified or implemented incompletely, then the budgetary effects of repealing PPACA and the relevant provisions of the Reconciliation Act could be quite different—but CBO cannot forecast future changes in law or assume such changes in its estimates.
Even the CBO doubts the Health Care Affordability Act (the real name of “ObamaCare”) will be implemented as it was passed. Health care reform budget estimates depend on cuts that will be nearly impossible to achieve.

All such discussions are academic, though. No one is really going to repeal the complete health care reform. What is more likely is that it will be modified numerous times over the next two years — and into the future. That is what happens to most legislation.

For a rather depressing bit of research, you can read all CBO cost estimates (and the waffling required with Congressional budgets):


The CBO’s process is notoriously flawed. The mathematical models used by the CBO would work perfectly with a 100% tax rate, for example, which we know would destroy any real economic activity. That is the problem with models — no one knows at what point things are “too expensive” for customers or taxpayers.

Tuesday, January 4, 2011

Founding Documents

I have added texts of the Founding Documents to this blog, as static pages. I have formatted these quickly, to post them with minimal delay. In coming months, I will add some commentary to these documents and important historical facts that clarify the intentions of the Founders and of the authors of various Constitutional Amendments.

The process of adding comments and historical clarifications will be ongoing. I will also tackle larger issues in regular blog posts.

Please, read these documents from time to time. It's good to refresh our collective memories.