Greg Ip

Articles by The Economist’s U.S. Economics Editor

Technology and productivity: The hollow promise of the iEconomy

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Feb 28th 2013, 21:44 by G.I. | WASHINGTON, D.C.

IN THE battle between David Einhorn and Apple over the latter’s $137 billion cash hoard lies a deeper lesson about the outlook for the economy. Mr Einhorn, an activist investor, says Apple clings to its money out of a “Depression mentality”. Perhaps. But the more mundane explanation is that Apple, like many of the world’s big companies today, is generating more cash from its existing product line than it can usefully plough back into new projects.

And that’s a problem. Apple is the most creative, innovative and envied technology company of our time, yet investors clearly doubt its ability to keep churning out hits at current margins, valuing it at just 10 times this year’s earnings, a ratio more appropriate for a mature value company.

To some, this might be comforting. After all, while the Dow may be flirting with an all-time high, Apple’s valuation suggests there isn’t much irrational exuberance going around.

But in another way it’s rather distressing. Let’s go back to the spring of 2000, at the peak of the Nasdaq bubble, when Cisco Systems embodied the hype and hope of technology. Cisco was, briefly, the world’s most valued company, with a market cap of $555 billion. Unlike many dotcoms, Cisco was nicely profitable, but not nearly as profitable as investors thought it would be one day: it traded at 135 times that year’s earnings. (Click on the nearby table for a comparison.) Compared with Apple, Cisco was a veritable spendthrift. Despite sales that were barely one-sixth of Apple’s today, its R&D budget was almost as large. Its cash pile, at $20 billion, was big enough (evidence that the phenomenon of cash-rich tech giants is not new), but then, there was no widespread clamour that Cisco hand it back it to shareholders; no one doubted Cisco would find a higher returning use for it.
Because Cisco sold mostly to businesses, few consumers understood what its products did, much less owned one. But productivity was growing by 3-4% and credit for that often went to the products of Cisco and its ilk as the internet transformed the economy. The nosebleed valuations accorded tech companies had less to do with their product mix than a broadly held belief in their limitless possibilities. Every big company salivated over the market opportunities presented by broadband communications and B2B Internet applications. Indeed, because those opportunities easily exceeded profits, junk-bond issuance and initial public offerings were on a tear. That year corporations’ capital spending exceeded their cashflow by around 3% of GDP (see chart).

Today, we all know Apple’s products, and a lot of us own one. Yet it is hard to identify the impact they or any of today’s social-media giants have had on productivity. I was at first delighted with the convenience and freedom to read documents, check Twitter and search the web on the iPad mini I got in December, but it occurred to me recently that this was at best an incremental improvement over doing it on my BlackBerry or laptop. It also provides me with many more ways to waste time. As Tom Toles, the Washington Post’s cartoonist, puts it:

Are we excitedly planning and debating our new world possibilities? No we are all standing still, in the un-meaningful-employment line, thumbing our upgraded little personal communications devices, as if the answers to anything but text messages :-), trivia contests or restaurant locations are going to come out of those. It is our new daily prayer ritual, checking in to review the ever-diminishing returns of the smallest, most novelty-oriented aspects of mushrooming technological possibilities.
There are lessons in Ron Johnson’s move from head of retail operations at Apple to the helm of J.C. Penney. His effort to reshape Penney as a full-price, marketing-savvy retailer have so far been a bust. Fourth-quarter sales were down a sickening 28% from a year earlier, and for the full fiscal year, the department store lost $985m. The stock has lost roughly half its value. Apple’s success seems too idiosyncratic to hold many lessons for other companies, certainly department stores.

But I was especially struck by this anecdote in the Wall Street Journal’s story of Mr Johnson’s tenure:

[Mr Johnson’s new team] decided that the headquarters had grown overstaffed and underproductive. During January 2012, the 4,800 employees in Plano had watched five million YouTube videos during work hours, said Michael Kramer, a former Apple executive brought in by Mr. Johnson as chief operating officer. Thirty-five percent of the bandwidth at headquarters was routinely used for such loafing off. “I hated the J.C. Penney culture,” Mr. Kramer said. “It was pathetic.” Penney brought in Bain & Co. to assist with rounds of layoffs; there are now 1,600 fewer workers at headquarters.
No doubt some of those YouTube videos were being watched over Apple products. Not that I blame Apple for Penney’s culture (after all, Google owns YouTube), but it is a reminder that the social-media revolution has been a mixed blessing. Yahoo at one time stood atop the Internet but the ability of its workers to do their job from anywhere may be backfiring on productivity, which prompted Marissa Mayer’s new edict against telecommuting.

There are genuine benefits of social media and the related hardware. In its first few decades the computer/internet revolution re-engineered business processes, enabling companies to interact with each other and customers in more ways at lower cost than ever, producing measurable, bankable results. Now, it’s leading to brand-new consumer products, many of whose  benefits are unmeasured or unmeasurable. How to put a price on the contribution of Facebook or Twitter to the Arab spring?

But the distinction between measurable productivity and unmeasured consumer surplus matters when trying to ascertain why growth remains so weak. It is, of course, primarily due to weak demand—consumers and businesses reluctant to spend, and governments unable or unwilling to fill in the gap. The causes of weak consumer and household demand are interrelated.

In a liquidity trap real interest rates are too high for the supply of, and demand for, investable funds to clear. This could be fixed if business believed the risk-adjusted return on potential capital projects were higher.

Why don’t they? Perhaps because of uncertainty, though that’s a poor explanation for a phenomenon occurring globally. It’s more because of the paucity of compelling projects. Tyler Cowen says this better than I can, but what passes for the frontier of investment opportunity these days is awfully underwhelming. The holy grail of Barack Obama’s green energy and manufacturing policy seems to be an electric car that can make it from Washington to Boston without needing a tow truck. The enormous sums being thrown at unconventional oil and gas are mostly a sign of how political instability and scarcity have made the conventional stuff so much costlier to find. Shell has spent $5 billion preparing to drill for oil off Alaska without, so far, a drop to show for it.

But wait, aren’t robotics advancing so fast now that capital is displacing labour faster than new jobs can be created? This week’s Free exchange column highlights research by David Autor at MIT that suggests that is an obsolescent view of the production function:

A firm’s challenge is to decide how to allocate … between capital and workers of varying skills, according to their respective comparative advantages. Assignments evolve over time as costs and technologies shift: an innovation may displace humans from some jobs, for instance, but make them more productive in others.
If fact there is little sign in the data that machines are displacing humans any faster than usual. Productivity growth at non-financial corporate business averaged a paltry 0.4% for the past two years, one of the worst performances of the last two decades. This is almost as important as weak bargaining leverage in explaining why workers’ real wages are not growing.

The stockmarket’s rise this year and the generally upbeat tone to the economic data suggest the problem of weak demand may, bit by bit, be lifting. But we will still have a problem of stagnant supply. That may prove harder to solve, even if we have many delightful new apps with which to talk about it.

The original post is linked here.


Written by gregip

March 1, 2013 at 12:07 pm

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