The Pin Factory Blog

Capitalism has never been cuddly. But the promise of the market is that if you work hard to produce a good product, consumers will reward you. In the short term, these rewards come in the form of profits. If your products consistently deliver, you can develop a reputation for unique and distinctive excellence that garners consumer loyalty—this process is known as branding. Branding both allows you to charge a premium on your products as well as partially protecting you from competition from other firms offering similar products. In short, branding is essential for the future growth of a company.

Differences in the competitive nature of given industries create differences in the way that branding functions. Compared to an industry such as department stores in which a few giants have dominated for decades, the technology industry is characterized by creative destruction. On crack. The Internet platform allows for low start up costs and fewer other barriers to entry, so new companies are constantly popping up—and dying out. In this sort of cutthroat atmosphere, branding can be the only thing that saves an Internet company from fading into the oblivion of the world wide web.

However, while for the department store industry, branding rests on having a storied, traditional name like Harrods and Harvey Nichols, for technology companies branding means something completely different. Given the enormous amount of competitors who can all deliver roughly similar products quite cheaply, branding isn’t just about quality. It’s about Cool. Crucially, Cool is both the most important quality to have and also that which is most difficult to engineer. And cases like that of MySpace prove that it can be the most fleeting too.

Given that branding with social networking services relies so heavily on the Cool factor, it’s hard to understand the hype around Internet companies like LinkedIn and Groupon. Admittedly, these companies have proved successful thus far. LinkedIn, which provides professional networking services, saw its shares more than double in value on its first day of trading. In addition, the online deal website Groupon is attempting to raise $1 billion through an initial valuation of $20 billion. This is for a company that has yet to turn a profit.

Some companies, such as Google, manage to have created that magical balance of Cool and reliable in a brand—for now, at least. But within the highly combustible technology industry, such success is often as transient as it is rare. Remember the cool girls in high school? Still think they are so cool now? Welcome to Myspace.

Eamonn has a post on the Guardian's Comment is Free site today, criticising Nick Clegg's suggestion that shares in the nationalized banks be handed free out to every elector. You can read the whole thing here, but this extract should give you the flavour:

Colleagues and I contemplated such ideas in the late 1970s, as a solution to Britain's huge nationalized industry sector, but we quickly abandoned it…

We went through 20 years of privatizations and we gradually worked out the best ways to do it. The shares need to be offered to those who actually want to own part of a bank. They need to be offered cheap, and in installments, so that a wide number of the general public participates. There needs to be national advertising to generate interest. Shares must be easy to buy. There need to be incentives to discourage people from flogging them at the first opportunity. The share offer needs to be underwritten by financial institutions. Some part of the shareholding needs to be reserved for financial institutions – but that proportion scaled back if the public demand exceeds expectations. The shares should be sold a bit at a time, so the taxpayer gets the full value possible from a (hopefully) rising share price over two or three years. Which they wouldn't under the proposed scheme.

We have learnt all these techniques before, in previous privatizations. It would be a mistake to ignore all those lessons, even from the best of motives.

An interesting article by Stephen Metcalf, on Robert Nozick and libertarianism, appeared recently in Slate. The piece, entitled “The Liberty Scam,” claims that Nozick’s chief failure was to confuse capital with human capital. Editorialising on the man’s life and the era, Metcalf explains that this came from being a post-war arriviste on the tenure track at Harvard, who arrogantly thought his success the consequence of endeavour rather than the Keynesian welfare state. Nozick finally came to his senses in 1989 after realising that his star shone but faintly “in a world gone gaga for Gordon Gekko and Esprit.”

The pseudo-biography may be a bit suss. The article is sharpest when it challenges Nozick on his definition of liberty. “Nozick is arguing that economic rights are the only rights, and that insofar as there are political rights, they are nothing more than a framework in support of private property.” Metcalf contends that economic freedom means a minimum of economic opportunity, rather than complete private property rights, and thus requires a social welfare state and progressive taxation. Second, he claims political rights and civil liberties are components of liberty. “When I think with my own brain and look with my own eyes, it's obvious to me that some combination of civil rights, democratic institutions, educational capital, social trust, consumer choice, and economic opportunity make me free.”

This seems to get to the heart of the divide between classical and social liberals. Does freedom mean maximising opportunity or maximising one’s range of action within a given set of opportunities? That is, is freedom feeding one’s children according to the Department of Health food pyramid or buying whatever food one wants with an income untaxed but also unsupplemented by government? Moreover, can we apply utilitarianism to liberty? Let us leave aside trickle-down economics. Assuming that all this laissez-fair, privatisation, poll tax business really does leave the poorest worse off – according to whatever measurement you choose – does that justify stripping other people of their property?

The case for yes relies upon the logic that denying Mr. Gates another hot tub is better than leaving Mr. Bloggs’s children wearing tatty sneakers. This makes some moral sense, but social liberals should note two uncomfortable adjuncts. First, social justice usually means the loss of liberty in some sense. Taxation is coercive; there are no two ways about it. Second, it is impossible to measure utiles. Social liberals have decided that guaranteeing one kind of liberty is worth limiting another. Libertarians have decided that the only freedom is of unfettered individual action. The dichotomy is coarse, but worth chewing over. What is liberty? What can it mean to grant one freedom by restricting another?

Sweden is held up as a socialist’s paradise, proof that big government can deliver big results. However, a new report argues that Sweden’s economic success occurred because social and cultural capital as well as its unique historical circumstances. Indeed, Sweden came out on top in spite of, rather than because of, the socialist policies.

Firstly, the foundations of Sweden’s later success were created between 1870-1936, before the ascendency of the Social Democratic party. The giants of Swedish industry, Volvo, Ikea, and Alfa Laval, all arose during this era of largely unregulated capitalism. Low taxes and pro-business attitudes reigned, and the results are manifest.

Secondly, the authors posit that Sweden’s continued success rests upon social and demographic factors outside the reach of government policy. As they put it, “The perceived advantage of Swedes over other countries rose before the rise of the welfare state”. The factors underlying Sweden’s success are the “Lutheran work ethic” and the “cohesion of a largely homogenous population with particular social values”.

To prove the second point, the authors attempt to show that Swedes living abroad have enjoyed just as much success as their counterparts that did not emigrate. One example is that the poverty rate for Swedes living in Sweden is identical to the poverty rate for Swedes living in America (6.7%, using the same threshold calculations. Furthermore, many government programs in Sweden, such as the enormous State-run healthcare apparatus, have not produced a demonstrable difference in the life expectancy of Swedes. For example, “In 1950, before the rise of the high0tax welfare state, Swedes lived 2.6 years longer than Americans. Today the difference is 2.7”. Enormously expensive socialized medicine has produced only a negligible difference in citizen’s health.

Since governments cannot force their citizens to adopt a Lutheran work ethic or create a largely homogenous population without engaging in large scale social engineering (inappropriate on one side of the scale, genocide on the other), what lessons can the struggling state learn from the Swedish model? Simply: that growth and wealth creation is best left to individual entrepreneurs, and the best action the government can take is to create a pro-business environment in which these individuals have the highest chance of success.

Another update to the chart used by the Obama administration to promote its stimulus package. (Real figures charted as red dots.) Professor Steve Horwitz says that it's time to call it a failure. It's hard to disagree. Even on its own terms, the stimulus has not delivered the jobs promised. In fact, the situation is worse than the projection of unemployment without the recovery plan.

Those of us who see a recession as a painful but necessary process of economic reorganization will be unsurprised. If there's been a period of investment in things people no longer want, you need a period where that investment and energy shifts to things people do want. (I wrote about this idea a few months ago.) Of course, it's impossible to show that the stimulus has made things worse than they would have been otherwise, but it's clear that it hasn't worked as it was supposed to.

Greece cannot both stay in the Euro and sort out its debt crisis. The country has been living well beyond its means. It needs not only to cut expenditure and borrow less. It also needs to let its exchange rate fall to a more realistic level. It cannot do that inside the Euro.

In February we showed how Ireland could leave the Euro. The same approach would work for Greece. Here are the steps. It's not pretty, but it is more orderly than what could happen.

1) Announce you are leaving. (It would have been better to do this a while back, when it would have been a surprise, and before people started to pull their capital out of Greece.)

2) Denominate all Greek assets and liabilities in the 'Greek Euro' at a 1:1 initial rate. People continue to use Euro notes with the letter Y (for Greece) in the serial number. So cash machines still work. And Gresham's law means that non-Greek Euros will soon be driven out by Greek ones.

3) Announce that all your Euro debts are also now also denominated in Greek Euros at 1:1. You won't be able to maintain that exchange rate for long, but that's the idea. It will be your creditors who take the exchange risk hit, not you.

4) Default. It's inevitable anyway. Offer creditors (say) a 50% haircut, or a new bond maturing (say) 15 years from now. Hope that they take the 50% haircut. Sure, you won't be popular in the capital markets for a while. But if you can balance your budget you won't have to borrow anyway, and devaluation will help that happen. Investors will see you are doing the right things for the future, and will return sooner than you think.

5) You can print your own new currency and gradually exchange the Greek Euros for it. But don't tie your currency to any other. The whole idea is that you should have exchange rate flexibility, so that when another crisis hits, you can adjust.

What a great paper City AM is. Much punchier, nimbler and cheaper (it's free) than the pink 'un. And sounder too, under the editorship of economic brainbox Allister Heath. His editorials are particularly frank and informative. Like today's on the public finances.

You've heard about the government's 'massive, reckless cuts'. Poppycock, says Heath. Public spending in April-May was 4.1% higher than the year before. The official inflation rate is 2.9%, so that's still a real-terms increase. Meanwhile, public sector borrowing was £27.4bn, up substantially from last year's £25.9bn. So we're getting deeper in debt, too. On the official figures, the national debt stood at £920.9bn (that's 60.6% of GDP) at the end of May – compared to £778.9bn (53.8% of GDP) a year ago. And that doesn't include off-balance-sheet items like pension liabilities, which are escalating fast.

All that means, says Heath, that 'austerity still remains more of a goal than an actual reality'. Until we see better numbers, it is 'too early to declare Britain back on the path to fiscal stability'. Remember that when you get stranded by the planned strike by public sector workers, who want to keep their generous inflation-proof pensions and carry on retiring at 55 or 60.

European insurance companies are busy preparing the implementation of the European Solvency 2 Directive. This law increases the degree of governmental control of the already strongly regulated industry.

State interference at present

Britain has one of the least regulated insurance markets in Europe but, despite this and even before Solvency 2, the state is heavily involved in running insurance businesses. Firstly of all, to set up an insurance company, an authorisation from the Financial Services Authority (FSA) is needed. From this moment on, the insurer must use government-approved accounting, reporting and actuarial standards. This means that basic tools of processing financial information are imposed by the political process.

The FSA also decides who can do the most important jobs in an insurance company. It is not the owner or the shareholders who have the final say on who will be the sales, risk or finance director, but a government agency approves individuals to perform such functions.

On top of that, all important meetings in an insurance organisation must be minuted and the FSA can review the minutes, check who said what and question them about it. This stifles internal discussions and challenge process because people are less willing to say what they really think when an FSA auditor can later be questioning them about this.

The regulator also approves every insurer’s principles of customer service. Under the “Treating Customers Fairly” regulation, insurance companies cannot freely change their claims handling processes, call centre procedures or complaints handling. Significant changes to those may require FSA approval.

Pricing of insurance services is at least partly regulated too. The recent decision of the Office of Fair Trading limits the use of some market information for pricing and underwriting. Similarly, the European Court of Justice prohibits (PDF) the use of an important risk factor – gender – in pricing. The Transport Committee Enquiry may well result in additional government interventions.

The FSA also decides how insurance should be distributed. The FSA’s Retail Distribution Review will be a massive change to the way life insurance is distributed in the UK.

As if this was not already too much, in the near future, the FSA wants to regulate the terms and conditions of insurance contracts and be directly involved in product design and development.

State interference under Solvency 2

Solvency 2 comes into force in 2013, but it is already affecting insurance companies today. It introduces new requirements for management data collection and reporting. Even today, although the implementation of Solvency 2 is still in progress, large insurance companies send every day half a dozen e-mails to the FSA with data and information on the strategy, risks, governance and financial results.

Solvency 2 introduces new ”controlled functions” in insurance businesses. Those include (PDF): the actuary, chief risk officer, and a new audit function. As a result the government is increasing its control over the senior management and governance of insurers.

Under Solvency 2 the FSA approves individual insurers’ internal risk management models. These models must then be used in all strategic decisions such as mergers, spin-offs, entering a new market, distribution strategies or investment and reinsurance programs. By deciding which internal models to approve and which to reject, the FSA gains additional influence over all strategic decisions of insurance enterprises.

Private ownership, mixed control

Watching the European insurance regulatory expansion feels like reading Schumpeter’s “Capitalism, Socialism and Democracy” again. The ownership of insurance enterprises remains in private hands but their decision making processes and operations are to a significant extent controlled by the state. With Solvency 2, Europe and the UK take another step towards statism.

A sad fact of politics is that social and economic liberals often find themselves on opposing sides of the debate. Support gay marriage and drug legalization and you're on the left; support low taxes and private enterprise and you're on the right. A new Gallup poll suggests that, in America at least, that might be changing. Gallup regularly does polls of people's liberalism, asking social and economic questions separately. Both viewpoints are now on the rise:

It's encouraging to see both on the rise in the US. The old left-right dichotomy may be dying, and thank goodness for that. There's no paradox between wanting freedom in your private life and freedom in your working life. Quite the opposite, in fact. It's the people who only care about freedom in one sphere, while trying to control other people's lives in the other sphere, who are engaged in a contradiction. Let's hope we see more evidence that those fair-weather liberals are on the way out, and consistent freedom-lovers are on the way in.

Back in 1859, the self-styled Colonel Drake famously struck oil in Titusville, Pennsylvania and, in effect, laid the foundations for the global oil industry. A similar hype is now being accorded to energy’s latest wonder weapon, shale gas, which has boomed of late in the southern states of the US. The Barnett Shale site in the Fort Worth Basin in Texas was the first to be developed. Just a decade later, the Barnett Shale field accounts for 5% of the US’s natural gas supply. Crucially, the arrival of shale gas has both depressed US gas prices and apparently broken – temporarily at least – the long-term relationship between international oil and gas prices.

Estimated US and EU shale gas reserves are massive, although the level of recoverable reserves is far more questionable. Nonetheless, against this background, it would suggest that the many concerns about EU energy security – long-term gas price supplies and prices, serious delays in developing carbon capture technology, nuclear generation costs as well fears and expensive renewables - could be readily overcome. But many environmentalists harbour serious concerns about shale gas’ ‘fracking’ technology and its impact on the water table.

However, developing shale gas in Europe has particular challenges compared with the US. Less favourable geology, differing sub-soil property ownership laws, less experience in ‘wild-catting’ technology, less attractive tax regimes and tighter environmental legislation all argue against a straightforward read-over from the US experience. In the UK, following two minor earthquakes in the Blackpool area, where it has recently been drilling for shale gas deposits, Cuadrilla Resources has now suspended its operations there.

In short, despite its popularity and rise in the US, it is unlikely that the development of shale gas will transform the mainland European energy scene – with all its vested interests – over the next decade. Without serious regulatory reform, the scenario in the UK is unlikely to be any different.