You never really own a Patek Philippe, you merely look after it for the next generation. It has been one of the most successful advertising slogans ever. It appeals to our vanity, yet tempers it, it appeals to our immortality, yet reminds us of our mortality, it panders to our hopes for our progeny, yet gets us to buy today, and by suggesting an element of investment for the future it makes us less price sensitive and willing to move up the complication and price point curve.

The thing is that luxuries like Patek Philippe have become more accessible over the generations. While prices have surged in the last ten years compared with previous decades, the broadening of the range among luxury makers, from watches to apparel and accessories, means that manufacturers now cater to a much wider spectrum of society.

Which brings us to the investment thesis. Where in the past luxuries like Patek were the preserve of the few, the number of clients has grown. Moreover, where once a person might have a single watch the modern customer tends to have several watches. They also have many more shoes, suits, bags, scarves and whatever else the luxury companies are able to sell them. Today the value of the 1960s complicate watches may encourage one to invest in such a collectible; we are a species prone to naive extrapolation. But how many such examples of these watches are there? And how many limited editions and apparently collectible watches have been launched in the last decade. Beyond quality, luxury, ostentatiousness, perhaps these objects derive most of their value from scarcity. Now there’s a new concept.

Owners of Patek Philippes and other such luxury items had better hope the next generation values these watches as much as they do, since they will inherit a whole bunch of them.

Apologies to Patek Philippe; I actually like their watches, but they are merely a convenient example of the broader principle: We never really own anything, we merely lease it like everything else on this crazy planet, even life.

Capital gains tax should be reduced over the life of an investment. This creates an incentive for long term investment and discourages short term trading. Every year that an investment is kept, there should be a 10% discount on the capital gains tax payable on that investment so that an investment that is held for 10 years attracts no capital gains tax. A similar principal would apply to losses eligible for offset against income or profits. Such loss offsets would decay similarly.

This encourages long term investing. It discourages short term trading except where the investment is a loss. It doesn’t drive management to greater or less transparency. Successful companies have no incentive to be less transparent, or more. Unsuccessful companies who are not transparent will be quickly sold off as quickly as unsuccessful and transparent companies.

Anyone who has ever worked in a bureaucracy will have figured out what’s wrong with our world. Apocalyptic risks can present themselves in no uncertain terms to the market and still evoke the calmest, most dazed and serene of reactions. Solutions to calamitous problems can stare a herd in the face, and the herd will stare blankly back without even the slightest pupil dilation.

Bureaucracies and herds turn good people into fodder. They turn action into circular motion, friction and heat. Inertia is one of the greatest forces on earth. Given a path that doesn’t work, the bureaucrat will always demand trying harder, in the same direction.

A friend of mine once did work for a tire manufacturer making wheels which were heptadecagons. They didn’t work as they weren’t circular and resulted in a lot of ‘volatility’ for their clients.

Try a circle, he said, it works better. No, he was told, our molds are heptadecagons, so please just make more and sell more heptadecagonal tires.

The passengers will be vibrated to death, he said. The auto manufacturers will not buy our tires. They would have a liability. Which they might even pass back to us.

How about a discount? Or perhaps we can give our salesmen incentives to sell.

OK, but then they’d be selling something nobody wants.

We used to sell tons of those tires, came the retort.

Well, yes, but back then, streets were cobbled. Nobody noticed our wheels were heptadecagonal. Today, things have changed. Streets are paved with tarmac, they’re smooth and clients will notice the bumpy ride of our tires. The car makers will not buy tires which jolt their suspensions to bits and vibrate their passengers into the 4^th dimension.

Really? How are you going to sell smooth tires until you’ve successfully sold our heptadecagonal tires? Let’s get the basics right first, before we try these funky ideas.

Yes, but nobody wants our heptadecagonal tires. They want smooth tires.

What are you talking about? We have some round tires in stock but no one has bought any. If you can’t sell round tires, you’d better sell heptadecagonal tires.

The reason we can’t sell our round tires is that our sales people only have expertise with heptadecagonal tires. We need to train them. And besides, our sales people have recently been asked to sell shock absorbers as well. They don’t have time to do both. And their commissions are much higher for shock absorbers. Many of them refuse to sell any tires, round, heptadecagonal or square for that matter.

Look, you’d better just get on with it. You’re way behind in sales of tires. And shock absorbers.

Shock absorbers? I have enough on my plate that I have to make the bloody tires I’m selling and nobody will give me the round moulds. Why on earth do we even have heptadecagonal tires in the first place?, he said.

They are much easier to make. You
know how hard it is to make a perfectly round tire? And you can’t even sell our heptadecagonal tires…

Because nobody wants them. We need round tires. And how about separating manufacturing from sales?

Just sell the damn heptadecagonal tires. If you sell enough of them then you can invest some time and money into the round tires but you’ve got to do the low hanging fruit first. Maybe then we’ll get you someone in manufacturing. They said.

Under his breath he muttered, the low hanging fruit are necrotic, you idiots.

Thanks.

Thanks.

And before long there is a lawsuit against tire manufacturers who are genetically incapable of making a round tire, thus resulting in a class action suit by plaintiffs who have been rattled to death on their 17 sided wheels resonating their car chassis until they are spat out of their sunroofs like a low level James Bond villain being ejected for being tedious.

For as long as one can remember the path to a better future began with a college degree. Especially in emerging markets where college graduates used to be a scarce commodity this was particularly true. In small, rapidly growing markets the scarcity premium was high. Even public sector jobs paid a substantial premium for college graduates while providing them with job security.

There was also a certain respect for college graduates over and above their economic value which today seems quaint. The disciplines of choice were medicine, law, the sciences, followed by the arts. Economics, business and commerce were subsumed under the arts and have not commanded a premium in either prestige or remuneration.

As with all human endeavors extrapolation, mistaken strategy, slow reaction times have led to a certain cyclicality in the supply of certain trades. The 3 to 4 year gestation of a college degree, (sometimes longer as in medicine for example) also exacerbate cycles as supply lags demand.

A college education has a strong element of signaling embedded in it. Often the precise content of the degree courses bear little relevance to the jobs the graduate actually obtains. Generalist degrees prepare the individual for a wide range of jobs by equipping them with a spectrum of abilities and skills. The MBA is a prime example. The MBA may be specialized with particular accents but is usually sufficiently diverse in scope to equip its bearer with generalist skills to tackle most problems. It’s value lies in its versatility; it can be thought of as an option whose value depends on the diversity of jobs it opens up to its bearer. Be that as it may, the unemployment problem is best addressed by more specifically meeting the labour demands of the economy. Wage transparency should be encouraged to signal the evolution of demand for different types of labour to encourage supply. Current wage data is noisy and suffers from agency issues. Individual’s pay is often secret. First and second moment aggregates and time series should be published to improve he dissemination of labour market information in the economy.

Broadly, finance, managerial, social sciences are oversupplied while the sciences, engineering and the professions are under supplied. Some disciplines are easier than others in terms of obtaining a degree. The hard sciences and engineering are more difficult or considered dry subjects whereas social sciences are more popular, the professions have purposefully established high barriers to entry to encourage under supply but each discipline has its own supply dynamics.

Wages are not just determined by demand and supply, individuals are rewarded based on the return they generate for their employers. Employees are paid depending on their marginal product as well. Certain industries command more assets per person and thus are able and willing to pay higher wages. The highly leveraged financial industry is one such industry that tests the limits. Service industries, and intellectual property based industries also exhibit this capital efficient feature that leverages assets per employee. Consultants offer another good example.

The mismatch between supply and demand of jobs leads to increasing inequality of compensation. Under-supplied labour markets face rising wages and remuneration while oversupplied sectors see unemployment and wage stagnation. Income inequality is not sustainable over the long run. Apart from building social pressures, a rich poor divide encourages Socialist progressive and redistributive tax policies. Governments are vulnerable to such populist policies at a time when they struggle for legitimacy and a balanced budget. This will delay enlightenment in tax policy and keep marginal tax rates high while tax revenues languish and economic growth stagnates.

A more promising goal must be to provide as much information as possible about the demand for jobs in order to facilitate their matching and to encourage effort and enterprise through friendlier tax regimes. In addition to helping allocate resources to training, try content of each course should be made more practical. Purists may argue against this but ultimately the labour market will decide. A theoretical foundation without practical delivery is a waste. Application without fundamental basis is incomplete and risky. While the purists have defended learning for learning’s sake it is expected that pragmatism will prevail. Underfunded universities dependent on government subsidies will eventually be swayed towards a more utilitarian curriculum. Time will tell if this is efficient.

Dynamic systems involving human behavior are invariably cyclical as a result of delays in signal interpretation, reaction times, gestation periods and extrapolation. The soft disciplines such as he arts and social sciences will likely see a contraction in supply while engineering, the hard sciences, and professions will likely see an adjustment upwards in supply. Between science and engineering, immediate demand favours engineering while longer term demand requires scientists. Short term-ism may prevail as corporate management and government tenures favour shorter horizon investments.

A further factor in employment is risk. 30 years of stability, Great Moderation, low volatility and risk mitigation has led to individuals being more willing to accept greater career risk in return for higher reward. The financial crisis of 2008 was a turning point. In the immediate aftermath of the crisis and recession individuals clearly struggled to reconcile risk and reward, many seeking the rewards available in the past but refusing to accept the risks associated with the new landscape. Individuals are already adjusting their preferences and many now seek stability over reward.

Western governments with unsustainable fiscal cash flow characteristics are trying to limit the growth of public sector jobs. In the Emerging Markets which were able to navigate the crisis, healthier balance sheets and cash flow may afford latitude in increasing public sector employment. In any case the demand for public sector employment will likely outstrip supply at least on a relative basis across the globe.

How is the global economy evolving in terms of demand for talent? What are the relevant skills for the next few decades?

How should and how will education respond and evolve to address the needs of the economy going forward?

What are the implications of the evolving nature of labour demand, supply and production on innovation, risk and growth?

These questions will not be answered quickly. The answers will be revealed over multiple years.

Tangent:

There are other factors as well such as automation and robotics where machines may replace or compete with humans in filling certain functions. Repetitive, hazardous, unrewarding tasks will likely find some sort of automated solution. Yet it is not clear how efficient robots will be at replacing humans in a given job. Humans will have a monopoly over certain types of jobs which require that hard to define ‘human touch.’ Even this criterion is a moving target as the abilities of robots adapt and evolve. What is also interesting is to understand the economics of a world where robots are a viable competitor for most if not every job. As robots perform more and more functions, will this create more unemployment? Who owns the robots? Is a more utilitarian economy one that lends itself better to automation and is thus more vulnerable to having machines replace humans? It is well to argue that automation may create more new jobs but it is more reassuring to those about to be replaced if they knew what those jobs might be so they could prepare to fill them. In the limit, if every job was done by a machine, then who owns the machines becomes a very important question. Also, how do people who have no work and do not own machines generate income?

Instability: Macro, Banking and Agency:

Thirty years of prosperity, falling interest rates, rising stocks and bonds, moderate inflation and widening inequality of wealth within nations had led to an unstable position. While inequality has receded between countries, it had increased within countries regardless of their economic model or system of politics.

The financial industry was not alone in seeing greater inequality of remuneration and reward but it was the extreme example that stood out when matters came to a head in 2008. The financial crisis was not the simple product of these imbalances which included imbalances within economies and between them. The current account imbalance between East and West, the export dependency of China and other Asian economies, the consumption dependency of he Western economies were contributors to the instability in the system, but no single factor precipitated the crisis. Neither was 2008 such a milestone in the dynamics of this theme in history. It was certainly no terminal point, more of an important node. What it did do was to expose the failure of principal agent relationships by focusing public attention on their particular manifestation in the financial industry.

Leverage in the banking system had increased steadily over multiple decades. There are a number of reasons for this including greater diversification of business within banks, a great moderation of volatility resulting in higher model prescribed optimal leverage, a non-trivial dose of complacency, and diminishing marginal returns to scale. The Basel framework for prescribing appropriate levels of capital to be held in order to absorb the riskiness of assets was a reaction to reign in excessive leverage. Central banks recognized that in the event of a sufficiently large bank failure they would have little choice but to bail out the errant bank in order to secure the system as a whole. This was a reality not lost on the banks.

The intellectual capacity dedicated to the financial industry is considerable. Banks, insurance companies and hedge funds hire mathematicians, physicists and engineers among a wide array of scientists to help them make money. They also hire legal and regulatory minds of the highest calibre to help them to engage with regulators. No wonder then that regulators efforts to control the behavior of financial institutions have been confounded at every turn.

An example of this was the growth of the so-called Shadow Banking industry, a system of financial institutions which operate largely beyond he control of regulators by eschewing deposit taking and other retail investor interface. In the years leading to the 2008 crisis banks created massive off balance sheet entities such as SIVs, which were little more than off balance sheet banks with complex capital structures designed to run unregulated, and CDOs which had a similar structure with a few additional stabilizing constraints. These structures allowed the application of almost boundless leverage which escaped he regulators’ control if not scrutiny. As a system therefore, leverage surged beyond he estimation of the regulators and conventional metrics.

The attraction of the financial industry was precisely this leverage seen from a different angle. For a given capital base the financial industry offered the highest per employee assets of any industry. Since labour is compensated with a proportion of its marginal product, labour naturally seeks such industries out which deploy more assets per person. Pay levels and bonuses in the financial industry surged attracting he brains which would perpetuate the increase in assets per employee.

Diminishing marginal returns afflict even the financial industry. It is necessary to increase assets per employee but it is not sufficient. In order to generate high levels of pay and bonuses returns on equity capital need to be maintained, grown and maximized. This is the principal agent contract. Shareholders will only tolerate high payouts if the custodians of their business are generating sufficient returns on their equity capital. As the size of the system’s combined balance sheet grew, too much money was chasing too few opportunities. Returns on assets understandably fell or moderated leading managers to increase leverage in order to maintain returns on equity. The principal agent compact is incomplete in that it fails to address the prospect of losses. An agent is paid a basic salary to cover living expenses, or so the theory goes, and paid a share of profits. In order to retain talent and to align interests a portion of the years bonus is retained for a number of years usually 2 to 3 years. Unfortunately there is usually no clawback so contracts do not prescribe for losses. Traders who lose a sufficient amount of money are either fired or incentivized to leave the firm rather than work for free. Since contracts provide agents with upside but no downside they resemble call options and option pricing theory advises that the value of an option is highly dependent on the volatility of the underlying instrument or asset. Agents are therefore incentivized to increase the riskiness of their portfolios in order to maximize the value of the option which they hold.

In the wake of each crisis come regulations to prevent recurrence. Glass Steagall which was enacted during the Great Depression was repealed during the Clinton administration as the world came to accept the Great Moderation. The 2008 financial crisis has led to reconsideration and the introduction of Dodd-Frank with similar content and intent. Basel 3 is another piece of regulation intended to stabilize the banking system, among a slew of other regulations. Each new regulation comes with its own complications and unintended consequences. Basel for example, starves the economy of credit while governments are trying to reflate their flagging economies. Gradually, the shadow banking industry is expected to rise again as mainstream banks are hobbled by regulation. Talent can be expected to bifurcate to the safest banks and to the unregulated shadow banking institutions, at least until a clearer future emerges.