Wednesday, January 24, 2007

Good News You Probably Won't Hear

Pension Plans Take Healthy Turn

Rising Markets Aid Big Firms' Funds; Failure Risk Lessens

By THEO FRANCIS January 23, 2007; Page A4

After years of steep underfunding, pension plans are now healthy, thanks to several years of double-digit investment gains and rising interest rates, separate studies from benefits consultants suggest.

The pension plans of Fortune 100 companies ended 2006 with 102.4% of the assets needed to pay pensions indefinitely, according to an estimate expected to be released today by Towers Perrin, a Stamford, Conn., benefits consultant. That is up sharply from a low point of 81.9% in 2002, though still below the 125.8% recorded at the height of the stock-market boom in 1999.

PENSION HEALTH

• The News: Pension plans have enough funds to cover their obligations, a study found. • The Background: Concern over underfunded pensions helped legislation through Congress last year. Stock gains were the biggest factor in the plans' recovery. • Outlook: Estimates for 2006 show further improvement.

Consultants and pension experts said the change suggests fewer pension plans are at risk of failing. That bodes well for workers dependent on the plans for retirement income and for the Pension Benefit Guaranty Corp., a federally run pension insurer that pays basic benefits if the plans aren't able to.

'The Right Direction'

"There's no reason why their funding shouldn't have improved -- everything's going in the right direction," said Jack Ciesielski, a pension-accounting expert who writes the Analyst's Accounting Observer newsletter. While some companies faced serious funding shortfalls, for many employers "it was cyclical in nature," he added.

Similar findings are echoed by a separate study of pension funding based on 2005 data, released yesterday by benefits consultant Watson Wyatt Worldwide. That study found that pensions for a group of 1,000 companies were about 91% funded in 2005, up from a little more than 80% funded in 2002.

Widespread concern over underfunded pensions and corporate decisions to freeze or cut pension benefits has helped pension legislation through Congress last year. The legislation was billed as shoring up pension plans weakened by a "perfect storm" of low interest rates and poor stock-market performance early this decade. Few provisions of the new law took effect before this year, so any improvements they may bring about aren't reflected in the estimates by the benefits consultants.

Towers Perrin's study examined the 79 companies in Fortune magazine's list of the 100 largest U.S. firms that sponsored defined-benefit pension plans. Pension plans are backed by trust funds that typically pay retirees a set amount each month for life, or a one-time payout based on that stream of payments. A plan's funded status is a measure of any gap between the fund's assets and the company's obligations under the plan.

Company Contributions

Stock-market gains were the biggest factor in the plans' recovery, averaging about 12% in 2006. In addition, rising interest rates likely reduced plan liabilities by about 3%, Towers Perrin estimated. Interest rates determine how the company converts future pension payouts into a liability on its books today.

Company contributions also improved pension funding, with average contributions rising more than fivefold since 1999. But these contributions boosted plan funding by only about 1%, Towers Perrin said.

One factor unexamined in the study: How big a role pension freezes and cuts have played in improving pension funding. Freezing or cutting benefits reduces a company's pension liabilities, which means the existing assets cover more of the company's obligations.

Towers Perrin used publicly disclosed data for each company, including asset, liability and asset-allocation figures, and took into account subsequent market returns and interest-rate changes.

Improving plan fortunes could encourage some companies to stop contributing to their plans, as many did in the late 1990s; however, pension-industry officials say last year's legislation makes that less likely.

Separately, new pension-accounting rules taking effect this year mean companies must start reflecting net pension liabilities on the balance sheet, instead of recording them in a footnote as they have for years. Under Towers Perrin's projections, "on average, the Fortune 100 will be booking an asset" rather than a liability for their plans, said Bill Gulliver, Towers Perrin's chief actuary for human-resource services.

Big Exposure to Stocks

The transition from prior accounting rules to the new ones, however, mean that the Fortune 100 companies are likely to see a combined decrease in shareholders' equity of about $160 billion, improved from prior estimates of $245 billion, Towers Perrin said.

Watson Wyatt's study showed that plan funding improved by about $10 billion in aggregate between 2004 and 2005. Investment returns improved funding by about $114 billion, and company contributions added about $51 billion, offset by the growth of benefits for employees in the plans, Watson Wyatt said.

"The bottom line is, things are getting better," said Mark Warshawsky, Watson Wyatt's director of retirement research and a former Bush administration Treasury official. He said preliminary estimates for 2006 show further improvement.

Still, Watson Wyatt's analysis shows that pension assets were invested about 64% in stocks, on average -- meaning another sharp downturn could wreak havoc with pension funding once again.

Write to Theo Francis at theo.francis@wsj.com¹

	URL for this article: http://online.wsj.com/article/SB116952316892484545.html
	Hyperlinks in this Article: (1) mailto:theo.francis@wsj.com

A Simple Monetary Truth

P=MV/Q

By ROBERT D. MCTEER January 23, 2007; Page A19

The main question on financial TV lately has been whether the economy will continue to weaken and possibly slip into recession, but allow inflation to decelerate, or whether it will pick up and cause inflation to accelerate. More slack in the economy, or a larger output gap, would reduce inflation; more output, it is presumed, would make inflation worse. While a weaker economy might well reduce inflation, that isn't a necessary condition. Faster growth can also reduce inflation.

While inflation may respond to a reduction in aggregate demand, it would also logically respond to an increase in aggregate supply. In the simple equation of exchange, MV=PQ, so P=MV/Q. In other words, other things equal, prices respond positively to an increase in MV, or aggregate demand, and negatively to an increase in Q, or aggregate supply. This is not rocket science.

But it is a truism rarely articulated. The Phillips Curve is rarely mentioned anymore, but it still pervades the common view that inflation can be tamed only through a weaker economy. Disinflationary growth is not considered an option, probably because we think of output as responding only passively to changes in aggregate demand, so that they rise together or fall together.

That may be the usual case, but it doesn't have to be. Supply-side factors may stimulate output independent of aggregate demand, through shifts in investment, exports or shifts from imports to domestically produced goods. Or animal spirits.

Monetary policy is currently in pause mode as far as interest rates are concerned, but moderate increases in the monetary base must be considered anti-inflationary whether output remains weak, or strengthens, as I expect.

Supply-side economics is out of favor at universities that don't have good football teams. But that's largely because its bar for success has been raised too high. Tax-rate cuts may not fully pay for themselves at current rate levels, but they certainly have gone a long way in that direction, as the recent sharp decline in the budget deficit despite rapid spending growth clearly indicates. Tax-rate cuts that substantially pay for themselves in higher tax revenue are clearly a good thing.

Our economy is remarkably healthy. Inflation has crept above our comfort zone, but current policies are bringing it down without a recession. Monetary policy is just about right, and is being helped in its fight against inflation by other factors: the Internet, globalization, China, India and other new players. Let's not be afraid of growth.

Mr. McTeer is a distinguished fellow of the National Center for Policy Analysis and former president of the Federal Reserve Bank of Dallas.

	URL for this article: http://online.wsj.com/article/SB116952096154684554.html

Healthcare Debate

Health and Taxes The Bush proposal opens a debate for 2008. Wednesday, January 24, 2007 12:01 a.m. Now we're getting somewhere. The U.S. has long needed a debate over health care and tax subsidies, and President Bush got ready to rumble last night with his proposal to make insurance more affordable for most Americans.

For all the griping about our system, Americans have the most advanced health care in the world in part because we still have something resembling a private market for insurance. But it is not a truly efficient market because current tax policy lets businesses--but not individuals--deduct the cost of health expenditures. Thus most Americans with private insurance get it from their employers, which leads to inequities and insulates individuals from the real cost of their treatment decisions.

Mr. Bush's "standard deduction" for health care would move in the direction of solving both problems. Instead of giving employers an unlimited deduction and individuals none, Mr. Bush would give every family a $15,000 deduction ($7,500 for individuals) regardless of their insurance source.

That might mean a slight tax increase for those who currently have the most expensive insurance plans. But the average employer-sponsored family plan runs about $11,500 annually, and about 80% of the 160 million employer-insured Americans would benefit. All Americans with employer-sponsored insurance would have to report the value of their health benefit as income, but they could deduct the full $15,000 no matter how much their insurance cost.

The 17 million Americans who buy their own coverage would be big winners. And because the tax deduction would apply to payroll as well as income taxes, the benefits would be large even for low-income earners. So a family making $60,000 would wind up with a tax savings of $4,500, which would offset the cost of acquiring coverage in many states. Meanwhile, a young person making $40,000 could buy a high-deductible plan for, say, $1,000 and actually get a tax break of $2,250 for doing so. The Treasury estimates the new deduction would add at least five million Americans to the ranks of the insured, but our guess is that would be higher given the incentives all of this would provide for new private insurance products.

Individuals who buy their own health insurance now struggle because there are so few of them and they can buy only in a single state market. That means insurers have little incentive to develop and market innovative products. But this will change if the equalized tax treatment convinces enough people that it makes more sense to have their own, portable policies than take whatever their boss offers. Imagine the same kind of capitalist energy devoted to selling health insurance as you now see selling where to roll over your 401(k).

These new products are also likely to be policies that put individuals directly in charge of more routine spending. That's because removing the tax advantage would mean it will make less financial sense to "insure" for predictable expenses like several annual office visits. That in turn could put pressure on health care providers to post--and actually compete on--prices. Such new price awareness might even generate pressure for states that overregulate their insurance markets (New York, Massachusetts) to ease their costly mandates.

It's true that additional subsidies might be needed for some people with chronic illnesses who might have a harder time finding private insurance in this kind of world. And we'd also like to see a more national insurance market, with companies able to sell policies over the Internet free of the worst state mandates.

But the biggest problem with Mr. Bush's plan is that it wasn't offered two years ago, when it had a better chance to pass. The White House wasted its first term health energies on a failed attempt to buy votes with the Medicare drug benefit. Now the GOP is a minority in Congress, and Democrats aren't likely to favor Mr. Bush's ideas because they think health care is a winner for them in 2008.

Ways and Means Chairman Charlie Rangel was quick out of the box to call the President's idea "a dangerous policy that ultimately shifts cost and risk from employers to employees." But the numbers show that most Americans would have lower costs, and in any case the current tax treatment of health care benefits tends to benefit the well-to-do over the poor. Figures from the Lewin Group show that the average tax subsidy under the current system was $2,780 for families earning over $100,000 in 2004, while those with incomes below $30,000 got less than $725 in aid. Democrats ought to favor this idea on equity grounds alone.

But no matter if they don't. We're fated to debate health care in 2008 anyway, and Mr. Bush is finally offering a GOP reform based on market principles that the editorial page of The Wall Street Journal has encouraged for years. Most Americans can see for themselves that the current employer-based system is breaking down, as more companies pass along the rising cost of their insurance to employees (in higher co-pays and deductibles). Yet the system remains opaque and frustrating because of the underlying tax bias for businesses instead of individuals.

This status quo won't hold, and the political race is going to be between those who want to move to a more genuine market and consumer-based health care, and those who want to move toward Canada, Europe and more government control. The Bush plan ought to jump start that debate.

Tuesday, January 23, 2007

Energy Security

'Energy Independence'

By DANIEL YERGIN January 23, 2007; Page A19

A cry is being heard across the nation, and loudly so in Washington. It is the call for "energy independence," and it will be at the center of the national energy debate over the next several months, providing the rationale for new policies and expansion of existing ones. Indeed, one might even anticipate a "declaration of energy independence" this July 4.

But what does "energy independence" mean for a $13 trillion economy that uses the equivalent of 50 million barrels of oil every day? Is it realistic and achievable? Or is it rhetorical overreach that will lead, as in the past, to disappointment and cynicism, the kind that drives the cycles of inconsistency in energy policy and leaves the U.S. no less vulnerable? The latter is more likely -- at least without a realistic appraisal of the U.S. position and the country's possibilities. But "energy independence" can provide a constructive framework for policy if it is properly thought through and the realities are recognized.

* * *

With geopolitical turmoil, volatile prices and continuing reminders of the international political power of oil, the concept of energy independence is compelling and deeply appealing. In fact, it has been appealing for quite some time. The idea was introduced by Richard Nixon in November 1973, three weeks after the Arab oil embargo, when he introduced "Project Independence" and pledged that the U.S. would, within seven years, "meet our own energy needs without depending on any foreign energy source." It was a bold assertion but one that puzzled his own advisers. "I cut the reference to 'independence' three times from the drafts, but it kept being put back," recalled Richard Fairbanks, a drafter of the speech. "Finally, I called over, and was told that it came from the Old Man himself." Nixon knew that energy independence was something that Americans would crave after the 1973 oil shock: He deliberately modeled his Project Independence on John F. Kennedy's Apollo goal of getting a man on the moon within a decade.

Back then, the goal may have seemed only somewhat unlikely. After all, when Nixon began his political career after World War II, the country already had a long history of energy independence -- and then some. For it had actually been the world's No. 1 oil exporter; indeed, out of seven billion barrels of oil used by the Allies in World War II, six billion were produced in the U.S. By the late 1940s, the U.S. had become a net importer of oil, although the real surge in imports did not begin until the 1970s.

It proved much easier to get a man on the moon than to make a nation energy independent. In the three and a half decades since Nixon, the U.S. has gone from importing a third of its oil to importing 60%, and that share is set to continue rising. The country is on a similar path for natural gas (which is about 25% of our total energy usage). North American supply has flattened out. Yet large amounts of new natural-gas-fired electric power generation have been added over the last decade, which means that demand will increase. Natural gas is also used in the making of ethanol, adding to the demand growth. This means growing imports of liquefied natural gas -- LNG -- rising from 3% of our current demand to more than 25% by 2020.

All of which suggests that thought needs to be given both to what energy independence means and what can be achieved. For, right now, the U.S. is moving at some speed in the opposite direction, toward greater integration into the global energy markets.

How dependent is the U.S.? If we look at total energy -- including coal, nuclear and a small but growing share from renewables -- the country is over 70% self-sufficient. Oil -- refined into liquid fuels for transportation -- is where most of the current dependence comes from. The risks do not owe to direct imports from the Middle East, contrary to the widespread belief. Some 81% of oil imports do not come from that region. Thus, only 19% of imports -- and 12% of total petroleum consumption -- originates in the Middle East

Our largest source of oil imports is Canada. It's also the source of most of our current natural gas imports, via pipelines. One can hardly say that either Canada or energy imports from Canada constitute a major threat to national security. The energy trade is part of a normal trading relationship with the country with which we're conjoined economically and which just happens to be our biggest trading partner. Our second largest source is Mexico, with which we are also in a dense relationship. Mexico depends upon oil for about a third of total government revenues.

The picture becomes more complex when one turns to our third largest source of oil imports, Venezuela. The once much-discussed "hemispheric energy solidarity" loses much of its resonance when balanced against the "21stcentury socialism" of Venezuela's Hugo Chávez. After all, President Chávez is currently nationalizing the private sector, has on occasion threatened to embargo oil shipments to the U.S., and is putting much effort into fashioning an anti-U.S. alliance, the latest manifestation being the visit of Iranian President Ahmadinejad to Caracas. These are not the actions one normally associates with a good friend or a reliable trading partner.

Yet the source of imports is significant only up to a point. Energy security is a global issue. Although oil around the world varies greatly in terms of physical qualities and transportation costs, there is only one world oil market. So disruptions and loss of supply in one place radiate throughout the global market -- and global politics -- affecting consumers everywhere. Even if the U.S. did not import a drop of oil, it would still be vulnerable to turmoil involving oil outside its borders.

What are the prospects for "energy independence" in the way that Richard Nixon defined it 34 years ago -- that is, 1930s-style "autarky" and total self-sufficiency? Based on where we are today, very small, at least for a couple of decades. In terms of vehicles, as pointed out in our new study on "Gasoline and the American People," only about 8% of the auto fleet turns over every year. So the lead times are long for more efficient vehicles to enter the fleet. Ethanol, derived from corn, is on track to grow to about 10% of our total gasoline pool in a few years. This is certainly not inconsequential; it represents diversification and is equivalent to creating a new Indonesia-level oil-producing country in America's Midwest. But signs are already evident of an upper bound on corn-based ethanol, as the fuel-versus-food trade-off pushes up corn prices, setting off vocal protests from livestock growers and dairy farmers and, in due course, from those who buy breakfast cereals and soft drinks made with high fructose corn syrup.

What about technological advances that provide new answers? There is a "great bubbling" all along the innovation frontier of energy, ranging from conventional energy and efficiency to, especially, renewables, alternatives and "clean tech." Activity this wide-ranging has never been witnessed before. The impact could well be considerable, or even transformative. One would be very hard-pressed today, however, to say when and what form this impact will take.

In the end, if energy independence is presented as self-sufficiency, it will likely fall flat. And, as prices run through their cycles, disappointment will undermine the longer-term commitments that are required for a sound energy future. Today, quite simply, cutting ourselves off from global energy markets is not realistic.

But, if the goal of energy independence is understood differently, to mean energy security -- resilience, robustness, reduced vulnerability -- then it is much more useful.

This kind of definition recognizes that trade, in itself, is not bad. At the same time, it emphasizes the central goal of diversification -- encouraging investment and higher levels of research and development in both alternative and conventional energy sources. It means a new push for energy conservation, higher energy efficiency, lower energy intensity -- a theme that German Chancellor Angela Merkel will make the centerpiece of her agenda as chairman of the G-8 countries later this year. It certainly requires a consistent commitment to pushing the innovation frontier in ways that, eventually, lead to economically competitive alternatives and new technologies.

And it requires an understanding that this kind of energy independence -- as measured in energy security -- actually requires interdependence with other nations, both consumers and producers of energy. Indeed, how we manage our relations with other countries and other regions is a very essential ingredient for our own energy well-being.

Mr. Yergin, chairman of Cambridge Energy Research Associates, is writing a book on energy and geopolitics.

	URL for this article: http://online.wsj.com/article/SB116951954739284514.html

Health Care Whoops!

Illegal Health Care January 23, 2007; Page A18

GOP Governors Arnold Schwarzenegger and Mitt Romney have become media darlings for proposing sweeping state health insurance reforms aimed at achieving "universal" coverage. Now out of office, Mr. Romney is trying to ride his plan to the Republican Presidential nomination. But it turns out state schemes that feature "pay or play" employer taxes or mandates are probably illegal.

At least that's the clear implication of a significant but underreported ruling last week by the Fourth Circuit Court of Appeals, which said that Maryland's "Fair Share" health legislation -- otherwise known as "the Wal-Mart tax" -- violates a federal employee-benefits law known by the acronym Erisa.

In this case, Maryland had sought to require all companies with 10,000 or more employees to spend at least 8% of their payroll on employee health care or pay the state the difference. Wal-Mart happened to be the only employer in Maryland large enough to fit that precise definition. But it joined with other firms under the Retail Industry Leaders Association to challenge the law, which was first struck down by a district court last summer.

Judge J. Frederick Motz wrote for that court that "The Act violates Erisa's fundamental purpose of permitting multi-state employers to maintain nationwide health and welfare plans, providing uniform nationwide benefits and permitting uniform national administration." Last week's Fourth Circuit ruling affirmed that decision, and it could spell trouble for the California and Massachusetts schemes.

Leave aside that the plan muscled into law by Maryland's Democratic legislature was far less ambitious. The basic similarity is that all three plans feature employer mandates or taxes aimed at changing employee-benefit plans -- in this case by requiring employers to provide health insurance.

Like the Maryland law, the California plan is explicit on the point, and would require all firms with 10 or more employers to provide health care or pay a 4% tax. This would seem clearly illegal according to the reasoning of the Fourth Circuit, which also said that the ostensibly "voluntary" nature of the Maryland tax was irrelevant from the standpoint of Erisa. No reasonable firm, it said, could be expected to choose to pay money to the state to avoid changing its employee-benefit plan.

Mr. Romney's Massachusetts scheme is slightly different, since it doesn't feature the same kind of percentage tax. But not only would Massachusetts charge a $295-a-head fee to employers that don't provide insurance, it would also make them liable for the catastrophic medical costs of uninsured employees. Again this is likely to fall afoul of Erisa, says one legal expert with whom we spoke, because these penalties are aimed at changing employee-benefit plans that are supposed to be voluntary according to federal law.

There were sound reasons that Congress decided to create a uniform national regulatory framework when it wrote the Erisa law way back in 1974. To wit: Freeing employers from the administrative burden of having to comply with a multitude of state and local requirements leaves them with more money to spend on actual health care and other benefits. It doesn't speak well of Messrs. Schwarzenegger and Romney and their staffs that they didn't seem to have given this well-known legislation much, if any, thought when crafting their reforms.

This week brings one other piece of bad news for proponents of the Massachusetts model, by the way. Early bids suggest the soon-to-be compulsory insurance policies that will pass muster under the scheme will be expensive -- starting at a whopping $380 per month, or $4,560 a year, for an individual. That's hardly surprising when you look at costs in other states that overregulate their insurance markets, such as New York. But it's more evidence that the better way to get people covered is to mimic the practices of less-regulated states such as Connecticut, where a 35-year-old man can get covered for as little as $50 per month.

We're all for state policy experiments, but these ballyhooed health care reforms are policy blunders that won't stand scrutiny in court, much less in the marketplace.

	URL for this article: http://online.wsj.com/article/SB116951662631884439.html

Tuesday, January 09, 2007

Intelligence - signal vs noise

Roberta Wohlstetter, Codebreaker January 9, 2007; Page A18

When Roberta Wohlstetter set out, in the early 1960s, to explain why the U.S. had been surprised by the Japanese attack on Pearl Harbor, she confronted a puzzle that to some seemed like a conspiracy.

Unlike classic military surprises, the U.S. had received ample intelligence that the Japanese were prepared to attack the Hawaiian base. That nothing was done to remove American ships to safety was proof, for Clare Booth Luce among others, that Franklin Roosevelt had "lied us into war because he didn't have the courage to lead us into it." But Wohlstetter, who died Saturday at age 94, knew better, and she spelled it all out in "Pearl Harbor: Warning and Decision," perhaps the most important book ever written on military intelligence.

Yes, the U.S. had intelligence that Pearl Harbor was a potential Japanese target. But other intelligence suggested Siberia could be a target, or the Panama Canal, or the Philippines. Previous indications of an impending attack had served, like so many false alarms, to lower America's guard. And American planners had trouble believing the Japanese would launch a war against the United States that they couldn't possibly hope to win.

From this, Wohlstetter drew the essential conclusion that the U.S. failed to anticipate the attack on Pearl Harbor because, amid mountains of incomplete and often conflicting data -- what she called "noise" -- intelligence analysts couldn't distinguish the information that really mattered. This tended to lead, as the future Nobelist Thomas Schelling wrote in his preface to Wohlstetter's book, to "a routine obsession with a few dangers that may be familiar rather than likely."

The lessons are timeless, and foretold the findings of the 9/11 Commission. Contrary to the views of many so-called realists, nations do not always act from rational calculations of their self-interests: They can be reckless gamblers, something that should give pause to those who see nothing to worry about in the prospect of an Iranian nuclear weapon. And contrary to the instincts of many CIA "professionals," the best intelligence analysis requires judgment and imagination, not simply the widest possible data set.

Wohlstetter was also remarkable not simply as a woman working in what was then a "man's field," but also as the wife and intellectual partner of the late Albert Wohlstetter, the legendary nuclear-strategy theorist. Both Albert and Roberta were great friends of this page, as well as great patriots.

	URL for this article: http://online.wsj.com/article/SB116831048526770960.html

Tuesday, January 02, 2007

Healthcare - on a better track

For Better Care, Work Across Lines

By WILLIAM J. HOLSTEIN

THE American medical system is failing to deliver affordable health care because it is too fragmented and poorly regulated, and it therefore needs a major cross-industry consolidation, says Clayton Christensen, a professor at the Harvard Business School and author of such books as “The Innovator’s Dilemma” (1997) and “The Innovator’s Solution” (2003). Here are excerpts from a conversation:

Q. Do you think that the United States medical system is woefully inefficient?

A. It is. In many industries, the ability to provide the product or service far more cost-efficiently and far more conveniently has moved at a pace that really outstrips the progress the medical industry has made.

Q. How much does the system cost in whole?

A. Between 13 and 17 percent of the economy, depending on how you measure it.

Q. The nation’s medical system is regularly offering increasingly advanced procedures and treatments. Isn’t that a good thing?

A. If you look at the progress that today’s hospitals and the medical profession have made, they continue to push the leading edge of what’s very difficult to do. But that’s a very different dimension of performance improvement than the one that makes more people better off, and that is making it affordable and accessible. In other industries, whenever affordability and accessibility have come, it has not come from making mainframe computers better but rather from commoditizing mainframes so that average people with average money can have access to high-quality computing, meaning personal computers. It came from disruptive technology rather than improvements on the existing system. Michael Dell could assemble one of these things in his dorm room.

Q. What’s the relevance to health care?

A. In health care, rather than replicating the expensive expertise of Mount Sinai Medical Center or Mass General Hospital or replicating the expensive expertise of doctors, we have to commoditize their expertise. That comes through the precise ability to diagnose the diseases that people have. Our ability to diagnose the diseases is moving ahead at a breathtaking pace, but regulation and reimbursement are trapping the delivery of rules-based medicine in high-cost business models.

Q. An example of what you mean?

A. A hundred years ago, there was a big disease that nobody understood and was often fatal, called consumption. Little by little, medical science began to unpack that symptomatic description, which was that your lungs filled up with gunk and you died. The reason we couldn’t cure it was that what we thought was a single disease was a whole bunch of different diseases. You had tuberculosis there, at least three types, and you had pneumonia. We thought it was all one disease. So the care had to be left with doctors because they were the ones with the training and the judgment, but once you could precisely diagnose the cause of the disease, you could then develop a cure. It was so rules-based that you didn’t need a doctor any longer. Today a technician can diagnose those diseases and a nurse can treat them.

Q. Are you saying doctors rather than the pharmaceutical industry are the root cause of what’s gone wrong?

A. The pharmaceutical industry has been focused on therapy, not diagnosis. The medical profession has simply accepted that many of these diseases are well-diagnosed, when in fact they aren’t. As a consequence, we haven’t moved the health care profession into a world where nurses can provide diagnosis and care. Regulation is keeping the treatment in expensive hospitals when in fact much lower cost-delivery models are available.

Q. Wouldn’t your solution require a dramatically different regulatory environment?

A. It differs state by state. In Massachusetts, nurses cannot write prescriptions. But in Minnesota, nurse practitioners can. So there has emerged in Minnesota a clinic called the MinuteClinic. These clinics operate in Target stores and CVS drugstores. They are staffed only by nurse practitioners. There’s a big sign on the door that says, “We treat these 16 rules-based disorders.” They include strep throat, pink eye, urinary tract infection, earaches and sinus infections.

These are things for which very unambiguous, “go, no-go” tests exist. You’re in and out in 15 minutes or it’s free, and it’s a $39 flat fee. These things are just booming because high-quality health care at that level is defined by convenience and accessibility. That’s a commoditization of the expertise. To have those same disorders treated in Massachusetts, you’ve got to go to a regular doctor, go through a long wait in their office, you go in and see the doctor for two minutes. He says, “You have an earache,” which you knew already, and then they charge you $150.

Q. Aren’t the pharmaceutical companies also profiting?

A. They are. But in general, pharmaceutical breakthroughs that involve a precise diagnosis of a disease and an effective therapy save the system a tremendous amount of money even though the drugs may appear to be high-cost.

Q. There are many other players in the system, including hospitals and insurance companies. What’s your prescription for them?

A. The whole system is broken. It will take a major overhaul to unlock it. Forgive me by talking by analogy, but when color TV was first invented by RCA, nobody would broadcast in color because nobody had color TVs and nobody would buy color TVs because nobody was broadcasting in color. They just couldn’t make the system come together until David Sarnoff, who ran RCA, bought NBC. By integrating across the whole system, he made it all happen.

The current health care system is divided into buckets. You have the insurers, the employers who put up the money, the providers such as doctors and nurses, and the hospitals. Because they exist as independent companies, they can each improve themselves, but they can’t re-architect the system in the way that it needs to be changed.

There are two health care systems in the West, Intermountain Health Care in Utah and Kaiser Permanente in California, that are in fact integrated across each of those pieces of the system. They are far ahead of the rest of the world in bringing rules-based diagnosis and therapy in cost-effective business models to their patients.

Q. Who would make such a sweeping transformation happen?

A. What we are hoping to do with our research is to bring to this disparate community an understanding of the root cause of the problem. Giving them a common language and a common way to frame the problem takes you a huge distance toward a solution. We’re targeting the chief executive officers of the major insurance companies and hospital companies and medical schools and drug companies to help them understand where we are today and where they need to go. Once they frame the problem correctly, smart people can come up with pretty good solutions.

The government will be the hardest because a lot of the regulations that require that care be given by people with particular expertise and in expensive hospitals were put in place during a prior era when the science was not really as well-defined. The regulations just haven’t kept up with the science.

William J. Holstein is editor in chief of Directorship magazine.

Healthcare Fallacies

Health Care Problem? Check the American Psyche

By ANNA BERNASEK

WHAT is the most pressing problem facing the economy? A good case can be made for the developing health care crisis. Soaring costs, growing ranks of uninsured and a steady erosion of corporate health benefits add up to a giant drag on the nation’s future prosperity.

While the outlook seems scary, it doesn’t have to be. There is a solution, proven effective for hundreds of millions of people: single-payer health insurance.

Yes, single-payer — that much-maligned idea that calls for everyone to pay into one insurer, typically the government or a public agency. The insurer then pays doctors, pharmacists and hospitals at preset rates. Patients who want unapproved procedures and doctors not willing to accept the standard payment remain free to deal with one another directly, outside the system.

Such a system makes it much easier to deal with the growing costs of medical care, like administrative expenses and prescription drugs. It could also reduce the mountains of paperwork plaguing the current system and provide insurance coverage for the 46 million Americans now doing without it.

What’s more, as demonstrated in France, Britain, Canada, Australia and other countries with functioning single-payer systems, significant savings can come without hurting the overall health of the population.

There’s only one catch. Most Americans just don’t believe it can be done. The health care crisis may turn out to be more of a problem of ideology than economics.

The economic case for a single-payer system is surprisingly strong. Start with what we already know. Countries with single-payer systems have long records of spending less on health care than the United States does. The United States spent an average of $6,102 a person on it in 2004, according to the Organization for Economic Cooperation and Development, while Canada spent $3,165 a person, France $3,159, Australia $3,120 and Britain just $2,508.

At the same time, life expectancy in the United States, a broad measure of health, was slightly lower than it was in those other countries in 2004, the latest year for which complete figures are available. And the United States had a higher rate of infant mortality.

To be sure, a single-payer system has plenty of critics. Unattractive features of some such systems, including waiting lists for particular types of care, are often highlighted by skeptics. But supporters note that the overall health of people fares well in those countries.

“The story never changes,” said Gerard F. Anderson, a professor at the Johns Hopkins Bloomberg School of Public Health. “The United States is twice as expensive with about the same outcome.

“As a consumer, I don’t mind paying more if I’m getting more, but that’s just not the case in the U.S.,” said Professor Anderson, who publishes an annual review comparing the American health care system with those of its peers.

What may be less well known is the level of administrative waste in the United States health care system, versus that of well-designed systems elsewhere. Although Americans tend to equate efficiency with private enterprise, that’s not the case with the current system.

The American system, based on multiple insurers, builds in more unnecessary costs. Duplicate processing of claims, large numbers of insurance products, complicated bill-paying systems and high marketing costs add up to huge administrative expenses.

Then there’s an enormous amount of paperwork required of American doctors and hospitals that simply doesn’t exist in countries like Canada or Britain.

“There’s little disagreement among economists today that a single-payer system would lead to lower administrative costs,” said Len Nichols, a health economist with the New America Foundation, a policy research organization in Washington. But he said that estimates varied widely over how big the savings could be.

One of the first major studies to quantify administrative costs in the United States was published in August 2003 in The New England Journal of Medicine by three Harvard researchers, Steffie Woolhandler, Terry Campbell and David U. Himmelstein. It concluded that such costs accounted for 31 percent of all health care expenditures in the United States.

More recently, in 2005, a study by the Lewin Group, a health care consulting firm commissioned to examine a proposal to provide universal health coverage in California, estimated that administrative costs consumed 20 percent of total health care expenditures nationwide.

Then there’s the test of time. Health care costs tend to rise over time as new technology and procedures are introduced. Yet here, too, government-funded systems appear to help contain long-term costs.

Consider Canada’s system. Professor Anderson points out that in the 1960s, Canada and the United States spent roughly the same per person on health care. Some three decades later, though, Canada spent half as much as America. How did Canada manage this? By controlling the use of medical equipment and hospital resources, which statistics show has helped Canadians keep a lid on costs without measurably compromising the overall health of the population.

Economic studies also show that a government-funded system could reduce costs while providing coverage for everyone. The Lewin report on the proposal to provide universal health coverage in California calculated that if such a system had been operating in 2006, it would have saved $8 billion, or around 4.3 percent of total health spending in the state. From 2006 to 2015, it estimated, savings would total $343 billion. Currently, California spends about $180 billion a year on health care.

Despite everything that is known about the economic benefits of a single-payer system, there’s one big stumbling block: many Americans don’t believe in it. They have heard horror stories from abroad, often spread by partisan advocates, focusing on worst-case examples. Such tales play upon the aversion of many Americans to government involvement in the economy.

Victor R. Fuchs, an economics professor at Stanford and a specialist in health care economics, explained it this way: “The Canadian system is a nonstarter for the U.S. even though it’s a good system for Canadians. You’re dealing with two very different countries. We were founded on life, liberty and the pursuit of happiness. They were founded on peace, order and good government. It’s a difference of values.”

Others in the field echo his skepticism. But that raises questions about how well Americans understand the system they have, and what the alternatives are.

JUDGING from other countries, many features that Americans really like — being able to choose their own doctor, for example — would remain available in a well-designed single-payer system. And a single-payer system need not mean government-provided care: it often means government-provided insurance that encourages competition among providers.

Much of the resistance to a single-payer system appears to stem from a lack of confidence in the nation’s ability to make positive change. With all of its prowess in research and technology, can’t the United States match the efficiency of other developed nations, or do even better?

Changing the minds of so many millions of people isn’t done overnight. But sooner or later, persuading people to do something that’s in their own economic interest ought to succeed.

Saturday, December 30, 2006

Financial Innovation

The Risk Business December 30, 2006; Page A10

The Dow Jones Industrial Average closed yesterday near an all-time high, up 17% for the year. Long-term bond yields rose this year but remain remarkably low given the Federal Reserve's short-term rate ratchet to 5.25% from a low of 1%. Economic growth has slowed but remains solid. And by some measures financial market volatility is at lows not seen in a decade -- the Dow, for example, is still adding to its longest stretch (910 days) without a one-day decline of 2% or more since 1900.

All of this stability naturally fills people with dread. It has led to a round of questioning about why, in an undeniably dangerous world, risk premiums seem to have drained out of whole classes of financial assets. Has Mr. Market become complacent, and so set himself up for a fall? What is everyone missing?

HOT TOPIC

Financial Risk: Where Has It Gone?¹

When someone tells us that the old rules don't apply anymore, we tend to check our wallets. But this is not to say that nothing ever changes. One of the things that has changed over the past 30 years is the extraordinary extent of financial innovation. When it comes to the decline of risk premiums and financial stability, securitization and the use of derivatives have both played an unsung role.

The very word "derivatives" produces a remarkable range of reactions, not all of them polite or rational. Warren Buffett has long described them in apocalyptic terms. Regulators think "risky" and dream of untilled pastures to monitor. The average newspaper reader, meanwhile, sees the word and understandably moves on to the next story.

Derivatives can be very complex, but they are fundamentally a tool for hedging financial risk. Say your business has borrowed money with a floating interest rate. Rates go down, and you decide you'd rather lock in today's rates than risk having them move against you in the future. You could borrow new money at a fixed rate and pay off your debt.

Or you could engage in a form of derivative known as a "swap." In a swap, you exchange your obligation to pay a floating rate for a commitment to pay a fixed rate of interest. Your actual debt doesn't change, but the other party in the swap has contracted with you to pay you the difference between the floating-rate interest and the fixed rate you've agreed upon -- if rates move higher. Likewise, if rates go down further, you would pay your swap counterparty the difference.

Through this basic mechanism, all kinds of risk in an economy can be shifted around, often to everyone's benefit. The risks haven't disappeared, but almost by definition they tend to shift toward whoever feels they can best bear them. Perhaps, in the example above, the counterparty has a reason for wanting exposure to interest-rate movements. Perhaps he has a risk of his own he is trying to mitigate. Perhaps he simply disagrees about where rates are going.

Take another, very real, example of a small-town bank in the mortgage business. By the nature of things, it is heavily exposed to the shifting fortunes of the local economy. If a plant nearby closes, it could be hit with defaults that could overwhelm its capacity to lend. To compensate for this risk, it may raise interest rates, or lend less, or both. But suppose it can sell the mortgages on its books to another bank or some other party. It gives up the income from the mortgages, but it gets new capital in return while also lowering its exposure to the local economy.

The purchaser may then hold the mortgages, or package them into securities with thousands of other mortgages and sell them to investors. These "securitized" mortgages are less exposed to any one town than that small bank was, which may make the security less risky overall. The small bank, meantime, has more money to lend, or to invest in assets that are less likely to crash along with the local economy. The buyers of the securities get the income from the mortgage interest and the bank gets money to lend.

The sum of a myriad of these transactions over the economy means that everything moves a little faster. Credit becomes marginally cheaper and more plentiful. Risk is dispersed to those who feel they can better afford it. Thus does the supposedly non-productive financial sector of the economy provide fuel for future growth. Seemingly obscure transactions lower the cost of capital to businesses and consumers and spread risk in a way that decreases the danger of catastrophic financial accidents.

None of which means financial accidents won't happen. Market players sometimes bet wrong -- there are always two sides to a transaction, and one party can always miscalculate its ability to withstand an adverse event. Just ask the investors in Amaranth Advisers, which bet wrong on energy prices.

More broadly, danger always exists from abrupt government policy shifts, especially from monetary mismanagement; think of the Asian crisis of the late 1990s. Another such danger can come when government subsidies push too much risk from a single sector such as housing into just two companies (Fannie Mae and Freddie Mac). Two of the biggest current risks, in our view, are the chance of U.S. tax increases and that the Fed may still have underestimated the inflationary pressures it let loose in 2004 and 2005.

But these are not reasons to fear derivatives and other financial innovations. Risk is still out there. But as we leave a successful financial year and enter a new one, take comfort in the fact that all that buying, selling, swapping, trading and securitization of risk has actually made the financial system less risky.

	URL for this article: http://online.wsj.com/article/SB116743535745362902.html
	Hyperlinks in this Article: (1) http://online.wsj.com/article/SB116742871112462755.html

Tuesday, December 26, 2006

Growth of Wages and Benefits

The Wages of Growth To lift worker incomes, cut the corporate tax rate. Tuesday, December 26, 2006 12:01 a.m. The latest reports on wages and income have been rolling in, and with them we can discount one more canard about the current economic expansion--namely, that wages are stagnant and workers are doing far more poorly than they did in that second Age of Pericles known as the 1990s.

Over the past year, the real average wage for non-supervisory employees has risen 2.8%. That equates to about a $1,200 increase in purchasing power for the typical household this year. Last year, real median household income was also up 1.1% after inflation. This rise in take-home pay helps to explain how Americans have had the disposable income this Christmas shopping season to pay $600 for PlayStation 3 computer games and $150 for the Kid-Tough Digital Camera for three-year-olds.

It is true that income and wages are still about 2% below the peak they hit in 2000 before the dot-com bust and recession. But a new Treasury Department analysis finds that, measuring from the start of the peak of each expansion, wages so far in this decade's cycle are running ahead of the recovery pace during the 1990s. Thus the "stagnant wages" story can join the "jobless recovery," the "outsourcing" crisis and the runaway budget deficit as other tales of woe that have all turned out to be evanescent.

Why are wages finally starting to show smart gains for workers? First, the labor market is tight with very low unemployment (4.5% nationwide), giving workers more bargaining power. Second, the big spike in energy prices in recent years raised the cost of living and offset nominal pay hikes, but energy costs have declined since Labor Day and those lower costs translate into higher real wage gains. Third, the surge in business capital spending that began in 2003 with the passage of the investment tax cuts has increased the capital to labor ratio that is a major driver of wage increases over time.

Contrary to popular myth, worker benefits have also been rising, not falling. Yes, many companies are changing to more sustainable 401(k)s from traditional pensions, and most are passing along some of the costs of rising health insurance to workers in co-pays and higher premiums. But the Labor Department measures employer pay packages and finds that fringe benefits paid to workers have risen 39% since 2000, or nearly twice the 22% rate of increase in nominal wages.

Take-home pay would be rising even faster if the cost of health benefit plans hadn't climbed by 65% since 2000. Health insurance now costs the average employer $2 an hour per employee--money that could otherwise be paid in wages. But that $2 still goes toward benefits, not into corporate profits.

All told, the pattern of wage growth this decade isn't all that different from that of the 1990s. Wage increases always lag behind economic growth, corporate profits and productivity gains. In the 1990s in fact, workers didn't enjoy really big paycheck gains until 1997. This isn't to disparage the 1990s, but only to point out that those who assail this decade's gains either have short memories or political agendas.

We certainly agree with those who'd like to do more to lift worker paychecks, so here are two ideas. First, make the Bush tax cuts permanent. If Congress lets them expire in 2010, as many Democrats are urging, the average family will suffer the equivalent of a $2,000 a year pay cut.

Second, slash the corporate income tax. A recent study for the American Enterprise Institute by economists Kevin Hassett and Aparna Mathur examined 72 nations over 22 years and found that "wages are significantly responsive to corporate taxation." In today's global economy, capital migrates across national borders away from high-tax nations to places where tax systems are less punitive. Workers suffer when capital flees, and job and wage growth slow.

Many political leaders have adapted to this reality, which is why the average corporate tax rate across the globe has fallen over the past 25 years to an average of about 30% from 50%. The AEI study finds that, if the U.S. were to cut its 35% corporate tax to the OECD average of 30%, American manufacturing workers would gain nearly a 10% pay raise dividend within five years, which is the equivalent of roughly a $3,500 a year pay boost.

Some on the political left have other ideas for raising wages, such as more and easier unionization, more trade and tariff barriers, or a government takeover of employer health care. But all of these would make the U.S. more like Old Europe, where job growth is far slower than it is here. Now as ever, policies that keep the economy growing and employers hiring will lift wages for everyone.

Platform Companies and The Evolving Economy

Welcome to Sizzle Inc.

By JONATHAN R. LAING

A CLOUD HANGS OVER THE U.S. ECONOMY and stock market, even though both have enjoyed a spirited recovery since 2003.

Bears worry that a serious recession lies ahead, spurred by overleveraged consumers cutting their spending in response to a collapse in home prices. Longer term, gloomsters bemoan the U.S.' huge current-account deficit, a reflection, they insist, of America's lust for consuming more than it produces and spending more than it saves. Only the kindness of strangers (mostly Chinese and other Asian central bankers buying U.S. debt securities) lets Uncle Sam continue his profligate ways.

Inevitably, all this will end in a vale of tears, the pessimists argue. They foresee an economic ice age. First, foreigners will withdraw their largess, sending the dollar plummeting and interest rates soaring. Meanwhile, all the good manufacturing jobs will have been outsourced overseas, leaving the average Joe in Dallas, Dubuque or Denver bereft of economic opportunity. Grim stuff, indeed.

But such opinions aren't shared by everyone. In fact, an international research boutique called GaveKal views these forebodings as poppycock. To the firm, the much-ballyhooed U.S. current-account deficit is largely a product of antiquated statistical measures that mainly miss the favorable impact of surging U.S. corporate cash flow and profitability. Likewise, no housing bust impends, according to GaveKal, a respected strategic adviser to some of the globe's largest financial concerns, including some of Wall Street's largest mutual funds. In fact, third-quarter federal data indicate, the consumer has never been more flush on a net-worth basis, with stock gains more than offsetting the flattening of homeowners' equity.

NOR IS WALL STREET POISED on a precipice. Stocks actually are cheap by many measures, says GaveKal. And shares of a certain type of nimble and tech-minded U.S. multinational could rise the most in coming years.

DOW JONES REPRINTS

This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com. • See a sample reprint in PDF format • Order a reprint of this article now.

GaveKal asserts that the global economy is on the cusp of a decades-long deflationary boom that will lift America and much of the emerging world to unprecedented prosperity. In a book entitled Our Brave New World, the research outfit even invites derision by asserting that, these days, "things are indeed different."

The optimism arises from a clutch of profound economic changes that GaveKal's founders, Frenchman Charles Gave, his Hong Kong-based son, Louis-Vincent, and British financial writer Anatole Kaletsky (the firm's name is a contraction of the principals' last names) argue have been largely ignored by most commentators. GaveKal's central aperçu revolves around a business model that has evolved in advanced nations, such as the U.S., Sweden and Great Britain. They call it the "platform company."

These corporations concentrate on high-value-adding functions in which knowledge and technology are paramount. The platform company farms out to low-cost manufacturers at home and, increasingly, abroad low-return, volatile portions of its operations, including manufacturing. In essence, they are focused as much on the sizzle as the old multinationals were on the steak. "Instead of producing everywhere to sell products around the world, the platform company harnesses endemic global overcapacity and cheap information transmission to produce almost nothing directly, but sell everywhere," Charles Gave says in an interview at his loft apartment in Manhattan's trendy Soho district.

Although privately held Ikea, for example, has a worldwide presence, it largely consists of a bunch of furniture designers in Gothenburg, Sweden. Then there's Apple (ticker: AAPL), which is minting money from the development and distribution of its iPod line, while relying on Asian manufacturers to produce it. Motorola (MOT), Hewlett-Packard (HPQ), Dell (DELL) and tool and appliance maker Black & Decker (BDK) are among the companies that have embraced the model with signal success. Software outfits, likewise, are increasingly using low-wage Indian programmers to write codes for routine, nonproprietary portions of new programs. And IBM (IBM) is relying heavily on India to boost its outsourcing presence.

The implications of this trend are vast, according to GaveKal. For one thing, platform companies trim risk by fobbing off the most cyclical parts of their business. If sales hit an air pocket, the platform firm merely reduces its orders to, say, a Chinese supplier, rather than shoulder the financial burden of liquidating inventories, laying off workers and perhaps having to take a punishing restructuring charge on idle plants and equipment.

GaveKal partner Steven Vannelli says that companies are reluctant to discuss the scope of their platforming for public-relations and competitive reasons. Yet their financials often afford telltale indications of their embrace of the strategy. Most tend to generate more cash then they did in the past. Likewise, revenue per employee surges as plant, property and equipment on the asset side, and debt on the liability side, dwindle on corporate balance sheets.

Capital instead is poured into research and development and worker training. Working-capital requirements swoon, as the need to finance inventories disappears, and platform companies pressure their foreign suppliers to accept slower payment for goods.

The platform model seems to be behind the surge in U.S. corporate profitability in recent years, whether measured by net income or cash-flow margins. For one thing, platform companies have reduced capital-spending needs, thus slashing their debt-service burdens. Motorola has seen its capital spending fall from 80% of its cash flow in 2001 to just 12% this year. In the past decade, its net investment in property, plants and equipment has dropped from more than 30% of its assets to 5%.

At the same time, research and development spending has soared in the platform economy. It's crucial, of course, for companies outsourcing in China to stay one step ahead of the local manufacturers because theft of intellectual property is rife in the Middle Kingdom. This year, the U.S. will spend some $330 billion on research and development, versus No. 2 China's $136 billion. And the Chinese number is inflated mightily by U.S. and European multinationals, which have shifted some less critical research operations there.

FOR MANY PLATFORM companies, R&D now dwarfs capital spending. At Danaher (DHR), a maker of tools, sensors and testing equipment, research spending jumped from an amount equal to 150% of capital outlays in 2001 to one equivalent to more than 300% last year. And the ratio of R&D to capex has zoomed in the high-tech arena. At semiconductor company Analog Devices (ADI), it's now about 6-to-1, versus 1.5-to-1 in 2001.

The advent of China and other developing nations as the modern world's workshop is a Faustian bargain. In return for their new prominence, these countries are willingly importing much of the risk and cyclicality from platform economies like the U.S. Reliance on manufacturing is eminently preferable to that most risky of activities -- agriculture. Indeed, millions of unneeded farm workers are streaming into Asian cities, seeking better jobs. "In effect, China is trading job growth for the profits flowing to U.S. and other platform economies," Louis-Vincent Gave notes of a phenomenon that he has closely tracked from GaveKal's office in Hong Kong.

And this trend is in its early stages. More than 300 million agricultural workers figure to move to industrial areas on China's eastern and southern coasts over the next two decades. Similar migration patterns are evident in India, Vietnam, the Philippines, Indonesia and Malaysia.

From left: GaveKal's Steven Vannelli, Charles Gave and Louis-Vincent Gave argue that Corporate America and the U.S. economy in general are far healthier than many pundits believe.

Thus, there's little indication that Beijing will slow its prodigious spending on manufacturing and logistical infrastructure like roads, ports and industrial parks, despite huge overcapacity in many of its domestic industries. China may have more than 300 car makers and 3,000 ball-bearing outfits, but each local entrepreneur is eager to accept cheap government financing and continue to grow, regardless of profitability. Perversely, each figures he will survive the Chinese economy's inevitable shakeout only by being deemed "too big to fail," Louis-Vincent asserts. Such operators become easy pickings for the West's platform companies.

THE MASSIVE REORDERING of the global economy engendered by the platform model is an unalloyed good, according to GaveKal. Productivity is enhanced. And intellectual property and knowledge is harnessed to garner the higher returns that accrue to breakthrough products and technologies.

GaveKal developed the platform concept after noting global economic developments that seemed inexplicable on their face. Perhaps most important was a quite noticeable drop in economic volatility or swings in growth in many post-industrial Western economies. Annual swings in industrial production or non-farm employment since the 1950s have traced a telling pattern. Beginning in the early-'90s, jagged peaks and valleys begin to flatten at relatively favorable levels.

U.S. consumer delinquency rates on mortgages, credit cards and auto debt plunged from over 6% of the totals outstanding at the beginning of the '90s to 1.5% to 2.5% over the past decade, even as consumers leveraged their household balance sheets to unprecedented levels and "subprime" transactions became common.

Meanwhile, corporate earnings went on a tear. After-tax profits and cash flow as a percentage of gross domestic product are at record levels, exceeding 8.5% and 15%, respectively, according to the Bureau of Economic Analysis. "The platform model seemed to offer the clearest explanation as to what was happening," says Charles Gave. "We first noticed these economic changes in Sweden in the mid-'90s, but now the U.S. has embraced the change full-hilt."

High on every pessimist's list is America's yawning and growing current-account deficit, which represents mostly our negative balance of trade with the rest of the globe, supplemented by the difference in income that U.S. and other nations earn on investments in each other. The nation's current-account shortfall, which has steadily worsened since the early '90s, is expected to equal about 7% of GDP this year -- a banana-republic level.

THE CONVENTIONAL WISDOM holds that foreign central banks eventually will tire of sopping up the sea of excess dollars generated by chronic U.S. trade deficits and stop buying debt from Uncle Sam. If this happened, interest rates would soar, and the dollar would tumble. Or foreigners recycling excess dollars into American stocks and bonds would end up controlling most of the U.S. economy. Warren Buffett, for one, argues that America is well on its way to becoming a sharecropper society -- hocking its family jewels to finance insensate consumption.

To GaveKal, such doomsday prophesies are silly. For starters, even if one assumes that the current-account deficit will stay at its current level for some time, this would pose no particular peril, in the firm's view. U.S. household net worth, including stock and bond holdings, the value of private businesses and homeowner equity, stands at $54 trillion, according to the latest Federal Reserve data. This is far larger and is growing far faster than the $2.5 trillion we owe the rest of the world (in excess of U.S. asset holdings abroad).

So instead of saying that this year's expected current-account deficit of $800 billion is 7% of GDP, it's more to the point to say that it's slightly less than 1.5% of national wealth. U.S. net national wealth has risen over the past 50 years at a steady 5% to 6% per annum in nominal terms. At a current national net-wealth growth rate of about $3 trillion a year, the U.S. generates more than enough assets to cover the $800 billion it must borrow abroad. The current U.S. ratio of net foreign debt to national net worth is 4.6%. That hardly bespeaks impending doom.

According to GaveKal, quirks in international trade accounting paint a misleadingly melancholy picture. Trade measurements do a much better job of capturing the flow of physical products, which can be precisely measured by shipping manifests, than that of services, America's strong suit. Much of the latter involve the dark matter of intellectual property, such as consulting, training and financial-management services that often move electronically and are uninvoiced.

DOW JONES REPRINTS

Of even greater moment is the fact that trade statistics measure dollars per sale, rather than the profits derived from sales, according to GaveKal. The sale in the U.S. of a $700 Dell computer might generate a negative trade balance of $450, representing the purchase from Asian companies of various components shipped for assembly in the U.S. Yet that same transaction might generate only a $30 profit for the Asian vendors working on slender margins, while the American companies -- Dell for its mark-up, Microsoft for its software and Intel for its microprocessor -- might realize a profit of about $250. The U.S. comes out a big winner, even though, through the prism of the trade balance, it appears to be sucking wind.

Pessimists also worry that the foreign capital flowing into the U.S. is being squandered on consumption, rather than being spent on the productive capacity necessary to make the nation competitive on the trade front. America is deemed to be eating its seed corn by wasting recycled trade surpluses from China and the like on cheap mortgages, flat-screen TVs and lids of cocaine.

GaveKal vigorously disputes this notion. In fact, much U.S. consumption goes toward health care (an investment in human capital, according to the firm) and education. "Who can calculate in a knowledge economy the importance of the U.S.' superior university system, for example?" asks Charles Gave. "Not when you realize that important global enterprises like Google, Cisco and Sun Microsystems literally emerged from the dormitories and labs at Stanford University."

Likewise, Corporate America's world-leading spending on research and development -- the aforementioned $330 billion a year -- counts as consumption, not investment, under generally accepted accounting principles. R&D is treated as an intermediate cost and expensed annually, rather than as a capital item to be written down over several years. Yet research can yield revenue for years to come.

THERE'S LITTLE WONDER why foreign nations are willing to finance the U.S. trade deficit. America boasts cutting-edge technology, high-margin companies and enviable productivity growth, plus liquid financial markets, political stability and strong private-property protection.

A platform economy is inherently less volatile than a developing one like China's, which is high in both growth and risk. That's a big plus for wealthy investors. Only severe capital controls in nations like China, which force businessmen to remit their excess trade dollars to central banks, keep even more private investment capital from streaming into the U.S.

"The big risk is not that foreigners will lose their appetite for U.S. assets, but that Americans will refuse to sell assets to foreigners," Charles Gave notes acidly. The greenback was pummeled this year after Congress wouldn't permit Dubai to keep a controlling stake in a company managing key U.S. seaports and when a Vietnam trade-normalization bill was delayed. Currency markets abhor impediments to the free flow of investment capital.

Yet GaveKal foresees no impending collapse for the buck. In fact, it expects the dollar to strengthen over the next year or so. The greenback, after all, is the basic medium of exchange and font of liquidity for the global economy, and promises to remain so for years because of Washington's political, military and economic might.

In fact, it was the large U.S. current- account deficits of the past decade or so that permitted the global economy to emerge relatively unscathed despite the 1995 Mexican peso collapse, the 1997 Asian financial meltdown, the 1998 Russian ruble crisis, the 2001 tech meltdown and the recent surge in commodity prices.

The Telltale Charts: Over the past few decades, U.S. corporate profitability and cash flow have risen sharply, while gyrations in industrial output have moderated and swings in non-farm payrolls have plunged. Meanwhile, the credit-delinquency rate has plummeted, despite a rise in subprime loans. The cause, according to the GaveKal research firm: the rise of a new kind of business model that bodes well for the future.

As GaveKal's Anatole Kaletsky has observed, while U.S. trade deficits have consistently grown over the past 20 years, the global economy has enjoyed unprecedented stability and growth. And the U.S., Britain and other chronic trade-deficit lands have significantly outpaced Japan, Germany, Saudi Arabia and some other nations with surpluses.

THE RESEARCH HOUSE also thinks that U.S. stocks are still dramatically underpriced, despite their recovery since the 2000-2002 bear market. A key to this is the stability that platform companies have injected into the economy and which shows up in corporate earnings and the financial markets themselves. An indication is seen in the collapse in yield spreads between low- and high-risk bonds. Or take a gander at the Chicago Board Options Exchange Volatility Index. The VIX closed around 10 Thursday -- less than half its level three years ago.

This new stability alone would argue for a jump in price-to-earnings ratios from the current level around 16 for the S&P 500. When risk premiums fall, stocks rise. GaveKal also contends that the recent jump in corporate profit margins and returns on invested capital isn't yet fully reflected in stock prices. And, the firm argues, the growing adoption of platform strategies in the U.S. argue against a serious reversion to the mean.

In addition, the supply of common stock in the U.S. is beginning to shrink as a result of heavy corporate share buybacks and a frenzy of leveraged buyouts. This development is hardly surprising to GaveKal. Platform companies require far less capital because they concentrate on product development and sales, leaving to parties abroad the heavy financial lifting entailed by manufacturing.

Meanwhile, a huge global pool of capital has developed from rising corporate cash generation and the prodigious savings rates in China and elsewhere in the developing world. "It's thus no mystery," Charles Gave maintains, "why buyouts are escalating when folks can borrow at 6% and buy S&P companies that earn an average of around 9% on their cash flow divided by their market price. That's a 50% return on your money. That alone argues for a melt-up in U.S. stock prices."

A MELTDOWN IN U.S. housing prices could play hob with such a scenario by crushing consumer demand. GaveKal doubts that housing prices will fall much, however.

For one thing, the U.S. consumer is no more levered with mortgage debt than households in, say, Great Britain, Australia and the Netherlands. For another, over the past eight years, real housing price growth in Ireland, the U.K., Spain, Sweden, France, Australia and the Netherlands have all outpaced that of the U.S. Nor has the housing markets in Britain or Australia suffered any major ills, even though the central banks in both countries tightened earlier and more aggressively than the Fed, causing more of an economic slowdown than the U.S. has yet experienced.

Housing bears tend to ignore the favorable impact of the increased stability that platform economics have brought to the U.S. True, America has lost manufacturing jobs as a result of outsourcing abroad. But blue-collar workers -- the employees most at risk in an economic downturn -- now make up just 9% of the workforce.

U.S. jobs are still increasing nicely, particularly in higher-paying managerial, administrative and professional categories. More workers now are ensconced in the recession-resistant service economy and have the additional security of a working spouse and the prospect of parental financial assistance in a pinch. This, perhaps, explains why consumer delinquencies have dropped so drastically.

CHARLES GAVE DOESN'T deny that his Brave New World platform economy could come a cropper. The biggest risk is protectionism, fanned by demagogic politicians bemoaning the U.S. loss of jobs to China and other countries. A large tax boost or monetary-policy mistake could threaten GaveKal's scenario, too. And, of course, a major war could imperil the huge U.S. global asset base so painfully accumulated since World War II.

Optimism is often a tougher sell than bearishness. But, based on the trends of the past half-century, GaveKal's argument looks like one worth buying.

	URL for this article: http://online.barrons.com/article/SB116683363879458212.html
	Hyperlinks in this Article: (1) http://online.barrons.com/article/SB116683362317058211.html

Great Guys Supplement