Weekend reading links

1. Changes in interest rates from June till 20th September 2024.

2. The long US equity market run.

3. This is the graphic on how inflation was tamed.

And this is the graphic on how monetary policy responded.

This raises two questions. How much did monetary policy contribute to taming the post-pandemic bout of inflation in developed economies? If inflation is tamed without pushing the economy into a recession, is it a success of the practice of monetary policy by the central banks?

Inflation across advanced economies exceeded 7 per cent in 2022 while nearing 10 per cent in emerging markets. As official interest rates surged in 2022, the World Bank was among the institutions flagging the risk of a global downturn. Analysis by Oxford Economics shows that of 42 rate raising cycles since the 1950s in the US, UK, Germany or the Eurozone, and Japan, those associated with recessions outnumber those without by two to one. Instead, the US has helped the world economy weather the synchronised rate-raising cycle unexpectedly well, with the IMF predicting global growth of a respectable 3.2 per cent this year. “This is a very different easing cycle than most other ones,” says Seth Carpenter, the global chief economist at Morgan Stanley who spent 15 years at the Fed. “Most other easing cycles happen because of recession.” The US economy is expanding at a solid clip, with the Atlanta Fed estimating this week that GDP growth will rise to about 3 per cent for the third quarter. The US labour market has lost some momentum as inflation has collapsed from a peak of about 7 per cent in 2022 to 2.5 per cent as of July, measured by the personal consumption expenditures price index. Demand for workers has cooled off at the margins as the unemployment rate has risen, but much of that increase has been driven by higher supply from rising immigration, economists say... 

Yannis Stournaras, governor of the Bank Of Greece notes that Eurozone inflation has fallen from 10.6 per cent in October 2022 to 2.2 per cent now. “We brought it down in just 18 months and managed to have a soft landing in the economy.” The fact that the ECB from mid-2022 could raise interest rates by an unprecedented 450 basis points within 14 months without pushing the economy off a cliff is remarkable, says Piet Haines Christiansen, a ECB strategist at Danske Bank. “Two years ago, most economists would have said that such a dramatic increase would result in a deep recession.” 

4. Fourteen countries and the European Commission have come forward under a Minerals Security Partnership (MSP) to finance critical minerals projects and thereby break the Chinese stranglehold on the market. 

The Minerals Security Partnership, a coalition of 14 nations and the European Commission, will unveil a new financing network at an event in New York on Monday as they try to ramp up international collaboration and pledge financial support for a huge nickel project in Tanzania, backed by mining company BHP. A joint statement due to be published on the margins of the UN general assembly says the network will “strengthen co-operation and promote information exchange and co-financing”. It lists 10 critical minerals projects that have already attracted support from MSP partner governments. Representatives of BlackRock, Goldman Sachs, Citigroup, Rio Tinto and Anglo American are scheduled to attend the meeting, amid a push to attract private investors and miners to invest further in the sector. Jose Fernandez, US under-secretary of state for economic growth, said a further 30 critical minerals mining projects are being evaluated by the MSP, as western governments race to secure the raw materials needed to make everything from electric vehicles to advanced weapons... The US, Australia, Canada, Estonia, Finland, France, Germany, India, Italy, Japan, the Republic of Korea, Norway, Sweden, the UK, and the EU are members of the MSP.

5. An important part of Candidate Trump's Maganomics 

A second term of Trump would see levies on imports supercharged to levels last seen during the 1930s following the passing of the landmark protectionist Smoot Hawley Tariff Act. After initially saying he wanted to impose 10 per cent tariffs on all imported goods, Trump has recently said they could be up to 20 per cent. For Chinese imports, he has talked about imposing a 60 per cent tariff. This month he said countries that planned to reduce their dependence on the dollar would also be hit with 100 per cent tariffs as punishment. Trump hopes the trade barriers will not only raise revenues, but lead to the restoration of US manufacturing...

If enacted, they represent a return to an era where substantial chunks of government revenue came from trade tariffs, rather than from taxes on people’s incomes and the profits of businesses... The Peterson Institute for International Economics think-tank in Washington calculates that 20 per cent across-the-board tariffs combined with a 60 per cent tariff on China would trigger a rise of up to $2,600 a year in what the average household spends on goods... PIIE senior fellows Obstfeld and Kimberly Clausing think that the maximum amount of additional revenue the administration can raise — by applying a 50 per cent tariff on everything — would be $780bn.

6. Health of Indian manufacturing firms.

The Indian corporates have been deleveraging and their debt levels have fallen. But this does not mean investment will be forthcoming. The important thing for investment is expectations of market demand. 

7. A peek at the mechanism of Chinese industrial policy with the illustrative example of laptops.

Chinese officials are now combining the heft of state spending and financial support with top-down directives to buy local tech, particularly in semiconductors. Late last year state buyers were directed to phase out computers powered by American processors. Since implementing the directive in March, central agencies have transitioned from exclusively purchasing laptops running on Intel and AMD processors last year to now acquiring three-quarters of their devices with chips from Chinese companies such as Huawei, Shanghai Zhaoxin and Phytium, according to public records. Huawei’s Qingyun L540 has won a majority of the orders. What kicked off as a campaign to cut foreign tech products out of the offices of governments and state-owned groups has gradually expanded into a wider array of products. Automakers, including major European groups that produce cars in joint ventures with Chinese state-owned firms, have been directed to step up their use of domestic semiconductors, according to four people familiar with the matter. Two of the people said they had been given a target to use Chinese chips for 25 per cent of the total by next year, though there were not yet consequences for failing to do so.

8. A debate rages in Australia on a Parliamentary vote to reform the Reserve Bank of Australia and establish a dedicated monetary policy Board within it to decide on interest rates. The vote has left parties sharply divided with the Greens' demand being the most interesting. 

But the Greens said this week they would only support the bill if the government used its powers to override the RBA and force it to cut interest rates — or if the bank did so of its own volition — arguing that monetary easing was necessary to help renters and mortgage holders. Both major parties derided the Greens’ proposal, saying that forcing the RBA to cut rates would undermine its independence. “They’re economic terrorists and you can quote me on that,” Taylor said at the prospect. Prime Minister Anthony Albanese said on Monday that acceding to the Greens’ demand would amount to undermining the independence of the central bank in order to pass legislation strengthening its independence. But the Greens questioned why the central bank should be treated as “above politics”. “The RBA board are not infallible high priests of the economy who are above criticism,” said Nick McKim, a Greens senator. On Tuesday, the RBA board kept its key cash rate at 4.35 per cent for the tenth straight month, saying it maintained its view that inflation was not yet under control.

9. Interesting article on the topic of walkability-workability from metro to office in Tokyo.

In a September 10 note to clients, Goldman’s real estate analyst, Sachiko Okada, took a look at office relocation trends within central Tokyo, overlaying that with a calculation of average walking distances between offices and the nearest station — a metric commonly used in Japan’s commercial and residential real estate markets and pivotal in a metropolis where the overwhelming majority of commuters travel by rail. Okada’s analysis comes at a time when the five innermost wards of Tokyo have never looked so frenetic, with Godzilla-scale office construction in prime locations. Around 1.2mn square metres of new space is due to come on to the market in 2025, she says... But the issue, as ever, is location. For offices within Tokyo’s five central wards, the average walk from a station is a breezy three minutes 42 seconds, with 64 per cent within the four-minute walk zone that even the heaviest-footed sloth cannot grumble about. But a significant amount — roughly 7 per cent — lies outside an eight-minute walk. Back in the days where Japanese companies were routinely able to make staff feel grateful to have a job, and surveys showed far higher ratios of people prioritising their work over everything else, that was less of an issue.  But now, with priorities shifting, labour more willing to quit and companies increasingly unable to meet their staffing targets, proximity to stations is yet another battleground in the war to attract and keep good staff.

Just 7% of work commutes in Tokyo falls outside the 8 minute walking time from metro to office!

10. Global EV sales have stagnated this year.

11. Coffee chains in India.

Cricket batting and management theory

In management theory, there are two duelling approaches to how incoming leaders should manage their initial days. 

On the one hand, some emphasise the first 50 or 100 days as the time for the leader to make his mark. The leader should seize the initiative from Day One and lay down priorities, get some quick wins, and establish credibility. Another approach is to wait and watch, and gradually ease oneself in. Under this approach, the leader should start imposing him/herself only after having settled down.

The first approach can be compared to a T20 cricket match batting, while the second compares with a Test match opener’s batting. 

This comparison is also appropriate for the posting tenures of the officers of the Indian Administrative Service (this might be true of many other occupations).

The career of IAS officers starts with field postings in sub-divisions and rises along local governments, districts, corporations and public sector units, and state and central governments. These postings cover program/policy implementation and policy/program formulation. Their tenures in a post range from 2-4 years. Needless to say, most of their postings are deeply enmeshed in the political economy. 

Let’s discuss the cricketing analogy for IAS posting tenures. 

A good classical test match opener displays some of the following attributes, especially at the beginning of the innings. He tries to leave as many balls as possible. He plays close to the body and late to adjust for the movement of the ball. He plays the forward defensive to straight balls. He generally plays in the V, driving along the ground with a straight bat. He avoids horizontal bat shots. He prefers singles instead of boundaries. He rotates the strike. Generally, he’s technically correct.

The range of his stroke play will be determined by his assessment of the pitch, the weather conditions, the bowler, the team batting strength, the match situation, the innings score, and his own form. 

He waits for the cloud cover to lift, the morning moisture to disappear, the pitch to ease up, the bowlers to get tired, and get some runs on the board, before he starts to attack the bowling. 

On the same lines, the IAS officer must account for the nature of the post (pitch), the political economy (weather conditions), the opponents of all kinds (bowlers and fielders), the team of officers available (batting strength), the organisational or departmental capabilities (bench strength or team depth), the stakeholder support (the team score), and his/her own credibility (form and class). 

While starting, he must avoid abrupt changes and critical decisions (leave balls), keep his cards close to the chest (play close to be body and late), continue following precedents (forward defensive), go strictly by rules (play in the V), avoid any new initiatives (avoid horizontal bat shots), prefer incremental changes (singles over boundaries), studiously avoids media glare (rotate strike), and generally follow the rules (technical correctness).

Just like the opener, the IAS officer too could use the initial weeks to build confidence among colleagues and credibility among external stakeholders, before he starts to open up with his policy decisions and actions. 

Further, just as the test opener varies his approach based on the types of bowlers, the IAS officer too should bat differently against pace (populist opposition), seam and swing (opposition from experts and opinion makers), and spinners of all kinds (internal saboteurs). 

In contrast, the T20 batsman/officer adopts an opposite approach. He goes hard at the ball from the start. He charges the bowler. He’s loath to give away a dot ball. He’s unafraid to take the aerial route. He plays horizontal bat shots. He prefers boundaries over singles. He arouses the stadium. He’s generally unorthodox. 

He shows no respect for the bowler, pitch, weather, score, and his own form. He displays no fear and does not worry about the reputations of bowlers. Painstaking accumulation is not his forte. 

On the same lines, the T20 batter equivalent IAS officer enters and immediately initiates changes (goes hard at the ball), transfers and suspends officials (charges the bowler), throws aside conventions and precedents (takes the aerial route), goes after big bang changes or disruptions (boundaries over singles), courts the media (arouses the stadium), and exhibits a willingness to stretch the rules (unorthodox).

He’s also indifferent to the opponents and critics, adopting the same approach of unbridled aggression against all. 

He’s in a hurry to establish himself, no matter the department, political conditions, opposition (or lack of support), capabilities of colleagues and organisation or department, and his own inexperience. 

So which could be the right approach for an IAS officer?

It’s easy enough to argue that certain batsmen are instinctive hitters who are suited to the T20, and certain technically correct accumulators are best suited for the test match opener’s role. To an extent, there’s some nature, but as the history of cricket shows, it’s about adapting. 

In any case, in the case of IAS officers, I’m inclined to argue that it depends. Generally, but not always, field postings may require the cavalier attitude of T20 batting whereas policy-making roles demand the caution and restraint of test match opening batting. 

In the field postings, you are thrown into the deep end of a pool and there’s most often a need to establish credibility quickly. By their very nature, implementation and work exigencies are immediate and there’s little time to settle down. 

Besides, in weak state capability environments and given the enormous implementation challenges, there’s a case to galvanise the organisation by imposing the officer’s personal stamp. The sincerity, hard work, inspections, rigour of reviews and follow-up, and discipline of the young officer can paper over the institutional weaknesses and personnel deficiencies to ensure effective implementation. It’s most often like how Brian Lara used to carry the West Indian batting on his shoulders and win matches on his own. 

In contrast, policy-making roles in state and central government require understanding the context and the issues, mobilising stakeholder support and coalitions, deliberating the proposal, ensuring procedural correctness, finding the opportunistic Overton windows, and so on. All these require the learnings from the initial caution and restraint of the opening batsman. 

But just like the test opener who goes on the offensive after having watched and assessed the match situation, playing conditions, and opponents, the policy-making IAS officer should start to hasten with policy ideas, decisions, and approvals after having done the hard grind of assessing and creating favourable conditions. Like with a settled batsman who finds scoring easier with time (starts to see the ball big), the officer too would have established credibility to push ahead faster with his/her reforms. 

In conclusion, like with the good all-format batsman, the IAS officer too should adapt to the nature of the posting and the conditions and strike a balance between restraint and caution and breakneck-paced execution. 

FIIs in Indian equity markets

Debashis Basu points to some very interesting data about how FIIs recurrently get it so wrong with their Indian equity market investments.

From the bottom of 15,183 in mid-June 2022, the benchmark market index Nifty has soared 69 per cent to hit 25,791. In the past 18 months alone, the index has surged 52 per cent... Between June 2022 and September 20, 2024, FIIs were massive net sellers during a big bull market... They recorded net sales of Rs 1.82 trillion, the biggest monthly sales coming in June 2022, exactly at the bottom of the short, depressed period between November 2021 and June 2022. Even at those low valuations, panic sales by FIIs — of over Rs 58,000 crore in June 2022 — remain unsurpassed... Who did the FIIs sell to in the dark days of June 2022? To DIIs, who were huge buyers of almost Rs 47,000 crore that month, at what turned out to be the market bottom. This trend was repeated with boring regularity. Take, for instance, January last year, when the Hindenburg allegations against the Adani group shook the market. The mini-crash was an opportunity for DIIs to buy (over Rs 33,000 crore) while panic-stricken FIIs sold shares worth over Rs 41,000 crore... FIIs collectively took surprisingly poor calls at almost all major market turns. While they did invest strongly between May and July last year, the earliest stage of the ongoing bull market, they quickly turned bearish over the next three months, pressing net sales of Rs 76,000 crore, which were lapped up by DIIs (net purchases over Rs 70,000 crore). And so, when the market took off in mid-November 2023, it was DIIs who gained handsomely, with FIIs looking rather foolish.

Undeterred by the experience, FIIs remained net sellers every month between January and May this year barring March, when they had a timid net purchase of only Rs 3,300 crore. In the pre-election months, they sold over Rs 1.26 trillion, while DIIs made net purchases of over Rs 2 trillion. That call went wrong again for FIIs... Surprisingly, even in the past four months, after the election, FIIs only made a small amount of net purchases and pressed over Rs 20,000 crore of net sales in August. However, they have been net buyers so far in September. While these figures may be influenced in a small way by large bulk deals, where one side of the transaction is not an FII or DII, the trend is unmistakable. Over the last 29 months of a strong bull market, DIIs were net buyers of over Rs 5.91 trillion and FIIs were net sellers of over Rs 1.82 trillion.

And such trends of herding, sudden stops and capital flights have been historical features of FII investing in India.

In a bull market, they chase the flavour of the day and act like retail investors. In 1994, they had loaded up on the global issues of asset-heavy, poorly governed Indian companies. In the bull market of 1999, they frantically charged into shady software companies, either based on imitation or rumours or joint positions with speculators/another fund, or in expectation of a price runup before overseas equity floats. The flight to irrationality, reminiscent of 1993-95, led them to create an exposure of 60-80 per cent in technology, media, and telecom companies at huge valuations. In the crazy bull market of 2005-08, they were over-committed to real estate and infrastructure companies, earning poor returns on capital.

Two observations here. 

1. Sudden stops and flight to safety during market downturns are characteristic features of foreign portfolio investors worldwide historically and developing markets are especially vulnerable to such trends. India is only one more data point reinforcing this reality. Contrary to economic orthodoxy, there’s so much evidence today that macroeconomic fundamentals cannot be insurance against such reversals. 

As Basu writes, this raises questions about the perception of FIIs being objective and competent professionals informed by deep research and due diligence. In reality, no matter what drives the downturn or even the likelihood of its immediate reversal, algorithmic triggers get activated among the managers of the large international fund allocators that mandate such reversals. Once a flight becomes evident, the herd takes over and amplifies the flight. 

As we have seen with VC investments globally, public market investment allocation decisions of foreign institutional investors are generally driven by momentum and herd. Therefore, we should not be surprised by such herding in either direction. 

2. The sudden capital flight at downturns is a note of caution against capital account liberalisation. India has managed to stave off the perils of the capital flight due to domestic investors. In recent years have been associated with the arrival of a new generation of domestic retail investors, and DIIs too appear to have become discerning enough to spot opportunities and stay invested. So India could avoid the market destabilisation effects of such sudden large-scale withdrawals by FIIs. Will the domestic trends of capital inflows continue to remain robust during future episodes of capital flights?  

Indian government bonds were recently included in the JP Morgan Emerging Markets Bond Index, which means that foreign ownership of Indian T-Bonds could rise from the current 2% to 10% and more by next year. This creates vulnerabilities for government borrowings and macroeconomic stability. Will retail investors and DIIs to provide the backstop and buy the inevitable sales by FIIs? Or will the government be forced to become the buyer of last resort by nudging publicly owned institutional investors and banks to step in to backstop the G-bond markets?

The private equity transformation of capitalism

Capitalism is undergoing a quiet transformation as institutional private capital increases its ownership footprints across vast swathes of the economy. What are its implications? 

John Gapper in FT has an excellent article highlighting the journey of Pimlico Plumbers, a family-owned plumbing and home repair service founded in 1979 by Charlie Mullins, and which was sold three years back to US home services platform, Neighbourly, owned by the PE firm KKR for £140 mn. The firm distinguished itself by the reliability and quality of its service and charged a high hourly rate to well-off customers. 

Pimlico was a pioneer of charging well-off customers a higher hourly rate for reliability. Instead of plumbers who turned up late if at all, and exploited their customers’ ignorance of home piping to overcharge, Pimlico offered a consistent service from uniformed engineers who were polite and cleaned up their mess afterwards. It was a simple formula, but someone had to reform a fragmented, opaque cottage industry and Mullins was the innovator. Private equity has now seen its own opportunity, having rolled up family-owned veterinary and dental practices. Brookfield Asset Management struck a £4bn deal in 2022 to acquire HomeServe, the UK home repairs cover group. As family founders of home services companies approach retirement, investors want to increase the scale of the industry, while maintaining quality.

The article informs that the Mullins family (of three generations) are now going back to their business after the expiry of a three-year non-compete clause by launching a new home service firm, WeFix. 

WeFix bears all the hallmarks of his formula for Pimlico: a call centre on the premises, vans waiting to be cleaned and valeted, a space for apprentice training. It will squarely target the same group of customers… If anything, it will be more elite: the new business plans to charge £180 an hour for daytime jobs, compared with Pimlico’s £125 hourly minimum for plumbing. This will enable its top engineers, classed as self-employed with some workers’ rights after a 2018 Supreme Court ruling involving Pimlico, to earn between £150,000 and £200,000 per year... The family has become a dynasty, with 15 members, including partners, now involved in WeFix. Scott is chief executive and Ashley managing director; Charlie has no stake, but the company is infused with his philosophy. Scott compared its approach to personal service with the luxury department store Harrods: “You know the prices, you know the quality, you know you’ll be looked after.” 

But while they have high ambitions for quality, they are modest about WeFix’s potential size. They are keener to replicate and refine the old Pimlico model than to extend it further. Charlie said that Pimlico had about 250 engineers when he sold it — many more than the average home services business — but standards had been slipping. “We took on some people who were not up to our standards. We fell into the trap of growing too fast because demand was so high,” he said. They intend to proceed more slowly this time, aiming ultimately to reach about the same size as Pimlico. WeFix London will not expand beyond the city: the family feels most comfortable on its home turf.

Interestingly, Charlie Mullins, the founder and patriarch, does not think the PE model will work in the business.

A family business is more personal, more caring, we put more into it.

The case study points to an important and less appreciated trend in the economy, especially pronounced in the United States. 

Historically, most of the regular consumption services for households and offices were provided mainly by small family-owned shops (mom-and-pop shops) and small businesses. They include clinics and hospitals, pharmacies and diagnostic facilities, schools and colleges, bars and restaurants, old age homes and terminal care services, security, home repairs and other services, office services, personal care (salons, beauty and cosmetic centres, nails etc.), veterinary care, local sports teams, and so on. 

Now, after establishing their dominance in finance, technology sectors, startups, real estate, infrastructure etc., PE firms are expanding into these markets. They realise that these market segments that serve people’s daily lives offer low-risk and stable revenue opportunities. No matter what happens, good times or bad, there will always be stable demand for these goods and services. They are the so-called essential services with very low elasticity of demand. 

There are at least three concerns I have with the rise of PE firms in these business areas. Is it the right kind of capital to finance these activities? Can they offer the kind of quality of service that many of these activities require? Can they ensure the kind of responsibility to its customers, workers, and communities that local or public capital provides? 

In the spectrum of financial intermediation (compared to debt, personal financing, and public equity), PE firms provide equity and represent high-net-worth individuals (and increasingly institutions). By its very nature, it’s capital with high risk appetite and searching for high returns. Further, the high fees demanded by its managers, add to the returns expectations. Can the kinds of essential services like those mentioned above command the sort of margins to justify these return expectations? 

If not, then the only way the returns will be generated would be by asset stripping and squeezing the firm’s cash inflows and passing the parcel till it becomes insolvent. The incentives of the PE fund managers and investors are aligned towards pursuing such practices. This blog itself has documented several examples from recent times of such practices. 

Most of the services of the kind mentioned above demand some form of personal connect. The family-owned provisioning of these services provided some neighbourly personalised touch that disappears with the distant ownership by PE investors and their fund managers. The PE fund managers invariably rely on the standard approach of giving targets for the number of customers served and their unit efficiency of service, and minimising the cost of this service delivery while maximising the prices. It’s impossible to do all this and also maintain quality and the personalised care. 

Finally, the nature of the PE ownership almost eliminates any fiduciary relationship between the company owners and its customers, employees, and communities. The single-minded pursuit of cost minimisation and profit maximisation leaves both customers and employees worse off. The diffused ownership, portfolio approach of PE funds, and their outsourced management also mean that the PE firm can cut losses and exit a company with fewer restraints and costs. 

As to what’s driving this kind of capital, I can think of two important contributors - ultra-cheap capital and regulatory arbitrage. Since the Global Financial Crisis (or perhaps since the turn of the millennium), barring limited periods, the advanced economies led by the US have experienced extraordinary monetary accommodation by central banks. 

The low interest rates were a big boost to the PE business model that relies on extensive use of leverage to juice up returns. It also allowed PE firms to attract massive volumes of capital from both wealthy individuals and institutional investors (searching for yield in times of low fixed-income returns), which in turn found its way into these newer and stable return market segments. 

Spurred by imperatives like financial market regulation, trade standards, and addressing climate change, governments have become more invasive over the last two decades in terms of regulations and compliances. Accordingly, the costs of being a small business (and a public limited company) have steeply risen whereas the advantages of being a privately held company have increased just as sharply. This attractive regulatory arbitrage opportunity even incentivizes firms to remain private and exit the public markets. 

As long as PE was confined to a few sectors and its investors were just ultra-high-net-worth individuals, it might have been all right to allow light-touch regulations. But with PE ownership expanding its roots across the economy and with institutional investors like pension funds and insurers contributing an increasing share of PE investments, there’s a greater case for regulation of PE firms on similar lines as public capital. In fact, with an increasing share of capital from tightly regulated institutions, it may no longer be appropriate to even describe PE as private capital.

Weekend reading links

1. Pointer to where India could be focusing its semiconductor chip ambitions

India already has a fifth of the world’s chip designers, but only 7 per cent of actual design facilities.

2. The US Government has announced plans to close off an old de minimis rule that allows importers to bypass US taxes and tariffs on goods as long as shipments do not exceed $800 in value. Shein, Temu, and other Chinese retailers have exploited this rule to ship cheap items directly from China to shoppers, thereby forcing other retailers including Amazon to consider the same option.

To bring goods into the United States, retailers have traditionally arranged for shipping containers full of products to arrive from China at U.S. ports. Those goods would then be trucked to a company’s warehouses and retail stores before being sold to consumers. But retailers have been increasingly bypassing that process by individually packaging and shipping items directly from China to consumers under the de minimis law. With that method, the shopper is the official importer, rather than the retailer or e-commerce platform, and the value of the shipments largely stays under an $800 threshold.

In addition to avoiding tariffs, sellers do not have to provide as much information to U.S. Customs and Border Protection as with larger shipments. That model has taken off since the Trump administration in 2018 and 2019 imposed tariffs on many Chinese goods that retailers brought to the U.S. through traditional channels. The surge in online ordering during the pandemic also helped to popularize such shipments, which now make up roughly a fifth of e-commerce orders. The number of packages entering the United States each year under the de minimis rule has ballooned to more than one billion in 2023, up from 140 million a decade ago. China is by far the biggest source for such packages, sending more than all other countries combined, according to the customs agency.

U.S. companies and trade groups have complained that those rules set up a two-tiered system, in which brands with U.S. stores and warehouses had to pay higher tariffs than those that shipped directly to consumers. For example, an importer shipping 10,000 cellphone screen protectors into the United States could save more than $7,000 in taxes and duties if it individually packaged and shipped the protectors to consumers, rather than routing them through a warehouse, according to a presentation Apex Logistics prepared for its clients. Other U.S. businesses have complained that the de minimis exception puts pressure on retailers that employ Americans in their distribution centers. Lobbying groups in favor of eliminating de minimis have said the provision has recently led to the shuttering of some of the remaining textile plants around the United States.

3. The contrasting fortunes of US and Chinese stock markets

But in the year so far, the benchmark S&P 500 index is still up by 18 per cent. China, meanwhile, is in a deep hole. The CSI 300 index has fallen by about 7 per cent this year.

4. A defining graphic that captures one of the biggest challenges in mobilising climate finance.

5. Some facts about lock-in periods and India's IPO boom

According to the regulations, for company promoters, 20% of the post-issue paid-up capital must be locked in for 18 months, while any allotment exceeding this 20% threshold is subject to a lock-in period of six months. For anchor investors, 50% of the allotted shares is locked in for 30 days from the date of allotment, with the remaining 50% locked in for 90 days. The lock-in period for non-promoters ends after six months... From an equity market perspective, the true test of such companies is when the lock-in shares are released in the market. This is where most domestic startups seem to be floundering. The report card of the startups listed over the past two years makes for a sobering read.

Out of the five startups listed in 2023, two are deep in red, one is barely in the green while only two have delivered respectable returns. Even for the last two companies, stock prices have stagnated after around six months, coinciding with the release of lock-in shares. Out of the three startups listed in 2022, Delhivery is down 25%, Tracxn Technologies has inched up 2% and DroneAcharya has delivered a modest 12% returns.

6. Some findings from a SEBI study of investor behaviour in IPOs that examined 144 IPOs listed between April 2021 and December 2023 which collectively raised Rs 2.13 lakh Cr from 21.9% allotment to retail investors and 64.6% to qualified institutional investors. 

About 54% of IPO

shares

(in value terms)

allotted to Investors

(excluding anchor investors) were sold within

a week

from listing

About 54% of IPO

shares

(in value terms)

allotted to Investors

(excluding anchor investors) were sold within

a week

from listing

Excluding anchor investors, it was observed that 53.9% of IPO shares (in value terms) were sold within a week and 72.6% within a year.... Individual Investors sold 50.2 per cent shares (in value terms) allotted to them within a week from listing. Non Institutional Investors (NIIs1) sold 63.3 per cent shares by value. Retail2 investors sold 42.7 per cent shares by value... Mutual Funds sold about 3.3 per cent of allotted value within a week, as compared to 79.8 per cent for Banks... 39.3 per cent of Retail Investors were from Gujarat, followed by Maharashtra (13.5%), and Rajasthan (10.5%)... A positive association was observed between IPO subscription, listing day returns, and exit of investors (in terms of percentage of shares sold in value terms). Higher subscription was associated with higher listing day returns and in turn higher exit by investors. For Individuals, the exit from IPOs roughly doubled from the oversubscribed IPOs in the range 5x-10x, compared to those in the range 1x-5x.

Further disaggregation reveals the following break-up of exit patterns

7. India's household non-mortgage debt is among the highest in the world at 30% (compared to 10-11% housing debt), even compared to developed countries.

8. S Korean exporters are facing heat from Chinese competitors.

South Korean exporters of products ranging from steel and petrochemicals to textiles and cosmetics are struggling to compete with a glut of goods from Chinese rivals, as the effects of overcapacity and sluggish domestic demand spill over into global markets. Even Korean makers of kimchi, the fermented vegetable product widely seen as a symbol of national identity, are feeling the heat. South Korea imported more kimchi in the first half of 2024 — almost all of it from China — than it exported, amid intensifying competition from Chinese kimchi that cost six times less than the Korean equivalent.

9. Nice description of how the US FTC and DoJ are shifting the framing of the anti-trust debate

As the FTC put it in a recent statement launching a deep investigation into algorithmic price discrimination, while the transparent use of freely given information to price products and services is normal, “now data collection has become common across devices, from smart cars to robotic vacuums to the phones in our pockets. Many consumers today are not actively aware that their devices constantly gather data about them, and that data can be used to charge them more money for products and services. An age-old practice of targeted pricing is now giving way to a new frontier of surveillance pricing.”... Jonathan Kanter, who has brought a record number of cases during his tenure. More important than the breadth is the approach. His department has pulled ahead on issues like algorithmic pricing before private actors were able to build a body of judicial victories in lower courts that would make it hard to do so. In 2022, Kanter launched what he calls Project Gretzky, named after ice hockey great Wayne Gretzky, because as he puts it, “what made Gretzky great is that he skates not to where the puck is, but to where it’s going.” When you are dealing with large technology platforms that can leverage the network effect to create competitive moats around areas entirely outside their own industries — such as healthcare, groceries, automobiles, or AI — that kind of prescience is crucial.

10. On caste inequalities in India

Two recent studies based on the panel data from Indian Human Development Survey indicate rather clearly that caste plays an important role in determining income level. The first study regresses income on a variety of determining factors and finds that the annual income of lower-caste individuals is 21.1 per cent lower than that of the rest of the population. On a more disaggregated basis, the model shows that Adivasis’ income is, on average, 28.7 per cent lower than that of upper caste groups, while the income of Dalits, Muslims, and OBCs, are 27.74 per cent, 20.17 per cent, and 19 per cent lower, respectively... The study shows that lower-caste individuals with higher education have a significantly lower disparity, which is 10.3 per cent relative to the upper caste. The reduction is even more substantial for Adivasis. As for the state-specific effect, the study shows that for every Rs 10,000 increase in the real gross domestic product (GDP) per capita at the state level, there is, on average, a 9.05 percentage points reduction in caste-based income disparity for Adivasis. For Dalits, OBCs, and Muslims, the reductions are 7.6, 4.9, and 1.8 percentage points, respectively. Note, however, that the difference, though reduced, is not eliminated. 

Another study, based on the same survey data, focuses on the differences experienced by lower and upper caste groups who are business owners. The study finds that Dalit business owners have a lower income compared to those who do not face the stigma of exclusion but who do face socio-economic disadvantage, namely, OBCs, Adivasis, and Muslims. The study takes into account what it describes as social capital, which is defined in terms of the extent of inter-personal contact that the individual has with other professionals, particularly from other castes. It finds that even when the social capital of the Dalit individual is higher, the income gap persists, indicating that caste stigma continues to play a role. This study also finds that education improves the incomes of Dalits to a similar degree as it improves the incomes of non-Dalits.

11. China steel industry facts of the day

China’s exports of steel have surged, reaching 90m tonnes in 2023, up by 35% on the previous year. That may be a fraction of China’s total production, but it is more than what America or Japan make in a year... As the commodity-intensive property sector has suffered, its steelmakers have taken a beating. In August barely 1% of the 250 steel mills in China that report their finances to the government turned a profit, according to Isha Chaudhary of Wood Mackenzie, a consultancy. The domestic price for hot-rolled coil steel, a benchmark product, has fallen by 16% over the past year. Despite the slump in prices, many of the country’s producers have been reluctant to curtail production; idling a blast furnace takes months and is often costlier than keeping it running. Facing lacklustre demand from their usual customers at home, steelmakers are looking elsewhere. The result is surging exports.

12. The first US Fed rate cut in four years.

13. Volkswagen and Wolfsburg is Europe's equivalent of Geeneral Motors and Flint, Michigan.

For decades, Wolfsburg and its car plant — the world’s largest — symbolised Germany’s miraculous post-war industrial revival. VW’s crisis, and its plan to close some German factories, has unleashed angst among the city’s 120,000 inhabitants, many of whom are employed by the carmaker... Wolfsburg was founded by the Nazi government a year before the outbreak of the second world war to house workers who were to build the Volkswagen — the people’s car. Since then, more than 48mn cars have rolled off the city’s production lines, more than anywhere else in the world. VW employs 60,000 people in Wolfsburg and just as many more in the wider central German state of Lower Saxony, where it also supports thousands of jobs at automotive suppliers that exist only because of the demands of Europe’s largest carmaker... the company’s importance to the region stretched beyond the automotive sector to “the baker around the corner, the hairdresser”.

The problems stem from cheap Chinese imports and electric vehicles (and also declining VW market share from the highly profitable Chinese markets). 

VW last week notified its worker's unions that due to growing competitiveness issues, its three-decades-old job security guarantee was now void, provoking a strong reaction from the IG Metal union.

14. Finally, the latest data point in Xi Jinping turn is the spectacular fall in Chinese startup activity and VC funding.

In 2018, at the height of VC investment, 51,302 start-ups were founded in China, according to data provider IT Juzi. By 2023, that figure had collapsed to 1,202 and is on track to be even lower this year.

The FT has an investigation that describes how the Party stifled entrepreneurship.

The crisis in the sector partly reflects the slowdown in the Chinese economy, which has been buffeted by the protracted Covid-19 lockdowns, the bursting of its property bubble and the stagnation of its equity markets. As bilateral tensions have risen, US-based investors have also largely pulled out. But it is also the direct result of political decisions taken by President Xi Jinping that have dramatically changed the environment for private business in China — including a crackdown on technology companies regarded as monopolistic or not attuned to Communist party values, and an anti-corruption crusade that continues to ripple through the business community. Desmond Shum, author of Red Roulette and a former real estate mogul, says the party “has throttled the private sector”...

Jack Ma was hauled in by the authorities for what were termed “supervisory interviews”, kicking off a wider crackdown on the technology sector that underscored the unpredictability of investing in China. Since then, the optimism that fuelled a generation of risk-taking entrepreneurs has been systematically eroded... VC firms have laid off investment professionals and in some cases replaced them with lawyers or former judges to enforce the repayment terms... The pool of capital that VCs can tap into is also shrinking. Foreign investors, wealthy Chinese, and corporate investors have been divesting or reducing their exposure to China, leaving state-backed players with an outsized role... Beijing’s efforts to cut what it views as excessive salaries in finance have also reduced the incentive for high-risk but potentially high-reward investments. State limited partners have either mandated that fund managers either cap their salaries at the Rmb2.9mn (around $407,000) annual limit that has been more rigorously enforced this year at state-backed financial institutions, or slash management fees by half, according to several people with knowledge of the matter.  

Management theory meets reality

Paul Graham listens to a speech by Brian Chesky of Airbnb and questions the conventional wisdom on managing companies (or more specifically startups that have started to scale).

As Airbnb grew, well-meaning people advised him that he had to run the company in a certain way for it to scale. Their advice could be optimistically summarized as "hire good people and give them room to do their jobs." He followed this advice and the results were disastrous… The audience at this event included a lot of the most successful founders we've funded, and one after another said that the same thing had happened to them. They'd been given the same advice about how to run their companies as they grew, but instead of helping their companies, it had damaged them…

In effect there are two different ways to run a company: founder mode and manager mode. Till now most people even in Silicon Valley have implicitly assumed that scaling a startup meant switching to manager mode… There are as far as I know no books specifically about founder mode. Business schools don't know it exists… The way managers are taught to run companies seems to be like modular design in the sense that you treat subtrees of the org chart as black boxes. You tell your direct reports what to do, and it's up to them to figure out how. But you don't get involved in the details of what they do. That would be micromanaging them, which is bad. 

Hire good people and give them room to do their jobs. Sounds great when it's described that way, doesn't it? Except in practice, judging from the report of founder after founder, what this often turns out to mean is: hire professional fakers and let them drive the company into the ground.

Coming from the likes of Paul Graham and Brian Chesky, hope this is taken seriously by management schools. 

I have a slightly nuanced take on this, drawn from leadership trends in government organisations. 

Consider the example of an officer who heads a department, a local government or a public sector unit who is passionate and committed to bringing significant change (not those interested primarily in virtue signalling to their political masters as a pathway to a better posting/opportunity). Such officers are like the founders of startups, in full ownership of their roles. 

Here I distinguish between such government leaders, and the rest - those who are not only doing virtue signalling but also the median leaders who tend to put in effort but don’t fully own up their roles. 

Management 101, as Graham writes, would have it that bureaucratic leaders should clearly define tasks (at most prescribe them in detail), allocate task responsibilities to the senior officials reporting to them, empower them, and let them implement the tasks. Then periodically review them, address co-ordination failures, guide them where required, and use rewards and punishments appropriately. I’m not sure this will work. 

The challenge that they face is that at the level just below him/her, there are a tiny few, if any, who are both self-motivated and are bought into the Department’s mission and objectives. Only such people can be entrusted with a task and be expected to take it to its conclusion. All others require varying levels of micro-management. 

Such micro-management involves prescribing tasks with their details and constantly monitoring their compliance. It would involve level-skipping to engage directly with their subordinates to give directions (already made to their unit heads) and assess progress, and periodic inspections to directly experience field realities. Finally, it would also involve opening multiple formal and informal feedback channels to assess what’s going well and more importantly, what’s failing. 

This routine must be followed with rigour and militant intensity, especially in the initial months of a posting. It’s an almost essential requirement for success within government (and as Chesky says, within private corporations too).

The challenge is with right-sizing this strategy. Not get deep enough and you lose out on valuable feedback and information. But get too much into the weeds and you are lost. This balance varies across organisational contexts and figuring it out will take time, but is time well spent. It’s also required to vary the level of such intense engagement depending on the responsiveness of the reportee officer. 

On this, a note of caution is to avoid extending this management strategy to the tiny few direct reportees who are already self-motivated and bought into the vision. That will be self-defeating for multiple reasons. For one, it demoralises the officer and the leader loses a very powerful force multiplier. Worse still, he’s demoralising an organisationally respected individual (as these officers are likely to be) whose impacts will be adversely felt across the department. This will only hurt the leader, and significantly at that. 

It’s also a challenge identifying the few self-motivated and passionate second-rung officials. It can often take time. And mission-alignment with such individuals requires the leader to spend time understanding and engaging with them. It’s an investment well worth it. 

I’m not sure that management theory can ever teach us something insightful about getting the balance right or identifying the committed officers. Instead, management schools could acknowledge the realities of the field, and clearly propose alternative frameworks like the one described here. It would be up to individuals to choose from among them, and iteratively right-size the strategy to suit their specific requirements.

The practical application of the strategy and its right-sizing is akin to an immersive problem-solving exercise, where you diagnose, choose the framework, and then iterate with it with tight feedback loops to get to the right strategy. It can appear daunting when done first. But once you internalise the process, it’s not as complicated. 

The point that Graham makes about management theories and business schools resonates with the point this blog has made on several occasions (see here and here) regarding our excessive (even blind) faith in theoretical experts for practical advice. This turns out consistently bad in areas like macroeconomic policy-making, public policy issues, and, as Paul Graham writes, management. Theory unfiltered by practical considerations generally leaves the system worse off. 

A corollary to this is the allure of ideas (among all of us) while discounting their implementability. It’s a cognitive blindspot. It’s all too common for experts offering ideas to address all the ills in the world, with scant attention to the really hard part of the details of their implementation. I blogged here highlighting that no matter how brilliant the idea or policy, what matters is its implementation. 

As I have blogged here, it’s a near-impossible task for theoretical experts to appreciate the challenges of practical implementation and the several layers of nuances and conditions required for the application of their theories. The practitioners have no option but to undertake the struggle (as with most other complex problems in life and career) to be able to get the strategy right. It’s just the same for founders of startups or corporate leaders, as it’s for bureaucratic leaders. 

They only know management who have struggled long enough with actual management! 

R&D expenses, productivity, and growth in the age of Big Tech

Econ 101 informs us that R&D investments spur innovation and productivity growth, which in turn lower production costs and create newer products, boost consumption, drive further investments, job creation and economic growth. In short, R&D investments and innovation trigger a virtuous loop.

Gillian Tett points to an interesting paradox that questions this conventional wisdom that R&D investments invariably result in innovation, productivity growth, and expansion of economic output. Sample some numbers.

On the one hand, American R&D has risen in recent decades, from 2.2 per cent of GDP in the 1980s to 3.4 per cent in 2021. That reflects a doubling of private sector R&D to 2.5 per cent of GDP. Meanwhile, the proportion of the population involved in patent production nearly doubled in this period. But there is a big catch. Although “conventional economic models” imply that increases in R&D spending on this scale “should have led to accelerated economic growth”, this has not occurred. Michael Peters, a Yale economist, lays out the grim news: while labour productivity rose on average by 2.3 per cent between 1947 and 2005, between 2005 and 2018 it fell to 1.3 per cent. This cost America a putative $11tn of output, he calculates.

Micheal Peters in the IMF’s latest F&D magazine points to the US productivity growth being on a secular decline, that has become pronounced during the digital age since the turn of the millennium.

There is growing evidence that the US economy is not as dynamic as it used to be. A key aspect of business dynamism is new business formation. It is often measured by the entry rate, or the share of enterprises that started operating in a given year. The entry rate fell from 13 percent in 1980 to 8 percent in 2018, according to the US Census Bureau. In addition, US enterprises became substantially larger, with the average number of employees rising from 20 in 1980 to 24 by 2018. Older and bigger companies thus account for a much larger share of economic activity than they used to. These trends indicate significantly declining dynamism in the US economy over almost four decades…

First, the rise in corporate concentration has been shown to go hand in hand with expanding market power. The average markup by publicly traded US companies surged from about 20 percent in 1980 to 60 percent today. Large incumbent businesses thus seem to be shielded more and more from competition, allowing them to jack up prices and widen profit margins. A second line of research shows the flip side of rising corporate market power: the weakening of workers’ bargaining position. Since 1980, labor’s share of the US economy has fallen by about 5 percentage points. The plunge was faster in industries that experienced more concentration… Third, there has been a secular decline in business-to-business reallocation since the late 1980s, as shown in a series of papers by John Haltiwanger and other researchers. This suggests that the process of workers moving from declining to expanding businesses is not as fluid and dynamic as it once was.  

Peters also explores the possible causes for this productivity decline.

The ten biggest tech companies by capitalisation in Nasdaq spent a total of $222 bn in R&D in 2022, of which Amazon alone spent $73.2 bn. 

Remarkably, these kinds of R&D expenditures have not been accompanied by job creation. As an illustration, even as Amazon, Microsoft, and Alphabet spent a record $139.3 bn on R&D, the three laid off 40,000 workers at the beginning of 2023. 

Germán Gutiérrez and Thomas Philippon measured the evolution of dominant firms in the US since 1960 (top 20 firms by global sales and top 4 firms in each 3-digit industry) and globally since 1990 (top 100 firms by global sales in a given year and the top 20 firms in 25 industries), and found that their contribution to aggregate productivity growth has fallen by more than one-third since 2000. 

In another paper Philippon writes

I estimate that markups in the United States have increased by about 12% since 2000. Such an increase in markups implies that wages and consumption are at least 10% below their potential… increasing markups in the United States have lowered labor income by about $1.44 trillion… the stars of the digital economy—Amazon, Google, Facebook, Apple, and Microsoft (GAFAMs for short)—are not as “special” as one might think… Along all qualitative dimensions, including profit margins and productivity, the stars of today are… they are smaller than market leaders of the past, and they matter less for overall GDP growth than General Motors, IBM, or AT&T did at their peak… rising market concentration since the early 2000s has produced market inefficiencies. Dominant firms have succeeded in erecting barriers to entry, which has resulted in lower investment, higher prices, and slower productivity growth.

Given the aforementioned facts, here are some observations:

1. Joel Mokyr has made the distinction of useful knowledge as one that promotes material progress. It consists of propositional knowledge (“what”) and prescriptive knowledge (“how”), with the former consisting of people who know things (savants) and the latter of people who make things (fabricants). He uses this distinction to explain why the Industrial Revolution originated in England and not in continental Europe. On the same lines, it may be useful to make the distinction within R&D investments and categorise some as useful R&D. Ditto with innovation. 

Are R&D expenditure and innovation increasing the economic output? Is it creating jobs? Or is it being used to create moats around the markets served by the big technology companies? Given the nature of the digital technology markets, with their network effects and the advantages conferred by access to large data, are the large R&D expenditures conferring an unbridgeable advantage to the large incumbents?

There’s a case for distinguishing between defensive and productive R&D, with the latter aimed at protecting the turf/market. More on this latter in the post.

2. In the last 2-3 years, there has been a surge in AI-related R&D investments. As the graph above shows, each of the US Big Tech firms - Amazon, Alphabet, Apple, Microsoft, Meta, Nvidia etc. - have been making AI-related investments in the tens of billions of dollars every year. So much so that the entire US equity market is now riding almost entirely on the AI investment boom. However several questions are being raised about the likely value generation from these investments. The vast majority of commentators view this boom as being driven by FOMO and disconnected from any value creation. 

Is it then the case that the returns from R&D investments, or their productivity, have declined? Or is it that the technology will take time to mature and start to show its benefits? Or more generally, are large firms being inefficient in their allocation of R&D expenditures? Or a combination of all three?

Ufuk Akcigit writes in the same issue of the IMF’s F&D magazine:

In earlier research, Harvard’s William Kerr and I found that small businesses are more innovative relative to their size, suggesting they use R&D resources more efficiently. As companies grow and dominate their markets, they often shift their focus from innovation to protecting their market position. In a more recent study, Salome Baslandze, Francesca Lotti, and I showed using Italian data that larger enterprises tend to innovate less and instead engage in activities that limit competition. One such activity is hiring local politicians. As businesses climb the ranks among the largest 20 players in their industry, they hire more politicians, while their patent production declines. This highlights what we call a leadership paradox, where leading companies plow resources into maintaining dominance rather than fostering innovation… As dominant players prioritize strategic moves over genuine innovation, the economy as a whole is almost certainly missing out on potential growth opportunities.

3. Most importantly, it’ll be useful to examine where these R&D investments are going. These are astronomical sums, larger than the entire R&D expenditures of several large countries combined, including those like India. Are they actually going into research and development? Or is it some accounting trick to benefit from tax rules?

The primary reason to doubt these numbers is a palpable absence of their signatures on the products and services being delivered. Has e-commerce, social media engagement experience, and internet search got so much better in say, the last five years, to justify even a small part of these expenditures? Does building and maintaining data centres (whose buildings and operations are outsourced to PE funds and their boring infrastructure contractors) demand such levels of R&D expenditures?

It’s hard to imagine or rationalise that e-commerce, social media, and internet search (and advertising) can consume anything even remotely close to the amounts being spent on R&D. One associates with R&D in digital technologies to some equipment and software costs, and considerable manpower costs. Even at the higher end of such expenditures, $73.2 bn (and similarly high numbers in earlier years) appears mind-boggling. So where is this likely coming from (or what’s it going into)? 

A comment on a discussion thread in Hacker News nails it:

This $73.2B figure was pulled directly from their 2022 10-K filing under an operating expenses line item labeled technology and content, which includes R&D and then some. The devil in the details is buried in a footnote on p. 26:

Technology and content costs include payroll and related expenses for employees involved in the research and development of new and existing products and services, development, design, and maintenance of our stores, curation and display of products and services made available in our online stores, and infrastructure costs. Infrastructure costs include servers, networking equipment, and data center related depreciation and amortization, rent, utilities, and other expenses necessary to support AWS and other Amazon businesses.

At face value, to handwave this figure as just R&D and purport that it's directly comparable to other publicly-traded companies who report disaggregated research and development strikes me as somewhere between shotgun analysis and hoodwinking.

Read this Forbes article which says the same things, and see this. 

Here is the table indicated above.

Amazon spends large amounts on its AWS data centres. All those expenditures are lumped together into the basket of technology and content. Even its prime Video content is classified under R&D. In short, it appears that Amazon lumps all its personnel, software and hardware costs under R&D. 

Is all this disingenuous accounting motivated by tax minimisation strategies adopted by these companies? Is Amazon benefiting from the greater tax benefits accorded to R&D expenses? Akcigit again

The Federal Reserve’s Sina Ates and I examined market competition trends in the US over the past several decades. Since the early 1980s, there’s been a noticeable increase in market concentration and a decline in business dynamism… This period aligns with the 1981 introduction of the R&D tax credit, a component of President Ronald Reagan’s sweeping Economic Recovery Tax Act. The credit was intended to encourage businesses to invest in research and development. Minnesota was the first state to adopt a similar state-level R&D tax credit, in 1982, and many other states followed, expecting to promote innovation and economic growth. Which companies are most likely to take advantage of the R&D tax credit? Our research with Goldschlag shows that large businesses are much more likely to benefit than smaller ones. The policy—perhaps unintentionally—favors big companies, encouraging them to dominate in R&D spending… Our research provides direct evidence that businesses actively claiming R&D tax credits are more likely to engage in stifling hiring practices. These enterprises often offer higher salaries to inventors, and the inventors become less innovative after joining.

It’s therefore clear that all the so-called R&D expenditures are mostly about the general operational and capital expenses! So after all, real R&D expenditures might not have gone up as much as we imagine, which also explains the apparent paradox of low productivity growth. 

4. In this context, it’s also worth making the distinction between the R&D expenditures of firms in digital technology and traditional economy sectors. Technology firms like those above are constantly iterating and improving their algorithms and user interfaces (and the logistics operations in the case of Amazon and advertising engine in the case of Google) as part of their regular operations. The nature of digital technologies (for example, with digital trails that serve as fuel for data analytics and AI-algorithms) ensures such iteration and refinement. 

There’s an indistinguishable line between the R&D expenditures of technology firms and their operational expenses. It’s different from the distinct role of R&D in the traditional economy where it’s about inventing new technologies, products, and services. The likes of Amazon, Meta, Alphabet, Apple etc., have not brought out any new product, but are only marginally refining their algorithms and at best moving into emerging adjacent markets (where too they have a head start due to the nature of their platform business models). They are, for all practical purposes, one trick ponies.

This raises the need for greater clarity in the accounting of R&D expenses of digital technology firms. 

5. One of the surprisingly less discussed but widely known features of technology markets today is the stifling grip exercised by the big firms. This hold covers hiring and retaining critical personnel, patent acquisition, protection of their own patents, and even protecting themselves from being gobbled up. Big Tech (and large incumbents generally) firms employ armies of lawyers to engage in the likes of patent trolling, squatting, and hoarding to copy, steal and intimidate startups. 

More from Ufuk Akcigit

Over the past two decades, there has been a notable reallocation of innovative resources toward large, established companies, Goldschlag and I documented in 2022. At the beginning of this century, roughly 48 percent of American inventors worked for these big incumbent companies—those that are more than 20 years old and employ more than 1,000 workers. By 2015, that figure had surged to 58 percent, marking a significant shift in where the nation’s innovative talent is concentrated… research shows a concerning trend: inventors that move to large firms become less innovative compared with inventors that move to young firms.

A specific practice identified in our research is innovation-stifling hiring. This occurs when big, established enterprises hire key employees from younger competitors, often by offering higher salaries. However, instead of using these new employees to drive innovation, the big businesses may place them in roles that do not fully leverage their skills. As a result, these individuals become less innovative, and the overall innovative capacity of the economy suffers. After 2000, there was a notable increase in the wage premium offered by established companies, compared with salaries paid by younger businesses. The pay differential widened by 20 percent, prompting many innovators to switch jobs and join larger, well-established companies. However, these inventors’ innovativeness dropped by 6 percent compared with that of their peers who joined younger employers… By hiring away top talent from rivals, these companies not only weaken their competitors but also prevent these individuals from contributing to potentially disruptive innovations elsewhere. This strategy may benefit the hiring business in the short term, but it poses a long-term risk to the economy’s overall innovation and growth. 

Given all these, startups stand little or no chance of competing with large incumbents. It’s an open secret that the Big Tech firms unleash their lawyers and financiers to intimidate and squeeze any startup trying to compete with them. I don’t know whether the libertarians and tech evangelists who wax eloquent about digital utopia and lose no opportunity to argue for deregulation and getting government out of the way are being ignorant or disingenuous or plain dishonest when they overlook the egregious manner in which Big Tech firms unleash their lawyers and corporate brokers to intimidate startups. 

Why are none of the economists in the big Economics Departments silent about one of the commonest market practices which is also the biggest threat to competition in digital markets?

I have written here (and here) about how Amazon uses anti-competitive practices to copy and forcibly buyout emerging startup competitors and then kill off their technologies or adopt them itself. 

The final word to Akcigit

The evidence suggests that while the US is investing more in R&D, the concentration of resources among large businesses has led to diminishing returns in terms of productivity growth. This outcome challenges the assumption that simply expanding R&D spending will automatically lead to economic growth. Instead, it highlights the need for a more nuanced approach to industrial policy—one that not only incentivizes R&D but also encourages the effective reallocation of resources. To foster a more dynamic and innovative economy, the US needs to design policies that support not just large incumbents but also smaller businesses and start-ups, which often have a greater capacity for disruptive innovation. This could include targeted tax credits for small businesses, grants for early-stage innovation, and policies that encourage competition and reduce barriers to entry for new players.