Going Global

Inefficiencies in International Energy Markets and the Search for a New Paradigm for the Value of Renewable Resources -- Part II

This is Part II of what I anticipate will be a 3 part post.   In Part I, I tried to set up the intractable dilemma that has prevented the net oil consuming nations such as the U.S. from formulating a rational energy policy that the majority of people can readily support. 

On the one hand, the international oil markets are not open and competitive in that the majority of producing oil reserves are in the hands of countries which view it not as an open economic commodity but as a strategic asset with political ramifications.  As such, the historically high and escalating prices that are constraining economies worldwide cannot be simply relegated to the inevitable consequences of supply and demand and market economics and the limited control of these strategic assets poses a risk to the stability of the global economy.

On the other hand, current alternative energy technologies such as solar and wind are not yet financially viable and therefor economically rational substitutes for oil as an energy source, particularly if one honestly assesses the social costs associated with their large scale implementation.  Their position as viable economic substitutes is further diminished by the unpredictability of oil prices which are not reflective of a competitive market such that a near-term price reversal could be engineered to undermine at great cost whatever investment were spurred in alternative technologies by the current high price levels.

The Basis of Economic Value -- Why We Want What We Want and Why We're Willing to Pay What We Pay

As a foundation for finding a way through this dilemma, I think we need to consider what drives certain people to want one thing and others to want something else, how diverse goods wind up priced relative to one another, and how we decide what we're willing to pay for both seemingly similar and seemingly different products.  Or to put it differently, how a value proposition relates to the economic value we see in a certain good or service.

The value inherent in a good as reflected in its price has been a key question for economists since there became such a thing as an economist.  Early on, economists postulated that the value of a good should correlate to the extent that the good is needed by consumers.  This quickly gave rise to the classic paradox of diamonds and water -- other than some very specialized industrial cutting applications, diamonds are hardly needed at all, and yet they have always been priced far higher compared to water which we can't live without and yet is virtually free.

From this line of thinking quickly came the idea that prices are determined by scarcity -- the harder a good is to come by, the higher the price it can command.  While scarcity is certainly a driver of prices, it can only impact the prices of things for which there is a corresponding demand -- people must want it for some reason -- must attach some value to it -- or it doesn't really matter whether its scarce or not existent at all.  And the issue of scarcity itself can be more complex than it might seem at first blush.  Applying the question to alternative energy, there is no scarcity of sun and wind in many parts of the globe, but the high cost of converting these resources to energy is not a function of the availability of the underlying resource itself.

Some understanding of how we place value on things can be gained by comparing buyers of different automobiles.  Take for example a Toyota Prius, a Porsche 911, and a Hummer.  At the root they are all means of transportation, and similar means of transportation at that -- four rubber tires driving along the identical asphalt roadways powered principally by internal combustion engines.  Further, they are all sold to consumers through pretty much the same distribution channels -- independent dealers relying primarily on direct sales through show rooms.

But I don't think anyone would seriously believe that a person buying one of these three cars is buying the same thing as someone buying one of the others.  Indeed, I'm not sure a person buying a Prius could even have a civil conversation with a person buying a Hummer.  The importance of the emotional value we associate with the things we purchase and how the alignment of our world views with a product's value proposition affects our desire to make a particular purchase and how much we're willing to pay for a particular good is well presented in the works of a number of modern marketing gurus, my favorite of which is Seth Godin (author of such must read books as "All Marketers Are Liars" and "small is the new big"). 

The buyers of a Prius might say that they are trying to save money on gas, but most studies I've seen make it pretty clear that it takes a few years to save enough gas to make up for the higher price of the hybrid engine in the first place.  The truth is, the owner of a Prius is willing to pay a little more for the car than can be saved in gas because at a deep emotional level they want to be doing something to help save the planet.  It's not a car as much as a statement about environmental consciousness.  The buyer of a Hummer, on the other hand, doesn't need to save the planet -- he owns the planet.  He rules it whether it's paved or not.  Meanwhile, the Porsche buyer is seeking to be one with the world -- at least that part of the world covered with long stretches of smooth asphalt and well engineered curves.  Zen meditation would probably be a cheaper route to "oneness", but for this person "oneness" isn't about the price tag, but about speed and handling. 

The point here is that people want these things and are willing to pay certain prices for them not because they need the particular functionality or because of their relative scarcity or availability, but because of a deeper emotional value associated with what the product says about them as people.

Another modern illustration of this is how people are willing to pay considerably more for a cup of coffee at Starbucks when they could get a very similar cup of coffee elsewhere for much less.  Let's face it -- when it comes to Starbucks, the higher price is certainly not because they're scarce.  Starbucks would be the first to say that coffee isn't even their core product.   They sell a community and a sense of cultural identity that sparks a gratifying emotional response from their loyal customers.  Serving coffee just happens to be one part of creating that emotional response.

We can come full circle on this by updating the paradox of the economic value of water -- only instead of water and diamonds, we can compare water and bottled water.  In most places in the developed world, clean drinking water is free.  And yet millions of people pay quite a bit of money for bottled water.  Indeed, when translated from the average 16 ounce to 24 ounce bottle to a gallon, the price of this water can be well over $10 per gallon -- and we willingly pay this price when in most cases we could get a cold drink of water for free.  And yet we blanch at $4 per gallon gasoline.  Talk about a paradox.

Some of this water comes from as far away as Fiji, and some is bottled from the municipal water supply.  The price isn't driven by the cost of the container or the cost of transporting the water from the well head to our refrigerator.  And it certainly isn't driven by the scarcity of the product or unique control over the essential natural resource or the value of some proprietary technology for finding and bottling water.  Bottled water readily commands a price that is more than twice that of a gallon of premium gasoline because of some intangible emotional response between the consumer's world view and the value proposition wrapped around their perception of battled water.   In some cases it has to do with the simple convenience of ready portability in an off-the-shelf container.   In other cases it has to do with an emotional response to staying clean and healthy by, for example, avoiding chemical additives such as fluoride or chlorine often found in tap water.

The point here is that bottled water does not seem to be a price point sensitive substitute for tap water.  One is delivered directly to your home for free while obtaining the other requires a trip to the store and a cost of $10 per gallon.   Viewed from the vantage of the emotional laden perceptions that drive economic value and what consumers are willing to pay, these are obviously quite different products.

My contention is that understanding this paradox and how different goods are in fact valued by consumers provides the key to overcoming our energy policy dilemma and, in turn, can provide the basis for an openly competitive and vibrant international market for energy resources for the 21st century.  But that final leap is for Part III of this post yet to come.

Inefficiencies in International Energy Markets and the Search for a New Paradigm for the Value of Renewable Resources -- Part I

Regular readers will have noticed the lack of recent posts -- I've been too busy with business lately to blog.  I always keep a running list of potential blog topics, but unfortunately many of the short pithy ones are related to some immediate event in the news that makes them relevant, and once the moment has passed without the opportunity to sign on and put a post up, they no longer seem quite so pressing or interesting.

Since I don't have as much time these days to get at it, I thought I might try to tackle instead one of the big ideas I've been noodling about.  It's a work in progress and will need to be laid out in several parts, but I wanted to begin to get some of these thoughts out there on one of the huge issues of our day for any comment or further thinking that it may stimulate.  I'm afraid at times it may seem more like theoretical economics than international business, but my thinking begins and ends with the topic of this blog -- where and what are the opportunities for businesses in the international marketplace.  In this case the specific international market I'm focused on is energy resources, production, and whatever it takes in the way of services and equipment to support those markets.

Oil Cartels and the Impact of Market Inefficiencies

One of the critical inducers of economic turmoil in the world today is the historically high and continually escalating price of oil and the myriad of products and services derived from or dependent upon oil whose own cost structure is adversely impacted.  At first blush it is easy to explain much of this by the simple supply and demand dynamics in the international markets for crude oil -- as a finite natural resource, the supply is continually being depleted while the high octane industrial growth of emerging markets such as China and India are simultaneously pumping up demand.  Higher prices are the natural and inevitable consequence.

The problem with this simple explanation is that for supply and demand to drive price in such a predictable way, it assumes that the market is free, efficient and competitive.  In reality the vast majority of currently producing oil reserves are in countries with relatively autocratic governments which, not surprisingly, view their oil reserves as a key strategic and political asset.  The means of production are not under the control of freely operating private enterprises responding rationally to the price mechanism created by supply and demand.  Instead, these resources are controlled largely by governments themselves or government controlled corporations whose decision making is directly and usually not so subtly influenced by their domestic political and economic agendas.  As such, the international energy markets seem to be anything but bastions of free, open and competitive trade that would allow for the efficient distribution of resources across borders. 

Without an openly competitive international market for energy resources, it is at best difficult to determine how much of the high price of oil is due to the predictable market dynamics of supply and demand and how much is due to engineered inefficiencies tied to some country's or cartel's own political agenda.

In a functioning market, of course, the price elasticity of demand would result in the development of alternative energy resources as substitutes for high priced oil.  The problem is that, even at currently inflated oil prices, currently feasible alternatives are still not economically viable in a free market governed by rational returns on investment, and even less so if one considers social costs such as the massive despoliation of land and visual pollution associated with large scale solar or wind farm projects or the risk of a nuclear plant malfunction or disposal of radioactive waste.  The risk of investment in these alternative resources is further exacerbated by the fact that because the current high prices for oil are not truly the result of competitive market forces, the controllers of the oil reserves potentially could engineer a price decline sufficient to wipe out the value of any investment in alternative energy just when it was looking promising, pulling the rug out from under the entire economic rationale for substitute energy sources.  Anyone who saw the boom and subsequent collapse of the shale oil industry here in Colorado in the 1980's knows how this fool's game is played.  

Thus, as the international energy markets currently function, those of us in net oil consuming countries are damned if we do and damned if we don't.  We can either continue playing the losing game of consuming a finite product subject to inevitable depletion but priced low enough to prevent the rational development of economic substitutes while fluctuating at high enough levels to pose an on-going threat to our economic well-being, or we can make what by any rational economic estimation remains a bad financial investment in alternatives subject to potentially high and insufficiently accounted for social costs and a near certain collapse of the price support creating what financial rationale for the investment does exist in the first place.

We are trapped in a box that makes it nearly impossible to formulate a rational energy policy on which even a majority of intelligent and clear thinking individuals can agree.  It seems to me in pondering this dilemma that the only way out of the box is to make a paradigm shift in how we understand and respond to the market for and economics of energy resources and production.  And with that steep and craggy climb in sight, I will pause before picking up again in Part II of this post.

The United Nations Speaks Out for Free Trade -- At Least When It Comes to the Global Food Supply

Among the many positive attributes of the United Nations, and I think there are many, I wouldn't normally include a penchant for free trade.   Sure it's an international body and by its very nature is on the leading edge of political globalization, but when it comes to commerce, like most government funded bureaucratic oriented institutions, my impression of the UN is that it favors public regulation and oversight.  It was for this reason that I found some of the official comments made at the UN summit on the global food crisis held this week in Rome to be both surprising and a bit heartening.

The participants at the summit of course argued over the multitude of contributing causes to the current problems resulting from the recent run up in the prices for basic foods which, as noted elsewhere in this blog, imposes a more egregious penalty on poor nations whose populations must spend a far higher percentage of their incomes on basic necessities.  These causes include increasing demand by the growing (both in numbers and in wealth) populations of India and China, the energy policies of nations such as the US which are using subsidies and government mandates to move agricultural product from food source to the raw material for bio-energy production, as well as localized weather phenomena that affect local food supplies.

But the number one cause zeroed in on by many of the participants, including UN Secretary General Ban Ki-moon, was the refusal of governments to allow free trade in the import and export of food supplies.  As quoted in a report from Reuters, Ban complained that "[s]ome countries have taken action by limiting exports or by imposing draft controls."  He argued (correctly I might add) that this "distorts markets and forces prices even higher."

Similarly, while defending his country's bio-fuel policies, Brazilian president Lula da Silva decried what he described as "intolerable protectionism" -- a phrase I never thought I'd hear said in a positive vein at a UN summit.  Succinctly stating the case that I think would be made by most rational economists who study international trade theory, Lula da Silva went on to state that "[s]ubsidies create dependency, breakdown entire production systems and provoke hunger and poverty where there could be prosperity. It is past time to do away with them."

While it is encouraging to hear such sound economic analysis providing the framework for a UN summit, I hope that the august members of this body remember that these comments apply equally to other goods involved in international trade, not just the food supply.  The next time there is reason to decry the impact of the globalization of commerce at an environmental or labor oriented confab, it would be helpful if these same international governmentalists keep in mind their own arguments to the effect that protectionism, whether through government mandates, trade restrictions or subsidies, distorts markets, causes higher prices, breaks down entire production systems, and provokes poverty where there could be prosperity. Strong but wise sentiments.  

Can Today's Mis-educated High Schooler Become Tomorrow's Global Leader?

Among the concerns with secondary education today is that in teaching to the lowest common denominator dictated by standardized tests, the average American high school student is woefully undereducated in subjects critical to the world of the future (and today of course), particularly math and science. Add international trade to the list of subjects in which a good education is lacking.

I have the pleasure of serving as a mentor in a program for students attending one of our local large urban public high schools.  We were catching up this morning on how things were going in his geography class.  When I asked what they were working on, I was momentarily pleased to hear that they were studying international trade.  My pleasure turned sour when I asked what he was learning about global trade.  His answer:

Basically we're learning how international trade is good for rich countries like the United States, but that it's really hurting the poor countries in the world.

I guess I should have seen that coming.  I asked whether there is much class discussion or whether it was primarily lecture from the teacher.

There's discussion . . . but since we don't really know anything about it other than what our teacher tells us, basically what we discuss is how harmful trade is to the poor countries in the world.

My mentee's teacher is not alone of course in substituting a belief in a political ideology for a grounded understanding of international economics and business.  An example of this school of thought is found in Antonia Juhasz's book "The Bush Agenda, Invading the World One Economy at a Time"  in which the author argues that the only country benefiting from globalization is America to the point that she believes that globalization itself is a conspiracy between the U.S. government and its large corporations to use global economics as an express arm of foreign policy enabling the U.S. to assert its hegemony on the world without having to resort to strictly military means.

There are a number of aspects of this view that strike me as odd -- not the least of which is that in this presidential election season the two liberal candidates are bashing international trade and calling for the renegotiation of agreements such as NAFTA claiming that international trade only helps other countries while harming the U.S.   And in the strange bedfellows department, this anti-trade chorus is joined by right wing pundits such as Lou Dobbs who in his utterly wrong headed diatribe entitled "Exporting America", argues that the only people benefiting from globalization are foreign countries which are taking advantage of what he sees as a conspiracy of greed driving American corporations to export jobs and to undermine the very existence of the American way of life.  It seems that quite a number of ideologues outside of this teacher's classroom think international trade is bad for exactly the opposite reason -- that it is bad for the U.S.  [The coexistence of these contrary ideological views of the role of the United States in world trade is discussed in a slightly different context in an earlier post entitled "Ben Bernanke on the Benefits of Globalization".]

I also wonder how my mentee's geography teacher addresses the real world juxtaposition of the experience of countries such as China and India when contrasted with countries such as North Korea or Myanmar.   Not too long ago, both China and India had nationalistic policies that isolated them from world markets.  They were also among the world's poorest countries.   Since fully embracing international trade, of course, they have become shining examples of the ability of expanding markets to produce widespread economic opportunity to a previously destitute population.  Meanwhile countries such as North Korea which have regimes that continue to isolate their people from world markets in order to keep the citadel walls around their autocracies remain countries with the most abject poverty.

My student told me that his teacher particularly focused on poor countries in Africa as examples of how international trade keeps poor countries under the boot heels of wealthy nations.  As discussed elsewhere in this blog, interestingly the problem many countries such as those in Africa have with making headway in a global marketplace isn't international trade, but the lack of free trade.  The principal products that many of these countries could naturally export in order to gain the currency necessary to participate in international trade are agricultural.  But it is in agriculture that the wealthy nations are most protectionist both in terms of subsidies to their domestic agri-businesses and tariffs on the import of agricultural goods from elsewhere.  This is exactly the problem that the Doha round of trade talks is trying to address -- talks repeatedly scuttled by the wealthy nations' insistence on protectionism, not the existence of free trade.

I suppose it would be too much to ask that a teacher broaching the subject of international trade begin by imparting an understanding of the theory of comparative advantage and then allowing students to examine case studies of how the theory plays out for better or worse in the real world and then see where an objective discussion on the subject leads from there.  In any event, global commerce is a significant part of the world dynamic that future leaders need to understand and be comfortable with, and if our education system in this area concerns itself with political ideology rather than established trade theory and practice, our future in this regard will not be so bright.

So here's a few suggestions:

• Business organizations (chambers of commerce, World Trade Centers) and individuals engaged in international business might volunteer time and resources to support secondary education in the area of global trade and economics;
• College degree programs aimed at future teachers might include more substantive education in international economics and business as a core subject;
• Secondary schools might offer a course in business and economics rather than leave the subject up to ill-prepared geography and social studies teachers to cover as an aside to other topics such as the comparative wealth of nations. 

If suggestions such as these were to be implemented, I would be saved from having to dispense the wimpy advice that I ultimately imparted to my mentee this morning -- since my role in this particular program isn't to provide an alternative education, but rather is to help the kid get through high school, after suggesting some alternative ideas on international trade, I counseled him that usually with teachers such as this, the way to get a better grade is to parrot the teacher's political view point.  My charge was happy with that advice, particularly since the only information he has on the subject is what he was told by his teacher -- which is where the problem starts in the first place.

Presidential Primary Edition -- The Candidates, the Parties and Their Positions on Global Trade

This will be my only post for February, but the truth is it has taken all of February to research and write and it's been a moving target.  I started before Super Tuesday when each party had at least 3 candidates whose positions needed to be evaluated.  When time got away from me, it turned into an analysis of where we stood with the candidates still standing after Super Tuesday.  Well it's time to get it done for better or for worse, so having evaluated the candidates' positions on their official websites, as quoted in news stories, and as revealed in their voting records as public officials I've shortened up the analysis. In the end this is probably a good thing anyway -- let's face it, if you're looking to an international business blog to get a handle on where the candidates stand on global trade, you're looking to shortcut some of the detailed analysis anyway.

I should stress at the outset that this is not a political blog, but a blog about international trade and business -- and while I feel that international trade and relations is a critical issue for the US and its soon to be new president, there are certainly a great many other issues that can drive a legitimate difference of opinion over who is the best candidate.  Accordingly, this is not an endorsement column, but I did think it might be a good time to at least look at the remaining candidates' records and stands around international trade.

First off, as a general matter, it used to be that the Republican Party was pro-trade and the Democratic Party tended to be more protectionist given its traditional base of support among labor unions.  On the one hand Bill Clinton, the first Democrat to have been elected to two successive terms as president since FDR, was very much a free trade supporter having spent considerable political capital championing the passage of NAFTA.  At least among Democrats who share Bill Clinton's perspective, there seems to be a realization that the US needs to lead in the world and that exercising that leadership role requires active engagement with the world, and that global commerce is the principle platform on which the engagement will take place -- you need to either play or get out of the game, and they seem to realize that getting out of the game is not an option.

Conversely, the Republican faithful seem to have gone in the other direction.  While I can't lay my hands on the reference, there was a poll reported in the Wall Street Journal last year indicating that over two thirds of Republican's now feel that international trade disadvantages the United States, putting Republican's perspectives on an equally negative footing as the traditional Democratic protectionist view.  As discussed in previous posts, this perspective seems to rest on an unfortunate ignorance of the reality of global trade, but it is this ignorant perception that will nonetheless be forging the GOP platform going into the general election.

Bill Clinton's pro-trade policies notwithstanding, the fact also remains that a great number of the current Democratic leadership are still hostile to free trade. In a post last month on the Economist's View blog, there is a great quote from Alan Blinder in a piece from the NY Times entitled "Stop the World (And Avoid Reality)" in which Mr. Blinder writes:

Opinion polls show that Americans are both weary with and wary of the rest of the world. It’s as if they wish it would all just go away. Naturally, this sentiment is reflected in the current presidential campaign. Among Democrats, it may manifest itself in attitudes toward international trade that range from lukewarm support to outright hostility. Among Republicans, it shows up in attitudes toward immigration — and most things foreign — that border on xenophobia.

So the bottom line is that party affiliation is no guide as to where a particular candidate stands on free trade -- which brings us to the individual positions of the 3 remaining serious contenders and what I can now only describe as a couple of hangers on.

Given the general mood regarding global trade described in Alan Binder's article, I suppose it should be no surprise although it is still disappointing from an international business perspective that none of the candidates address free trade as an issue worthy of consideration on their official websites.  International issues are pretty uniformly cast in terms of the war in Iraq, combating global terrorism, support for Israel, and calls for reform and enforcement of immigration policies.

On the Democratic side, Hillary Clinton comes the closest to suggesting a stand on her official website, labeling one of the substantive issues "Restoring America's Standing in the World".  The discussion it turns out is more around engaging the world on social issues, but her emphasis on the need for America  remaining a "preeminent leader for peace and freedom" through cooperative alliances seems to echo Bill Clinton's view of the need for the US to be affirmatively engaged with the world, avoiding the protectionist jargon that colors so much political rhetoric on international issues.  As discussed more below, however, with the make or break primary in the industrial heartland of Ohio looming, Ms. Clinton's own position on international trade seems to be taking a sharp list on the road to nowhere.

On the Republican side, Mitt Romney (who unfortunately from an international trade standpoint has suspended his campaign effectively dropping out of the race) came the closest to addressing global trade issues on his official website, casting a part of his "Strategy for a Stronger America" as "Winning the Global Economic Competition."  Again, the discussion itself didn't exactly hit the nail on the head, focusing almost entirely on domestic tax policies that Romney promotes as a means of ensuring the competitiveness of American business, but the fact that he sees the issue in terms of competition in a global market of privately held businesses was at least encouraging.  Governor Romney is quoted as follows: "Are we going to stay ahead of the world, are we going to lead the world, or are we going to instead pull up the drawbridge and try to hang on to everything we've got and say we can't compete with the world" -- language reflective of arguments made elsewhere in this blog.

Given the critical importance of global trade to international relations and security and its increasing impact on our own economy, it is both a bit surprising and more than a little disappointing that none of the candidates are willing to address the issue head-on on their official websites other than the somewhat round about indicators on Ms. Clinton's and Mr. Romney's sites.   One would surmise that if the candidates truly believed some of the rhetoric that they use to pander to the protectionist rank and file, they would have no qualms about heralding those positions.  One possible explanation is that being leaders, they in fact recognize that global trade and engagement are real, inevitable and necessary, but rather than antagonize their party base they have decided the better part of political valor is to say nothing at all and hope no one probes too deeply on the question.

Given the paucity of clear positions on their official sites, we can examine their records on the issue.  With respect to voting records, unfortunately Mssrs. Romney and Huckabee (also pretty well out of it at this point), having been state governors but never having held a national office with responsibility for foreign trade issues, do not have any easily identifiable record.  I have not taken the time to this point to investigate with any state trade officials in Massachusetts or Arkansas what positions if any they took on trade related issues as governors.

From his public remarks, one would have to sum up Mr. Huckabees expressed positions as a bit out in left field.  On the one hand he expressed a pastor's compassion for immigrant families, but on trade itself, he has advocated the use of trade sanctions against countries in the Islamic world as retribution for what he sees as their discrimination against Christians.  Somehow further escalating tensions in the middle east and Asia by imposing faith-based and religiously motivated trade sanctions sounds like a step in a very scary direction.  The fact that it looks like we won't really have to answer for that is probably a good thing.

On the other hand, Senator McCain -- the "presumptive" nominee for the Republicans -- has the longest national public record of any of the candidates and therefore has established perhaps the most definitive positions on trade.   If one is pro international trade, McCain has a record to be admired.  According to OnTheIssues.org, the Senator has a near perfect voting record in supporting free trade agreements including NAFTA and even the recently defeated CAFTA.  Last October he gave a speech making the point that "every time the U.S. went protectionist, we paid a heavy price."  Just this month he gave a speech calling for a continued reduction in barriers to free trade, recognizing that "globalization is an opportunity."   

Of the 3 U.S. Senators in the race, Barack Obama has the shortest tenure and therefore a somewhat truncated voting record.  He was firmly against CAFTA.  Although he wasn't around to vote on it, he has made it repeatedly clear that he thinks NAFTA should be reopened and amended to provide more protectionist labor provisions.  In his one departure from a fairly consistent anti-free trade record, he voted in favor of a free trade agreement with Oman.  I'm not sufficiently familiar with the provisions of that agreement to understand what it was that distinguished that agreement from other FTA's in the Senator's mind, but at least it does indicate that he's not anti free trade all the time under all circumstances.

If I had completed this post closer to when I started it, I would have suggested that Hillary Clinton was the most pro free trade of the Democratic contenders including those that have dropped by the wayside.  In addition to the general comments cited from her campaign website above, although she voted against CAFTA, she has voted in favor of quite a few other free trade initiatives including most favored nations status for China, normal trade relations status for Vietnam, free trade agreements with Singapore and Chile, and the removal of many common goods from export restrictions.

Unfortunately, now that she has been forced to fight for survival in the remaining big primaries, she has had to veer back towards the partisan extremes that drive political debate leading up to a party's nomination, and in the case of Democratic activists in an industrial state like Ohio, that apparently means NAFTA bashing.  Although Ms. Clinton applauded NAFTA when her husband championed it during his presidency, and despite the fact that it is probably the single most important free trade initiative ever undertaken by the U.S., she now not only professes to be against it, but seems to feel the need to express shame and remorse for ever having supported it.  At the risk of saying too much, I like Ms. Clinton and think she would make a very good president, and I can think of numerous reasons why it's just plain time to have a woman president, but I do find the backsliding on NAFTA to be disheartening.

So to sum it all up, although Republicans as a group have become increasingly isolationist and protectionist, the party's apparent nominee seems to be very much a free trader, and is willing to go even further in staking out what I think is a sensible but apparently unpopular stance on immigration as well.  Among the Democrats, their records would suggest that Ms. Clinton has a more favorable view of international trade than Mr. Obama, though their pitched battle for the nomination is forcing both of them to skew their rhetoric to play to the protectionists in the labor movement bloc of the party.

Fortunately, each of the 3 remaining serious candidates seem to be bright worldly people.  I have to believe that whatever they may say in the nominating process to appeal to their party's extremes, when faced with the responsibility of leading the free world, they will recognize the benefits to the US of being fully engaged in international commerce and global competition.

Global Interdependence and the Challenge of Risk Diversification Across Markets

The stock markets are in turmoil.  I've been too busy searching for the great Oz in an effort to find out how to best invest in such a volatile environment -- too busy to blog in fact.  The answer has not been forthcoming.

One dependable theory of investing used to be that one could mitigate risk by diversifying across companies, industries and, yes, across markets.  With respect to markets, the thought was that the political, social, economic and other market influencers at work in one part of the world were not the same as were at work in others.  As a result, if the market were to decline in the U.S., there was an excellent chance that it would be still be going strong in Europe or Asia.

The performance of various broad stock market indexes over the past month of upheaval in the U.S. market suggests some problems with the efficacy of the latter part of this diversification theory.  For the month of January before the up-tick of the last 2 days, the broad U.S. market as measured by the Wilshire 5000 index was down 12.4% -- a pretty dismal month by anyone's reckoning; a month in need of some portfolio diversification away from such a bearish market.

Unfortunately here's the hook: over the same month, the performance of other key world stock indexes were as follows:

• China CSI 300      -- down 13.9%
• Russia MICEX       -- down   9.4%
• U.K FTSE 100       -- down 18.1%
• Japan Nikkei 225 -- down  14.8%

Thus far in 2008, it would appear that the worst place in the world to invest in stocks was the U.S., except for all the others.  It would seem that global financial markets are becoming so interdependent and that the information that shapes perceptions of market risk travel so fast and seamlessly that risk mitigation by diversifying across markets is no longer a viable strategy.

So what's the answer?  Investment and business decisions should not be based on market generalities, but rather on specific companies or opportunities.  If you're looking to export to Thailand for example, the question isn't so much whether Thailand's economy as a whole is good or bad, but whether the market dynamics regarding your product or service are good or bad.  Decisions shouldn't be based on the latest hot marker fad, but  rather on the following types of questions:

• Is there real money being made?
• Do the market dynamics make sense in terms of supply and demand?
• What market forces will allow the opportunity to be sustainable?

Of course this approach sounds like the lessons learned after the dot bomb meltdown a few years ago.  When investing, at a minimum one should avoid coupling a bad short term memory with a belief that globalization hasn't already happened.

[Note of attribution: The statistics on changes in global stock indexes from January 1, 2008 to January 23, 2008 taken from the Wall Street Journal -- Chart accompaning story entitled "Stocks Show Classic Bear Signals, And This Time, Impact IS Global"]

What English Shop Stewards Understand About Global Business that Ford Motor Company May Not

It's hardly news that Ford Motor Company has been struggling along with the other US car makers.  Actually, "struggling" is putting it mildly, having reported a net loss of $12.6 billion in 2006.

As part of it's strategy to turn the business around, Ford is exploring the sale of its Jaguar and Land Rover brands.  The company's announced intent is to focus on its North American operations and the Ford brand.  This strategy was highlighted in an article in today's Wall Street Journal reporting on a vote by shop stewards representing the Jaguar and Land Rover manufacturing operations in England on Ford's plans to sell those operations.  The labor leaders would prefer that Ford keep the operations itself, but, failing that, they voted to favor a bid by Tata Motors Ltd., part of the Indian conglomerate, Tata Group.

I think both the labor and management sides of this dance are instructive on the realities of the global market place.  What may be most interesting here, however, is that labor may have a better handle on where to cast one's hope for the future.

It's not surprising in the general that a company faced with major financial challenges would want to rein in its horns and focus on its core competencies.  Ford's case is interesting, however, if one drills down into their financial statements.  In 2006, the company sold over 3.5 million vehicles outside of North America, including almost 2.6 million in Europe, compared with just over 3 million in North America.  Thus, on a unit sales basis, by focusing on North America, Ford has decided to focus on less than half its business.   What's more, from 2005 to 2006, Ford's unit sales in South America grew 14%, its unit sales in Europe grew 2%, and its unit sales in Asia grew 9%.   At the same time, its unit sales in North America declined 11%.   So it has also chosen to focus on the part of its business that is shrinking over the part of its business that apparently has real growth potential.

According to management's discussion, the problems accounting for the losses in North America include unfavorable volume and mix and unfavorable net pricing -- i.e. bad business.  Conversely, management attributes increased earnings in South America to favorable net pricing and favorable volume and mix, and the company's improved results in Europe to favorable volume and mix and favorable cost changes -- i.e. good business.

I don't pretend to understand the automotive industry or the complex challenges facing Ford better than the company's management who is wrestling with these issues day in and day out, but looking at the company's own assessment of its business from the outside and given the advantages of being able to move in a global economy toward those markets in which you can grow as leverage against markets in which business is declining, it seems that Ford might want to focus on its international business as the source of its future success.   

The English shop stewards understand that they already work for a global company with ownership abroad.  They seem content to keep it that way.  In favoring Tata's bid over the other potential suiters, the labor leaders were looking for a company with an established presence in manufacturing and the willingness and financial muscle to return the brands to global competitiveness.  While their official position remains that they would prefer not to have any change in ownership at this point, they are evolving toward the reality that, with no domestic British acquirer in the mix, an Indian company focused on international growth and expansion might be better for them than an American company on retreat.   After all, it is a global marketplace and retreat is not an option. 

If Wal-Mart Can't Impose a Global Standard, Can You?

Even as it faces new challenges to its business model, Wal-Mart remains an entity with considerable market power and global reach.  As chronicled elsewhere in this blog, at $315 billion in sales (or gross company product if you will), if Wal-Mart were its own country, it would be the 21st largest economy in the world ranked by GDP, ahead of countries such as Austria, Argentina and Indonesia.  And the company has global reach -- with $63 billion in revenues derived from foreign markets, Wal-Mart's foreign sales alone would be sufficient to make the company number 21 on the Fortune 500. 

But among Wal-Mart's challenges is its ability to impose its business model in international markets.  The company is struggling in Japan and recently folded up its tent in South Korea and in Germany, moves that the Wall Street Journal attributes to the retail giant's failure "to adapt to local tastes."

Certainly one would think that if any company has the ability to act as a global corporation imposing standardization wherever possible to achieve economies of scale, one would think that Wal-Mart would be such a force.  But apparently even Wal-Mart needs to adapt to local tastes, cultural preferences and parochial market forces to succeed in its international efforts.  I think this underscores the reality that a small to medium size company seeking to enter global markets needs to go into it with an eye toward flexibility and customization, using the agility of its size as a competitive advantage.  One great thing about foreign markets is that they provide an entirely new playing field in which beating the Wal-Mart's of the world is a very real possibility.   

 

Micro-brews and Micro-markets -- Developing a Global Brand Portfolio

Sorry I'm late with a new post.  Any baseball fans will appreciate the fact that I've been busy reveling in the monumental feat the Colorado Rockies have pulled off over the past 2 weeks, coming from nowhere to climb over 6 teams into the NL playoffs with a story book late season run.  Of course the Rocks play at Coors Field, which is as good a segue as any into the interview with Leo Kiely, CEO of Molson Coors Brewing Co. that appeared in yesterday's Wall Street Journal (note: This on-line link is actually to the article as it appears in a reprint in the Denver Post).

In addition to being the number 3 (by sales) purveyors of beer in the U.S., the company is itself an international amalgamation resulting from the 2005 merger of Colorado's Coors and Canada's Molson.  In terms of international scope, besides its position in the U.S. market, the company is the largest brewer in Canada, the second largest in the U.K. and the third largest in Brazil.  In a testament to the fluidity of international borders in a global market place, even though Canada's Molson was essentially the acquiring company, with Molson shareholders garnering 55% of the combined company and Eric Molson continuing as chairman, the company's world headquarters are in Golden, Colorado -- a nod to the fact that when your shareholders, employees and customers are spread across the globe it may not matter much which flag you fly over the head office.

All of which brings me to the point -- i.e., what does it take for a company to compete in a global marketplace.   A continuing exploration in this blog has been the strategic necessity for global companies to change from Ted Levitt's conception of a global corporation tirelessly pushing standardization across all markets to a need to respond to micro-markets of consumer demand made all the more numerous by a company's geographic reach.  The beer market is another perfect illustration of this phenomenon.

In the foggy days of yore, beer drinkers in the U.S. fancied either Bud if domestic or Heineken for a more worldly palate.  Now it depends whether you're in the mood for a lager or a pale ale or something darker or a seasonal brew.  Local micro-breweries are able to grow into larger successes and the major brewers look to compete in the upscale market with brands that have no visible association with the company flagship.  Rather than attempting to get the world to drink Bud (which was the Levittian approach to global marketing), Anheuser Busch has put together substantial shares in foreign companies such as Grupo Modelo in Mexico and Tsingtao in China to compete effectively for market share among local tastes and preferences.   

When asked by the WSJ what it takes to succeed in today's environment, Mr. Kiely responded:

I think to be a successful global brewer today, you have to be really good at portfolio selling.  Having a strong portfolio of local brands, augmented by a big potential global brand like Coors Light, is really the formula to success looking forward.

I can say from my own experience in industries very different from beer, having a portfolio of local brands that appeal to local tastes and preferences tied to a corporate brand that speaks of global presence and capabilities is indeed a good start on a winning formula.  As for standardization of product offerings, the beer market in the U.S. alone is becoming increasingly fractured as brewers both large and small offer a growing variety of boutique brews aimed at the many micro-markets of tastes and lifestyles.  If standardization no longer works as a strategy in a company's domestic market, it would seem that expanding to international markets would only compound the effect.         

LIBOR and National Funds Rates -- How the Globalization of Markets Displaces Politics and Governments

Between hedge funds and mutual funds and international M&A activity, markets for credit and debt instruments have gone global.  As a result, what started as the sub-prime mortgage implosion in the U.S. has caused tightened credit across international financial markets. 

The money used to fund mortgage loans to otherwise uncreditworthy buyers was raised largely by reselling the mortgages in pieces on the secondary markets.  The idea, not unreasonable at the time, was that this spread the risk of default across a wide swath of secondary instrument buyers, each of whom held a diverse portfolio of slices of potentially bad loans.  Unfortunately the result in retrospect has been to spread the credit collapse across the world like a passenger with a bad cold on a long intercontinental flight. 

Large banks around the world wound up holding, either directly or through participation in hedge funds, enormous portfolios of securities whose net asset values were crashing as the underlying loans supporting that value went into default.  As banks saw their asset base declining, they tightened up their lending practices accordingly.  More than just tightening their lending of money, a couple of large banks, most notably in France and Germany, barred certain customers from even withdrawing their own money held on account -- often a sign of a real impending banking meltdown.

Tight credit leads to a corresponding decline in consumer and industrial spending in an era of borrow now and pay later budgeting.  And a sharp decline in private sector spending can quickly lead to an economy spiraling downward into recession.   Not surprisingly in the face of this prospect, and bolstered by nervous constituents about to see a cutback in their credit enhanced lifestyles, governments around the world are trying to loosen up credit markets in the hopes of keeping money on the street and the economic engine well-oiled.

The vehicle that governments use to accomplish this is to lower their equivalents to what in the US is called the federal funds rate, that is the rate which the central bank charges its national constituent banks to borrow overnight money.  By lowering the cost of money from the central bank, the expectation is that the constituent banks will borrow more money which can then be put out onto the street through a chain of loans to each banks respective customers.   

This all worked quite well of course so long as banking was largely a business that operated within national borders so that the principal source of new money to a country's major banking institutions flowed from that country's central bank.  Changes in the federal funds rate would cascade down through the system and each country's government could use this monetary control to ensure that its political / economic agenda was pushed out into the market place.

As with all these national policy constructs, a funny thing happened when the economy went global while governments remained national.    Large international banking companies, it tuns out, raise much of their capital through the trading of securities and purchasing of credit instruments (i.e. borrowing money) from other international banks.  Money flows around the world markets very much like every other good and service.  In order to regulate this commerce through a market price mechanism, international interbank borrowing is generally pegged not to an individual county's federal funds rate equivalent, but to the London Interbank Offered Rate or LIBOR. 

LIBOR is essentially the interest rate charged by banks on short term loans made to each other.  The rate is set daily by a distinctively private sector institution, namely a British banking trade association.  It has become so widely accepted as an international standard for the cost of short term money, that the published rate is also used as a bench mark for a wide variety of private financial transactions, from intra-company lines of credit to adjustable rate mortgages.

Here is the rub -- when lending money gets riskier, in a free market, the cost of borrowing money goes up to adjust for that added perceived risk.  Thus, while government controlled central banks are lowering rates in an effort to ease credit, LIBOR which is a private market based rate is going up to reflect the fact that all these defaults are making credit more risky than previously perceived.  And since so much money flows through international financial markets based on LIBOR pricing rather than the federal funds rate, the increases in LIBOR may well offset any efforts that governments are making at easing credit markets and increasing the flow of funds.

Somewhere here lies a fundamental philosophical question -- i.e. in the long run, are we better off responding to problems like the subprime mortgage mess by having prices reflect changes in supply and demand in private markets or by having prices reflect the government's view of sound political / economic policy (the government being made up of learned experts or bureaucratic buffoons depending on your personal point of view).  Then again, as with many other such questions, the seemingly inevitable globalization of markets may have rendered our individual answers to such questions largely irrelevant.

[Note of Attribution: This post as with most is an application of my thinking over the past couple of months around a plethora of articles and sources on the subprime mortgage mess and the reactions of central banks and financial markets.  To give credit where credit is due, however, the immediate inspiration to get it down in a blog post came from an excellent article on the subject that appeared in this past Wednesday's Wall Street Journal entitled "Why Libor Defies Gravity: Divergence of a Key Global Rate Points to Strain".]