...that WAS a nice rally, NO?
We had ML SUX Upgrades, AJC yapping the "worst is over" and tons of other guru's yapping and posting like mad....seems too good a short to be true <GGG>
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nice stuff here, factual:
Global: The Next Leg of the IT Downturn
Stephen Roach (New York)
There’s no dark secret to the abrupt about-face in the US economy over the past year. It has been dominated by a stunning reversal in business capital spending, especially for information technology (IT). But this technology is, of course, different. IT is widely viewed as the sustenance of a New Economy that is revolutionizing America and, eventually, the world. As such, most believe that the United States can’t do without it -- that it’s only a matter of time before the once powerful IT growth machine starts humming again. How close at hand is that magical moment?
I suspect the answer lies in the deep recesses of a most unusual capital spending cycle. There can be no mistaking the IT-led down-phase of this cycle. Over the past four quarters, current-dollar outlays for business fixed investment have declined 2%. Shrinking IT budgets -- which currently account for 47% of all business equipment spending and 34% of total business outlays on plant and equipment -- explain this entire drop and then some. The year-over-year IT comparison went to -6.5% in 2Q01-- a dramatic reversal of the +16.6% surge over the prior four quarters. Significantly, the year-over-year decline understates the full force of the IT-led downturn. On a sequential basis, current-dollar IT outlays fell at a 22.6% annual rate in 2Q01. As steep as this decline appears to be, there’s every reason to suspect that it’s only the beginning. The capital spending share of nominal GDP still stood at 12.4% in 2Q01; while that’s down 0.8 percentage point from the cycle peak of 13.2% in 3Q00 (downwardly revised from 13.9%), it is still well in excess of the post-1970 norm of 11.6%. Moreover, history suggests that capital spending overshoots are usually followed by undershoots; for that reason, alone, there’s probably a good deal more to come on the downside of the current capital spending cycle.
(Note: In this essay, all capital spending and IT data are expressed in current dollars. This avoids the rather dubious "hedonic" adjustments that form the basis of the deflation exercise into constant-dollar, or real, outlays. By using the current-dollar variant of IT, I am focusing on actual dollars spent -- not a statistical construct of quality-adjusted computing power.)
But there’s another more important reason to look for further weakness in the IT cycle. Thus far, the bulk of the consolidation has been concentrated in business spending on hardware. Since peaking in 4Q00, business spending on computers, telecommunications equipment and other IT hardware has plunged at a 31% annual rate. By contrast, business software outlays have declined at just a 5% annual rate over the same two-quarter interval. As a result, the software share of current-dollar IT budgets ballooned to 43.6% in 2Q01 -- an increase of nearly four percentage points in the past two quarters, alone. While the software share of total IT spending moved up especially sharply in early 2001, this merely continues a trend that has been under way for years; indeed, this share stood at a pre-bubble low of just 31.1% in 2Q95. Over the six years ending in 2Q01, software outlays accounted for fully 60% of the total growth in business IT spending. Make no mistake about it, the recently ended IT boom was more about software than hardware.
I suspect that the software cycle will now follow the hardware cycle to the downside. I base that conclusion on what I believe is a fairly rational relationship between software and the hardware that it is supposed to run. Over the 1990-97 interval, for every dollar spent on computers and peripheral equipment, another $1.40 was spent on enterprise software; it was lower in some years and higher in others, but the relationship held in a relatively tight range. However, over the 1998-2000 period, the software outlay per dollar of hardware rose to $1.70. This appears to reflect the explosive growth of B2B and, to a lesser extent, B2C. However by 2Q01, US businesses were spending $2.09 on software for every dollar of computer hardware -- an unprecedented misalignment between these two major pieces of the corporate IT budget well in excess of that realized at the height of the e-commerce frenzy. Recent history demonstrates that software cycles normally follow hardware with a lag. That was the case in the early 1990s and again in the middle of the decade. And I have every reason to suspect that it will be the case over the next year. The only difference is that when the downside of the software cycle hits this time around, it will come off a much higher base as a share of total IT than it did in the past. As a result, the macro consequences of a software downturn are likely to be considerably greater this time around.
But there’s probably a much deeper meaning to all this. The IT downturn strikes at the heart of America’s fabled New Economy: It challenges the great productivity saga. Dick Berner hinted at this in a recent piece describing the government’s annual revisions to the GDP accounts (see his 30 July Forum dispatch, "Corporate History Rewritten, Darkly"). To the extent that the resurgence of productivity growth in the latter half of the 1990s was a by-product of a powerful wave of IT-led capital deepening -- a substitution of capital for labor -- a downturn in such spending would be expected to crimp productivity growth. That’s exactly what the latest numbers have shown, with productivity falling at a 1.2% annual rate in 1Q01 (latest available estimate). In addition, the just-unveiled statistical revisions point to a significant downward revision of the productivity windfall in recent years -- probably knocking at least 0.5 percentage point off the previously published trend over the past couple of years (data to be released on 7 August). Little wonder the corporate earnings carnage has been so severe. The productivity dividend of the New Economy has turned out to be a good deal smaller than it was initially thought to be.
Which takes us to the age-old question: Is the IT productivity payback temporary or sustained? The capital deepening thesis argues in favor of the former. During a period of surging investment in new technologies, the math of economic growth virtually guarantees a pickup in the productivity trend. Output is boosted temporarily by surging tech spending; if that spending happens to be labor-saving -- precisely the case insofar as the measured data on labor input suggest -- then a productivity dividend is virtually automatic. (Note: That of course, raises the labor input measurement critique, a point I have addressed ad nauseam; see my 11 July Forum dispatch, "Measuring Work Time.") But once the investment surge runs its course, mean-reversion takes over on the productivity front. It literally takes a New Paradigm to repudiate this math. Maybe that day will come, but I suspect it’s still way down the road.
The hype of the Information Age has, of course, led many to draw a more upbeat conclusion. But in my humble opinion, this new era is still very much a combination of hype and substance. The substance rests largely on the world’s new connectivity and processing capabilities. These breakthroughs are truly extraordinary and could well lead to revolutionary changes in the economic organization of communities, companies, and nation-states, although we are in the very early stages of such a transformation. But the hype is also unmistakable. Ten years later, I’m still waiting for my first clean video conference call, a cell phone conversation that doesn’t get disconnected, and a remote computing experience that is painless and time-efficient. Yes, we’re getting there. But for all the hyper-speed of the Information Age, the progress is coming at a snail’s pace. And it’s progress with a fully loaded cost bill that blows the mind -- to say nothing of the profit margins of a vast corporate user community.
This IT downturn will probably go down in history as a critical juncture on the road to the New Economy. And if I’m right, it’s far from over. Painful as it is, the purging of IT excesses also offers a time for reflection -- an opportunity to relearn the art of rational decision making. Only then can lasting value be extracted from new technologies. All of that was missing during the bubble. Until it popped. As I said, there’s probably a deeper meaning to all this.
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United States: Refunding Preview
David Greenlaw (New York)
The Treasury will announce details of the upcoming refunding auctions on Wednesday morning at about 9:30 a.m. We look for a standard package consisting of $11 billion 5-year notes, $11 billion 10-year notes and a $5 billion 30-year bond. The 5's and 30's will be reopenings.
Earlier this week, the debt managers indicated that they are reducing the targeted amount of buybacks in the current quarter -- from $10 billion to about $8.75 billion. This came as a bit of a surprise. We had thought that the somewhat smaller than usual operations conducted during July were a reflection of a temporary shortfall in the Treasury's cash position and would be made up once the new 4-week bill program got underway. However, it appears that the debt managers don't want to push the size of individual buyback operations above $2 billion. So, the $8.75 billion quarterly target is a signal that they will revert back to $1.75 billion or so operations in August and September -- but will not "make-up" for the smaller operations conducted in July.
This raises some uncertainty surrounding the likely pace of buybacks in coming quarters. In today's announcement, we suspect that they will indicate that they are sticking with a target right around $9 billion for Q4. Longer term, we continue to believe that budget surpluses will be sustained and that the pace of buybacks will escalate by 2003. For a more detailed discussion of our long run expectations for Treasury financing see "Now You See It, Now You Don't (Or Do You?)" in the July 16 Global Economic Forum.
Finally, it's worth noting that neither Brian Roseboro, the recently appointed Treasury debt manager, nor Peter Fisher (his boss), has been formally confirmed yet by the Senate. Since they are just getting up to speed, it's doubtful that there will be any major changes to the Treasury's financing strategy announced this time around. We're probably more likely to get some hints about the prospects for buybacks, TIPS, and bond issuance at the November refunding announcement.
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Thailand: Understanding Mr. Thaksin's New Development Model
Daniel Lian (Singapore)
Prior to the 1997-98 Asian crisis, Thailand, like Malaysia, was viewed by the global investment community as one of the more promising blue-chip emerging markets. Its attractions were underpinned by rapid export-oriented industrialization and an aggressive expansion of its domestic capital markets. The country, however, has been languishing since the crisis and is increasingly being labeled, together with Latin America, as offering poor growth prospects and hampered by a bad-debt and bad-asset overhang that threatens its fiscal sustainability and stifles credit creation. Thailand appears to be rapidly losing its appeal to international investors.
My prior pieces on the East Asia Economic Model (see "Dismantling the East Asia Economic Model" and "Tycoon versus Labourer") outlined reasons why I believe the single-track East Asia Economic Model (EAEM) of FDI by multinational corporations (MNCs) can no longer fulfil the development needs of most Asian countries. China, we argued, should successfully create a dual-track EAEM (combining the export growth model with the promotion of competitive domestic enterprises) to the detriment of other Asian countries that are sticking to the single-track EAEM. In this respect we are in agreement with Thailand's policymakers.
Single-Track EAEM Has Not Benefited Thailand's Development
While we acknowledge the single-track EAEM strategy has created jobs and promoted growth, it was largely an illusion of prosperity. The single-track EAEM earned Thailand no pricing power on its exports but bred excesses that eventually led the kingdom to the devastating 1997 crisis. The model encourages excess investment in production capacity and unproductive assets. MNCs, attracted by fiscal and infrastructure incentives and cheap labor carried out the former. The latter was carried out by local corporate giants that thrived on infrastructure contracts and monopoly and oligopoly rights granted by governments on non-tradable goods and services, financed by cheap bank and international credit. In a nutshell, the pursuit of EAEM has subjected the Thai economy to the malaise of triple global imbalances, resulting in weak pricing power for Thai exports.
The single-track EAEM has not benefited the country's development because the comparative advantage analysis (a country should specialize in producing goods where it has a comparative cost advantage) put forward by proponents of EAEM and traditional economists are flawed, in our view. As a result, Thailand was indiscriminately placed, together with other developing countries, in the generic "labor rich, capital poor" camp and prescribed the standard FDI-MNC export model. While we do not dispute that Thailand is labor rich and capital poor, this simplistic grouping has ignored certain strengths of the Thai economy (discussed below). The result is that the country has been prescribed an inappropriate development remedy.
We believe that Thailand cannot create sustained prosperity, as it is unable to achieve pricing power under the mass-manufacturing export development model. Supporters of EAEM, citing that Thailand's comparative advantage is its abundance of labor, tend to give one of two reasons why Thailand should stick to EAEM:
(1) Economic development is a long process and it will take time for Thailand to move up the value chain. Stick to the law of comparative advantage, be patient, and the country will eventually graduate and move into the next phase of the value chain.
(2) While recognizing that Thailand cannot fully move up the value chains through EAEM, EAEM is not necessarily inappropriate. An inadequate education system and lack of an IT foundation in schools and industry at large are obstacles, which could be overcome by investment in education.
We reject the above analysis, as, in our view, it is based on a flawed analysis of Thailand's comparative advantage.
Key Attributes of the New Model
From discussions with senior policy makers in Thailand we have been able to gain a better understanding of Mr. Thaksin's alternative development model. The new model, in a nutshell, is to grow SMEs that utilize locally embedded skills to create new products and services to cater to the discerning tastes of affluent middle and upper class global consumers. The overriding objective is to secure pricing power and raise living standards.
Below we elaborate on what we view as the two important attributes of the new development model:
(1) We believe that Thailand's comparative advantage does not lie in its abundant cheap generic labor that catered to mass-industrialization, but rather a population and workforce endowed with an aesthetic culture and tradition, supplemented by rich natural resources. Indigenous enterprises have a long tradition of creating unique products such as food processing, alloy toys, textiles, and ceramic products. This tradition and these artistic skills, coupled with a rich and diverse geography, mean that Thailand's mass-tourism industry can also be transformed into a higher value-added export sector.
However, there are two major obstacles to developing these industries to a critical mass sufficient to support and increase living standards: First, the lack of support for these industries to enable them to "blend" the embedded local skills with international technology (not IT, but knowledge on consumer tastes and marketing); second, the need to create international brand names to secure pricing power. The present government is addressing both impediments.
(2) These skill-driven enterprises require no large industrial base, as optimum size dictates they are SMEs. Thus, they are appropriately called skill-driven SMEs (SDSME). Such enterprises organize workers who excel in their local skills and other inputs in a flexible manner. As a consequence, they are able to adjust to shifting global demand and supply. Excess capacity is thus no longer an issue or problem.
Therefore, under Mr. Thaksin's new paradigm, these SDSMEs will bring new products and services to the international market on improving terms of trade and pricing power, based on flexible production capacity. They stand in sharp contrast to the organization of production under the single-track EAEM paradigm, where supplying mass-produced industrial products through MNCs, which often overbuilt capacity, meant workers were at the mercy of swings in global demand.
Why the SDSME Is a Workable Model?
We believe SDSME is a workable model for the following reasons:
-- It leverages the true comparative advantage of Thailand outlined above, i.e., the aesthetic tradition and artistic nature of the population endowed with local skills and rich natural resources, rather than the supply of cheap labor for MNC-driven industrial production.
-- It practices sound basic economics. Thai producers will be shifted from meeting a single elastic demand curve to simultaneously selling many different products in separate downward-sloping demand curves. The result obviously would be increased pricing power, as the Thai economy would not suffer from worsening terms of trade. Nevertheless, effective execution, as well as managing the transition from one development platform to another, is key.
-- It adheres to global economic dynamics. Global trade and capital flows will continue to dictate global economic dynamics, and a workable development model cannot reject free trade and global capital. In our view, Thaksin's model is an export-based, outward-looking paradigm. This is contrary to the perception that it is inward looking, based either on the concept of domestic subsistence self-sufficiency or on the import substitution model. By pursuing such a strategy, we believe Thailand will no longer compete with China and other emerging markets on the EAEM platform.
-- It caters to the increasing trend toward more affluent global consumers. Under the EAEM platform, Thailand is more exposed to swings in global investment demand rather than global consumer demand. This is a function of the fact that a large part of the existing manufacturing base is linked to the global investment cycle (i.e., often these are parts for global industrial goods -- IT and automobile are two such examples). More importantly, consumption by discerning and affluent middle and upper class consumers appears to be growing much faster than overall consumption. In our view, it is a correct and far-sighted strategy to target niche but direct consumption demand from upwardly mobile and affluent households in Europe, North America and Japan, Greater China and elsewhere.
-- It helps avoid both excess industrial capacity and financial excesses. Excess capacity, a major weakness of the EAEM model, will be replaced by a more flexible production capacity. SDSME entrepreneurs will divert capacity based on the shifting tastes of global consumers. The model also substantially lessens the chances of a repeat of past financial excesses and the creation of unproductive assets by uncompetitive local corporate giants.
-- It rolls back excessive urbanization. Both urbanization and industrialization have occurred at a major social cost to the Thai economy, as evidenced by income disparity and environmental damage in Bangkok. We believe the SDSME model will promote de-urbanization, as production can take place in a sub-urban/semi-rural setting.
Misconceptions about the Alternative Development Model
International investors and EAEM proponents are worried that adopting an SDSME model would result in dismantling the EAEM. We do not believe this to be the case. Rather, we believe the new strategy resembles an effort to reinvent the single-track EAEM as a Thai version of the dual-track EAEM. The reasons for this are given below:
-- The alternative model is not anti-foreign or anti-MNC. The single track, MNC-sourced FDI EAEM will run parallel with the new strategy as long as they both contribute to the Thai economy. However, the type of foreign investment that will be actively courted is from foreign corporates looking to forge synergies with local enterprises. International fashion houses, health food companies, art galleries, and exotic tour operators are more likely to be investors and partners under the new paradigm than Toyota, IBM, Thomson, or GoldStar.
-- While rolling back its reliance on MNC-sourced FDI, Thailand will honor its international financial obligations. We have analyzed the country's fiscal and external debt situation extensively and believe that the fiscal situation is sustainable and external debt will be met by adequate external liquidity.
-- Mr.Thaksin's other macroeconomic policy of rejuvenating the rural sector is at the core of this model, as a revitalized rural sector will provide the impetus and required inputs for SDSME growth. We believe his program to develop alternative financial institutions (i.e., setting up credit cooperatives to tap rural savings and to provide financing for SDSME startups, and SME banks), is an attempt to develop the SME sector, rather than to sidetrack the big domestic commercial banks or foreign financial institutions.
Potential Hurdles to the SDSME Growth Model
The SDSME model is an attractive one, in our view. However, we also identify several significant hurdles:
-- Under the EAEM single-track model, external demand has been readily identified and met by MNCs through their link to global IT and industrial goods supply chains. Under the new paradigm, Thai producers would have to identify and exploit simultaneously many different consumer markets. This requires good and up-to-date market intelligence and penetration, something that has typically been the strength of service producers in developed countries rather than in developing countries.
-- Government participation is significant and could be a drag on the fiscal sector. As the government has to identify start-ups and engage in direct investment and lending until the SMEs have the critical mass to warrant bank credits or even IPOs, it will be a significant stake holder in the development.
-- At present, the Thai education system does not cater to the IT/New Economy or the SDSME model. Its IT orientation is weak and it does not promote creativity. As the government does not believe that comparative advantage lies in IT/New Economy, the education system will be revamped to stress creativity to leverage the country's esthetic heritage. This change in the education landscape will be less costly and less time-consuming than a shift towards IT/New Economy but nevertheless will still take considerable time.
-- Managing the transition is another major hurdle. The Thai economy has invested heavily in the EAEM model for almost three decades. Unwinding certain EAEM economic activities will exacerbate cyclical and create structural problems, in our view. As such, growth of the SDSME model will need to match the unwinding of EAEM to lessen the economic pain.
Bottom Line: The Antithesis of Single-Track EAEM Is Born
As spelled out in "Dismantling the East Asia Economic Model", and "Tycoon versus Labourer," Asia needs to either dismantle or reinvent EAEM. Mr.Thaksin's SDSME model is the antithesis of EAEM, in our view. He aims to shift from supplying cheap labor to MNCs to mass-produce IT or industrial products at the lower end of global supply chains to capitalizing on selling differentiated branded products and services to affluent global consumers. We believe the single-track EAEM has outlived its usefulness for Thailand, and that Thaksin's new economic paradigm could be an effective alternative to single-track EAEM.
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