Nostradoofus

What happens to the price of new things when you can get absolutely anything used?

Any frequent eBay user has done something like what I did last month. I decided to upgrade a creaky 2000-vintage Dell server with 5 new hard disks. Each disk needs a little mounting tray, made only by Dell. Total cost to buy the trays and disks through Dell is about $1,000.

Enter eBay. After a 5-minute search, I found a guy in Arizona selling the exact same thing for a total of $75, including shipping. How does the guy in Arizona do it? He buys and disassembles ancient Dell servers, adds overstock new hard disks purchased in bulk, and resells to guys like me. EBay is almost perfectly competitive, so prices are driven nearly to marginal cost. Total saving: 92.5%.

EBay is still growing fast, of course. What happens between now and the equilibrium point, someday in the future, when everyone routinely buys and sells used items that way?

Beneficial deflation.

Prices on all readily shipped manufactured goods appear likely to fall in real terms. The longer an item lasts, the farther the price seems likely to fall, as the market is saturated with an ever-growing supply of used items.

Given the global imbalance in manufacturing these days, you might interpret this as great news for the US, and terrible news for China. What happens to China’s toy manufacturers (which now make 85% of all new toys worldwide) if parents suddenly start buying used toys for Christmas? Don’t laugh — it’s still very early in this transition. Culture can change in unexpected ways when presented with huge financial incentives.

If something like that happened, toy makers would be forced to compete on a large scale with their own past output. The results aren’t pretty. Manufacturing overcapacity. Falling prices. Intense pressure to innovate and automate. It’s a consumer’s dream and a manufacturer’s nightmare.

Naturally not every product works as a used item. But this force is so powerful, and its effects so far-reaching, that it might not be such a bad thing that manufacturing is all going offshore…

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Biologists have come to recognize that the untrained human mind is not a reasoning machine, but simply a bunch of evolved heuristics that imitate reasoning. Good marketers already know this. Economists and politicians, take note.

Historically, the smartest politicians know that everyone loves the underdog. The smartest ones set policy to make themselves appear the underdog.

Recall Clinton’s self-anointment as the “Comeback Kid.” Why was that appealing? Fundamentally, and whether Clinton understood this or not, it was because human minds are predisposed to prefer the story in which a local boy overcomes the odds to win the title.

This applies in particular to war policy. If only Bush understood it. Unless given a good reason not to, people instinctively root for a plucky rebellion against imperial power. Smart policymakers try to position themselves as the underdog, the defender, or the offended party.

Abraham Lincoln understood this. In 1861, when he took office, much of the South had already seceded, and he had only tenuous support in the North to fight for the Union. A simple invasion would actually have galvanized opposition in both North and South, preventing him from being re-elected, and probably preventing the survival of the Union.

So what did he do? With much fanfare, he sent a supply convoy to the Union’s Fort Sumter in South Carolina, which had already seceded. But the ships did not land, and Lincoln did not attack. He simply waited offshore, looking threatening, until the South Carolina militia attacked the fort.

This was the pretense Lincoln needed. For the next 4 years, he managed to hang on to popular support for a bloody, divisive conflict, largely because he could argue the whole thing was defensive. The South had fired the first shot. They became Goliath, the Union David.

Fast forward to 2001. The United States invades Afghanistan, a sovereign nation, and no one complains. To the contrary, nations around the world are pouring their hearts out to support America. Why? Because there was a smoking-gun connection to the 9/11 attacks, so we could credibly claim that the invasion was actually defensive. The U.S. had managed to portray itself as the plucky defender against a global al Qaeda conspiracy.

Fast forward to 2003-5. Everyone suddenly hates American imperialism. Why? Because no credible case was made that an Iraq invasion was defensive. I’m not asserting that no credible case was made; I’m observing that no credible case must have been, given that most now perceive the U.S. as an aggressor. Iraq became David. America became Goliath.

The extent of America’s diplomatic foolishness here only comes into focus when you consider that this conflict’s David was one of the most reviled autocratic rulers on the planet. Yet we’re still the bad guy. There should be a signal here that we blew it in the PR department.

Note that nothing in this article argues against the invasion. It argues that the justification was amateurishly handled, given readily observable traits of human motivation.

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There is a battle brewing between Google and eBay. Google looks stronger.

Adwords is a significant substitute for eBay. Small vendors can buy customer visits through micropayment advertising, as an alternative to paying eBay an auction fee for access to eBay visitors. Signals have been accumulating for some time:

1. eBay discovered in January that it no longer has power to raise auction prices, because larger sellers are balking.
2. eBay announced it is entering the private-label merchant site business, to slow down departures of its major sellers.
3. Google announced Tuesday it is entering the payments business.
4. It’s been true since Adwords inception that Google does not accept PayPal as a form of payment.
5. Meg Whitman was caught angling for Eisner’s job at Disney a couple of months ago.

Taken together, one might infer that Google plans to eat eBay’s lunch, and eBay is scared. Will be interesting to see what happens.

I don’t mean to suggest eBay would cease to exist. Their auction business is still great, still a natural monopoly. However, a big chunk of eBay sales (a third? don’t know for sure) come from professional sellers that aren’t really auctioneers, but rather fixed-price vendors holding auctions to take advantage of eBay’s network. They would probably rather operate their own websites and run their own ads, if they can make just as much that way. Their presence on eBay has never made sense to me — private sites and Adwords are a simpler, better branded, more logical arrangement, if the scale and ROI are similar.

See this post in its original implication at Income Profiles.

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U.S. industrial policy should aim to identify competitive dynamics and limits of offshoring, and feed this understanding back into the educational and research grant system.

Note I don’t say, “stop offshoring,” or “do more offshoring.” Offshoring is just a plaything of Adam Smith, like the electric motor. It happens, and you plan around it. All you can do is build a society that is competitive in the new circumstances.

For example, suppose — and this is just one possible direction — suppose that we’re on a trajectory in which 99% of software development ends up in well-educated developing countries. This might mitigate toward U.S. universities teaching abstract system design instead of implementation. It might imply creating new, extremely high leverage programming languages like Ruby. It might imply new modes of industrial organization such that a substantial part of the value chain is still captured here.

At minimum, the U.S. should be funding university research on this subject. While they still can. As the founder of India’s InfoSys told The World Is Flat author Thomas Friedman, “The global playing field has just been leveled, and you Americans are not ready.”

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This “is China the enemy?” stuff in the press is silly. China is not an enemy but a rival for geopolitical leadership. That’s an important distinction.

Does that matter? Yes. There is a game theory aspect to geopolitical ranking, such that we do enjoy benefits of leadership. We already speak the language of global commerce; we issue debt denominated in our own currency, at favorable prices; and we have outsize geopolitical influence.

China’s victory in this rivalry is almost inevitable: because of the huge population, they need attain only the GDP per capita of Mexico to take the global #1 position in aggregate GDP.

So what is an American geopolitical strategist to do? How could China dominance be delayed or prevented (if that were even desirable, which is a different question). Well, you could try to cause China to be broken up, to slow down its growth, or to speed up your own growth.

The first two require interfering with the rival’s internal politics, which would almost certainly turn rival into enemy. It’s a really bad idea to make an enemy of your biggest rival, as Japan and Germany learned in the 1940s.

So the only viable alternative is to improve yourself: increase your own growth and/or population to retain the lead as long as possible.

For example, note that China’s population growth rate is slowing, while America’s isn’t. With clever management, the U.S. may be able to increase GDP per cap by 4% between now and 2050, at which point we’ll have 600 million people. If China by then has a mature growth rate and population of only 900 million and falling, then U.S. dominance might be extended by 100 years or more.

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Lest we think all regulation is bad, look at unregulated Baja California.

Baja should be a tourist magnet: it has 2,000 miles of warm coastline, dry to subtropical weather, and rich and unusual flora, fauna and natural beauty. It is adjacent to California, one of the most prosperous places on the planet.

Yet outside of Tijuana and Cabo San Lucas, the whole peninsula sits impoverished and abandoned. Why? Too little regulation. Property rights are weak, so property doesn’t stay bought, leaving little incentive to develop. Government builds almost no infrastructure, so there’s little water (despite a huge, mostly untapped acquifer) or electricity. Bandits occasionally run amok for lack of adequate policing.

The environment is being trashed. Inside Baja’s national park, spraypaint graffiti covers boulders for mile after mile. Trash litters fields. Truckers perform roadside oil changes by simply draining engines directly onto the ground, leaving toxic black slicks at turnouts. Outside the national park, it’s worse.

Now imagine what would happen if the U.S. bought Baja, subdivided and resold it to developers, and used the proceeds to build infrastructure. A property gold rush, coincident with environmental cleanup. Why? Regulation — of property rights, civil order, environment, and much more.

Chew on this before you check “Libertarian” on your next voter registration card. A little bit of carefully designed, universally applied regulation is much better than none.

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Say you are a doctor trying to collect payment from Blue Cross. You employ an offshore call center to do your collections. Your guy in India phones Blue Cross, which also employs offshore call centers to process payments. The call is patched back to India. Presto! Two call centers are yakking with each other on your nickel.

Picture two sari-clad women walking into a Bangalore office building each day, saying, “Morning Ralph. Morning Sam.” They sit with headsets in adjacent cubicles, arguing about American medical payments — with each other — for 8 hours. “Good night Ralph. Good night Sam.” Repeat for 40 years.

Adam Smith works in mysterious ways.

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In the past 10 years, we have witnessed two of the four biggest asset bubbles in U.S. history: the Nasdaq in 1997-2000, and the mortgage bubble of 2005 (and counting). (5/3/07 update: a third mega-bubble is now taking shape in private equity.)

Irrational exuberance runs rampant, it seems. Why?

Interestingly, this historical anomaly has occurred at almost exactly the same time that SRI drugs (seratonin reuptake inhibitors, including Prozac, Paxil, etc.) rose to prominence, with millions of prescriptions written. Their express purpose: to make you exuberant, regardless of circumstances.

Not to say SRIs don’t serve a legitimate purpose. But somebody ought to run a regression analysis of Prozac prescriptions against Nasdaq — there’s a story there.

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To see the truth, ignore what people say, and examine their incentives and actions. Here’s a great example.

Iran enriches uranium for, they say, “peaceful purposes.” Now, why would the world’s 4th largest oil producer need nuclear power? They can extract oil practically free, and generate electricity from oil at less than a tenth the cost of nuclear.

What, then, could be their only remaining incentive for developing nuclear energy? Of course they are building a bomb.

The U.S. habit of shouting and beating drums is much less effective than simply pointing out the comical misalignment here between statements and incentives.

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