A Theory of Union-Employer Dynamics

A few weeks ago, an Ontario PC’s White Paper publication titled “Paths to Prosperity: Flexible
Labour Markets” made national headlines for proposing what some analysts called “bold” labour reforms. As usual, whenever anybody shines a negative light on unions in this country, the public reaction is rarely friendly. But whether you side with the Progressive Conservatives or unions, the issue at stake has little to do with economics, prosperity, or economic prosperity. What we are hearing are the drums of an emerging political war.

Listening to politicians talk about “the economy” is like hearing Bieber music, I struggle to find deep meanings behind these strings of words put together to please certain ears. The unions aren’t any better. Their responses have been poor. My favourite criticism comes from PSAC - Public Service Alliance of Canada; Canada’s largest public service union is calling Ontario PC’s Flexible Market a “scam”. These types of rhetoric effectively lower the credibility of both sides for a well-intentioned public discourse.

In Mr. Hudak’s introduction, he cites that Ontario lost over 300,000 manufacturing jobs since 2008. Though not stated explicitly, the underlying tone in the Ontario PC’s “Flexible Market” is to blame unions for the decline of Ontario economy, which saw a growth of just 0.3% in employment over the past year (Statistic Canada). Essentially, the Ontario PCs’ reforms attempt to reduce the power of unions as means to “open” the market and to enhance labour and capital allocation. Weaker unions imply lower wage, less workplace regulation, thus a more “flexible market” that attracts businesses and investments. Will this approach eventually lead to job creation and prosperity? I’m not the only one skeptical of this game plan. As Harvard
Professor Michael Porter points out, lower wage is not a source of long-term competitive advantage.

Even if the PCs have the right idea to improve union functions, they are selling it the wrong way to the public. Because of the general lack of substance and excessive “hand-waving” in the report, it’s not a surprise that many critics find the Ontario PC’s “paths” as a distasteful attempt to undermine union powers behind a promise of “economic prosperity”. The PCs’ mistake is fatal; as policy-makers, they are failing to understand the real problems. The critical component they missed is the dynamics between unions and employers. After all, unions cannot exist without employers. We need to balance both sides of the equation to establish an equilibrium.

At the core of the union-employer is an eternal conflict surrounding the wage. Employers want to pay less, workers want to earn more, from which forming an innate conflict. While both sides gave valid theories to support their respective stance, history provides a greater understanding on whether high wage is sustainable, and if so, under what conditions.

When Henry Ford introduced assembly lines to Ford Motors in 1913, factory workers from every corner of America converged to Detroit to work for him. Even this day, Ford Motors is proud of this segment of history. Not only did the method of assembly line production revolutionized the manufacturing industry, Ford also paid workers $5 a day while the national average was $750 a year (or less than $3 per day). $5 a day was the “American Dream”, and Ford made it possible.

How is it that an automotive company had altered the fate of Americans in such a short period of time? Answer: management. Ford Motors was able to provide such high wage and low price for its cars because its managers found a more efficient  way to build cars through assembly lines; they turned production into algorithms that produced consistent results (for more on algorithm, see Roger Martin’s book “The Design of Business”). The workers are, of course, justified with such high wage because of their overall productivity. Within a decade, they turned Ford into the largest automobile manufacturer in the world.

Our “$5-a-day-at-Ford” story tells us it isn’t out-of-this-world to pay workers above-average salaries as long as the firm has the comparative advantage in the industry to back it up. Firms can become more competitive through product and process innovation, as well as sound management. Paying higher salaries could be beneficial to companies as it allows them to attract the best workers to produce products of the finest quality. There could be a “win-win” outcome for both the employer and employees. The responsibility is upon the managers to optimize their use of human resource and establish a new equilibrium at a higher wage level.

Fast forward 100 years (99 years to be exact), that  “American Dream” is still alive; unions such as CAW (Canadian Auto Workers) made sure of it. According to CAW, general production workers, similar to the average workers in the 1910’s, start at about $24/hour and earn up to $34/hour excluding overtime and benefits. Skilled-trade workers can earn up to $40/hour. This translates to a starting base-salary of around $50,000 to over $80,000 per year - not bad for a high school or tech-college graduate, considering the median Canadian family/household income is only $65,000. The “American Dream” is very much alive and can still be dreamed by just about anybody willing to roll up his or her sleeve, and carry a union card.

So aren’t unions doing everyone a favour then? Not quite; not every firm is revolutionizing the industry the way Ford Motors did in 1913. And those companies who are? They pay employees well enough that they dedicate their energy to work than starting an union. Just look at Apple and Google.

While not every company needs to be “revolutionary” in order to provide a high wage, they need to be at least efficiently managed and somewhat innovative in order to be competitive in today’s economy; this is where unions enter the game. First, unions prevent optimal allocation of human resource. Second, they create a less competitive corporate culture. Third, unions put up barriers during company restructure and expansion. These setbacks ultimately robs firms’ ability to provide higher wages to employees.

Without unions, firms can freely compete for the best workers in the labour market by offering competitive salary and compensations. However, unions are changing the rules of the game. In most unionized shops, seniority matters when it comes to positional promotions. When positions open, employers are required to consider internal candidates first, with seniority acting as the deciding-factor when candidates have equal skills and qualifications. Though it sounds “innocent”, this is more significant than it appears in manufacturing, because general factory labours tend to have similar skill-set and qualification. Therefore, the only thing that sets candidates apart is seniority. The problem with “seniority” is that it favours not necessarily the most experienced workers but those who have been with the union the longest. This is problematic; as firms cannot optimize their labour allocation; well-qualified workers might just have to “wait their turn” before assuming a more advanced position. But who said life is fair? Even the Gods play favourites.

On top of promotions, seniority also provides job protection. While a union’s protectionist measures benefit many families, on the downside they create moral hazard problems for both the employees and the employer. In unionized shops, the union is responsible for workers’ salary increase, job security, compensations, and complaints. This implies that the workers will always side with the union rather than with their employer in the event of a dispute. Rather than having managers engage with their employees directly, union representation takes away the opportunity for direct communication that indeed benefits both sides. The presence of union quietly creates a fissure between the workers and the managers. As in any collective endeavour, disunity hinders overall performance.

Moreover, since both salary and security are linked to one’s seniority level, seniority, not skills, is the most sought-after quality for union members. Ironically, seniority is attained naturally and effortlessly over-time. Even if one put in the time to acquire new skills, there is no guarantee he or she will get a promotion. Job security, therefore, robs a worker’s incentive to improve and acquire new skills. This discourages the younger union members from advancing in the company through acquiring new knowledge. As most intellects would agree, a young and competitive workforce is a key ingredient of a competitive company.

The problems surrounding unions is also profound on the macro level. Unions are creating what I call a “wage bubble”, and its effects are devastating to the economy.

An economic bubble is described as “a trade in products or assets with inflated values”. Assume a worker’s work has some value, when his or her service is over-valued compared to the wage he or she receives, what we have is a wage bubble. This happens when a union limits an employer’s ability to hire the best workers at a given wage in order to protect union members, as well as when wages increase much faster than productivity.

The CAW has had significant effect on creating a wage bubble. When workers at Magna International joined CAW in 2007, their wages increased by $3/hour across the board. The union’s success in negotiating higher wages puts pressure on other firms to follow or risk losing human capital. As such, unions are affecting more than just the workers they represent. While we discussed earlier that higher wages could benefit both workers and the firm, this is no longer the case because firms are not paying the highest wages to the most deserving workers thanks to seniority clauses.

Like all bubbles, a wage bubble could build up and eventually burst to restore equilibrium. And even if does not burst, it gives manufacturers a smaller buffer to accommodate external shocks. Because of the interrelatedness of the manufacturing sector and the integration of our economy, when one firm goes down, many others are affected. Thus, a wage bubble increases the risk across the whole industry. Since about 3 out of 4 Ontario workers choose not to be part of a union, the majority of workers actually risk losing their jobs when an union inflates the wage bubble.These negative impacts of wage bubble to the economy outweigh its benefits to a smaller portion of protected, unionized veteran workers.

While some economists dismiss the existence of “bubbles”, arguing that the market always trades at a “fair price”, this reason has little grounds in the labour market. Unions often succeed in negotiating above-equilibrium wages for their workers by leveraging its size or using pressure tactics such as general strike. This means that the wage level is artificially constructed and not a result of free-market.

If you are an optimistic thinker like me, then we may not always see firm failure to be the end of the world. Through creative destruction, productive companies could take over the idling resources and immediately put them into more efficient use. This speeds up the recovery process and increases economic output. But once again, union protection haunts again. Common in collective agreements are seniority clauses that protect veteran workers from layoffs or salary-decrease. This means that productive firms cannot upgrade their workforce as they wish when they have the opportunity to do so. Furthermore, with unions’ codified tasks and responsibilities at each position, companies face greater difficulties in expansion through merger and acquisition. Altogether, these restrictions effectively slow down the process of creative destruction and economic recovery.

The economic environment is changing. Union laws need to change, so do corporate laws.
As much as unions are to take blame for certain inefficiencies, the root of the issue remains with the management. Unions are the products of when push comes to shove. Unions are the absolute last resort for workers to protect themselves in terms of both health and wealth. The discrepancy of power between employers and workers allow room for abuse. To not address the issue of exploitative management is to be ignorant of an inherent misfortune of capitalism. Since it is the workers who ultimately have the choice to unionize, good firms will satisfy their employees in a manner that they wouldn’t need to unionize. Competitive firms rely on competitive strategies rather than lower wages; unions need to let loose of certain constraints on management so that the company can be competitive.

What the Ontario PCs have discussed is only the tip of the iceberg surrounding what I think is the most critical economic topic for the next 5-7 years. While unions have been an integral part of economic history, some unions are heading in a wrong direction. Often unions react abruptly to the global economic climate using their shear size and power, and in the process creating more harm than good.

The government has yet to react to this shift in dynamics. While the problem of “too-big-to-fail” is addressed to the banks, unions should be viewed through the same lens. In Canada, PSAC (172,000 members) has been active in its Third-Choice campaign against austerity measures. CUPE, Canada’s largest unions, has an astonishing 618,000 members. CAW and CEP, representing 200,000 and 315,000 workers respectively, are set to merge. Ontario teachers are set to strike this coming fall if a new deal is not reached with the provincial government. Under current labour law, unions of this size pose tremendous threat to the stability of our society, as they represent workers in every aspect of our lives.

Unfortunately the Ontario PC is taking the wrong approach to address this issue. All of the PCs’ proposed “paths”, with the exception of closed-tendering, actually have nothing to do with the economy when the matter deeply concerns our country’s cornerstone of democracy. When large unions take political stance on behalf of their members, who have no choice but to associate, they infringe on the individual liberty. The Ontario PC caucus needs not to hide behind with “economic prosperity” to abolish the Rand formula. All workers, regardless of union status, are entitled to a fair wage and an acceptable working environment; these should not be something a worker obtains through paying union dues.

Perhaps one way to restore equilibrium is to give people the choice. Rather eliminating unions, the government should work to ensure workers their right to unionize. A true and democratic representation will reveal poorly managed firms, make good unions even stronger, and weaken the corrupt organizations – all of which benefit our society.

In the years ahead as global economies face greater uncertainties, our society will become greater polarized. People will simply take a stance and place the blame on another group. Yet the fact of the matter is, we are all in this together.

MUNACA Strike - Halloween 2011

Japanese Vs. North American Manufacturing: Management Matters

In the last decade, we saw the DotCom bubble burst and the US housing and financial market collapse, triggering lengthy recessions. Somewhere in-between the good times and the bad, North Americans realized they have to make certain changes in lifestyle; many turned away from the gas-guzzling cars and bought smaller cars, ones that are more reliable, better in quality, and more fuel-efficient. Some turned to the Japanese automakers.

When Toyota entered the North American market in 1984, they brought in more than just Japanese cars, machines, and robots; they also brought in a management system that eventually allowed the company to oust General Motors as world’s #1 automaker in 2008. There is no coincidence in that and Japanese firms’ strong emphasis on quality, detail, and teamwork, of which North American firms fare poorly.

I spent the last few weeks working as a blue collar operating machines on the assembly line of a Japanese-owned factory. Comparing my experiences here with that of working for a North American factory, I notice the subtleties in management practises that might have altered the fate of the companies. Below is an email from the general manager of one of the largest Canadian manufacturer based in Ontario. The letter is sent out to all supervisors-and-above employees to prepare for their Japanese clients’ visit.

AS part of long term planning and securing new business with high demand, but stable and loyal customers, every COMPANY X employee should raise their performance level in every category including 5S. On  June 21st we will have COMPANY J in our plant, and then on June 28th COMPANY K, one of the world leaders in transmission manufacturing and assembly,  from Japan, will stop by in their attempt to find machining source for different transmission components.

We want to present COMPANY X  in the best possible way.

To make it successful we must:

1.      Clean our work area and maintain it spotless.

2.      Fix as many leaks as possible.

3.      Stop leaving footprints everywhere

4.      Make sure that visual aids are available and kept in working order.

5.      Gauge tables must be very clean at any given time.

6.      Every part must be properly tagged and stored on proper location.

7.      Chip bins, outside/inside dunnage , should be placed in assigned areas.

8.      Tire marks, chips on the floor, oil and coolant in aisle way should be cleaned and areas maintain such

9.      Documentation should be up to date  i.e. operator instructions, ODS, gauge instructions, Process specifications etc.

Your cooperation is greatly appreciated.

Thanks

General Manager

From this email, notice the Japanese management’s attention on details. They are not concerned with a company’s quality reports, rather, they assess a company’s corporate practice through littlest things like footprints on the floor.

My experiences working for an Ontario-based Japanese-managed factory agree with the conditions described in the General Manager’s keynotes above. I could not find a single item misplaced at any given time in the work area. Everything at our workstations are properly labeled and organized that it seemed “cute” at first. When it comes to quality, Japanese manufacturers adopted a “just in time” system that allow management to trace every product manufactured to its maker, down to within half-hour of its production. The management study these records constantly to improve quality and efficiency through optimization calculus. Moreover, I was surprised by the level of automation at Japanese factories. They implemented sensors everywhere to eliminate human error. The company does not tolerate quality issues; if a part is accidentally scratched or dropped onto the floor, it is immediately scrapped. They follow the “5S” (sort, straighten, shine, systemize, sustain) methodology to heart. Because they are so attentive to details, Japanese firms achieve quality at every level of production.

Similar system is in place at the North American manufacturer I worked at, but it is never successfully enforced. We talked about quality, but never applied the principle to reality. Faulty parts are shipped anyways despite our knowledge of them. Had this happened in the Japanese factory, we would’ve held a plant-wide lecture on why quality matters. This is a matter of corporate principle. Over time, these organizational problems lead to catastrophic outcomes the way a butterfly creates a hurricane.

Lastly, we have to talk about corporate values. In the business world, corporate values and management abilities set competitive and noncompetitive manufacturers apart. The Japanese management found a way to indoctrinate its core values in each and every worker. When the Japanese top managers walk the floor and talk to assembly line workers, they ask not about technical questions, but how their family is, how their children are doing, whether they will are aware of the dates for the next company barbeque or golf tournament. The same is not true for North American manufacturer. Floor workers are often questioned on what they are doing. A colleague of my was fired on the spot when he failed to answer a technical question.

I know I’ve made the fallacy of sweeping generalization. But I do find merit in looking at the little things. Perhaps this is because this whole “Japanese-management” has gotten into me. I’ve yet to decide whether this is a good thing or not!

One of my work stations

An Economic Model of Leafs Hockey

The accomplishments of NHL General Manager is not easy to assess. Exactly how much of a team's success is owed to the General Manager and how much of it is just pure luck? That's the question we can answer with an economic model of hockey.

Take Pittsburgh Penguins, Chicago Blackhawks, Los Angeles Kings, and compare them with Boston Bruins, Anaheim Ducks, Detroit Red Wings, we have two models of how to win a Stanley Cup. The first group found success through years of "tanking" and accumulation of upper first round picks. The second group secured long-term success through trades and free-agent signing. Certainly the impact of the GM is different in the two groups!

No offense to Oilers GM Tembellini, but with three consecutive 1st overall picks (Hall, Nugent-Hopkins, Yakupov) it's kind of hard to screw up. Therefore, to model the assets of a hockey team, we need to separate a team's natural growth and induced growth in assets.

Since NHL is set up in a way that balances the powers of the teams through draft picks, we can assume a fair game. In other words, all teams will win equal number of Stanley Cups in the long run. What causes the short-term "fluctuation" is the works of the General Managers.

Some groundwork

There are four ways in which a team's assets can increase (or decrease):
1. Draft picks
2. Player development
3. Free-agent signing
4. Trades
(5. Cap space increase)

Even without any trades, a team will see its asset increase naturally; this is because each team is awarded with 7 draft picks each season. Draft picks are commodities that could be traded for other draft picks or players. Each draft pick has a specific value attached to it; the earlier the pick, the higher the probability of selecting an impact player. However, once a draft pick is used to select a player, the draft pick is no longer an asset of the team. Instead, the team gains an asset in a young player. The young player's value is subject to "Player Development".

For instance, Ottawa Senators was awarded the 1st overall pick in the 1993 NHL draft. With the 1st overall pick, the assets of Ottawa Senators increased significantly. But as soon as they selected Alex Daigle, Ottawa lost the value of the 1st overall pick. Instead, they gain a young player in Alex Daigle. And since Alex Daigle never lived up to the expectation of a 1st overall pick, Ottawa's assets decreased.

For the equalization process to work (that all teams are equally competitive in the long-run), we assume GMs have perfect knowledge of players. It is assumed that GMs always select the best player available with their draft picks. This allows us to use draft picks as a benchmark to evaluate a team's assets. The difference between the team's assets and the benchmark evaluates the performance of the GM.

This may sound confusing, but let's use my favourite team Toronto Maple Leafs as an example to clarify things.

When Brian Burke took over the Leafs in 2008, he inherited some assets in players (both in the NHL and AHL). Under natural growth, Leafs gains 4 x 7 = 28 draft picks, one pick in each round of selection from 2009 to 2012. Players, draft picks, and some cap space make up the Leafs' total assets.

In terms of draft picks, Leafs did not miss a single pick from the first three-rounds of selection from 2009 to 2012. This means that Leafs were able to at least grow at the natural rate of growth.

R. Player
1. Kadri
1. Biggs
1. Percy
1. Rielly
2. Blacker
2. Ross
2. Ryan
2. Finn
3. Devane
3. McKegg
3. Olden
3. Leivo
....

Since these assets are added for free and that we assumed the GM always draft the best player available with each pick, Burke cannot take credit for these additions. This is also the reason Tembellini cannot take credit for adding Hall, Nugent-Hopkins, and Yakupov.

Next, let's look at what Burke did with his roster players (stock capital). The list below includes all transactions Burke conducted since his take-over. Any change in asset value would be considered the work of the GM.

Traded away                                                  Received

1st (2010) Seguin	1st (2011) Biggs
1st (2011) Hamilton	1st (2011) Percy
2nd (2010) Knight	2nd (2009)
2nd (2011)	2nd (2009)
3rd (2011)	2nd (2010)
3rd (2012)	2nd (2010)
4th (2010)	2nd (2012)
4th (2012)	3rd (2010)
5th (2010)	3rd (2011)
6th (2010)	4th (2009)
6th (2010)	4th (2010)
7th (2010)	4th (2010)
7th (2011)	4th (2013)
7th (2012)	5th (2010)
Antropov (1st -1998)	5th (2010)
*Beauchmin	6th (2011)
Berry	6th (2011)
Blake	7th (2010)
Earl	7th (2011)
Giliati	7th (2012)
Hagman	Ashton (1st -2009)
Hayes	Colborne (1st -2008)
Kaberle	Deschamp(2nd -2008)
*Kubina	Franson
*Lebda	Gardiner (1st -2008)
*MacDonald	Kessel (1st -2006)
Mayers	Lashoff (1st -2005)
J. Mitchell	Liles
D. Mitchell	Lombardi
*Moore	Lupul (1st -2002)
Petiot	Phaneuf (1st -2003)
Pogge	Steckel
Ponikarovsky	van Riemsdyk (1st -2007)
Schenn (1st -2008)	*MacArthur
Slaney	*Komisarek (1st -2001)
Stajan	*McClement (2nd -2001)
Stalberg	*Connolly (1st -1999)
Stapleton
Stefanovich
Stralman
Tlusty (1st -2006)
Toskala
White

Bolded names are roster players

*Picked up through free agency

From the list of players Burke traded away, arguably only a handful are currently regular roster players, most of which are past their prime. In the list of players Leafs acquired, however, most of them are young players yet to reach their full potential. It's also worthwhile to note the players acquired were mostly former 1st or 2nd round picks. Clearly, Leafs assets increased quite significantly under Burke management.

Now, let's factor in "Player Development", which is a form of natural growth (or decline).

Projected Leafs Line-up:

Kessel - van Riemsdyk - Lupul
Kulemin - Grabovski - MacArthur
Frattin - Bozak - Kadri
Steckel - McClement - [Open]

Phaneuf - Liles
Gunnarson - Gardiner
Komisarek - Holzer

Reimer - Scrivens

Many of these roster players are already in the system before Burke arrived. Their values of increased over the years due to their development as hockey players. These values should be accredited to Ferguson and Fletcher.

For a more accurate evaluation of a team's assets, we need a mathematical model that assigns a numerical value to each player, also taking account of his age, potential, and development level. Fortunately, this has been done by EA Sports in the making of its NHL videogames.

Hopefully, now you have a new perspective of the Toronto Maple Leafs and GM Brian Burke.

Fixing Homelessness

Soup kitchens are great, so are shelters and such. They provide people in-need with the necessities to jump-start their lives. But there're intrinsic problems with these services provided by both public and private entities. Limited supply, lack of availability, and exclusivity prevent various organizations from truly resolving the issue of homelessness and poverty.

I think the problem of homelessness is rooted deeply in the mismatch between one's psychology and social norm. Some folks wonder the street because there is nothing else they could do; they are denied access to public services, such as libraries, restaurants, and grocery stores, due to their poor hygiene accumulated from days and weeks out on the street. Without access to such places, their lives are stuck in a vicious cycle that further limits their outlooks despite any will to improve themselves. Over time, continuous rejections lead to dejection, corroding away any remaining confidence, self-respect, dignity, and hope one has for himself.

The question is: how do we break this cycle? How do we help the people who have the will to change their lives for the better?

Here is a case where we should be thankful for materialism (not to be confused with consumerism). Fortunately, our society respects people based on just proper hygiene, clean clothes, and good manners. The abundance of second-hand clothing stores solves the clothing problem, cheap laundromat helps, and good manners can be learned - all it takes a little understanding, which is innately human. This leaves us with the last issue: hygiene.

So the answer? Showers. Yes, community showers.

The government (and also NGOs) should look into financing community showers for the homeless. These venues could stand on their own, or be part of an expansion project on existing social enterprises. Doing so, we necessarily, though not sufficiently, close the gap between the individual and the social norm. If homeless people could improve their hygiene at a public shower, they gain instant acceptability into the society. This means that they now have access to public services and more places to spend their time instead of wondering the streets and occupying metro stations. They could be reading at a library or surfing the internet to increase their knowledge. The low barrier to learning provides an outlet for the homeless.

More importantly, good hygiene and clean clothing raise a person's confidence and self-respect levels, thus breaking the vicious cycle with renewed hope and aspiration. And over-time, community showers could also change the image of urban homeless, when they are no longer perceived as "dirty, smelly, and idle".

As my fellow physicists would say, when conventional models fail to match the empirical, it's time to go back to the drawing board and work out a new theory.

EDIT: JULY 7th, Now, be inspired by this beautiful short-film below...

The Social NetWAR (Part 2/2)

Of the three big social networks, I find LinkedIn to have the highest potential. LinkedIn offers an irreplaceable and invaluable services.

Less than 13% of Facebook users are above the age of 44; the majority of users are between the age of 18 and 25. Despite LinkedIn's smaller user pool, the majority of LinkedIn users have higher education level and higher income. This makes LinkedIn a channel to a "niche" market. There is a reason for this, and that reason is the intrinsic value of the services it provide: professional networking.

http://www.quantcast.com/linkedin.com/demographics

People working in the same industry are bound to have "3rd level" connections (for example: A knows B, B knows C, so A is connected to C). However, this connection is difficult to be unveiled through probability and randomness of strong and weak network-interactions; there is simply no time at an interview for you and the interviewer to go through your entire network to find a mutual connection. Enters LinkedIn. LinkedIn fully reveals a person's professional network. This network access allows firms to improve its hiring decisions, speed up negotiation processes, and allow faster information flow. In terms of value creation, LinkedIn wins.

Despite some analysts are predicting Facebook will disappear in 8 years, sharing the fate of MySpace, I think Facebook will remain as a large social network that plays a large part in the lives of Generation Y. But as we grow older and get busier with our professional and private lives, Facebook will see a reduction in activity levels unless it captures the attention of the next generation. Exactly how Facebook could achieve such? Time will tell.

EDIT: Looking at the stock prices since my last post, $26 is indeed the best time to buy.

The Social NetWAR (Part 1/2)

Three weeks ago I witnessed a historical moment via Internet, the Facebook IPO. At that time, I forecasted that its price is over-valued at $38, I also wrote that $26 is a more reasonable price.

This morning while I was at the local cafe, Facebook fell below $26 for the first time, but by the time I met my friends at O’Burger for lunch, the price went above $26 once again. Is today a good day to own a portion of Facebook? I think so, if you are looking for some pocket money due in 3 months.

But for folks like myself who always look at the fundamentals and look into the long run, we only care about how Facebook will perform years down the road. In the next few paragraphs, I hope my insights will influence your investment decisions.

To look at the fundamentals, it means we have to put Facebook into the global, long-term perspective. To my knowledge, there are currently three players in the social “netWAR” (excuse the pun): Facebook, Twitter, LinkedIN. As much as I am a fan of Facebook, I am skeptical of its potential.

1. Services and Clients

As a service that helps people connect with one another on a daily basis, for Facebook to be an effective marketing machine, it’ll have to incorporate more details than what a regular person would share on the internet. Facebook will need to perfect its algorithm to extract information about a person’s preferences beyond what a person likes, reads, and posts. There is a huge untapped potential in what a person chat about with his friends, regular hang-out spots, daily routines, dietary habits, sleeping patterns... many of which is not usually shared, but could be extracted using advanced algorithms.

Because of the sensitivity of such information, Facebook will need to over-come regulations the same way bankers got their ways on Wall Street. This is problematic.

For Twitter and LinkedIN, they operate on a less information-sensitive platform. After all, “tweets” and resumes are meant to be shared, but not the things you chat about on the Facebook messenger.

Whereas Facebook certainly emphasizes the “social” part of social network, LinkedIN focuses more on the “network” aspect. This has huge implications for investors and analysts.

The types of ads on LinkedIN are inherently different than those on Facebook. Whereas Facebook sells a little bit of everything, from discount t-shirts to brand-name perfumes, LinkedIN offers a platform for high-end professional services such as financial, consulting, career, and planning services. If we assume the effectiveness of social marketing is the same for Facebook and LinkedIN, LinkedIN has a greater marketing potential because it has a higher per-contract value than that of Facebook; and this is simply because of the nature of goods/services advertised.

However, I think the real power of social network is beyond advertising; the most effective way to achieve marketing results is by harnessing the power of the masses. KONY2012 anyone?

Lately I joined Twitter (@pieconomics), and I find the Twitter to be the more powerful marketing machine.

1. Because we are dealing with non-sensitive information on Twitter, we are more likely to keep many acquaintances and strangers within our Twitter network. This makes the Twitter network more dense, thus greater information exposure.

2. Your Facebook page is a space for both you and your friends, whereas Twitter is your own space. This makes a person more likely to give updates on Twitter than Facebook, which implies that information is more recent and more frequent on Twitter.

3. With the emergence of Twitter, many celebrities and businesses have gotten on board. On Facebook, we are careful in choosing what we "like" to avoid having our newsfeed spammed by ads. On Twitter, we are less careful. This means a greater exposure to businesses, thus greater potential.

That's all the time I have, in the next part, we'll discuss the "externalities" each social network brings, and which is the most valuable.

Dutch Disease: Cure and Prevention

Policy makers have placed a lot of attention on the Dutch Disease in Canada. Some analysts have noted that for every job created from oil sands, another is lost elsewhere, hence a reason to shut down or slow down the project development.

I've spend much time grinding in my mind on solutions to the Dutch Disease the last few days. Whether you believe in a shut-down or slow-down, I think it's worthwhile to seek solutions beyond the oil sands. Because fundamentally, Canada should take advantage of the high oil price to gear up for the tough times ahead. To resolve the issue, various players in Canada need to cooperate and collaborate: provinces and the fed, oil companies and manufacturers.

The problem of Dutch Disease in the Canadian context is unique thanks to our constitution. The responsibility for natural resources belongs to the provinces, not the federal government. Because of such, the fees and taxes collected are largely allocated to the provincial account. This means that the province could spend the money as it wishes, thus putting upward pressure on inflation and housing prices within the province. At the same time, some transfer payment is made to less-developed provinces, namely Quebec, as an artificial way to balance regional development. However, the positive impact of transfer payment is hardly ever seen. Quebec continues to lose population; it experienced slower growth in the last few decades.

The solution, I believe, lies in changing the industries across the nation. Policy attention should focus on how to make Canadian manufacturers more competitive on the global market such that even if our goods cost, countries will still purchase from us. One way to help the industries is through selective tax-cuts to lower the financial burden for manufacturers to adjust for the changing market. The government could also sponsor training programs to make their workers more efficient, thus offsetting the higher cost of production. Furthermore, R&D credits could also be granted for firms to expand their product line. If Canadian manufacturers are able to become more competitive, the effect of Dutch Disease can be minimized.

On the provincial level, the Albertan government should take advantage of its resources to diversify its industries. By diversifying businesses, Alberta would start to attract skills workers of various backgrounds, which is essential in developing new industries, such as the space, IT, automotive, biomedicine, and renewable energy. The government needs to create policies to lower barriers to entry in these non-oil sectors to help these firms emerge. Moreover, it also makes sense for Alberta to start investing money instead pursuing rapid infrastructure development within the province. By allocating wealth outside of the province, Alberta diversifies risks and achieves a more stable growth. Investments in secondary-education will also help the province in the long run.

Lastly, oil companies need to understand the critical roles they play in Canadian economy. They need to work with local industries to assist them rather than blocking entries. Oil companies should look into providing discounts to domestic industries and expertise. By collaborating with local businesses, they form a  network with fluid information flow. This helps non-oil companies better manage risks and thus maximizing output potential.

If the provincial government could collaborate with the fed, and the oil companies cooperate with industries to make Canadian manufacturing more competitive. Not only do these strategies cure but also prevent the Dutch Disease. So when the prices fall and oil runs dry, Canadians would still benefit from a sound and competitive economy.

The Curious Case of Canada

Rather sticking with the "environmental" arguments, the NDP is recently stepping into a territory that it probably shouldn't venture into: the economy.

But, on the subject of "Dutch Disease", NDP Leader Thomas Mulcair has the right idea that it needs to be "cured". As I explained previously, because Canadian regional economies are structured differently -BC and Alberta have concentrations of natural resource sector, and Ontario and Quebec have larger industrial base- the gain in one region is the loss of another. General Motors, for instance, is shutting down one of its two assembly lines in Oshawa, leaving thousands without work.

Mulcair wants to shut down the oil sands project to save the economy. This doesn't work for several reasons:

1. To "cure" the Dutch Disease, Canadian dollar must devalue to make exports more competitive. Since Canada adopts flexible exchange rate, Mulcair has to control Canadian money supply on the international money market. The only country able to do this for a sustained time is China. Oil may bring in foreign dollars, but it does not print money.

2. The Dutch Disease is caused by rising commodity prices. Oil is only one of the resources. To effectively ease the symptoms of the Dutch Disease, Mulcair needs to end all other natural resource exports: mining, lumber, natural gas, fishing, water, wheat... Why single out the oil sands?

3. Natural resources are inputs to manufacturing. Rather than "shut down" the oil sands, Mulcair could've simply ask to place a cap on oil export. Since Canadian manufacturers also benefit from Alberta's oil sands, it back-fires to shut down the oil sands.

The guys in blue aren't that much more brilliant than the Orange.

1. Harper-led Tories have criticized Mulcair for preaching "Canadian resources are a disease"; this kind of rhetoric just shows how the Tories don't understand the issue-at-stake either.

2. Tories' arguments such as "raising the taxes will drive away the oil companies and create unemployment" is just bogus. If oil companies want to leave Alberta, go ahead ;) Where else are they going to find oil?

3. Alberta government plans to spend $16Billion on infrastructures over the next 3 years. While that's all good until the inflation takes place, housing bubble rises, and the little cashier at Tim Horton's makes $20+/hour. How about some plans to improve secondary-education resources or to save for the future when all that oil is gone?

Oh silly Canadian politicians... When it comes to the issue of Dutch Disease, it isn't even a matter of "Left Vs. Right" clash in ideology. I'll let you make your own conclusions, and I'll talk about some viable solutions next time.

Understanding Dutch Disease

Sickness could be very troubling; it makes the body ache and the mind cloudy. Some sicknesses go away on with a few days of proper care and timely rest, others...well, don’t disappear as easily. Nonetheless, a good doctor will point to you the right direction on the road to recovery.

But let’s look at another kind of sickness, sickness of Canadian economy, the symptoms of which persist regionally today.

The diagnostic process to cure economic sickness is one similar to reading 20th century American literature; it requires knowledge and active reasoning. Unfortunately, I find the players in the Canadian political game today lacking both, the Orange and the Blue alike. Worse, the media coverage on these stories has been nothing but misleading and unclear.

The “question” in question is the “Dutch Disease”. NDP Leader Thomas Mulcair has criticized Alberta’s oil sand project for hurting the Canadian economy; he’s actually quite vocal about it.

But before we get too far, we need to talk about “what is Dutch Disease?”, its causes, symptoms, and solutions. This isn’t difficult, we only need to borrow a concept from your first-year microeconomics course: the law of supply and demand -when the demand goes up, holding all other factors constant, the price also goes up.

The rapid growth of developing nations in the last decade, such as China and India, increases the demand and the price of raw materials. This increase in price makes natural resources more valuable, thus provinces such as British Columbia and Alberta benefit from this resource boom, as their export brings in higher revenues.

“So what” you ask?

Well, let’s add in currency exchange into the equation. To trade with Canada, one must use Canadian currency, meaning they need to purchase Canadian dollar on the money market. As such, the increase in export also increases the demand for the Canadian dollar. Thanks to the law of supply and demand, we know that the increase in demand must also be accompanied by an increase in price, holding all else constant. The “price” here is the value of Canadian dollar against another currency. So in other words, when countries buy resources from Canada, Canadian dollar appreciates.

So what’s so bad about having a strong currency? Doesn’t that mean we can head to down to the States shop-till-we-drop?

Yes indeed.
But if you are selling certain things, having a strong currency may not so appealing.

The Ontario and Quebec manufacturing sector, for example, took a big hit from the resource boom. The reason for it is beyond the fact that the resource boom makes production more expensive; the appreciating currency makes Canadian goods more expensive on the global market, so foreign firms buy less of Canadian manufactured goods.

This is precisely what the “Dutch Disease” refers to: the decline in the manufacturing sector as a result of resource boom. Such phenomenon happened in the Netherlands in the 1970s, hence the name.

Now that we understand what economic impacts ACTUALLY take place, we are in position to take a position in this “Orange Vs. Blue” war. It turns out, Mulcair doesn't know what he's talking about, neither do Harper and his goons. I'll save that for next time;)