A Nation of Self-Interested Devils

Howard Schultz, ex-CEO of Starbucks and unofficial presidential candidate, gave a speech in San Francisco on February 1, 2019. Mr. Schultz touched on many issues, including healthcare, immigration, and climate change. He also announced that he may run as an Independent in 2020, which provoked the ire of Democrats. As an assumedly left-of-center candidate, Schultz could split the Democratic vote and thereby ensure President Trump’s second term. But, some are optimistic about the possibility of a viable third-party candidate.

Mr. Schultz has a constitutional right to run for the presidency. More power to him.

Mr. Schultz is responding to the nation’s appetite for an Independent candidate (much like President Trump’s hints at running for the presidency a few times over the years). The theme of Mr. Schultz’s potential candidacy appears to be bringing the two parties together—something an Independent would be better equipped to do than a partisan president—to overcome the problem of self-interest in lawmaking.

With respect to health care, Mr. Schultz explained that the ACA was the “right move,” even though rising premiums “have clearly become a problem.” That’s like saying that communism in Soviet Russia was the right idea, even though the starvation of millions of people was a problem. The ACA, regardless of its policy objective, was designed so that those who could afford to pay would have to cover the cost of insurance for those who would not otherwise qualify.

But, it’s Mr. Schultz’s proposed solution with which I have a particular problem. He claims that Congress “made a deal with the devil.” According to Mr. Schultz, if we could just remove ideology and self-interest from the room, then our health care problem would be solved.

I don’t think so.

The last time Congress got enough votes for a bill on health care, we got the ACA. Mr. Schultz wants to bring in health care professionals, pharmaceutical companies, and the government to solve the problem. Isn’t that exactly how the ACA was concocted? Maybe we’ll get a different solution this time if we can just “put pressure on pharmaceutical companies to remove the self-interest from the equation.” I am not so hopeful.

The health care industry was heavily regulated even prior to the enactment of the ACA. Could it be that government regulation is the cause of this health care problem? Perhaps the part of the health care equation that needs changing is the degree of government involvement.

A Nation of Self-Interested Devils

Nissan Charges at the Competition

Increasing fuel prices, environmental concerns, and the demand for traveling in style and convenience have ushered in an era of electric vehicles. When consumers think about electric cars, Tesla Inc., with its exclusive focus on electric cars, is at the forefront of the era. However, more traditional automakers such as Acura and Volkswagen are ready to challenge Tesla and to take a piece of the market share for themselves. Amongst these automakers, Nissan’s innovative vision for the electric car took the 2019 North American International Auto Show by storm—a vision that arguably redefines the boundaries and possibilities of the electric car.

Adding to its slate of electric vehicles, which currently consists of the highly successful Nissan Leaf , Japanese automaker Nissan announced that eight new electric models are in the queue for release by 2022. In addition, the company presented its Nissan IMs. The Nissan IMs offered a glimpse of what the automaker is envisioning for its electric car series beyond the eight slated to appear in 2022. Nissan describes its IMs concept as an “elevated sports sedan.” The IMs features a sedan car shape but contains SUV-like capabilities.

Of the IMs’ many features, two stood out concerning the car’s autonomous driving capabilities. One of these features includes the ability of the vehicle’s steering wheel to retract and the front seats to turn toward one another to allow occupants to face each other to converse and interact more naturally while the car is in autonomous mode. The effect of this feature would be a mobile living room or office-like setting. Another feature that stood out in the IMs concept is the car’s 3D augmented reality system called “Invisible-to-Visible.” This system would enable drivers to activate a human-like 3D avatar in the car that can provide directions, give advice, or just converse with you. Furthermore, the driver has the option to make the avatar look like a family member or a friend. The effect of this feature would be a more intimate and personal driving experience.

In order to win consumer mindshare in the electric vehicle market, automakers will have to differentiate themselves on three main aspects: cost, creativity, and safety. We’re already seeing the cost benefit of electric vehicles with Tesla stating it could produce a more economic electric model at a $25,000 price range in three years, compared to its current Model 3 with a $35,000 to $45,000 price range. Now, competitors such as Nissan are leveraging technology such as augmented reality to increase the creative boundaries of electric cars. As to safety, automakers will have to cooperate with stakeholders such as their respective regulatory bodies to instill customer confidence in features like autonomous driving. Nevertheless, as competition intensifies in the electric vehicle market, consumers should expect to benefit from companies’ efforts to differentiate their electric models and to be the quickest to market.

Nissan Charges at the Competition

U.S. Economy Lost $11 Billion to Government Shutdown

The longest government shutdown in U.S. history ended on January 25, 2019, after a 35 day partisan standoff between Democrats and Republicans. One primary point of contention was Trump’s demand for $5.7 billion to fund a border wall, which Democrats vehemently opposed. In response to Democratic leaders’ refusals to fund a physical barrier for the border, President Trump told Democrats “he was willing to have the government shut down for ‘years’ over border wall funding.”  Fortunately for American people, that turned out not to be the case. Yet.

When President Trump finally signed a bill to reopen the government, amid flight delays and other shutdown-instigated crises resulting from understaffed government jobs, many federal workers went back to work. However, many of these workers, who went weeks without pay, were left feeling demoralized, like “pawns” in a “political game of chess.”

Further, the 800,000 federal employees working for the affected government departments and agencies still can’t breathe a sigh of relief. Since the bill Trump signed did not contain border funding, the President only reopened the federal government for three weeks for the purpose of “negotiating” boarder security funding. That means if Trump and Congress cannot reach an agreement, it could mean another partial shutdown beginning on February 15.

The government shutdown has also had far-reaching financial impacts on the American Economy. Standard & Poor’s released a report on January 25 estimating that the partial government shutdown would end up costing the U.S. economy at least $6 billion, which ironically, is more money than it would have cost to fund the border wall that started the entire month-long debacle. However, on January 28, the Congressional Budget Office released an even more troubling report stating that the five-week shutdown cost the U.S. economy $11 billion, “with nearly a quarter of that total permanently lost.”

In its initial assessment, S&P expected businesses to bounce back quickly once the government reopened but found instead a delay in indirect costs. Now, S&P is cautioning Americans about the “end” of the shutdown, reminding us that “little agreement on Capitol Hill will likely weigh on business confidence and financial market sentiments.” The initial funding battle is over, but in a few weeks if an agreement is not reached, a new shutdown will likely begin. If shutdowns become a pattern, the economy will react, and we may experience further reductions in growth expectations.

U.S. Economy Lost $11 Billion to Government Shutdown

The Orchard: One Bad Apple?

Whether it’s an issue with hardware, privacy, or both simultaneously, Apple has recently found itself facing criticism.

Most recently, a 14-year-old boy found a bug on FaceTime, which allowed users to eavesdrop on others even if they never answered a FaceTime call. Apple was quick to respond and acknowledge the issue. However, a fix will not be available until next week, and for now, Apple has deactivated group chat. In addition, a “high-level” Apple executive flew to Arizona to thank the young boy and noted that he may be available for Apple’s bug bounty program, which awards invited users with monetary awards for finding bugs.

While Apple was quick to respond, this has not always been the case. When Apple first released its new keyboards with butterfly switches, it took several class action lawsuits for Apple to admit that there was a problem. Once Apple acknowledged the problem, it created a new repair program and updated its keyboards; however, users have continued to list complaints.

It is hard to discern the effects these hardware and software issues have had on Apple’s value, especially given the decrease in demand of smartphones. However, it is unlikely that these issues have led to a decrease in many users as made evident by the large host of online articles discussing how Apple has “trapped” them on iOS, “perhaps forever.” Nevertheless, Morgan Stanley believes that Apple’s new video streaming and associated businesses will catalyze Apple’s stock in the coming year.

The Orchard- One Bad Apple?

The Losers of the AI Revolution

In an effort to adapt to an economy largely fueled by e-commerce, retailers are beginning to merge their distribution centers with their stores. The intermingling of inventories in stores and warehouses has some retailers testing the use of shelf-scanning robots that roam store aisles and provide restocking data in real time. Because the data provides an accurate snapshot of store inventory multiple times a day, consumers can purchase their items for same day pick-up, and managers can target areas to restock based on profitability, all for a lower price than hiring a human armed with a scanner.

Robots displacing humans is not a new phenomenon. Robots are even penetrating white collar service jobs, which was once thought to be shielded from automation. What is happening here is the same story we have seen in each of the industrial revolutions—disruptions in the market caused by innovation and globalization—except today the digital and socioeconomic sphere lay the groundwork for a far more unsettling result.

Americans already face competition from foreign workers working, virtually, in U.S. offices. Through platforms like Upwork, companies hire freelancers from across the globe, often at a much lower wage. This obviously takes jobs away from the U.S., but it allows for a redistribution of income to those who are willing to work for less. Through a process called “machine learning,” essentially an advanced version of pattern matching, computers using AI are now able to perform the same service type jobs that freelancers using Upwork are looking to do while at a much lower cost. As more companies adopt this technology, labor income that would go to a human gets redistributed as capital income to the owner of the robot. This will exacerbate U.S. wealth and income inequality for two reasons: first, capital is already extremely concentrated at the top; second, taxes on capital income are much lower than taxes on labor income.

The fact that technological innovation creates jobs is very unlikely to mitigate this effect. Newly created job positions, such as robot monitoring professionals, data scientists, automation specialists, and content curators, all require higher education, which has become increasingly expensive. If interest rates continue to increase, lower and middle class people not looking to enter into computer science or engineering majors will be less willing to go to college, leaving mostly those at the top going to school. This trend further concentrates wealth and income at the top.

A second mitigating factor might be the fact that as the economy becomes more capital driven the rising stock of capital should cause the rate of return for capital to fall. Intuitively, this makes sense, but what drives the reduction in the rate of return of capital is more complicated than supply and demand alone and depends on the elasticity of substitution between capital and labor. A high elasticity suggests more substitutability between capital and labor, which elicits a slower reduction in the rate of return for capital. A low elasticity suggests that capital and labor are complements, which elicits a quicker reduction in the rate of return. Think of calculators. If you hand an accountant one calculator, she becomes extremely productive and the owner gets a high rate of return. Hand her two, and the second calculator does not add any more productivity, and the owner’s rate of return on the second calculator is minimal. The rate of return sharply falls because calculators complement labor and are useless without a human to operate them. Now imagine you can completely replace the accountant with an AI-enabled computer. You may not see a substantial reduction in the rate of return until the third or fourth AI-enabled computer.

Unless the U.S. government is willing to intervene, by perhaps raising taxes on capital income, the future looks bleak. The losers of the AI revolution are not just the low-skilled laborers without a college degree, it’s everyone but those at the top who are unable to enjoy the fruits of what many call the fourth industrial revolution, falling victim to a widening gap between the middle class and the rich.

The Real Losers of the AI Revolution

In an Unpredictable Climate, Businesses May Find the Need to Prepare for the Worst

Sub-zero temperatures and crippling wind chills hit large parts of the Midwest and East Coast this past week, as schools, businesses, and government services shut down in the face of hostile weather conditions. While cities like Chicago, where temperatures reached as low as negative twenty degrees Fahrenheit with a wind chill bringing that number closer to negative fifty degrees, are used to bitterly cold winters, the intensity and irregularity of these conditions represent a major threat to businesses in the affected areas. Climate data from the last half-century suggests that these cold snaps are and will continue to be less frequent. While on the surface this might bode well for those cities in the path of these cold snaps, just the opposite is true; a volatile climate makes these temperature drops all the more devastating, as businesses struggle to acclimate quickly enough to a new norm yielded by a changing climate. Further aggravating this problem is a rising threat of conflicting misinformation disseminating from the highest levels of government. President Trump took to twitter on January 20 with a message that poked fun at the concept of global warming; the National Oceanic and Atmospheric Administration, or NOAA, was unable to respond to the President’s tweet, as it was closed during the partial government shutdown.

Moreover, the damage that cold snaps cause cannot be overstated. In addition to an inexcusable loss of life, the cold forced small business and major manufacturers to close shop or significantly reduce production. Following a fire at a Southeastern Michigan natural gas facility, the big three automotive manufacturers, Ford (NYSE:F), General Motors (NYSE:GM), and Fiat Chrysler (NYSE:FCAU), suspended some operations for fear that energy supplies would not satisfy the greatly increased energy demand needed to heat their factories. Automotive manufacturers were not alone in making changes to accommodate the cold reality of the week. American Airlines (NASDAQ:AAL) resorted to using tanker trucks to refuel its planes; the freezing temperatures had disabled its underground refueling systems. As hope for a “green new deal” driven by improved environmental, regulatory frameworks and government incentives for green technologies looms over the horizon, business may find themselves facing eerily similar problems. Wind farmers across the central United States were forced to close as less renewable, more expensive coal facilities were activated when the extreme cold threatened to shatter fiber-glass wind turbines and seize up lubricated bearings.

As climate change continues to affect weather patterns, governments and businesses face the daunting task of preparing for a climate that facilitates sudden, potential catastrophe. Their ability to work together, to work quickly, and to work with a mind toward possible future events may shape numerous industries and the lives of countless people.

In an Unpredictable Climate, Businesses May Find the Need to Prepare for the Worst

WTO to Tackle E-Commerce

E-commerce, unsurprisingly, plays a rapidly expanding role in the global economy. A report from the World Trade Organization estimated that in 2016 alone the value of e-commerce transactions totaled $27.7 trillion. Spurred by advances in computing power, increased analysis of consumer behavior and tailored platforms to facilitate online transactions, e-commerce’s growth is a direct reflection of the increased digitalization of the economy.

Given e-commerce’s presumptive incompatibility with existing trade regulations, organizations like the WTO continue to struggle with how to comprehensively and fairly regulate, or de-regulate, the online marketplace. Further, the difficulty of accurately amassing relevant data, as well as the complexity of addressing a global market with many international players who often have disparate interests, creates additional hurdles that prohibit the WTO from making any meaningful progress. As a result, outdated regulatory frameworks remain in place. As Japan’s trade minister poignantly noted, “The current WTO rules don’t match the needs of the 21st century.”

In response to this regulatory lag, 76 of the WTO’s members agreed to actively negotiate and set forth trade-related e-commerce rules beginning in March 2019. Representatives from Japan and the European Union were amongst the first members who signaled their interest, and China recently confirmed its willingness to participate as well. The members who will engage in the negotiations represent a breadth of perspective across both developed and emerging e-commerce markets. But the initiative markedly lacks at least one significant participant in the e-commerce space—India. In 2018, India’s e-commerce sales were projected to reach over $32.7 billion. The absence of India’s representation in these negotiations, despite its role in the global e-commerce landscape, might create a blind spot in proposed regulations. Nevertheless, the group remains open and other countries, including India, may still elect to join.

The initial Joint Statement issued by the members specifically points to the “unique opportunities and challenges faced by Members.” This is perhaps meant to acknowledge the fact that while these negotiations will focus on e-commerce and trade, the forthcoming adoption of new regulations will inevitably have broader economic and socio-political effects. Issues ranging from the digital divide, to personal privacy, to the concentration of market power could be impacted by the regulations. The potential for expansive influence increases the need for a multifaceted and collaborative approach when designing any proposal. In this spirit, Canada has already established an online questionnaire where Canadian stakeholders can provide their views on e-commerce and better inform Canada’s position in future negotiations with other members.

The renewed focus on regulating e-commerce signals a progressive and cooperative approach to addressing a considerable part of the international economy. Hopefully, the fact that 76 WTO members have agreed to participate signals a strength of buy-in from multiple constituents and an end to passive, ineffective regulation.

WTO to Tackle E-Commerce

Goldman Sachs Likely to Escape Accountability for 1MBD Scandal

Goldman Sachs’ board of directors authorized the potential claw back of a number of top executives’ compensation pending the outcome of the 1MBD scandal. Ex-CEO Lloyd Blankfein and CEO David Solomon are among the executives who could have to pay back stock awards.

The board of directors responded to increasing scrutiny around Goldman Sachs’ role in the 1MBD scandal. Last year, the Justice Department claimed that $2.7 billion had been misappropriated from a Malaysian sovereign wealth fund. Goldman’s exposure stems from the bank’s arrangement of three large bond offerings in 2012 and 2013. Nearly half of the $6.5 billion in earnings for the Malaysian fund were misused to pay for kickbacks, fine art, jewelry, and bribes. The scale of the fraud committed—and the murkiness of the transactions—begs the question: What did Goldman executives know?

That question was partly answered when Tim Leissner, Goldman’s former Southeast Asia chairman, pleaded guilty to conspiring to commit money laundering and conspiring to violate the Foreign Corrupt Policies Act. The government also filed charges against another former Goldman Sachs banker and a Malaysian financier, both of whom the government claimed were central to the embezzlement plot.

Goldman has worked to paint these individuals as rogue bankers who conspired to defraud the fund for their own benefit. However, the charging documents indicate that the prosecutor may be reluctant to accept Goldman’s “bad apples” defense. The government alleged that Goldman perpetuated a culture of prioritizing deal-making with little regard for regulations. While the government may have left the door to indictment open, such actions are exceedingly rare. Rather, all signs point to Goldman paying a hefty fine and presumably returning to business as usual.

Goldman Sachs Likely to Escape Accountability

PG&E Files for Bankruptcy as Wildfires Liability Looms

On the hook for billions of dollars in wildfire liability, Pacific Gas and Electric Corp. filed for Chapter 11 bankruptcy protection on January 29th. Despite PG&E’s precarious finances, shares rose 16.5 percent and its market value soared to over $7 billion in the hours after the bankruptcy filing. Though executives claim that insolvency is “the only viable option,” in many ways PG&E will benefit from bankruptcy proceedings.

PG&E faces lawsuits for dozens of wildfires in 2017 and 2018 and is currently under investigation for contributing to the deadly Camp Fire in November, in which 86 people died. The company has estimated that its liability will exceed $30 billion. However, this number is far from certain. Investors are betting that PG&E’s actual liabilities will be much lower after the company beats many of the wildfire claims in bankruptcy court. Further, the liabilities will not hit the company all at once; many of the lawsuits will take years to resolve.

PG&E has used its financial uncertainty as an excuse to benefit from bankruptcy. Bankruptcy protection shields the company from further claims and buys executives more time to figure out next steps. The filing also eases financial pressures by allowing the company to delay payments to creditors and to take out more loans. Further, bankruptcy court gives PG&E leverage to renegotiate contracts with clean energy suppliers.

While PG&E stands to benefit, the immediate costs of the utility company’s bankruptcy likely will be borne by consumers. Though interim CEO John Simon promised customers no disruption and that “the power and gas will stay on,” PG&E hopes to achieve this by hiking electricity bills. Thus, filing for bankruptcy puts pressure on regulators and elected officials to allow PG&E to raise customer rates to cover losses and ensure that its 16 million customers continue to have power.

PG&E’s bankruptcy highlights the urgent need for California to rethink how it assigns responsibility and pays for wildfire disasters. As fire seasons become more destructive, this is not the last time that PG&E will face massive wildfire liability.

PG&E Files for Bankruptcy as Wildfires Liability Looms

The Implications of Twilio’s Multibillion Dollar Acquisition of SendGrid

Twilio, the “mightiest unicorn” of Silicon Valley, first went public in 2016 at a $1.2 billion valuation. Just last week, the company was soaring with a valuation of $11.2 billion. Twilio is a developer-centric communications platform focused on providing easy access to global telecommunications companies. This is accomplished by turning archaic and decentralized services into a convenient one-stop shop. The company started off with simple APIs for messaging, phone calls, and recording but has since expanded to upwards of fifty different APIs for all types of services.

SendGrid is another communications platform, originally debuting at $700 million but currently valued at around $2 billion. In contrast to Twilio, SendGrid services email. This is the claimed “missing channel from Twilio” that Twilio CEO Jeff Lawson says the company has been trying to avoid. Following a ski trip full of cloud and business software leaders sharing a common investor, Bessemer Venture Partners, SendGrid CEO Sameer Dholakia and Lawson came to an agreement. Twilio had made bids for SendGrid since 2017, but all were rejected by Dholakia because he thought the “offers [were not] good enough” and would rather continue with their planned IPO. Now, with an accepted offer of $2 billion in an all-stock transaction, Twilio’s acquisition of SendGrid allows them to expand their market into email and other Internet communication. Lawson already considers his company an irreplaceable “super-network” of communications “light years ahead” of their competitive field. If the acquisition comes to fruition—as it is currently pending authorization by the SEC—Twilio will become “the unquestioned platform of choice for all companies looking to transform their customer engagement.”

The marriage of these two companies reveals the drive for a ubiquitous communications platform for developers and entrepreneurs, who would much rather spend time innovating than slogging through mundane tasks of setting up robust communication channels. Built on a similar idea to Amazon’s AWS (cloud computing services), Twilio is one of the many companies offering up infrastructure-as-a-platform, which saves smaller developers the time and capital by chalking up their economies of scale at a fraction of the cost it takes to build an independent network. Twilio has already brought in $168.9 million from their latest quarter’s financials by servicing around 60,000 active customers, including technology giants Uber, Airbnb, Yelp, Facebook, and Netflix.

In 2016, JP Morgan analyst Mark Murphy commented that “it is very possible that Twilio will compound its growth nicely for many years to come.” And indeed, in the three years since Twilio has been public, their dominance illuminates their path to becoming a lasting pillar in the technology industry. So long as companies retain the need to communicate with customers, Twilio’s service will remain an economically relevant choice.

The Implications of Twilio’s Multibillion Dollar Acquisition of SendGrid