The Frontier: Africa and the Irrationality of Equity Home Bias

By Joe Kearns

Africa has long been, and largely still is, avoided like the plague by investors from developed economies due to concerns over government corruption, war, and poor infrastructure. It shouldn’t be. Though declining commodity prices, China’s economic downturn, and policy failures have eroded investor confidence in Africa, the International Monetary Fund (IMF) projects the continent’s economic growth to reach 4% in 2016, a modest increase from 3.5% in 2015. In contrast, 2015 World GDP growth was -0.4% and U.S. GDP growth was 0.0%. The rational action for investors in developed economies searching for positive returns is to jump on a largely untapped opportunity to invest in Africa and go against the conventional bearish sentiment.

The bedrock assumption of classical economics that individuals make rational choices is challenged by a concept in international finance called the equity home bias puzzle. Financial economist Kenneth French and public economist James Poterba wrote in “Investor Diversification and International Equity Markets” (1991) that individuals and institutions in most countries predominantly hold domestic equity and only a marginal amount of foreign equity. According to French and Poterba, at “the end of 1989, Japanese investors had only 1.9% of their equity in foreign stocks, while U.S. investors held 6.2% of their equity portfolio overseas.” In December 2014, David Snowball, publisher of the Mutual Fund Observer newsletter, estimated that just 0.3% of the average portfolio in the United States, or $3 of every $1000, is invested in African assets.

It is true that many African investments have not fared well recently. Nigeria’s stock market index is down by 16% since the start of 2016. The S&P Zambia Index plunged 45% and its currency, the kwacha, depreciated by 45% relative to the dollar in one year. Ghana became mired in an economic crisis and had to pay a steep 10.75% interest rate for $1 billion in Eurobond. But even amidst unfavorable economic circumstances, the Ivory Coast stock exchange gained 7% in 2015 and the Kenyan stock exchange has been in the black since January. Both the Ivory Coast and Kenya are energy importers that benefit from the very phenomena which hurt economies like Angola, Nigeria, and Equatorial Guinea for whom 90% of export revenue is accounted for by oil.

It hardly seems rational for investors—even risk-averse investors—to invest so little in such a promising opportunity. It is best not to look at Africa as a monolithic entity, but a variety of economies with their own unique investment opportunities that fare differently over time. There are several reasons to remain optimistic about the future of Africa and the recent dip in African stocks and currencies means now is an excellent time to join the party.

Why Will African Economies Outperform the Developed World?

Demographics suggest that Africa is attaining a labor market which is conducive to strong economic growth. Africa has the youngest population in the world with 200 million people aged between 15 and 24. According to the United Nations, this figure will double to 400 million people by 2045.

It should be stressed that the economic situation is far from completely rosy in Africa. Six of the ten fastest growing economies in the world are in Sub-Saharan Africa, but the unemployment rate for the region is 6%. The African Development Bank (AfDB) reports that regional youth unemployment is twice as high as the general unemployment rate. North Africa especially suffers from high youth unemployment with a youth unemployment rate at 30%. Botswana, the Republic of the Congo, Senegal, and South Africa are among the countries which fare even worse than that region.

Nevertheless, Marketwatch reporter Sara Sjolin conveyed a valid reason to believe the labor market will improve: “In the strongest African economies, as the workforce expands, economists expect demographics to drive higher demand for services, goods, housing and infrastructure, which in turn will help drive domestic economies.”

To make this happen, African policymakers need to shift government spending towards facilitating growth in sectors like agriculture and manufacturing. Thomas Vester, manager of $875 million at the LGM Frontier Markets fund, credited Kenya, Ghana, Botswana, and Zambia as countries which have recently committed to longer-term projects like infrastructure and housing construction to support sectors with strong future growth. Vester forecasts that these economies will experience a 20-year trend of growth of about 6%-7% due to the fiscal stimulus. African policymakers have recognized that the optimal role of government is to intervene to facilitate economic growth and are slowly beginning to reap the rewards.

Most importantly, data suggests that Africa is undergoing a transformative moment in its economic history. The natural resources and mining sectors have been the fastest-growing sectors for years in Africa, but Sjolin argues, “With rapid economic growth also comes a rising middle class that wants to go out, open bank accounts, buy branded groceries and, eventually, buy cars, houses and life insurance.” The biggest African economy, Nigeria, saw its middle class grow by 600% between 2000 and 2014. Sjolin also believes that by 2030 Ghana, Angola, and Sudan will experience a steep increase in middle-class families as well.

The growth of a large middle class will be vital for African economic growth. Middle class consumers have a high marginal propensity to consume relative to their upper class counterparts, but also more disposable income than the poor. For this reason, the forecast of a substantially expanded middle class is the biggest reason to be optimistic about African economic growth.

What Are The Best Investment Opportunities in Africa?

The question for investors is who benefits from the consumption patterns of the new African middle class. Vester indicates that these middle-class consumers are likely to boost profitability for telecom companies, food and beverage companies, and banks. His fund has holdings in companies like the Guaranty Trust Bank in Nigeria and Senegalese telecom provider Sonatel. Meanwhile, Mark Mobius, executive chairman of Templeton Emerging Markets Group and manager of the Templeton Africa Fund, owns holdings Guaranty Trust Bank as well, along with Zenith Bank (Nigeria), Nigerian Breweries (Nigeria), and telecom firm MTN Group (South Africa).

Vester and Mobius, however, entered into long positions with these firms at the end of 2014, prior to the volatility of 2015 and the asset market plunge in 2016. Consequently, the stock prices for companies have recently plummeted as shown below:

Guaranty Trust Bank PLC

Zenith Bank PLC

Nigerian Breweries PLC

MTN Group PLC

These companies have seen sharp dips in their market value in the past year, but there are reasons to be confident in their fundamentals.

This small sample shows that it is reasonable to believe that there are long-term opportunities to invest in Africa and earn a high return. Though investors are afraid of the macroeconomic outlook in the short term, financial analysis of these companies indicates these fears are misdirected. The relatively high earnings per share, along with the relatively low price/sales and price/earnings (Nigerian Breweries PLC excepted for the P/E pattern), indicates that African companies can be solid bargains.

With that being said, it is rational for short-term investors to have some anxiety. Like many frontier markets, African economies have struggled because of monetary policy divergence with the Federal Reserve Bank of the United States which has begun to raise its benchmark interest rate. More significantly, however, many African economies are dependent on exporting commodities like brent crude, foods, and metals. For instance, Nigeria’s net exports of commodities consist of 34.5% of its GDP.

For the time being, many African countries—especially the ones shaded in dark red on the graphic from The Economist shown above—are vulnerable to price swings of commodities like the drop in brent crude from $104.90 to its current level of $32.70. But given the fact that African governments have begun to diversify their economies, it is reasonable to believe that the woes of African stocks are transitory. If the map above looks much different in twenty years as I suspect, that means assets in Africa will have increased in value exponentially from where they are now. It is a risk to make that assumption, but I believe it is a well-calculated risk.

The Future

The long-term potential of African economic growth has created an excellent opportunity to exploit the risk aversion of other investors. There are short-term pains now, but it is best to follow the advice of Laura Garitz, manager of the U.S.-based Wasatch Frontier Emerging Small Countries fund. One quarter of her fund’s assets are invested in Africa and she has made no reductions this year. “Africa’s countries can no longer depend on a booming export market for resources to China,” Ms. Geritz said to The Wall Street Journal. “Africa will have to depend on its greatest asset—it’s pool of young, bright, driven people.”

Moreover, the equity home bias puzzle demonstrates the validity of contributions from behavioral finance. There are not many fundamental reasons investors should allocate almost all of their assets in their home country, which creates an opportunity for risk-seeking investors willing to look elsewhere. Data indicates that Africa is clearly the best region for these investors to earn a high return. By continuing to miss out on the vast economic growth from the continent, developed market investors are leaving easy money on the table. Simply put, it pays to not always root for the home team.

Author’s Note: As always, this post reflects solely my own views, not those of the Penn State Economics Association or any other entity I represent. 

Is College Really Worth It?

By Steve Leonard

Before reading on, it should be noted that I write this article from a neutral point of view. As I sit, I feel particularly jaded when it comes to college, as most seniors probably do. From these feelings come thoughts of the alternatives I could have picked four long years ago instead of going to college such as selecting a blue collar job like becoming an electrician. Out of curiosity I decided to make a few simple assumptions to determine if getting a degree is really more advantageous than working a blue collar job when it comes to retirement. We’ll pretend life begins at retirement then, and he who has the most saved at age 65 is the winner. We’ll need to make a few more assumptions to simplify this scenario enough to come to a conclusion.

The first assumption will be that retirement contributions towards a 401k are 10% of salary. Salaries used will be $31,969 for a blue collar job, which is the average salary for an entry level electrician , and $45,327 for those with a bachelor’s degree, which is the average salary for a new college graduate. Savings work out to be $3,196 for a blue collar job and $4,532 for those with a bachelor’s degree. The second assumption will be that savings for retirement begin at age 18 for a blue collar job and at age 28 for those with a bachelor’s degree. While most people graduate at age 22, we’ll assume that savings won’t begin until age 28 to account for student loan debt. If graduates contribute $4,532 per year to a 401k and average student loan debt was $29,000 in 2012, we’ll assume those 6 years of would-be retirement savings are used to pay off debts instead. Third, we’ll assume the average retirement age is 65. The last assumption we’ll make is that the average rate of growth for a 401k is 5%.

Under these assumptions, a blue collar worker who contributes $3,196 per year for 47 years earning 5% would have $569,269. Those with a bachelor’s degree contributing $4,532 per year for 37 years earning 5% would have $460,578. That’s a difference of $108,691. An electrician earns $108,691 more in retirement savings over their career than those who have earned a bachelor’s degree. In fact, someone with a bachelor’s degree would have to retire at age 68 if they wanted to have the same amount saved as an electrician who retired at age 65.

I recognize that the assumptions made here simplify this complicated scenario to a great extent. I also recognize that those who attend college have higher lifetime earnings potential than those with blue collar jobs. However, there are many jobs that require degrees such as elementary education jobs where lifetime earnings are nearly on par with that of blue collar jobs.

In the end, there is no right or wrong answer to whether college is worth it. Aside from a retirement standpoint, there are many other ways in which individuals gain value from going to college and there are many other ways in which individuals place value on not going to college. When it comes to retirement though, some blue collar jobs do in fact come out on top. And even for those blue collar jobs that may not come out on top, the retirement savings difference between college graduates and their counterparts may not be as large as some people imagine. For me, going to college was definitely a decision I’m glad I made, but I was certainly surprised to see how retirement savings can stack up against those who chose not to make the same decision  I did.

Sources:

http://www.forbes.com/sites/kerryhannon/2013/01/13/the-three-surprises-in-401ks/#16b0c4c932ea

http://naceweb.org/salary-resources/starting-salaries.aspx

http://ticas.org/sites/default/files/pub_files/Debt_Facts_and_Sources.pdf

http://www.hamiltonproject.org/papers/major_decisions_what_graduates_earn_over_their_lifetimes/

http://www.bls.gov/oes/current/oes472111.htm

Insider vs. Outsider: Should Wall Street Feel the Bern?

By Joe Kearns

It is no secret that former U.S. Secretary of State Hillary Clinton, like her husband Bill, has Wall Street’s ear. She has built personal relationships with prominent banking executives like Goldman Sachs CEO Lloyd Blankfein, Morgan Stanley CEO James Gorman, JPMorgan Chase CEO Jamie Dimon, and Bank of America Merrill Lynch CEO Brian Moynihan. This outreach to Wall Street executives and their employees is particularly useful to Clinton in fundraising for the 2016 presidential campaign. “The money is already behind her,” a Wall Street money manager told Politico. “I don’t think it’s starting to line up behind her: It’s there for her if she wants it.”

Like her establishment Republican counterparts, Clinton faces an opposition characterized by distrust of political elites. This opposition in the Democratic presidential primary has virtually been personified in the form of U.S. Senator Bernie Sanders, a democratic socialist from Vermont who once honeymooned in the Soviet Union and had a softball team called the “People’s Republic of Burlington.” It is safe to say Sanders has not endeared himself to the capitalist crowd backing Clinton.

Sanders does not rival Clinton’s endorsements or fundraising in this campaign, but he has become a thorn in her side with surprising success in generating support in early primary states. Recent polls indicate that Sanders and Clinton have a virtual tie in both Iowa and New Hampshire. Clinton has a huge lead in the next primaries (South Carolina and Nevada), but it is worth watching if news from the early primaries produces a feedback loop which trims her advantage.

A major reason for Sanders’s unlikely ascendance is the attractiveness of his anti-Wall Street populism to progressive voters in the Democratic Party. The concise diction (“Break up the banks”) of his proposals is catchy and easily understandable at a superficial level, in contrast to wonkiness of Clinton’s proposals. Financial markets, however, are complex and the question of which candidate’s regulatory policies have more social benefit requires a nuanced analysis.

Glass-Steagall: Should It Be Resurrected?

The Glass-Steagall Act was originally enacted in 1933 and it prohibited commercial banks from participating in the investment banking business. This was the case until the act was essentially repealed in 1999 under President Bill Clinton.

Sanders has argued that the repeal of Glass-Steagall allowed investment banks to speculate with depositors’ money held in commercial banks, and, consequently, paved way for banks to merge with one another at a rapid pace to create institutions that were too big to fail. “Let’s not forget: President Franklin Roosevelt signed this bill into law precisely to prevent Wall Street speculators from causing another Great Depression,” Sanders said in a speech, according to boston.com. “And it worked for more than five decades, until Wall Street watered it down under President Reagan and killed it under President Clinton.”

Clinton, like her husband, refutes the idea that Glass-Steagall triggered the financial crisis, pointing to the fact that the law would not have applied to any of the institutions at the heart of the crisis. New York Times columnist Andrew Ross Sorkin adds credence to Clinton’s argument by noting the irrelevance of Glass-Steagall to these institutions. For instance, Bear Stearns, Lehman Brothers, and Merrill Lynch were investment banks with no commercial banking business. For commercial banks like Bank of America and Wachovia, the problems stemmed from acquisitions of lenders Countrywide Financial and Golden West respectively. Other entities are not banks at all, and would not be regulated under Glass-Steagall: American International Group is an insurance company, while Fannie Mae and Freddie Mac are government-sponsored enterprises. When asked whether the financial crisis or JPMorgan Chase’s crisis-era $2 billion trading loss would have prevented by Glass-Steagall, U.S. Senator Elizabeth Warren (a leading proponent of restoring the act) conceded to Sorkin, “The answer is probably ‘No’ to both.”

In fact, Bill Clinton argued that the rollback of Glass-Steagall made it easier for institutions to recover from the 2008 financial crisis, citing the acquisition of Merrill Lynch by Bank of America. In this context, it is difficult to prove that the rollback of Glass-Steagall has had adverse economic effects and there is some evidence was beneficial. There is a role for regulation of merged investment and commercial banks, but this should not inhibit the positive attributes of larger firms. While Glass-Steagall is an effective boogeyman for Sanders, it appears to be little more than that.

Is Bigness Really Bad?

Sanders’ campaign taps into an American political legacy of distrust in capitalistic institutions which consists of Andrew Jackson’s demonization of the Second Bank of the United States as the “monster bank,” William Jennings Bryan’s “Cross of Gold” speech, and Theodore Roosevelt’s trust-busting campaign. The prospect of undermining the power of elite institutions especially resonates with the public in the aftermath of the 2007-08 financial crisis.

POLITICO senior staff writer Michael Grunwald complicates the uplifting populist narrative underlying Sanders’ financial reform proposals by arguing that the size of the largest U.S. financial institutions is not merely a necessary evil in a capitalist economy, but a positive good: “If JP Morgan hadn’t been big and strong enough to absorb the hemorrhaging balance sheets of Bear Stearns and Washington Mutual, we might well have endured a depression. Ditto if Wells Fargo hadn’t been big and strong enough to let Wachovia collapse in its arms. The world is also lucky Bank of America was big and (arguably) dumb enough to salvage Countrywide and Merrill Lynch from the jaws of death.”

Sanders’ fear of institutions becoming “too-big-to-fail” is rational to an extent given the interdependence between banks, but he is wrong to believe simply reducing the size of banks eradicates risk. His solution in the “Too Big To Fail, Too Big To Exist Act” even exacerbates risk by creating enormous uncertainty in financial markets: “the Financial Stability Oversight Council shall compile and submit to the Secretary of the Treasury a list of entities that it deems Too Big To Fail, which shall include, but is not limited to, any United States bank holding companies that have been identified as systemically important banks by the Financial Stability Board…the Secretary of the Treasury shall break up entities included on the Too Big To Fail List, so that their failure would no longer cause a catastrophic effect on the United States or global economy without a taxpayer bailout.”

The act lacks any definition or guidelines on what constitutes an institution that is “Too Big To Fail” or what procedure is to be used to break it up. Moreover, the risk-averse nature of investors suggests that the natural result of this act’s vagueness will be lower lending to all individuals including those who are low-income and, consequently, lower economic growth. In essence, Sanders’ solution is worse than the problem.

What is Clintonian Capitalism?

Aware of the need to counter Sanders’ populist message, Clinton wrote an op-ed which awkwardly attempts to reconcile leftist sentiment with an array of piecemeal reforms which enhance, rather than undermine, free-market capitalism. In one vein, she copies Sanders’ message by arguing, “I would also ensure that the federal government has—and is prepared to use—the authority and tools necessary to reorganize, downsize and ultimately break up any financial institution that is too large and risky to be managed effectively.” Like Sanders, she does not clarify what kind of tools she would use to orchestrate such a breakup.

On the other hand, there is a less ambitious, but more useful theme underlying Clinton’s reforms: to level the playing field and equalize information for financial markets. Her proposal to increase leverage and liquidity requirements for broker-dealers and impose strict margin requirements for short-term borrowing might be onerous, but, if comprehensibly constructed, it would equalize the oversight of the traditionally less-regulated shadow banking system and its more heavily-regulated commercial banking counterpart. This is laudable, as the financial crisis was partly a product of the disproportionately low regulation of hedge funds, investment banks, government-sponsored enterprises, and other non-banking financial institutions which make up the shadow banking system.

Moreover, Clinton’s proposal to independently fund the Securities and Exchange Commission and Commodity Futures Trading Commission would provide more stability and consistency in the enforcement of financial regulations. Her suggestion of a tax on high-frequency trading not only fulfills this goal, but it reduces the ability of some investors to exploit others who lack their quality of information to make an optimal decision. The virtue of these reforms come from the positive externality of lower uncertainty for investors which leads to a bigger societal risk appetite sufficient for economic growth. Clinton’s proposal has flaws, namely its absence of adequate details regarding the size and scope of future regulation, but its promise lies in an understanding of the nuances of financial markets that Sanders lacks.

The Verdict

Sanders suggests that the nature of capitalism is inherently flawed and requires a drastic upheaval of large financial institutions. Clinton’s reforms instead are largely designed to tweak the framework of financial markets to more optimally utilize the capabilities of capitalism. I have concluded that Clinton’s plan is more conducive to economic growth, a stronger risk appetite, and even the goal of reducing wealth inequality championed by Sanders. Yet, I credit Sanders for pushing financial reform to the forefront of this presidential election campaign and pressuring Clinton to respond to his ideas. Ironically, the democratic socialist senator has demonstrated the virtues of a competitive marketplace of ideas with his presence in the Democratic primary.

Author’s Note: As always, the content of this post solely reflects the views of the author, not the Penn State Economics Association. 

 

Urban Migration in the 21st Century

We’ve all experienced the inevitable logjam that results from entering the city, whether it’s New York or Los Angeles. We’ve pulled off the freeway, slowed to a crawl in the exit lane, and sat back for a long wait, as the traffic bottlenecks. And the closer we are to the stunning skyscrapers and bustling boulevards, the denser the logjam. Rush hour never ends in the city. But why? Why do hundreds of thousands of people pour in to these areas every day? And what does it mean for today’s world?

Although several factors push people to move to cities, an overarching theme among them is the desire for a modern way of life. Workers come in search of employment opportunities in burgeoning sectors like services and technology that are less abundant in small towns and rural areas. Cities also tend to be more politically and socially progressive, due to greater accountability and cultural diversity. New York, for example, is a leader in “open data,” an urban policy that grants citizens access to a trove of information about the day-to-day operations of public services and government programs within the city. People – certainly young adults, who embody those flocking to the city – are attracted to this dynamism.

According to the United Nations, approximately 4 billion people, or 54 percent of the global population, now live in urban areas. This number is projected to rise to nearly two-thirds of the global population by 2050, with most of the growth occurring in developing countries. Of the 4 billion today, 1 in 8 live in so-called “mega-cities” of over 10 million inhabitants, such as Tokyo, Delhi, Shanghai, and Mexico City. The world is urbanizing faster than ever before.

As demographic power shifts towards cities, economic power is moving in the same direction. Cities account for over 80 percent of world GDP and are central to economic development. Not only do they benefit from large pools of consumers and talent, but they concentrate government, financial capital, and transportation and utilities infrastructure. This concentration helps to lower transaction costs and create networks conducive to innovation. The enhanced productivity of cities can drive growth and raise a country’s standards of living, including life in rural areas. They are also associated with lower fertility, a crucial aspect of the transition from “developing” to “developed.”

However, not all cities are equally effective, nor are all inhabitants within a city equally well-off. On the contrary, cities are often known for stark income inequality. For every high-rise, there may be ten who are homeless or barely sheltered on the fringe; for every limousine and luxury boutique, there may be twenty who are struggling to pay bills on minimum-wage jobs. Indeed, cities often have vast informal economies in which workers earn much less than the minimum wage and cannot expect any stable income. These workers, especially women, are highly vulnerable to poverty traps. The disparity between the very wealthy and the extremely poor in cities is nowhere as apparent as in the slums, or informal settlements of the indigent. Here, crowding, unsanitary conditions, crime, and lack of access to utilities, healthcare, and education prevail. As population density increases, it becomes harder and harder to scale and share these resources among more people.

The challenges to sustainability explain why megacities, despite their rapid rise and distinct advantages for economic growth, are not considered the ideal destinations for those seeking to relocate. Every year, the Economist Intelligence Unit ranks cities around the world by “liveability,” or a combination of their stability (safety), healthcare, education, infrastructure, and environment. At the top of the list are “mid-sized cities in wealthier countries with a relatively low population density,” rather than seemingly obvious world-class candidate cities like London.

Fortunately, deliberate urban planning can bring cities of all sizes closer to their economic and social potential. The World Bank, one of many institutions to take on research in urban planning, is developing strategies focused on building affordable housing and climate-friendly infrastructure. The ability of governments to address these priorities and implement solutions will shape the future of cities – and in our increasingly urban world, our future as well.

This blog post was written by Eleanor Tsai.

Sources

http://www.economist.com/blogs/graphicdetail/2015/08/daily-chart-5

http://www.ted.com/topics/cities

http://www.theatlantic.com/business/archive/2012/05/what-is-the-worlds-most-economically-powerful-city/256841/

http://www.worldbank.org/en/topic/urbandevelopment/overview

http://www.mckinsey.com/insights/urbanization/urban_world

http://esa.un.org/unpd/wup/Highlights/WUP2014-Highlights.pdf

The Economics of Movie Sequels

Sometimes, it seems like movie studios would rather produce sequels than original material. Often, some sequels feel like an afterthought, unlike the planned sequels to the original Star Wars or Lord of the Rings movies. Taken, which has had two subsequent movies released since the original, was surely not meant to have sequels, right? Why would movie studios rather piggyback their previous work instead of making something that’s creatively original? Of course, the obvious answer is that there’s money to be made, but two not-so-obvious trends show us why.

First, the number of weekly movie-goers is shrinking, down from about 80% of households in the 1940s to about 5% of households now. As a result, movie studios have begun catering towards audiences they’ve already captured with an original movie. This is a successful strategy because people are much more likely to return to the box office to view characters and environments they’re already familiar with. In 2011, one fifth of all movie releases were some sort of sequel, prequel, or movie otherwise based off of an original. Likewise, last year, 18 of the top 25 films by box office revenue in North America fell into the same category. While a decreasing box office audience can’t be linked directly to an increase in sequels, it certainly creates a compelling argument for why studios have shifted their focus over time.

The second trend, which was revealed by Edward J. Epstein’s The Hollywood Economist, shows that movie revenues have shifted away from the box-office, which now accounts for only 20% of total movie revenues. Instead, revenues are coming from things like DVDs and streaming services, which make up 80% of total movie revenues. Because of this, the possibility of a movie becoming a hit through ticket sales, merchandise, and licensing is decreasing, which also means that the opportunity cost of investing substantial amounts of money into an original movie is increasing. The result is that studios are investing in sequels where the success of a story and its merchandise and licensing is already established. This allows them to minimize the risk associated with the creation of a new movie. In fact, in 2011 The Wall Street Journal estimated that Disney would allocate 80% of its budget towards franchise films, up from 40% a year before. This substantial budget allocation is a testament to the money-making power that sequels hold, and these trends give no surprises as to why we see so many.

It’s interesting to note that the idea of piggybacking the success of a previous title also applies to the video game industry, where sequels are perhaps more prevalent than in the movie industry. Some of the most popular gaming titles are long running franchises, like Assassin’s Creed, Grand Theft Auto, Far Cry, and Call of Duty. And the idea of returning to these concepts works, as evidenced by Grand Theft Auto V’s record breaking release. It broke 6 Guinness World Records including best-selling video game in 24 hours, fastest selling entertainment property to gross $1 Billion, and highest grossing video game in 24 hours. Even the Call of Duty series, which is 10 titles deep, continues to see an upward trend in sales for each new title. Few movie series in the long history of cinema have pulled this off, and the ones that do are able to do so in a clever way. The James Bond franchise has seen 24 releases; however, the series can reinvent itself with every new Bond face, which allows it to stave-off franchise fatigue. Likewise, The Avengers is another title that has been extremely successful. Although the series has seen 13 releases, nearly every movie is different from its predecessor because they all follow the life and times of different superheroes, which allows the franchise to feel fresh and unique with every new release.

It should be interesting to watch how the movie industry is shaped moving forward, especially by websites that allow people to watch movies for free on the internet. It’s become easier than ever to watch movies online, and even new releases aren’t safe. For example, I found The Martian on the internet not two weeks after its release to theaters. The amount of revenue that these websites deny movie franchises is likely no small amount either. And despite the efforts of law enforcement, movie studios, and movie cinemas to curb this illegal activity, it’s hard to say that they will be able to remove this illegal streaming activity all together. As a result, the success of new and original movies will likely become increasingly rare. If this is true, and current trends continue, perhaps sequels will be the only things that are released in the future. Although I must say, I’m really looking forward to seeing Star Wars: Episode XLIV.

This post was written by Steve Leonard.

Sources:

http://www.moviescopemag.com/market-news/featured-editorial/economics-hollywood-sequels/

http://www.theatlantic.com/business/archive/2013/07/the-6-graphs-you-need-to-see-to-understand-the-economics-of-awful-blockbuster-movies/277691/

http://www.guinnessworldrecords.com/news/2013/10/confirmed-grand-theft-auto-breaks-six-sales-world-records-51900/

http://www.statisticbrain.com/call-of-duty-franchise-game-sales-statistics/

http://www.gamesradar.com/30-longest-running-movie-franchises/

The Life Cycle Hypothesis and the Puzzle of the Philadelphia 76ers

By Joe Kearns

It would be a massive understatement to claim that Philadelphia 76ers general manager Sam Hinkie defies the conventional wisdom of the NBA. It is much less recognized that Hinkie defies the conventional wisdom of macroeconomic theory as well.

Hinkie’s amassment of draft picks at the expense of short-term success runs contrary to the Life Cycle Hypothesis developed by economist Franco Modigliani. Modigliani’s research suggested that individuals plan their consumption and savings behavior over their lifetimes. Specifically, individuals smooth consumption over the course of their lifetimes, borrowing when their income is low and saving when it is high.

To use this analogy properly, I would say Hinkie’s tendency to trade veteran players for draft picks is analogous to saving, sacrificing short-term utility in an attempt to provide a positive net utility in the long run. In other words, this is the opposite approach the Life Cycle Hypothesis suggests he should take.

The best contrast with the Sixers is the Cleveland Cavaliers. The Cavaliers had the first overall pick of the 2014 NBA Draft and selected Andrew Wiggins, only to trade him and Anthony Bennett to the Minnesota Timberwolves for 3-time All Star Kevin Love as part of a 3-team deal (incidentally, the Sixers were the third team and I will delve into that angle soon). It should be noted that the Cavaliers were in an unusual situation, having signed 4-time NBA MVP and Ohio native LeBron James. Still, Cleveland’s resources were heavily allocated towards the short-run, at least relative to the Sixers.

Meanwhile, in the same trade that sent Love to the Cavaliers, the Sixers received a first round pick from Cleveland. Trades like this have been the norm for the Hinkie-era Sixers. For example, in 2013, the Sixers traded All-Star point guard Jrue Holliday and their second round pick for the draft rights to First Team All American center Nerlens Noel and a 2014 first round pick.

Hinkie’s second draft actually geared the Sixers further toward the long-run at the expense of the short-run than his first. In 2014, the Sixers selected Big 12 defensive player of the year Joel Embiid with the third overall pick. The remarkable part about Embiid’s selection is that it was known he would likely miss the entire 2014-15 season due to a foot injury. Thus, the Sixers gained no short-run benefit from this selection.

Then, the Sixers traded for the draft rights of Croatian power forward Dario Saric, who is under contract for Andalou Efes S.K. of the Turkish Basketball League. Saric said he would play at least one more season in Turkey before joining the Sixers. The Sixers yet again resist the proverbial marshmallow.

The 2014-15 regular season saw the Sixers make the most curious display of delayed gratification yet. They dealt point guard Michael Carter-Williams, the team’s first round draft choice in 2013, for a future first round pick. Carter-Williams earned NBA Rookie of the Year honors, but proceeded to struggle with a low field goal percentage of .380. Still, it is curious that the Sixers essentially gave up on his potential so quickly.

There is value in acquiring future assets to make the team more potent in the future, but risks are immense as well. The biggest risk is that the Sixers have removed themselves almost completely from one avenue of player acquisition by becoming the least attractive destination for free agents. Why would a free agent possibly want to come to a team that is structured to lose often for the foreseeable future? Additionally, the players the Sixers are selecting might decide they want to leave the team when they have the chance as well, unhappy with the track record of losing. Intentionally tanking a season for an early pick one season is an accepted, albeit unspoken, practice in the NBA, but to do so two or more seasons is unprecedented. Uncertainty is rampant.

In the two seasons since Hinkie was hired in 2013 along with head coach Brett Brown, the Sixers have earned a record of 37-127. This would normally be perceived as an unequivocal catastrophe for an NBA team. But, in fact, earning such a poor record to this point is precisely the plan Hinkie has prescribed for the team. Hinkie has fully resisted the temptation of eating the marshmallow. The question is this: Will the marshmallow even exist by the time he is ready to eat it?

The NFL Draft’s Keynesian Beauty Contest: Enter Marcus Mariota

By Joe Kearns

Trading up in the NFL Draft for a premier player generally comes at a steep price because of the perception of an equally steep opportunity cost. Let’s discuss a few examples:

• In 1999, the New Orleans Saints traded all six of their draft picks to the Washington Redskins. They moved from the 12^th overall pick to the 5^th overall pick, so they could select Heisman Trophy winning running back Ricky Williams.
• In 2011, the Atlanta Falcons traded their first round (27^th overall), second round, and fourth round picks from the 2011 draft, as well as their 2012 first and fourth round picks to take the sixth overall pick from the Cleveland Browns. They selected future Pro Bowl receiver Julio Jones.
• In 2012, the Redskins traded their 2012 first round (sixth overall) and second round picks, along with their 2013 and 2014 first round picks to take the second overall pick from the St. Louis Rams. They selected Heisman Trophy winning quarterback Robert Griffin III.

All of these teams would have preferred to have avoided trading up, and simply taken the player they coveted with their own first round pick. However, high expectations that at least one competitor would use their own earlier pick on a player increased the price the team was willing to pay.

Economist John Maynard Keynes described a similar phenomenon in his seminal work, General Theory of Employment, Interest, and Money. He analogized price fluctuations in the stock market to a beauty contest, in which the contestants are judged not on the opinion of each individual judge, but what the judge perceives to be the predominant opinion of his peers: “It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.” (Keynes, General Theory of Employment, Interest and Money, 1936).

The slew of media rumors this offseason point to Oregon quarterback Marcus Mariota as this year’s proverbial beauty pageant contestant. Not only is Mariota the most recent Heisman Trophy winner, but quarterbacks generally get valuated much higher than the average prospect due to the perception of higher value attached to that position.

This hypothesis is contingent on the Tampa Bay Buccaneers using the first overall pick on Florida State quarterback and 2013 Heisman winner Jameis Winston. Assuming Tampa Bay selects Winston, the Tennessee Titans (second overall pick) are the team all of the other front offices have their eyes on. But why should we not assume the Titans would just draft Mariota themselves?

First, their poker-playing abilities have been suspect. In February, Titans general manager Ruston Webster downplayed the notion that they would pursue a quarterback with the second overall pick and talked up incumbent starter Zach Mettenberger. Then, Titans head coach Ken Whisenhunt shifted gears in March by heaping praise on Mariota. It made absolutely no sense for the Titans to initially downplay the notion that they might want a quarterback early. Because of that, the perceived value of the second overall pick fell. Whisenhunt might have been trying to undo some of the damage to the value of his team’s asset caused by Webster’s comments.

Second, the Titans have the potential to create a deep market among NFL teams interested in acquiring Mariota. The more teams show interest in trading up, the higher the return the Titans can earn. Basic microeconomics dictates that the higher the demand goes, the higher the price will climb.

The most visible rumor is that the San Diego Chargers will offer the seventeenth overall pick and top tier veteran quarterback Philip Rivers to the Titans for the second overall pick, which they will use to select Mariota. While this rumor has some credibility with Rivers refusing to sign a contract extension, game theory suggests the Titans have every reason to spread these rumors to artificially inflate the value of their pick.

Who might the Titans be trying to draw in? Look first at teams with a steep supply of desirable assets. Perhaps the Cleveland Browns, who have 35 year old Josh McCown and Johnny Manziel—coming off an underwhelming rookie season—as their top two quarterbacks. Not to mention the Browns have two first round picks to offer. Or maybe it’s the New Orleans Saints who have 36 year old Drew Brees and two first round picks of their own.

The New York Jets are a strong possibility to select Mariota as well, either by trading up or staying put at the sixth overall pick. Jets owner Woody Johnson has entered the poker game and, in my opinion, made an obvious bluff: “[Incumbent Jets starting quarterback] Geno [Smith] is probably way ahead of him at this point, believe it or not, whether you guys [reporters] have skepticism of that or not. Certainly, [Mariota’s] college career was good.” Consider me skeptical when you claim a player who lost his starting job to a 34 year old Michael Vick is superior to the defending Heisman Trophy winner.

There are plenty of other teams including the Washington Redskins, Chicago Bears, New York Giants, St. Louis Rams, Houston Texans, and Kansas City Chiefs that could look at Mariota as a valuable asset.

But the most interesting wildcard of all in this Keynesian beauty contest is the Philadelphia Eagles. Prior to coming to Philadelphia in 2013, Eagles head coach Chip Kelly was Mariota’s head coach at Oregon. Kelly helped Mariota record impressive statistics as a freshman in 2012 (2677 passing yards, 32 touchdowns, 6 interceptions). Kelly is arguably the biggest reason why Mariota’s expected draft value could inflate.

Despite this personal connection, Kelly has either given up on drafting Mariota or is playing his cards close to the chest. In March, he traded incumbent starting quarterback Nick Foles and a 2016 second round pick to the St. Louis Rams for starting quarterback Sam Bradford. Shortly after the trade, he spoke to the media unannounced at a press conference that was supposed to be for one of his players: “Let’s dispel that right now. I think that stuff is crazy. You guys have been going with that stuff all along. I think Marcus is the best quarterback in the draft. We will never mortgage our future to go all the way up to get someone like that because we have too many other holes that we’re going to take care of.”

Also, at the press conference, he went out of his way to say another team offered him a first round pick for Bradford. Unbelievably, he said the Eagles had not looked into what it would cost to trade up for Mariota, the very quarterback Kelly just called the best in the draft. The same quarterback who executed his offensive scheme masterfully as a freshman in college. It’s perfectly reasonable to think Kelly will not pay a certain price to trade up, but it cannot be ignored that he has every incentive to reduce Mariota’s expected value to an acceptable price.

A good maxim to abide by when trying to understand the economic structure of the NFL Draft comes from House’s titular protagonist: “Everybody lies.”

Venezuela Today: A Terrible Situation

By Camille Mendoza

Venezuela’s future is still not bright. After President Barack Obama issued economic sanctions against seven Venezuelan individuals for their involvement in several human rights violations, Venezuelan President Nicolas Maduro took the opportunity to express his dismay in the Summit of the Americas held in Panama. President Maduro claimed these policies were “the most aggressive, unjust and poisonous step that the U.S. has ever taken against Venezuela” and pledged a campaign to collect 10 million signatures on a petition he plans deliver to Obama demanding the order be rescinded. While these sanctions were ill-timed (U.S. allies like Columbia have spoken out against the policies), perhaps it is time Venezuela focused on other, more pressing matters.

Instead of criticizing the United States for what he calls an “imperialist threat” to his country, President Maduro should be concentrating on the horrible economic situation his country is currently facing. Despite having the world’s largest oil reserves, inflation in the Venezuela is the highest in the world for certain markets. Basic goods like coffee, cooking oil, and flour are almost impossible to get, as shortages increasingly impede even necessary goods from reaching people of almost all economic standings. People wait in mile-long lines for hours and hours simply to find out that the goods have either run out or are unavailable. Worst of all but completely expected, crime has soared. As many as 8 kidnappings per day are the norm in Caracas, the capital. Some last 24 hours, others may go for weeks, many end in death. What they all have in common is that they involve groups of lower-income people seeking large sums of money from the more privileged Venezuelans. The nation’s economy–already struggling after years of fiscally irresponsible government spending under Chavez–deteriorated even more after oil prices dropped by half in 2014. Oil exports are 95% of the Venezuelan exchange, and the sudden devaluation has put Venezuela in a position to default on foreign debt, pushing it to the brink of failed-state status.

Even after all of the inner turmoil, Marselha Goncalves Margerin, advocacy director for Amnesty International USA, agrees it may not be in U.S. interest to speak out on Venezuela’s domestic problems. “In this case, it’s probably counterproductive,” Goncalves Margerin says. “Not because there are no [human rights] violations in the United States but because there is lack of trust in both governments and it’s probably better done by governments that trust each other.” In the Summit of the Americas, the Venezuelan economic crisis is a topic that remained untouched once again.

Sources

http://www.usnews.com/news/articles/2015/04/10/venezuela-sanctions-backfire-on-obama

The Quagmire for the Unhired

By Cole Lennon

Even the best economic news can be laden with caveats.  Such was the state of the Labor Department’s April 7th announcement on the estimated number of job openings in the United States, as a positive headline was accompanied by sobering reminders that the recovery is not finished.  The good news is that there are an estimated 5.9 million job openings in the United States, more than at any time since January 2001.  The bad news is that increases in hirings continue to lag these increases in job openings, and the underlying reasons why are even more sobering still.

The first explanation is one that appeals to some economists: a skill mismatch.  The theory goes that a deficit of workers who are skilled enough to fill these newly open jobs is the problem, and economics journalist Danielle Kurtzleben speculates that it may hold for some occupations.  The other explanation is the one that she and others are arguably more focused on: hesitancy in hiring.

Articles in the Harvard Business Review and the New York Times confirm that an important impact of the Great Recession on the labor market is more cautious hiring, as employers reportedly spend more up-front financially and in hidden costs to attempt to find the perfect candidate.  The companies that have not found the candidate they find to be perfect continue looking, and the general results is that companies miss out on filling their openings for longer periods of time than normal.
This article puts that broader trend into focus, as hiring will then lag the amount of openings.  Sometimes the fact that great economic news like this comes with warnings labels is not a bug. This time, given the economic scarring of the Great Recession, it is a feature.

Sources:

http://www.vox.com/2015/4/7/8363463/job-openings-have-come-back-since-the-recession-why-not-hiring

https://hbr.org/2013/01/dont-hire-the-perfect-candidat/

http://www.nytimes.com/2013/03/07/business/economy/despite-job-vacancies-employers-shy-away-from-hiring.html?pagewanted=all&_r=0

Fame and Fortune: The YouTube Way

By Camille Mendoza

Long live the internet! What began as a hobby for most has become a career for some. By now, it is well known that many of YouTube’s video bloggers (or “vloggers”, as they are known) have become actual celebrities with devoted fan bases, event appearances, book deals, and even TV/movie gigs. YouTube, which has become an online network in which the viewer gets to control what content they’d like to watch, is now a springboard for familiar faces. Justin Bieber, Austin Mahone, and Jimmy Tatro are only a few of those who “made it”, so to speak, and now have successful careers outside of the internet. However, those who chose to remain on Youtube and make their careers from there are the new species of celebrities cropping up, and they are really coming into their own.

While they are making names for themselves, one has to wonder how it is that they are able to sustain themselves financially, i.e. how do you make money off Youtube? CBS reports that as soon as an account has enough views and followers (albeit the exact amount remains undisclosed), the account creators can then become Youtube Partners. What this means is that they can get up to 55% of the ad revenue that comes in from their posts. While, once again, it is difficult to pinpoint how much ads pay from the outside, Business Insider attempted to calculate it, and they came up with some very appealing figures.

Michelle Phan, makeup guru turned lifestyle personality, potentially makes over $1 million annually with her videos alone; Smosh, a duo of sketch-comedy geniuses, are estimated to make over $5.7 million; and PewDiePie, the Swedish video gamer with over 33 million subscribers, potentially makes an annual figure of over $8 million.

These salaries are simply astonishing, and while it definitely takes talent and guts to expose oneself the way YouTubers are now famous for, it definitely explains why more and more people are turning to the internet and not casting directors for jobs in the entertainment world. Fame may be fleeting, but the internet is forever.

Sources

http://www.businessinsider.com/richest-youtube-stars-2014-3#4-smosh-17

http://www.cbsnews.com/news/how-web-stars-make-money-lots-of-it/