Homeownership and Social Justice

I am reading and enjoying Simon Johnson and James Kwak's 13 Bankers. Like a lot of recent stuff (including an OECD report), it takes a swipe, if a mild one, at the virtues of homeownership.   If people think homeownershipp is overrated, I can live with that (even if I disagree with it. Where I do have a problem is when people argue that government "pushes" homeownership on people, whether they really want it or not.

I am not sure that the pushing matters that much--it is entirely possible that people, for reasons beyond financial reasons, want to own houses in particular and real estate in general.  Two things stick with me:

(1) I was talking yesterday with a developer here in India who is trying to building market-rate affordable housing.  He faces a number of hurdles, one of which, he said, is "Indians' obsession with homeownership."

(2) Years ago, when I was in Madison, the guy who cut my hair loved to talk about the rental property he owned in Florida.  It would, he said, be the source of his retirement income.  I asked him why he was so undiversified--why he didn't sell his place and put the money in an index fund.  His reply was that he didn't trust Wall Street, and that he needed an investment that he could "touch" as well as control.  I told him his mistrust of Wall Street was misplaced--shows what I knew at the time.

The point is that there is something about real estate that reduces agency problems,  One may not be able to control markets, but one can control the management of real estate that one owns.  I do remember when I left the rental market for the owner market, I was very happy, not because I thought I would make out financially (house prices in Madison had been stagnant for years), but because I disliked my landlord, and was relieved that I would no longer have to write a check to him. 

This is not to say putting people in houses they cannot afford is a good idea, and I have long been dubious of very low downpayment schemes (I do think homeowners who put no equity into their houses are not really owners).  But it is a little too easy for people who own houses (or have the choice to do so) to say it is not important to make the option available to others.  Freedom to some extent means the ability to take control of one's own life, and to avoid agency issues as much as possible. 

I freely confess that this is all supposition based on informal observation.  Some work has been done on how ownership solves some agency issues, but I think it is an understudied phenomenon.  If anyone wants to help me think about how to model such things formally, I would welcome the assistance.

According to an informal vote of Indian School of Business MBAs...

...the cities with the most potential for real estate investment in India are Pune and Ahmedabad. 

How much freedom to choose?

Ed Glaeser argues that the "moral heart of economics" is "freedom" and in particular the "freedom to choose:"

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.    

Uh-oh

I met with a large developer here in India.  He told me that "rent models," (i.e., discounted cash flow models) don;t work in India--that everyone wants to own property in India, and so India is different.  I remember a Japanese real estate guy telling me the same thing about Japan in the late 1980s.

At least there isn't a lot of leverage here, so the systemic risk of a collapse in prices is lower.  But still....

Mark Thoma passes on terrible news about Maxine Udall, girl economist

To all Maxine Udall Girl Economist Readers

I didn't know who she was, but I felt like I knew her.  She was smart and wise.

Land use regulation and the cost of housing, Indian style

Mumbai is among the densest cities in the world: as a metropolitan area, it is roughly ten times denser than New York (h/t Alain Bertaud).  Yet residential zoning codes typically have FSIs (the equivalent of a floor-area ratio) of between 1 and 1.33.  This compares with typical central business district FSIs of between 5 and 15 in other cities around the world, and there are places in Hong Kong, which is a very attractive city, where it reaches 20.  

So what happens when the most crowded large city in the world forbids intense development?  Prices get very high.  The most expensive parts of Mumbai are more expensive than Manhattan; the least expensive are comparable to the American Midwest, but people's "middle-class" incomes are perhaps 1/8 as large in Mumbai.

A developer I spoke with last night told me that if FSIs were raised to 4 (still low by world standards), prices would fall by about 50 percent.  While this is not an econometrically determined elasticity, it does make a certain amount of sense.  It would be worth at least doing the policy experiment of raising FSI uniformly.

As for services, well, there are already plenty of people using services.  The average person in Mumbai consumes about 30 square meet of residential floor space, so allowing more vertical development might, if anything, alleviate crowding, both inside and out.  

The present value relationship still doesn't work in India

I had students here in Hyderabad gather data on rents, and then we put together a valuation pro forma.  We determined that the present discounted value of flats here is roughly 40 percent of their sale price.

I have been doing this sort of exercise since I first visited south Asia seven years ago, and I get about the same outcome every time.  It is not credit that is driving this market--many people buy property with cash.  People tell stories about "black money" financing property--this is untraceable, and therefore untaxed, money.    But our calculations imply an implicit tax rate of 60 percent--taxes in India are not that high (in fact, other than an eight percent transfer tax, they are fairly similar to the US).

So the story must be about expectations, and indeed, that is the story I hear.  But current yields are well under 3 percent, and if values rise faster than rents, those yields will get even lower.  Something has got to give.  I just have no idea when.

The OECD says imputed rent should be taxed

When homeowners own their property with equity, they get a tax benefit as important as the mortgage interest deduction: the imputed rent they pay to themselves goes untaxed.  To think about how this works, consider two nieghbors who own their houses free and clear.  Suppose the houses are identical, and that the nieghbors swap houses, paying rent to each other.  They now have a tax liability that they would not have had they remained in their houses.  Avoiding this liability is tantamount to a tax expenditure--a benefit to those who own their houses without debt.  The OECD is correct that countries rarely tax imputed rent, and argues that this lack of taxation has tilted investment toward housing to the detriment of more productive uses.  It also argues that the benefits to homeownership are overstated.  I am not sure that this is true (see here and here), but I will leave that for another time.

The question is how does one go about taxing imputed rent?  It is not easy.  One could start by imposing an ad valorem tax on property values (such as a local property tax), but that doesn't tax imputed rent per se, because it does not take into account expected inflation (if one person expects her house to go up in value, and another does not, the rent the first person pays is lower than the second).  Alternatively, one could find comparables in the rental market and attribute rents found there to the owner market.  But owner and rental markets are so segmented that this would be difficult to do.

This has implications for fairness; if we don't know what we are taxing, it is hard to know how much to tax it. 

Amy Chua and the Reflection Problem

I saw Amy Chua speak some years ago (at the World Bank, I think) about her book, World on Fire. She was an excellent, witty and provocative speaker, so much so that I read the book as a result. And while the book was indeed thought-provoking, it was not convincing. Her basic point was that democracies can produce instability: minorities in democracies can amass economic wealth, which in turn leads to resentment, which in turn leads to political scapegoating and instability and all other kinds of bad things. The problem is she never presented to me a convincing counterfactual; she never showed me how a world devoid of democracy would also be devoid of resentment and instability.

As a result of reading World on Fire, I will not read Battle Hymn beyond the excerpt in the Wall Street Journal (although I understand that the excerpt is not representative of the book). If the book is only a memoir, then it is almost certainly fine, but this is not how it is being represented. Instead, it is being characterized as a comparison between "Chinese parenting" and its results and "Western parenting" and its results. Again, this may be unfair to Ms. Chua, but the book has spurred myriad commentary about the virtues and deficiencies of various parenting styles.

What is lost in all of this is how difficult it is to actually draw inferences about the effects of parenting styles on outcomes. Charles Manski calls this "the reflection problem." Here is Manski:

Here is an identification problem from everyday life: Suppose that you observe the almost simultaneous movements of a person and of his image in a mirror. Does the mirror image cause the person's movements, does the image reflect the person's movements, or do the person and image move together in response to a common external stimulus? Empirical observations alone cannot answer this question. Even if you were able to observe innumerable instances in which persons and their mirror images move together, you would not be able to logically deduce the process at work. To reach a conclusion requires that you understand something of optics and of human behavior.

A like inferential problem, which I have called the reflection problem (Manski 1993a), arises if you try to interpret the common observation that individuals belonging to the same group tend to behave similarly. Two hypotheses often advanced to explain this phenomenon are endogenous effects, wherein the propensity of an individual to behave in some way varies with the prevalence of that behavior in the group; and correlated effects, wherein individuals in the same group tend to behave similarly because they face similar environments and have similar individual characteristics.

Similar behavior within groups could stem from endogenous effects (e.g., group members could experience pressure to conform to group norms) or group similarities might reflect correlated effects (e.g., persons with similar characteristics might choose to associate with one another). Empirical observations of the behavior of individuals in groups, even innumerable such observations, cannot per se distinguish between these hypotheses. To draw conclusions requires that empirical evidence be combined with sufficiently strong maintained assumptions about the nature of individual behavior and social interactions.

Why might you care whether observed patterns of behavior are generated by endogenous effects, by correlated effects, or in some other way? A good practical reason is that different processes have differing implications for public policy. For example, understanding how students interact in classrooms is critical to the evaluation of many aspects of educational policy, from ability tracking to class size standards to racial integration programs.

Suppose that, unable to interpret observed patterns of behavior, you seek the expert advice of two social scientists. One, perhaps a sociologist, asserts that pressure to conform to group norms makes the individuals in a group tend to behave similarly. The other, perhaps an economist, asserts that persons with similar characteristics choose to associate with one another. Both assertions are consistent with the empirical evidence. The data alone cannot reveal whether one assertion or the other is correct. Perhaps both are. This is an identification problem.

Whatever one thinks about Ms. Chua's parenting, we have no firm evidence whether her kids' outcomes are a function of Chinese parenting, Chua-specific parenting, or just her kids' endemic talents. It is a serious problem when we forget that.

Some evidence about state government spending multipliers.

Three abstracts. The findings should give the pain caucus some pause.

Daniel Shoag:

The effect of government spending on income and employment is a central unresolved question in macroeconomics.

This paper employs a novel identification strategy to isolate exogenous and unexpected variation in state government spending. State governments manage large defined-benefit pension plans for which they bear the investment risk. Using a newly-collected dataset on the returns and portfolios of these plans, I show that the idiosyncratic component of their returns is a strong predictor of subsequent
state government spending. Instrumenting with this ‘windfall’ component of returns, I find that state government spending has a large positive effect on income and employment. Baseline estimates indicate that each dollar of spending raises in-state income by 2.12, and that 35,000 of spending generates one
additional job. These effects are not due to in-state investment bias, are concentrated in the non-traded sector, and are larger during times of labor force ‘slack.’ Finally, I consider how these results compare with the predictions of a standard macroeconomic model and outline which features in the model are
consistent with the empirical findings.

Nakamura and Steinsson:

We use rich historical data on military procurement spending across U.S. regions to estimate the e ffects of government spending in a monetary union. Aggregate military build-ups and draw-downs have diff erential e ffects across regions. We use this variation to estimate an open economy government spending multiplier of approximately 1.5. Standard closed economy estimates of the government spending multiplier are highly sensitive to how strongly monetary policy \leans against the wind." In contrast, our estimates "diff erence out" these eff ects because diff erent regions in a monetary union share a common monetary policy. This allows us
to better distinguish between alternative business cycle models. We show that our estimates are consistent with a New Keynesian model with GHH preferences. They are consistent with a small closed-economy multiplier when monetary policy is highly responsive (as in the Volcker- Greenspan era) and a substantially larger closed-economy multiplier when interest rates are less responsive (as at the zero lower bound).

Clemens and Miran:

Balanced budget requirements lead to substantial pro-cyclicality in state government spending outside of safety-net programs. At the beginnings of recessions, states tend to experience unexpected deficits. While all states ultimately pay these deficits down, differences in the stringency of their balanced budget requirements dictate the pace at which they adjust. States with strict rules enact large rescissions to their budgets during the years in which adverse shocks occur; states with weak rules make up the difference during the following years. We use this variation to identify the impact of mid-year budget cuts on state income and employment. Our baseline estimates imply i) a state-spending multiplier of 1.7 and ii) that avoiding $25,000 in mid-year cuts preserves one job. These cuts are associated with shifts in the timing of government expenditures rather than differences in total spending over the course of the business cycle. Consequently, our results are informative about the potential gains from smoothing the path of state government spending. They imply that states could reduce the amplitude of business-cycle fluctuations by 15% if they completely smoothed their capital spending and service provision outside of safety-net programs.

ASSA Interviewing Etiquette

Here is a suggestion for freshly-minted Ph.D.'s looking for Assistant Professor jobs: take time to at least glance at the web sites of the places to which you are applying.  Even in academia, people who are hiring you want to know that you have at least a little interest in the place where they work.

Apologies to Mark Thoma

I was sloppy in characterizing Mark's comments about Gene Sperling.  He writes:

I think this misstates what I have said. I posted something defending Sperling, and the claim that 

"their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs."

I didn't say he was a protege, and said nothing about the money, etc.

I did say that from a political view I thought the administration would be better off breaking its ties with the Clinton administration personnel, just as I said the same thing about Summers. But that is different from saying there is something wrong with Gene in particular other than the political baggage that comes with him.

Here is what I said specifically. First, I echoed a post defending him. Then, I said "I still think a break from the Wall Street connected side of the Clinton administration would have political value."

See: 

http://economistsview.typepad.com/economistsview/2010/12/who-should-replace-summers.html

Tim Duy had much more to say, but those are his words, not mine.

Goldman Sachism?

I enjoy Felix Salmon and Mark Thoma's blogs a lot.  In the last day, both have lamented the possibility that Gene Sperling might replace Larry Summers; their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs.

I suppose I should disclose that I once got to sit next to and talk with Gene Sperling on an airplane from Jackson Hole to Denver, and he struck me as a person of great intelligence and even temperament.  That doesn't particularly matter--it does matter, however, that the people who I know who know him also regard him as a person of great intelligence and even temperament.  Let me emphasize the temperament part.  He also pushed for the very good idea of imposing Pigou taxes on banks.

So far as I know, his critics do not suggest that he is really personally deficient, but that he is a problem because (1) he worked in the Clinton Administration under Robert Rubin and/or (2) he received money from Goldman Sachs.  To me, the first part is actually a recommendation, but I feel the need to comment on the second.

Goldman Sachs has done things for which it should not be proud.  Does that mean that anyone who worked at/for the place should be disqualified from government?  In its history, the Ford Motor Company has done unlovely things; Boeing has done some not-so-great things; I am not please at some of the things my one-time employer, Freddie Mac, has done.  This does not mean people who worked at Ford, Boeing and Freddie Mac should be disqualified from government.  All these places, as well as Goldman Sachs, have many intelligent, honest, capable people.

If you have a beef with the substance of Sperling, fine.  If you think Furman would be better in the job, that is fine too.  But guilt by association is just too easy, and has its own ugly history.

Top Ten Cities for Real Estate Investment (h/t Wisconsin Graaskamp Center and Francois Ortalo-Magne)

The Association of Foreign Investors in Real Estate surveyed real estate investors from around the world about places and property types.  Among other questions, they asked respondents to list cities that had the best prospects for commercial real estate.  The list:

1. New York
2. Washington
3. London
4. Paris
5. Shanghai
6. Singapore
7. Hong Kong
8. Madrid (!!!)
9. Sydney
10. Los Angeles

Urban recovery: Pareto improvement is hard

The first time I visited Pasadena, in 1980, the place was a bit down-in-the mouth.  The corner of Fair Oaks and Colorado (the heart of what would become Old Town) featured disreputable establishments, and many beautiful old houses had fallen into disrepair.  Air quality was dreadful.

Now, 30 years later, Pasadena is among the loveliest and most lively cities I know (it also happens to be where I live).  New Urbanists should love the place: pedestrians fill Old Town and, to a lesser extent, Lake Avenue.  The craftsman bungalows--the sort of houses that people like Andres Duany like to copy--have been restored to their former glory, and range in size from modest to obscenely large.  Air quality, while still not great, is much, much better.  One can see the San Gabriel Mountains every day.

This produces unhappiness on the part of Occidental College sociologist Peter Drier.  He writes:

New US Census data reveal a troublesome reality about the Rose City. Pasadena’s has become a tale of two cities — one that welcomes affluent residents and another in which middle-class and poor families are pushed out by rising housing prices. 

Pasadena officials like to boast about the city’s recent “renaissance,” pointing to the major (and expensive) renovations of City Hall ($117 million) and the Convention Center ($150 million), and the just-approved $152 million facelift for the Rose Bowl, as well as the addition of new condominium complexes and upscale stores. 

 But who, exactly, is benefiting from the city’s renaissance?...

...At the very top, the wealthiest 5 percent of Pasadena households — those with household incomes above $249,841 — have almost one-quarter (22.7 percent) of city residents’ total income. Only five cities – Los Angeles (25.9 percent), Glendale (25.8 percent), Rancho Cucamonga (25.2 percent) San Francisco (23.4 percent) and Oakland (23.1 percent) — have a higher concentration of income among the richest 5 percent.

 In contrast, the poorest one-fifth of Pasadena households — those with incomes below $23,042 — combined have only 2.6 percent of all residents’ income. As Table 2 reveals, only in San Francisco do poor households have a smaller share of citywide income.

In Pasadena, those in the next poorest one-fifth — those with household incomes between $23,043 and $45,174 — bring home only 7.6 percent of residents’ incomes. Together, the poorest 40 percent of Pasadena’s households have only 10.2 percent of Pasadenans’ total income.

...Pasadena lost 2,420 households with incomes below $50,000 — an 8.8 percent drop. By far the biggest losses were among households earning under $10,000. The number of these households fell from 5,273 to 4,094 — a 22.9 percent decline.

None of this should be surprising in light of spiraling rents and house prices, the accelerating conversion of affordable apartments to expensive condominiums, the predominance of new luxury units among the condos approved by city officials and the paucity of affordable housing in Pasadena’s development pipeline. 

So Peter underscores a fundamental problem.  We want out cities (and inner ring suburbs, such as Pasadena) to improve.  But when cities get better, they become more desirable places to live.  To use a metaphor, 30 years ago, Pasadena was a K-car, and now it is an Acura (one needs to travel south to San Marino for the BMW).  Consequently, when cities become successful, they tend to attract richer people and push out poorer people.  This is true in New York, San Francisco, London, Paris, and so on.


So whom does this help?  It certainly helps homeowners, regardless of income, because it leads to greater wealth.  The median person in Pasadena is a homeowner, but just barely; nearly 50 percent of Pasadenans are renters.  Because rents are higher, renters might appear to be worse off.  On the other hand, rents reflect desirability.  If the change of the value of the bundle of amenities arising from living in Pasadena is greater than or equal to the change in rents, renters are at least as well off as before.  Pasadena is cleaner, safer and healthier than in was 30 years ago, and these things are valuable.


The exception is those people who are forced to move because wealth prevents them from choosing to live in Pasadena.  Those who are forced out of their homes are worse off than before, and so a revived Pasadena is not a Pareto improvement (in the strict sense of the phrase) over dowdy Pasadena.


So what should we do?  Discourage the kind of renaissance that Pasadena has produced?  I think not.  I can think of three policy responses that might help.  First, make Section 8 vouchers and entitlement, so that people can choose to live in whatever city they like.  That is a federal responsibility.  Second, use Pasadena's relatively high property values (relative to other communities; not to five years ago) to improve social services.  But that is not possible to do without changes to Proposition 13 (parcel taxes are not as efficient or equitable as ad valorem taxes).  Third, get rid of regulations that make in extremely difficult to build inexpensive units, such as granny flats, in Pasadena.  This is the only lever than is in Pasadena's hands.


It is difficult to get around a very uncomfortable question: should all people have financial access to all communities?  As an economist, I tend to think the answer is no.  As a human being, I am not sure at all.

Fearless Predictions for 2011

"A man who goes around with a prophecy-gun ought never to get discouraged: if he will keep up his heart and fire at everything he sees, he is bound to hit something by and by."  --Mark Twain

It's that time of the year when journalists, analysts, and bloggers fire their prophecy guns, predicting what will happen in the next 12 months.  Most year-end predictions fall into four categories of uselessness: Fish in the Barrel, Shots in the Dark, Wish-Fulfillment, and Self-Service. 

Fish in the Barrel are predictions so obvious that they're almost sure to come true.  You make this sort of prediction if you're afraid someone will come back in 12 months and point out how many things you missed.  Any good prediction list should include about 60% fish, to ensure a nice overall score.  For example, the San Jose Mercury News recently predicted that M&A activity will increase in cloud computing in 2011 (link).  Gosh, really?

In this spirit, I'd like to predict that water will flow downhill throughout the year.  Please keep track of that; I know I will.

Shots in the Dark are things that no one can really predict, but that involve prominent names, so they sound insightful and interesting.  You need about 20% of this sort of prediction on your list -- not enough to ruin your average, but enough so you'll sound bold.  Besides, if you get lucky and hit on one of these, you can claim credit for the rest of your career.  The Merc predicted that Google will buy Twitter this year.  Nice.

My shot in the dark is the Newt Gingrich will marry Lindsay Lohan in 2011.  I know it's a stretch, but if I'm wrong I can pass it off as a joke, and if I'm right I'll be famous forever.

Wish fulfillment.  This is the other 20% of a good prediction list: You should predict one or two things that everyone agrees ought to happen, even if it they aren't likely to actually come true.  You don't get blamed if these are wrong, because the failure of the prediction shows that there's something wrong with reality, not wrong with you.  The Merc's prediction that Carol Bartz will be fired from Yahoo in 2011 fits in this category.

My wish fulfillment prediction for 2011 is that mobile web apps will take over from native mobile apps.  I've been predicting that for years (link); if I keep doing it long enough I'll eventually be right.  But in reality I think it won't happen in 2011, because APIs and browser infrastructure for disconnected web apps aren't fully mature yet.  Maybe 2012...

Self-Service.  These predictions are a whole separate activity.  Many industry publications fill valuable column-inches, and reward advertisers, by asking industry CEOs to predict the next year.  Most of the CEOs have no idea what to say, so they pass off the task to their PR departments, who naturally predict that the most important event of the next year will be the total dominance of their employer.  That's how Wireless Week came up with the following stunning forecasts (link):

--A mobile operator predicts that this will be the year of 4G
--A mobile transactions company predicts that it'll be the year of mobile payments
--A networking equipment company predicts that it'll be the year of WiFi

And on and on.  Along these lines, I'd like to predict that 2011 is the year that my startup, Cera Technology, will take over the galaxy.

(By the way, it really will.)


The trouble with all of these sorts of predictions is that you can't do much with them.  They're fun to read (and that's probably their main point), but if you take action based on them you'll put your business at risk.  Even the fish in a barrel are riskier than they look, because they're built on straight-line predictions of current events, and the past is a poor predictor of the future.  For example, here's ReadWriteWeb in 2007 on a thing called SecondLife (link):

SecondLife will become an important platform for marketing, promotion, and of course social networking - as people and businesses figure out different uses for it. Also we think SecondLife will continue its expansion worldwide. Currently you can find Habbo and SecondLife cards in most supermarkets (Wallgreens, CVS) in the US, so this trend should continue in other parts of the world. In short, virtual worlds will become an integral part of the real world in 2007.

Ooookay.

I am not trying to pick on ReadWriteWeb; it's an excellent site, and there were huge numbers of predictions like this at the time.  But you get my point.

Since it's impossible to accurately predict the future, the forecast I'd like to see isn't a list of what will happen, but a list of what could happen.  And I'm not looking for small things, but the big surprise changes that make or break companies and industries.  Specifically, what assumptions are we making that could turn out to be wrong?  How would that change the balance of power in the market?  And what should we do about it?

Here are my four forecasts of possible game-changers in 2011:


1.  The Mobile Data Market Stops Growing

That's a prediction you won't see in many places, but think about it for a minute.  Every market eventually saturates. The question isn't whether mobile data will saturate, but when.

Right now everyone's assuming the saturation point is far away, because smartphones are owned by only at most a third of phone users in the US and Europe (link).  The other two thirds are still available!  I have no doubt that most of those people will eventually get smartphones as their prices drop.  Horace Dediu has made this case very persuasively (link).

What I'm not sure of, though, is that those people getting cheap smartphones will pay for data plans.

When I was at Palm, we studied the market for mobile devices very intensely.  At the time, about a third of mobile phone users were willing to pay extra for any sort of advanced feature.  The other two thirds weren't willing to pay anything extra.  Many of them were too poor, some of them were too cheap, and some of them just didn't see any value in it.

If you gave them free hardware, like a cameraphone, they'd take it of course.  But when it came time to pay for camera-related services, they took one look at the first month's bill and then stopped sending photos to each other.  That's why multimedia messaging was a business failure.

Things have changed since I left Palm.  Smartphones are a lot more capable than they were four years ago, the networks are better, and Apple has spent years advertising the benefits of an iPhone.  I'm sure that has increased the number of people willing to pay extra for mobile data.  But by how much?

No one I know of has studied this directly, but I did recently see some consumer research from one of the major analysis firms.  It suggested that the percent of people willing to pay extra has risen to about 40%.  If that's true, then rather than being a third penetrated, the mobile data market may be about 75% penetrated.  Given the rapid growth of smartphone sales, we could hit the demand wall as soon as late 2011.

I'd be delighted to be wrong in this forecast.  Maybe the willing customers are growing much faster than the studies indicate.  Maybe the new devices coming this year will suck in a bunch more people.  I hope so.  But if you think 100% of the population is going to willingly add $200 or more a year to their phone bills just to browse the web from a bus, you're living in fantasyland.  And the end may be a lot closer than you think.

What it means.  The major mobile companies should be conducting careful consumer research on the willingness of people to pay for data plans.  Match that up with the growth rate of smartphones, and see where the lines cross.  Then invest (or hide) appropriately.


2.  Facebook Becomes Passé

No, Facebook won't die in 2011; I'm sure it will continue to grow throughout the year.  But right now Facebook is seen as the hottest player in the Internet, the leading disruptor that forces everyone else to react to it (link, link).

By contrast Google, the previous lead disruptor, is looking more and more like a typical big company trying to hit its growth targets.  The most striking evidence for this has been Google's public switch from internally-generated innovation to acquisitions.  At the peak of Google's rise, analysts fawned over its plan to innovate internally by hiring bright people and turning them loose on problems.  An article in Fortune Magazine in 2006, Chaos by Design, said Google had figured out how to create an internal atmosphere of "structured chaos" in which new ideas would bubble to the top automatically (link).  Four years later, Google's VP of corporate development says acquired companies can move faster than Google itself can (link).

"The stunning success of acquisitions that led to products like Google Maps, Android and YouTube has also opened Google to criticism that the company has become Silicon Valley's answer to the New York Yankees, using its wad of cash to buy talent rather than developing it from within." --San Jose Mercury News

It's not a shocking change.  Tech Overlords don't last forever, and in fact it seems like their reigns have become shorter over time.  IBM was the dominant player for about 25 years, Microsoft for maybe 15, and Google has held that role for less than ten.

If Facebook is the new leader in disruption, what could knock it off the throne?  I think its own success may carry the seeds.  As Facebook has become more and more popular, the young people who first fueled its success have started to look elsewhere for their social connections.  I've been watching the online habits of my teenage daughter and her friends.  They use Facebook, of course, but it's just one in a constellation of social tools they use, and it's not at the center.

The hot property among the people I watch appears to be Tumblr, which is a combination of social network and blogging platform.  Unlike Facebook, which focuses on your connections, Tumblr focuses on shared self-expression.  It's a new social medium, the easiest place online to say "I love these shoes" or "here's how I feel" or "listen to this song that my friend just posted."  For users who want to communicate feelings more than ideas, Tumblr is a unique vehicle.  No wonder it's popular among teens, who by definition are sorting out their feelings.

The other thing that makes Tumblr different is that it's not overrun by 40-year-olds reconnecting with their high school classmates.

This is a very typical Tumblr page (link).

Here's a Tumblr user on the difference between Tumblr and Facebook, expressed through video clips, which is very typical of the way Tumblr users communicate: link.

I'm not saying that Tumblr is the next Facebook.  Right now Facebook has about 30 times more traffic in the US; comparing them is like comparing a ladybug to a wolverine.  For all I know, in another six months the kids may have moved on to something else.  But the lesson of Tumblr is that Facebook encodes one particular type of social interaction, the friends-list-with-status-updates.  The real world of social interaction is far, far richer than that, and we don't know how it will translate online.  Chances are that at some point Facebook's powerful paradigm will turn into a straitjacket.

Will that happen in 2011?  I have no clue.  But I bet it'll take a lot less than a decade.

What it means.  Rather than trying to compete with Facebook head on, I'd be looking at other paradigms for social interaction online.  What social needs do people have?  Approval?  Validation?  Stimulation?  How can you deliver those things online, more effectively than people can get them in person?


3.  Book Publishing Dies
  
Someday, ebooks will enable established authors to sell their writing directly to the public, bypassing the publishers and bookstores and taking 70-80% of the revenue for themselves, rather than giving 85% of it to middlemen.  I have no doubt whatsoever that this will happen.  The trick is figuring out when.  People have been predicting it for more than a decade, but so far the publishers are still in charge.

As you know if you've been reading this blog for a while, I've tried to do some economic analysis on when we'll reach the tipping point where publishers become redundant (link).  I won't repeat the whole analysis here, but the summary is that when about 20% of the book-buying public has ebook readers or tablets, it'll make economic sense for an established author to drop print entirely and go straight to electronic distribution (because they can make so much more per copy sold electronically).  We're likely to see slow progress for ebooks until that point, and then an accelerating stampede after.

We're not close to the 20% tablet penetration figure yet, and we won't hit it in 2011.  But 20% is just an average across all authors; some may find that the market has shifted for them earlier than others.

So I was fascinated when I ran across this LA Times article on authors who have already decided to start ditching their publishers (link).  These aren't vanity writers going electronic because they can't get into print; they're established authors who are pulling their backlist books out of print because they can make more money selling them electronically.  One of the authors, Joe Konrath, detailed the economics of his decision here.

Check out the Times article and Konrath's scenario on the potential death spiral for bookstores (link).  The rumbling sound you'll hear is the Four Horsemen riding after the book publishing industry.  Will they arrive in 2011?  Not for all publishers, and not all at once.  My guess is that we'll continue to hear more hype than action in 2011, with the big switch starting in 2012 or 2013.  But the situation is fragile, and today's migration could turn into a stampede sooner than I expect.

What it means.  As I've said before, publishers need to find a way to deliver real value to authors and readers in an electronic world.  Maybe it's editing services, maybe it's marketing, maybe it's something I can't think of.  But it's different from what most of them do today.  And no, helping an author navigate the variety of ebook stores is not the answer.  An agent can do that.


4.  The Year of the Tablet Backlash

I'm sure Apple is going to sell a lot of iPads, Amazon (and maybe B&N) will sell a lot of e-readers, and hopefully the HP/Palm tablet will be interesting.  But I think it's very likely that most of the other tablets entering the market this year will exit just as quickly.  Why?  Because there's no particular user problem they're solving.

I've seen these consumer electronics bubbles before.  One company has a successful product, somebody else copies it ineptly, and everyone else piles on because they don't want to be left behind.  Never mind that they don't know why they're building the products, or for whom.  The result is inevitably a big overshoot, inventory writeoffs, damaged careers, and a press backlash as the manufacturers run away from the market and customers feel burned.

This is another case where I'd be very happy to be wrong, but the situation smells very much like the other product bubbles I've lived through.  If the tablet market does take off, it'll probably be because the manufacturers were rescued by an unexpected killer app.  If things end badly, give some blame to Google for feeding the overshoot by pushing Android as a tablet OS even though they have no clear idea what the market is for it.  Credibility is a precious resource, hard to accumulate and easy to squander.  When you have a powerful brand, you can convince people to follow you up the hill on a crusade once, or maybe twice.  But after you've burned them enough, they won't follow you readily again.  Just ask Microsoft.

What it means.  If you're making a tablet app, don't depend exclusively on Android.  And if you're creating tablet hardware, the product you should be building is an info pad (link).


There you are, my four forecasts of big game-changers that could happen in 2011.  What do you think?  You're welcome to disagree with these, but I'm most interested in your predictions of other big, surprising changes that could happen in the next 12 months.

Looking for Information on Real Estate Market Conditions in Hyderabad

I will be spending a few weeks visiting the Indian School of Business at the end of January; in the past, I have gotten welcome comments on the market environment in Hyderabad.  Anything that gives me more context is helpful.