The Great Debate

How home prices helped kill the first tech boom

By Ryan Avent
The opinions expressed are his own. 

The late 1990s was a wild time in Silicon Valley. The NASDAQ was soaring, and seemingly anyone could start a company, stick a .com at the end of its name, put together an IPO and retire a millionaire. The great boom ultimately took on a speculative character that led to wasted investments and the collapse of many poorly-grounded operations. But it was rooted in a surge of not-unrealistic optimism about the potential of the internet to change the world of business.

Among the striking features of the era, one of the most startling is this: the rate of high-tech entrepreneurship in Silicon Valley seems to have been below the national average from 1996 to 2000, according to a recent analysis of business creation during the tech boom. And from the late 1990s to the early 2000s — after the bust — Silicon Valley’s rate of high-tech entrepreneurship actually increased. How can this be? How is it that during the first great boom of the internet era, Silicon Valley was less of a hotbed for new firm formation than the country as a whole?

Economists Robert Fairlie and Aaron Chatterji suggest that the answer lies in the extremely tight labor market conditions that prevailed at the time. The tech boom was remarkably good for Silicon Valley workers. Average earnings rose by nearly 40% from 1997 to 2000 — more than twice as fast as the increase for the country as a whole. Non-salary compensation also soared, thanks to the popularity of stock options and the skyrocketing value of equity in tech firms. These generous pay increases made it unattractive for workers to leave established companies to strike out on their own. Entrepreneurship fell because life on salary was too lucrative to risk self-employment.

Why was pay so high? Rising productivity was a big reason, as were expectations (some more reasonable than others) of high and rising profitability across the tech sector. But these factors could just as easily have driven an increase in new firm formation and employment as a rise in salaries. Silicon Valley experienced more of the latter than the former because workers were scarce. During the late 1990s, the unemployment rate across Silicon Valley dropped well under 3%, eventually sinking to nearly half the national level. There was essentially no surplus labor in the whole of the region. Firms therefore had to bargain hard to hire qualified workers, and this meant giving up a substantial share of firm surplus in the form of salary, benefits, and profit-sharing. That, in turn, made it more attractive to be a worker than an entrepreneur.

And this brings us to the crux of the matter: why was the Silicon Valley labour market so tight? If the unemployment rate was so much lower than it was elsewhere in the country, and if compensation was rising so much more rapidly than elsewhere in the country, why weren’t people pouring into Silicon Valley from elsewhere in the country? More remarkably, why were people moving in the opposite direction?

The post-bubble world: what’s next?

The American Enterprise Institute is hosting a panel with Nouriel Roubini and Reuters contributor Chris Whalen on “living in the post-bubble world: what’s next?” It is being livestreamed today from 2pm – 4pm ET. You can watch the video of it here:

From AEI’s website:

Americans are living in the wake of the great credit bubble of the twenty-first century. They have experienced the crisis of its collapse, massive increases in government intervention and debt, and now more uncertainty. What’s next? Are we in for a long slog, or will the economy rebound? What will happen to housing prices, mortgage defaults, commercial real estate, the banking system, and post-bubble Europe? Will we have defaults on sovereign debt? Deflation? How big will the Fed’s balance sheet get? What steps should be taken now? These and related questions will be discussed by our panel of economic and financial experts.

The debate is moderated by AEI fellow and former president and chief executive officer of the Federal Home Loan Bank of Chicago Alex J. Pollock. Other panelists are:

Betting on tail risk seriously endangers your wealth

Investment strategies designed to benefit from tail risks are fast becoming the next bubble. Investors are paying over the odds to reap benefits from remote catastrophic risks and are ignoring more moderate but much more likely outcomes that will cost them a great deal in the interim.

Following the banking crisis and the flash crash, Wall Street is rushing to meet demand from investors wanting to make money from betting on extreme market dislocations and other “black swans” by taking long positions in rare, high-impact events at the tail ends of probability curves.

Bets on tail risks have become increasingly popular and come in a variety of guises. Buying out-of-the-money puts on the major stock averages to benefit in the event of another crash; commodity futures and options to benefit from resurgent inflation or a sudden supply disruption in supply; or physical gold and long-dated Treasury bonds to protect against deflation.

Cheap credit cannot restore broken illusions

Hans Christian Andersen’s fairy tale about the “The Emperor’s New Clothes” is a good explanation for the spectacular expansion and implosion of the bubble economy in the 2000s.

For a time, a collective suspension of disbelief allowed markets and investors to ignore risks produced by cheap credit, subprime mortgages, securitisation and the shadow banking system.

The system worked until someone impolitely shouted out the risk had not gone away, it was just hidden in plain sight, and many institutions were insolvent.

from The Great Debate UK:

Is a bubble burbling in financial markets?

JaneFoley.JPG-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The discrediting of the efficient markets theory in the aftermath of the financial crisis appears to have been accompanied with growing support for the view that rather than efficient in nature, financial markets are predisposed towards the formation of bubbles.

A bubble can simply be defined as an occurrence that begins when the price of an asset has been driven significantly above it "fair" value. According to the efficient markets theory this would not happen.

China must avoid a Japanese-style bubble

WeiGucrop.jpg – Wei Gu is a Reuters columnist. The opinions expressed are her own –

Everyone agrees that China’s economy must be rebalanced, but few have bothered to delve into the costs. Japan’s experience has shown that even well-meant changes could sow the seeds for a bubble.

China cannot stay with its current economic model forever. But as the economy has become extremely unbalanced, to some extent even more so than Japan’s in the 1980s, rocking the boat too much risks tipping it over. Instead of rushing into changes, it would be better to make reforms gradually.