Nov

29

Barriers to Riches [book]You might not think manhole covers float, but they do. As readers of a recent New York Times story learned, they float to New York City all the way from India ("New York Manhole Covers, Forged Barefoot and Sweaty in India," Nov. 26, p. A1). Every other Nov. 26 front page story was about play (college football) and foolishness (politics). But this one story was about hard work "eight thousand miles from Manhattan." Without much capital, Indian workers without shoes carry and pour molten iron by hand. It is a story of early capitalism but set in 2007 instead of 1857 or 1907. Why only now? India missed the boat when it blocked innovations and capital investment nearly a century ago.

Virginia Postrel's excellent 2001 New York Times article "Wealth Depends on How Open Nations Are to Trade" cites an MIT Press book "Barriers to Riches" [2001] by Parente and Prescott . Postrel quotes from the book: "poor countries are poor because some groups are benefiting by the status quo," and those groups use the law to block change. India has a long history of this. In the early 20th century, strikes kept Indian textile mills from increasing the number of looms each worker operated, and the government protected the old ways through steep tariffs on foreign textiles. As a result, from 1920 to 1938 textile productivity rose by only a third as much in India as it did in Japan, which was beginning its climb to prosperity." Established French textile firms similarly blocked advances and innovations by competitors a century earlier.

Government regulations in India blocked capital from iron foundries as well as textile mills. Jobs were saved, but not the sort of jobs that should have survived to the 21st Century. Even without enough capital, iron from India is competitive with U.S. foundries. India might seem a long way from New York City, but for manhole covers it is probably closer than Pennsylvania. Transportation costs are key to costs for heavy and inexpensive goods like manhole covers. Wikipedia says manhole covers weigh more than 100 pounds. Whether cast in India or Pittsburgh they have to be shipped (or "railed"?) to New York City. Going by ship has always been less expensive than over land. Railroads with their overland rivers of steel closed the difference (but dense railroad regulations widened it again). England, Western Europe, and America benefited greatly from cheap transport along plentiful rivers and ports connecting cities, compared to expensive overland transit in Eastern Europe, China, India, and Africa.

Shipping is cheap from India but capital is still in short supply. Iron foundries in India need capital to boost productivity (and, at the least, to buy shoes for workers). What rivers or rails will direct capital flows to India? Well, foreign aid and the World Bank is one tried and false route. Hundreds of millions have flowed to various projects over the years. One bright-idea from development economists was a large recycling plant for India. Millions were spend importing the high-tech recycling equipment, but India lacked enough junk to keep it running. With armies of underemployed workers sifting through waste for anything valuable, not enough valuable waste was left to feed the imported recycling plant. Another failed aid project added to the one (or two?) trillion plus dollars wasted (so far) on foreign aid.

Stock markets are different than foreign aid projects. With private stock markets, firms announce to investors their plans and offer shares of the profits to investors. A stock offering for a recycling plant for India would not have attracted many investors who knew anything about reality in India. But an iron foundry making manhole covers for New York City might. Though the average investor will have trouble discerning opportunity from fraud in faraway India, Eastern Europe, or Latin America, my friends Stefan, Simona, Ana, and Verena, from Sri Lanka, Romania, Moldova, and Argentina, along with thousands of other emerging market advisors, can help investors evaluate opportunities overseas. Young men and women from Ukraine, Romania, Kenya, Moldova, Argentina, and dozen other countries work for Morgan Stanley, T. Rowe Price, Credit Suisse, Fortis, and other investment banks and fast-growing emerging market funds.

In a sense, stocks are smarter than commodities and bonds. Stocks don't know the future and are not bound by the past. They are free to grow unbound, remaking the world sector by sector. Money is invested in an idea with no outer limit. Returns are not fixed at inception, they grow with the dreams of free men and women. Diversified portfolios can fund a range of new ideas with only few needing to succeed.. My cousin in Seattle was invited to invest $50,000 in his best friend's sister's boyfriend's new company. Who could know what the upside might be? He invested in silver instead. (Bill G.–his best friend's sister's then boyfriend– found other investors). Silver and gold might rise in value, or might fall, and as insurance they have a place in any portfolio. But neither gold, silver or bonds are ever likely to awake one morning with dreams of Windows, Excel, iPods, or iPhones.

The power of open-ended inspiration is shown in a nice WSJ piece (Nov. 28, p. D1) that compares stocks and bonds over the last 80+ years. I don't know if the 1925 start date biases the findings, but one million dollars invested in bonds in 1925 would yield an annual interest income of $48,000 a year today vs. $33,000 in 1926. Inflation, sadly, drops the purchasing power of today's income to "less than a tenth of spending power of $1 in 1926." That same one million invested in "large-company stocks" [journalistic shorthand for S&P 500 type stocks] would have done better, a lot better. "[Y]our $1 million would have ballooned to $111 million over 81 years–and your income would have jumped from $54,000 in 1926 to almost $2 million in 2006." Not bad. Stock gains shouldn't be expected every year though. Average stock prices fell in 15 of the years from 1925 to 2006, but prices rose in the other 65 years.

Why have long-term returns from stocks been so much higher than returns from bonds and commodities? Well, look at the picture accompanying the NYT manhole cover article. In the center is a man carrying a pot of molten iron glowing just inches from his fast moving bare feet. He, and the men in front and behind are thinking beings. Each day as they work (or at home, after they have recovered), some search for ways to improve their lives. Workers and managers search for productivity gains. When free to pursue opportunities they will move to better jobs, or find ways to boost production at their current firms. But without capital from savings somewhere, there is limited scope for their dreams and ideas to take hold.

As trade and investment restrictions have fallen in recent decades, capital can again cross borders. To China, India, Africa, Eastern Europe, and Latin America, fast-growing investment firms are opening the gates to capital flows from rich western investors to capital-starved millions in the developing world.

"Give me a fulcrum," Archimedes is reported to have said, "and a place to stand–and I will move the world." The place to stand is in India, or China, or Latin America, or Africa. And the fulcrum is capital from stock markets and investors around the world.


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