Deconstruction

I’ve written before that value investors look for stocks that are priced at less than their fair value. Often, these opportunities in the stock market come around as a result of misperceptions, where the market’s concerned about an issue that, on the surface, looks scary, but is unlikely to be as significant as people fear. That’s the case with one of my favorite stocks right now, Concordia Healthcare (NYSE:CXRX) (TSE:CXR).

The Business

Concordia’s in the pharmaceutical business. Over the last few years, they’ve grown rapidly by purchasing drug portfolios from other companies and then optimizing the sales and marketing opportunities. Thus far, they’ve been successful with this strategy. They now have a broadly diversified portfolio of 1190 drugs, projected to bring in over a billion dollars of revenue this year.

Concordia has a particular focus on niche products, products with smaller markets and often off-patent. No single drug accounts for more than 10% of their revenue, and all but one are under 5%. Now, one could view this as a bad thing. After all, a bigger market means more sales. Patents mean that you can charge more for your drugs. However, there’s a flip side to that coin. Bigger markets mean more competition. Patents eventually expire, leading to huge overnight drops in revenue as generics invade.

Many of Concordia’s products don’t have those issues. Their markets are small enough it that it isn’t worth the effort for other companies to develop competing drugs. Many of their drugs have already encountered generic competition, so there’s no big drop-off in sales pending as a result of patent expiry. Consequently, their business may be more consistent and predictable than many other pharmaceutical companies.

That’s not to say that there isn’t growth. They’re planning to release 60 new drugs in the next few years, leading to revenue growth in the upper single digits. For a drug company, Concordia is still fairly small—Pfizer (NYSE:PFE), for instance, makes more revenue from a single drug than Concordia makes from its entire portfolio. So, Concordia still has room to expand.

What’s it worth?

So, roughly speaking, what’s a company like that with reliable revenue streams and reasonable growth worth? Well, they expect their earning, before extraordinary items, to be about $6.50 a year.

Suppose that I want a 14% return, and Concordia grows their earnings by 9% a year for the next decade. Then the fair value of Concordia is about $100.

And that’s interesting, because on the most recent trading day, shares closed at $26.50.

The flies in the ointment

Of course, nothing is that easy. There’s a reason why Concordia’s trading at a huge discount. Several of them, actually.

The first is Valeant (NYSE: VRX). Valeant is another Canadian drug company with a similar strategy. They’ve been buying up other pharmaceutical companies and pumping up the prices of their drugs, often to multiples of the original price. They’ve also been aggressive in their marketing tactics, to the extent that people are concerned about fraud and Valeant has had to restate its financials. It’s gotten so bad that the board is in the process of cleaning house, all the way up to the CEO.

The market’s lumped Valeant and Concordia together. They often move in lockstep. But, I don’t think they deserve to. Concordia hasn’t had any of the fraud allegations, doesn’t bump up drug prices to nearly the same extent as Valeant, hasn’t had to restate its financials, and hasn’t forced out its CEO. The market seems to view these companies as equivalent, but they aren’t.

The election

The second issue is Hillary Clinton and Martin Shkreli. Shkreli’s Turing Pharmaceuticals has played the same pricing games as Valeant, increasing drug prices by hundreds of percentage points, causing a huge backlash. Hillary’s recognized that these massive increases are a problem, and has vowed to do something about them, even mentioning Valeant directly. It isn’t good for pharmaceutical companies when regulators challenge their prices.

This is an issue for Concordia, but possibly less than might appear. First, 60% of their drug sales are outside the USA. Second, they have been far less aggressive with price increases than Valeant, so likely won’t be directly targeted. Finally, their drugs aren’t overpriced relative to the market—many of them are priced at levels less then their competition. That won’t help if the price of every drug is cut, but that sort of outcome is unlikely. Thus, I don’t consider this issue that big a deal.

My biggest concern

While the market seems to be worried about these macro issues, the thing that concerns me the most about Valeant is their debt. They owe over $3.4 billion, that’s more than three times their revenue, and over five times their EBIDTA—earnings before interest, depreciation, amortization, and taxes. Concordia has fantastic margins, but this is still a lot of debt. And half of it is floating rate, right when the Federal Reserve is starting to raise interest rates.

So, that’s not great. Debt reduces flexibility and drains cash flow. If there’s a bump in the road and debt covenants are violated, lenders can drive the company into bankruptcy, even if the company is still meeting their debt payment schedule. If Hillary does do something that causes Concordia’s revenue to tumble, that debt would give them almost no time to react. Thus, that debt increases risk.

Yet the debt seems to be manageable when you consider the consistency of Concordia’s business. People will still need their drugs, and it’s unlikely that a patent expiry or new competitor will ruin Concordia’s business overnight.

The bottom line

Thus, despite the debt, Concordia seems like a reasonable bet. The stock is extremely volatile, often moving more than 5% in a day. In light of Valeant and Hillary, this volatility is likely to continue. Nevertheless, one day Concordia’s stock is likely to disconnect from Valeant and leave these troubles behind. Thus, I think there’s a good chance that within a couple years, Concordia will be trading at twice the price or more.

Back in 1999, before 9-11, before Snowden and Assange, The West Wing had an episode about choosing a new Supreme Court justice. Seaborn says that the judge’s views on abortion are noteworthy, but the really important thing over the next 20 years will be privacy.

Today, this comment seems prescient—privacy is in the news more than ever before. One of the comments on the last blog asked about to what degree privacy actually exists online today. I think that’s a difficult question to answer, because people tend to keep privacy violations, well, private. So, I think I’ll instead talk about what people should expect in terms of privacy.

Social Media

The terms and conditions for using many websites indicate that any information you submit on that website becomes the property of the website itself. As such, you shouldn’t have any presumption of privacy for most websites. On some social media platforms such as Facebook, it’s a bit different—you continue to own the content and grant Facebook a temporary license for as long as the content is on the site.

According to Facebook’s privacy policy, they will keep track of all sorts of information about you, not just what you submit. They’ll also look at your device information, physical location, all the websites you go to (Facebook or not), and your relationships with all your friends. They’ll sell this information to advertisers and data miners, though sometimes personally identifying information will be stripped. Thus, if you use Facebook, you should expect your interests, demographic, friends, location, browsing habits, and mobile phone applications are all known by Facebook and its customers.

Similarly, like most companies, Facebook will abide by requests by the US government and other governments for data. To me, the language around that clause is weak:

 We may access, preserve and share your information in response to a legal request (like a search warrant, court order or subpoena) if we have a good faith belief that the law requires us to do so.

They use court orders as examples of legal requests, but don’t specify that the request must be a court order, or that they won’t reveal information if they aren’t required to do so. Thus, I interpret this clause as not limiting. It’s saying, “we’ll certainly reveal information under these circumstances, and we may give them information just because we feel like it.”

To me, this means that you can assume anything on Facebook is in the government’s hands and the hands of people who will give Facebook money. But they’ll consider stopping people who don’t pay from knowing about you.

Cloud Data

When data’s stored in the cloud, there are four main parties that you have to be concerned about:

• the general public
• the cloud application company: the company that’s building the application that stores the data in the cloud. e.g. Reddit
• the cloud service company: the company that owns the servers and communication infrastructure comprising the cloud, that is providing a service to the cloud application company. e.g. Amazon Web Services, AWS
• the government

The ability of the general public to access your private information is similar to anything electronic—in theory, they have no access. In practice, they have access to whatever they can (illegally) hack.

The cloud application company has access based on their terms and conditions and privacy policy. Often, these would be fairly expansive. Frequently, the company would own the content in the cloud, and be able to use it however they liked.

The cloud services company typically will have clauses in place that deny them access to the data. Thus, while they would be capable of violating privacy, they are usually limited from doing so. This is a noteworthy contrast to the Social Media guys, a differentiation which exists because of the distinct customer bases. While Facebook has to convince the unsophisticated everyman to use their service, AWS has to convince knowledgeable and suspicious application developers to develop their applications on the AWS platform.

You can see the difference in the strength of AWS’s disclosure clause:

We do not disclose customer content unless we’re required to do so to comply with the law or a valid and binding order of a governmental or regulatory body. Unless prohibited from doing so or there is clear indication of illegal conduct in connection with the use of Amazon products or services, Amazon notifies customers before disclosing customer content so they can seek protection from disclosure.

Of course, the biggest potential privacy violator is still the government. Cloud providers are subject to legal requests like any other organization and will provide information as necessary. What’s more, PRISM—leaked by Snowden—provides backdoor for the government to access Internet communications at most of the large technology companies, including Google, Facebook, Apple, Microsoft, and Yahoo. Basically, the NSA can specify keywords or personal identifiers, and have all relevant information routed to them directly from the Internet companies’ servers.

So far, the information about PRISM seems to focus on communication-based cloud applications like email and Skype. However, it would surprise me if the NSA wasn’t trying to add backdoors into cloud infrastructure in a more general way (if it doesn’t have them already).

The bottom line

Thus, when it comes to online and cloud interactions, the safest thing seems to be to presume a lack of privacy, particularly when it comes to the government. As if that wasn’t enough, we’re still in the early stages of this transformation—as artificial intelligence is applied to the task, I’d expect that the government will be able to access almost anything they want about you online and I’d expect companies like Facebook will only know a little less.

So be careful. The key rule of thumb is, if you aren’t paying for the product, you are the product. To that I’d add, and even if you are paying for the product, you’re probably also the product as well….

With the proliferation of mobile phone cameras, the growth of social media, and explosion of electronic communications, one of the biggest civil rights questions this century will be about right to privacy. On one side will be the police and security establishment who will argue that they should be completely private and they should be able to view what everyone else is doing. On the other side will be the ACLU and other privacy advocates, who will argue that privacy should be the default option for everyone, and the government should have to go through extraordinary measures when they want to violate that privacy.

This battle is going on right now in court with Apple versus the FBI. If you remember, back in December 2015, two terrorists shot and killed fourteen people and attempted to detonate a pipe bomb. The couple was killed in a police shootout, but their phones remained. Now the FBI is taking Apple to court in an attempt to get them to write an operating system to allow them to circumvent the security on those iPhones.

I think this is a bad idea and support Apple for standing its ground.

The small stuff

There’s quite a few reasons why this is unreasonable. Let’s start with the less interesting, common sense arguments.

First, it’s a waste of effort. In the decade from 2004 to 2013, 313 Americans died as a result of terrorism. On the other hand, 316,545 Americans died as a result of firearms while on U.S. soil. So, either the FBI, NSA, and CIA are already fantastic at preventing terrorist deaths, or the terrorist problem is way overblown. If these security organizations actually cared about saving American lives, they wouldn’t be trying to eliminate the right to privacy, they’d be going after the second amendment, the right to bear arms.

Second, it’s a bit ridiculous to require a company to work for free, creating an operating system specifically for the FBI and in the process, weakening their business. Operating systems are complex—even small changes are huge amounts of work. And, if it becomes known that Apple’s OSes are less secure than other OSes—as they will be if Apple is deliberately required to weaken iOS—then people who care about security will avoid the iPhone.

The biggest issue

Those two issues should be sufficient, but the biggest issue to me is that once protection of privacy is eliminated, it’s all but impossible to get back. This means that we should be extremely careful in creating precedents that reduce privacy and generalized privacy-infringing tools. Once Pandora’s Box is opened, it can’t be closed again.

Even if the government as a whole can be trusted, the individuals on the ground can and will pervert the original goals. For instance, look at civil forfeiture, where assets can be seized from people suspected of criminal activity without charging the owner with wrongdoing. The police are using these laws to steal money from innocent people. This clearly isn’t even close to the spirit of the original law, yet the police are eager to do what they can to get money, even if it’s unethical.

If the police would go so far over the line with civil forfeiture, why would we believe that, if we give these agencies the ability to spy on people, they won’t abuse it?

WWHD?

And that’s just assuming low-level corruption, as opposed to an organized, deliberate governmental attack. In general, it’s a bad idea creating the apparatus for a police state, even if we don’t live in one today, because things change. At one point, both Syria and Lebanon were wonderful places to live with nice weather, good jobs, friendly people, and modern economies. Now, not so much.

Thus, instead of assuming the government will always be benevolent, think about how the technology would be used by other governments. Take, for instance, the democratically-elected National Socialists in Germany. What would Hitler do with this technology? If the answer is “turn the country into a hell-hole of brutality and persecution”, then you should be cautious about giving that technology to your own government.

The anti-privacy proponents might claim that everything will be fine because courts will watch over the technology to ensure it isn’t abused. But it’s already clear that hidden courts—courts where the public is forbidden to view the proceedings or judgements—are no more than a rubber stamp. Out of the 35,529 FISA applications (court requests for electronic surveillance), only 12 have ever been denied.

And even if we could trust the security complex with this technology, it’s extremely unlikely that the technology would remain there. It would almost certainly get out of their hands—either through corruption or hacking—simply because the rewards for getting such technology are so high.

Why is the FBI trying?

One of the ironies of this case is that the FBI has hacked phones before and has claimed to be capable of hacking iPhones. So, if that’s the case, then why would they bother with this court case?

My guess is that the information on the phone isn’t actually valuable for avoiding future terrorist incidents. Instead, the case is extremely valuable for moving the line, established a precedent in court that could be used far beyond this case.

The FBI loves that this is a terrorist case. They love that people are scared of terrorist attacks, because they can leverage that fear in the PR battle. They can imply that anyone who opposes them is soft on terrorism, doesn’t care about the people who were killed, and is willing to leave America open for another terrorist attack. If they can get the public on their side, it will help get the courts on their side.

Then, once they win the case, they’ve got a precedent. And they’ll use that precedent in all sorts of other court cases, not just related to terrorism, but anything illegal. Their argument will be “we suspect that guy might be bad, so we need to spy on him, and the Apple case means you have to help us.”

And argument will soon morph into “any device you sell must have a back door allowing our spy agencies to peer inside it.” In effect, this would mean any device will be easily hackable to anyone who would care to try.

You might think that FBI would never go so far, to completely destroy any notion of privacy on electronic devices. But I don’t think it is. The security agencies are already requiring back doors into cloud information repositories such as Google and Amazon. Why would they stop there?

The bottom line

Thus, I think this is a very important court case for the right to privacy. If the FBI wins, I think there’s a reasonable chance that within a decade, individuals will have no expectation of privacy on anything electronic. Not their computers, not their phones, not the online storage. It’ll all be wide open for the government to see.

And if that happens, you better hope that the government—and everyone else in the world—remains benevolent for your entire lifetime.

I’m finding I have a thing for British TV shows—Skins, Misfits, Dr. Who, Sherlock….  I’m not sure if it’s just the different culture, or different standards, but these sorts of shows just seem better than most American shows. Perhaps it’s because they’re targeting a narrower audience.  Or, maybe it’s because they often have far fewer episodes per season. Shorter seasons require tighter writing, ensure that only the best ideas are being filmed, and allow more time for the production of each episode.

Regardless, my latest British addiction is Black Mirror. This show focuses on the negative effects of technology on people and culture. It is an anthology show—like The Twilight Zone, every episode is in a different universe and has different characters.  Only one of the episodes could actually happen with the technology today, but much of the technology is just an extension of the gadgets people are developing now, such as Google Glass.

Black Mirror’s ideas are compelling. The social commentary is brilliant. My favorite episode, the second episode of the first season, is what Brave New World would be if Huxley had written it today.

But for all that, the impact of the technology on the characters is what really makes the show work. One general theme is that, regardless of the technology, human nature is constant. Advanced technology simply magnifies our capability to demonstrate our best and worst traits—and, since fiction thrives on conflict, that means mostly the worst traits.

As such, the show is bleak. It’s certainly not for kids, and is not necessarily the sort of show you’d want to binge watch. (On the other hand, with only 7 episodes, maybe that isn’t an issue.)

Thus, there’s a lot in this show that I liked. But, the thing that most impressed me was my own reaction to it. Every single episode made me think. Not for just a few minutes afterwards, but for hours and often days later. No other TV show has ever had that sort of impact on me with every episode. So, I’d recommend it to anyone who enjoys thoughtful speculative fiction.

One of the technological developments that will affect society to a huge degree is the creation of cheaper and smaller cameras. It remains to be seen whether this trend will be good or bad for society. One of the positive outcomes is the crowdsourcing of entertainment—essentially, much of youtube is a result of this transformation. One of the negatives is that it makes it much easier to implement a police state, particularly when combined with facial recognition and artificial intelligence.

As such, I’m always interesting in seeing how the government misuses technology. Thus, this article discussing a study of police dashboard camera use in Chicago caught my eye. The killer statistic is that as a result of either broken or misused equipment, 80% of the police department’s dashcam video recordings didn’t have audio. The cause in most cases seems to be police officers sabotaging their own microphones.

Why would police officers do that?

To me, this is a big problem with the justice system. I can only think of two reasons why officers would deliberately want to ensure that evidence is not recorded for later use in court. The first reason is because the evidence might help defendants in court. It might increase the chance that the people the officers arrest will be found not guilty.

For this to be the case, officers must believe that the evidence provided by the dashboard cams will often show that the police officers are arresting people that shouldn’t be arrested. Essentially, it means that police are disabling the cameras because they prevent the police from putting innocent people in prison.

The second possibility is that police are disabling these cameras because they prevent police misconduct. Police officers believe that some of their own actions are illegal, and the only way to continue doing such actions without being held accountable is by destroying the evidence. Essentially, the police are acting as criminals, and, like other criminals, they want to eliminate the evidence for their crimes.

The other side of the story

Of course, if you were a police officer, you might frame this sabotage in others ways. For instance, perhaps you believe that the law has so many loopholes a defendant can exploit that, if there is recorded evidence, then guilty people who have good lawyers will get off on technicalities. Essentially, with accurate recordings, it might be impossible to convict guilty people because of factors unrelated to the crime itself.  This premise is the basis of hundreds of “rogue cop” stories, where, in order to deliver justice, the heroic police officer has to work outside the restrictions of the law.

The second option is the exact opposite: that there are so many potential crimes and the rules are so complicated that anyone who is constantly being recorded is likely to be filmed committing a crime. Police officers, knowing the law and justice system better than most, recognize this fact and realize that with proper dash cams, some of their own crimes will be recorded. To avoid this near certainty, they sabotage their own equipment.

What’s really happening?

I think a combination of these two cases is true. I suspect police officers recognize that without cameras, their testimony in court has a huge amount of weight. They can say whatever is needed in court to both get the conviction and portray their own actions in a positive light. Almost regardless of what they say, they’ll be believed by the jury and the judge, certainly more than the defendant.  Once the camera enters the scene, the value of their testimony falls. They can no longer frame the narrative in a way that helps their own agenda.

As big an issue is the fact that the camera forces police officers to be perfect. Over the long term, officers themselves will be filmed more than any other people. Their voices will be in every one of hundreds of videos.

But policing is a tough job, with split-second life and death decisions. Occasionally an officer might make a mistake, doing something that they shouldn’t, and if the camera’s recording, that mistake will be captured. And when people are reviewing the tapes, they won’t look at the 100 instances where the officer was perfect, but rather the ten seconds when they messed up. That’s the video that will be played on the news over and over again. If there was an easy way to avoid having that perfectly human mistake cost you your entire career, why wouldn’t you take it?

So, from the police officer’s perspective, the vast majority of the time, the camera has negative value for both their job and their careers. Is it any surprise that they get broken?

What should be done?

Nevertheless, the bottom line is that these cameras give us the ability to see the truth, to ensure that the innocent are set free and the guilty are held accountable. While it might be understandable that police officers don’t like them, that isn’t a good reason to not have them.

So, I’d suggest three things be done to remedy the situation.

First, there should be an inquiry that includes interviews with police officers so we have a better understanding of why this is happening. Are we in a case where loopholes in the law are such that criminals will be able to escape anything if there is video evidence of the arrests? Are officers concerned that they will be prosecuted or lose their jobs for the sorts of mistakes anyone would make? Once we understand the causes better, we should change the system to alleviate the worst of the problems.

Second, in cases where a dashboard camera was available but disabled (or the footage lost) police testimony should be considered inadmissible. This would avoid the problem of police disabling cameras so that they can frame the narrative in their own terms, and would encourage them to care a lot about keeping their cameras working.

Third, if cameras are disabled for any reason other than human error—which, statistically, should be a very infrequent occurrence—police officers should be charged with vandalism and the destruction of evidence. Just like anyone else.

The bottom line

Dashboard cameras are largely a positive technological development. To me, anything that makes legal outcomes based on what actually happened rather than what people say happened is a good thing. Plus, these cameras will reduce police corruption and improve the skills of our police force by ensuring that officers are accountable for their actions. The fact that we’re having these growing pains in Chicago isn’t a sign that the cameras don’t work, but rather that police officers themselves believe that these cameras are effective.

They wore suits, but they weren’t gentlemen. They pushed through the door the instant he answered. He tried to hold them back, but was shoved aside. He fell against the wall, hard.

“You didn’t pay,” the one with the sunglasses said. He stared down at the man on the floor. “Where are they?”

“Mindy, run!” the man shouted. He struggled to his feet, blocking the stairway up. Blood dripped from a cut just above his cheek. “Not them. Do it to me instead.”

“You know that’s not how it works.” The fist to the gut put the man on the floor once more. The men stepped over him on their way up.

They found her standing in the master bedroom, pale and but resolute. “They’re not here,” she said. “Out at a friend’s.”

“I see.” The man with the sunglasses strode forward until he was but a foot away from her. Behind the frames, his eyes narrowed. “Hold her.”

“No!”

The others strode forward, grabbed her arms, pushed her onto the bed.

The man stared at the woman for a second, and then turned back to where she had been standing. Slowly, methodically, he reached his hand and slid open the closet door.

Crouched there under the clothes were a boy and a girl, ten and seven. His hand was over her mouth, but he couldn’t completely silence the squeak she made as the light shone on her wet face.

“You can’t do it,” the woman said. Her eyes were wild, but she knew how futile it was to struggle.

He looked at her and pursed his lips. “It’s not personal.”

“They’re only kids.”

“Exactly.”

The man pulled out the revolver, and carefully put the bullet in the chamber. The click as he returned the cylinder to its resting place seemed to echo. Then the woman began to struggle.

The boy stood there, his eyes wide. His body was rigid, but his lip trembled.

The man spun the cylinder, raised the gun to the boy’s head, and pulled the trigger.

* Click *

“There. It’s done!” screamed the woman. “Get out of here!”

The man looked at her and shook his head. “Two school-aged children. It’s the law.”

“No!” The woman tore her hand free for an instant, scratched against the other man holding her. His shirt was torn before they regained control of her arm.

The girl crouched on the ground, tears flowing down her cheeks. “Mommy, help me!”

The man spun the cylinder one more. He had to bend over slightly to press the gun against the girl’s temple.

“Just the law.”

* Click *

The man returned the revolver to his coat. He nodded at the others and they released the woman. She fell to the floor, grabbing desperately for her children.

The man stared at her for a second, and then turned back toward the door.

“See you next year.”

***

So, in British Columbia, the provincial government has struggled against the school board, cutting funding enough that the schools can’t even afford to stay open on every school day. Their perspective appears to be that the primary goal of government is to minimize expenses, to do the bare minimum to keep things running, and cut everything else.

Unsurprisingly, the school board isn’t a big fan of this strategy. Their (admittedly biased) belief seems to be that having a well-educated society provides long-term benefits that greatly exceed the short-term costs.

One of the more interesting ways that this conflict has played out is in the Vancouver School District. The government wants to close underutilized schools that are wasting space on things like computer rooms, music rooms, and special needs classes. It’ll save some money, but despite this clear logic, the school board is resistant.

So the government’s come up with a really innovative approach to the problem. Vancouver is on a major fault line. Nevertheless, many of the schools are nearly a century old, build before we had a good idea on how to keep a school standing through an earthquake. They need seismic upgrading. Otherwise, if a big one comes, many of them could be rubble.

Obviously, this presents an opportunity. The government has said that it won’t bother doing any more seismic upgrades until the school board accedes to its demands. Because really, governing isn’t about education, building a strong labor force, or even saving a child’s life.

It’s about making the tough choices that will save money.

I’ve discussed the idea of a guaranteed annual income several times. The biggest concern with the idea of a guaranteed annual income is the impact that it would have on people’s incentives to work. Essentially, the argument is that if people don’t need to work to survive, they’ll sit around and do nothing, and this would be a bad thing. Frank, one of the commenters on the blog, recently suggested one solution to this issue.

On ‘Cross Country Checkup’ (24 Jan 2016) the guaranteed annual income issue was raised with stress on the incentive to do something useful within the society. The caller felt that no incentive would lead to many ‘gaming the system’ and choosing not to work toward anything. The caller’s solution was to require those on GAC to demonstrate that they were directly involved in educational upgrading or demonstrably working for the public good (volunteering?). ie. you have the GAC as long as you demonstrate that you are trying to improve life.

On the face of it, this seems like a reasonable solution. However, I’m not a big fan of it for several reasons.

My experience

In Canada, we have an employment insurance (EI) system. Employees and employers pay into the system an amount equal to 1.88% and 2.632% of the employees’ income, respectively, up to an annual cap. If the employee gets laid off, then they get a weekly income for up to 45 weeks or until they find a job.

Just over a decade ago—soon after my newborn son arrived—I was laid off from a business that was failing. As such, I was qualified for EI. However, I didn’t want to look for a new job. I wanted to start my own business.

The problem was, EI doesn’t actually allow people to start their own business, or at least not in a way that anyone would actually want to use. At the time, if you wanted to start a business, you had to jump through a variety of hoops—taking hours of time every week—just to prove to the government that you weren’t trying to exploit the system.

The problem

And when you’re starting a business, time matters. Spending time convincing bureaucrats that you’re doing something useful is a complete waste of time. Possibly the most important component of entrepreneurialism is enthusiasm and momentum. If that enthusiasm and momentum gets blunted—such as by wasting time doing “make-work” tasks—it makes it far more difficult to succeed. And that seemed obvious to me, and probably to everyone else who isn’t a civil servant or politician.

This was frustrating. I might fail, but I wasn’t going to fail because the government sabotaged my ability to succeed. And, I’ve always been pretty good with money, so I had savings. Thus, I decided to not even bother applying for EI, but just start the business without it, living off my savings.

It turned out well. The business hit 30 employees within a few years.

My bias

That experience makes me biased against the idea of bureaucrats and politicians deciding what is a productive use of people’s time. My business idea was good, yet if I hadn’t had those savings, I wouldn’t have been able to start that business. I had a baby. I couldn’t put my family’s well-being at risk to pursue a dream.

So what happens to the people who don’t have those savings? I think the answer is, they are forced go work for someone else. They don’t innovate, don’t create new products, and don’t have the chance to build a business that provides jobs to 30 people.

To me, that seems like a bad thing.

So, when you talk about adding a “doing worthwhile” criterion to a guaranteed income proposal, it raises the question of what the government considers worthwhile. Is starting a business worthwhile?  Is writing a novel?  Is creating music?  Is taking care of children? How about writing a blog? Is learning only worthwhile if it’s done at an accredited school?  Is research only worthwhile, if it’s done at university, rather than on your own, like Da Vinci?

The issues I have

Thus, I’m not a big fan of adding a “doing worthwhile things” criterion on guaranteed annual income payments. First, if “worthwhile” isn’t broad enough, it seems like many productive activities fall on the outside. If it is broad enough, then the criterion is a waste of time, because then almost anything could be justified. It’s not even clear to me that “productivity” is the right criterion. (Do we really care about maximizing the productivity of society, or happiness, or well-being, or something else?)

Second, I’m not a fan of governments deciding what’s productive because I don’t think they’re good at it.

Third, it seems to me that the infrastructure to monitor people to determine if what they’re doing is worthwhile has a good chance of being more costly than any savings we’d get from adding that infrastructure. The cost isn’t limited to the legions of “monitoring bureaucrats”, but also the time people spend appeasing those monitoring bureaucrats, and the lost opportunities from people not doing what they want because doing so would make dealing with the monitoring bureaucrats more difficult. What’s more, I suspect the latter two costs would be the highest, and they likely wouldn’t even be measured.

Finally, this solution doesn’t take care of the “excess labor as a result of automation” issue. If production becomes automated to the extent that we don’t need people to act as laborers, it’s not clear that forcing people to use their excess time on “government-approved” activities helps things at all.

My take

I wonder, when we have this sort of discussion, how much of this “people must be productive” attitude comes from a Puritanical work ethics and a belief that people are intrinsically evil and lazy. To me, it’s not that clear that people are intrinsically lazy and would be non-productive if they didn’t actually need to work. I suspect that people would still do productive things because otherwise they’d be bored. Heck, even Paris Hilton is productive—she’s young and doesn’t need to work, but has made more money than most people will in their lifetimes.

Of course, this argument doesn’t address the other big issue with guaranteed income—whether we can afford it. But, to me, it makes sense to do what we can to implement a simple guaranteed income system without “worthiness” criteria initially, rather than deciding that a guaranteed income can’t possibly work and sabotaging it with arbitrary Puritanical restrictions right from the start.

Last week, I discussed how government services and budgets could be impacted by a demographic shift towards the elderly, as–for the first time ever–Canada’s over-65 population is larger than the under-15 population. However, governments aren’t the only things that will be impacted. Society itself may change.

Different priorities

Many of the changes in society may be a result of the different priorities of the elderly compared to most of the rest of the population. For instance, health issues are one of the biggest concerns of the elderly. What’s more, the scope of healthcare problems tends to increase as we age. While younger people likely worry mostly about traumatic injuries and disease, the elderly not only have to worry about that, but also chronic illnesses, mental illnesses, and disabilities.

Consequently, I’d expect the resources society dedicates towards healthcare to increase. This is more than just adding more hospital beds, nurses, doctors, and assisted living personnel. As the elderly demographic grows, the rewards for creating successful products targeting this demographic increase, which should lead to increased innovation.

For instance, suppose it costs $100 million to do the research and development to create a new drug, but after the initial upfront cost, you can sell a 25c pill for $10. If you only have a hundred thousand patients a year, it might not be worthwhile developing the drug. But, as the elderly population expands and the market grows to two hundred thousand patients a year, it may become economic to create the drug.

Thus, as entrepreneurs recognize the profitability of this demographic, I’d anticipate they will increasingly focus on innovative life-extension technologies and quality of life enhancers.

The economy

This demographic shift will likely impact the job market, though it may be hard to disentangle the effects of the demographics versus automation. As people become older, they can no longer do many tasks that they were able to do when they were younger.  Cleaning the gutters, mowing the lawn, driving, or even tidying the house may be beyond the abilities of some of the elderly. In combination with the labor-intensive healthcare space, I would anticipate that this shift will continue the ongoing trend away from manufacturing towards the service industries.

Manufacturing jobs traditionally pays much better than service jobs, and, with the exception of some healthcare jobs, I’d expect this relationship to continue. Though the demand for services will increase, low-income retirees will not be able to pay significantly higher costs for services and employees displaced by automation will likely migrate into service sectors, avoiding a supply crunch.

What’s more, as people retire, they will be the highest paying jobs of their careers, likely being replaced by people making less money. Thus, I’d anticipate that this demographic trend will result in sluggish Gross Domestic Product (GDP) growth, and maybe even negative GDP growth per capita.

The markets

While stock and bond markets aren’t directly tied to the GDP, it is much more difficult for companies to increase profits in a slow-growth economy. What’s more, the proportion of elderly hoping to extract money from the market will increase, while the proportion of younger people investing their earnings will fall. So, if you look at investments from a supply-demand perspective, there will be a lot of people looking for yields. Thus, I’d expect interest rates to remain low (because the demand for bonds will be high).

Similarly, the elderly will be downsizing their houses to extract retirement income at a time when there aren’t a lot of young people to buy. Thus, I’d expect this demographic shift to have a bearish impact on the housing market.

Immigration and diversity

Finally, this demographic shift should lead to increased immigration and a more diverse our society. As a group, the elderly are likely more homogeneous than the younger segments of our population. As they die off, it will increase the diversity. Plus, the elderly aren’t having babies, while the younger, more diverse population is.

What’s more, politicians will recognize that one way to mitigate problems caused by low birth rates and the demographic shift (i.e. too few young workers trying to produce enough to take care of the elderly non-workers) is to increase immigration. We’ll attempt to import young, inexpensive, energetic labor to take care of the elderly and continue to grow the GDP. Thus, I’d expect immigration to increase and–since many immigrants today aren’t arriving from the European countries that historically made up most of Canada’s immigration–I’d expect diversity to increase with it.

The problem with predictions

Of course, one of the major failings in these sorts of predictions is the demographic trend might not be as important as other trends. For instance, suppose the rise of ISIS leads to a backlash against Muslims and increasing distrust of outsiders. In that case, immigration may actually fall as politicians reduce the number of people we let in and Canada becomes a less attractive destination for immigrants. I think this is a major problem with most forecasts–they tend to focus on one dimension, ignoring the 300 other factors that impact the outcomes.

In Canada in 2015, an interesting thing occurred that had never happened before. The number of people older than 65 began to exceed the number of people under fifteen. What’s more, the government projects that this divergence will increase for the foreseeable future. By the mid-2030s, the elderly could outnumber the kids by more than 50%.

This development is more than just trivia. I think it’s quite important, likely to affect our lives significantly in the future. For all of history, the elderly have been greatly outnumbered by the young. Our world has been built around this invariant. So what happens when things change?

Pensions collapse

Governments don’t save money in the same way that people save money. Or even the way businesses save money.

When a business runs a pension fund, it typically has to ensure that the pension is fully-funded. In other words, it has to contribute enough to ensure that all payouts of all the members can be met. If it looks like it doesn’t have enough assets in the pension fund, it has to contribute money to the pension, lowering the earnings of the business.

Government pensions, on the other hand, tend to be more like Ponzi schemes. Under their “pay-as-you-go” strategy, the government does not invest the money you contribute to your pension on your behalf. Instead, they give that money to the people who are collecting their pensions today. Thus, most government pensions are pyramid schemes where new “investors” are used to pay off the old “investors”. (Yes, this is the same thing that landed Bernie Madoff and many others in prison.)

It’s ridiculous, but historically, it’s worked. With dozens of workers for every pensioner, there has always been enough money to pay the bills. It’s a pyramid scheme, but it is one that has achieved the goal because the bottom of the pyramid has always been far broader than the top.

And this is where demographics can really mess things up. If you only have a few workers supporting each pensioner, the math falls apart. So, when the elderly outnumber the kids, you start to have a problem.

Canada’s solution

Luckily, Canada doesn’t actually use a pay-as-you go system. Rather, it uses a “steady state” system where contribution rates are set at levels that are sufficient to fund the system on a long term basis (75 years). Thus, in the decades with better ratios–more workers and fewer pensioners–the pension fund pulls in more contributions than it needs to pay out immediately, thereby accumulating reserves. Then, when the ratio worsens, it takes money out of the reserves.

This system isn’t as conservative as the system businesses use. If nobody new were to join the Canadian Pension Plan, then the reserves and future contributions of workers already in the system aren’t sufficient to pay the pensions. They’re over $800 billion short.

But new people will join the pension plan, which should make the combination of the contributions and reserve fund sufficient for the next 75 years.

That’s not to say that contribution rates won’t increase with these demographic shifts. If the number of elderly increases in proportion to the number of workers, the contribution rate will need to gradually increase. But it won’t be a huge, panicked, “we’re out of money” increase that could happen with some pay-as-you-go systems. Instead, it will be a slow increase as Canadian demographics change within the 75-year sliding window.

The medical bills

Thus, the big economic issue for Canada might not be pensions, but rather the cost of healthcare. The elderly tend to have more medical issues than the young. Only about 11% of Canadians die before they’re 65. And roughly a quarter of lifetime healthcare costs occur during the last year of life.

Canada, of course, has socialized medicine. Healthcare spending is about 38% of provincial budgets. Thus, this sort of demographic shift is quite problematic from an economic perspective. The increase in healthcare costs will likely function like a pay-as-you-go pension system since health insurance premiums aren’t going into a fund to pay your future costs, but rather are used to pay off the expenses of others today. So, with this demographic shift, we’re likely to end up with too few workers paying for the healthcare costs of too many elderly.

Luckily, a simple solution is presented in a 1976 movie called Logan’s Run….

Death and taxes

No, actually, exterminating anyone over the age of 30 isn’t a great solution. Because I am over the age of 30.

Debt isn’t a good option either. Canada’s provincial governments’ debts have already been increasing for decades. Rather, the solution is likely to involve higher taxes and fees.

British Columbia, for example, has about $46B in revenue and the government claims that the budget will be close to balanced. The government will spend about $17.5B of that revenue on healthcare, about the same as the 38% that is spent nationally.

Now, let’s suppose that that, over the long term, demographics cause that number increase by 50%. That would mean that we’d need about another $9B in revenue.

If you look at BC’s provincial budget, personal income taxes bring in about $7.8B. Corporate taxes are $2.4B. Sales taxes are $6.2B. Fuel and carbon taxes are about $2.1B. Health insurance premiums are about the same. Health transfers from the federal government are about $6.1B.

The total of all of these numbers is $26.7B. So, the $9B in revenue we’d need (admittedly a number that has no basis, just a guess) could be achieved by increasing these taxes and fees by about a third.

The bottom line

Is such an increase doable? I would guess so. I don’t think people would like it. But I also don’t think they’d like the idea of letting Grandma die because those green pills she devours are just too darn expensive.

I’m certainly willing to pay my share, particularly if the taxation is designed to add to the costs of those who create negative externalities. For instance, carbon taxes would be a nice way to start closing the gap.

Thus, I think there is a solution to the two key tax-related issues that will arise with this demographic shift. In a future blog, I will discuss other changes that may occur as the elderly start outnumber the young.

I’ve discussed the possibility of a guaranteed minimum income several times. My general opinion is, with the rise in automation, there’s a reasonable chance that we’ll produce far more goods than we need using a small amount of human labor. Thus, there’s the risk that the people who control the production will live in luxury, while those who are no longer needed for their labor will be destitute.

When there’s a huge amount of excess in the world, it seems like a bad idea to leave some people in abject poverty. Even the wealthy should understand this point of view to a certain extent, since, if the differential between the rich and the poor becomes too great and the poor too numerous, the poor are likely to rise up and kill the rich.

One of the solutions to this conundrum is a guaranteed basic income, ensuring that everyone has a minimal living income to ensure a low standard of living. I don’t know if the idea will “work”, but I do think it is worthwhile trying to determine if it does. That’s why I’m particularly interested that Finland is now considering implementing a national basic income (NBI) of €800 per month.

The details

This national basic income would replace other benefit programs (i.e. unemployment insurance, welfare, old-age security) and would be provided tax free to all adult citizens. The program would be rolled out first as a pilot offering €550 per month.

Today, a euro is worth about 1.10 US dollars, so the full program would pay the equivalent of almost $900 US. Of course, that means nothing without understanding what that’ll buy in Finland.  To me, Finnish prices look roughly the same as USA, but in Euros rather than Dollars.

The average after-tax monthly salary is just under €2200. A one bedroom apartment in the city costs about €700, while in the suburbs it’s more like €550. A litre of milk costs about a euro, while a dozen eggs are €1.92. A pair of Levis costs about €83. A meal at McDonalds is €7. The living expenses for a student are around €800 per month.

Thus, by itself, this national basic income is enough money to survive. You won’t live in luxury, but you’ll have enough for food, shelter, and cheap entertainment.

Incentives for the unemployed

Of course, though this project sounds interesting, there are still potential problems. I’ll leave aside the irrational Puritanical concerns (e.g. “Work is good for the soul”, “Anyone who doesn’t work is a worthless bum”) because I think such arguments are inherently stupid. Instead, I’ll focus on the big concerns.

The biggest concern about guaranteed basic income is that it reduces the incentive to work. After all, if you can get paid not to work, why would you bother working?

Interestingly, some Finnish politicians are saying that the NBI could have the opposite effect, incentivizing people to work. Their argument is that right now, there’s no motivation for the unemployed to get off welfare to do a low-wage job because in doing so, people lose their welfare benefits. Their new income will only offset the loss of welfare benefits, not really putting them ahead

With the NBI replacing welfare, the income from work will no longer offset welfare. So, for any unemployed person, working will lead to incremental gains over not working. So the economic incentive for the unemployed to work should increase, assuming the tax rate on those incremental gains is reasonable. Thus, I buy this aspect of the politicians’ argument when it comes to the unemployed.

Incentives for the employed

That said, I think the politicians are missing the other side–people who are employed who may chose to become unemployed because the NBI is sufficient to meet their needs and decide that they’d rather not work. Without the stigma attached to welfare and employment insurance, this may be a bigger issue than the politicians realize.

While I believe this is a problem, I also think that in general, people like to earn more money and are often willing to work harder to do so. People seem to prefer a higher standard of living while working to a lower standard of living with not working. Or, stated another way, I think most people will trade some of their free time so that they can acquire better toys.

These beliefs makes me think that it’s possible that the incentives are aligned in a way that NBI might actually increase the employment rate relative to the current welfare system. I’m not certain, but it is conceivable to me.

Paying for it

Thus, if the NBI could a net benefit when it comes to employment, the biggest remaining concern is how to pay for it. Above €70K income, residents are paying marginal rates of 30% in state income taxes and over 20% in municipal income taxes. Today, pension and employment insurance can be another 5% on top of that. What’s more there’s also a 24% value added (sales) tax. So, if you live in Finland and are making a lot of money, you’re paying a lot of tax already.

Presumably, a significant chunk of the funding for such a proposal would come from the current pension and employment insurance taxes–in 2014 Finland was spending about €30B a year on social expenditures. However, the calculations that I’ve seen seem to imply that it would cost Finland €46.7B per year to implement the NBI, much more than the €30B.

The problem looks even worse when you consider that Finland’s Federal government will only bring in €49.2B in 2015. So, assuming the government wants to do something besides pay its citizens the NBI, there’s a significant gap that needs to be filled.

And to me, that’s a big problem that needs to be addressed. It might be difficult to increase taxes any further considering Finland’s already high tax rate. What’s more, tax increases will reduce the incentive for people to work–thereby lowering the tax base–and encourage both tax avoidance strategies and tax fraud.

The bottom line

So, to really understand whether this project can work, we need a better understanding of how it would be funded to see if the math actually works.

But despite this problem Finland’s national basic income is an interesting proposal. Every other experiment in guaranteed basic income seems to have been externally funded (i.e. not funded exclusively by the people who are in the GBI study). So, I’m curious to see how this would work on the scale of a country where it would have to be almost entirely internally funded.