Purity or Universalism?

This article first appeared at Quillette.

A few days after his recent passing, the Manhattan Institute reposted a speech by V. S. Naipaul from October 1990. The title, “Our Universal Civilization,” captured the triumphal and optimistic spirit of that moment, nearly one year after the fall of the Berlin Wall. In order to render this universal civilization in greater relief, Naipaul related the following about his travels in Asia [emphasis added]:

Traveling among non-Arab Muslims, I found myself among a colonized people who had been stripped by their faith of all that expanding intellectual life, all the varied life of the mind and senses, the expanding cultural and historical knowledge of the world, that I had been growing into on the other side of the world. I was among people whose identity was more or less contained in the faith. I was among people who wished to be pure.

If we had read this paragraph without knowing its date or the subjects’ actual geography, religion, and history (in this case colonized non-Arab Muslims), we might have surmised that Naipaul was talking about parts of America and Europe that he had perhaps visited in the months preceding his death. “People whose identity was more or less contained in the faith” could easily apply to certain constituencies in the West today, the more so if one allows some latitude in the definition of the word ‘faith.’

Nearly 30 years after he delivered this speech, Naipaul’s assumption that this was primarily a religious or Muslim phenomenon seems quaint. Today, we can see that the wish to be pure has emerged in opposition to universalism in many parts of the world including our own. We can no longer claim that it is just Islam that has grown resistant to the universal civilization envisioned by the West in the late twentieth century. Some groups within the West itself have also rediscovered their own craving for purity. Continue reading at Quillette >>>

Capitalism Did Not Win the Cold War

This article first appeared at Foreign Affairs.

Why cronyism was the real victor.

When the Soviet Union collapsed 26 years ago, it was generally agreed that the West had won the Cold War. This was affirmed by the prosperity and possibilities awaiting citizens of Western countries, as opposed to the political and economic stagnation experienced by those in Communist states. A natural conclusion, much repeated at the time, was that capitalism had finally defeated communism.

This sweeping statement was only partially true. If one took capitalism and communism as the only two protagonists in the post–World War II struggle, it was easy to see that the latter had suffered a mortal blow. But there was a third, stealthier protagonist situated between them. This was a system best identified today as cronyism. For if capitalism did win over the other two contenders in 1991, its victory was short-lived. And in the years that have followed, it is cronyism that has captured an ever-increasing share of economic activity. A survey of the distribution of power and money around the world makes it clear: cronyism, not capitalism, has ultimately prevailed. Continue reading at Foreign Affairs >>>

The Economics of Dependency

This article first appeared at Foreign Affairs.

How countries hit the demographic sweet spot.

Demographics are among the most important influences on a country’s overall economic performance, but compared with other contributors, such as the quality of governance or institutions, their impact is underappreciated. Demographic factors, such as the age structure of a population, can determine whether a given economy will grow or stagnate to an even greater extent than can more obvious causes such as government policy.

One of the most consequential aspects of demographics as they relate to the economy is a phenomenon known as the “demographic dividend,” which refers to the boost to economic growth that occurs when a decline in total fertility, and subsequent entry of women into the work force, increases the number of workers (and thus decreases the number of dependents) relative to the total population. The demographic dividend has contributed to some of the greatest success stories of the twentieth century, and countries’ ability to understand and capture this dividend will continue to shape their economic prospects well into the future. Continue reading at Foreign Affairs >>>

Should Children Vote?

The rising cost of entitlements will test inter-generational harmony.img_6331

In the week following the Brexit vote, a recurrent complaint from the losing side was that a majority of older people voted to leave while a majority of younger people voted to remain. In the eyes of the complainers, this rendered the leave outcome less legitimate because younger people have more years of life ahead of them and therefore would allegedly suffer more than old people from a decision to leave the European Union. So much for the wisdom of old age knowing what is best. And so much for the principle of one person one vote, regardless of age, gender or race or whatever.

Instead of disenfranchising a group of older voters, we may consider allowing children some representation in our voting system. In the United States, the voting age is 18 which means that there are approximately 74 million US citizens aged under 18 who do not have the right to vote. That is a sizable 23% of the entire population who will all be adults by 2034 and who may not in the future take kindly to the long-duration budget commitments that were made in their absence. Read more

The Bridge from Laissez-Faire to Socialism

Cronyism remains unchecked in the world’s largest economy.

We might object to the phrase crony capitalism for two reasons:

First, because cronyism is in some ways the antithesis of capitalism. The freedom to compete and the freedom to fail that are central tenets of capitalism are severely compromised by cronyism when in the former case powerful politicians intervene to shield their friends in business and finance from competition, and in the latter intervene again to save them from bankruptcy or occasionally from criminal prosecution. Of course, these friends in turn are no disloyal slouches and they later show themselves to be supremely appreciative by underwriting, financially and otherwise, those same politicians who had all but guaranteed their continued dominance in normal times and their survival against bad odds in times of distress. Read more

America Without Immigration 2015-50

Be careful what you wish for, if that is what you wish for.

Except for the oil shocks of the 1970s and a few other recessionary years, the US economy has generally been strong in the postwar era since 1945. Huge advances in technology and trade, a favorable business environment and strong demographics combined to create tens of trillions of dollars of new wealth in the US and around the world.

The demographic component played an important supporting role. During the baby boom years, the number of Americans grew at an average annualized rate of 1.6% (see chart). In subsequent years starting in the mid 1960s, this growth faded to about 1% where it remained until 2007-08. Since then, it has fallen to 0.7% and, on current UN projections, it will continue to fall through 2050 when it may dip under 0.4%. Read more

The Relationship Between Fertility and National Income

We all heard that “demography is destiny”. But how many of us truly believe it? If demography was destiny, the world would look very different today. The two demographic giants China and India would be uncontested economic and military powers. The United States would be a regional power struggling to keep up. Larger European nations such as Britain, France and Germany would barely register on the economic map, while smaller ones such as Switzerland and Finland would be invisible. Nigeria and DR Congo would be African powerhouses. Brazil, Indonesia and the Philippines would be the shining stars of their continents. Read more

The Lottery of Birth Place and Time

“When I attempt to find a simple formula for the period in which I grew up, prior to the First World War, I hope that I convey its fullness by calling it the Golden Age of Security.”

Thus begins the autobiography The World of Yesterday in which the Austrian author Stefan Zweig, born in 1881, recounts his early life in Vienna at the height of the Belle Époque. It was a time of high culture, of prosperity, and of people who believed that war was forever relegated to the past. Then came the shock of WW1, the breakup of Austria-Hungary, the difficult inter-war period, Zweig’s own forced exile, the horrors of WW2, and finally death. Zweig and his wife committed suicide in Brazil, far from Vienna and very far from the Belle Époque, in early 1942 at a time when the Nazis still looked unbeatable. Read more

Portfolio 004 – Boeing vs. Airbus: Orders and Profits

Boeing has a better product lineup and is more profitable but Airbus has more room for improvement.

The rising tide of globalization has boosted growth prospects for the airline industry all over the world, and in particular in emerging markets such as China and India.  As air travel has become more accessible to hundreds of millions of people, airplane orders and deliveries have boomed. We examine the evolution of orders and profits at Boeing and Airbus.

Airbus Market Share Strategy

Given the Boeing – Airbus duopoly and buoyant demand markets, both manufacturers should now be highly profitable but this is only true of Boeing.  Airbus made some strategic decisions in the late 1990s and early 2000s that continue to depress its profitability, namely the development of the super jumbo A380 which is still loss-making, and the sale of planes below cost or at razor-thin margins in the early 2000s in a drive for market share.

If Airbus’s main mission has been to gain market share, one has to recognize that this mission has so far been highly successful.  In the year 2000, Airbus delivered 311 planes to airlines and Boeing delivered 489.  Eleven years later in 2011, Airbus delivered 534 planes and Boeing 477.  As important, the backlog at EADS (European Aeronautic Defence and Space Company, the parent of Airbus), including non-Airbus divisions, grew from €132 billion in 2000, the equivalent of 5 years of revenues, to €541 billion in 2011, the equivalent of 11 years of revenues.  Boeing’s comparable backlog grew from $153 billion in 2000, 3 years of revenues, to $355 billion in 2011, 5 years of revenues.  Because the Euro has appreciated against the dollar in that decade, these figures actually underestimate the scale of the shift in favor of EADS/Airbus.  In dollar terms, EADS’s backlog has grown from $124 billion in 2000 to $700 billion in 2011, a near six-fold increase.

But Boeing has been more profitable.  In 2011, its EBIT margin in commercial planes was 9.7% vs. 1.7% at Airbus. This dichotomy between one party’s push for market share gains and the other’s focus on profitable orders has defined the relationship between the two competitors for over a decade.

In a decade of astounding revenue and order growth, Airbus has not improved its profitability.  In fact, its operating income (EBIT) was negative in three of the last six years (2006-2011) despite healthy revenues and deliveries.  Boeing has remained profitable but its commercial airplane sales and operating income have been range-bound for a decade.  From 2000 to 2011, Boeing sales grew at a small 1.4% annualized rate and EBIT at only 2.3%.  At Airbus, sales have grown at a 7.6% annual rate (11% in dollar terms) but EBIT has nosedived into the red for the past six years.  Boeing’s commercial plane division accounted for 66% of its group sales in 1999 and now accounts for 52%.  Airbus sales have remained consistently above 60% of EADS group sales and reached a new high of 67% in 2011.  Airbus’s drive for market share at the expense of profits has had a very measurable impact: its revenues are up, its profits are down, and Boeing’s airplane sales and earnings have flatlined.

EADS went public in July 2000 at €19 per share and ended 2011 near €24, a subdued performance for an 11-year period in which sales more than doubled. In January 2012, Airbus promised better returns for its shareholders for the years ahead and the share responded by rising to €31 in March (it recently traded at €28.8). EADS’s reasons for optimism are a decline of the Euro vs. the US dollar and a long-awaited improvement in operating margins for its superjumbo A380.

Prospects

Long-term headline prospects look nominally encouraging. Airbus and Boeing estimate that 25,000 to 33,500 new planes (including both passenger and cargo) will be delivered to airlines in the next twenty years.  However, according to Boeing, single-aisle aircraft (the A320 for Airbus, the 737 for Boeing, and their successors) will account for two thirds of units sold and for half of the value.  And as many as one third of new planes will be sold in the Asia-Pacific region.

As a market segment, ‘single-aisle in Asia-Pacific’ is not the ideal sweet spot for profit growth because smaller planes have lower margins and because Airbus and Boeing face new entrants in the single-aisle category, notably from China’s COMAC C919 and from Russia’s Sukhoi Superjet 100. The COMAC C919 seats 165 to 190 passengers and is therefore directly positioned against the larger versions of the A320 and the 737. It already has 175 orders, nearly all from Chinese airlines, and it plans to start deliveries in 2016.  Note in passing that Airbus is now assembling some of its own A320s in Tianjin, China, with a target production rate of four per month in 2012. It says on its web page Airbus in China that it “has several major technology transfer programmes underway” some of which have ostensibly already been filtered to COMAC.

The Superjet 100 is smaller than the C919 at 75 to 95 passengers and is positioned against the smallest versions of the A320 and 737 and against Brazil’s Embraer and Canada’s Bombardier. Although it has 240 orders, there are only eight in service now, seven of them with the Russian carrier Aeroflot. Last week’s tragic crash in Indonesia raises fresh safety concerns about Russian aviation just as it tries to rebound from its accident-prone Soviet legacy.

Turning to recent orders, we see that as of the end of April, Boeing had received 415 new plane orders in 2012 and Airbus 95. This huge lead in favor of the American is a temporary anomaly because most of it comes from orders for the new Boeing 737MAX which came on line about 12 months after the competing Airbus 320NEO.  If 2012 is the year of the MAX, 2011 was the year of the NEO with Airbus logging a commanding 1419 total orders (of which 1226 for the NEO) against 805 at Boeing (of which 150 for the MAX).

Wide-bodies

Looking at wide-body categories, the Airbus lineup includes the A330, the A340, the perennially loss-making superjumbo A380, and the A350 still under development.  Boeing’s competing lineup includes the aging but ever-updated 747, the 767, the new 787 ‘Dreamliner’, and most importantly today, the hugely successful 777. Stripping out single-aisle aircraft from 2011 orders, we see that Boeing secured 254 orders for wide-bodies and Airbus 193.

The 777 in particular now enjoys a quasi-monopoly in some segments, vindicating Boeing’s decision to develop this plane while Airbus exhausted itself on the prestige-minded A380 double-decker. Boeing delivered its 1,000th 777 to Emirates in March.  Airbus has positioned different versions of the upcoming A350 against both the 777 and the 787 Dreamliner. The A350 is years away from service but it now has a total of 548 orders. Recent cancellations by Abu Dhabi-based Etihad Airways have slowed down the momentum for the largest version A350-1000 which competes with the 777-300ER.

Airbus still loses an estimated €30+ million on each A380 that it builds but it expects the program to break even in 2014-15 on an EBIT pre R&D level, which is break-even on an operating level, ignoring much of the upfront investment.  That would place the EBIT break-even point somewhere between 200 and 250 unit deliveries (so far 72 A380s have been delivered).  In 2005, Airbus estimated the program would break even on an IRR basis at 270 units.  But in 2006, it revised the break-even point to at least 420 units.  The A380 now has 253 orders, two thirds of which have come from airlines based in emerging markets. And one airline, Dubai-based Emirates, accounts for 90 orders.

Airbus sees a total market of over 1,200 units for the A380 (all versions) in the next 20 years, but Boeing believes the potential market is only 325 units. Depending on where one stands on either end of this range, the A380 will either be handsomely profitable in a few years or one of the most visible financial failures in modern industry. For context, consider that in the 42 years since the introduction of the Boeing 747 in 1970, Boeing has sold nearly 1,500 versions of the plane.  With its A380 projections, Airbus is hoping to sell 80% as many units in as few as 20 to 25 years. It is true that the overall market is much bigger today but it is also true that airlines seem more interested in smaller planes. Rising world demographics do not necessarily create a correspondingly large demand for jumbo planes, as much as they do for a larger number of destinations and higher frequency of flights serviced by smaller aircraft.

It would be beneficial for both manufacturers if the A380 turned a profit (at least at EBIT level).  The plane has a list price of $375 million but list prices are generally above contracted prices.  Boeing’s revamped 747, the 747-8 Intercontinental, has a list price of $318 million. If the A380 stays in the red, the question becomes how long will Airbus continue to build it at a loss? Thousands of European jobs depend on the plane and Airbus will probably keep the program for as long as possible. Selling the A380 at a loss for an indefinite period would be detrimental to the Boeing 747-8’s own profitability if Airbus has to offer greater and greater discounts in order to keep the program alive.

It is still early in 2012 but both manufacturers have had difficulty selling wide-body aircraft this year.  Of Boeing’s 415 net orders, only 2 were for wide-bodies (there were 8 new orders and 6 cancellations). Of Airbus’ 95 net orders, only 6 were for wide-bodies (there were 22 new orders and 16 cancellations). The A350 has lost a net 7 orders in 2012. Boeing’s newest plane, the 787 Dreamliner lost a net 6 orders. However, both manufacturers have large backlogs, equivalent to 5 years of 2011 revenues at Boeing and to 11 years at Airbus, which should keep their factories humming in any downturn, barring large cancellations.

Profitability

Airbus is trying to improve its poor profitability.  Its EBIT margin in 2011 was a dismal 1.7% vs. 9.7% at Boeing’s Commercial Airplanes division. Airbus management is targeting an EBIT margin of 10% for 2015, a level last reached in 2005. The margin is expected to start expanding in 2012 as A380 losses subside and low-margin orders from the early 2000s are finally phased out.

By contrast, there may not be a lot of room for margin improvement at Boeing. Its group EBIT margin was 8.5% in 2011 and its margin in commercial planes was 9.7%.

Long-term expectations remain high and both manufacturers are likely to add more capacity in coming years. Because these expectations are predicated on continued growth in emerging markets, a cyclical downturn in these markets will depress utilization rates and put pressure on pricing at the same time that new competitors enter the lower end of the market. On the other hand, continued expansion of emerging market airlines and operational improvements at Airbus could result in better pricing power unless COMAC manages to gain significant market share.

In conclusion, both companies stand to benefit or suffer from emerging market developments. Operationally, Airbus has more room to improve. If it can narrow the margin gap with Boeing, EADS’s EV/Sales and stock should rise correspondingly. But its manufacturing location in Europe may make it difficult to reach its stated margin targets.