Bubble or Bank for Web 2.0: Microsoft Friends Facebook for $240 million

Last week, Microsoft bought a 1.6 percent stake in the social network Facebook (see right). The international powerhouse handed out $240 million for the tiny portion valuing the site at $15 billion, the fifth most valuable internet company after Google, Yahoo, Amazon, and eBay. With 50 million users and 200,000 more daily, Facebook hosts a significant customer base on which to draw for companies like Microsoft, and Microsoft’s investment isn’t the only one Facebook has received. Articles from CNN also mention two hedge funds also putting in similar bids, which Facebook accepted. In all, the social network picked up $700 million dollars to put towards a badly needed structural overhaul and R&D for the future according to British newspaper The Guardian. They also plan to use the money to more than double their staff from four hundred to seven hundred employees. However, Facebook’s revenue is one-tenth its $15 billion price tag, and the site produces no profits according to one. At this point, many might be remembering the 1990’s dot.com bubble and rags to riches and back to rags rollercoaster that ensued. The inflated price tag is partly the result of an online advertisement war (see below left) being waged by technological powerhouses Microsoft and Google. The investment in Facebook was a defensive maneuver on the part of Microsoft as Google has the upper hand in the online arena. Google already has advertisement deals with other social networks such as MySpace and even has its very own online meeting place called Ortuk. However, some experts like Matt Rosoff, an analyst specializing in Microsoft, believe that even though the deal was a good move, the price tag smells suspiciously of the 1990’s dot.com era. On the other hand, a recent article in Business Week claims that the parallel is weak when considering the context of the situation. For one, Facebook is not going truly public for a few more years. Another reason is a result of changes in the technological market. More than 70% of adults in American are online as opposed to 40% in less than ten years ago. Compounded with the fact that most of the new startup companies, or Web 2.0 companies, advertise themselves online instead of using costly television ads. In light of this, I believe that there is justification for the price tag. With so many users already and more joining every day, Facebook is a massive potential advertising machine. Traffic is so high on social networking sites and other Web 2.0 applications that revenue from advertising would be more than significant. Microsoft needs this deal to increase its online presence in the face of a looming internet war with Google. Blocking Google out and increasing advertisement presence is a significant move especially when the price tag only makes up less than a percent of your own companies value.

King of the Road: Who Owns The Highway

In the past few decades, states having a hard time balancing their checkbooks have looked for creative ways to avoid costs and produce revenue. One choice these states have been turning to is the option to privatize their highways. This alternative to fully public funded construction and maintenance allows states to cut costs in production and gain significant revenue from the selling or leasing of the highways (see right). However, some detractors are afraid of giving the private sector too much control over the roads and worry that maintenance will decline.
Lately, states like California and Texas have used privatization to create roads and revenue in one swoop. With the war and the general overspending of the current administration, the budget belt for states has been cinched tight, and states have been worrying where they can cut costs or generate revenue. In addition, the infrastructure of many existing highways has been called into question especially in light of the summer’s collapse of a bridge in Minneapolis. An article in Newsweek quotes the American Society of Civil Engineers estimating a cost of about $1.6 trillion over the next five years to bring highway infrastructure up to date. Needless to say, states that need to expand or renovate their highways do not have the money to fund these projects. If public funds come up short, who can bridge the gap? Companies like the Australian based Macquarie and Spanish based Cintra do not need any encouragement. In the past few years, Macquarie and Cintra have built and leased back highways in Indiana, Texas, and California with some projects having price tags upwards of a billion dollars like the new Chicago Skyway (see bottom right) which earned $1.8 billion for the city after being leased back to Maraque for 99 years. In total, about $25 billion dollars in projects are in development with private firms states a Wall Street Journal article. States set the terms and “force the owner (or leaser) to provide certain levels of service and maintenance and to keep tolls and other costs under control.” The companies then build the highways and sign ownership over to the government. Almost immediately, the government leases the toll roads back to the private companies for a certain amount of money upfront, which they can use for whatever reasons. The companies get a long-term cash cow, and the government gets liquid capital to use upfront. Using an economic model, the privatization should promote competition between firms. This would lower final costs and increase efficiency on the roads, as private firms would want greater quantities of people using their roads instead of an alternative. The firms might produce a solution to traffic the government has not cared too.
All in all, this solution sounds like it works out for both the private firms and the state governments with firms getting profits and the government getting revenue and cutting the costs of maintenance on highways. However, critics argue that private firms might raise tolls to high and drive motorists back onto the already overloaded public highways, and Newsweek cited Fortune magazine’s Bethany McLean “raising questions about the sustainability of Macquarie’s business model.” Selling these highways is a one shot deal for states and promises no future funding for state governments. As a way to make a quick buck for states and perhaps promote efficiency in the construction and maintenance of highways, this model has been fairly successful; however, I think state governments need to find a more permanent solution for the problem they think they are fixing. I doubt owners of highways will raise tolls enough for drivers to avoid them all together. In the end, these private firms want to make money and gain nothing if people do not travel on their highways. Privatization may clean up highways, decrease traffic, and promote efficiency on a general basis; however, I believe state governments are making a mistake in banking on highways to fill their coffers.

Crimson Skies: The Dogfight over Dollars

Recently, there has been a clash between the two major producers of aircraft (see right) and the subsidies they get from their respective countries. Airbus Industrie is a joint venture between the British, French, and German governments. It is Europe’s leading producer of commercial aircraft and takes up around half of the global market share in the industry. Boeing is Airbus Industrie’s American counterpart and covers the other half of the global market share (see below left). Both have been firing shots at each other across the Atlantic over their respective government’s subsidies, the beginning, perhaps, of a international trade war. Each is convinced that the other’s government is giving unfair advantages to their domestic industries.

Right now, the two companies have lodged complaints with the World Trade Organization over the apparent use of illegal subsidies on both sides. The European Commission, representing Airbus, claims that Boeing receives illegal state subsidies in the forms of “federal, state, and local programs that could total $23.7 billion.” This money includes contracts from NASA and the United States Department of Defense. The EC also called into question the export subsidies Boeing receives that violate global trade laws and the lack of paperwork showing Boeing will give them up. The United States Trade Commission, representing Boeing, presented a case complaining that Airbus had received $15 billion in what is called “launch aid” which, after compound interest is added in, amounts to $205 billion. Airbus also receives loans from the EU “below commercial rates that Airbus uses to launch new projects and which are repaid only if the aircraft are a commercial success.” In addition, Airbus receives aid in the form of state “infrastructure projects” which provide Airbus with money to establish new buildings and infrastructure as well as expand on existing facilities.

Misinformation has also been playing a large part in the scandal as each accuses the other of distorting figures by exaggerating aid given by the other’s government while underplaying the aid they receive themselves. Comparing the numbers side by side, the discrepancy is huge. The EC accuses Boeing of receiving upwards of $10 billion from NASA for R&D in an indirect subsidy. Boeing, however, presents $750 million as the true figure. The EC also cites a $2.4 billion contract from the Defense Department, but Boeing refutes this as inaccurate as military contracts are not visible to the public eye.
Either way, both companies are clearly getting illegal subsidies from their governments. In a way, the subsidies provide security for each country. In an industry as specific as the aircraft market, having a domestic producer for military as well as civilian aircraft can provide security in times of war and a level of secrecy and confidentiality in times of peace. Subsidies can also look attractive to domestic workers as large projects by domestic aircraft producing firms provide massive employment opportunities. However, these subsidies make both companies weak in the long term and reduce the growth as a whole in the economy. By providing a crutch on which to lean, the governments breed inefficiency in the companies, as there is no impetus to streamline production and bureaucracy. These subsidies may also be a harbinger to a greater trade war across the Atlantic. Both sides agree that a trade war would be detrimental to each party as well as those not even directly involved since all countries need airplanes. The economic implications of these subsidies, in themselves as well as in the context of a greater looming trade war, draw a picture of economic disaster. In my opinion, the existence of these subsidies is economically unsound and provides a staging ground for a detrimental snowball effect that ends in a big explosion of money and fuselage.

Pay to Pollute: The Commerce of Carbon

In the past fifty years, greenhouse gas emissions have almost quadrupled from 1.6 billion to 6.5 billion tons (see graph right). This unprecedented growth of pollution over the past few decades is thought to be the main contributor to everyone’s favorite sometimes myth, global warming. In efforts to combat these rising levels of pollution, especially carbon emissions, many countries like Brazil, the United States, and most of the European Union have adopted emissions trading schemes that limit the amount of carbon and similar greenhouse gases produced by power plants or their industrial corporations. The process assigns monetary values to “carbon credits” which companies can buy or sell. This is designed to present an economic incentive for polluting less as companies that reduce their emissions can sell their excess carbon credits for cold hard cash.
In the United States, President George W. Bush’s “Clear Skies” initiative concentrates its efforts to reduce emissions of SO2 (sulfur dioxide), NOx (nitrous oxides), and mercury from power plants (see graph left). According to the White House, the United States government uses a cap-and-trade system to regulate emissions without having to get too involved. The government “caps” the level of emissions allowed in the country and doles out allowances to individual companies. Certain levels have to be maintained and then reduced at predetermined deadlines. Companies that reach the reduced levels before the deadline are allowed to “trade” their extra credits on the market to plants that have not reached their reduction levels. Personally, I like the cap-and-trade model. It solves an environmental problem with an economic solution. The most basic laws of economics determine the best allocation of credits and ensure maximum efficiency in reducing pollution. Self-interest, not federal sanctions, motivates companies to be more environmentally friendly. In addition, the cap-and-trade method allows the government to take a hands-off approach. Instead of wasting billions of dollars on litigation and manpower, the government simply has to set the limits, distribute the allowances, and make sure each plant has enough allowances to get them through the year. To contrast directly, the cap-and-trade program has “achieved reductions at two-thirds the cost of achieving the same reductions” using the previous system of regulation and penalty over the past ten years.
This glowing picture of emission trading systems founded on solid economics seems to good to be true, and according to some, like the Sierra Club, it is just that. An article from the Sierra Club states that the “Clear Skies” proposal actually increases pollution levels. In contrast with the previous “Clean Air Act,” “Clear Skies” loose[ns] the cap on NOx pollution to… an increase of 68 percent” and SO2 pollution 225 percent from “Clean Air.” Since this information comes from studies performed by the U.S Environmental Protection Agency, it is difficult to refute. Related to the high caps in the “Clear Skies” proposal, The United States government, as well as the EU with their Emissions Trading Scheme and the UN’s Clean Development Mechanism, has come under fire recently due to recent claims from Professor Catrinus Jepma of the University of Amsterdam that these systems have failed to provide “…the excepted benefits due to a collapse in the price of carbon credits.” In short, the governments deciding how many carbon credits allowed overestimated. The high emission caps have led to a surplus of carbon credits in the market, and in accordance with economic modeling, the price of the carbon emissions has dropped dramatically. All the way back in May of last year, it was revealed that countries using the European Trading Scheme, think “Clear Skies” for the EU, had set caps too high “resulting in fewer firms than expected having to buy credits.” This led to a drop of the price of carbon credits from thirty Euros to less than five. If the price of credits drops too low, the incentive to reduce pollution drops next to nothing as reducing emissions will result in profits next to nothing when sold on the market. This in turn directly influences companies’ decisions to research new ways to reduce emissions more efficiently. This, however, is not a failure of the economic system but a failure of the governments setting the limits. By setting a limit too high, a government does not constrain the firms enough and the whole process fails to achieve market equilibrium.
As an economist, I believe in the “invisible hand” of the free market. Left alone and under the proper constraints, I think that the cap-and-trade system will lead to the most efficient use of resources to reduce pollution. You catch more flies with honey in the same way you catch more people with the promise of money than the fear of litigation.