Keep Your (Invisible) Hands To Yourself...

Regulatory bodies exist for a reason and play an important role across an abundance of industries, sectors & geographical borders. But there are times when they overstep their role and want to be overly active within the market they should be 'regulating', resulting in strategic and operational involvement, which leads to pricing inefficiencies that take the market out of equilibrium. Sometimes way, way out of equilibrium.

For a sports analogy (which will be a theme of this particular blog), I equate regulators to a referee or umpire. They are there to ensure the rules are adhered to and to intervene succinctly when they aren't. Referees/Regulators have done their job when you don't notice them and the flow of the game/industry is smooth and fair. But when they get trigger happy (or should we say 'whistle happy'), they make sports/business unwatchable and grossly unfair. Even unlawful - just ask Ron Paul, he has some extremely interesting thoughts on the Federal Reserve, one of the biggest regulators on the planet.

Some forms of regulatory over-activity are pricing ceilings, pricing floors, subsidies, import taxes, tariffs, embargoes, trade permits, duties & quotas. You can also find any of these disincentives (or incentives if you happen to fall on the 'right' side of them) wrapped up in multiple convoluted, cross collateralised product names, aimed to veil their intentions. The key point is that the over regulation is one of the most damaging but under analysed scenarios within the corporate world. And when something is damaging but under analysed, it gets exploited and becomes dangerous. And by dangerous, I mean that it distorts and can even destroy an industry.
In Australia, a well governed and world leading country, in many aspects, over-intervention is rife. The Department of Industry, Innovation & Science focused on this point in their 'Office of the Chief Economist Australian Industry Report 2016' and we are seeing multiple huge market inequities make their way through the agricultural, primary production, resources, importation and financial industries, as well. One of the most topical being the multiple stimulus incentives in the residential real estate market. The market is now way out of equilibrium and is being widely called a 'bubble'. People call 'bubble' on anything and everything these days and it is a completely subjective term, but if we see the Australian property market crash, millions of families will be effected. People lose their marriages and even their lives over these inevitable retracements, which is why I use the words dangerous and destructive. The mind boggling part is that these results are avoidable, when you let markets self-govern and their their own pricing, based purely on supply and demand.

Today, I will blog about a sporting over regulation (and one that is extremely commonplace) and a business over regulation. Both are very commonplace within their respective industries, so there will be plenty of real life evidence and examples provided. I will compare them and show why they, while having novel intentions, stymie the industries they are introduced to improve.
At this point, I should add that I am a huge adherent of the 18th Century Scottish economist, Adam Smith and an avid believer in his theory and writings regarding "the invisible hand of the marketplace". For those who haven't heard of this theory, do yourself a favour and have a read. It is the backbone of macroeconomic & microeconomic theory and will help you in your understanding of markets both inside and outside the business world. For those who are familiar, the following writings are underpinned by Smith's timeless principle.

Firstly - sport. And today I'm taking on salary caps. Various sporting leagues around the world use salary caps as a way of limiting the amount of spending each team can make towards their playing group. They guise themselves as a way of ensuring that all of the teams within a given competition retain an equal chance of winning. But what they are really doing is oppressing the players, so that they can't earn their true market value and so that team owners (or the league if teams are not privately owned) can stay nice and fat along the way. It's all about 'an even playing field'.

DO YOU SEE HOW RIDICULOUS THAT IS? Where else does this exist outside sport? Where else do we encourage this bizarre 'level playing field'? In the corporate world, we value firms who 'go for the throat' and aim to steamroll anybody in their path. They get the investor support, the Forbes articles and ultimately, the lion's share of revenue.
Even as individuals, we are raised to be competitive from the moment we take our first breath. We are analysed, ranked and compared from the minute we get our birth weight, through to the minute we clock out and receive our 'age of death'. Our most important factor through childhood - our education systems actually don't even allow a level playing field! We issue directives for our educators to grade based on a bell curve. As young adults, we compete for University spots, we compete for jobs and bonuses, we compete for attention from would-be-partners. Each of our six human needs, we compete one way or another, to fulfil. I actually can't think of any other situation or stage, where we are forced to accept below what we can (and therefore should) achieve. Yet we see it as an appropriate regulatory tool in the sporting world.

LIFE ISN'T A LEVEL PLAYING FIELD. WHY DO WE ENFORCE THE BEST PHYSICAL (AND MENTAL) SPECIMENS ON THE PLANET TO ACT WITHIN THIS LEAGUE ENFORCED, UTTERLY INEFFICIENT MANDATE?

Imagine for a minute if the U.S.A implemented a 'tech salary cap', where Apple, Google, Amazon, Microsoft & Facebook were mandated that they could only pay their executives up to a certain level. Within about 15 minutes, they would all be gone and be working for Samsung, Alibaba, Tencent, Atlassian & SAP. The companies would fall within a heap and would not attract any top talent into their ranks.
Even if the 'tech salary cap' was a global one, they'd just leave tech and go work in pharma, finance or commodities.
It would be completely untenable, utterly unthinkable for this to happen. But it is EXACTLY what happens in sport.

Ironically - and trust me, these interventions DO NOT WORK, so there is always irony, DO NOT ensure evenness. Just as paying players more money DOES NOT ensure either individual or collective success. Salary caps are a price ceiling and price ceilings DO NOT WORK. We have seen them fail in pharmaceuticals, where price ceilings have reduced innovation and R&D. We have seen them fail in real estate, where price ceilings have seen good neighbourhoods turn into ghettos. And we have seen them fail them fail in fuel pricing, where price ceilings have left demand so high that people are waiting in line for hours to even fill up their car.
And so it will go with sports that keep a salary cap in place. Parents will steer their kids in other directions, where they feel they have the potential to be paid what they deserve, not what a league arbitrarily decides they should.

Why can't these young men and women, who are at the peak of their powers, be paid according to their market worth? Why should Lebron James only be paid $23m p.a by his employer if John Hammergren is free to take $131m p.a from his? Or ten times that if he so desires (and can of course show it to be commercially viable to get it past the board).

Of course, the invisible hand of the market is all powerful and it finds a way to filter in, ensuring that the players the more financially sound sporting clubs want to pay more money to, actually receive greater benefits. The market may not be bought into equilibrium by paying them in salary but the teams find ways to make their lives better, be that ensuring they have their own dedicated staff (trainers, chefs, chauffeurs etc). Clubs have been known to speak to local brands or business contacts and help nurse along sponsorship deals, with the old 'you scratch the players back and I'll scratch yours' trick. There have been housing deals done, jobs for wives and family. You name it, the invisible hand of the marketplace is a hard thing to stop. But again, having to find workarounds like these, is inefficient and does not allows leagues or teams to focus on their craft.

"But what about the teams with less fans, less money, less resources. They will never win. They will become obsolete". Yes I hear you. But you are wrong. Money doesn't equal success and we have seen this time and time again in both sport and business. There is so much that goes into creating a winning team and there have been countless examples where throwing money at it just brings ego clashes and ultimately, failure. Whereas creating the right culture - sometimes even in spite of money - is the real recipe to success. For some examples, check out Leicester City or the Western Bulldogs in 2016 and for business, you can never go past the Wright Brothers.

So why not let teams pay athletes what they are worth? Nobody has ever questioned an executive pay packet because the company isn't profitable. In fact, there's a ton of listed companies that don't turn a profit but their 'star players' aren't any worse off for it. I'm looking you, Snap Inc!

And for my business example, Donald Trump's war on trade. President's and Government's loved declaring 'a war on ...'. It makes them seem concerned and proactive. But watch the cloak and dagger policies they make and you will see where they wage their real energy and their real wars. For Donald Trump, that is TRADE.
Last week, we learned that President Trump wants to impose a ~20% import tax on goods entering the country. If you are to believe the commentary, approximately 80% of the top administration officials that were involved in the discussion, advised the POTUS that tariffs were a bad idea but it looks as if that sage advice has fallen on deaf ears.

The reason behind this 'thinking' is that it protects U.S industry. It gives domestic manufacturers and producers a 20% price buffer to bring their goods to market and in doing so, creates U.S jobs and economic growth.

BUT

IT DOESN'T WORK.

Economics 101 focuses on the concept of 'specialisation', which in the context of international trade, states that each country should focus on the industries that they are the best at. Traditionally, this has been innovation for the U.S.A, which is why we have seen it create some of the most amazing companies we will see in our lifetime. But taxing everything that other countries are the best at, just so that the U.S can remain momentarily competitive... Not so amazing.

Let's focus on facts. The U.S.A cannot compete with China, Taiwan, Mexico & India when it comes to manufacturing. If the Trump administration wants to give them an artificial boost, so that they can, then good luck to him but pouring government money into something you do not have a competitive advantage in, is NOT GOOD BUSINESS. You can compete for a while but ultimately, you are destined to be uncompetitive and all that money you poured in, has a negative ROI.

Think about it like this, my son is in Year One. I could help him in his spelling competition and have him beat out all of his peers. But while they're learning and we are effectively cheating, by Year 5 they'll be a better speller than both me and my son, so we will have achieved nothing. We are no longer the best and he hasn't learned anything along the way.

So that I don't look like I'm pretending to be able to predict the future, let me qualify. THIS HAS BEEN DONE BEFORE. AND YES, YOU GUESSED IT, IT DIDN'T WORK.
This is the invisible hand of the market again. Just like the example above where sporting teams find a way to reward their star players while remaining in the salary cap. Economies too find a way to do this for their citizens.

In 1690, the UK imposed a 25% import tax on all goods coming from France to Britain. France responded likewise. For the next 200 years, until about 1860, British people who wanted to drink French wine paid 25% more per bottle than anyone else. Trade between the two countries almost vanished.
The intent of the tax was to boost domestic makers of wool, silk, and linen, and to protect British merchants selling salted fish and cattle. It was a blanket tax, and it covered wine as well.
Adam Smith (yes, him again) covered the subject of tariffs in his 1776 book, Wealth of Nations. He made a very interesting observation - when he noticed that there was one specific group of British businessmen who benefited more than the others from the tariffs — SMUGGLERS. The good ultimately found their way into the UK (and vice versa into France) and the ones hurt were the very merchants that the tariffs were introduced to protect, who were ultimately put out of business.

So unfortunately, the war on trade is a really bad one for everybody in the US. It raises the price point that consumers pay for goods. It artificially allows certain US industries to grow for the short term, until their competitors find a way to get their products into the U.S or until the government gets sick of funding a black hole. And it wastes countless taxpayer dollars sustaining the commercially unsustainable. Not a great idea for a country that's already $19t in debt.

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So, without further ado (as I hope you get the picture by now), let me summarise with the following...

Dear governments, regulatory bodies, sporting leagues, please get your fingers out of the pie and please keep your hands to yourself. The invisible hand of the market can do a completely equitable and efficient job of ensuring that markets, industries, sectors and leagues can operate just fine on their own.

Thanks for your concern.

Sincerely,

Citizens, consumers and athletes worldwide.

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THINKING POINT: This may be worthy of a blog of it's own but I would like to suppose a hypothetical. How long will it be until teams/clubs/organisations within a league start additionally financially incentivising their athletes with cryptocurrency? To my knowledge, there is no sporting organisation in the world right now that recognises that there are other mediums of exchange, outside 'fiat'. So if a team were to say, pay one of their players, a 'maximum' salary as per league allowances under the relevant salary cap and send them an additional one hundred (or however many) Bitcoin's per year, would they be breaching the salary cap?

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