Creakonomics 2: Single Points of Failure

What do Salo, Finland and Stockton, California have in common? They were both fast growing economies that were built on one market or economic driver. In the case of Salo, it was Nokia and cellular phones. In the case of Stockton, it was real estate. When Apple disrupted Nokia and foreclosures wrecked Stockton, the towns were crippled economically. What is more worrisome, is that they threaten to cripple their mother ships as well, Finland and California.

Salo and Stockton had single points of failure. As Nokia failed or started to move manufacturing and jobs out of Finland, it undermined the economies of the towns built around Nokia factories and headquarters. However, Nokia was also an icon of the Finnish economy. It was the pride of the nation and, hence, that single point of failure could cascade into a full blown Finnish disaster. (for an incredible account of the demise of Nokia, read Assaf Gilad’sepic piece in Hebrew (use Google translate)).

Nokia is not only a major employer in Finland, it is also essentially the national pension. According to news reports, 10% of Nokia’s stock is held by citizens of Finland and a lot of that stock was bought over the last years. Nokia’s stock is off over 90% since 2008 and is currently trading at a roughly $6 Billion market cap. Roughly $5.5 Billion dollars has been wiped off the balance sheets of Finns holding Nokia’s stock. Nokia was 14% of Finnish exports in 2011. I do not know what that number is now but be certain that it is off dramatically. That is compounded by the layoffs from Nokia that have contributed to rising unemployment, causing Nokia-centric cities to cut back on famous social safety nets of civic services. Graduates of technology universities who looked to Nokia’s bosom for employment, will now need to find work elsewhere, perhaps depriving Finland of crucial young talent.

This single point of failure, Nokia, becomes a cascading series of economic problems for individual cities and then a country. As cities cut back on services due to high unemployment it becomes morally OK for other cities to do that, reinforcing a downward spiral. Which brings us from Salo to Stockton.

Stockton, like many municipalities, has a single point of failure. Real Estate Taxes. When 1 in every 30 homes foreclosed in Stockton and property values declined 44%, the city was left with a fixed cost base for its municipal employees, services and pensions. These municipal costs always rise when the economy is good as everyone has their hand out, and the costs rarely go down when the economy is bad because it is politically difficult to negotiate with unions. This single point of failure has cascaded as well, and, in two directions. First, in Stockton, layoffs by the municipality were inevitable as there was no money to cover all the services, pensions and people. This serves to further reduce property values and economic vitality in the city. But this was only the local cascade. The more serious one was the moral air-cover the Stockton Bankruptcy gave to other municipalities like San Bernadino, and now 4 others, to declare bankruptcy. All this from a single point of failure.

****Added Saturday July 21st****

Last week’s rise in corn prices should also cause us to pause. Corn (and maybe soy) is a single point of failure in the US food system. Years of subsidies have pushed farmers to plant endless corn fields which caused food companies to base a large portion of their products on corn and they even feed their cattle corn. What happens when a single hot summer severely harms the corn crop? Well all of those hectares of corn get wiped out in a single stroke. There is no resilience to the system because the system is the antithesis of a diverse food system. It is neither diverse in product nor in geography and it is about to hit every American’s pocket! Corn is a single point of failure for the US food system.

This is instructive because it should motivate us to find the single points of failure at all levels in our economies. Boards of Directors look at companies for risks and dependencies, buy-side investors are very accustomed to looking for revenue dependencies and customer concentration but somehow we (government or citizenry) do not look at this on an economy-wide level or on a municipal/state level. Cities and states are important because as autonomous economic units, they have both the economic and psychological impact to cascade down.

Unless I missed it, I have seen zero analysis by either the government or the press examining which local or national economies have significant single points of failure. Other than the obvious guessing game at this point of which municipality could declare bankruptcy next, I have not seen a map of those autonomous units that could fail and a plan for what to do about them.

Ironically, there has been incredible focus by the government and the press on the JP Morgan Whaling loss but none about the Whale JP Morgan’s impact on the US economy. JP Morgan, with its trillion dollar plus balance sheet and its talented, detail-oriented, dogged and responsible CEO can absorb the whaling loss. But can the US economy absorb the risk that is JP Morgan? Where is the discussion on that single point of failure?

Ignoring these single points of failure does not make them go away. We live in an era of hyper innovation that is disrupting businesses that many have come to assume are permanent fixtures. We are living in an era of Hyper-connectivity, that makes actual and psychological cascading inevitable. This demands economic diversity and business model flexibility at both the government and business level. Government and Business institutions that are fixtures on the landscape or have fixed costs, are just dominoes waiting to fall. And that fall will cascade if we do not identify the single points of failure.
Can we at least bring them into broad daylight and talk about them as a start?

To see the first blog post in the Creakonomics Series, click here.

[Originally published on 18th July 2012 by MIchael Eisenberg]