I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

I work for ThoughtWorks, the global leader in software delivery and consulting.

Saturday, April 30, 2022

Has Labor Peaked?

I wrote some time ago that labor is enjoying a moment. New working habits developed out of need during the pandemic that in many ways increased quality of life for knowledge workers. Meanwhile, an expansion of job openings and a contraction in the labor participation rate created a supply-demand imbalance that favored labor.

There appears to be confusion of late as to how to read labor market dynamics. With fresh unionization wins and increased corporate commitment to location independent working, is labor power increasing? Or with a declining economy and more people returning to the workplace (as evidenced by increases in the labor participation rate) is labor power near its peak?

The question, has labor peaked?, intimates a return to the mean, specifically that labor power will revert to where it was pre-pandemic (i.e., “workers won’t continue to enjoy so much bargaining power.”) The argument goes that fewer people have left the workforce than have quit jobs for better ones; that hiring rates have increased along with exits; that the labor participation rate has ticked up slightly; that labor productivity has increased (thus lessening the need for labor); and that demand is cooling (per Q1 GDP numbers). Toss in 1970s sized inflation compelling retirees to return to the workforce and there’s an argument to be made that labor’s advantages will be short lived.

But this argument is purely economic, focusing on scarcity in the labor market that has created wage pressure. For one thing, it ignores potential structural economic changes yet to play out, such as the decoupling of supply chains in the wake of new geopolitical realities. For another, it ignores real structural changes in the labor market itself, things like labor demographics (migrations from high-tax to low-tax states), increased workplace control by the individual laborer (less direct supervision when working from home), and improvements in work/life balance.

The question, has labor peaked?, becomes relevant only when there is an outright contraction in the job market. For now, the better question to ask is how durable are the changes in the relationship between employers and employees? It isn’t so much whether labor has the upper hand as much as labor has more negotiating levers than it did just a few years ago. The fact that there hasn’t been a mad rush to return to pre-pandemic labor patterns suggests employers are responding to structural changes in labor market dynamics.

Trying to call a peak in labor power is a task wide of the mark. And for now, the more important question still seems some way off from being settled.

Thursday, March 31, 2022

Crowding Out

Tech has had a pretty easy ride for the last twenty years. It only took a couple of years for tech to recover from the 2001 dot-com crash. In the wake of the 2008 financial crisis, companies contracted their labor forces and locked in productivity gains with new tech. Mobile went big in 2009, forcing companies to invest. Then came data and AI, followed by cloud, followed by more data and AI. The rising tide has lifted a lot of tech boats, from infrastructure to SaaS to service providers.

The ride could get a little bumpy. Five forces have emerged that threaten to change the corporate investment profile in tech.

  1. Labor power: workers have power like they've not had since before the striking air traffic control workers were fired in the early 80s, from unions winning COLAs in their labor agreements to the number of people leaving their jobs and in many cases, leaving the workforce entirely. Labor is getting expensive.
  2. Interest rates: debt that rolls over will pay out a few more basis points in interest rates than the debt it replaces. Debt finance will become more expensive.
  3. Energy inflation: energy prices collapsed before the pandemic, only for supply to contract as energy consumption declined with the pandemic. It takes longer for production to resume than it does to shut it off. True, energy is less a factor on most company income statements than it was fifty years ago, but logistics and distribution firms - the companies that get raw materials to producers and physical products to markets - will feel the pinch.
  4. Supply chain problems: still with us, and not going away any time soon. Sanctions against Russia and deteriorating relations with China will at best add to the uncertainty, at worst create more substantive disruption. By way of example, the nickel market has had a rough ride. And there has been increasing speculation in the WSJ and FT of food shortages in parts of the world. As companies stockpile (inventory management priorities have shifted from “just in time” to “just in case”) and reshore supply chains, supply chain costs will rise. Supply will continue to be inconsistent at best, inflationary at worst.
  5. Increase in M2: adding fuel to all of these is a rise in M2 money supply. More money chasing fewer items drives up prices.

All of these except for interest rate rises have been with us for months, and we’ve lived with supply chain problems for well over a year now. These factors haven’t had much of an impact on corporate investment so far, largely because companies have successfully passed rising costs onto their customers. Even if real net income has contracted, nominal has not, so buybacks and dividends haven’t been crowded out by rising expenses.

But the economy remains in transition. Many companies are starting to see revenues fall from their pandemic highs. While rising interest rates may cool corporate spending, it has to cool a great deal to temper a labor market defined more by an absence of workers than an abundance of jobs. With real wages showing negative growth again, it will become more difficult for companies to pass along rising costs. Rising resistance to price increses will, in turn, put pressure on corporate income statements.

Of course, this could be the best opportunity for a company to invest in structural change to reduce labor and energy intensity, as well as to invest for greater vertical integration to have more control over upstream supply, with an eye toward ultimately changing its capital mix to favor equity over debt once that transformation is complete. That’s a big commitment to make in a period of uncertainty. Whereas COVID presented a do-or-die proposition to many companies, there is no cut-and-dried transformational investment thesis in this environment.

Monday, February 28, 2022


Silicon chips are in short supply, ports are congested, and as a result new cars are expensive. The shortage of new cars has more people buying used, and as a result, used cars are fetching ridiculously high prices as well. The same phenomenon of supply shortages and logistics bottlenecks have been playing out across lots of basics, manufacturing and agricultural industries for months now.

At the same time, we have M2 money supply like we’ve never seen. All that cash is pursuing few investment opportunities, which bids them up. Excess liquidity seeking returns has inflated assets from designer watches to corporate equity.

Supply shortages twined with excess capital have created inflation like we’ve not seen in nearly 40 years.

Included among the supply shortages is labor. The headline numbers in the labor market have been the number of people leaving the workforce and the labor participation rate: fewer people of eligible age are working than before the pandemic, and many have simply checked out of the labor market forever, electing to live off savings rather than income. This means those who are working can command higher wages. In the absence of productivity gains, higher wages contribute to the inflationary cycle, because producers have to pass the costs onto consumers. Inflationary cycles can be difficult to stop once they start.

But labor market tightness can do something else: it can be the genesis of innovation. When a business cannot source the labor it needs to operate, it innovates in operations to reduce labor intensity. By way of example, businesses contracted their labor forces (including the ranks of their core knowledge workers) in the wake of the 2008 financial crisis. While this reduced corporate labor spend, it put remaining workers under strain. Soon after the reductions-in-force, companies invested in technology to lock in productivity gains of that reduced force. Capitalizing those tech assets reduced their impact on the income statement while those investments were being made. Once recovery began and revenues rose, that tech kept costs contained, resulting in better cash flow from operations after the financial crisis than before.

We are potentially in an inverse of the same labor dynamics. Whereas in 2008 the corporate innovation cycle was driven by corporate downsizing of the labor force, today it is driven by the labor market downsizing itself. And just as in 2008, when it was a secular problem (finance had an abundance of labor, while tech did not), it is secular again today.

Among the labor markets suffering a supply shortage is K-12 education. Education has become a less attractive occupation since the pandemic. A highly educated cohort disgruntled with work is an attractive recruiting pool for all kinds of employers.

The exodus of people from the teaching profession has created a shortage of teachers. The K-12 operating model is based on physical classroom attendance of teacher and student at increasingly high leverage ratios - 20, 30, 35 students to one teacher. This model becomes vulnerable with a scarcity of teachers. Classroom dynamics - not to mention physical facilities - don’t scale beyond 35 or 40 K-12 students in a single classroom. If there are fewer people willing to teach in the traditional paradigm, then the teaching profession will be under pressure to change its paradigm in one way or another.

I’ve written before that technology is generally not a disruptive agent. Technology that is present when socioeconomic change is happening is simply in the right place at the right time. Where there are acute labor shortages today - public safety, education, restaurant dining - the socioeconomic change is certainly afoot. What isn’t obvious is whether the right tech is present to capitalize on it.

Monday, January 31, 2022

How City Hall Can Fight City Hall

I live in a rural area. There isn’t a whole lot of agriculture or heavy industry, but there are a lot of inland lakes and national and state forest acreage. No surprise that one of the principal industries here is tourism. It’s a year-round industry as the area supports fishing and hunting, silent and motorized water- and winter-sports, youth summer camps and RV parks. A great many of the local businesses cater to tourists, from bait shops to bars, resorts to equipment rental, boat docks and off-season boat storage.

Like any community, there is tension. One source of tension has to do with how the land is used. There are those who advocate for more motorized activities (e.g., open more roads to ATV / UTVs) and those who advocate for less (e.g., more no wake zones on lakes). To some extent, the motorized v non-motorized debate is a proxy fight for the tourism industry. It is believed that opening more roads for ATV usage will bring more people into town centers where they’ll spend money, at the cost of noise pollution. Similarly, it is believed that creating more no wake zones will reduce shoreline erosion beneficial to homeowner and habitat alike, at the cost of vacationer experience. The extent to which the tourist is accommodated is, like any economic issue, very complex: the year-round resident who is dependent directly or indirectly on tourism has different goals from those of the year-round resident who is not dependent on tourism, or the non-residents with a second home here, or the tourists who visit here for a myriad of reasons. While an economic phenomenon, it is inherently political, and there are no easy answers.

Unsurprisingly, some flashpoints have emerged. One, specifically regarding land usage, has to do with income properties. From roughly 2008 until 2019 or so, real estate in this area was inexpensive, a long-lived aftereffect of the 2008 financial crisis (fewer buyers) as well as changes in where and how people vacationed (fewer tourists). COVID-19 changed this. With international borders closed and vacation options limited, people vacationed where they had once spent their summers. Some stayed permanently. The property market went from stone cold to red hot in a matter of months as people gobbled up properties as first and second homes as a means of social distancing while working or vacationing.

COVID-19 also put a premium on rental properties. This created an acute supply shortage. Low interest rates and cash accumulated by households made for a lot of willing property investors. Quite a few bought properties, hired tradespeople to fix them up (or fixed them up themselves), and listed them on vacation rental property sites.

The trouble is, while the properties may have been improved, many didn’t get the building inspections required for an income property, nor the permits required to rent out the properties.

The zoning commission for at least one county here is treating this as a compliance problem, which of course it is. They’ve done an analysis (more about that in a bit) and concluded there are hundreds, possibly thousands of properties that are out of compliance. They have also concluded that the task of (a) ascertaining whether they are in fact out of compliance and (b) bringing them into compliance will be time consuming and difficult.

A different way of looking at this is as a fraud problem. Property owners without permits are defrauding the county (out of tax revenues) and their customers (that the property is up to building code, health & safety code, and the like).

Fraud management consists of three types of activity: prevention, detection, and investigation. Let’s start with detection. The county entered into an arrangement with a software company that analyzes rental property sites and county tax filings to identify (that is, detect) which properties are out of compliance (committing fraud). According to their analysis, there are somewhere between 700 and 2,000 potential income properties in the county without the appropriate inspections and permits.

This brings us to investigation. Two thousand properties potentially out of compliance may not sound like a lot, but it is when there are only a few building inspectors who work for the county. Plus, many of the property owners receiving citations in the mail are disputing them in court, delaying resolution and tying up an already limited staff of inspectors. This doesn’t just point out the problem of labor intensity of inspections as much as it makes clear how the scale of the problem has changed: something that had for decades been a problem at a human scale is now at machine scale. While scaling the detection of the problem was relatively easy, scaling the inspection will not. Sure, a small fleet of drones could probably assist with investigation and alleviate some of the labor intensity, but that would require the county to spend money on both labor and tech for a limited solution with no guarantee of results.

Which leads us to prevention, the third activity of fraud. The best way to make the investigation activity manageable is to prevent it from getting out of control in the first place. Yes, the numbers suggest it is already excessive, but the amount of undeveloped land in this area up for sale suggests there is room for more property development. Plus, per our earlier definition, fraud is committed with every rental of an out-of-compliance property, so in theory the intent would be to prevent the next rental of an out-of-compliance property.

Practically speaking, there is very little a single county or even a handful of counties with small tax bases can do to prevent fraud like this. Prevention will probably require state-level-legislation, and by several states. There have been similar actions taken by state governments. For example, in the past five years most states have enacted marketplace facilitator laws to make it easier for the multitude of state, county and municipal level departments-of-revenue to collect sales taxes from online marketplace retailers: instead of needing to collect from the individual merchants, the marketplace facilitator is responsible for collecting and remitting sales taxes. States could similarly enact legislation obligating property rental booking services to require listing owners to register valid permits at risk of penalty for non-compliance, and report rental data to counties where properties are rented. The onus would then arguably be on the vacation property listing sites to confirm merchant compliance, which would be checked via periodic audit similar to a sales tax audit of an online marketplace. There would still be leakage (there will always be) but not likely as much as there is today.

“You can’t fight city hall” has a different meaning today. Half a century ago, it meant the individual couldn’t expect to win a fight with a government bureaucracy. Today, a county bureaucracy can’t expect to win a fight against the modern day equivalent (socioeconomic trends of cheap capital and changing vacation patterns amplified by tech). But one thing has not changed: the underdog can only win by redefining the problem, and collaborating with many others to change the rules of the game.

Friday, December 31, 2021

What does it let us do that we couldn't do before?

In the past year, activist investors have pushed for retailers like Macy’s and Kohl’s to separate their eCommerce operations into separate listed entities. The argument goes that eCommerce retail growth is rapidly outpacing bricks-and-mortar business growth, and saddling a high-growth business to an ex-growth legacy company depresses enterprise value. Separating them into two listed entities liberates the trapped value and allows investors to benefit: the eCommerce business for growth, the bricks-and-mortar business for its stable (if declining) cash flows, real estate holdings and intellectual property (e.g., brand) value.

Not so fast. There are counter-arguments to making this separation, and not just that a growing eCommerce division covers up for a struggling traditional retail operation.

Principal among the arguments for keeping the business whole is that even with - and perhaps especially because of - COVID, there’s a strong argument that the omnichannel strategy is the strongest hand to play. Omnichannel requires a seamless customer experience that independent eCommerce and physical store legal entities will struggle to curate. It stands to reason that what is good for the brick and mortar business is not necessarily the same as what is good for the eCommerce business, and vice-versa. Having eCommerce and brick-and-mortar working independently - if not at cross-purposes - will do little to harmonize the customer experience, not helpful at a time when doing so is deemed essential to survival.

An extension of this argument is that an omnichannel strategy doesn’t distinguish among channels, so separating the two - and thereby creating a distinction between them - is solely an act of financial engineering. Assessed as a financial act, the obvious question is, who wins? The consultants, attorneys and banks that collect fee income from the separation are clear beneficiaries: they’ll collect their fees regardless the outcome. Investors may or may not win out, as bond and equity prices in both legal entities may plummet after their separation, but at the start they will have no less value than they do today plus upside exposure through clearer value realization paths. Unfortunately, it’s hard to imagine how the pre-separation business itself gains from the separation: does it stand to reason that even more formalized organizational silos, redundant corporate overhead functions, and executives with polarized incentives are customer-value generative outcomes?

This flare-up in retail is interesting because it is the latest incarnation of a long-lived phenomenon of companies touting a change in their capital structure as a strategic initiative. I first wrote about this almost nine years ago. At the time, activist investors were attacking tech firms to create new classes of preferred shares or issue new bonds solely for the purpose of extracting cash flows from operations for the benefit of investors. But it wasn’t just an outside-in phenomenon of investors pressing tech firms: Michael Dell had at that time proposed to take Dell private, which did soon thereafter. With only wolly words to describe the justification for going private, it raised the question, what can Dell do as a private company that it cannot do as a public one?

The current kerfuffle in retail allows us to ask this question more broadly. Changing capital structure is no different from any other use of corporate cash, be it distribution of dividends, to replatforming operations, to simply strengthening the credit rating. Those bankers, lawyers and consultants don’t come cheap. The question is, what does it let the business do that it couldn’t do before?

With the benefit of hindsight, we know that Dell the publicly listed company became Dell the private equity fund. Among its acquisitions was EMC, and in particular EMC’s stake in VMWare, a position so lucrative that when Dell went public again in 2018 the implied value of the business excluding that holding was effectively nil. Dell the public company could have acquired EMC; publicly listed tech companies make acquisitions all of the time. What going private let the business do that it couldn’t do before was to concentrate ownership, and subsequently the returns from those acquisitions, in fewer people’s hands.

In the retail sector, the answer is not necessarily so cynical. Saks made the split into separate bricks & mortar and eCommerce legal entities earlier this year. In the words of the eCommece CEO, as quoted in the WSJ this week, both businesses benefit overall because they don’t have the same dollars chasing conflicting investment opportunities exclusively in an IRL and online realm, the eCommerce business has expanded its eCommerce offerings and reach, the brick and mortar business has better integration with eCommerce than it did before, and eCommerce now has an employer profile attractive to tech sector workers. In short, to destroy a longstanding phrase, by being two entities, the Saks eCommerce CEO argues that the sum of the parts is greater than the whole could ever have been. The CEO argues that the separation lets Saks do something - probably many somethings - it could not do before.

This, in turn, begs the question why.

There’s a quote attributed (quite probably erroneously) to the late Sir Frank Williams of the eponymous Williams Formula 1 team. When asked whether he approved of a proposed change to the race car, the legend is that his only response was, “does it make the car go faster?” It’s a deceptively simple question, one that I long misunderstood, because I took it at face value. Engineers can do any number of things to make a car go faster that also make the car less reliable, less stable, incompatible with sporting regulations, and so forth. While the question “does it make the car go faster” appears a simple up-or-down question, it actually questions the reasons behind the proposed change. How does it make the car go faster? Why hasn’t anybody thought to do this before? In answering those questions, we find out if the proposed change is clever, or too clever by half.

And that’s the question facing traditional retail. A commercial restructuring that alleges it creates value for the business (that is, not just investors) flies in the face of conventional wisdom. Sometimes that conventional wisdom is correct: Dell shareholders who accepted something less than $14 / share in 2013 lost out on a quadrupling of the enterprise value over an 8 year span (and no the S&P 500 didn’t perform quite that well over that same timeframe). But then, as John Kenneth Galbraith pointed out, conventional wisdom is valued because it is convenient, comfortable and comforting - not because it is necessarily right. Perhaps Saks and parent HBC are onto something more than just financial engineering, if in fact separating eCommerce from bricks & mortar let them do something they could not do before.

Tuesday, November 30, 2021

Do we need IT Departments?

The WSJ carried a guest analysis piece on Monday proclaiming the need to eliminate the IT department. While meant to be an attention-grabbing headline, it is not a new proposition.

Twenty years ago, the argument for eliminating the IT function went like this: while IT was once a differentiator that drove internal efficiency, it was clearly evolving into utility services that could be easily contracted. And certainly, even in the early 2000s, the evidence of this trend was already clear: a great many functions (think eMail and instant messaging solutions) and a great many services (think software development and helpdesk roles) could be fully outsourced. Expansive IT organizations are unnecessary if tech is codified, standardized and operationalized to a point of being easily metered, priced and purchased by hourly unit of usage.

While the proponents of disbanding IT got it right that today’s differentiating tech is destined to become tomorrow’s utility, they missed the fact that tomorrow will bring another differentiating tech that must be mastered and internalized before it matures and is utilified. Proponents of eliminating the IT function also ignored the fact that metered services - particularly human services - have to be kept on a short leash lest spend get out of hand. That requires hands-on familiarity with the function or the service being consumed, not just familiarity with contract administration.

The belief that enterprise IT departments should be disbanded is back again. This time around, the core of the argument is that a silo’d IT organization is an anachronism in an era when all businesses are not just consumers of tech but must become digital businesses. There is merit in this. Enterprise IT is an organization-within-an-organization that imperfectly mirrors its host businesses. IT adds bureaucracy and overhead; hires for jobs devoid of the host business’ context; and by definition foments an arms-length relationship between “the business” and “IT” that stymies collaboration and cooperation and, subsequently, solution cohesiveness. Not a strong value prop there by today’s standards.

Today, [insert-your-favorite-service-name-here]-aaS has accelerated the utilifcation of IT even further than most could imagine two decades ago. And, or at least so the argument goes, modern no-code / low-code programming environments obviate the need for corporate IT functions to hire or contract for traditional language software developers. Higher-level languages that non-software engineers can create solutions with reduces the traditional friction among people in traditional roles of “business” and “IT”.

Best of all, there is a reference implementation for disbanding centralized IT: the modern digital-first firm. While a digital-first firm may have a centralized techops function to set policies, procure and administrate utility services, it is the product teams that are hybrids of business and tech knowledge workers create digital solutions that run the business.

If you had the luxury of starting a large enterprise from scratch in Q4 2021, you would have small centralized teams to create and evolve platform capabilities and standards from cloud infrastructure to UX design standards, while independent product teams staffed with hybrid business and technology knowledge workers to build solutions upon the platform. The no-code / low-code tech notwithstanding (these tend to yield more organizational sclerosis and less sustainable innovation, but that’s a post for another day), this is a destination state many of us in the tech industry have advocated for years.

So why not model legacy enterprise IT this way?

Why not? Because enterprise IT isn’t the problem. I wrote above that enterprise IT is an imperfect mirror of its host organization. However, the converse is not also true: the host business is not an imperfect mirror of its enterprise IT function. In the same way, enterprise IT is a reflection of an enterprise problem; the enterprise problem is not a reflection of an IT problem.

Companies large and small have been reducing equity financing in favor of debt for over a decade-and-a-half now. A company with a highly-leveraged capital structure runs operations to maximize cash flow. That makes the debt easily serviceable (high debt rating == low coupon), which, in turn, creates cash that can be returned to equity holders in the form of buybacks and dividends. Maximizing cash flows from operations is not the goal of an organization designed for continuous learning, one that moves quickly, makes mistakes quickly, and adapts quickly. Maximizing cash flow is the goal of an organization designed for highly efficient, repetitive execution.

The "product operating model" of comingled business and tech knowledge workers requires devolved authority. Devolved authority is contrary to the decades-long corporate trend of increased monitoring and centralized control to create predictability, and consolidated ownership to concentrate returns. Devolved decision-making is anathema to just about every large corporate.

Framing this as an “IT phenomenon” is the tail wagging the dog. As I wrote above, enterprise IT is an imperfect reflection of its host organization. Enterprise IT is a matrix-within-a-matrix, with some parts roughly aligned with business functions (teams that support specific P&Ls, others that support business shared services such as marketing), while other IT teams are themselves shared services across the enterprise (in effect, shared services across shared services). Leading enterprise change through the IT organization is futile. Even if you can overcome the IT headwinds - staffing lowest-cost commodity labor rather than sourcing highest-value capability, utility and differentiating tech under the same hierarchy - you still have to overcome the business headwinds of heavy-handed corporate cultures ("we never making mistakes"); studying mistakes and errors for market signals indicating change rather than repressing them as exceptions to be repressed; and capital structures that stifle rather than finance innovation. Changing IT is not inherently a spark of change for its host business, if for no other reason than no matter how much arm waving IT does, IT in the contemporary enterprise is a tax on the business, a commitment of cash flows that the CEO would prefer not to have to make.

To portray enterprise IT as an anachronism is accurate, if not a brilliant or unique insight. To portray enterprise IT as the root of the problem is naive.

Sunday, October 31, 2021

Is the Tech Cycle More Important than the Fed Cycle?

In 2014, Andy Kessler wrote an intriguing op-ed in the WSJ, positing that beginning in the last half of the 20th century, the tech cycle had replaced the Fed cycle as the engine responsible for economic growth.

His argument went like this. Historically, the economy ran in 4 year cycles. Initially, cheap capital stimulated business investment and employment, which spurred spending, but increased spending eventually brought inflation. Inflation meant prices of goods rose and eventually tempered demand; lower demand meant inventories climbed, causing companies to slow the rate of production. Lower production forced companies to lay off workers, while the Fed raised interest rates to tame inflation which culled business investment. As inventories depleted and inflation abated, the cycle started all over again. Many interpreted this as the Fed cycle of interest rate adjustments. As it was once said, the Fed brings the punchbowl to the party before the guests arrive, and takes it away once the party heats up.

Seven years ago, Mr. Kessler pointed out that economic cycles are much longer today than they once were and attributed this to the tech cycle. His basic argument was that each new generation of tech - in his narrative (a) mainframes, (b) personal computers, (c) early internet, (d) mobile / cloud - had a greater influence on the longevity and vitality of economic performance than anything that the Fed did. The technology enabled changes in business models that made them less susceptible to traditional forces. His case study was that supply chain integration meant less inventory buildup, which meant less volatility, and subsequently longer cycles.

It’s a very intriguing proposition. I’ve wrestled with this from a few different perspectives. Yes, undoubtedly, new generations of tech have changed business models, making companies less vulnerable to the broader business (and subsequently capital) cycle. Technology has also increased worker productivity, which reduces labor intensity, which means less labor volatility when things slow down. Yet at the same time, quite a few tech firms have shown themselves to be vulnerable to the business cycle. To wit: the Fed cycle matters a great deal to tech firms dependent on benign credit conditions. Tech has no special immunity that way.

The traditional economist in me has two problems with Mr. Kessler’s argument. First, the “tech disruptor” mantra ignores financial orthodoxy - not to mention the over-abundance of other would-be disruptors - at its peril. It tends to be a self-referential argument that “tech is disruptive and is therefore ascendent.” Which is true, until the tech in question runs out of money or ends up in a bizarre stasis where a bunch of tech disruptors with overvalued equity deadlocked in internecine warfare, each simply waiting for all the others to run out of cash before they do. Second, long wave theory tends to read like narrative fallacity, something that Nassim Taleb specifically warned about. Nikolai Kondratiev was clearly onto something, but how much of a long-wave cycle is cherry-picking data points to fit a narrative rather than the data itself exposing the narrative?

That said, capital makes itself irrelevant when it is so cheap and so abundant for so long, as it has been for decades now. The traditional economist in me is an idiot for clinging to a set of parameters that have made themselves irrelevant to a broader set of trends.

That’s a long preamble to say that Mr. Kessler’s 2014 argument has contemporary relevance in light of economic performance during the COVID-19 pandemic.

The Federal Reserve’s response to the pandemic in 2020 was to apply the playbook it developed in response to the 2008 financial crisis: (a) expand the balance sheet through bond buying (this Fed page is representative of the period, look at the second and third columns); and (b) increase the money supply. Theoretically, cheap capital would mean that businesses and consumers would have no reason not to invest and spend.

But those businesses and consumers couldn’t invest or spend if they didn’t have the means of investing or spending. Traditional ways of working were analog, requiring people to conduct business in person. Fortunately, the technologies had long existed for commercial activity to continue despite people being unable to leave their homes. The existence of those technologies wasn’t just serendipitous: the fact that productivity tools enabling a remote, geographically distributed labor force to work collaboratively existed at all fits Mr. Kessler’s point that the tech cycle had far greater influence on economic performance during the pandemic than anything the Fed did. While some sectors of the economy did fall off a cliff (e.g., air travel, hospitality), most carried on. And despite the fact that the pandemic has been going on for nearly 21 months now, S&P 500 earnings are very strong. Without the technology the entire economy would have fallen off a cliff no matter how much money the Fed printed.

The pandemic also exposed winners and losers. Not created, exposed. Pre-pandemic, the tide in customer interaction, whether B2C or B2B, was already moving toward digital channels. The companies caught without viable digital channels were losers during the pandemic. The justification for digital channel development during the pandemic - and true right up to today - has less to do with beating the hurdle rate for investing capital, and more to do with simply staying in business. Sure, the decision to invest is easier to make when interest rates are meaningless, but it isn’t interest rates that make the investment in digital channels compelling. Survival makes them compelling.

The concern today - October of 2021 - is whether or not the Fed cycle has finally become inflationary. I write “finally” because Fed policy targets 2% personal consumption expenditure inflation, and PCE inflation has by and large fallen short of that target since 2008. In recent months, inflation has not only topped that 2% target but run a few laps round it. In the traditional Fed cycle, the measured policy response would be to raise interest rates, which will cool economic activity and bring an end to the cycle.

But how will this play out?

Let’s look at the drivers. Inflation, twined with a labor participation rate plumbing depths not seen since the early 1970s, is creating pressure for real wage increases. After decades of losing, labor is having a moment (link to blog). Unionized workforces are on strike. Amazon may have to increase warehouse labor comp.

Historically, the Fed response would be to increase interest rates aggressively to tame inflation. Yet markets are still pricing the Fed funds rate to rise only to about 1.20% by 2026. That might seem a huge jump from the 0.06% the Fed funds rate stands at today, but by historical standards 1.18% is ridiculously cheap capital, not the kind of rate that discourages spending. That means markets expect capital to be cheap (and therefore abundant) for the foreseeable future.

As labor costs rise, companies will look for ways to increase labor productivity so they can reduce labor intensity of operations. Labor productivity comes from increased tech density. Drones, robots, distributed ledger technology, vehicle electrification, and many more technologies will be the drivers of that labor productivity. If capital is cheap, the hurdle rate is low for productivity-enhancing investments. And even if the Fed upped interest rates much higher to tame inflation, corporate balance sheets are awash in cash. A lot of companies simply don’t need to raise capital to finance new investments.

Inflation may persist into 2022, and even beyond. But Mr. Kessler got it right in 2014: it won’t be the Fed that determines how the economy performs in this cycle, it will be tech.