27 May 2017

How Real Estate Has Distorted Trump's View of Economics

There is never just one economy. One person experiences the pain of a shrinking industry and another the exhilaration of a rapidly expanding one. "The economy" is an abstraction that no one person experiences and affects us each differently. One person can be happily working and getting rich and literally walk by another person on his way to work, a person who is homeless and miserable. We could probably use a million categories to describe the many and varied experiences individuals have of the global economy. We all piece together our picture of how the economy works with incomplete data. If you're Donald Trump - a man who eschews abstractions, models and data - that individual experience becomes the basis for a worldview, his single data point becoming the source of his confidence that he understands the economy.  He does not.

The guy who makes his money in real estate lives in a different economy from the guy who makes his money creating new technology or building a company. Here's the trick, though. Real estate is only worth more today than it was 50 years ago because there are more people bidding for it and those people make more money. Why do they make more money? Because folks have figured out how to create new technologies and new industries. If technologies and businesses hadn't evolved in the last half century, real estate wouldn't have gone up much in value. The value of real estate depends on the value of work in that area that produces new technologies, products, and companies. Real estate far away from where people are working to create value is worth far less. In Menlo Park - the heart of Silicon Valley - the median home price is nearly $2 million; the median home price in Kansas is $125,000, about 1/15th of the price in Silicon Valley. The real estate in Menlo Park is worth more because that community is more adept at wealth creation not because the land is better for crops.

How do you make money in real estate? You bid more for the property at the corner of 5th and Broadway than the other guy. And then you hold onto it. If you own that property, no one else does. And to be fair, you add value by developing the right kind of property. You create apartments or offices that command a premium - or at least a competitive - price. Negotiations matter at every turn. If you pay 6% interest on the loan to finance this property you might make no profit; if you can negotiate a deal for a loan at 3%, you might make millions in profit. Getting tenants to pay $3,500 in rent instead of $3,000 could make the difference between having enough capital in five years to buy more real estate, to expand your empire, and just paying down debt on the property you own. In real estate, you face a series of win-lose negotiations that result in either you or the other guy getting the property, you or the tenant pocketing an extra $500 a month or the banker taking all your profit or just half.  Posturing, bluffing, negotiating and cajoling are keys to success in this world.

How do you make money in the creation of companies, technologies, and products? (What I'll just call the entrepreneurial economy.) You humble yourself before reality. People don't bluff their way into interfaces that users find addictive, that compel them to spend hours with your app. You can't bluff a chip fresh from fab into revealing its bugs. You have to problem-solve, test, challenge beliefs and collect data. And how do you create a new market? You reach out to customers to listen and to potential partners who have some special skill set or knowledge you need. This entrepreneurial world is full of win-win negotiations. If you capture the market, your suppliers and partners win; if you lose the market, your suppliers and partners lose. Nobody creates something new alone. Menlo Park is full of immigrants who have been drawn from all around the world in the search for the best employees, partners, and entrepreneurs able to create what is next. You need to collaborate with the best regardless of their eye color or accent.

Real estate rewards bluffing. Tech development punishes it. If you lie your way into financing or a partnership in developing something new and can't deliver, what you've talked your way into is worthless. Do that more than once and your reputation will also be worthless. By contrast, if you lie your way into a great deal on a loan or a property, you win. It's still yours at the end of the negotiation. Generally speaking, negotiations around the creation of something new just give you permission to collaborate in creating something valuable. Negotiations around the purchase of real estate gives you what is valuable.

The entrepreneurial economy requires that you loosely hold beliefs, continually willing to challenge them with new ideas, possibilities and data. To discover what is newly true before anyone else could mean creating a new industry and billions in wealth. In this world, you're rewarded for challenging your beliefs.

Of course your employees realize this; you don't hire the best employees in Silicon Valley without offering them equity in your company. Again, to win means embracing a win-win mindset. You either bring along others or you don't move forward; billionaire Mark Cuban claims to have created more than 300 millionaires in the process of creating his wealth. It's rare that you hear the story of a successful entrepreneur who has not made others rich in the process.

Trump has made his wealth through real estate, which rewards zero-sum thinking and behavior in ways that the entrepreneurial economy does not. One of the many problems with this is that it is the entrepreneurial economy that is going to create jobs and wealth for the next generation. The zero-sum portion of the economy is just going to follow the success of the entrepreneurial portion of our economy.

Trump wants to put up walls because he believes that value is something you protect, like a moat around a castle. It's not. At least not in the entrepreneurial economy. Value comes out of creating connections and expanding networks of suppliers, customers, and technologies. (Think of the millions of technologies, apps, and supplier and retail networks that have built up around the iPhone, for instance.) Walls that isolate sections of this network destroy value rather than create it in the same way that sectioning off portions of your brain would destroy it. Breaking down walls - not erecting them - creates value.

Had Trump made his billions in tech rather than real estate, his beliefs about the economy would be much different. (Or even if he read books or listened to others who had been in this other economy.)  One of the many problems with his economy is that only one person (or organization) can own the property at the corner of Fifth and Broadway. It inherently accepts scarcity and the notion that there are elites and then the rest. By contrast, the entrepreneur realizes there are always more problems to solve, more value to create; his making billions from the creation and sale of a smart phone actually means that you can now make billions from creating and selling an app. The entrepreneur sees opportunities for progress in every direction.

One of the most important concepts behind the entrepreneurial economy is the concept of variable sum, the notion that how we cooperate or compete will change the total value we have to share. In a zero-sum economy, the land has value regardless of our actions. If I get that land or you get it, that land's value is the same. What differs is how much of that value I got. In a variable-sum economy, the product I'm creating might sell hundreds of units a year or hundreds of millions of units; how we work together can make the difference between whether that market is worth billions or thousands. Your behavior and approach will be wildly different depending on whether you see the economy or market as variable sum or zero-sum.

All indications are that Trump sees the economy as zero-sum. He is going to stop Germans from selling so many cars and the Chinese from making so many of our products and he's going to make sure that jobs stay in America. He says nothing that indicates an awareness of how China and Germany and Africa and the US can jointly become more prosperous through trade, through a blend of competition and cooperation, mutual investment and development. He's determined to be the guy who owns the skyscraper at the corner of Broadway and Fifth once the negotiations are over.  (And this is just one reason that despots like Putin, Erdogan and the Saudis so appeal to him. This is their world and worldview.) He's not trying to create; he's trying to conquer.  His is a medieval mind in a modern world. The more success he has in walling off this economy and treating it like a zero-sum game, the less prosperous this economy will be.

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