Category Archives: Economics

More Cost-Plus Contracting Thoughts

In comments at the previous post on this subject, Karl Hallowell comments:

It’s not government’s job to suck up risk for a contractor. As I see it, if contractors really were giving their best cost estimates, then they’re regularly overestimate prices not consistently underestimate them.

The other commenters who seem to think that designing a brand new UAV, or the first successful hit to kill missile (SRHIT/ERINT/PAC-3, not the dead end HOE), or an autonomous helicopter (all things I’ve been heavily involved with) is something that can and should be done on a fixed-price contract (after all, one bridge is like any other, right?) . . . it can maybe be done, but only if you’re willing to let system development take a lot longer.

I don’t know who posted this, but it’s unrealistic.

Let’s give an example of how the real world works in salvaging ships on the high seas:

Salvage work has long been viewed as a form of legal piracy. The insurers of a disabled ship with valuable cargo will offer from 10 to 70 percent of the value of the ship and its cargo to anyone who can save it. If the salvage effort fails, they don’t pay a dime. It’s a risky business: As ships have gotten bigger and cargo more valuable, the expertise and resources required to mount a salvage effort have steadily increased. When a job went bad in 2004, Titan ended up with little more than the ship’s bell as a souvenir. Around the company’s headquarters in Fort Lauderdale, Florida, it’s known as the $11.6 million bell.

Exactly the scenario where it is claimed that fixed price contracts can’t work. Huge risk, lots of uncertainty, time pressure. A similar example is oil well firefighters. As I see it, there’s almost no circumstances when government needs to help the contractor with risk. The money, paid when the job is done right, does that. If it’s not enough, then nobody takes the contract. Simple as that.

Yes. The reason that cost-plus contracts are preferred by government is that government, by its nature, has an aversion to profit. It’s the same sort of economic ignorance that drives things like idiotic “anti-gouging” laws, and it results in the same false economy for the citizens and taxpayers.

The problem isn’t that companies are unwilling to bid fixed price on high-tech ventures. The problem is that, in order to do so, they have to build enough profit into the bid to make it worth the risk. But the government views any profit over the standard one in cost-plus contracts (generally less than ten percent) as “obscene,” and to allow a company to make more profit than that from a taxpayer-funded project is a “ripoff.” So instead, they cap the profit, and reimburse costs, while also having to put into place an onerous oversight process, in terms of cost accounting and periodic customer reviews, that dramatically increases cost to the taxpayer, probably far beyond what they would be if they simply let it out fixed price and ignored the profit. I would argue that instead of the current model of cost-plus, lowest bidder, an acceptance of bid based on the technical merits of the proposal, history and quality of the bidding team, even if the bid cost is higher, will ultimately result in lower costs to the government (and taxpayer).

As I understand it, this is the battle that XCOR (hardly a risk-averse company, at least from a business standpoint) has been waging with NASA for years. XCOR wants to bid fixed price, and accept the risk (and the profits if they can hit their internal cost targets), while NASA wants them to be a cost-plus contractor, with all of the attendant increases in costs, and changes in corporate culture implied by that status.

This is the debate that will have to occur if John McCain wants to make any headway in his stated desire Friday night to get rid of cost-plus contracts. Unfortunately, he’s not in a very good philosophical position to argue his case, because he’s one of those economic simpletons in Washington who think that making money is ignoble, and that profits are evil, particularly when they’re so high as to be “obscene.”

Gas Lines

I keep hearing about shortages and lines in the south. The last time we had gas lines on any major scale was in the seventies, when oil prices were kept artificially low by federal fiat. Is that what’s happening here? Are the “anti-gouging” laws keeping prices too low, and discouraging new supply? For instance, if you can’t get any more for it in North Carolina than you can in Ohio, where’s the incentive to spend the money to ship it in from there?

Can anyone in the areas where the lines are tell me?

The Real History Of America

A very interesting essay by Roderick Long:

There’s a popular historical legend that goes like this: Once upon a time (for this is how stories of this kind should begin), back in the 19th century, the United States economy was almost completely unregulated and laissez-faire. But then there arose a movement to subject business to regulatory restraint in the interests of workers and consumers, a movement that culminated in the presidencies of Wilson and the two Roosevelts.

This story comes in both left-wing and right-wing versions, depending on whether the government is seen as heroically rescuing the poor and weak from the rapacious clutches of unrestrained corporate power, or as unfairly imposing burdensome socialistic fetters on peaceful and productive enterprise. But both versions agree on the central narrative: a century of laissez-faire, followed by a flurry of anti-business legislation.

Every part of this story is false.

Observant libertarians have long noted that in general, captains of industry are not capitalists (or to use Jonah Goldberg’s (via whom I found his link) more accurate phrase, “free-market economists”–“capitalism” is a Marxist term), and never have been.

Four Questions

Newt Gingrich says not so fast to Paulson’s bailout plan. I particularly agree with this:

Four reform steps will have capital flowing with no government bureaucracy and no taxpayer burden.

First, suspend the mark-to-market rule which is insanely driving companies to unnecessary bankruptcy. If short selling can be suspended on 799 stocks (an arbitrary number and a warning of the rule by bureaucrats which is coming under the Paulson plan), the mark-to-market rule can be suspended for six months and then replaced with a more accurate three year rolling average mark-to-market.

Second, repeal Sarbanes-Oxley. It failed with Freddy Mac. It failed with Fannie Mae. It failed with Bear Stearns. It failed with Lehman Brothers. It failed with AIG. It is crippling our entrepreneurial economy. I spent three days this week in Silicon Valley. Everyone agreed Sarbanes-Oxley was crippling the economy. One firm told me they would bring more than 20 companies public in the next year if the law was repealed. Its Sarbanes-Oxley’s $3 million per startup annual accounting fee that is keeping these companies private.

Third, match our competitors in China and Singapore by going to a zero capital gains tax. Private capital will flood into Wall Street with zero capital gains and it will come at no cost to the taxpayer. Even if you believe in a static analytical model in which lower capital gains taxes mean lower revenues for the Treasury, a zero capital gains tax costs much less than the Paulson plan. And if you believe in a historic model (as I do), a zero capital gains tax would lead to a dramatic increase in federal revenue through a larger, more competitive and more prosperous economy.

Fourth, immediately pass an “all of the above” energy plan designed to bring home $500 billion of the $700 billion a year we are sending overseas. With that much energy income the American economy would boom and government revenues would grow.

Also, SOX was the disastrous result of the last time Congress decided that it had to “do something.”

“Welcome To History”

Jim Manzi has a good, albeit depressing, description of the financial crisis and its likely outcomes.

[Saturday morning update]

One bit in the piece that I found amusing (and a little depressing):

[They] Promulgated a temporary ban on naked shortselling for about 800 financial stocks (in related news, the new recommended medical practice when you discover that you have a fever is to smash the thermometer against the wall, since this makes the problem go away).

Yes, I don’t think this was necessary, and it will probably have bad consequences.

The Pixel Race

I’ve long thought that the resolution of most digital cameras has reached the point at which it’s overkill, and there are a lot of other improvements that the camera needs. Unfortunately, the marketing people at Canon don’t agree:

Canon engineers are being held back from developing new sensor technology by marketing departments in a “race for megapixels”, claims an employee of the Japanese photography company.

The employee told Tech Digest that Canon have the technology to “blow the competition away” in terms of image sensors, but are instead being asked to focus on headline figures like the number of megapixels a camera has. When asked for his opinion on the Canon EOS 5D Mark II, which we covered this morning, the employee said:

“I am hugely disappointed because once again Canon engineers are dictated by their marketing department and had to keep up with the megapixel race. They have the technology to blow the competition away by adapting the new 50D sensor tech in a full frame format and just easing off a little on the megapixels. Although no formal testing has been done on the new model yet, judging by the spec and technology used, it just seems to be as good or as bad as the competition – not beating them by a mile (which we used to).”

I’d rather have more speed and better S/N ratio myself.

There’s an amusing discussion of this, and the perennial war between marketing and engineering, including examples from Dilbert, over at Free Republic.

No Free Marketeer

That’s what John McCain is. One of the reasons it’s hard to get enthused about him. I suspect that Palin might be a little better.

[Update a while later]

Both presidential candidates are completely economically incoherent.

No surprise, since they’re both economic ignorami. Though in Obama’s case it’s worse, because he thinks that he understands economics, and much of what he knows for damned sure is wrong.