Macro Roundup

"... Honolulu... planners proposed an ambitious rail transit line that would sweep riders 20 miles into downtown. The $4 billion estimate in 2006 was hardly cheap, amounting to $200 million per mile. The launch dates slipped forward and the cost estimates crept upward — at latest count, $11.4 billion, with a target completion date of 2031..... When California voters approved a bond in 2008 for a high-speed rail system from Los Angeles to San Francisco, the project was supposed to cost $33 billion and be completed by 2020. The job is now projected to finish in 2033 for $100 billion, though those estimates are dated..... Lengthy delays have also affected New York’s East Side Access extension of the Long Island Rail Road. That project was supposed to be completed by 2011. Early estimates put the cost at $2.2 billion, then $4.3 billion in 2006 and $6.4 billion in 2008. The Metropolitan Transportation Authority now envisions completion in December 2022 at a cost of $11.1 billion....At the former Hanford nuclear weapons site in Washington State, the Energy Department announced a 17-year delay and estimated the system would become fully operational in 2036.The last cost estimate for the plant was $17 billion, up from $12.3 billion in 2013 and about $4 billion 20 years ago.... tribulations are far from a lone cautionary tale. To the contrary, they signal the kind of cost overruns, engineering challenges and political obstacles that have made it all but impossible to complete a major, multibillion-dollar infrastructure project in the United States on budget and on schedule....Bent Flyvbjerg, a professor at the University of Oxford who has studied scores of projects around the world, found that 92 percent of them overran their original cost and schedule estimates, often by large margins — in part, he said, because cost estimates are “systematically and significantly deceptive.”...Setbacks that resulted in delays... plague nearly all major infrastructure projects; the common mistake is in not planning and budgeting for them, said Joseph Schofer, a Northwestern University civil engineer and originator of the “Infrastructure Show” podcast. "We haven’t gotten honest estimates in a lot of cases.”... In a candid admission of how the political world operates, Willie Brown, the former mayor of San Francisco, once dismissed cost overruns on a transportation hub intended for the bullet train.....“In the world of civic projects, the first budget is really just a down payment,” he wrote in a guest newspaper column in 2013. “If people knew the real cost from the start, nothing would ever be approved. The idea is to get going. Start digging a hole and make it so big there’s no alternative to coming up with the money to fill it in.”..."

Ralph Vartabedian, "Years of Delays, Billions in Overruns: The Dismal History of Big Infrastructure,"New York Times, November 28, 2021, https://www.nytimes.com/2021/11/28/us/infrastructure-megaprojects.html

Years of Delays, Billions in Overruns: The Dismal History of Big Infrastructure

As Honolulu sprawled into new suburbs west of Pearl Harbor over the last two decades, city planners proposed an ambitious rail transit line that would sweep riders 20 miles into downtown. The $4 billion estimate in 2006 was hardly cheap, amounting to $200 million per mile.

The cost escalation since then has been an engineering marvel all its own. Concerns over Native Hawaiian burial grounds stalled early construction, then problems with welding and cracks in the tracks appeared. Earlier this year, engineers realized that in some sections, the wheels were a half-inch narrower than the rails. Order new wheels? Tear up the tracks?

The launch dates slipped forward and the cost estimates crept upward — at latest count, $11.4 billion, with a target completion date of 2031.

Honolulu’s tribulations are far from a lone cautionary tale. To the contrary, they signal the kind of cost overruns, engineering challenges and political obstacles that have made it all but impossible to complete a major, multibillion-dollar infrastructure project in the United States on budget and on schedule over the past decade.

As the nation sets out on a national spending spree fueled by the $1.2 trillion infrastructure bill signed by President Biden this month, the job ahead carries enormous risks that the projects will face the same kind of cost, schedule and technical problems that have hobbled ambitious efforts from New York to Seattle, delaying benefits to the public and driving up the price tag that taxpayers ultimately will bear.

American cities and states were long renowned for some of the greatest bridges, water systems and freeways in the world, but challenges have grown more potent. Agencies have less internal technical talent. Legal challenges have grown stronger under state and federal environmental laws. And spending on infrastructure as a fraction of the economy has shrunk, giving local agencies less experience in modern practices.

The $1.2 trillion package has bold goals, directing the majority of $500 billion to highways, $39 billion to urban transit, $65 billion to broadband projects and $73 billion to electrical grids, among other items. The nation’s busiest passenger rail line, Amtrak’s Boston-to-Washington corridor, would get the biggest slice of a $66 billion rail package. The infrastructure spending plan is unlikely to rescue some existing infrastructure projects that are bogged down with problems.

And even with the new infusion of money, analysts say it will be tough to ramp up infrastructure progress as swiftly as envisioned in the current timetable.

The construction industry is facing sharply growing costs for steel products, up by 142 percent in the last 12 months, and other key materials. Shortages of skilled labor are worsening, exacerbated by Covid-induced retirements.

“A lot of people would like to see the money quickly spent,” said Anirban Basu, chief economist of Associated Builders and Contractors, a construction industry trade group. “They are going to look at the costs they are facing and extend out the projects because of constraints.”

Bent Flyvbjerg, a professor at the University of Oxford who has studied scores of projects around the world, found that 92 percent of them overran their original cost and schedule estimates, often by large margins — in part, he said, because cost estimates are “systematically and significantly deceptive.”

“A lot of projects are not delivering what they promised to deliver,” he said.

In Baltimore this month, Mr. Biden lamented that U.S. infrastructure was once rated the world’s best and now, “You know what we rank in infrastructure? Thirteenth in the world.”

In some cases, U.S. construction costs are higher than those in Western Europe and democratic nations in Asia, according to an upcoming University of California, Berkeley, analysis, said Ethan Elkind, a law professor and director of the school’s climate program.

“It is a lot harder to build projects here, and we are not as skilled at doing it,” he said.

When California voters approved a bond in 2008 for a high-speed rail system from Los Angeles to San Francisco, the project was supposed to cost $33 billion and be completed by 2020. The job is now projected to finish in 2033 for $100 billion, though those estimates are dated and there is an $80 billion funding gap.

The ambitious project, the nation’s most serious effort to build a full-scale bullet train, has encountered serious delays because of land acquisition issues, environmental litigation, permit setbacks, employee turnover and significant design changes. The problems have triggered political infighting even with the Democratic supermajority in California.

Lengthy delays have also affected New York’s East Side Access extension of the Long Island Rail Road, which is supposed to cut up to 40 minutes off commuter time on the last segment, from Queens to Grand Central Terminal, with up to 24 trains per hour at peak times.

Conceived more than a half century ago, with a construction contract awarded in 2006, that project was supposed to be completed by 2011. Early estimates put the cost at $2.2 billion, then $4.3 billion in 2006 and $6.4 billion in 2008. The Metropolitan Transportation Authority now envisions completion in December 2022 at a cost of $11.1 billion. Design changes, underground tunneling problems and coordination with other agencies were some of the factors in the delays and cost increases.

One of the nation’s most important environmental infrastructure projects, and perhaps the most technically difficult one, has been underway in Central Washington State for decades at the former Hanford nuclear weapons site. Since 2013, major construction has been stopped at two partially built plants to treat and vitrify 56 million gallons of radioactive sludge.

When an independent review in 2015 found 362 significant design problems, the Energy Department announced a 17-year delay and estimated the system would become fully operational in 2036.

The problems included the failure to anticipate the potential for an earthquake to damage equipment and the possibility that the chemical processes to separate high-level radioactive materials could cause explosive hydrogen gas to form.

The delays have pushed the Energy Department to adopt an alternative that would start treating low-level waste by the end of 2023, Washington State officials said. The last cost estimate for the plant was $17 billion, up from $12.3 billion in 2013 and about $4 billion 20 years ago.

The rail project in Hawaii was intended to relieve congestion on a par with Los Angeles along the urban band from East Kapolei to the core of Honolulu.

The Honolulu Authority for Rapid Transportation believes it can address the latest track problems by welding certain sections of track and later replacing wheels to match the track size, said a spokesman, Harry Cho.

The setbacks that resulted in delays — archaeological surveys, labor costs, utility relocations and land acquisition — are the kind of challenges that plague nearly all major infrastructure projects; the common mistake is in not planning and budgeting for them, said Joseph Schofer, a Northwestern University civil engineer and originator of the “Infrastructure Show” podcast.

“You can’t say these were an accident,” he said of most cost overruns. “We could do better. We haven’t gotten honest estimates in a lot of cases.”

Mr. Schofer said many projects are justified by estimating that future benefits will exceed costs, but when the costs go up astronomically, no one recalculates the ratio.

In a candid admission of how the political world operates, Willie Brown, the former mayor of San Francisco, once dismissed cost overruns on a transportation hub intended for the bullet train.

“In the world of civic projects, the first budget is really just a down payment,” he wrote in a guest newspaper column in 2013. “If people knew the real cost from the start, nothing would ever be approved. The idea is to get going. Start digging a hole and make it so big there’s no alternative to coming up with the money to fill it in.”

U.S. Transportation Department officials declined to comment for this article, but Biden administration officials have said the new infrastructure package will redress decades of neglect and will boost the efficiency of the American economy, address climate change and provide immediate jobs in construction.

“We’re going to reduce congestion,” Mr. Biden said. “We’re going to address repair and maintenance backlogs, deploy state-of-the-art technologies and make our ports cleaner and more efficient.”

Mr. Flyvbjerg, the Oxford professor, said infrastructure keeps getting more expensive at a time when many products, such as televisions, refrigerators and computers, get cheaper or better each year.

“Big infrastructure is becoming cost prohibitive,” he said, a problem he blames on institutional sclerosis at government agencies that keep repeating mistakes and choose infrastructure projects that are unlikely to succeed.

The mistakes, he said, include a lack of transparency to the public, flawed contracts that put government agencies at the mercy of contractors and a failure to attract enough private investment to bear some of the project’s risk.

The new infrastructure law, he said, does little to change the outlook.

Ronald N. Tutor, chief executive of Tutor Perini, a California firm that is building some of the nation’s largest projects, said the industry has done a good job of advancing and completing projects that by their nature are complex and unpredictable.

“All the major projects have cost and schedule issues,” he acknowledged. “The truth is these are very high-risk and difficult projects. Conditions change. It is impossible to estimate it accurately. That is naïve.”

The infrastructure law takes some initial steps at reforms, including codifying a Trump executive order to name a lead federal agency for each project, reducing the number of chefs in the kitchen, said Diana Furchtgott-Roth, who formerly oversaw Transportation Department research and technology and now is a George Washington University adjunct professor.

A key factor is the amount of time federal agencies spend to review environmental reports and issue records of decision, she said. In many cases, she said, projects are put on hold for years, while agencies review voluminous documents.

Mr. Biden also named a task force to carry out the infrastructure program with an aim to “invest public dollars efficiently, avoid waste and focus on measurable outcomes for the American people.”

The environmental review process has become so complex, in part to defend against inevitable lawsuits, that neither state agencies nor federal departments can write and review the documents without teams of outside consultants.

Most of the spending under the $1.2 trillion infrastructure plan has been previously authorized, but the law includes $550 billion of new money to be spent in as little as five years.

Federal, state and local agencies were working their way through $270 billion a year in authorized spending in 2019, before the pandemic hit. An attempt to bump that up by an additional $100 billion annually, as envisioned, represents a 37 percent jump that may not be possible to achieve, industry analysts warn.

“It is a very big bump,” said Ken Simonson, chief economist at Associated General Contractors of America, which represents major infrastructure builders. “My guess is that we are not going to see $550 billion spent in the first five years.”

“… Global venture investment—which ranges from early “seed” funding for target firms that have not yet developed a product to funding for more established startups—is on track to hit an all-time high of $580bn this year, according to PitchBook, a data provider. That is nearly 50% more than was invested in 2020, and about 20 times that in 2002 (see chart)….The type of investor piling into venture activity has changed just as dramatically. It was once the preserve of niche venture-capital firms run in Silicon Valley…So far this year, however, only three of the ten biggest venture investors by assets under management have been traditional VC firms. Instead, deals led or solely struck by private-equity shops, hedge funds and others that used to conduct little venture activity are on track to nearly double from $144bn in 2020 to $260bn this year. That accounts for a staggering 44% of global VC activity, up from 20% in 2002. “Crossover” funds like Tiger Global Management, which straddle public and private markets, are deploying capital at a breakneck pace. Behemoth pension funds are increasingly directly investing in startups…. Although VC-backed companies represent less than 0.5% of American companies created every year, they make up nearly 76% of the total public-market capitalisation of companies started since 1995…Why, then, is the model being disrupted? The frenzy reflects both the entrance of competitor funds and greater interest from end-investors. That in turn reflects the fall in interest rates across the rich world, which has pushed investors into riskier but higher-return markets. It has no doubt helped that venture capital was the highest-performing asset class globally over the past three years, and has performed on a par with bull runs in private equity and public stocks over the past decade. End-investors who previously avoided VC are now getting involved. In addition to alluring returns, picking out the best-performing funds may be easier for VC than for other types of investment: good venture performance tends to be more persistent, according to a paper in the Journal of Financial Economics published last year. The success of big tech, much of which was backed by VC dollars, may have been another attraction. Investors may have previously underestimated the revenue-earning potential of the industry, says Fred Giuffrida of Horsley Bridge, a fund that invests in VC funds. They may now be correcting for this. The rush of capital has pushed up company valuations. Seed-stage valuations today are close to where series A valuations (of companies that are typically already generating revenue) were a decade ago. The average seed valuation for an American startup in 2021 is $3.3m, more than five times the level in 2010….Stellar returns for investors, then, may not be assured. But the broader question is whether the innovation that is taking place is worth the risk. “If too much stuff gets funded, that’s generally good. It’s much better than nobody funding Moderna,” says Mr Horowitz. And capital can drive new ideas, not just the other way around. Investors have typically been willing to bet on riskier but more innovative startups during past venture booms, finds a study by Ramana Nanda of Imperial College, London and Matthew Rhodes-Kropf of MIT Sloan School of Management. Resilience, a capital-intensive drugmaker founded last year, has raised $800m and already bought several factories. This would not have been possible even two years ago, says Drew Oetting of 8VC. Venture activity in the space sector grew by 70% globally to $7.7bn in 2020. “There are more moonshots”, reckons Mr Lerner of Harvard…. In tech the result could be more vibrant competition. The big-tech firms used to gobble up challengers: acquisitions by Amazon, Apple, Facebook, Google and Microsoft rose after 2000 and hit a peak of 74 in 2014. But they have fallen since, to around 60 a year in 2019 and 2020, perhaps owing to a fear of antitrust enforcement. More startups are making it to public markets. Listings, rather than acquisitions or sales, now account for about 20% of “exits” by a startup, compared with about 5% five years ago….”

The bright new age of venture capital

Young companies everywhere were preparing for doomsday in March 2020. Sequoia Capital, a large venture-capital (vc) firm, warned of Armageddon; others predicted a “Great Unwinding”. Airbnb and other startups trimmed their workforces in expectation of an economic bloodbath. Yet within months the gloom had lifted and a historic boom had begun. America unleashed huge stimulus; the dominance of tech firms increased as locked-down consumers spent even more of their time online. Many companies, including Airbnb, took advantage of the bullish mood by listing on the stockmarket. The market capitalisation of American vc-backed firms that went public last year amounted to a record $200bn; it is on course to reach $500bn in 2021.

With their pockets full, investors are looking to bet on a new generation of firms. Global venture investment—which ranges from early “seed” funding for firms that are only just getting going to funding for more mature startups—is on track to hit an all-time high of $580bn this year, according to PitchBook, a data provider. That is nearly 50% more than was invested in 2020, and about 20 times that in 2002.

The type of investor piling into venture activity has changed just as dramatically. It was once the preserve of niche venture-capital firms run in Silicon Valley. These raised funds from and invested on behalf of pension funds and other end-investors, often relying on their vast networks of connections with company founders. Now, however, only three of the ten biggest venture investors by assets under management are traditional vc firms.

Instead, deals led or solely struck by private-equity shops, hedge funds and others that used to conduct little venture activity are on track to nearly double from $144bn in 2020 to $260bn this year (see chart 1). That accounts for a staggering 44% of global vc activity, up from 20% in 2002. “Crossover” funds like Tiger Global Management, which straddle public and private markets, are deploying capital at a breakneck pace. Behemoth pension funds are increasingly directly investing in startups.

The flood of money from deep-pocketed investors has helped swell valuations. But it is also flowing to once-neglected corners and new opportunities. Venture activity now extends well beyond Silicon Valley and America more broadly, and is financing enterprises working on everything from blockchains to biotech.

The wave of capital is also transforming how vc works. vc firms are adopting new strategies as they seek to differentiate themselves in some respects, and to mimic their Wall Street competitors in others. That comes with both benefits and drawbacks for the business of innovation.

The modern venture-capital industry sprouted from a laboratory at Fairchild Semiconductor, a Silicon Valley chipmaker, in the 1960s. Arthur Rock, the first to leave Fairchild for investing, raised $5m in his first fund and returned $100m over seven years. Eugene Kleiner and Don Valentine soon followed, setting up Kleiner Perkins and Sequoia respectively. Both are still large vc firms today.

The approach was to back risky startups in the hope that the big successes, like Google, would carry an entire portfolio. Seed investments were often made before a startup earned any revenue. Then came an alphabet soup of successive funding rounds, typically ranging from series a to c, as a company matured. The vcs’ funds were closed-ended, meaning they distributed returns to investors, usually pension funds, endowments and other long-term-oriented investors, within seven to ten years, after taking a cut of their own.

Veni, vidi, vc

The venture capitalists did not just provide finance. They also played consiglieri, often taking a seat on a company’s board. They offered a wealth of experience and access to a network of contacts, introducing startups to professional chief executives, for instance. Entrepreneurs flocked to Sand Hill Road, the home of many Silicon Valley vc firms, in the hope of being funded. The industry’s reliance on personal connections made it rather like an old boys’ club.

The model proved astoundingly successful. Although vc-backed companies represent less than 0.5% of American companies created every year, they make up nearly 76% of the total public-market capitalisation of companies started since 1995. Over time vcs increasingly bet on slightly older “late-stage” startups (which, for their part, delayed going public). Some vc firms opened offices abroad. Andreessen Horowitz, also based on Sand Hill Road, was founded in 2009 and rose towards the top.

Why, then, is the model being disrupted? The frenzy is a result of both the entrance of new competitors and greater interest from end-investors. That in turn reflects the fall in interest rates across the rich world, which has pushed investors into riskier but higher-return markets. It has no doubt helped that vc was the highest-performing asset class globally over the past three years, and has performed on a par with bull runs in private equity and public stocks over the past decade.

End-investors who previously avoided vc are now getting involved. In addition to alluring returns, picking out the star funds may be easier for vc than for other types of investment: good performance tends to be more persistent, according to research in the Journal of Financial Economics published last year. The success of big tech, much of which was backed by vc dollars, may have been another attraction. Investors may have previously underestimated the earning potential of the tech industry, says Fred Giuffrida of Horsley Bridge, a fund that invests in vc funds. They may now be correcting for this.

The rush of capital has pushed up prices. Seed-stage valuations today are close to where series a valuations (of older companies that may already be generating revenue) were a decade ago. The average seed valuation for an American startup in 2021 is $3.3m, more than five times what it was in 2010 (see chart 2).

But funding is also reaching new terrain. In 2002 84% of venture activity, in terms of value, took place in America. That share is now about 49%. China’s share grew from below 5% in the 2000s to 37% in 2018, before its tech crackdown brought it down to nearer 20%. Capital has instead sought greener pastures in Europe (see Business section). Keith Rabois of Founders Fund, a vc firm, argues that, if done right, investing in less heated sectors can help produce attractive venture returns.

Software startups continue to be popular with venture capitalists. But “you’re seeing a broadening of who gets funded,” says Josh Lerner of Harvard Business School. Riskier biotechnology, crypto and space ideas are being backed. Moderna, a pharmaceutical company that produces covid-19 vaccines, was spun out of Flagship Pioneering, a vc firm. Green tech, which saw a boom and bust in the 2000s, is resurgent. pwc, a consultancy, estimates that between 2013 and 2019 climate-tech venture deals grew at five times the rate of overall startup funding.

For many old-school venture capitalists, this new competitive world is unsettling. “We need to react,” acknowledges Roelof Botha of Sequoia. Though rising valuations bolster returns on current portfolios, they dry up future returns. Crossover funds are less price-sensitive than traditional vcs. And for later-stage startups, investors’ money is more fungible, says Mr Giuffrida. It matters less who is investing than how much they are willing to pay. Furthermore, the market for orthodox vc firms is becoming tougher. Despite the venture boom, fundraising by new niche vcs in America has fallen from a peak of $14bn in 2018 to an expected $5.5bn in 2021.

One part of the traditional firms’ response is differentiation. Many crossover investors tend to take a data-driven approach, building portfolios of startups that resemble an index of top performers in each sector. They eschew playing large roles in their portfolio companies. To contrast with this, some vcs are emphasising their personal touch. Crossover funds “are transactional capital. We are relationship capital,” says one early-stage investor.

One fund in Austin, Texas, 8vc, is expanding its startup “incubator”, which currently nurtures and spins out five or so companies a year. Slow Ventures, another vc firm, is even investing directly in the career paths of individuals, such as online-content creators, who may not yet run a proper business. Without a compelling offering, says Ben Horowitz, co-founder of Andreessen, vcs either need to be willing to overpay or close up shop altogether.

Another response is to scale up. Some angel investors, who invest their own money without a team or firm, are spreading their wings and evolving into solo venture capitalists, who invest external funds. They can move fast—there are no other partners to convince before doing a deal. Elad Gil, a prominent solo vc, made around 20 investments in the first half of 2021 and is raising a $620m fund, an astonishing sum for an individual investor.

The biggest and best-known vc firms are also expanding. Andreessen has grown its investment team from about 25 to 70 in the past four years. It offers companies support on everything from diversity and inclusion policy to a vast network of potential hires and customers.

The line between vc and other investors is also blurring further, and not just because Wall Street is encroaching onto Sand Hill Road. Big vc firms are becoming more like other asset managers, too. Sequoia is expanding its presence in public markets. In October it said that its American and European venture funds will sit within a larger, timeless fund. When portfolio firms go public, their shares will flow to the superfund instead of to end-investors. This allows Sequoia to capture returns even after an ipo. Crossover funds like Tiger already seamlessly transfer holdings from their private to public funds. Other large vc firms may follow suit.

Sequoia’s superfund mirrors Wall Street’s fascination with permanent capital. “Many of the dynamics in private-equity markets are now spilling over into venture markets,” says Mr Lerner. vcs and private-equity funds used to raise money from investors every few years, which can be costly and prevent them holding on to investments. Leading buy-out firms like Blackstone and kkr found ways around this. Nearly a third of kkr’s assets under management are now permanent.

Sequoia is also becoming a registered investment adviser, joining Andreessen and other large funds, like SoftBank. That allows it to hold more “secondary” shares—stakes that are not bought directly from the issuing company. (vcs’ secondary holdings are usually capped at 20% of their portfolios.) Andreessen’s status as an adviser allowed it to launch a $2.2bn crypto fund in June that mainly invests in digital tokens, rather than startups.

The biggest funds are best placed to benefit from the new world. Funding from a top vc firm sends a signal of a startup’s quality, argues Mike Volpi of Index Ventures. And because non-traditional investors often rely on such signals to guide their dollars, their value has only risen. The result is that the industry has become more unequal: although the average American vc’s assets under management rose from $220m in 2007 to $280m in 2020, that is skewed by a few big hitters. The median, which is less influenced by such outliers, fell from $70m to $48m. But this is not to say that the industry has become dominated by a few star funds. Market shares are still small. Tiger Global, for instance, led or co-led investments worldwide worth $5bn in 2020, just 1.3% of total venture funding. Startups have diverse enough needs so there is plenty of scope for a variety of vc firms to exist, reckons Mr Volpi.

Company founders, for their part, have gained bargaining power as investors compete. “There’s never been a better time to be an entrepreneur,” says Ali Partovi of Neo, a vc firm based in San Francisco. Ten years ago, most new founders had not heard of a term-sheet, a document describing the terms and conditions of an investment, says one venture capitalist. Now, many startups work with “accelerators” like y Combinator to learn the basics. Cloud computing and other software-as-a-service (SaaS) tools allow some firms to expand without much capital investment.

The time taken to strike a deal has shrunk from several weeks to days, if not hours. Zoom has changed the nature of fundraising. Biodock, a microscopy startup, had ten calls with vcs scheduled in a day, which gave it more power in negotiations, reckons Michael Lee, its founder. Founders receive “refreshes”, top-ups of equity during fundraising rounds. To get ahead of the rush, some investors are offering companies cash even before they start looking for more funding.

The shift in power away from investors is welcome in some respects. The outsized returns of vc firms will be competed down. Moreover, tech is no longer terrain that only well-connected venture capitalists in Silicon Valley can make sense of. The performance of SaaS firms, for instance, can be assessed using data on users’ behaviour. The relationship between founder and venture capitalist might matter less than it used to, particularly as the startup grows.

But there are costs, too. Shortened deals can lead to fomo (fear of missing out) for investors and, sometimes, worse investment decisions, says Mr Partovi. The shift has also weakened governance. As the balance of power tilts away from them, vcs get fewer board seats and shares are structured so that founders retain voting power. Founders who make poor chief executives—such as Travis Kalanick, the former boss of Uber, a ride-hailing firm—can hang on for longer than they should. The relationship between vc firms and a founder lasts about ten years, longer than many marriages, notes Mr Partovi. You wouldn’t choose your spouse in a hurry.

Another risk is that the market is too frothy. Some investors point to bumper profits for tech companies and the financial health of even the youngest startups as reasons for being optimistic about valuations. But “companies are being priced on the assumption that everyone will win. Statistically that won’t happen,” says Mr Giuffrida of Horsley Bridge.

Stellar returns for investors, then, are not assured. But the broader question is whether the innovation that is taking place is worth the risk. “If too much stuff gets funded, that’s generally good. It’s much better than nobody funding Moderna,” says Mr Horowitz. And capital can drive new ideas, not just the other way around. Investors have typically been willing to bet on riskier but more innovative startups during past venture booms, finds a study by Ramana Nanda of Imperial College London and Matthew Rhodes-Kropf of mit Sloan School of Management. Resilience, a capital-intensive drugmaker founded last year, has raised $800m and already bought several factories. This would not have been possible even two years ago, says Drew Oetting of 8vc. Venture activity in the space sector grew by 70% globally to $7.7bn in 2020. “There are more moonshots,” reckons Mr Lerner of Harvard.

In tech the result could be more vibrant competition. The big-tech firms used to gobble up challengers: acquisitions by Amazon, Apple, Facebook, Google and Microsoft rose after 2000 and hit a peak of 74 in 2014. But they have fallen since, to around 60 a year in 2019 and 2020, perhaps owing to a fear of antitrust enforcement (see United States section). More startups are making it to public markets. Listings, rather than acquisitions or sales, now account for about 20% of “exits” by a startup, compared with about 5% five years ago.

Wherever valuations go, it looks like the changes to the structure of vc will last. Outsized returns in early-stage investing were bound to be bid down eventually. As vc firms themselves are forced to innovate, a broader range of ideas is being backed in a wider variety of places. The pandemic was not the disaster that venture capitalists had first expected. It has nevertheless transformed what they do.

Economist Staff, “The bright new age of venture capital,”The Economist, November 27, 2021, https://www.economist.com/finance-and-economics/2021/11/23/the-bright-new-age-of-venture-capital/21806438

"...But Europe never recovered its appetite for high-growth business creation. In the past three decades, America has spawned four behemoths—Google, Amazon, Tesla and Facebook, now known as Meta—whose valuations have topped $1trn. (Meta’s has since fallen back below this threshold.) Not one of Europe’s corporate youths, meanwhile, has risen as high as $100bn. One champion of the 2000s, Skype, was in 2011 bought for $8.5bn by Microsoft. The other, Spotify, is today worth only $48bn. SAP, the closest thing the continent has to a tech giant, was founded three years before Microsoft and is worth less than a fifteenth of it....A new influx of capital is proof of an altered mood. Ten years ago, European firms grabbed less than a tenth of all venture capital (VC) money invested globally, though the European Union’s share of global GDP was a little over a fifth. This year has seen dealmaking volumes soar in many regions, but particularly in Europe, which now attracts around 18% of global VC funding, according to Dealroom, a data provider (see chart 1).All the cash has pumped up the value of European startups. The continent now boasts 65 “unicorn cities”, or those which have produced a privately-held startup worth more than $1bn. That is more than any other region. The continent’s previous paucity of funding was not for lack of returns. Measured by total value (cash returned to investors plus current portfolio value) as a multiple of capital risked, the average European VC fund founded in the past two decades has not fared materially worse than the average American one (see chart 2)...Two big questions hover over Europe’s entrepreneurial renaissance. The first is the extent to which the capital being poured into it is simply spillover from the liquidity that has flooded markets since the onset of the pandemic...Another important question is whether the boom results in Europe building its own, American-style tech behemoths, or simply a cluster of middling firms that are gobbled up by larger, possibly non-European acquirers...."

Economist Staff, "Tech investors can’t get enough of Europe’s fizzing startup scene,"The Economist, November 27, 2021, https://www.economist.com/business/tech-investors-cant-get-enough-of-europes-fizzing-startup-scene/21806435

Tech investors can’t get enough of Europe’s fizzing startup scene

The idea of a Europe hostile to entrepreneurs would once have seemed laughable. At its 17th-century peak the Dutch East India Company’s appetite for capital was so voracious that it demanded the invention of the public stockmarket. Investors then did not balk at its violent treatment of native peoples. The turn of the 20th century saw the founding of giants like L’Oréal, today’s highest-earning beauty empire, and Denmark’s ap Moller Maersk, the largest container-shipping line. Most of Germany’s Mittelstand firms, employers of more than half of all the country’s workers, were born at the same time.

That a continent shattered by two world wars produced far fewer businesses destined for high growth in the second half of the 20th century is perhaps unsurprising. But Europe never recovered its appetite for high-growth business creation. In the past three decades, America has spawned four behemoths—Google, Amazon, Tesla and Facebook, now known as Meta—whose valuations have topped $1trn. Not one of Europe’s corporate youths, meanwhile, has risen as high as $100bn. One champion of the 2000s, Skype, was in 2011 bought for $8.5bn by Microsoft. The other, Spotify, is today worth only $48bn. sap, the closest thing the continent has to a tech giant, was founded three years before Microsoft and is worth less than a fifteenth of it.

Yet change is in the air. Venture capitalists, who want to sniff out the next Google while it is still being run from the founders’ kitchen tables, are homing in on European startups. There are many more to choose from. European entrepreneurs who would once have gone west to start a business are now likely to start up at home rather than in Silicon Valley.

The continent’s previous paucity of funding was not for lack of returns. Measured by total value (cash returned to investors plus current portfolio value) as a multiple of capital risked, the average European vc fund founded in the past two decades has not fared materially worse than the average American one (see chart 2). Nevertheless, American venture capitalists thought of Europe as “a place to take their families on summer holiday not somewhere to start a business,” says Danny Rimer of Index Ventures, a vc firm headquartered in San Francisco and London.

Venture capitalists are chasing a generation of startups that has benefited from the trail blazed by their predecessors. The likes of Skype and Spotify may not have reached the dizzying valuations of their American peers, but they showed it was possible to start a successful tech company in Europe and scale it at speed, explains Michael Moritz of Sequoia. Now, says Mr Moritz, “it’s no longer frowned upon if you’re young and bright to leave university and join a tech company, or to drop out and found one.” They also provided startups with a pool of potential employees and board members with prior experience of fast-growing, innovative companies.

The combination of seasoned executives and access to experienced talent has fuelled the growth of a cluster of European firms founded after the ructions of the financial crisis that are now reaching maturity. More importantly, notes Hussein Kanji of Hoxton Ventures, another vc firm, they include companies starting to dominate their respective niches. The huge new category of social media was won by Facebook, he notes. “Now Spotify is the winner in music streaming, Klarna is the winner in buy-now-pay-later and UiPath is the winner in robotic process automation—they’re all European,” he says. With returns in the world of tech flowing disproportionately to the firms in first place, that makes Europe too attractive a prospect for global investors to ignore.

The boom extends far beyond a few of the largest companies. For Xavier Niel, a billionaire French tech founder-turned-investor, repeat founders in Europe are key. They are launching new waves of firms, he says, meaning “more entrepreneurs, more talent, more capital, more success, it’s a flywheel in progress”. Rachel Delacour sold her first business, bime Analytics, a business analytics platform, in 2015 for $45m, six years after co-founding it in Montpellier. She started Sweep, which helps companies track carbon emissions, last year. “Now that I’m starting this second business, I know right from the off that it can be a global story,” says Ms Delacour.

It also helps that Europeans working for startups are becoming owners. A Analysis by Index Ventures of 350 European startups found that 15-17% of firms on average is owned by employees. That is up from 10% five years ago, although still below the comparable figure of 20-23% for American startups. Workers’ willingness to be part-remunerated with stock options makes it easier for startups to compete with bigger firms for talent, says Mr Rimer.

Technological trends have also been driving costs down and enabling would-be founders to get their firms off the ground at home in Europe rather than leaving for California. Starting an internet business used to involve buying banks of servers and the space to store them. The advent of cloud computing means firms can instead rent processing power from hyperscale clouds like Amazon Web Services, and rent smaller offices. The pandemic has forced fund managers to accept doing due diligence and deals over Zoom. That lowers the importance of geographical proximity.

Two big questions hover over Europe’s entrepreneurial renaissance. The first is the extent to which the capital being poured into it is spillover from the liquidity that has flooded markets since the onset of the pandemic. Since then, the world’s four largest central banks have collectively pumped more than $9trn-worth of cash into the global financial system, driving down bond yields. That has sent investors into ever-riskier asset classes in pursuit of returns. Early-stage equity investment in a previously calcified continent is a prime candidate. As central banks dial back, the yields on safer assets will start to look less anaemic, putting Europe’s ample vc funding at risk.

Another question is whether the boom results in Europe building its own, American-style tech behemoths, or a cluster of middling firms that are gobbled up by larger, possibly non-European acquirers. That, in turn, will determine whether the continent’s entrepreneurial moment flares out or ignites something bigger. Governments have devised schemes to catalyse business creation for decades, but the answer turns out to be simple. “There is nothing that beats examples of success to inspire confidence in people,” says Mr Moritz. It is up to today’s European giants-in-waiting to decide how much inspiration to provide.

"...A growing number of private companies, including First Light, are now hoping to commercialise those years of public research by proving fusion power can work and connecting it to the grid as soon as the 2030s....“I couldn’t be more optimistic,” says Silicon Valley venture capitalist Sam Altman, who recently invested $375m in the US fusion start-up Helion. “In addition to being our best path out of the climate crisis, less expensive energy is transformational for society.”...a series of public and private sector breakthroughs in the past six months, some industry participants are far more hopeful. In China in May a machine known as East — the Experimental Advanced Superconducting Tokamak — managed to sustain a fusion reaction at 120m degrees Celsius for a record 101 seconds. Temperatures over 100m C generally required for magnetic confinement fusion had been attained before but never sustained for such a long time. Then in September a Boston-based start-up demonstrated the use of a high-temperature superconductor to generate a much stronger magnetic field than a traditional tokamak. The group, Commonwealth Fusion Systems, which grew out of the Massachusetts Institute of Technology, believes the discovery will enable it to make a more efficient fusion machine that will be smaller, cheaper and more viable as a commercial source of power....The US Department of Energy helped establish MIT’s Plasma Fusion Center — now the Plasma Science and Fusion Center — in 1976 in response to the oil crisis and rising prices. The Joint European Torus, which remains the world’s most advanced tokamak, was opened in Culham, a village south of Oxford, in 1984. Then in 1985 US president Ronald Reagan and Mikhail Gorbachev, his Soviet counterpart, agreed to co-operate on ITER — the International Thermonuclear Experimental Reactor — the world’s largest nuclear fusion project, to ease cold war tensions. Some experts believe ITER is still most likely to produce net energy first, but the project, a collaboration between 35 countries that remains under construction in France almost 40 years later at an estimated cost of more than $20bn, has become a byword for glacial progress.... In total, private fusion companies have raised $2.3bn in investment, according to the industry association. More than a fifth of that funding was raised just this month by Altman’s Helion, which uses yet another approach that it calls pulsed non-ignition fusion.It involves raising the temperature of the fuel to 100m C in a 40-foot-wide, six-foot-high dumbbell-shaped “plasma accelerator” to capture the energy as the reaction expands and pushes back on the system’s magnetic field. Mowry argues that the variety of approaches is one of the emerging sector’s strengths. “Private industry accepts more risk to go faster and cheaper,” he says. “That means that not all shots will go in but the world doesn’t need them all to go in.”..."

In 2050, the world will need 12 times more clean electricity than is produced today, he says, citing the work of climate author Solomon Goldstein-Rose. “Anything at all that we have which adds on top of the existing picture is a great thing,” Hawker says, “and we should be doing it at maximum speed.”

Hawker echoes that view. Existing renewable energy sources, particularly wind and solar power, can be scaled up to replace fossil fuels but will struggle to also meet forecast increases in power demand owing to the electrification of the global energy system and rising energy consumption in developing countries, he says.

Tom Wilson and Ian Bott, "Nuclear fusion: why the race to harness the power of the sun just sped up,"Financial Times, November 24, 2021, https://www.ft.com/content/33942ae7-75ff-4911-ab99-adc32545fe5c

Nuclear fusion: why the race to harness the power of the sun just sped up

A nervous excitement hangs in the air. Half a dozen scientists sit behind computer screens, flicking between panels as they make last-minute checks. “Go and make the gun dangerous,” one of them tells a technician, who slips into an adjacent chamber. A low beep sounds. “Ready,” says the person running the test. The control room falls silent. Then, boom.

Next door, 3kg of gunpowder has compressed 1,500 litres of hydrogen to 10,000 times atmospheric pressure, launching a projectile down the 9-metre barrel of a two-stage light gas gun at a speed of 6.5km per second, about 10 times faster than a bullet from a rifle.

On the monitors the scientists are checking the next stage, when the projectile slams into the target — a small transparent block carefully designed to amplify the force of the collision. The projectile needs to hit its mark perfectly flush. The slightest rotation risks derailing the carefully calibrated physics.

“Thank God,” exclaims one of the technicians, after reviewing a video playback of the impact of the scientific artillery. It was the perfect shot.

Those in the room at First Light Fusion, in a business park outside the English city of Oxford, had just witnessed another hopeful step in a 60-year mission to answer one of science’s most complex problems: how to harness the fusion reaction that powers the sun to generate clean, limitless electricity on Earth.

“Fusion is probably the greatest technical challenge humanity has ever taken on,” says Arthur Turrell, whose book The Star Builders charts the decades-long effort by engineers, physicists and mathematicians to achieve what some still believe is impossible. “How close it is depends not on time, but on the will, the investment and the commitment of resources to actually get there.”

A growing number of private companies, including First Light, are now hoping to commercialise those years of public research by proving fusion power can work and connecting it to the grid as soon as the 2030s.

Unlike nuclear fission when atoms are split, fusion does not produce significant radioactive waste and could never result in a nuclear accident, such as Chernobyl. The most efficient chemical inputs for fusion — deuterium and tritium — are also widely available.

Just one glass of the fuel created by the process has the energy potential of 1m gallons of oil and could generate, depending on the fusion approach, as much as 9m kilowatt hours of electricity, enough to power a home for more than 800 years, scientists estimate.

Those characteristics, its proponents say, mean fusion, by providing cheap, unlimited zero emissions electricity, could genuinely save the world.

“I couldn’t be more optimistic,” says Silicon Valley venture capitalist Sam Altman, who recently invested $375m in the US fusion start-up Helion. “In addition to being our best path out of the climate crisis, less expensive energy is transformational for society.”

Soviet physicists developed the first fusion machine in the 1950s using an approach known as magnetic confinement fusion. The tokamak — short in Russian for toroidal chamber with magnetic coils — enabled a plasma of deuterium and tritium, both hydrogen isotopes, to be held in place by powerful magnets and heated to temperatures hotter than the sun so that the atomic nuclei fuse, creating helium and releasing energy in the process.

The problem is that while scientists have become adept at fusing the two isotopes, the Soviet tokamak, and all other fusion systems developed since, require a vast amount of power. And in more than half a century of trying, no group has been able to generate more energy from a fusion reaction than the system consumes.

“When will we get electricity from fusion? Who the hell knows?” says Steven Krivit, a science writer who for 20 years has been a critical observer of fusion energy’s false starts. “Until we see somebody delivering electricity cost effectively we’re still doing science, we’re not doing technology.”

But after a series of public and private sector breakthroughs in the past six months, some industry participants are far more hopeful. In China in May a machine known as East — the Experimental Advanced Superconducting Tokamak — managed to sustain a fusion reaction at 120m degrees Celsius for a record 101 seconds. Temperatures over 100m C generally required for magnetic confinement fusion had been attained before but never sustained for such a long time.

Then in September a Boston-based start-up demonstrated the use of a high-temperature superconductor to generate a much stronger magnetic field than a traditional tokamak. The group, Commonwealth Fusion Systems, which grew out of the Massachusetts Institute of Technology, believes the discovery will enable it to make a more efficient fusion machine that will be smaller, cheaper and more viable as a commercial source of power.

Bob Mumgaard, CFS chief executive, compares the breakthrough with the evolution of computing. “Computers, back when they had vacuum tubes, took up whole rooms. Then when they had transistors you could make the computers smaller and, all of a sudden, people that weren’t doing computers could do computers,” he says.

“Fusion has so many really desirable attributes, if you think about what is required for the entire world to live in the way people deserve to live and to also have a liveable planet,” he says. The next step towards power production is the construction of a demonstration plant called Sparc, about half the size of a tennis court, which CFS hopes will achieve net energy by 2025 and then a commercial power station in the 2030s.

“We’re using known science, with new engineering and new materials,” says Francesca Ferrazza, a physicist at the Italian oil major Eni, which has collaborated with MIT since 2008 and is the largest outside investor in CFS. “The ambition would be to be a player in the field with a substantial presence in various parts of the value chain,” she says.

“Fusion is coming, faster than you expect,” says Andrew Holland, chief executive of the newly formed Fusion Industry Association, which counts the number of private businesses in the sector worldwide at 35 and growing.

Private participation in the sector is relatively new. In the second half of the 20th century fusion research was advanced by international public consortiums and the biggest projects in the world remain government-funded.

The US Department of Energy helped establish MIT’s Plasma Fusion Center — now the Plasma Science and Fusion Center — in 1976 in response to the oil crisis and rising prices. The Joint European Torus, which remains the world’s most advanced tokamak, was opened in Culham, a village south of Oxford, in 1984. Then in 1985 US president Ronald Reagan and Mikhail Gorbachev, his Soviet counterpart, agreed to co-operate on ITER — the International Thermonuclear Experimental Reactor — the world’s largest nuclear fusion project, to ease cold war tensions.

Some experts believe ITER is still most likely to produce net energy first, but the project, a collaboration between 35 countries that remains under construction in France almost 40 years later at an estimated cost of more than $20bn, has become a byword for glacial progress.

“None of the private fusion companies would be here today without the science that was developed in the ITER programme,” says Christofer Mowry, chief executive of Canada’s General Fusion. “But the cost and timeline for ITER should not be used as a point of reference for what it takes to develop and commercialise fusion energy.”

Mowry, who joined the Jeff Bezos-backed company in 2017, is certain it will be the private sector that makes fusion power a reality. He compares it to the role Elon Musk’s SpaceX has played in advancing the prospects of commercial access to space.

“SpaceX did not invent the science of rocketry. It took 50 years of research, sprinkled a little bit of these modern technologies and made a better, faster, cheaper Apollo,” he says, referring to the US space agency programme.

General Fusion’s approach, which it calls magnetised target fusion, is unusual in that it has been designed with a commercially viable power plant in mind, Mowry says. It uses an array of steam-powered pistons to rapidly compress the plasma to fusion conditions and a wall of liquid metal to absorb the heat from the reaction, which is then used to produce steam to drive a turbine generator. Construction on its first demonstration plant is scheduled to start next year, also at Culham, and be completed in 2025.

Mowry argues that the variety of approaches is one of the emerging sector’s strengths. “Private industry accepts more risk to go faster and cheaper,” he says. “That means that not all shots will go in but the world doesn’t need them all to go in.”

A tainted sector

At First Light in Oxford, the scientists’ hopes are pinned not on the gas gun — which is used to test the science but will not be part of the future power system — but on the target used to house the deuterium-tritium fuel and amplify the impact of the projectile.

First Light’s hypothesis, based on the theory of inertial confinement fusion, is that by firing a projectile at the target at speeds in excess of 20km a second — enough to travel from London to New York in 4 minutes — they can create enough energy to force the deuterium and tritium to fuse, vaporising the target, while generating the energy equivalent of burning 10 barrels of oil.

Founded by 36-year-old chief executive Nicholas Hawker and his former physics professor Yiannis Ventikos, First Light is cagey about the target’s composition and design, which the company keeps closely guarded. The replica at their headquarters — a clear cube, a little over a centimetre wide, enclosing two spherical capsules — looks like a prop from a superhero movie.

It is exactly this complexity, however, that makes claims difficult to verify and has tainted the sector.

In 1951, at the height of the cold war, Juan Perón, Argentina’s president, convinced the world his scientists had harnessed fusion power, generating global newspaper headlines. Fusion fuel would soon be available, like milk, he said, in half-litre bottles. Almost four decades later in 1989, two chemists at the University of Utah said they had been able to fuse nuclei at room temperature in a simple electrochemical cell on a lab bench, a claim that unravelled in weeks.

Such incidents continue to weigh on the industry. Krivit, the science writer, argues that until a group shows it can generate electricity from a fusion reaction, prospective investors should treat private companies’ claims with scepticism.

Yet progress is undoubtedly being made, including at the US government’s National Ignition Facility, where in August scientists used 192 lasers to generate a fusion reaction that appears to have come the closest yet to achieving net energy.

“It was the biggest breakthrough in fusion for literally decades,” says Turrell, adding that getting fusion energy on to the grid in 2030 is a “great ambition”.

“But if they get there in 2040 instead that is still going to be a huge win for the world,” he adds. “And even if they get there after 2050 and the world has reached net zero that will still be a massive win for humanity because we need a portfolio of energy sources.”

At that stage, Turrell says, fusion could be used to power energy-intensive carbon capture systems enabling the world to begin to reverse, rather than slow, some of the environmental damage brought by climate change.

Research from the Fed finds evidence of risk adverse savings flowing out of the PRC into the United States having a significant impact on real estate prices in impacted area“…We find evidence of an impact of foreign capital inflows on the evolution of house prices in major U.S. cities. The magnitude of the premium in price growth in China-exposed over non- exposed areas averages about 2 percent in the two years following each of the two episodes of China shocks in the last decade. Then, using local projections, we find that Chinese capital inflows to the United States explain the majority of the widening in price growth differentials after Chinese stress episodes. Overall, the evidence we present is consistent with U.S. residential real estate serving as a safe haven asset for foreign Chinese households….”

William Barcelona, Nathan Converse, and Anna Wong, "U.S. Housing as a Global Safe Asset: Evidence from China Shocks," Federal Reserve Board, November 2021, https://www.federalreserve.gov/econres/ifdp/us-housing-as-a-global-safe-asset-evidence-from-china-shocks.htm

Relationship Between Excess Price Gaps and Capital Infows from China

".... Figure 12 plots the relationship between deposit inflows from China and Hong Kong along with the evolution of the gap in house price growth between China-exposed ZIP codes and the matched controls.10 Recall that in Section 2 we presented evidence that funds brought to the U.S. via the banking system were being used for house purchases with a lag. The relationship between inflows and the estimated treatment effect also exhibits this behavior: the contemporaneous correlation is only 0.06, but rises to 0.36 with a three-quarter lag. This is why Figure 12 plots the treatment effect three quarters ahead. The degree of comovement between the two series is striking, and we see that peaks in capital infows from China and Hong Kong coincide with peaks in the treatment effect three quarters ahead. It is also notable that there was essentially no relationship between the two series prior to 2010, the year in which China liberalized some controls on capital outflows...”

The Effect of Chinese Demand on U.S. House Prices

"..The difference in the mean growth rates of the two distributions provides the average treatment effect on the treated (ATET) of exposure to foreign Chinese capital over the 6-year window. For treatment definition 1, the mean house prices over this period for the treatment grew 7 percent faster than for the control group, or 1.1 percent faster per year. For treatment definition 2, mean house price growth for the treatment group was 14 percent faster over the 6 year period, or 2.2 percent per year, compared to that of the control. Another way to visualize the cumulative impact is to look at the evolution of the house price index of the treatment and control group (Figure 9). Because of their differential growth rates, the house price level of the treatment group has diverged significantly from the control group in recent years. For the 20 cities included in the treatment definition 1, the divergence picked up after 2008, and for the 34 cities in the treatment group 2, the divergence picked up since 2010...."

Core of paper, "...Aggregate capital flows data from balance of payments (BOP) accounts offer additional clues to the size of foreign purchases of U.S. residential real estate. While the most recent IMF Balance of Payments Manual (BPM6) species that foreign purchases of residential real estate should be included in foreign direct investment, the U.S. and indeed many countries do not measure such flows. As a result, these flows are captured only in the residual statistical discrepancy line of the balance of payments, or as the difference between the U.S. measured current account deficit and the measured financial inflows from abroad that finance that deficit. When the measured current account deficit exceeds the recorded net financial inflows, a positive statistical discrepancy arises. In the U.S. case, the statistical discrepancy primarily reflect two missing assets: financial derivatives, and the object of interest for our study foreign purchases of U.S. residential real estate assets.Since 2008, the U.S. BOP statistical discrepancy experienced several episodes of turning positive, meaning that some U.S. capital inflows are not being captured in official statistics. In particular, since 2010 we note a striking increase in the comovement of private capital outfows from China and missing net capital in ows to the United States as captured by the statistical discrepancy line in the U.S. BOP. Figure 1 shows that the 12-quarter rolling correlation between the two variables went from being zero or negative to above 0.8 and remained elevated from 2012 to 2017. We next explore bilateral capital ows data between the U.S. and China at a more granular level...."

Specifically, “…house prices in major U.S. cities that are highly exposed to demand from China have on average grown 7 percentage points faster than similar neighborhoods with low exposure over the period 2010-2016….”

What this looks like in terms of an impact on American real estate, “.. , the estimates in Figure 13 imply that a one percentage point increase inflows generates an 0.008 percentage point widening in the gap in price growth between China-exposed and non-exposed areas in the U.S. This effect may seem small at first glance, but recall from Figure 12 above that inflows reached roughly $70 billion during periods of concern about a China hard landing in 2012 and 2015. Taking a concrete example, banking inflows from China were $10.1 billion in July of 2015 and $32.2 in August of that year. Our estimates imply this increase explains 90 percent of the widening gap in house price growth between China-exposed areas and those not exposed...."

Their bottom line, The results, shown in Table 1, further confirm that negative (positive) shocks from China are associated with an increase (decrease) in U.S. statistical discrepancy net inflows since 2010Q2, with a three quarter lag. The pre-2010 China shocks are not important in explaining the safe haven flows, as none of these Chinese variables are significant when interacted with the pre-2010Q2 dummy. The VIX, our measure of global financial conditions, is insignificant across all specifications,suggesting that unrecorded capital inflows to the U.S. are better explained by Chinese factors than by global financial conditions more generally. Strikingly, the regressions using Chinese capital outflows variables have substantial explanatory power: the R-square is 0.42 for the net foreign reserves sales regressions, and 0.28 for the regressions with Chinese money and deposit outflows. A back of the envelope calculation based on these results suggests that each $1 billion in net reserves sales by the Chinese authorities since 2010Q2 is associated with a $0.3 billion increase in unrecorded capital inflows to the United States; for each $1 billion in net money and deposit out flows from China, there is a $0.7 billion increase..."

Xavier Giroud, Simone Lenzu, Quinn Maingi and Holger Mueller report on their research (attached) that showed productivity spillovers diffuse through the economy though firms with dispersed geographic footprints, "....We first assess the effects of an increase in within-firm, across-location knowledge sharing on the distribution of economic activity. Intuitively, an increase in knowledge sharing between plants of multi-region (‘multi-county’, or MC) firms makes these plants more productive. Given a reduction in marginal costs, the plants increase labour demand, pushing up nominal wages (but not enough to offset the reduction in marginal costs). As a result, goods prices decline, which pushes up real wages. At the macroeconomic level, this influences the spatial distribution of economic activity. Surprisingly, knowledge sharing between plants widens economic disparities across regions. In relative terms, highly populous regions with high real GDP become richer, while rural regions with low real GDP become poorer (Figure 1, panel A).The fundamental economic force driving this result is the sorting across locations by multi-county plants. In equilibrium, counties with more multi-county plants experience relatively large average real wage increases, as well as labour inflows, while counties with fewer multi-county plants experience smaller average real wage increases and thus labour outflows. In our model economy, as well as in the data, 60% of all multi-county plants are in the 10% most populous counties (Figure 1, panel B). Hence, the productivity gains from an increase in knowledge sharing between plants are disproportionately concentrated in the richest, most populous counties....we examine the welfare implications of place-based policies in environments with and without knowledge sharing between plants. In each scenario, we simulate local productivity shocks - such as those arising from place-based policies - and measure the resulting changes in worker-level utility. While, on average, the welfare gains are much higher with knowledge sharing (64%), they are unevenly distributed. In particular, workers in other regions working for plants that are connected (through plant-level networks) to the region with the productivity shock experience utility gains that are five times larger than workers at non-connected plants. At the regional level, the welfare gains are disproportionately concentrated in highly populous regions, as those tend to have the most connected plants. Hence, knowledge sharing through plant-level networks leads to a highly uneven distribution of the welfare gains from local productivity shocks. These results complement the ones in Gaubert (2018a, 2018b), proving an additional explanation for why place-based policies may increase spatial disparities across regions....."

Xavier Giroud, Simone Lenzu, Quinn Maingi, Holger Mueller, "Propagation and amplification of local productivity spillovers," Center For Economic And Policy Research, December 1, 2021, https://voxeu.org/article/propagation-and-amplification-local-productivity-spillovers

Propagation and amplification of local productivity spillovers

Local governments spend billions of dollars every year on subsidies for companies to locate within their jurisdictions (Story 2012, Bartik 2020). From an efficiency standpoint, a common rationale for such place-based incentives is the existence of ‘Marshallian agglomeration economies’ - spillovers to the local economy in the form of input sharing, labour market pooling, and knowledge externalities - that raise the productivity of local workers and businesses (Moretti 2010, Kline and Moretti 2014, Neumark and Simpson 2015, Gaubert 2018a, 2018b). While the success of each individual place-based policy ultimately depends on how the policy affects the equilibrium balance of agglomeration and congestion forces (Redding and Esteban 2016), it is widely believed that productivity gains are highly localised and confined to the region in which the policy is implemented. In a recent paper (Giroud et al. 2021), we challenge this view, providing both reduced-form and model-based evidence showing that local productivity spillovers may propagate throughout the economy through the plant-level networks of multi-region firms.

Local versus global productivity spillovers

To identify local productivity spillovers, our empirical analysis builds on the natural experiments in Greenstone et al (2010), who study the effects of large plant openings (‘million dollar plants’, or MDPs) on the productivity of incumbent plants. In this setting, plants in ‘runner-up’ counties, which narrowly lost the competition to attract an MDP, provide a counterfactual for plants in the ‘winner’ county, where the plant was ultimately located.

Using confidential plant-level data from the US Census Bureau, we show that the MDP openings raise the productivity of incumbent plants by 4%. This local productivity spillover is strong within a 50-mile radius around the plant, weaker within a 100-mile radius, and insignificant beyond. Hence, and consistent with a large empirical literature, the productivity spillovers between (plants of) different firms decay rapidly with geographical distance.

A different picture emerges when one examines how productivity spillovers spread spatially within firm boundaries. We consider large multi-plant, multi-region firms which are exposed to the MDP openings (and thus to the local productivity spillover), by having a plant in the winner county. Comparing plants in the same county, industry, and year that belong to firms which either own plants in the winner county (‘treated plants’) or in the runner-up counties (control), our research finds that in response to the MDP openings, treated plants outside the winner county experience productivity gains of 1.8%, along with employment gains of 1.6%. Unlike the local productivity spillover, which takes place across plants of different firms, this global productivity spillover, which takes place across different plants of the same firm, does not decay with geographical distance. Indeed, the estimated global spillover effect remains virtually unchanged if we exclude all plants within a 500-mile radius, or within the same state or census division as the MDP in question.

In A survey article, Rosenthal and Strange (2020) write:

“Implicit in the idea that spatial concentration increases productivity is another idea: the degree of proximity matters. Agglomeration economies must decay with distance. How close, then, do firms and workers need to be to each other to benefit from agglomeration economies? Or more colloquially, how close is close?”

We provide a nuanced answer to this question. On the one hand, firms must have a nearby plant to benefit from local knowledge spillovers, as the local agglomeration economy is strongly significant only within a 50-mile radius around the MDP. On the other hand, not all of a firm’s plants need to be located nearby. In fact, it may suffice if only one of the firm’s plants is near the MDP. Once the knowledge spills over to that plant, it can be passed on to other plants inside the firm’s boundaries, increasing the productivity of distant plants hundreds of miles away.

Knowledge sharing across regions within firm boundaries

What explains the global productivity spillover? The evidence presented in our latest paper is consistent with knowledge sharing between plants of the same firm across different regions. While the local productivity spillover may be due to either labour market pooling or knowledge externalities, it is unlikely that a thicker labour market in the winner county would affect the productivity of treated plants hundreds of miles away. Knowledge, on the other hand, can be used in local and distant plants alike. Indeed, once it spills over to the firm’s local plant, it can be freely shared with other plants inside the firm’s boundaries (Markusen 1984). Consistent with this notion, the global productivity spillover does not decay with geographical distance. Further, and consistent with knowledge sharing, the global productivity spillover is much stronger if the distant plant and either the MDP or the firm’s plant in the winner county are in the same industry or in knowledge-based industries characterised by mutual R&D flows or patent citations.

Does knowledge sharing between plants reduce regional disparities?

While the reduced-form evidence points to sizeable spillover effects on distant regions, the importance of the significance of plant-level networks for regional and aggregate outcomes requires a meaningful quantitative framework. Since all plants in the economy are affected through general equilibrium effects (labour flows, goods trade), non-treated plants in distant counties provide an imperfect counterfactual to quantify the significance of knowledge sharing for the amplification of local productivity shocks. For example, as (manufacturing) goods are tradable, changes in goods prices affect real wages across all plants in the economy, including non-treated plants.

To quantify the significance of plant-level networks for the propagation and amplification of local productivity shocks, we develop and estimate a quantitative spatial model with goods trade, labour mobility, plant-level networks, and a rich geography - where plants of the same firm, across regions, are linked through shared knowledge. We estimate the model via indirect inference by exploiting the close link between structural parameters and reduced-form regression coefficients, and then use the structure of the model to undertake counterfactual analyses.

We first assess the effects of an increase in within-firm, across-location knowledge sharing on the distribution of economic activity. Intuitively, an increase in knowledge sharing between plants of multi-region (‘multi-county’, or MC) firms makes these plants more productive. Given a reduction in marginal costs, the plants increase labour demand, pushing up nominal wages (but not enough to offset the reduction in marginal costs). As a result, goods prices decline, which pushes up real wages. At the macroeconomic level, this influences the spatial distribution of economic activity. Surprisingly, knowledge sharing between plants widens economic disparities across regions. In relative terms, highly populous regions with high real GDP become richer, while rural regions with low real GDP become poorer (Figure 1, panel A).

In our second counterfactual, we examine the welfare implications of place-based policies in environments with and without knowledge sharing between plants. In each scenario, we simulate local productivity shocks - such as those arising from place-based policies - and measure the resulting changes in worker-level utility. While, on average, the welfare gains are much higher with knowledge sharing (64%), they are unevenly distributed. In particular, workers in other regions working for plants that are connected (through plant-level networks) to the region with the productivity shock experience utility gains that are five times larger than workers at non-connected plants. At the regional level, the welfare gains are disproportionately concentrated in highly populous regions, as those tend to have the most connected plants. Hence, knowledge sharing through plant-level networks leads to a highly uneven distribution of the welfare gains from local productivity shocks. These results complement the ones in Gaubert (2018a, 2018b), proving an additional explanation for why place-based policies may increase spatial disparities across regions.