Ich Bin Ein Berliner

Bad Economics
Before returning to Chicago, I took a short trip to Berlin. Quite the contrast from Paris. The latter is the most northern of Mediterranean cities, with glitz, espresso, and scooters. Everybody wears black. Berlin, in contrast, has a Northern European flavor, offering open space, bicycles bicycles bicycles, and bio-organic food. 

My favorite hour in Berlin was my visit to the small DDR Museum, which documents the former country of East Germany. It's not only a visually arresting, fun exhibit, as well as a memory trip for those who remember the days before Justin Bieber, but it's also fabulously instructive. Sometimes, one learns best about success by examining failures. And as failures go, East Germany was quite spectacular.

As West Germany flourished, remaking itself into a global manufacturing powerhouse, East Germany sank into economic ruin. It was trapped in a vicious cycle, wherein it needed to spend money to purchase raw materials for its manufacturing-based economy but could not generate enough income from its exports to pay for those raw materials. It built goods, all right, but nobody would pay good money for them. The country's exports were so shoddily built, and so outdated, that they could only be sold at very lower prices. East Germany was a bottom feeder. The country was so desperate for outside cash that it exported cobblestones.

The museum makes clear why East Germany flopped. 

A primary reason, of course, is that free markets collectively make sounder decisions than do top-down planners. East Germany's tight central controls cut off the flow of information that comes from the exercise of free markets, leading planners to make poor allocation decisions--from supply chains and labor to the volume of production and pricing. Adam Smith, yes. Karl Marx, no.

That is the answer that we all know. However, there was more to East Germany's demise than solely the problem of top-down planning. 

One was the country's approach to education. East Germany invested little into higher education, as the government believed that practical, vocational training was sufficient for the vast majority of workers. Few would need the specialized knowledge and skill that came from attending university. Making matters worse, at the lower levels of education, primary and secondary schools, the emphasis was rote learning. Critical thinking and creative classwork were actively discouraged. The result of these policies was a drone workforce that was capable of following simple orders and executing basic tasks, but little more.

Reinforcing the skepticism about advanced knowledge were the country's pay scales. A chemical researcher made roughly the same monthly salary as a manual laborer. The former needed several years of university education to do his job; the latter needed to have graduated eighth grade. Not only was the supply chain for education limited but also was the demand.

The shortage of trained thinkers was exacerbated by a national culture that rewarded conformity and penalized individualism. From early childhood, children in East Germany were taught by state organizations about the importance of obedience, of not questioning authority. 

As adults, they learned to keep their heads down, so as not to attract the attention of the nation's pervasive internal security system. By the time of East Germany's demise, at least 2.5% of the country's adults worked as informants for Stasi, the internal security police. (Some argue that the true figure is much higher, as the Stasi records are incomplete and, quite naturally, informants who were not identified did not step forward to acknowledge their participation.) It was a culture of paranoia.

As potential enemies of the state, artists were strictly controlled. Rock musicians were expected to sing only in German. If they did, they received prominent play time on East German radio, which was given a quota of homegrown music that it was required to play. (Rather like the old days of wire-house mutual funds, wherein the brokers were instructed to place at least 50% of their mutual fund sales with in-house funds.) Theater, film, and television production was monitored and the content restricted.

The result was a product that not only could not be exported--the East German government never did realize that, like manufactured goods, intellectual property could also be sold for cash--but that also did not serve the internal market. East Germans, in particular East Berliners who had easy access to West Berlin's radio and television broadcasts, refused the in-house products and opted instead for Western artists. This preference for things Western held true for clothing as well, as a pair of Levi's sold for 25% of the average monthly salary in East Germany.

The country's multiple failures all came together in its national car, the Trabi, displayed at the museum. (Visitors can open the door and seat themselves.) East Germany's national car did have the advantages of being cheap, easy to operate, easy to repair, and able to haul a high cargo load for its size. Thus, the Trabi wasn't a complete joke when it was launched in 1957. But it did not change. Ever. By 1991, it was essentially the same car as in 1957, still featuring a two-stroke engine that delivered 26 horsepower. What once was vaguely competitive had become completely, utterly noncompetitive.

The DDR Museum illustrates the conditions necessary for innovation. Innovation benefits from a high level of national education; critical thinkers; a culture that permits experimentation, questioning, and nonconformity; and a system that rewards those who do innovate with success. East Germany had none of those features. As a result, it was powerless to change the Trabi. East Germany, like its national car, was doomed to slide into extinction.

Naked Economics
One amusing--and visually arresting--sidelight of the museum is the story of East Germany's Baltic summer vacations. The East German government did provide well for its citizens in certain respects, among them the construction of cheap block housing for the homeless, abundant daily bread, and summer vacations. Under East Germany rule, millions of city dwellers who never before could afford to travel to the Baltic Sea for vacation were able to do so for the first time. The government underwrote much of the trip's costs.

However, few people owned bathing suits. Bathing suits were something of a luxury item. And East Germans could afford few luxury items. So, when the vacations took place, many people had no bathing suits. They did without. When the government signaled its disapproval but also signaled that it didn't view the matter as critical (that is, an item would appear in a Stasi file), that was all that the populace needed to hear. It could thumb its nose at the government in a form of symbolic protest, while saving money.

It's all there at the museum, in dozens of pictures and a video. The Berlin sixth graders on a school field trip scampered past that section with barely a glance or giggle. The reaction would be different among U.S. schoolchildren, I should think.

Mea Culpa 1
I, too, have an opportunity to learn from failure. In Friday's column, I overstated the all-in annual expenses for Altegris Futures Evolution Strategy (EVOIX). My calculation seemed straightforward, and, as I was on the road, I did not double-check. It turned out that the fund recently altered how it accounts for its expenses, and I got caught out on the change. (The gory details are covered in that column's correction.) 

My apology, Altegris. Your fund is most certainly not cheap but also most certainly not as expensive as I portrayed.

Note to self: Don't do that again. 

Mea Culpa 2
I made a more amusing error in 1988, when hedge fund manager Stan Druckenmiller left the Dreyfus organization. Druckenmiller had run several mutual funds for Dreyfus. He was replaced by a woman named Fiona Biggs. Shortly after Biggs assumed control of the funds, she made several big trades. When I interviewed her, she discussed other upcoming changes.

I therefore wrote in an analysis to one of her new funds, "This is now Biggs' fund, not Druckenmiller's. This fund in the future will bear no relationship to this fund in the past."

Biggs, it turned out, was (and is) Druckenmiller's wife. Oops.

Mea Culpa 3?
Veteran writer and editorial board member Dorothy Rabinowitz made a howler on Saturday. She mocked author Malcolm Gladwell for relying on analysis from LeBron James. The Mr. James cited by Gladwell, however, was not LeBron, but rather baseball analyst--and Boston Red Sox employee--Bill James. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.