Published: September 6 2011 17:27 | Last updated: September 6 2011 17:27
Switzerland’s reputation as a safe haven has long supported the country’s currency and Tuesday was not the first time that the central bank has tried to put a ceiling on the franc’s appreciation.
In October 1978 – a little more than five years after Switzerland abandoned its fixed exchange rate – the Swiss National Bank set a ceiling above which it would not allow the Swiss franc to rise against the Deutsche mark.
The central bank faced similar circumstances then as it does now. A rise in the Swiss franc had raised the chances of a recession and deflation. The SNB had intervened in the foreign exchange market but with little success. It had introduced levies on foreigners’ Swiss franc deposits – again to little avail. With interest rates already very low, the SNB regarded the ceiling as the only option left.
In one regard, the ceiling worked. The Swiss franc declined against both the Deutsche mark and the dollar. But inflation rose. In order to defend the ceiling the SNB had to buy foreign currency in exchange for Swiss francs. But the central bank was forced to buy foreign currency on such a grand scale that the amount of Swiss francs in circulation rose to a level that caused inflation to rise, eventually peaking at 7 per cent in 1981.
The SNB abandoned its fixed exchange rate in 1973 for similar reasons – inflation had surged to as high as 12 per cent in the early part of the decade. Throughout the 1970s, very loose US monetary policy – and high global inflation – not only pushed the Swiss franc higher but contributed to price pressures when the central bank tried to cap the currency’s gains.
More than 30 years later, monetary policy in the US – and across advanced economies – is equally loose. But, so far, central banks’ willingness to cut rates and increase the size of their balance sheets has not pushed inflation to the levels of the late 1970s. The SNB will hope Switzerland does not prove the exception.
After mistaken claims made ahead of the global crisis won much academic support, long-held assumptions were called into question – but the real world often remains overlooked or ignored
The reputation of economists, never high, has been a casualty of the global crisis. Ever since the world’s financial system teetered on the abyss following the collapse of Lehman Brothers three years ago next month, critics from Queen Elizabeth II downwards have posed one uncomfortable yet highly pertinent question: are economists of any use at all?
Some of this criticism is misconceived. Specific predictions of economic growth or levels of the stock market – gross domestic product will rise by 1.8 per cent; the FTSE 100 index will stand at 6,500 by year-end – assert knowledge that those making such predictions cannot have. Economic systems are typically dynamic and non-linear. This means that outcomes are likely to be very sensitive to small changes in the parameters that determine their evolution. These systems are also reflexive, in the sense that beliefs about what will happen influence what does happen.
If you ask why economists persist in making predictions despite these difficulties, the answer is that few do. Yet that still leaves a vocal minority who have responded cynically to the insatiable public demand for forecasts. Mostly they are employed in the financial sector – for their entertainment value rather than their advice.
Economists often make unrealistic assumptions but so do physicists, and for good reasons. Physicists will describe motion on frictionless plains or gravity in a world without air resistance. Not because anyone believes that the world is frictionless and airless, but because it is too difficult to study everything at once. A simplifying model eliminates confounding factors and focuses on a particular issue of interest. This is as legitimate a method in economics as in physics.
Since there are easy responses to these common criticisms of bad predictions and unrealistic assumptions, attacks on the profession are ignored by professional academic economists, who complain that the critics do not understand what economists really do. But if the critics did understand what economists really do, public criticism might be more severe yet.
Even if sharp predictions of individual economic outcomes are rarely possible, it should be possible to describe the general character of economic events, the ways in which these events are likely to develop, the broad nature of policy options and their consequences. It should be possible to call on a broad consensus on the interpretation of empirical data to support such analysis. This is very far from being the case.
The two branches of economics most relevant to the recent crisis are macroeconomics and financial economics. Macroeconomics deals with growth and business cycles. Its dominant paradigm is known as “dynamic stochastic general equilibrium” (thankfully abbreviated to DSGE) – a complex model structure that seeks to incorporate, in a single framework, time, risk and the need to take account of the behaviour of many different companies and households.
The study of financial markets revolves meanwhile around the “efficient market hypothesis” – that all available information is incorporated into market prices, so that these prices at all times reflect the best possible estimate of the underlying value of assets – and the “capital asset pricing model”. This latter notion asserts that what we see is the outcome of decisions made by a marketplace of rational players acting on the belief in efficient markets.
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A close relationship exists between these three theories. But the account of recent events given by proponents of these models was comprehensively false. They proclaimed stability where there was impending crisis, and market efficiency where there was gross asset mispricing.
Regulators such as Alan Greenspan, former chairman of the US Federal Reserve, asserted that the growth of trade in complex financial investments represented new and more effective tools of risk management that made the economy more stable. As late as 2007, the International Monetary Fund would justify its optimism about the macroeconomic outlook with the claim that “developments in the global financial system have played an important role, including the ability of the United States to generate assets with attractive liquidity and risk management features”.
These mistaken claims found substantial professional support. In his presidential lecture to the American Economic Association in 2003, Robert Lucas of the University of Chicago, the Nobel prizewinning doyen of modern macroeconomics, claimed that “macroeconomics has succeeded: its central problem of depression prevention has been solved”. Prof Lucas based his assertion on the institutional innovations noted by Mr Greenspan and the IMF authors, and the deeper theoretical insights that he and his colleagues claimed to have derived from models based on DSGE and the capital asset pricing model.
The serious criticism of modern macroeconomics is not that its practitioners did not anticipate that Lehman would fall apart on September 15 2008, but that they failed to understand the mechanisms that had put the global economy at grave risk.
Subsequent policy decisions have been pragmatic and owe little to any economic theory. The recent economic policy debate strikingly replays that after 1929. The central issue is budgetary austerity versus fiscal stimulus, and – as in the 1930s – the positions of the protagonists are entirely predictable from their political allegiances.
Why did the theories put forward to deal with these issues prove so misleading? The academic debate on austerity versus stimulus centres around a property observed in models based on the DSGE programme. If government engages in fiscal stimulus by spending more or by reducing taxes, people will recognise that such a policy means higher taxes or lower spending in the future. Even if they seem to be better off today, they will later be poorer, and by a similar amount. Anticipating this, they will cut back and government spending will crowd out private spending. This property – sometimes called Ricardian equivalence – implies that fiscal policy is ineffective as a means of responding to economic dislocation.
John Cochrane, Prof Lucas’s Chicago colleague, put forward this “policy ineffectiveness” thesis in a response to an attack by Paul Krugman, Nobel laureate economist, on the influence of the DSGE school. (In an essay in the New York Times Prof Krugman described comments from the Chicago economists as “the product of the Dark Age of macroeconomics in which hard-won knowledge has been forgotten”.) Prof Cochrane at once acknowledged that the assumptions that give rise to policy ineffectiveness “are, as usual, obviously not true”. For most, that might seem to be the end of the matter. But it is not. Prof Cochrane goes on to say that “if you want to understand the effects of government spending, you have to specify why the assumptions leading to Ricardian equivalence are false”.
That is a reasonable demand. But the underlying assumptions are plainly not true. No one, including Prof Cochrane himself, really believes that the whole population calibrates its long-term savings in line with forecasts of public debt and spending levels decades into the future.
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But Prof Cochrane will not give up so easily. “Economists”, he goes on, “have spent a generation tossing and turning the Ricardian equivalence theory, and assessing the likely effects of fiscal stimulus in its light, generalising the ‘ifs’ and figuring out the likely ‘therefores’. This is exactly the right way to do things.” The programme he describes modifies the core model in ways that make it more complex, but not necessarily more realistic, by introducing parameters to represent failures of the model assumptions that are frequently described as frictions, or “transactions costs”.
Why is this procedure “exactly the right way to do things”? There are at least two alternatives. You could build a different analogue economy. For example, Joseph Stiglitz – another Nobel laureate – and his followers favour a model that retains many of the Lucas assumptions but attaches great importance to imperfections of information. After all, Ricardian equivalence requires that households have a great deal of information about future budgetary options, or at least behave as if they did.
Another possibility is to assume that households respond mechanically to events according to specific behavioural rules, rather like rats in a maze – an approach often called agent-based modelling. Such models can – to quote Prof Lucas – also “be put on a computer and run”. It is not obvious whether the assumptions or conclusions of these models are more, or less, plausible than those of the kind of model favoured by Profs Lucas and Cochrane.
Another line of attack would discard altogether the idea that the economic world can be described by any universal model in which all key relationships are predetermined. Economic behaviour is influenced by technologies and cultures, which evolve in ways that are certainly not random but that cannot be fully, or perhaps at all, described by the kinds of variables and equations with which economists are familiar. The future is radically uncertain and models, when employed, must be context specific.
In that eclectic world Ricardian equivalence is no more than a suggestive hypothesis. It is possible that some such effect exists. One might be sceptical about whether it is very large, and suspect its size depends on a range of confounding and contingent factors – the nature of the stimulus, the overall political situation, the nature of financial markets and welfare systems. The generation of economists who followed John Maynard Keynes engaged in this ad hoc estimation when they tried to quantify one of the central concepts of his General Theory – the consumption function, which related aggregate spending in a period to current national income. Thus they tried to measure how much of a fiscal stimulus was spent – and the “multiplier” that resulted.
But you would not nowadays be able to publish similar work in a good economics journal. You would be told that your model was theoretically inadequate – it lacked rigour, failed to demonstrate consistency. To be “ad hoc” is a cardinal sin. Rigour and consistency are the two most powerful words in economics today.
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Consistency and rigour are features of a deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the universal validity of the axioms. The only descriptions that fully meet the requirements of consistency and rigour are completely artificial worlds, such as the “plug-and-play” environments of DSGE – or the Grand Theft Auto computer game.
For many people, deductive reasoning is the mark of science: induction – in which the argument is derived from the subject matter – is the characteristic method of history or literary criticism. But this is an artificial, exaggerated distinction. Scientific progress – not just in applied subjects such as engineering and medicine but also in more theoretical subjects including physics – is frequently the result of observation that something does work, which runs far ahead of any understanding of why it works.
Not within the economics profession. There, deductive reasoning based on logical inference from a specific set of a priori deductions is “exactly the right way to do things”. What is absurd is not the use of the deductive method but the claim to exclusivity made for it. This debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic: inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics.
Economics is not a technique in search of problems but a set of problems in need of solution. Such problems are varied and the solutions will inevitably be eclectic. Such pragmatic thinking requires not just deductive logic but an understanding of the processes of belief formation, of anthropology, psychology and organisational behaviour, and meticulous observation of what people, businesses and governments do.
The belief that models are not just useful tools but are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face. That blindness made a big contribution to our present crisis, and conditions our confused responses to it. Economists – in government agencies as well as universities – were obsessively playing Grand Theft Auto while the world around them was falling apart.
The writer, an FT columnist, is a visiting professor at the London School of Economics and a fellow of St John’s College, Oxford
Macroeconomic modelling: Ways to simplify that are very different from those of a physicist
Robert Lucas, aged 73, is John Dewey professor of economics at the University of Chicago. Prof Lucas and Chicago colleagues, along with others such as Edward Prescott and Thomas Sargent, are the founders of the programme known as “dynamic stochastic general equilibrium” (DSGE), which dominates teaching and research in macroeconomics.
The programme has been described as “freshwater economics”, because the leading proponents have been based at locations such as Chicago, Rochester and Minnesota, in contrast to those in the seaboard strongholds of “saltwater economics” at Harvard, MIT and Stanford, who followed a more Keynesian tradition.
In 1995 Prof Lucas was awarded the Nobel prize for economics, and in his prize lecture he provides a succinct summary of his central model. He makes a number of assumptions. Individuals are rational, calculating welfare maximisers. They live through two periods: work in the first and retirement in the second. There is only one good, which cannot be stored, or invested in capital projects. There is only one kind of work, and older and younger generations do not support each other.
This simplification method is very different from the physicist’s simplification, which abstracts to focus on a single element of a problem. Prof Lucas has described his objective as “the construction of a mechanical artificial world populated by interacting robots”. An economic theory is something that “can be put on a computer and run”.
Structures such as these are “analogue economies”, complete systems that loosely resemble the world, but a world so pared down that everything is either known or can be made up.
Such models are akin to a computer game. If game compilers are good at their job, events and outcomes loosely resemble those observed in the real world – they can, in a phrase that Prof Lucas and colleagues popularised, be calibrated against observation.
But it obviously cannot be inferred that policies that work in a computer game are appropriate for governments and businesses. It is in the nature of these self-contained systems that successful strategies are the product of assumptions made by the authors.
IN JULY, some business acquaintances approached Mr Nikhil Srinivasan, the Munich-based group chief investment officer of Allianz Investment Management, with a request: Could he get them a meeting with the Monetary Authority of Singapore (MAS)?
The people seeking an audience with the MAS were from the family investment office of a 'very reputable' European business house interested in setting up an asset management business here, says Mr Srinivasan, who was born in India but is now a naturalised Singaporean.
There is a self-reinforcing circularity in global banking: First, bankers move closer to where the money is. Next, money moves where the bankers are.
Singapore has already crossed the first stage of development. As a private banking hub serving the ultra-rich and the merely wealthy, it's already 'the Zurich of the East', says Mr Jeremy Anderson, the London-based chairman of the global financial services practice at KPMG.
Now that the banks have all pitched their tents here, the second part of the story is unfolding. Investors, such as the European family office that tapped Mr Srinivasan, want to bring in their own funds and manage them from here.
'Singapore is much more important in the world of money than it used to be,' Mr Srinivasan says. 'The financial ecosystem here is richer now than before. More participants are keen to come here.'
Asset management may be the next industry to watch. In its report, titled See The Future, PricewaterhouseCoopers predicts that by 2025 Singapore will attract enough of the 'internationally footloose capital' to emerge as the world's second-largest centre for asset management after New York, and ahead of London.
'It's the integrity of the environment here,' explains Mr Jose Isidro Camacho, the former Philippine finance secretary who is now the vice-chairman of Credit
Suisse in the Asia-Pacific. Recently, the bank chose Singapore as the hub for its emerging-market asset management business. Singapore is already the largest wealth management centre for Credit Suisse outside of Switzerland.
'We have doubled here in the last five years,' Mr Camacho adds, referring to the growth in Credit Suisse's employee base in Singapore to more than 5,000 at present. 'And we would hardly be alone in that.'
Intense competition for talent
SUCCESS creates its own unique challenges. In March this year, about 175,000 men and women in Singapore - or 5.6 per cent of the working residents - were employed by financial services and insurance companies. In seven years, financial sector employment in Singapore has risen 62 per cent. That is three times the employment growth in manufacturing in the same period.
Rapid expansion has made finding the right people, at the right time and the right price, the biggest headache for banks and other financial firms here.
'Competition for talent is fierce,' says Mr Camacho. 'It isn't just our global peers; we are also competing with local and regional banks. Inflation of compensation has made it more difficult to protect margins.'
Unless the global economy nosedives between now and December, Singapore will probably be able to look back at 2011 as a year in which it crossed an important milestone on its way to fulfilling its ambition of ranking alongside the world's most prominent global financial centres.
In March, the so-called Asian dollar market here topped US$1 trillion (S$1.2 trillion) in assets for the first time. That is about five times the size of Singapore's economy.
The Asian dollar market came into existence in Singapore in 1968 to make available US dollars and other hard currencies to banks, companies, individuals and sovereigns around the world at those hours of the day when it was too late for New York - and too early for London - to conduct such business.
Even today, the market primarily serves borrowers outside Singapore, with resident customers other than banks accounting for just 10 per cent of the total Asian dollar assets of institutions here.
In the short run, a murky global economic outlook and jittery markets could put pressure on financial flows channelled through Singapore. Depending on the severity of the shock, the time taken to recover from it could be anywhere from a few months to between three and seven years.
Or at least that is what past experience suggests: In the aftermath of the Asian financial crisis, assets in the Asian dollar market here took seven long years to reclaim the highs of 1997; the slump of 2008 cost Singapore three years in lost time and financial flows.
A repeat of those episodes cannot be ruled out. After topping US$1 trillion in March, Asian dollar assets increased further in April; and then in May and June, growth stalled. Financial-industry headhunters will be keeping a close eye on this statistic. If the number continues to slide, they may as well go on a long vacation.
'Both corporate and transaction banking sectors are likely to remain stagnant or hire opportunistically,' Robert Walters, a recruitment firm, says in its recent update of the employment outlook for the financial services industry here.
In the past three months, European financial institutions, including HSBC, Lloyds, UBS and Royal Bank of Scotland, have announced more than 60,000 job cuts globally. Bank of America has said it would prune headcount by 3,500.
But any pain that is felt by international banks, bankers and the bankers' landlords here will be transitory. In the medium to long run, gains in this part of Singapore's financial industry may be nothing short of bountiful.
Asia's growth offers opportunities
ONE reason is economic expansion in Asia to which the fate of the banking industry here is closely and inextricably tied.
'Asia is the flavour of our times,' says Mr Shirish Apte, one of Citigroup's two chief executives for the Asia-Pacific. 'A lot of people in our industry are saying they want to move to Asia - the two options are Singapore and Hong Kong.'
Contrast this optimistic scenario with the grim outlook for growth facing banks in more developed economies that have, thanks to their incontinent governments, already feasted on so much credit that they will not have much appetite for debt for decades to come. 'Banks in North America and Europe have huge challenges in figuring out where growth is going to come from,' says Mr Anderson of KPMG.
Incessant banker-bashing in the West is also going to send more business Singapore's way. What is more, Singapore will not have to bend over backwards by embracing regulation that is too soft to make banks and bankers welcome here.
'I would be astonished if there was substantial difference in capital or liquidity requirements for financial institutions in Asia compared with the rest of the world,' says Mr Anderson. 'But in the West, the tone of regulation is becoming adversarial. And that's going to make a difference.'
Banking in Singapore is like an iceberg. The part that has nothing to do with financing the local economy, and is submerged from public view, is 1.5 times the size of domestic banking. But the less visible part of banking is no less important.
Take the financing of commodity trades. Large commodity traders such as Wilmar International and Olam International are headquartered in Singapore, while Cargill runs its Asia-Pacific business from here. Singapore also has a full-fledged commodity trading bourse now in the form of the one-year-old Singapore Mercantile Exchange. The building blocks are in place for Singapore to increase its share of financing of cross-border trade. As intra-regional commerce expands in Asia, Singapore will become an even more prominent trade-finance hub than now, Mr Apte of Citigroup says.
Greater exchange of goods and services among Asian countries will also create new opportunities for trading of currencies and exchange-rate derivatives. That, too, is good news for Singapore, which is already the fourth-largest centre for such transactions after London, New York and Tokyo.
In April, the average daily volume of the traditional currency-trading business here - spot trades, forwards and foreign-exchange swaps - was US$314 billion, a 13 per cent increase from six months earlier, according to a twice-a-year survey by the Singapore Foreign Exchange Market Committee. A big chunk of the volume came from trading US dollars against euros. Over time, that is bound to change.
'Today, only a small percentage of the overall China trade is denominated in renminbi,' Mr Apte says. 'Given the size of the Chinese economy and the trade flows, one would expect renminbi to play a more important role in future. It will even become a part of the non-China trade.'
Funding needs of Asian - and in particular Chinese - companies are driving the growth agenda at global banks. Citigroup, which helped its corporate clients in the Asia-Pacific raise US$75 billion in the first half of this year from international capital markets, has recently opened China desks in the US, Britain, Brazil, South Africa, Dubai and Singapore to serve multinational Chinese customers.
Capital markets a weak spot
THANKS to its proximity to the booming economy of mainland China, Hong Kong is way ahead of Singapore in investment banking and capital markets-related activities. Last year, issuers raised more than US$54 billion in initial public offerings in Hong Kong, making it the second-biggest city for IPO fund-raising after New York. Shenzhen in China came in third place. Globally, the Singapore Exchange (SGX) was not even in the top five, KPMG's analysis shows.
In the first half of this year, Hong Kong equity offerings generated about US$500 million in investment banking fees, almost double the money underwriters made on equity issuances in Singapore, according to Bloomberg data.
The Singapore bourse's efforts to become a worthy challenger to the Hong Kong stock exchange received a blow this year when SGX failed to secure regulatory clearances to buy ASX, the operator of the Australian bourse. Still, experts say it is only a matter of time before Singapore's public capital markets grow in relevance, depth and stature. Last month, the bourse installed the world's fastest trading engine, a move that is expected to enhance liquidity. What it needs now are a few marquee names to sell stock here.
Excitement is building up around a possible US$1 billion stock offering here by debt-laden English soccer club Manchester United. If the Red Devils' issue succeeds, it will go a long way in boosting investor sentiment, which has been dented by a series of disappointments.
Of the 69 IPOs priced here since January 2009, only a handful - fewer than 20 - are currently trading above their initial offering prices, even though over this period the benchmark Straits Times Index has jumped 56 per cent. Other Asian markets have performed better in this regard. That begs the question if issues on SGX are so aggressively priced as to leave nothing on the table for investors.
'Soft' infrastructure crucial
FUTURE growth of the financial services industry in Singapore will, in large part, be determined by the real and perceived openness of the economy - not only to overseas capital, but also to foreign talent. 'If there were severe constraints on our ability to bring in talent, there would be an impact, not only on growing the business but also on sustaining it,' says Mr Camacho of Credit Suisse.
The other imperative is continuous enhancement of Singapore's infrastructure. 'Infrastructure covers many elements,' says Mr Apte of Citigroup, who himself left Hong Kong this year to live in Singapore. 'Schools as well as medical and recreational facilities are as important as, say, transport infrastructure. Without these, people would not move here.'
To a banker living in Singapore, the city offers a broader, more interesting menu of choices in 'cuisine, arts and culture now than when I was here with Bankers Trust in the early 1990s', says Mr Camacho. 'Sure, the cost of living has gone up, but then you would expect that in any global city.'
Financial regulators will have an unenviable job policing capital that now flows through many more nodes than before. Whereas in 1980 funds largely moved between developed markets - and between developed markets and Hong Kong and Singapore - by 2005, significant sums of money were beginning to traverse the world in many directions.
In this new, more complex scheme of things, Sao Paulo is important, as are Mumbai, Shanghai, Busan and Shenzhen. The more complicated the machine, the bigger the risk of a spectacular breakdown. What is needed is a regulator that is transparent, not beholden to dogma and open to feedback and consultation.
Through a colleague, Mr Srinivasan of Allianz did help arrange that meeting between MAS and the European investment office looking to set up operations here.
'I'm not aware of the outcome, but the ease with which a credible person can get an audience with the regulator here is remarkable,' he says. 'At a time when other financial centres are being hit by regulations, some of which one might argue are unnecessary, Singapore has maintained a pragmatic stance of sensible regulation.'
Walmart wants to open 15 to 20 Walmart Express stores by the end of next year
American shops are getting smaller as retailers seek to reach consumers through new compact formats in the face of a stagnant economy, demographic shifts and a growing demand for convenience.
Retailers including Walmart, Office Depot and Best Buy are introducing smaller stores in urban areas, a departure from the “big box” stores on which they built their success at out-of-town sites in the past three decades.
Tesco, which has forged into the US with stores that are smaller than traditional supermarkets, is shrinking its format further with convenience stores that might be dubbed “micro-boxes” by US standards.
“The cookie cutter, one-size-fits-all doesn’t seem to work that well any more,” says Ira Kalish, director of global economics at Deloitte Research, who links the shrinking of stores to the diversification – or fragmentation – of consumer profiles and preferences.
But the convergence of so many retailers on small formats is creating stiff competition and exacerbating the difficulties of operating on expensive and unfamiliar plots, squeezed between the offices, car parks and apartment blocks of big cities.
Walmart, the discounter that dominates US retail, has opened three Walmart Express test stores in recent months and says it wants to open 15 to 20 by the end of next year.
At about 15,000 sq ft, the Walmart Express stores are just 8 per cent the size of Walmart’s trademark Supercenters, which are 185,000 sq ft and cover the same ground as two-and-a-half standard football pitches.
Tesco of the UK began its move into California under the Fresh & Easy brand with stores of between 7,000 sq ft and 10,000 sq ft. But to push deeper into urban areas it plans to open stores as small as 3,000 sq ft, roughly the size of a UK convenience store.
“We are always looking at different sizes of stores,” says Tim Mason, chief executive of Fresh & Easy.
The shrinking of stores is partly borne of the “age of convenience”, says Ken Berliner, president of Peter J Solomon, a boutique investment bank. “Consumers want more choices. Retailers need to offer whatever the consumer wants to buy, however they would like to buy it, whether in stores, through a catalogue or online.”
Cash-strapped shoppers are also less willing to fund long drives to big boxes given high gas prices.
Consumers’ expectations for convenience have been raised by online shopping, an option that has harmed Best Buy, the US’s biggest traditional electronics retailer.
Part of its response has been to create small-format Best Buy Mobile stores, which sell telephones and tablet computers and will expand in number this year by 150 to 325.
Target, a Walmart rival, is next year planning to open five experimental City Target stores, which will be between 60,000 sq ft and 100,000 sq ft, compared with the typical 135,000 sq ft.
The downsizing also signals that retailers are adjusting to a higher concentration of people in urban areas – one result of the housing bust, which emptied new developments in the Sunbelt states of the south-western US.
John McIlwain, senior resident fellow at the Urban Land Institute, says two deeper demographic trends are also at play.
First, people in their 20s and 30s are living in urban areas longer than previous generations because they are marrying and having children later.
Second, baby boomers are moving back into city centres because they want to be able to walk to shops and entertainment.
But, in spite of retailers’ plans, city-centre stores are “typically not their first choice”, says Mark Keschl, national director of retail at Colliers, a property agency.
Retailers can run big-box stores off a single blueprint for inventories, staffing and fixtures.
But in each city location, they must adapt to a different set of constraints, ranging from narrow lanes for their trailer trucks to the existence of labour unions, he says.
Some retailers are not keen on the idea. Safeway, a grocery chain whose typical stores are half the size of a Walmart Supercenter, has two small shops in California but they are “a labour of love”, says Melissa Plaisance, head of investor relations.
“We are profitable in both, but it’s very hard … Hard to do enough volume to cover the costs.”