Over at Harvard Business Review‘s blog, there’s a provocative post by James Allworth: “How Corruption is Strangling U.S. Innovation.”

If there’s been one topic that has entirely dominated the post-election landscape, it’s the fiscal cliff. Will taxes be raised? Which programs will be cut? Who will blink first in negotiations? For all the talk of the fiscal cliff, however, I believe the US is facing a much more serious problem, one that has simply not been talked about at all: corruption. But this isn’t the overt, “bartering of government favors in return for private kickbacks” corruption. Instead, this type of corruption has actually been legalized. And it is strangling both US competitiveness, and the ability for US firms to innovate.

The corruption to which I am referring is the phenomenon of money in politics…

Allworth goes on to provide a series of examples from arenas– the automotive industry, intellectual property, accommodation and transport, telecom– that illustrate his point all-too-painfully well. For example…

When Walt Disney penned Steamboat Willie — the first cartoon with Mickey Mouse in it — copyright lengths were substantially shorter than they are now (but still enough such that it gave encouragement to Walt to create his famous character). And yet somehow, it seems that every time that Mickey is about to enter the public domain, congress has passed a bill to extend the length of copyright. Congress has paid no heed to research or calls for reform; the only thing that matters to determining the appropriate length of copyright is how old Mickey is. Rather than create an incentive to innovate and develop new characters, the present system has created the perverse situation where it makes more sense for Big Content to make campaign contributions to extend protection for their old work.

It’s not just copyright, either — the same mentality has been driving draconian legislation such as SOPA and PIPA.

And finally, if you were in any doubt how deep inside the political system the system of contributions have allowed incumbents to insert their hands, take a look at what happened when the Republican Study Committee released a paper pointing out some of the problems with the current copyright regime. The debate was stifled within 24 hours. And just for good measure, Rep Marsha Blackburn, whose district abuts Nashville and who received more money from the music industry than any other Republican congressional candidate, apparently had the author of the study, Derek Khanna, fired. Sure, debate around policy is important, but it’s clearly not as important as raising campaign funds.

Allworth didn’t go on; but he could have. He could have elaborated on the abuses in each of the sectors he identified; there’s certainly plenty of material. And he could have added other sectors– financial services, for obvious example.  But his important point is well made. (Readers of this blog will recognize the concern, as it’s been a continuing theme here; see “Beware the Land of the Giants,” “Thinking the Unthinkable,” “To Promote the Progress of Science and the Useful Arts,” et al.)

What’s fascinating– and encouraging– to me is that Allworth’s piece is running at HBR. Lord knows, it’s only too important for that audience: the “corruption” that Allworth describes is poisonously bad for the whole economy and for all of the businesses in it– even for those fearful incumbents whose reflexively greedy moves seem to them to yield short-term return.

* “Power does not corrupt. Fear corrupts… perhaps the fear of a loss of power”  -John Steinbeck

 

Readers of this blog will know that I am one of those deeply concerned by the consolidation afoot in our economy (e.g., “Beware the Land of the Giants…“), more particularly, in the financial sector (e.g., “Happy 9-15!“)

From Hypervocal, a powerful reminder of just how extreme the dynamic has become, “From 37 to 4: the Consolidation of Banks“…

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In 1990 there were 37 major banks in America. By 1999 there were 21. Just 14 in 2003. Now, present day, there are just four. Four major banks for consumers to choose from — Citigroup, Bank of America, Wells Fargo, and JP Morgan Chase — and we’d bet good money that number will be three soon…

As HV points out, the implosion began in the 90s with the erosion of the 1933 Glass-Steagall Act, legislation designed, after the bank failures of the Great Depression, to assure that there was no repeat of that debacle; it caught fire after the passage of the 1999 Gramm-Leach-Bliley Act, which finally and fully repealed Glass-Steagall– allowing financial institutions to operate as commercial banks, investment banks and insurance companies under one cross-collateralized roof, on the theory that the banks would be too big to fail.

Well, they’re big all right.  But as the events of 2008 demonstrated, they can fail… indeed, as we do our best to keep from disappearing into the sovereign debt sinkhole in Europe and try to find a road to recovery from the Great Recession, we have to hope that we haven’t created banks that are too big to save.

Further to “Will Work for a Job,” Part One (and Part Two), this bracing chart from the IMF…

(via Paul Kedrosky, TotH to Tim O’Reilly)

For a more detailed look, see this set of charts (pdf) from the April 2010 World Economic Outlook.

Government debt often finances crucial infrastructure, social services, or innovation.  But the huge upsurge in government debt from 2008 was much less a function of investment in “assets” or social goods than it was the price of stabilizing their economies– it was the bail-out.  Whatever my reservations about how the bail out was conducted across the developed economies (and how unevenly the benefits accrued), it seems to me clearly to have been necessary:  the alternative– total meltdown– being much worse.  Still, the reality is that this huge increase to national debts didn’t buy any future benefit or capacity; it simply covered the accumulated cost of irresponsible speculation.

And so, huge debt.

To be sure, more developed economies have more developed capacities to service debt.  For example,  U.S public debt was, in the years immediately following World War II, at the same kind of level (measured in % of GDP) as foreseen by the IMF; within a decade, it had been reduced by over half.  But that reduction was driven by the extraordinary economic growth of the U.S.in those post-war years, largely fueled by the increase in consumer demand occasioned by the growth of civilian employment, the rise in home ownership and spread to the suburbs, and the baby boom…  forces that laid the foundation for continued growth over the next couple of decades.

Current demographics in the U.S. and the rest of the developed world suggest that the next decade will have a very different character. The developed economies’ capacity to handle their debt will diminish as lower birthrates mean that their citizens will increasingly age out of the work force, and begin drawing services even as they cease to contribute to their funding…  add in the cost of responding to climate disruption, keeping aging infrastructure serviceable, et al., and it’s a pretty strained picture.

Necessity is, as we know, the mother of invention.  Japan, for example, is looking to robots to bridge the worker gap…  but even then, is having to plan for a tight squeeze.

For the rest of the developed world, immigration is the more obvious remedy; indeed, 2.5 million immigrants contributed to US growth in the Fifties (ten times as many as entered in the Thirties). These immigrants stepped into jobs all over the country– and they contributed new ideas, built new businesses.  They contributed to overall economic growth and contributed to support the social services available to all Americans.

But, as history reminds us, immigration will effectively remake societies even as it “saves” their economies.  Many see this growing diversity as a strengthening and enriching of the society (as well as the economy); I do.  But as the rise of anti-change nationalist nostalgia movements (like the Tea Party in the U.S., Le Pen’s National Front in France, and others throughout the developed world) illustrate, many others disagree– disagree loudly enough so far to have frustrated the reform of immigration laws in most of the (currently-)rich world.

In Part Two of this post (and elsewhere), I try to argue for a U.S. marketplace genuinely open to innovation and to the emergence of new, and new kinds of, businesses– as ours decreasingly is.  It seems clear to me that we need, similarly, to be more open when it comes to immigration as well.  On both those fronts, there are myriad ways to get it wrong.  Try as we might– and as we must– to legislate, regulate, and operate effectively, we could fail.  And indeed, opponents of these moves– apologists for advantaged incumbents and xenophobes– are quick to catalog the risks, to argue against taking action.

But the alternative?  We know that doesn’t work; indeed, that’s what drove us into the trench that we’re in.  We’ve got to find a way past the status quo– accelerating consolidation, enhancing the power of oligopolies, “retiring” people for whom there is no plan for support– or risk having to learn the same painful, costly lessons all over again.

In the meantime, further to Part One– and to observe the obvious– money spent paying interest is money that is not being spent on the things that can build a strong economy, reduce the level of debt, and fuel a healthy society.

As we face the situation recounted in Part One

We’re all going to be making economic sacrifices for awhile, making cuts in order to dig ourselves, individually and as societies/economies, out of the trench into which we’ve fallen. There is, in country after country (and household after household), a great deal of arguing about which things to cut, and how far; there’s even (I believe wise) talk of restructuring the worst of the debts to make them more manageable.  Still, there’s no disagreement that something has to give, and that one way or another, the sacrifices required will denominated in some combination of lower consumption and reduced government services.

But as Lou Gerstner knew when he took on the turnaround of IBM, we can’t save our way to growth.  We can cut to stop the bleeding; but if we want to create opportunity and the possibility of improvement and growth, individual or national, we have to find ways to add new value– value that will translate into employment and well-being.  In theory, this new value can be created in incumbent companies or in innovative new ones; historically, it’s come from some combination of both.

But this time around, there’s data suggesting that we will be unusually reliant on innovation and entrepreneurs to create jobs– that’s to say, that incumbent companies can’t/won’t…

Celerant Consulting, an HR consulting firm, has just released  a corporate workforce productivity study, drawing on a  review of hundreds of subjects across the developed world (download a pdf of the report here).  The striking findings are summarized in this chart:

source

As the report observes,

Across all four industries surveyed – Energy, Chemicals, Healthcare, and Consumer Staples – the Impactability Study revealed a similar pattern of inefficiency. Value-add activity accounted for 50 percent or less of time spent on the job, leaving significant room for improvement. Although areas such as Healthcare and Chemicals are to some extent exposed to greater bureaucratic hurdles that direct more hours to approval processes, there is no question that each industry can reduce costs by refocusing the organization’s workforce.

One can quibble with Celerant’s methodology, and argue for marginally higher or lower productivity numbers in one sector or another.  But I doubt that anyone feels that the report is fundamentally wrong.  In our hearts (and minds and stomachs) we know that organizations that struck their “Coase balance” when the state of technology and society were very different, and have accreted layers of organizational sediment ever since, are bound to be inefficient today.  From Dilbert to The Office, we recognize the situation even as we laugh at it.

So, there’s plenty of productivity to be had in incumbent companies without adding any staff.  Indeed, these big companies may even be able further to reduce their employee costs, either by continuing to reduce staff or by holding– even lowering– wages and salaries.  Indeed this is what the Bureau of Labor Statistics suggests is happening: productivity up; labor costs down…  Not very good news for the economy as a whole, in which employment is a continuing concern; but OK for shareholders, right?

In the very short-run, maybe; but overall, not so much.  Companies that are focused on cutting costs, in which employees are fearful of their salaries or jobs, are not hot beds of innovation.  There are exceptions, like IBM under Gerstner; but they tend to prove the rule:  most often, companies in the Celerant boat are trying to figure out how to do the same things with less (or, like the airlines today, to do less with lots less).  Innovation in companies like these too often amounts to figuring how how to charge more for the same thing (c.f., airline “service fees”).  This is, as Gerstner knew, no way to build a profitable, growing future.

Clearly, big, incumbent companies should try to innovate.  Some (again, pace Gerstner) may get it right.  But, for all these reasons, many more probably won’t– if they even try.

So, if incumbent companies aren’t likely to create the innovation and employment that we’ll need to achieve sustainable growth in our economies, where will we find it?

It’s been long believed that small businesses, and the jobs they create, lead economies out of recessions.  Surely, they have historically played play an important role (a role threatened by the current contraction of capital available to them.)

But Paul Kedrosky argues that we should look more specifically to new companies.  Using the mathematical  idea of the “drunkard’s walk” (a version of the probability theory concept of the random walk), he illustrates the “inevitability” that new companies are key…

…the central thing about job creation from young companies is its inevitability. It is a species of mathematical certainty (one driven by initial simplicity and a wall) that young companies must create the most jobs (even without assuming particular skill on their part, or taking into account sectoral or economic growth, both crazily conservative assumptions).

“Crazily conservative assumptions” indeed.  Those new companies are– certainly not entirely, but largely– exploring the frontiers of the market.  They are innovating products, services, and processes– creating the “stuff” of real economic growth.  And they are giving their employees the opportunity to learn the skills and work habits that can achieve it.

So while cutting away the fat in incumbent companies and established markets is both necessary and useful to economic renewal, it doesn’t begin to be sufficient.  Real growth requires the creation of new value, in new ways.  And while there are some older, bigger companies that can pull that off, it is historically the role of small, new entrants– of the entrepreneurs and their start-ups.

How do we encourage new business, create the conditions in which it can help us out of the trench that we’re in?  There are detailed answers being developed in lots of spots, e.g., at the Kauffmann Foundation.   Here, let me suggest one very obvious theme:

If we want to encourage innovation and entrepreneurship, then we have to stop pursuing policies that pre-empt them by advantaging large incumbent companies and their desire to preserve– and milk– the status quo.  From obvious fronts like financial, securities, and anti-trust regulations, to corners as seemingly arcane as the patent process, the deck is stacked.

Indeed, these policies knit together to become a kind of “pro-consolidation platform”– one that both parties have adopted.  The results, we’ve already begin to see:  the financial crisis, the reduction in meaningful consumer voice and choice in an increasing number of arenas, the feudal concentration of income, wealth, and power in a big-bank, big-company elite…

source

Beware the Land of the Giants– it is a barren place.

As Adam Smith argued, markets can be a wondrous thing, they can lead to increased economic growth, increased welfare, and increased equality– but only if the governments that legitimize and police them work to be sure that they are actually “open” and “free.”

Thursday’s mysterious Space Mountain-like stock market plunge aside, the domestic U.S. economic news last week seemed pretty good:  employment up, personal consumption expense up– sounds like a recovery.

And a recovery it may ultimately be.  But a peek underneath those number and a look out at the global economy each suggest that it’s premature to party…

My friend, anthropologist Grant McCracken, is an insightful observer of the American consumer.  Last year, as many were arguing that a new frugality– a “new normal”– was sweeping the nation, he begged to differ.  In The Harvard Business Review Blog, Grant argued that consumers would soon be spending again as though it were 1999. And indeed, in Q1 consumer spending added 2.6 points to GDP growth, following a strong Q4 last year.

But as Calculated Risk observes, the entire increase in consumption in Q1, and most of the growth in prior months, has been due to government transfer payments and reductions in personal savings.  That’s to say: Grant’s right, we’re continuing to spend…  we’re just not earning to support the expense.

click image to enlarge (source)

Perhaps that’s at least in part because we’re still not working.  This week’s report of 290,000 new jobs notwithstanding, the unemployment rate rose to 9.9%.  Add in the number of workers who are involuntarily on reduced hours and the number (U-6, as the BLS calls it) swells to 17.1%.  And then there is the record number of people unemployed for 27 or more weeks– 6.72 million, or 4.34% of the work force.  To put this in perspective, the recession of the early 80s peaked at 10.3% unemployment; but long-term (27+ weeks) unemployment never rose above 2.6%… to wit, the preponderance of transfer payments as noted above.


click image to enlarge (source)

There are lots of signs that can signal an economic rebound; but in the end, a sustainable recovery will be built on employment, on jobs.  In Part Two, a look at where those jobs might (and might not) be found.  But first, a quick look at the global context in which any U.S. recovery will have to make its way.  In a way that’s analogous to the domestic employment situation, underneath the good news of the moment, there’s trouble.

To wit, the news this morning of European-IMF agreement on a bail-out plan for Greece:  it’s encouraging…  But friend Peter Herford recently forwarded a terrific (albeit, mildly terrifying) piece from Der Spiegel, looking at the underpinnings of the European debt crisis: “The Mother of All Bubbles.”

Greece is only the beginning. The world’s leading economies have long lived beyond their means, and the financial crisis caused government debt to swell dramatically. Now the bill is coming due, but not all countries will be able to pay it…

Here, too, we find ourselves returning to jobs as a– the– central concern…

As we think about the ways in which we in the developed world have lived beyond our means, we arrive quickly at the extraordinary accumulation of public debt that’s the “hero” of the European drama (which isn’t to say, of course, that it’s not an issue in the U.S. and elsewhere):

click image to enlarge (source)

…and at the kind of private debt– commercial, mortgage and consumer credit– that contributed so powerfully to the 2008 meltdown:

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click image to enlarge (source)

But as we consider private debt, it’s worth calling out the corporate/commercial component– the bit that’s directly related to the businesses that provide jobs.  While there have been some bankruptcies among over-levered companies, corporate credit doesn’t seem, given the relative paucity of attention its gotten, to have played much of a role in getting us into our current pickle.  Indeed, most of the concern about corporate debt since 9-15-08 has been around whether there would be enough of it to support a recovery.

If governments are going to be reducing their services, then growth will have to come from new/higher incomes, from real growth… and that– the creation of those new jobs and of those higher incomes– is the role of business.   If we’re going to climb out of the trough we’re in (a trough that, if Spiegel is right, could be about to get deeper still),  business must create new (and new kinds of) value, and in so doing, create jobs.

And so, to Part Two

“The Vine that Ate the South” (source: WolfeReports)

When is a “green shoot” not a “green shoot”? When it’s kudzu

In yesterday’s New York Times, Andrew Ross Sorkin reports on two recent corporate mergers– Abbott’s purchase of a Solvay unit and Xerox’s absorption of ACS, each valued at over $6 Billion.  Good times are back, he suggests.

… taken in the context of what has been a merger drought — in the wake of the financial crisis, deal-making is still off by more than 50 percent from last year — the transactions suggest that the most senior ranks of corporate America may now have a more optimistic outlook on the economy than some people thought.

“Will you see us move with a lot of acquisitions over this next year? You betcha,” John Chambers, the chief executive of Cisco Systems, said in a recent meeting. “Especially if it plays out economically the way that I think.”

In fact, as noted here before, M&A activity has already run hot and heavy in the financial services arena, not despite, but because of the economic crisis and the bailout.  TARP and related funds, ostensibly meant to loosen credit for consumers and commerce, has instead been largely used to fund investments on the receiving banks’ own accounts– to help the favored “too large to fail”  banks buy up competition and expand their market shares.  (See the illustration here for a graphic– pun intended– depiction of your tax dollars at work.)

Now, Sorkin suggests, the imperial expansion moves to other arenas.

The greatest concentration of deal-making appears to be in the health care and technology sectors. Warner Chilcott made a $3.1 billion deal for Procter & Gamble’s drug business last month, for example, and Dell bought Perot Systems, a technology services company, for $3.9 billion. But deals are also being made in other sectors, like food; Kraft’s $16.7 billion unsolicited bid for Cadbury, which was rejected but remains a possibility, is the largest outstanding offer to date.

“If you’re healthy, it’s a great time to acquire inexpensively,” adds Ted Rouse, a head of Bain & Company’s global mergers and acquisitions practice. “But it’s an awful time for two weak companies to merge.”

The experience of the last several decades has trained us to see increased M&A activity as a sign of economic strength.  And indeed, when the economy is fertile– when every company that disappears via acquisition is replaced by two or three new start-ups with world-beating plans, it probably is a sign of economic health.

But when the companies that are swallowed up are not replaced– because funding/credit isn’t available or because IP laws are too restrictive or because oligopolists’ channel power freezes new players out or…  well, you get the picture– the prognosis is not so rosy.  At best, we get a return to the “gray flannel suit” 50s; at worst, a decline into the turbidity of the 30s.

As suggested in “Beware the Land of the Giants…“:

When oligopolies emerge, they do all they can to retard competition and innovation; it’s their self-interest.  But in a growing economy, their impact is measured in “decreases in the rate of growth,” “slowing rates of innovation.”  On balance, things are still trending up.  And to the extent that new entrants succeed, that innovation trumps defensiveness, the oligopolies fade.

But when oligopolies form by default in troubled times, their self-protection can salt the earth around them, can make it hard-to-impossible for ferment– for start-ups or disruptive innovation– to take root…  and it’s from those seeds that strong growth in a recovering economy can emerge.

We have a huge stake in making sure that the more concentrated economy with which we’ll emerge from this downturn is as “un-oligopolistic”– as free and open– as we can make it.

The problem is that it can be very hard to tell one kind of M&A activity from the other while in the midst of the deal stream.  A slide into oligopoly can feel, as it’s unfolding, just like the good old days of the 90s– one exciting deal after another– until it’s too late to do anything about it.  And when so many of the parties to the transactions are paid– and richly paid– on the transactions,  as opposed to the longer term outcomes of the deals (much less their utility to the economy as a whole), there is, to put it politely, no incentive for the actors to pause to consider.

But pause we should.  Vulnerable as we are in what may or may not yet be the trough of economic decline, We can ill afford an implosion of competition that resolves into a tar-baby of oligopolies.

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