HOW INVESTMENT MARKETS DESTROY INDUSTRY
The British government has been at great pains to protect the London investment markets from any intrusions by the European Community. When pressed, they justify their stance by claiming that The City of London financial markets are a jewel in the British economic crown. In the US, the financial sector exercises huge influence and has managed to preserve “business as usual” after the meltdown of the financial markets that began in America.
In countries not subject to market fundamentalism, the investment markets are more constrained and as often as not, governments play a significant role in the determination of industrial strategy and investment. This stance is denigrated by free-marketeers with the catch-all sound-bite “picking winners”.
Are they right?
Here are a few facts that may enable readers to make up their minds.
A recent article by Andrew Haldane, an executive director of the Bank of England for “Prospect” magazine shows that investment rates as a proportion of GDP in UK and US are the lowest in the developed world (OECD). The rate of industrial investment in Britain is about half that of South Korea. Haldane concludes, “There is compelling evidence that short-termism is slowing investment today and so growth tomorrow.” In the current environment, that is something the country can ill afford. What Mr Haldane fails to mention is that the rate of industrial investment in Britain has trailed that of leading industrial nations for many decades, leading to a catastrophic weakening of science and technology industries - and a consequent dependence on the Financial sector.
Some would claim that this does not matter, but:
- Manufacturing contributes far more to the long term balance of payments than finance and services
- Manufacturing and technology provides far more high quality well-paid jobs than general services. The British jobs market is becoming hollowed out in the middle, with growth in very high paid and huge expansion in low pay, low skill jobs.
- The finance sector draws wealth and employment to the area surrounding London, leaving many of the previously prosperous manufacturing areas in the Northern three-quarters of the country as economic deserts.
- Finance is not going to lead the UK and USA economies out of the slump caused by the collapse of the investment banks - in fact, in their current form, the financial markets are going to act as a severe brake on recovery.
- It has been conclusively demonstrated that the investment banking sector, especially in Britain, has a structural aversion to long term investment, especially in complex technologies. Attempts by the Bank of England to stimulate investment by giving banks cheap money to lend have simply caused the banks to hoard cash and pay the same big bonuses as always.
- The rate of attrition and destruction of larger companies quoted on the stock markets is alarming. The UK FTSE 100 of the largest companies has “lost” 90% of its original constituents of 1985. Whilst some attrition is to be expected, this is huge - and it has not been compensated by sparkling performance. The profit and sales growth of FTSE 100 companies hardly matches GDP growth, investment has been way behind that of competitor nations; companies in “intelligent” industries have failed at a high rate, being replaced by a plethora of outsourcing and lower-level service enterprises. The big “success” stories - growth in investor dividends and boom in top executive pay, both totally detached from performance.
The advantages of steering clear of the financial markets
Swiss Bank Credit Suisse researched the relative performances of some of the largest family-owned businesses in the world and concluded that their long-term performances far exceeded the aggregate of those exposed to external investors. They concluded that the reasons for this were a long-term commitment to the company, financial conservatism an aversion to big deals and financial engineering; and sticking to their core strengths.
Other forms of enterprise, such as partnerships, co-operatives and mutually-owned businesses, provided they stay faithful to their founding principles, demonstrate comparable performance and far greater durability than their investor ”owned” counterparts.
How do investors undermine and destroy good enterprises?
The following letter from the CEO of a manufacturing company with a 165 year successful record demonstrates an all too typical example of how the “financialisation” of industry is undermining economies. This kind of story has been repeated continuously over the 30 years or so that the financial markets have come to dominate industry.
ELEMENTIS CHROMIUM, EAGLESCLIFFE. UK
A STORY OF INDUSTRIAL VANDALISM.
Below is an open letter written in 2009 by Bruce Norman, who was the Managing Director of Elementis Chromium from 1992 to 1999. I have published the letter as I received it from him, and have not independently verified the facts, but the substance of his story is only too typical of the current investment system - huge profits for a small number of insiders, ruination and misery for the powerless majority.
“In the last few days there has been much media attention paid to the potential closure of the Corus Teesside Steelworks with the loss of thousands of jobs and the demise of one of Britain's Industrial successes What has received far less attention is an equally significant closure happening 10 miles up the river at the Eaglescliffe site of Elementis Chromium,an industrial site with a proud heritage that stretches back 175 years. The closure may only impact a few hundred people rather than several thousand, but is equally devastating for the employees and families involved.
During the 1990's Elementis Chromium, or British Chrome and Chemicals as it was then, was also a British industrial success story. It received a Queens Award for Export Achievement and during the period 1995-1999 was achieving operating profits in excess of £20 million a year. In 1998 the company commissioned a ground breaking new Chromic Acid plant, built using technology developed on the site, for which it which received a second Queens Award for Technological Innovation.
So how is it that only 10 years later the site is facing closure? During this time the site has faced many challenges......increased competition from Russia, China, and Kazakhstan, high UK energy costs, a strong currency........... but these are no different to those it has faced many times in the past....... The real difference has been in the quality of strategic decisions made to respond to these challenges and for this responsibility must lie with the London based board of the parent company Elementis PLC and successive generations of directors.
For the first 165 years of its existence, decisions about the future of Eaglescliffe were largely determined by management located at the site. Major investment decisions required approval of the board in London but the board trusted local management and respected their views. The goal of the experienced site management team was to take the right long term decisions for the chrome business so that they would be able to hand on a stronger business to their successors. This approach worked.
All that changed in the late 90's. A new Chairman and Chief Executive of Elementis PLC were appointed who believed that they understood the chrome business better than local management. Decision making moved to London and decisions were no longer taken with a view to the long term, but rather to meet the short term demands of the City. Worse was to follow. In 2005 the parent company in London came under the control of American Venture Capitalists. They bought a minority stake in Elementis PLC and, working with the Institutional Investors, ousted the existing board of directors and installed their own people. Having gained control they needed to do something dramatic to impress the stock market and boost the share price so that they could sell up and move on. The only dramatic short term action they could take was to cut costs, close plants and sack people. Eaglescliffe became the sacrificial lamb.
One of its two primary production kilns was closed along with the new award winning chromic acid plant .Two hundred people were made redundant. The share price rocketed and the venture capitalists sold out earning themselves a profit of £50 million. Where did this £50 million come from? It came from us, our pension funds and endowment policies, as the institutional investors bought back the same shares they had sold two years earlier at a much higher price. Not unsurprisingly the price is now well below where it was when the venture capitalists became involved .Not only did the new board shut down economically sound facilities they also stripped the site of its remaining experienced management and moved the management of the chrome business to a new headquarters in New Jersey. The PLC board remained in London but much of the decision making moved to the USA.”
What's to be done?
First, this is a fundamental problem. The investment markets in their current form are a cancer in the guts of the economy.
For decades, the London investment banking industry has been a net liability for the UK economy. It finally sealed its disaster status through the financial implosion of 2007 - ? Then, massive amounts of public money were spent to prop up the whole rotten system. If this amount of public money had been invested in the reconstruction of the productive manufacturing and technology sectors, the opposition from the right wing and free-marketeers would have been intense. Yet the money was wastefully spent, leaving the economy still devoid of constructive investment and heavily dependent on the dysfunctional and corrupt investment banks. As Andrew Haldane of the Bank of England has said, the banks are preventing economic recovery.
Some positive Actions
- Split the banks immediately - remove the influence of systemically dysfunctional “casino” S-called investment banks from the more serious matter of lending and investment to smaller businesses.
- Dispel the myth that institutional investors are the owners of enterprises and managers should serve their interests. They are not owners - they are in the main the agents of pension fund members and savers who entrust their money without any real influence on how the investors behave. Create a duty on investors to pay attention to the longer term interests of the organisations in which they invest and reduce the benefits of buying and selling shares by a transaction tax.
- Reward long-term shareholding. Give very strong incentives to those investors who demonstrate healthy values, avoid speculation and portfolio manipulation and take the trouble to understand the enterprises they invest in. This kind of investor should be given access to company information and tax incentives. However, they should NOT have special voting privileges over the employment of top managers, that should be left to boards.
- Make directors responsible for the long-term husbandry and health of the company. Remove the over-riding requirement to serve the needs of shareholders, who are only one stakeholder and not the most important. Ensure that directors are not rewarded for selling the company to the highest bidder - make Mergers and Acquisitions more difficult. Reward investment bankers and directors only on the longer term value created by mergers, not on the value of the deal.
- Create a national investment bank, independent of politicians, led by a board with practical experience of industry and technology, and open to small investors, who should have some downside protection on the value of their investments.
- Make science, engineering and technology special. Give special attention to developing technology skills at all levels. Most politicians have not the vaguest idea of how technological organisations work. Most investors have little idea of how any company really works - nor do they care. Their only interest is in shuffling their investment portfolios to achieve the best short term results - and even in this they usually fail. James Dyson, the massively successful engineering entrepreneur, recently said the success of his company relied on research and development investment and the quality of technologists - and that countries which did not offer special incentives for the training and careers of such people placed themselves at a fatal disadvantage in the modern world economy. If we look at the backgrounds of most political leaders, the heart sinks at the thought that they seem incapable of understanding this simple fact. The South Koreans as leaders in technology investment have got it right.
Facebook was recently floated on the investment market. Investors went mad, falling over themselves in a frenzy of speculative excess. The company was nominated as “The New Google” and the initial flotation price was massive. Now, the heat has died down and severe doubts about Facebook's value and prospects are emerging. Great is the whining from investors. There are demands for founder and CEO Zuckerberg to be removed and replaced by a more investor-friendly leader.
What the investment horde missed in their speculative frenzy was this piece of the company's prospectus:
Mark Zuckerberg's Letter To Shareholders
“Facebook was not originally created to be a company. It was built to accomplish a social mission - to make the world more open and connected.
We think it's important that everyone who invests in Facebook understands what this mission means to us, how we make decisions and why we do the things we do.
I will try to outline our approach in this letter.
Before I begin, let me remind you that I own 57% of the voting stock of Facebook, which means I have complete control over it. I organized the company this way many years ago, with the very deliberate intention of maintaining complete control over it. I did this so I wouldn't get overruled and canned by venture capitalists, a fate that unfortunately befalls many entrepreneurs. I also did it so in the event that we ever had to go public-which we unfortunately have to do now-I would never have to pay attention to whiny short-term public shareholders. Those whiny short-term public shareholders have destroyed many great companies by making management obsess about absurd near-term financial targets. I have made sure that that's never going to happen to Facebook. If there ever comes a day when you and I disagree about the future direction of the company, rest assured: Your choice will be my way or the highway”.
The contemporary world needs more industrial leaders with the creative spirit and desire to build something of lasting value of Zuckerberg and Dyson. There are bound to be some mistakes, but nothing could be worse than the current sterile and destructive dominance of the financial markets.