The developing relationship between top managers and the financial markets is having corrosive long-term effects on the performance and competitiveness of many larger British-quoted companies, which feeds into the economy more generally, affecting investment, performance, innovation and employment.
These effects are noticeable in the balance of the British economy, in the relative dominance of the financial services sector, in the lack of innovation by many British companies and in the rates of company decline and failure. International manifestations are the failure of British companies to compete in many technology-driven industries.
It is now the case that strategic and key investment decisions affecting many key modern industries are being made out-with British influence. Ownership of know-how and vital intellectual property has become foreign-owned and it is now becoming clear that many foreign-based technology companies are decreasing their investment on R&D in Britain.
But there are also noticeably positive effects. Inwardly investing foreign companies perform better and invest at consistently higher levels than their indigenous counterparts. They are often better managed and pay staff more than indigenous counterparts.
Given the relatively low rates of innovation, R&D and general investment by British companies, the health of the British economy is increasingly dependent on inward investment. Foreign owned companies in Britain now account for some 50% of gross exports.
The culture, tax, regulatory and education systems, location and general 'business friendliness' of Britain makes it a country with high potential to attain a sustainably high level of economic performance. However, the financial markets, as they are currently configured, do not enhance this potential and are a potential threat to the health of the UK economy. In particular, they do not generally support people and enterprises to innovate and invest for long-term competitiveness.
The 'system' represented by the relationships between industry and the financial markets needs far greater reform than is currently being contemplated.
The State of UK Industry.
- Inward Investment.
The UK economy is now significantly dependent on inward investment:
- Between 1998 and 2003, inward investment exceeded outward by £3530 Billion.
- In 2003, foreign investment accounted for 37.5% of GDP
- In 2002, 40% of UK's top exporting companies were foreign-owned, and nearly 50% of Britain's gross exports came from foreign-owned companies.
- Performance of foreign enterprises.
- The levels of investment, pay and productivity of foreign companies in Britain far exceeds that of indigenous companies:
Comparing the characteristics of foreign-owned and host country (UK) establishments in Britain, 2001.
British domestic British multi-nationals Foreign multi-nationals Manufacturing Value-added per employee 92 102 116 Investment/employee 94 98 115 Service industries Value-added per employee 94 113 120 Investment per employee 96 105 119 Average wage* 18.7 21.7 26** 24***
** US multi-nationals in UK
*** Other foreign multi-nationals in UK
Sources: Institute for Fiscal Studies, NIESR, DTI.
- The levels of investment, pay and productivity of foreign companies in Britain far exceeds that of indigenous companies:
- International Comparisons.
The UK still has a world class science research base in universities and other institutions:
The number of academic papers and citations produced per head is the highest amongst the G8 nations (Thompson ISI)
However, this apparent advantage has historically not been translated into practical innovation in industry and into new products and services:
The UK stands 8th in Europe, behind Germany, Ireland, Austria, Sweden, Netherlands, Finland and Spain in terms of revenues generated in industry from new or improved manufactured products. (DTI)
The UK also stands well behind all OECD countries in maintaining spend on industrial R&D:
Only the UK amongst OECD countries had a lower share of GDP spent on R&D in 2000 than in 1981. In Britain, in 2000, it was 1.9%, in the US, 2.7% and Germany, 2.5% (OECD). In 2005, the investment in R&D by Britain's 750 top-spending companies decreased by 0.5%. Most tellingly, this decline was driven by a 3% decrease by foreign-owned companies - deepening the concern that foreign companies are likely to 'offshore' research and innovation, whilst maintaining investment in productivity-enhancing capital expenditure. Thus, foreign ownership is likely to decrease the creation of 'break-through' and advanced knowledge creation in UK industry.
Also, the number of patents generated in Britain per million inhabitants was exceeded by the US and 15 of the largest developed countries.
The US achieved 70% more, Germany and Finland twice as many and Sweden three times.
Skills and Employment
We hear much of the UK skills gap, mainly based on the premise that the supply of skills will somehow drive demand through the creation of skilled occupations.
Is there any evidence of that happening? Not much:
Between 1991 and 2001, the most rapidly growing occupation has been Hairdressing.
Other huge growth areas were 'Elementary Occupations' like retail assistants and cleaners, Professionals in Health and Education, Associate Professionals, like nursing auxiliaries, social workers and community policing.
The number of people in management remained the same, but there was a change in the nature of what was managed towards office-based occupations like call centres, sales and 'customer service'.
There is no evidence of a marked increase in demand for technological and science-based jobs, as might be caused by a surge in demand for skilled employees in high-tech industries.
Other clues lie in the employment of qualified staff.
The table shows the proportions of employees with High, Intermediate and Low qualifications in the workforce in several developed countries:
The industrial sectors that have seen the greatest increase in employment are:
- Banking and finance, from 2.9% to 4.6% of total employment,
- Distribution and retailing, from 5.0% to 5.7%,
- 'Other Services', from 7.2% to 7.9%
The biggest 'loser' is Manufacturing - which in the US contains 25 out of the 29 concentrations of highly skilled occupations but is said not to matter in Britain - with a decrease from 4.5% to 3.9% and still dropping rapidly.
The most rapid growth in employment has been amongst part-time women, and then in other relatively low-skilled employment categories. This gives rise to the fear that we are seeing the emergence of 'hourglass' employment, with a group of very highly paid employees at the top, a declining middle group, containing skilled and semi-skilled workers, and burgeoning employment in relatively low-skilled, often part-time employment.
We should emphasise that we are not employment snobs - it is the apparent lack of balance in employment that is of concern. This does not smack of Gordon Brown's powerhouse of finance, enterprise and technology: "I want Britain to be not only a centre for the science-based industries of the future but also the hub for creative industries as a whole".
Commitment and Work-related Stress
Many commentators have been warning of a coming crisis of trust and confidence in the private sector - and by and large they have been exaggerating in the past.
Now the portents are really ominous:
- 'People who run large companies' now enjoy the same levels of public esteem as estate agents, politicians, Red-top journalists and banks - and that 'aint good!.
- Britain's long-hours culture is causing a crisis of health and declining productivity among white collar staff, according to research from the Chartered Management Institute, published in March 2006. The survey, by Professor Cary Cooper of Lancaster University and others established that over 90% of managers worked more than their contract hours, with 40% working more than 60 hours a week. In addition, the proportion of managers on short-term and fixed contracts reached 57%. Prof Cooper said 'Managers are telling us that the psychological contract has been broken between them and their employers. We are seeing a short-term contract culture added to a long-hours culture'.
- Yet more research by Prof. David Guest of King's College London identifies distinct longer-term trends in the attitudes of private sector employees. These trends begin to move in a markedly negative direction from the year 2000 and have continued into 2004.
In particular, there are strongly negative trends in perceptions of the relationship between pay and work demands, trust in management, work satisfaction, motivation and the intention to quit.
Employee satisfaction and the Psychological Contract, CIPD, 2004.
WHAT ABOUT THE FTSE 100?
The FTSE represents the apex of Britain's industrial and commercial economy. FTSE companies are the 100 largest in the land:
The figures below are for 2002, when the FTSE 100 was at a low point. In a word, the FTSE 100 is huge:
|Employment as a % share of UK employment||Pre-tax profit as a % of total UK corporate profits||Market Value as % of UK GDP|
|16.1 (2000, 14.6)||23.3 (2000, 42.3)||91.3 (2000, 148.7)|
In 2002, the average number of employees per company in the FTSE 100 and S&P 500 was 44,000.
In mid-March, 2005, the combined value of the FTSE top 5 companies was £527 billon.
FTSE 100 companies are subject to the most intensive investment analysis money can buy. Except for 'players' in the City and some entrepreneurs, their leaders are the most highly paid in the country. Surely the combined effects of stock market disciplines and inspired leadership must have created a powerhouse of innovation, efficiency and performance?
To start we return to the research published in early 2006 by professor Karel Williams and colleagues from the University of Manchester.
They describe massive changes in the nature of giant companies' corporate strategies that have occurred over the last 20 years.
Intense pressures from the capital markets have caused companies to focus mainly on how to satisfy investors. In turn, this has changed the character of corporate strategy, which has become, in essence, the production of numbers for the markets, supported by a 'narrative' that supports the numbers.
More important than this, the primary role of the corporate office is now to support top managers in their transactions with the financial markets, which are now estimated to take up about one third of CEOs' time.
This finding is supported by much corroborative evidence, as outlined in Propositions One and Two.
Corporate offices of many FTSE 100 companies have therefore become mirror images of the financial markets. The effect of this and the pressures for narrow corporate governance have been to distance boards from the businesses and organisations they are supposed to lead. This leaves corporate managers with a limited range of 'levers' that they can use to improve the business. A short tenure CEO is most likely to resort to transactional means to improve performance and impress the financial markets - thus the massive dependence on corporate restructuring and mergers and acquisitions - neither of which have been demonstrated to have the desired long-term effects.
Has this created a high-performance engine that can power the economy?
Judge for yourself.
FTSE 100 Performance
Annualised Percentage Increases 1983 t0 2002
|FTSE 100||S&P 500 (U.S)|
|Profit Before Tax||2.7||1.5|
|Return on Capital (2002)||3.6%||1.3%|
|Dividends/R&D spend (2005)||162.0%||48.0%|
|(Germany and Japan, 19%)|
|Directors' Pay||26.2||N/A (very large)|
|CEOs' Pay as multiple|
of average pay (2003)
Most data drawn from: Financialisation and Strategy, Froud et al, Routledge, 2006.
- The rate of sales and profit growth in both FTSE 100 and S&P 500 is not significantly greater than the underlying growth rate of the two economies.
- In UK companies, the rate of dividend growth far exceeds the rate of underlying growth in profits. This has supported share prices, (and directors' pay), but is probably one driver of a generally low rate of investment in R&D and capital expenditure.
- In 2005, the top 750 'British' R&D-intensive companies spent £17 billion (240 of these 750 were foreign-owned and overall reduced their UK R&D spending).
The minister in charge of technology announced "UK companies ranked 'intensive' for R&D have surged by more than 75% in the past 4 years".
This contrasts strangely with the revelation in the same report that R&D spend had reduced by 0.5% in 2005, continuing a long-term trend.
- By comparison, FTSE 100 companies spent £39 billion on mergers and acquisitions in 2003 - and £306 billion in 2000. It is very well known that M&A destroys far more value than it creates. So 'buy, not create', seems to be the order of the day.
- The 'spread' of FTSE 100 companies across industrial sectors is hardly that of a high-tech economy:
|Sector||Number of Companies|
|Banking and Financial Services||24|
|Media and Entertainment||14|
|Food, Drink, Tobacco||12|
|Mining and Resources||8|
|Transport and Distribution||1|
|Aerospace, Engineering, Materials||5|
Of this listing, only the last two, making up 9% of the FTSE 100, could be regarded as genuine creators of science and technology-based products.
There seems to be a definite bias towards financial companies and companies that have secure markets or are in industries where one can measure the tangible assets. Clearly, the lead for a science-led economy is not going to come from here.
Oh, and as manufacturing and technology account for a large part of UK exports, the decline of British companies in these sectors means that the burgeoning Balance of Payments deficit is likely to be permanent.
The driving force? Short-term, risk-averse investment.
Research into the values and practices of UK investors led by Prof. Andrew Tylecote of the University of Sheffield concluded that the UK stock market had a world-leading aversion to long-term investment in technology.+
The UK is strong in just two sectors of advanced technology - Aerospace and Pharmaceuticals. Pharmaceuticals is described by the researchers as a special case, where the need for R&D is understood on an industry-wide scale and risks are reduced by patent protection and having governmental and quasi-governmental bodies as customers.
The two UK players in aerospace, BAe Systems and Rolls Royce, are protected by a UK government 'golden share' that makes them difficult to acquire, although BAe Systems is known to have unsuccessfully hawked itself around US companies looking for a 'merger' partner.
Thus UK investors will support high levels of R&D in Pharmaceuticals, because the industry can be understood without having a close relationship with individual companies; and in the cases of BAe and Rolls Royce, because they find it difficult to stop them.
In all other high-investment, high technology sectors, the UK is markedly under-represented by big companies. These include:
- IT hardware
- Electronic and electrical equipment
- Office, accounting and computing equipment
- Radio, TV and telecommunications equipment
- Chemicals - a rapidly declining sector in the UK
- Industrial Gases and Cryogenics
- Computer software, except for standard software.
- And for good measure, Investment Banking, Ports and Airports, international Consulting - and probably to come, Stock Exchanges!
This list might be described as the sinews of a modern high-technology economy.
+'UK Corporate Governance and Innovation.' Professor Andrew Tylecote, University of Sheffield Business School and Dr Paulina Ramirez, Centre on Innovation and Structural Change, University of Ireland, Galway.
Where are we going?
There seem to be too many threads that indicate that, despite the talents and capacity for hard work of a generally well-educated workforce and apparently good news about the British economy - together with frequent trumpetings of schadenfreude from Treasury sources - all is not as well as it could be at the top end of British industry.
We have an uneasy feeling that Britain may be sliding ever so gently towards a high-employment, low wage, low added-value, and lowish-knowledge economy - with the creation of most of the fundamental technologies that underpin modern industry is carried out elsewhere. This is not the kind of economy that will continue to support the excellent academic and research facilities that we currently possess - nor will it retain many of the people with the highest innovative skills. We hope that we may be wrong, but feel that we are not.
Readers can make up their own minds.....
However, there is also good news, as we shall see in the next Section..........
You may also like to read our piece on Gordon Brown's Vision for Britain in the Hot Topics section of this site