WHEB Commentary

Tim Dieppe

Will Capitalism Survive the Long Term?


“Business leaders today face a choice: We can reform capitalism, or we can let capitalism be reformed for us, through political measures and the pressures of an angry public.”

dominic-barton

So says Dominic Barton, global managing director of McKinsey & Company in his 2011 Harvard Business Review article: “Capitalism for the Long Term.”*   I saw him speak at an event hosted by Tomorrow’s Value in earlier this month and the points he makes are challenging and pertinent for the future of capitalism as we emerge from the depths of the financial crisis.

Barton issued the following warnings for capitalism:

1. Trust in business is declining. From levels of 65% in 1966 to a low of 21% in 2012, though in Asia levels of trust in business are >50% and Brazil they are at 65%.

2. There is rising inequality throughout the OECD. In 1970 the top 1% took 7% of income. In 2009 the top 1% took 14% of income. Meanwhile the share of the bottom 10% has declined by 25% from 4% to 3%. Inequalities in the US and Italy are even more extreme.

3. Youth unemployment is too high. 21% of 16-24 year olds in the UK are unemployed. In Spain there is 56% youth unemployment.These warnings show that reform is required if capitalism is to survive. Regulators and politicians recognise the need to change – do business leaders? Barton also highlighted that we are facing a period of dramatic change. In fact he said that the next 10-30 years will be dramatic in world history because of the following factors:

  • There will be 3bn new middle-class consumers – 1,000 times the increase from the industrial revolution.
  • Technology is moving rapidly and disruptively. The lifespan of a tech company has reduced from 90 years to 18 years. Economic growth is being created without job creation.
  • Resource constraints will be an issue. It is expected that we will see a 40% excess demand of water over supply in 2030. Food and energy supply will also come under pressure.
  • Demographic trends predict that we will see a decline from 10 workers per retiree to 3 workers per retiree from 2000 to 2050.
  • Governments have become too short term. Politicians are not putting long term policies into place to tackle these issues.So how can capitalism be reformed to address these issues? Barton suggests three areas of focus.

First, businesses should focus on stakeholder value – not just shareholder value. The business must benefit all stakeholders in order to maintain a licence to operate. Businesses that focus on how they can benefit their local communities, the environment, their customers and employees as well as shareholders are businesses prepared for the long term.

Second, Barton advocates more owner-based governance. He says that boards spend too much time on fiduciary duties and only 4% of boards have a long term strategy committee.

Lastly, Barton discussed how we can shift from ‘quarterly capitalism’ to long term capitalism. He contends that CEO’s currently spend too much time on their latest results. A McKinsey survey found that 55% of CEO’s will reject an NPV (Net Present Value) positive investment if it means they will miss the next quarter’s earnings forecast. Average holding periods have declined from 7 years to 7 months. The move to DC (Direct Contribution) pension schemes has caused savers to churn their pension investments more. Institutional investors own more but are less active, engage less and accept shorter-term mandates.

There is a role for regulation in all of this. Quarterly reporting should be scrapped. The event was introduced by Lady Barbara Judge who was on the SEC when they decided to introduce quarterly reporting in order to improve transparency. She now recognises that it was a mistake as it only served to increase short termism. There is now a growing list of companies refusing to issue quarterly guidance, including Unilever, Coca-Cola, Ford and Google. Mark-to-market accounting should also be revised as it only serves to amplify short term moves.

Stock-based compensation also carries a considerable portion of the blame. It has been the principle cause of the rise in income inequality, and has motivated CEOs to think primarily in terms of shareholder value rather than stakeholder value. Urgent reform is required here and shareholders should be more active in voting down excessive pay packages that also serve to destroy shareholder value.

“For business leaders,” says Barton, “the most consequential outcome of the crisis is the challenge to capitalism itself.” This is no time to relax, relieved that the worst is behind us. The whole culture of capitalism needs to change. Will capitalism survive? Only if reform for the long term is successful.

*Dominic Barton, “Capitalism for the Long Term”, Harvard Business Review, March 2011.

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