Part 1 of Series of Opinions and Reflections on Responsible Capitalism.
We
are entering the unchartered waters of the new Modern Global Economy -
witnessing floundering politicians who look overwhelmed by the
magnitude of the task ahead, and the economists who have thrown out the
rulebook.
A Spanish philosopher once said, “Nations that
do not learn from history are condemned to repeat their past
mistakes”. And whilst he was talking specifically about the
national dilemma of Spain in the 18th century, these words of wisdom
can easily be applied to the personal, national and global situations
of today, be they economic or political.
Sadly, the modern
mantra of so-called Smart Management has been, “Don’t give
me the problem, give me the solution” – usually combined
with ‘the elevator pitch’ mentality, so we may find the
problem right here. We do not want to be reminded of failures, so we
never learn from the mistakes of the past, and hence are condemned to
repeat them!
For the uninitiated, the phrase ‘elevator pitch’ was coined by American businesses and refers to a 20 second précis of any subject. The idea is to imagine that you meet your boss, or an important prospective customer, as you are waiting for a lift. Suddenly you are presented with the golden opportunity to ‘make a pitch’, either to present an idea you have had to your boss, or to present your proposition to a potential client. You have around 20 seconds to do this, in a lift that is speeding towards your floor, so get to it . . .
This ‘elevator pitch’ mentality has created a culture of oversimplification in every aspect of business and life, whether you’re presenting a new advertising campaign, trying to communicate the value-proposition of your company or product, or even trying to explain what the problem in Middle East actually is!
The root cause of the current economic problem lies in the fact that people ignore the first rule of economics (supply and demand) in their rush to explain everything in those 20 seconds. The basic premise of this doctrine is the definition of ‘demand’. In an economic context, demand is a far cry from someone simply saying ‘I want one’, or the ‘spoilt child’ syndrome of wanting everything within sight. Though having said that, given the last three decades, the world’s consumers have unfortunately been conditioned to behave exactly like a wanting child! Demand, in the economic context, is defined as “the desire for a product or service, by those who have the means to acquire or consume it”. So in simple terms, ‘demand’ for anything only qualifies if it comes from those who have the means to acquire it.
However, to serve their individual ambitions of election or re-election, politicians of all political colours have encouraged a growth in ‘demand’ by creating an illusion of individual capacity to purchase. This was created by lifting restrictions on the supply of money into the economy, by relaxing the regulations on banks and other institutions to lend money. Loosening of credit regulations enabled many consumers to purchase goods and services on the back of potential future earnings, rather than on their individual and real ability to afford them, as defined by the true definition of ‘demand’.
In this perverse environment, roles and functions were distorted beyond any recognition. For example, consumers were purchasing second or third properties with mortgages of up to 120% of the bank’s valuation, and then proudly labelling themselves as ‘investors’! A further distortion and abuse of the English language and of economic principals as we know them. Investing money that you do not have into any asset, based on borrowing and in the hope of making a profit on its sale, is speculation at best or gambling at worst, but never an ‘investment’.
The Oxford English Dictionary defines the verb ‘to speculate’ as follows:
- to form a theory or conjecture about a subject without firm evidence – e.g. ‘my colleagues speculate about my private life’ or ‘observers speculated that the authorities wished to improve their image’.
- to invest in stocks, property or other ventures in the hope of gain, but with the risk of loss – e.g. ‘he didn't look as though he had the money to speculate in stocks’.
But sadly, it appears that most property buyers at the time did not have an Oxford English Dictionary to hand and alas our politicians, who were chasing re-election, did not wish to rain on the consumers’ parade!
So when the economy started to hit the buffers in the early part of the decade, the solution from the world’s governments was yet another loosening of credit regulations, so that we could borrow at an even madder rate than before - hence releasing the unbridled credit boom. Consumerism dragged the economy out of the doldrums and the governments hailed their policy as great success, carrying on regardless.
All appeared to be well until another economic rule showed its ugly head. In order for one person to borrow, another person needs to save. But more and more people were becoming borrowers and the question was, who was going to save so that all these consumers could borrow?! Britain had long ago given up its reputation as a nation of savers, and had travelled along the road of the American ‘consumerist’ model. The other big savers of the world such as China and India also got the bug for consumption and this left us with too many consumers and not enough savers. And I don’t think we need an economist to tell us what comes next!
The nail in the coffin of this economic charade came with the extraordinary rise of crude oil prices in 2008. A rise at this rate had not been seen since the oil shock of the 1970s and it had an immediate impact on every aspect of the supply chain. A rise in transportation costs led to material price rises, which were already experiencing upward pressure due to high demand from China and India. Price hikes manifested themselves in every aspect of life, from food to transport to housing.
Inflation became the big concern but this time the central banks, including the European Central Bank and the Bank of England, responded like zombies! At a time when industries around the world were grappling with price rises and were concerned about the future demand, the central banks increased the interest rates, in order to dampen demand and so reduce inflation! The last interest rate hike in the UK and the EU was as late as July 2008, by which time those of us in the real economy were getting concerned about slowdown and recession. Had the world gone mad? Had these respected and experienced central bankers seen something that us mere mortals could not fathom?
The truth is that our central bankers are rather conservative with a small ‘c’, but they also appear to have multiple personality problems. They were taking a huge chance by ignoring the credit supply market and the enormous risks which the retail banks were taking. And yet at the same time they were also voicing concerns over inflationary pressures. The bottom line is that they were too out of touch with the real economy. Their automatic response to inflation was based on the assumption that all causes of inflation are the same, and that the response and cure is therefore the same. Remember the 1970s?
The rationale was simple. Inflation is caused by hyper demand (be it real or illusionary), leading to wage increases and other unsavoury malaises of an overheated economy - so we must give it the good old medicine of Interest Rate Hike. Inflation as a result of oil prices did not compute with the central bankers, perhaps because they do not drive themselves to the petrol station or shop at the supermarket regularly enough to see what was really happening. As a result only three months after the last interest rate rise in July 2008, they could be heard murmuring ‘oops’, ‘oh dear’ and other phrases to that effect.
This unholy alliance of credit-driven demand, coupled with ill-judged interest rate increases pushed risky lending over the edge. Defaults by high-risk, or to be politically correct, ‘sub-prime’ borrowers started to increase - pushing the banks’ exposure beyond sustainable levels, and so the entire house of cards imploded.
What is even more stupefying is the response from governments around the world, championed by Mr Brown. They are cutting VAT and taxes (read - income), they are rescuing banks by purchasing toxic assets with taxpayers’ money (read - exposure) and they are pacifying taxpayers by these shareholdings in worthless banks (read - please re-elect me!).
These governments are also rescuing bankrupt auto manufacturers which should have gone out of business years ago, according to the ‘free market’ doctrine. Suddenly everyone is a socialist and free market advocates are little less vocal these days. Prime ministers and presidents (old and new) are telling the electorate “Don’t worry, we will fix this as soon as we can find some more money for you to borrow, then you can all go back to your buying sprees”. And the British Government is printing more money to solve the liquidity problem! At last Britain has something that it can agree on with Robert Mogabe of Zimbabwe and the genius President of Iran !
The fact is, driving demand by the easy supply of credit is only mortgaging the future. Consumers have borrowed up to their capacity, based on their future ability to earn and to service debt. Notwithstanding the fact that some are losing their jobs and their capacity to earn or consume, we have probably consumed our lot for the next decade or so! Bringing forward future demand by releasing credit into the economy is irresponsible and immoral, as well as being a recipe for economic and social disaster.
In reality, the electorate and the political elite need to make some hard decisions. The ‘free for all’ market doctrine has failed, so let’s hope it is buried for good and Rests In Peace! Our society needs to take stock of the new realities. We either want to live in a fool’s paradise or we want to be truly prosperous and civilised. Perhaps we need to stop defining ‘civilisation’ and ‘civilised society’ by the measure of how many expensive cars, large houses and widescreen TVs we have, and by all that is material. Instead, we need to reassess our definitions and make a new contract with humanity.
Economic success in a truly civilised and enlightened society is not dependant on an ‘every man for himself’ and ‘the end justifies the means’ mentality. The price for one man’s prosperity does not have to be another man’s poverty. We can be prosperous and look after the old, the infirm and those who are unable to cope. But to achieve this we have to introduce morality and responsibility into our economic activity and into our belief systems. It is right to ban ‘short selling’ permanently. It is right to put away fraudsters like Madoff. And it is morally correct and responsible to cap lending.
Morality, honour and justice are not the enemies of Capitalism but are instead the virtues of civilised societies, which respect the rights of their citizens to achieve their dreams and their potential. Responsible Capitalism is about having the freedom to fully realise personal potential, to achieve the best that one can and do so in peace and security. Responsible Capitalism recognises that the freedom of an individual is not boundless, but that its boundary is where the freedom of another person starts.
We cannot insist that we have a right to property, wealth and wellbeing - yet deny others the same choices, because we see our way of life as superior and so by definition the only one that has a right to exist. We can no longer stay disengaged from our politicians and not hold them accountable, as we are now waking up to the interdependencies of politics and the economy. However, we can with certainty claim that economic success is more likely when populations have the opportunity to exercise their free will - but free will, or democracy if that is what you wish to call it, comes with responsibility, accountability and social justice. We cannot separate our politics from our economics, so to be engaged in one means we have to get involved with the other. If we wish to live in a democracy, we need to accept the responsibilities that this freedom carries.
We cannot allow the economy to run at the hyper credit levels of the last two decades, creating illusionary and false demand, even if it costs the ruling party the next General Election! The future of the country is more important than the party. This does mean hard times for a number of years and there is a social cost that is inevitable and regrettable. We need to create the safety nets which are necessary to ensure we minimise hardship and suffering, but this cold is not going to go away without becoming a fever first. We have had the fun and it is time for the hangover, so may be next time we should drink a little less and not stay so long at the party!
So what is the practical answer to this? In economic terms, we need to recognise and come into terms with our national capacity to consume - which should be equal to the availability of funds (note not cash Mr Brown) at a reasonable risk. We need to stabilise falling demand by supporting companies with meaningful government loan guarantees, so that more people do not lose their jobs and so reduce the capacity in the economy even further.
These ‘gesture politics’, such as providing a laughable £20 billion in loan guarantees, need to stop. Take note Mr Mandelson. £20 billion sounds like a great deal of money, but in the context of the fourth-largest economy in the world, with a GDP of £1.47 trillion, it doesn’t even qualify as small change. Reducing VAT sounds great the next day when your aids are reviewing the papers, but as we have seen it achieves precisely zero - even though ministers have the audacity to claim that things would have been worse without it. Just do the maths on a £150 weekly food shop and see how much this policy has saved for every household.
In these uncertain times one thing at least is certain. Until governments stop playing games and using smokescreens to fool the electorate so that they can be re-elected, we will never find the solution. And that is a long time to be in recession.
Ali Zartash-Lloyd is Managing Partner at Cognisant Associates a business consulting partnership. He is a management graduate from the University of Leicester and was European Director for major US and Korean multi-nationals for over a decade.
