Six principles for saving American capitalism
Mar 29th 2009 2:00PM
Updated Dec 4th 2009 11:47AM
The newspapers are looking ahead to this Tuesday's G-20 summit in London. Since the leaders who show up there represent countries that control 80 percent of the world's economy, it could be an important meeting. If you live in the U.K. or U.S., your leaders will be attacked by those in other countries who believe that they should not be asked to bail out the errors of Anglo-American capitalism. Beyond that, little of substance is likely to be accomplished.
However, in an alternative universe, the G-20 meeting might actually accomplish something. Specifically, it could get agreement on six principles on which to rebuild American capitalism. Here's what I think those would be:
Grow through technology-based innovation. The United States used to be admired around the world for its ability to create new industries. In the 1990s, an Asian government wanted to emulate our success and asked me to discuss how the United States turns innovation into economic growth. Unfortunately, since 2000 our ability to take brilliant ideas from our top universities and turn them into venture-backed companies that sell their shares to the public to fuel the creation of new industries has largely been broken. If there is to be growth, it should come from reviving this process.
Return Wall Street to a support role. As I posted, Wall Street has played too prominent a role in the global financial system and in our politics. As a result of that power, it has been able to shape a regulatory structure that frees it to capture and pay itself all the profit it generates and shift all its losses onto the taxpayer. Such a system has sucked the most talented people in the world away from more productive activities. Wall Street should stop being the tail that wags the dog and return to its role of supporting the capital raising activities of technology-based innovators.
Free the global economy from excessive dependence on consumer spending. Seventy percent of U.S. gross domestic product (GDP) growth flows from consumer spending. This economic structure puts too much of the burden for growth on consumers whose incomes are dropping thanks to companies' eagerness to outsource work to the lowest cost country. Then consumers must make up the difference between what things cost and what they can afford by borrowing more than they can pay back. Instead, we should base economic growth more on enterprise and government spending and less on consumers.
Limit leverage to create a post-bubble economy. Now that consumers are unable to pay back their debts, banks and regulators are clamping down on lending. But that won't last forever since lower interest rates are permitting banks to rebuild their capital war chests by paying zero to depositors and charging 15 percent to borrowers. Once banks have reloaded their balance sheets, they'll start lending again and keep adding more and more debt until borrowers can no longer repay. Then the bubble cycle will begin anew. As I posted, a key lesson of the past several decades is that debt must be tightly regulated so that borrowing induced bubbles do not become an excuse for a failure to innovate.
Stop letting managers write their own report cards. At the root of many financial scandals over the last decades is a system that enables the people who are supposed to be looking out for the interests of shareholders to generate their own report cards. As I posted, Bernie Madoff would never have been able to pull off his fraud if a truly independent entity had been sending out account statements. Ratings agencies would not have AAA-rated toxic waste if they were not being paid by the investment banks that issued the securities. Enron would not have gone off the tracks if its CFO had not been able to hide its true liabilities. We need to take away financial reporting from managers and give it to a truly independent body.
Put deal-maker pay into escrow. People will do what you pay them the most money to do. And as much as it would be good for it to change, deal-makers will continue to be powerful. Therefore it matters how deal-makers get paid. As I posted, if you pay deal-makers for bringing in big deals that later lose money, they will keep bringing in big deals that later lose money. Here's a better way: Put their pay in escrow and if their deals make money, after, say, five years they will get the money in the escrow account. If the deals lose money, the escrow repays investors for their losses. This pay change would change deal-maker behavior -- they'd be more careful before booking bad deals.
The basic idea is that we need to get back to what really propels the world forward -- new technology that makes life better for consumers and enterprises. And the rest of it should fly in unison behind that banner.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.