Taking Responsibility (Part 1)

When our elected governments and institutions do the things we asked of them

We make implicit or explicit demands upon our institutions and we must follow them to their origins. A society in denial can not properly function in a competitive world. Here are some examples of current concern:

Foreign Outsourcing

Follow this line of argument.
Companies out source to lower costs.
In a Capitalist system companies must do whatever they can to remain competitive with others in their industry. This means lowering material-, labor- and financing-costs, among others. Those that fail to compete lose business and eventually fail.
It is customary to speak of a "market economy" these days, but nothing has changed in most western countries over the past two hundred years. The "market" is where goods are traded, but the economic organization of firms is still primarily private enterprise Capitalism.

Lower costs lead to higher profits.
Assuming that other firms have the same basic structure then lowering costs will increase the "bottom line", that is profits. In a truly competitive climate it is hard for single company to raise prices, it will be "uncompetitive". Thus the attempt to lower costs. Sometimes companies have sufficient control of a market that they have little or no effective competition. In that case they are more free to raise prices, but run the risk of product substitution if they become too expensive. Such companies are monopolies or shared monopolies.

Higher profits lead to a better rating on Wall Street.
The financial sector industry is now a significant part of the economy. This sector provides financing to companies in the form of direct lending and assistance in floating capital shares in the company. There are specialized analysts examining every important company looking at their expenses and income. A company that can control costs is regarded more favorably. Examples of this are seen almost every day in the newspapers. When a company announces a consolidation or layoff the stock typically rises. Just remember the prior point that it is easier to lower costs that raise prices.

Better ratings lead to higher stock prices and/or easier and cheaper access to capital.
An efficiently run company will try to use other people's money to finance its operations. This can be in the form of loans to the company (notes, bonds, commercial paper, etc) or the sale of capital shares. Once a company is established it is hard for it to raise additional capital by selling new shares as this potentially lowers the value of existing ones. Thus, new shares are usually issued only in conjunction with an activity that will increase the size of the company such as a merger or acquisition. So companies are very sensitive to their "ratings". The interest rate and other terms for a loan depend upon this. So improving their "bottom line" has a direct effect on their ability to raise new capital cheaply.

Wall Street's demand for higher profits comes from big institutional investors.
A second pressure on companies comes from the big institutions which are the most common purchasers of large blocks of stock and new bond offerings. Very few of these institutions buy for their own account. Exceptions are insurance companies which need to invest their premiums. Otherwise, the big investors are typically investment consolidators such as retirement plans and mutual funds.

Mutual fund holders demand as high a return as possible.
Mutual funds and retirement plans are also in a competitive market place. Since their source of income is from the yield on bonds and stocks they look for the highest yields. In some cases analysts from these companies or their agents from the financial services area meet directly with firms that they invest in to discuss performance and management issues. The also take seats on the boards of directors of some companies.

Mutual and retirement fund holders are us!
Ultimately the customers of the funds are individual investors or the retirement funds acting on their behalf. It is our contributions to our IRA's and 401 plans that fuels the whole cycle of investment. One hundred years ago most stock was owned by the wealthy as a long-term investment or was restricted to a very small speculative investor class. The last time stock ownership became widespread was in the 1920's and caused a horrific "bubble".

The average fund holder has unrealistic yield expectations.
The typical investor thinks that stocks should yield in the 10-30% growth range. Funds that "underperform" risk seeing a quick drop in the number of investors. Several have gone out of business in the past few years because of this effect. Similar expectations are then pushed on to the companies purchased by the funds.
The actual range of return over long periods of time for stock funds in in the range of 3-4% above inflation. To see that this is so realize that companies can only grow from two effects. First, their market can expand, but this is ultimately limited by the population growth (usually in the 1-2% range). An individual sector, say cell phones, can grow rapidly when it starts out, but eventually it tapers off and its growth is the small number of new customers and replacements. Averaged over the whole economy this is a small effect compared to the number of mature industries.
Second, they can become more efficient, commonly called "productivity growth". Over the past century or so this has generally been in the 2% range as new equipment makes it cheaper to produce things. If stocks could go up faster than this for a long period of time we would be making new money out of thin air. As we move into the "information age" it is not yet clear where such productivity growth will come from. Thus, the pressure on lowering labor costs by outsourcing.
So, ultimately we, the investing public are the source of the pressure on firms to lower their costs as they chase after an unsustainable rate of profit growth.
So our unreasonable expectations for getting rich without working or saving is the ultimate cause for the cut-throat policies of modern corporations. A rational personal investment policy would put aside enough money during the working years to allow a comfortable retirement. It is generally thought that for retirement funds to last for a lifetime not more that an inflation- adjusted 4% should be withdrawn each year. Combine this with the realistic investment return shown above and it is clear that most of us should be setting aside 10-20% of our annual income for retirement.

In the past thirty years heavy industry was destroyed in this country by a policy of taking short-term profits and ignoring long-term capital investment. The most visible example being the steel industry. This same short sighted pursuit of quick profits has now infected the country as a whole. In order for this dangerous trend to be reversed a plan has to be developed to transition from a profit-oriented society to an investment-oriented one. The capital must be diverted from non-productive areas such as militarism to infrastructure development. A key part of this planning must be a realization that blaming the "military industrial complex" without offering a plan on how to substitute for these economic activities during a reorientation will not be fruitful. Criticism without offering realistic alternatives is unproductive.

Moral: "We have met the enemy and he is us" -- Pogo

Read Part 2 - Automotive Society
Read Part 3 - Materialism

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Copyright © 2005 Robert D Feinman
Feel free to use the ideas, but the words are mine.