Remodelling of capitalism

28 JANUARY 2012

This column has spoken of Japan and Germany, having followed forms of stakeholder capitalism, threatening the economic hegemony of the US. The US countered by promoting shareholder capitalism, under which the interests of shareholders, the providers of funds, were the focus, and those of other stakeholders, such as employees, suppliers and customers, were subservient and expected to fall into place.

What has since happened is that excesses of shareholder capitalism have been revealed, leading to protests such as the 'Occupy Wall Street', in which the 99%ers protest the inequality of the top 1%ers. At the World Economic Forum in Davos which started last week, the protesters camped in igloos, driving home the point to world leaders gathered there.

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The pendulum of shareholder capitalism has swung too far, and amongst the main deliberations at WEF, Davos, was how it should be remodelled. One idea is to encourage the kind of stakeholder capitalism that earlier prevailed, which is exemplified, for example, by our policy initiatives on inclusive growth.

Seven of the American states have passed legislation allowing the formation of B (for Benefit) Corporations. These are corporations formed to use the power of business to solve social and environmental problems. So far some 517 companies have been registered as B Corporations. Under current laws, if a company is to be sold, or merged into another, its directors are obliged, for fear of being sued by shareholders, to obtain the best possible price. They may thus have to sell to the highest bidder, as did the owners of ice cream maker, Ben & Jerry's, instead of to a buyer who would preserve the ideals, such as also helping the community. If registered as a B Corporation, they would be protected from such lawsuits.

Much of the problem lies in the fact that the mutual fund industry has now grown larger than the banking industry, and hence corporate managers are required to be in their good books. Institutional shareholders, like these funds, now own 70% of corporate equity. Added to this problem which, this columnist feels is a key part of the problem, is the way compensation packages for the fund managers are devised. The packages have a larger component of variable pay, based on performance, than a fixed component. The effort of the fund managers is thus to ensure a good short term performance, and they try and beat the index rather than look at the longer term. This, in turn, translates to pressure on corporate managers for delivering better quarterly performance.

Which, in its turn, leads to other issues. Consider Apple Inc., which has just delivered excellent results, pleasing its institutional investor owners, declaring a net profit for the Dec quarter of $13.1 b. Revenues from IPhone alone exceed the entire revenues of Microsoft. Yet, as pointed out by Judith Warner there is a human cost to it. The profits come from manufacturing outsourced to China, where labour standards are far more lax than in the US. The same was brought out by monologuist Mike Daisey in his monologue 'The Agony and Ecstacy of Steve Jobs'. Daisey studied the incidence of increasing worker suicides at companies such as Foxconn, to which several US companies outsource manufacturing.

Not only labour, but also the environment bears the brunt of shareholder capitalism spurred growth. For years after the US mandated fuel efficiency standards, the auto industry successfully lobbied to exempt SUVs from the fuel norms. Auto companies made profits selling SUVs. In India, unfortunately, the Government has yet not woken up to the pressing need to set up, and enforce, fuel efficiency standards. It should. We are running out of fossil fuels.

To compound the neglect of setting up standards, we have encouraged the dieselisation of our economy by subsidising both diesel and kerosene (which, being cheaper than diesel, is used to adulterate it, to great health cost for the nation). It is only now that the Government is considering a hike in diesel prices, that too, because of fiscal reasons and not due to environmental or health reasons.

Geopolitical developments are heading towards another oil shock. The EU has just agreed to embargo oil imports from Iran, for its failure to yield on its nuclear development plans. In turn, Iran is threatening two things. One is to shut the Straits of Hormuz, through which much of the world's oiil supplies pass; the US has promised to keep the Strait open, with military might if needed. The second is to threaten Saudi Arabia not to increase its oil production to make good any shortfall due to reduced supply from Iran. Now, when a comparitively small producer like Libya dropped oil output due to its civil war, oil prices spiked $10/b. If Iran's oil production is affected, as seems likely, the spike would be higher.

That would severely dent India's growth story, as we are largely dependent on imported crude oil for part of our energy needs. For power generation, we are largely dependent on coal, and this is also a major concern. The cost of imported coal is going up because exporting countries have started to impose a tax on it. The cost of domestic coal is rising because of various reasons, including the need to set aside a part of profits to get environmental clearance for mining.

The CEO of Unilever, Paul Polman, has warned, at Davos, that the era of cheap food prices is over. The growth in global population, combined with better food habits as incomes rise, is outstripping growth in farm productivity. If true, then the ability of the RBI to contain food inflation through monetary policy, would be quite ineffective.

Despite 13 quarters of hikes in interest rates, inflation has barely come down. This suggests that the remedy may be de-linked from the disease and reminds one of the story of the guy chucking peanuts out of a train, at a railyway station. When asked why he was doing that, he answered, 'to keep the elephants away'. When it was pointed out that there were no elephants, he calmly replied 'see, its working!'

Last week the RBI helped cheer the market by cutting CRR (cash reserve ratio) by an unexpected 50 basis points, or half a %, to release Rs 32,000 crores into the system. However, there is little, or no, demand for finance for projects. Demand for credit is largely for working capital. At an analyst meet, the Chairman of Bank of India, one of the larger PSU banks, stated that they expected credit growth in the coming year to be around 16%, much lower than the 22-24% growth forseen last year. The demand for project financing has fallen because of high interest rates, policy paralysis and inconsistencies in Government policies (e.g. pacts between telcos allowing each others' networks to be used by customers have been allowed for roaming using 2G but not using 3G. This helps no one but only hurts customers).

The stock market cheered the Reserve Bank Of India (RBI) policy driving up the BSE-Sensex 244 points that day, and by 494 points over the week, to end at 17233. The NSE-Nifty gained 155 over the week to end at 5204.

The market seems to be nearing the end of the current rally. Elections to the first of five states, Manipur, have started, and by mid March results would be declared in all. The Union Budget, to be presented after the election results, would also not be a kind one. The fiscal deficit has overshot estimates by miles. (Funnily, if an income tax assessee were to make a similar misjudgement in assessing his income, he would be penalised by the same Ministry who is equally poor in making estimates). One can thus expect either higher taxes, on the plea to 'kindly bear with us', or innovative means of extracting more revenue.

The market expects the interest rate cycle to start moving down, as the RBI has promised to do, after taming inflation. But if Polman is correct, and food inflation continues unabated, one wonders if the RBI would change its position. Some countries such as Turkey have lowered interest rates, living with inflation and pitching for growth, and it is working.

Externally, the crisis in Europe is far from over, with Greece being the immediate problem. Greece faces a repayment on March 20 and desperately needs agreement on a deal before that. Private lenders are not willing to take a larger than 50% haircut, or cut interest rates on new bonds to be issued for old to be less than 4%. Now the EU, led by Germany's Angela Merkel, is asking for powers to veto a fiscal decision taken by the Greek Government if it fails to conform to the terms of any agreement to lend it more money. Thus a default by Greece seems a highly probable event. That, in turn, would trigger payments on the CDS (credit default swaps) and could cause a run on some of the European banks.

Over a longer term, such problems cause mankind to innovate, leading to solutions. The world would find a way to remodel capitalism. Technological solutions would be found for the food problem. In the case of energy, a technology called fracking, which uses horizontal drilling, has been found to make the extraction of oil from shale rock viable. The US has sufficient reserves of oil in its shale rock deposits, and in Canadian tar sands, to make it independent of Middle Eastern Oil. Which is why it has silently permitted the flowering of jasmine revolutions in the region. There are worries, however, that fracking can cause earthquakes, but one believes a technological solution can be found for that as well.

So, if the market dips due to domestic reasons (election results or disappointing budget) or international reasons (default by Greece) one could consider buying.

Note: The author is travelling and would not be in a position to submit this column next Saturday.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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2 Responses to "Remodelling of capitalism"


Jan 29, 2012

The article reflect the true picture and a near possibility of what is going to happen in the world economy


surajit som

Jan 28, 2012

there is really not much to do except publish learned articles. every effort is being is made to avoid a run on the big banks and markets. if markets collapse, then we will have 1929 all over europe and america and then the end of the day-forget all mumbo-jumbo- they are doing that only.the only way it could be done ,is print money.there is nothing else to do.

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