Capitalism in crisis

2011 was a pivotal year in many respects. On the political front the Arab Spring spawned new hope for peoples governed by totalitarian regimes. Here in the West, banks and capitalism in general came under fire from politicians as well as from the general public.

"There is something rotten in the state of Denmark"

Capitalism is the only system that has helped to improve living standards democratically in recent decades. To say it is responsible for the current situation to me seems an oversimplification, especially considering the period of unprecedented prosperity that we have just come through. The technological revolution that drove that prosperity was itself riding on venture capital and the stockmarket via IPOs. On the other hand, that capitalism focused entirely on short-term profit may have reached its limits is probably true. If the only way to boost earning power is to offshore jobs to low-wage countries, then we have run into a dead end. When society exists to preserve banks that are too big to fail and not the other way round, then as the great bard said there is something rotten in the state of Denmark.

Relocating too much of their substance abroad is counterproductive

This facet of globalisation is largely to blame for the jobless recovery in countries that have hollowed out their manufacturing sector, and for the resulting current-account imbalances between many industrialised countries and China. In America the imbalance reached 3.1% of GDP in the fourth quarter of 2011. With hindsight some companies are beginning to realise that relocating too much of their substance abroad is counterproductive. General Electric, for example, having been plagued by lower productivity and logistical problems rooted in intercontinental supply chains, is reinvesting in domestic production facilities. If numerous other players were to follow suit, trade gaps between the developed and emerging countries could be partially bridged.

Capitalism is in crisis and has to reinvent itself

Meanwhile, though, capitalism stands accused of all kinds of social and environmental transgressions and of milking society rather than nourishing it. Capitalism is in crisis and has to reinvent itself.
Without necessarily resorting to the creative destruction advocated by the Austrian economist Joseph Schumpeter, the notion of value creation has to be reassessed and adapted to the 21st century.

Michael E. Porter, a Harvard professor who helped to pioneer strategic analysis and wrote the bestseller Competitive Strategy, Techniques for Analyzing Industries and Competitors, delved into this issue in a recent article . He thinks the solution lies in implementing a new value-creating strategy not only for companies but also for society at large. This would consist in satisfying the needs of everyone concerned: customers, shareholders, employees, suppliers and the community. By fostering ties with stakeholders near at hand, firms contribute to local economic development and thereby recover the role that was usurped from them in the mad rush to globalise.

"Value sharing"

An approach based on training and on developing local expertise often results in productivity gains and even innovation. Such benefits lead in turn to entry barriers that make investment far more profitable long term than chasing after low wages. Although this may all appear utopian, multinational corporations such as Nestlé, Unilever, Google, Intel, IBM, Johnson & Johnson and even Wal-Mart have espoused Professor Porter's holistic strategy. Also called "value sharing", it has demonstrated its usefulness and goes a lot further than cultivating a good conscience by giving to charity.

"Benefit corporation"

Management experts are not the only ones promoting this approach. The state of California, famous for its Silicon Valley and innovative start-ups, has just adopted a new legal structure for companies called the "benefit corporation" . The main purpose of this type of firm is to pursue a long-term strategy that benefits society in general and has social and environmental objectives in addition to aiming for a return on investment. Patagonia, a sports clothing retailer, became the first benefit corporation in early January.

"Impact investing"

Another pioneering investment approach is called "impact investing". Here the idea is to buy into companies whose prime objective is to have a substantial positive influence on society and/or the environment while providing investors with a return. The Edmond de Rothschild foundations support such enterprises, mainly through their strategic holding in a fund called Impact Investment Partners. This ground-breaking vehicle invests in companies in India that can claim a beneficial impact on healthcare for low-income families but also have performance targets close to those of private equity.

A new growth cycle ?

After the dotcom boom and the drive to globalise, these novel approaches could help to spur a new growth cycle that would see the pendulum swing back towards more balanced development. Clearly they are consistent with investment themes ranging from population ageing and the related care to food, obesity-driven medical costs and environmental services driven by urbanisation.

These new brands of capitalism could also prove useful in the search for solutions to certain fundamental needs, e.g. for environmental protection and the eradication of poverty. Companies could be given incentives to come up with economical ways to fight pollution or help the needy. The late CK Prahalad, who fathered the BOP (bottom of the pyramid) concept and taught management at Michigan Business School, is a well-known writer on this subject .

Governments these days are taking the easy way out, for example by taxing polluters, without looking for other alternatives that create more value for society. It is much harder to set up an appropriate regulatory framework that would make it possible to properly value public goods such as clean air and water.

One of the basic objectives of capitalism is to allocate financial resources efficiently. If it is guided by clear-sighted, forward-looking legislation and well-though-out incentives, it can continue serving the development of mankind. The difficulty resides in implementing these measures and adapting them to new circumstances. Let's hope that our political leaders will have the judgment needed to overcome the obstacles. The changing perception that can already be seen within some multinational companies provides scope for optimism.

Martin Pearmund

January 2012