Business is a creator, not an evil destroyer
One of my pleasures is to listen to the accounts of great business enterprises told by their CEOs and CFOs to investor conferences. They seldom fail to impress with their sure grasp of the essentials of business success in a complex world.
These always contain the threat of competition from rivals and, even more dangerous, the disruption of their business models and their relationship with customers, from quarters previously unknown. They are in it for the long run.
They sense the growing opportunity data collection and analysis offers to produce, distribute and market their goods and services more efficiently. They know that to scale the advantages of their intellectual property and culture, they must have global reach that inevitably includes managing successfully in China. They are well aware of meeting the demands society and governments may make of them for them to be allowed to operate legitimately.
And one senses from them a new urgency about a disciplined approach to the management of shareholder capital. Business success and the performance of managers is increasingly being measured by (internal) returns on capital employed, properly calibrated, that adds value for investors.
The success of the developed world in raising output and incomes and consistently improving the standard of living is surely attributable in large part to the system design that accords so much responsibility to businesses large and small. The improvement in the average standard of living in the major economies, and those of the least materially advantaged in the bottom quartile of the income distribution, has been at a historically unprecedented level over the past 70 years.
While the rate of economic improvement may have slowed in the past 10-20 years, it sustains an impressive clip. Over the past 20 years, GDP per capita in constant purchasing power parity terms in the largest seven economies, as calculated by the IMF, has grown by a compound average 2.8% a year.
Over the past 10 years, this growth rate has slowed only marginally to an average of 2.7% a year, a rate rapid enough to double average per capita incomes every 26 years or so.
One might have thought the proven capabilities and potential of the modern business enterprise would enjoy wide appreciation. That is, for its ability to deliver a growing abundance of goods and services.
In doing so, well-rewarded employment opportunities are provided to so many while providing a good return to their providers of capital — both debt and share capital. A large majority of these, directly and indirectly, are anything but rich plutocrats. They are the many millions of beneficiaries of savings plans upon which they rely for a dignified retirement.
But this is not necessarily the case at all. The modern corporation is under attack for its many alleged failures. It is surely a grave misrepresentation to see the beneficiaries of the modern corporation as rentiers with a generous, guaranteed source of income secured by some conspiracy that protects firms against competitive threats.
The Financial Times’s Martin Wolf would have the leaders of large modern corporations accept much greater responsibilities for the (apparently) failing economic condition. He asks: “What are they doing to ensure better laws governing the structure of the corporation, a fair and effective tax system, a safety net for those afflicted by economic forces beyond their control, a healthy local and global environment and a democracy responsive to the wishes of a broad majority?”
This is to ask them to assume the essential role of governments, yet they are not fit for this purpose. Governments make the rules that firms have to observe. The firm has, however, been entrusted by society with an all-important economic function. That is to assume responsibility for the allocation of its scarce resources; to exercise the right to use its human and natural resources and its savings.
Earning profits provides the essential discipline to prevent the potential waste of valuable resources with alternative uses. For the firm exercising its freedom of action, earning a profitable return on capital is its essential justification.
If, that is, we are to preserve our highly successful economic way of life.
Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.