Book Review - Forbes Magazine

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johnkarls
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Book Review - Forbes Magazine

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Forbes Magazine – 5/23/2016


How Makers Became Takers: Is Wall Street To Blame?
By Steve Denning – International Business Consultant and long-time World Bank Official.


Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar (Crown Publishing, 2016) is a masterly account of the disproportionate power that the financial sector exercises in the economy and the disastrous consequences this has for society as a whole. As noted in my column last year, the excessive size of the U.S. financial sector reduces U.S. GDP growth by 2% per year.

One aspect of Wall Street’s power is financial: the financial sector represents about 7% of our economy but takes around 25% of all corporate profits, while creating only 4% of all jobs. Its power to shape the thinking of government officials, regulators, CEOs, and even many consumers and investors is even more important. It is behind decisions in the 2008 financial meltdown which resulted in large gains for the financial industry but disastrous losses for homeowners, small businesses, workers, and consumers.

A Predatory Financial Sector

The book vividly describes a horrifying array of problems including massive share buybacks aimed at manipulating corporate share prices, persistent short-termism in corporate decision-making, a focus on extracting rather than creating value, crippled investment in innovation, declining real corporate performance, stagnant wages for most citizens, loss of jobs, secular economic stagnation, growing income inequality and the apparent inability of government economic policy to resolve these problems.

Foroohar’s book argues that the increasing financialization of the economy is the prime cause of this economic and social debacle. “Finance has become a headwind to economic growth, not a catalyst for it… The financial crisis of 2008 was followed by the longest and weakest economic recovery of the post– World War II era. While the top tier of society is now thriving, most everyone else is still struggling.”

Instead of financial markets playing their historical role supporting Main Street, now corporations are increasingly becoming the means of money-making by Wall Street. Instead of financial markets enabling investments in real goods and services, corporations are increasingly seen as vehicles for “making money out of money.” The end results are growing income inequality and secular economic stagnation.

The book’s solution is “a dramatically different balance of power between finance and the real economy— between the takers and the makers— to ensure better and more sustainable growth.”

The Deeper Cause Of The Debacle

This proposal overlooks the fact that “the real economy” itself has been very active in creating the problems. In fact, the deeper cause of these horrifying economic dysfunctions is the poor performance of corporations themselves. Thus if corporations were making fabulous profits from investing in real goods and services, their share prices would be soaring and they have no need to resort to the financial shenanigans, such as share buybacks and stock price manipulation, that Foroohar so vividly describes.

Why did real corporate performance decline? In the 1970s and the 1980s, the world changed. As a result of globalization, deregulation, the growth of knowledge work and new technology, the management practices that had been so successful for much of the 20th Century became steadily less effective. Power in the marketplace shifted from the seller to the buyer. Suddenly the customer was in charge of the marketplace. Simply grinding out the same old products with command-and-control management was less and less effective.

Corporations were faced with a choice between two paths. One path was to change the way that corporations were managed and embrace continuous innovation for their new boss—the customer. The other path was to continue with obsolete management practices and use financial engineering to cover up their failing ability to make returns on their assets and their investments.

The Wrong Path Taken

By and large, major corporations in the U.S. chose the latter path and joined forces with the financial sector to extract value for their shareholders, rather than create and deliver fresh value to their true boss—the customer. For society, this was a disastrous choice because the welfare of society ultimately depends on generating real goods and services for real people. Extracting value for shareholders generates merely temporary Potemkin prosperity for the few, followed by financial crashes that afflict the many, once the lack of any real basis for the temporary financial gains becomes apparent.

Reducing the power of the financial sector, as Foroohar recommends, will therefore not in itself resolve today’s grave economic and social problems. It is part of the solution, but it is not enough. So long as corporations themselves are focused on what even Jack Welch has called “the dumbest idea in the world,” namely, the idea that the goal of a firm is to maximize shareholder value as reflected in the current stock price, it hardly matters what Wall Street does. The economy will still be in the grip of “money chasing money.” That’s because with shareholder value theory, no real value is being created: it is not a sustainable basis for running a company—or a society.

As Foroohar explains in chapter 3, shareholder value theory was proposed in the 1970s by three academic economists—Professors Friedman, Meckling and Jensen—as a way for firms to improve performance amid tougher competition. But it had the opposite effect. As a result, the real returns of U.S. corporations are now only a quarter of what they were in 1965. Real economic growth has been steadily slowing over the last five decades. The life expectancy of a large firm has declined from 75 years to just 10 years. American competitiveness has been undermined. As a result, the economy as a whole has gone into a secular economic stagnation. Yet shareholder value theory is still the accepted manner of doing business for a public corporation. As recently as April 2016, it was described by The Economist as “the biggest idea in business.”

A Better Path

Fortunately, some corporations chose the former path. They asked themselves different kinds of questions. Could organizations be devised that were more agile, innovative and creative that would deliver continuous value to customers? In effect, could the modern workplace be transformed so as to bring out the best in everyone, rather than the worst, with shared prosperity for all?

We are now seeing the fruits of these inquiries, including:

• The demonstrated capability of very large organizations to become entrepreneurial and innovative.

• The demonstrated capability to create workplaces that enable continuous innovation with high-quality, sustainable management practices that operate durably at scale for many millions of customers.

• The demonstrated capability to deliver to customers scores of innovations per day in a low-stress high-engagement working environment.

• The demonstrated capability to capture, analyze and respond to feedback from many millions -of customers receiving daily innovations.

• The demonstrated capability ability to create intimate customer experiences for hundreds of thousands of customers

By any standard, these are extraordinary developments in the management of entrepreneurship and innovation, most of which would have been inconceivable even a few years ago.

These findings are being documented by the Learning Consortium for the Creative Economy and will be presented to the Drucker Forum in November 2016.

It is increasingly obvious that the decline in real returns of traditionally managed organizations and the pervasive disruption of existing businesses are not just the machinations of Wall Street, although Wall Street certainly played a role. They are mainly the consequences of a changed marketplace and obsolete management practices. Like other fundamental transformations in history, now that there is a better technology—in this case, the technology of management—changes are occurring that will inexorably affect almost every person and every organization.

The reason why macro-economists and financial commentators can’t solve the problem of secular economic stagnation is now clear. They are looking in the wrong place. The problem isn’t fundamentally a macroeconomic problem, like a misguided interest rate or an inadequate fiscal stimulus or the machinations of hedge funds. Those are aggravating factors, but fundamentally the problems of our major corporations flow from running them in an obsolete fashion. Solving the macro-economic and financial problems also requires solving the management problem.

Many corporate leaders and investors are still in denial. They are puzzled by the ongoing disruption in the marketplace and the stagnation of the economy. They find it difficult to accept that the management practices which worked so well in the 20th century and on which people have based entire careers have become steadily less viable. It is natural to hope that more strenuous pursuit of past practices will eventually be successful. In effect organizations continue to pursue short-term profits and executive bonuses while tolerating a dispirited workforce, declining margins and real economic decline. Meanwhile economists wonder what’s gone wrong and sensible investors are troubled by increasingly severe financial crashes.

Those who work in these corporations are also puzzled as to why so many talented people are working so hard with such large resources with such unproductive and frustrating results. Analysts, regulators, central bankers and politicians are also concerned that the economy doesn’t grow the way it used to.

As the firms operating in the new way thrive and steadily put traditionally managed firms out of business, the question is not whether the transition to this different kind of economy—the Creative Economy—will occur, but rather: how long it will take?

Will the transition be long and slow and bloody, as traditionally managed firms go out of business faster and faster and massive financial crashes become steadily more severe? Or can the change be quick and elegant and intelligent, as firms wean themselves of their obsolete management practices and become inherently more prosperous? Blaming Wall Street is all the rage, but Wall Street is only one piece of puzzle.

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