An article, The Capitalist’s Dilemma from the Harvard Business Review, was sent to me with the provocative subtitle “Why capitalism is broken, and what we can do to fix it.” An excellent write-up, it certainly got me thinking. While there is much to agree with, there would be a few things that I would like to add, were I a Harvard Man myself. Read the article, as I mostly want to address the conclusions at the end.
Conclusion #1 focuses on (government) policy changes that would incentivize long-term investment. While an investor or a manager needs to look at the current situation (the abundance of cheap capital) as a given, this oversupply of money is, itself, the result of policy. This apparent over-supply of capital isn’t just a force of nature in these modern times. It is a direct result of stimulus, quantitative easing, and zero interest rate policy – not just from the government of the United States and the Federal Reserve, but as a coordinate effort around the globe. If you’re looking for a government policy “fix” for the perverse incentive of cheap money, why not look first at the cheap money policies?
Of course, I won’t try to lay out the mechanism of how a more rational interest rate and money supply would result in longer-term investment. Whereas the intended effect of something like a transaction tax may be obvious, the effects of rationalizing monetary policy are far less straightforward (unless you’re already on board). However, like long term investment itself, the elimination of the root cause of the investment problem should certainly pay off far more handsomely over the long term than reactive carrots and sticks.
Surely one of the problems in today’s investment environment is the elimination of the “safe” investment returns at 5 or 6 percent. In order to earn what most of us think of as a minimum, long-term safe rate of investment, the financial community is forced into riskier and shorter term speculation.
Looking at it another way, if we accept the premise that the current environment is artificially created by current monetary policies, and therefore look at the “cash” as disconnected from “capital,” we might assume that true “capital” is as scarce as it has ever been. The inability to make good decisions, then, is a result of being unable to evaluate the true cost of that capital in a world awash in cheap money. Returning monetary policy to the norm would be a major step in getting our systems to work properly again.
Conclusion #2, I don’t have an issue with the analysis given. However, the conclusion that the solution for all the troubles in the world should come out of the MBA curricula as a tad self-important. I guess that shouldn’t be surprising coming from the Harvard Business Review. Does anyone outside of the Business School community actually consider the organization of topics in Business School courses to be a major driver in the economy? Certainly, I would never expect a freshly-minted MBA to be ready to make the kind of complex investment decisions necessary to grow a business. Would you?
Conclusion #3 (and/or maybe #4) address changing the management style and incentives. This is the counter-balance to #1, where you do have to look at the current monetary policy environment as a given. I am struck by the description of this problem as a”dilemma” and a “paradox.” To quote Ayn Rand, “Whenever you think you are facing a contradiction, check your premises.”
The article discusses the irrationality of continuing to use a 20% IRR, as was common decades ago, makes no sense in the current monetary environment. And yet everyone continues to do it. Why? Maybe because it isn’t so irrational. Certainly, the Federal Reserve and U.S. Government intend to extend easy money policy into the foreseeable future. No doubt it has been a successful gambit so far, with the result of massive currency injections being low measures of inflation coexisting with record high stock markets. Shouldn’t anyone with common sense see this as the “new normal?
Let’s set aside for the moment my off-the-wall theory about the true cost of capital being independent of currency. Is it just possible that managers actually are rational? Perhaps common sense actually suggests to them to expect a regression to the mean. If a 20% IRR has served an institution well over the long term, then that might be the most rational figure going forward. Particularly if one is trying to make long term investments, isn’t it better to evaluate those investments using the logic of the last 100 years rather than the last 8? Zero interest rates today may come close to guaranteeing low interest rates over 3 years. But should corporations bet their future on this environment being around for 10 or 20 years?
Conclusion #4, part II.
My digressions on monetary policy aside, there are some solid points made in this article that suggest that we, as a society, need to do some serious re-evaluation. The authors criticize spreadsheet-driven decisions making in investments. However, I would say this same criticism can be leveled at almost every aspect of corporate America. Hiring decisions, promotions, purchasing decisions are all done far more “procedurally” or “algorithmically” than was the norm a few years ago. Even the day-to-day needs to follow the “right” technique for project management, a process which seems to me to emphasize efficiency and regimentation over creativity and innovation. It’s the implementation, on the grand scale, of that old phrase “no one ever got fired for buying IBM.” If you’re using the state-of-the-art HR/sales/project management software, it’s not really your fault when something goes wrong.
If you agree that “capitalism is broken,” then I’d see we are going to need some major disruption in the business environment before we right this ship. Those disruptions may come from the top down (e.g. another financial crisis) or it may continue to come from traditional sources, such as the innovative entrepreneur. As insightful as this article is, I don’t expect to come from the current crop of MBAs.
Finally, as a small reward (punishment?) for those who made it to the end of my post, I’ll give you the punch line. “You can always tell a Harvard man, you just can’t tell him much.”