CHAPTER TEN

Aftermath of a Go-Go Decade

EVERY FIFTY OR SIXTY YEARS, these past 250 years, there has been a decade in which businessmen, politicians, and economists in the world economy’s developed countries expected speculative growth to go on forever at an exponential rate: between 1710 and 1720; around 1770; after 1830; around 1870; and around 1910 (aborted in Europe by World War I but continuing in the United States until 1929); and finally the 1960s.

Every such era believed that there would be no limit to growth. And every one ended in debacle and left behind a massive hangover.

After every go-go decade prophecies of zero growth become popular. But except for the years between World War I and World War II, vigorous economic growth always either continued or was resumed very soon after the go-go years had come to an end. However, the aftermath of a speculative era always does bring substantial structural changes in the economy. Economic growth always changes and shifts to new foundations. And the demands on business management always change so greatly that what was considered smart management during the time of rapid expansion fast becomes inappropriate … if not stupid.

Some of the changes that the aftermath of the fast-action sixties is bringing about can be seen clearly.

1.

The balance sheet is again becoming as important as the P and L and may become more important. Liquidity and cash flow are replacing price-earnings ratios as managerial lodestars. Return on total assets is likely to become a more popular—as it surely is a more meaningful—yardstick than earnings per share.

Capital investment rather than consumption will have to become the engine of economic growth in the years ahead. The worldwide boom from the end of World War II until 1970 was largely fueled by consumer demand. From now on, the center of economic growth will be in areas which require large and massive capital investments: energy, the environment, transportation, and increased food production.

Above all, the great need of the next decade will be jobs, which require capital investment on a very large and steadily rising scale. In the United States we will, each year into the eighties, have to find some 30 percent to 50 percent more jobs for young entrants into the labor force than we needed in any year during the fifties and sixties. It will not be until the eighties that the “baby bust” that began in 1960–61 will have an impact on the number of new job-seekers, that the pressure of labor-force growth will lessen sharply.

In the developing countries the need for capital to create new jobs will be even greater. The babies of the late fifties and sixties who—unlike the babies of earlier generations—did not die in infancy, have grown to adulthood, and are streaming into the labor force.

At the same time, capital market structure is changing. The main channels for capital supply in this country are by now private pension funds. Even without inflation (and inflation has arrived with a vengeance), they will have to expand to satisfy the requirements of the Employee Retirement Income Security Act (ERISA) of 1974. We are thus in the process of switching capital formation from entrepreneurs, whose job it is to invest in the future, to trustees, whose duty has always been to invest in prudent investments, which usually means the past.

A growing share of the national income in every developed country goes into governmental transfer payments, which convert potential savings into consumption. And government deficits have the same effect. Unless there is a severe and prolonged depression, capital will, therefore, predictably, be in short supply—at least through the rest of this decade and probably well into the eighties.

With the passing of the go-go years the relationship between interest rate differentials and liquidity preferences has changed sharply, and with it the rules for borrowing and investment. During the sixties, interest rate differentials were high. Short-term bank loans were cheap for most of this period. Even the apparently very high interest charges of the last few years actually represented zero interest rates, if adjusted for inflation. Long-term borrowing was, by contrast, quite expensive. And cost of equity capital was to become astronomical for all but the stock market darlings of the moment.

During this period of abundant bank money, a short-term, open bank loan was almost as dependable a source of funds for a reasonably solvent borrower as long-term debt, and much cheaper. It was, therefore, rational behavior on the part of management—or at least it seemed so—to finance one’s business as much as possible with short-term and cheap open bank loans, while at the same time trying to boost price-earnings ratios in the stock market to attain acclaim as a growth stock.

During any go-go decade managers tend to believe that “maximizing earnings per share” is the same thing as “maximizing profit.” They tend to forget completely that “maximizing profit” is not an end in itself, but a means toward minimizing the cost of the capital a business needs.

In the period ahead “maximizing earnings per share” may become largely inappropriate. Maximizing total return on all assets should become increasingly the right way, with considerable consequences for financial structure. Leverage—as fashionable these last ten or fifteen years as in any earlier go-go period—then becomes dubious, if not outright wrong. [1981 note: If the stock market signals anything, it is this change. On every one of the world’s major stock exchanges most prices since the mid-seventies have not reflected earnings per share. They tend to reflect liquidity, cash flow, and defensive strength—that is, return on assets.]

If there is need for a shift from profit planning to asset management—that is, the kind of shift reflected in emphasis on the balance sheet at least on a par with emphasis on the P and L—executive compensation will also have to change. For cash flow and return on assets then become more reliable measurements of performance than earnings per share over a short time period. Stock options, which reward executives for high price-earnings ratios, and which indeed tend to lead managements toward manipulating their businesses for short-term gains and high stock prices, become inappropriate and indeed are at odds with the needs of the business and the judgment of the marketplace.

2.

In the sixties, growth was deified and any growth was good. In the middle seventies, growth, any growth, was widely attacked as evil in itself. But in the years ahead, at least until the babies of the “baby boom” of the fifties have been absorbed into the labor force, if not until they retire forty years hence, a substantial amount of growth will be necessary for minimal economic and social health. And the capital investments needed—in energy, in the environment, in food production and food productivity, in transportation, and so on—are so great in the long run as to make substantial growth appear more probable than zero growth.

But growth is likely to change direction; it has done so after every go-go era. Therefore, management will have to be able to manage the growth of its business and to appraise it, rather than be swayed by every stock market whim or media fashion.

The first thing for management to know is that growth is not something that is desirable. It is a necessity. A business needs to know the minimum of growth without which it would be in danger of becoming marginal in its market. If the market grows, the business must grow too—or else it ceases to be viable and is unable to compete in the long run.

One does not have to be number one. But a company has to have enough of a leadership position in its market not to be squeezed out when a minor setback forces the retailer to cut back the number of appliances he stocks to the two or three or four fast-moving brands. This, in a growing market, requires a growth goal that looks on growth as survival, requiring risk-taking investment at the expense of current earnings.

Equally important will be the ability of management to distinguish between desirable and undesirable growth. Strength and muscle are growth. Growth is strength if it results in overall productivity of the wealth-producing resources of capital, key physical resources, and human resources. Growth that does not make resources more productive is fat and as much a burden on the corporate body as it is on the human body. And growth that is being purchased at the expense of the productivity of the factors of production, as was much of the growth of the go-go years, is a malignant tumor and calls for radical surgery.

3.

There has been increasing concern of late with the multinationals. But the real impact of the emergence of a genuine world economy, of which multinationals are primarily results if not merely symptoms, is still ahead. Increasingly, even managements of small businesses confined to a national or even regional market will have to learn to factor the world economy into their thinking, planning, and decisions.

Since the end of World War II, the economic dynamics have not been based on any one national economy. The motor of economic expansion has been the world economy. And it was the world economy and its forward momentum that again and again during the last twenty-five years bailed out national economies and provided the thrust for the longest sustained period of economic advance in human history.

Any world economy is, however, on a straight collision course with the doctrine of sovereignty, which for almost four hundred years has ruled politics to the point where most of us believe it to be a self-evident axiom. Actually, the assertion of sovereignty, which claims that an economic unit and a political territory should be congruent, was first made in the late sixteenth century. It was then a startling heresy.

In the last thirty years—for the first time in four centuries—the unit of economic action and the unit of political control are again drifting apart. The unit of the economy has become larger and larger, until it can be called a world economy. But political territories in this century have become smaller and more splintered while at the same time more vigorously asserting their sovereignty.

Since 1905, when Norway separated from Sweden, every change of the map has been that of fission of a former political unit to the point where the fewer than forty independent nations of 1914 (more than half of them in the Americas, by the way) have now become almost two hundred sovereign national states.

There is no substitute in sight for the nation state in the political field—but also no substitute for the world economy in the economic field. The next decade, one can predict, will be one of turbulence, of ambivalence on the part of governments. They will want the fruits of the world economy without giving up one iota of their sovereignty. Economics will thus increasingly find itself at loggerheads with politics. The multinational company may well become a victim. It is squarely caught in the middle.

But the world economy will survive, even though it may be a poorer, more dilapidated, greatly hampered world economy. People are not going to lose their vision of the global shopping center—that is, their vision of goods, services, and values for which they strive. Indeed, economically, there are no more distinct cultures, excepting perhaps only Communist China. There are only richer people and poorer people, people who can afford more or less of the same goods and services. And this means that the world economy will continue to provide the economic dynamics for every country.

What does the businessman, therefore, have to know about the world economy? Fifty years ago, businessmen were running regional concerns. Even substantial firms in California or New England did not see that they had to know much about the U.S. economy, and they paid little attention to it until forced to see and to think nationally in the aftermath of the go-go era of the twenties. Now, it is reasonable to predict, they will have to learn to inform themselves similarly about the world economy.

4.

One final thought about the aftermath of any speculative decade: Each has always, in the past, given birth to a new major economic theory. We know we need a new economic theory that focuses on the world economy rather than on the national economy alone. That is, we need a theory that goes beyond the Keynesian apotheosis of national government as all-powerful and all-wise and that comprehends national economics as part of a larger world economy. We need theory focusing on capital formation rather than exclusively on income distribution. We need theory that integrates capital, key physical resources, and human resources with money, credit, and taxes.

Somewhere, today, an economist should be well along toward working out the new theories we need. At least this is the way it has happened in the earlier periods following a go-go decade. But so far neither the new theories nor the equally badly needed new economic policies to be derived from them can be discerned on the horizon.

(1975)