Decades ago I worked my way through college selling big-ticket merchandise on commission for Sears.
In those days — when a salesperson’s technology was a ballpoint pen and carbon paper — if I had a prospect on a $500 out-of-stock item, management permission was required to make a $1.23 long-distance call to check availability at a regional warehouse.
Approval had to come from one of two types of managers, each with a different philosophy about the impact of my request:
- An Operator — hard-wired to squeeze profit out of expense control.
- A Merchant — hard-wired to increase profit by growing sales.
If I asked an Operator, usually the assistant store manager, to approve my call, he saw a profit-eating $1.23 expense and often turned me down with a cost-control lecture.
But to a Merchant, the same request looked like a buck-and-a-quarter investment worth risking to get a potential $500 sale.
Back then my disdain for the Operator perspective, and attraction to that of the Merchant, was transactional and directly connected to the content of my pay envelope on Friday. In time I would learn that these two forces are in fact the yin and yang of any successful operating unit.
But what if the Operator philosophy were to become dominant in the marketplace writ large? What if Operator dominance became so pervasive it created an imbalance with Merchant influences that not only negatively impacted the economy, but the social fabric as well?
Well, I believe that’s what has happened.
When Operators Reigned
Fast-forward to 2009, post-financial crisis: Leadership of businesses large and small necessarily reverted to the Operator philosophy, literally for survival. Give them their due, Operators have a fish-eyed focus that’s especially handy when revenue is challenged by circumstances internal or external.
But more than a half decade since the financial collapse, Operators continue to dominate Corporate America, and the case can be made that, with regard to the greater economy, they’ve overstayed their welcome.
Indeed, it’s time to ask the question: Are Operators still dispensing essential management medicine, or can a portion of the not-so-great recovery be attributed to being over-medicated by their parsimonious prescriptions? (In referring to Corporate America, I primarily mean big banks, publicly-traded companies that kowtow every 90 days to Wall Street analysts with absolute fealty to share price, large corporations taken private and run by private equity firms, and corporate raiders who call themselves “shareholder advocates”.)
Prior to the financial crisis, Merchants had prevailed in Corporate America since the mid-1980s, a period of low economic volatility that former Fed Chairman Ben Bernanke referred to as the Great Moderation, which managed to weather two stock market crashes and two recessions. But now, six years into a moribund, not so great recovery, it’s not a coincidence that while Operators have controlled Corporate America, small-business optimism has never been lower for this long in the 42 years of NFIB’s Small Business Optimism Index.
Why This Matters
When long-distance phone calls cost $1.23, the marketplace dynamic was largely between Corporate America and consumers. For most of the last half of the 20th century, small businesses were predominantly local retailers, suppliers and service providers.
But simultaneous with the Great Moderation was the Great Downsizing, during which Corporate America converted non-core competencies from being managed and performed by employees to outsourced relationships with contractors — small business contractors. As a result over the past 25 years, Corporate America became more efficient and profitable as their new outsourcing strategy manifested in at least three ways for small businesses:
- No longer merely backwater mom and pops, increased contracts with Corporate America for deeper operational involvement caused millions of existing small businesses to evolve and grow from local supplier to integrated vendor-partner.
- Millions of new small businesses have been created to take advantage of the new corporate downsizing contracts by filling niches of niches.
- Small business numbers, sophistication, employment, and contribution to national GDP has increased significantly.
Consequently, during The Great Moderation the small business sector achieved enough critical mass to be responsible for more than half of the U.S. non-farm GDP, employ more than half of all private sector workers, create most of the net-new jobs and 55 percent of innovations (NFIB, U.S. Small Business Administration).
Those who wonder why the economy has been stuck at the 2 percent annual GDP range since 2009, instead of the 4 percent expansion that was the hallmark of past recoveries, need look no further than the current investment philosophy of Corporate America Operators. Investment restraint by Corporate America since 2010, a period of sustained profitability, has contributed to the failure of the recovery to become an expansion.
Of course, their first steps were cost cutting. Deep cost cutting. Later, with balance sheets brimming with cash, instead of investing in the economy, Operators have been more likely to buy back stock to support the share price. More recently, still looking for new ways to operate their way to profit and grow share price, Corporate America used their cash for acquisitions, as industry after industry consolidated.
This practice has resulted in several conditions that will only increase the disconnect between the financial economy of Wall Street and the real economy on Main Street:
- Consolidation typically results in net job loss.
- Consolidation reduces competition.
- Industry consolidation reduces contract opportunities for small businesses.
- Wall Street is happy and Main Street is left out.
Many experts recognize that the economy in the current post-recession period has performed at half the rate of past recoveries. In a recent interview on my radio program with Martin Wolf, internationally recognized chief economic commentator for The Financial Times, London, we discussed the causes of a recovery that won’t become an expansion.
When I mentioned my thoughts about the current dominance of Operators, he agreed, saying, “When Corporate America spends less than its income and is accumulating cash while not investing, then someone else in the economy has to spend more than their income, and there isn’t anyone else out there who can do that.”
In responding to the October 2014 announcement by the Bureau of Economic Analysis, the chairman of the Congressional Economic Committee, Representative Kevin Brady (R) said, “Business investment continues to fall below expectations and remains the missing ingredient to strong and sustained job creation.”
What’s Wrong with this Picture?
In Q1 2014, two things happened simultaneously that has never happened before:
- The Dow Jones reached a new record high (16,570), growing more than 2.5 times and 10,000 points higher than the 2007 low of 6,470, and the S&P 500 reached a record high (1,877) almost tripling from the 683 low in 2009.
- The economy went negative, with GDP descending to a breathtaking -2.9% in the first report, later upgraded to a still frightening -2.1%.
Incredibly, the same scenario happened in Q1 2015: Wall Street set new records, including a record high for NASDAQ, while GDP was initially barely above ground at 0.2 percent, but later downgraded to negative.
So Wall Street is euphoric while Main Street continues to reel from what is approaching a lost decade, in an economy that two years in a row is still dangerously close to double dip territory. What’s wrong with this picture?
Many factors led to this unprecedented run-up of equities, not the least of which was the most accommodative Fed monetary policy in the history of monetary policies, keeping interest rates historically low and equities above fundamentals. Unfortunately, that fiat money stayed very close to home, which is to say, on Wall Street, while the Main Street economy received scant little benefit.
In December 2008 no employer knew how bad things were going to get, causing companies large and small to take drastic cost-cutting steps. Admittedly in hindsight, the case can now be made that the shock-and-awe of the financial crisis caused Corporate America to cut payroll deeper than was necessary. But once done, Operators found a way to get Herculean production out of remaining employees, scared of losing their jobs.
In any given month since, five economic indicators have been reported that reveal the results of Operator dominance in Corporate America, and the impact of fealty to share price.
- Record levels for stocks.
- Dysfunctional employment metrics. Never mind the useless U-3 household rate, chronic under-employment (U6), continues at over 10 percent. Plus we’re experiencing the lowest employment participation rate — below 63 percent — in 37 years (when Carter was president), which seems to have become entrenched.
- Small business performance at historic low levels. The NFIB Small Business Optimism Index, tracking this sector for 42 years, reported the March 2015 survey showed all 10 Index elements were negative for the first time ever.
- According to the National Association of Counties’ 2014 County Economic Tracker, only one in 50 U.S. counties has fully bounced back. Just 65 of the nation’s 3,069 counties have met or surpassed prerecession levels in four measured categories: jobs, unemployment rate, economic output and home prices.
- Growing income inequality, especially among the middle class, which includes essentially all small business owners.
More recently, income inequality has been prominent in the news. It’s true. Middle class income has been declining for some time. But one of the more recent contributing factors is lack of investment in the economy by Corporate America, especially contracts with small businesses.
When Corporate America invests in growth, small businesses benefit. When small businesses get contracts from big customers, they don’t buy back shares or acquire competitors, they hire employees and make capital purchases. That churn grows the economy and, good times or bad, small business churn represents half of U.S. GDP.
Prior to 2008, one out of three Americans (more than 100 million) were directly connected to small business, including owners, employees and family. And when you understand the income levels for small business stakeholders, it’s easy to see that in 21st century America, small business represents a big chunk of the middle class.
Alas, due to factors identified herein, plus loss of access to capital due in large part to over-regulated banks, especially community banks, small business numbers have been decimated in the past decade.
In 2009 when many said, “Just wait until the startups get going, they’ll bring this economy back,” I predicted this recovery period would be a bad time for startups, because the two classic sources of startup capital — personal credit and home equity — were both essentially wiped out with the 2008 financial crisis.
In a recent comprehensive report by Goldman Sachs Global Market Institute, titled “The Two-Speed Economy,” the authors confirm my points about pressure on existing small businesses and startups. Their research found that in the five years since 2008, there are “an estimated 600,000 ‘missing’ small companies, and six million jobs associated with these firms.”
The report also found a 20 percent and growing gap in wages between big firms and small ones.
“This suggests that small businesses continue to struggle, and that their employees may be paying an ongoing price in the form of lost wages,” the authors concluded.
Meanwhile, Corporate America and Wall Street are thriving. Again, what’s wrong with this picture?
Everybody Isn’t Getting Paid
Many people are reporting the sad evidence of income inequality, but few have solutions. I propose that income inequality could begin to correct itself within one year if leadership of Corporate America were returned to Merchants who are predisposed to grow profits by business investment. More contracts would flow to small businesses, and virtually all of those dollars would accrue to the middle class in the form of increased investment, more paychecks, and bigger paychecks for all participants.
Consider this classic Wall Street maxim: “When a deal is done on Wall Street, everybody gets paid.”
Indeed, the reason Wall Street has worked so well for so long is because dealmakers made sure every contributor got their piece of the pie. And historically, that scenario also extended to participants in the greater marketplace.
In fact, there once was such a symbiotic relationship between Wall Street and Main Street that another maxim prevailed: “Wall Street is a leading indicator of the economy.”
When this maxim was valid, if the stock market went up the economy followed within a few months, and vice versa. But today, as Wall Street flourishes and Main Street languishes, these two maxims are now romantic notions from bygone days. Deals are being done and the rich are getting richer on Wall Street and in Corporate America, while Main Street isn’t getting paid because it’s not being allowed to participate.
Consequently, I’ve coined a new maxim: “The stock market is now merely a leading indicator of itself.”
Main Street Has Never Been Jealous Of Wall Street
When capitalism worked for everyone, small-business owners didn’t look at the compensation of Wall Street deal makers or corporate CEOs with any level of jealousy. They understand how capitalism works; everyone has a role to play and they’ve chosen theirs.
But that perspective has begun to erode as those at the top of the deal have gained new and sometimes artificial leverage that allows them to prosper without adding value to the economy, which by definition leaves Main Street out. For example:
- The Fed’s unprecedented Quantitative Easing policy with Wall Street as the primary beneficiary.
- Several new financial devices that create wealth for the innovator/manipulator without adding value to the product or economy. Moreover, these devices have produced systemic hazards on a macro-economic scale, like those that contributed to the financial crisis of 2008 when some assets were leveraged by a factor of 70:1.
- Flash/digital trading. In an interview on my radio program I once asked a respected financial expert if a retail investor had a fair chance on Wall Street today. His answer was short: “No.”
- Taxable income designations that provide billionaires with a tax rate below the average rate of a Main Street business owner.
- Fraud at the structural level of capital formation, such as the LIBOR scandal
A Reckoning Is Coming
In recoveries past, conversion from Operator dominance to Merchant leadership would have already occurred and investment in growth opportunities would already be happening. But a combination of the previous points, plus drastic payroll cuts under cover of the financial crisis, have contributed to Operators’ ability to maintain profits and share price levels for an unusually extended period.
Stock analysts are the only players more fish-eyed than Operators, so they will always demand share price performance. And with limited opportunity left for Operators to squeeze profit out of their budgets, Corporate America will have to pass the helm to Merchants to take back control and invest the estimated $2.5 trillions of cash on hand and look for ROI and share price support from the marketplace.
When that happens, everyone connected to the Main Street economy will win.
Corporate America and Wall Street are not the only factors causing disruptions for Main Street and middle-America these days. Anti-business policies (taxes, regulations, executive orders) and rhetoric coming out of Washington are creating a level of uncertainty not seen for generations, a cataloging of which would justify a separate essay, if not a book.
But regardless of assignment of blame, the current relationship between Corporate America/Wall Street and Middle Class/Main Street is approaching the boiling point. If adjustments aren’t made so that everyone participating in the economy gets paid, I believe there will be a revolution that will have three kinds of implications:
- Economic for Corporate America
- Financial for Wall Street
- Electoral for the Washington political class
Capitalists at the top of the heap have the tools and resources to quickly take advantage of disruptions and, as long as it’s legal, we shouldn’t expect anything different. But Americans will not continue to tolerate prolonged advantages by those who have found a way to manipulate their own prosperity without adding value and without allowing everyone in the economy to participate and get paid.
The reckoning I’m predicting will address the moral adjustment many believe Corporate America should incorporate into their long-term strategies.
Another maxim says, “Wall Street makes money when the market goes up or when it goes down, but not when it doesn’t move.” My greatest fear, as I warned in a 2012 article, is that when the equities correction happens, which could begin any moment, Wall Street and Corporate America will have profited enough from the run-up to not only weather that storm, as many did prior to the 2008 crisis, but also benefit from the correction.
Meanwhile, out here on Main Street, where we’re seven years into a lost decade, a stock market correction will create an economic downturn that will hit small businesses right between the eyes. When you’re undercapitalized and planted in the ground, hedging is less of an option.
We’re currently in what I’m calling “The Great Agitation,” a period that began no later than 2008 during which Corporate America and Wall Street became the tail wagging the economy’s dog.
The American dream, America’s classic form of free-market capitalism, and American exceptionalism — all unique in the world and from which the world has benefited — cannot long survive if the sector benefiting the most from the economy is adding the least value to it. It’s time for Merchant leadership in Corporate America. It’s time for Corporate America to use executive compensation metrics that include factors outside their four walls and beyond Wall Street.
“What are the markets doing?” is a question asked constantly during any trading day by Wall Street stakeholders. The reason is because the digitization of Wall Street has produced the mother of all hyper-markets with millions of trades every second. Today, stocks are more trading instruments than investments, with the average stock ownership period measured in seconds. No capitalistic economy or the society it serves can sustain itself with fealty to the metrics of a hyper-market.
Unfortunately, no one ever asks, “What’s happening on Main Street today.” Because that market — the original one — uses metrics based on investment and labor, as well as 21st century digital innovations. Those resources are planned, budgeted and committed over months and years, not traded and manipulated in nanoseconds. And also not subject to the short leash of a 90-day conference call with stock analysts, or the schizophrenic kneejerk reaction to some “Breaking News” from global markets or geopolitics.
In a 1970 interview with The New York Times Magazine, the venerable Nobel Laureate Milton Friedman said something many in Corporate America use to justify their current investment practices: “There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Friedman died in 2006, before the financial crisis. If I could talk with him today I would ask him:
- Since Wall Street is no longer a leading indicator of the economy, and with the unprecedented influences of globalization, digitization and Fed monetary policy, have the rules of the game changed?
- Is it free and open competition if one sector of the economy acquires the ability to increase their internal value while adding little or no value to the rest of the economy?
Whether Friedman agreed with me or not, I believe he would appreciate the validity of the questions.
In his 2002 book, “Managing in the Next Society,” management guru Peter Drucker weighed in on this: “I believe it’s socially and morally unforgiveable when mangers reap huge profits for themselves but fire workers. As societies we will pay a heavy price for the contempt this generates.”
In his seminal work, “The Wealth of Nations” (1776), Adam Smith described one of the pillars of modern capitalism. With only a slight paraphrasing, here’s Smith’s legendary Invisible Hand theory: “By pursuing his own interest a business owner frequently promotes that of the society more effectually than when he really intends to promote it.”
I believe Smith’s context was that the agnostic invisible hand was at least in the proximity of that society. Today, on Main Street, there is a missing hand.
Seven years after the financial crisis and six years since the end of the Great Recession, it’s time to address my initial proposition: A portion of the not-so-great recovery can be attributed to the cash-hoarding and investment practices of Corporate America, and their short-sighted commitment to share price over investing in the economy. The Friedman school of corporate behavior proposes devotion to the shareholder.
After all that has transpired since 2008, it’s time for Corporate America to take a page out of the small business merchant’s playbook — the one that shows long-term performance for the shareholder can only be sustained when prime fealty is to the customer and other operating stakeholders.
It’s time for all sectors to invest in an economy where all marketplace participants get to play and get paid.
Every day that Operators run Corporate America, and Wall Street is merely a leading indicator of itself, is a day closer to the end of America’s Golden Goose: the middle class and Main Street small businesses.
If that happens, I’ll leave what happens to America to your own imagination and foresight.