In the wake of WorldCom
The demands for caution and restraint could damage the economy far more than any accounting scandal.
The exposure of what is reputed to be America’s biggest-ever accounting fraud at the telecom giant WorldCom adds to a long list of US corporate calamities over the past six months.
There seems to be a new scandal every week, always trumped by an even bigger one before long: Enron, Arthur Andersen, Tyco, Global Crossing, ImClone, WorldCom, Xerox. US Incorporated appears to be in a deep crisis.
It is true that recessions discover what the accountants missed (or ignored) – but this time, things are different. The strange thing about today’s ‘crisis of capitalism’ is that it is unfolding just as the USA is exhibiting signs of economic growth (albeit limited ones) following the recession of 2001.
Indeed, some now doubt whether the USA suffered a recession at all, or claim that it must have been one of the mildest recessions ever. The technical definition of a recession is two successive quarters of negative growth – something that has not afflicted the US economy over the past year. The disjuncture between a flat but durable real economy and the spate of corporate scandals distressing a weak stockmarket gives a clue to what is really going on in US capitalism.
Over the past 30 years, and more markedly in the past 10, the real economy has receded into the background, while a new finance economy has come to the fore. Industry has tended to relocate to parts of the old third world, while services have filled the gap in the West.
These economic changes also reflect cultural and social shifts. Unabashed economic growth has lost its virtue in the face of environmentalism, with the business world adopting socially responsible and ethical agendas. Even in the straight world of economics, where production and tangibles were once central, indices of happiness, creativity and other non-material values have taken centre stage. Just consider the recent impact made in the USA by Richard Florida’s book The Rise of the Creative Class: and How It’s Transforming Work, Leisure, Community and Everyday Life.
In business, the combined effect of material shifts and our anti-growth climate is that finance has come to replace the ‘dirty’ process of actually making things. Until recently, this was talked up as a New Economy of innovation, knowledge and information technology. The reality was that financial activity and transactions played a more central role in the day-to-day life of business, which was often unrelated to real economic activity.
Of course production didn’t come to a standstill. Society cannot survive on the intangible ‘feelgoods’ of ideas and creativity – it needs to consume goods and services produced. But production did lose more than its intellectual credibility in the 1990s. It also lost its dynamic, and we moved into a world of restrained economic drift disguised by the froth of finance. Deals and debt drove the 1990s economy, not production and productivity. One prominent feature was the way company share prices raced far ahead of actual earnings potential.
The problem is that a financial world so divorced from real activity is inherently unstable, and has a tendency to implode.
So it was in the East Asian financial crisis of 1997 and 1998, when young but strong economies were overwhelmed by enormous flows of speculative finance. After that crash, the easy money then shifted to drive the internet and IT economy. But in a culture that is both obsessed by technology yet seems to have lost the strategic ability to use technology for productive ends, even the famed dotcom bubble was more a financial one than a real one. And in March 2000, that bubble burst too.
What we are witnessing in corporate America today is the further unravelling of this financial boom. While unproven internet companies with few revenues were the first to crumble, now we are seeing the wider ramifications focused, though not exclusively, on the technology, media and telecommunications (TMT) sector.
Much of the WorldCom debate is focused on who did (or hid) what, but there is nothing unprecedented about capitalist scandal, fraud, corruption or ‘creative accounting’. The names Michael Milken, BCCI, Polly Peck, Robert Maxwell and Barings spring to mind. What is different this time around is that more of American business – and British and European companies are by no means immune – got caught up in the new finance economy, where deal making and financial engineering almost becomes the business end instead of the means.
Many businesses now see short-term performance and share price levels, which are given the more respectable title of ‘shareholder value’, as the key criteria of success. Unsurprisingly, many CEOs, company boards and their financial advisers and auditors are encouraged to embrace the sort of ‘aggressive management of earnings’, which in extreme cases led to the accounting shenanigans at WorldCom, Xerox and elsewhere.
As one pack of financial cards falls after another, US capitalism will experience a cleansing of the most exposed and insubstantial parts of the financialised economy. To a certain extent, this process substitutes for the ‘purifying’ role that economic recessions played in the past. In past recessions, capital would be destroyed, unemployment would rise, the weaker companies would go under, and survivors would emerge stronger.
Given the torpidity of real production during the 1990s, the pressures normally required to bring about recession were muted and limited – hence the absence during last year’s mini-recessions of capital destruction and rising unemployment. Today’s corporate implosions play a similar role to recessions, but only in the limited areas that they are required. For example, we have already seen the collapse in the value of network assets in the ground, as several big telecom companies that over-invested in them during the late 1990s, spurred the availability of easy money, now find themselves in, or close to, bankruptcy.
But recent events are unlikely to reinvigorate capitalism the way traditional recessions did. The excess liquidity will simply find something else to latch on to. Maybe property prices will be the next bubble to expand and burst? The finance economy is likely to survive, but in new forms. More importantly, the kind of reaction we have seen to the perception of a great corporate crisis in America will only further subdue real economic activity.
Many have already turned recent events into another morality tale of American capitalism, claiming that American executives are getting their comeuppance for being so excessive and greedy. Rarely has such a critique of rampant capitalism been so far wide of the mark. Today’s corporate executives, with a few exceptions, are notable for their relative restraint and limited ambition. They have been reluctant to engage in genuine strategic expansion, notwithstanding the penchant for continuously rearranging the financial deckchairs.
Commentators worry about the negative effects of investors losing trust in companies and of consumers becoming less confident. But even more constraining is the crisis of confidence within business itself. Every recent crisis has been blown out of proportion, not least by the business world itself, and has become a further drain on corporate confidence, with business always expecting worse to come.
From the Russian debt default of 1998 to the dotcom collapses to the 11 September terrorist attacks to the economic crisis in Argentina and now Brazil, there has been a deepening sense of uncertainty within business. The common response to each of these crises has been a further embracing of risk aversion. Now, every time another company is revealed to be in trouble, the business mood becomes more conservative and less ambitious.
The clamour from within business is for more caution, cost-tightening and regulation – and for less investment in future growth. Companies will scale back their plans, while financial institutions will be less willing to lend to fund ‘risky’ investments. As BusinessWeek commented at the end of June 2002, shaky CEO confidence has curbed outlays on equipment and expansion: the ‘nearly daily revelations of corporate accounting scandals…[is] prompting chief executives to concentrate on cost-cutting and accounting rather than equipment expenditure and expansion’ (1).
The WorldCom, Tyco and Enron affairs are not expressions of a capitalist crisis driven by economic fundamentals. In some ways, they are even worse than traditional crises. The old boom, bust and recovery cycle is being replaced by a protracted era of languid productive activity and the waste of economic potential, punctuated by the latest financial disruption.
More of the same is not a beguiling prospect.
Phil Mullan is the author of The Imaginary Time Bomb: Why an Ageing Population Is Not a Social Problem, IB Tauris, 2000 (buy this book from Amazon (UK) or Amazon (USA))
Confidence goes bust, by James Malone
Accounting for Enron, by Daniel Ben-Ami
Enron: and on and on, by James Malone
(1) BusinessWeek, 24 June 2002
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