Pie-Slicers vs. Pie-Enlargers

...The most obvious offender here is the congerie of loopholes-mortgage interest deductions, homeowner's exemptions and capitalgains treatment-that indiscriminately subsidize the trading of existing real estate...

...All this is the result of the short-run balance sheet mentality, which translates into low investment in the research that may produce technological breakthroughs a decade from now, or in the modernized and expanded factories that may reduce costs and improve quality beyond the next turn in the business cycle...

...Instead, the company had simply adopted more liberal bookkeeping methods for depreciation, investment tax credits, and certain interest costs...

...Trying to recoup, unions demand catch-up raises, only to find that other unions do the same, which produces another round of inflation...

...Positions as special assistants to the heads of diversified companies are particularly prized, because they allow the application of sophisticated portfolio-management techniques (which favor current “profit centers” over longterm innovation...

...In the last three years some $100 billion of corporate cash resources have been used to acquire exist- ing corporate assets through tender offers...

...We could start with the incentives offered by our tax system...

...And the frenetic swapping of real estate that preoccupies our upper middle class continues, recession or not...

...At the time, buyers were climbing back into bigger cars, and small car sales were slumping...

...This article reflects his own views, and does not necessarily represent the viewsof the Commission or of any commissioners...

...When Ford finally brought out “downsized” sedans, they were still on the overweight side and they flopped badly...

...A second group of reforms would affect the means of financing business ventures...

...In the search for quick profits, they move in and out of large positions with little regard for the strengths of the underlying enterprise...

...The aging plants they purchase may be undervalued in terms of book value, but not in terms of what it will cost to replace them with inflated dollars...

...Their owners could be allowed to deduct losses more easily from personal income, and they could be freed from the host of levies-franchise taxes, gross receipts taxes, and social security taxesthat apply in full force whether or not their business has any profits out of which to pay them...

...If you have doubts, you should know that, in the antitrust area alone, $2 billion was spent last year by American corporations engaging in litigation with each other...

...The most sought-after jobs among business school graduates are inyou guessed right-finance and consulting, where the specialty is the shuffling of corporate boxes...

...Out of the same group in Japan, 400 are engineers and scientists...

...His only risk is that the IRS may prove he was trying deliberately to avoid taxes, an unlikely event...

...If you look at the other industries in which our competitive position is declining relative to that of Japan and West Germany- steel, consumer electronics, semiconductors- you will find the same pattern...

...We are now in the early stages of this cycle...

...And as corporate managers themselves become more militant in the face of declining profits, they are apt to resort to hostile counter-strategies-hiring consultants to “bust” their unions, moving factories to other states or countries...

...But they represent only a fraction of the yields available to lawyers, accountants, and financiers who continually discover new loopholes, shelters and gimmicks.Lawsuits are a final form of classic assetrearranging...

...Other plays are less obviously speculative, more like elaborate Ponzi schemes in which asset-rearranging yields high returns so long as no one calls the bluff...

...Instead, we should focus on what sort of enterprise we are encouraging, on how individuals are accumulating wealth, and we should take steps to ensure that more of our economic activity is of the assetexpanding variety, and that less effort goes into rearranging...

...Not surprisingly such small or closely-held firms, particularly in hightechnology industries, account for the lion’s share of new ventures, inventions and innovations...

...Tax straddles and similar strategies are being actively promoted by the “commodities advisory services” that have sprung up recently, and are estimated to net their practitioners about $4 billion a year in unpaid taxes...

...Some of it may eventually find its way into the hands of investors willing to take such risks-but just as surely, much of it does not...

...Instead of enlarging the economic pie, we are busy reassigning the slices...

...A final set of changes should focus on the ownership of productive assets...

...Here the portion of the pie shared by workers has been declining as inflation has outstripped wage hikes...

...Today, 75 percent of corporate stock is bought and sold by professional portfolio managers of mutual funds, pension funds, and insurance companies...

...But the current crisis has deeper roots...

...Even his compensation- in the form of incentive bonuses and stock options-is likely to be geared to short-term earnings...

...In 1979 the figures jumped to 2,128 acquisitions valued a t $43.5 billion, almost double the 1977 figures...

...The portfolio managers, in a sense, merely enable investors to pursue their short-term gains more efficiently...

...The average corporate chief executive may have an even smaller stake in future growth than the average stockholder, By the time he reaches the top, the typical executive may remain with a company only a few more years before retiring or moving t o a position with another firm...

...The loss may be deducted immediately, while the profit, if the straddler plays his tax return right, may be deferred indefinitely...

...Robert B. Reich is director ofpolicyplanningat the Federal Trade Commission...

...Pie-Slicers VS Pie-Enlargers by Robert B. Reich The United States now has the highest percentage of obsolete plants, the lowest percentage of capital investment, and the lowest growth in productivity and savings of any major industrial society...

...No matter...

...In evaluating the current rash of remedies, we need to look for those that would attack the imbalance of entrepreneurial effort at the core of our economy...

...Last year, for example, 76 million commodity futures contracts were traded, up from 13.6 million in 1970-a 458-percent gain compared ,to a 174-percent increase in stock market volume during the same period...

...The catch is that the groups seeking to grab assets from each other are often the very group$ whose collaboration is necessary for real growth to occur...

...Indeed, thanks to the high mobility of capital and management, those who have the strongest economic stake in the longterm health of an enterprise are apt to be its lower-level employees, whose mobility is more limited...

...But the potential benefits to society of this second investment would be vastly greater-the creation of an entire new industry, perhaps spawning other products and technologies, establishing thousands of new jobs, and shoring up entire communities...

...All this calls for a willingness to invest now for greater return in a distant future...

...Today, corporate executives spend an increasing portion of their days fending off takeovers, finding companies to acquire, responding to depositions in lawsuits, and seeking various forms of government largess, instead of worrying about how their products can be made and distributed more efficiently...

...But given the recent record of speculation and finagle, one must ask whether these benefits are worth what we’re paying for them, in terms of both direct cost and future productivity...

...Energy Crisis 2. Paper En trepreneurialism: Assetrearranging also harms productivity by using up the energies of our most talented citizens...

...Some reasons for our decline are obvious: Rampant inflation, fed by energy price hikes, discourages personal saving and productive investment...

...More of our top corporate executives are now trained in law and finance than in any other field-in contrast to three decades ago when most corporate leaders were trained in marketing, engineering, and sales...

...Not long ago, for example, the majority of stock on our exchanges was owned by individuals...

...Instead of generating future economic expansion, the m-one y circulates among companies like the stakes in a floating dice game...

...The reason is simple: If an investor puts $1,000 into an existing enterprise, he may, if his stock performs better than average, get back about $1,500 in five years...

...But asset-rearrangers typically require that investments pay off in the short term, even a t the expense of greater yields later on...

...But our more productive economic competitors, Japan and West Germany, both have governments that are larger and intrude more heavily into the private sector than our own...

...You will find a higher incidence of defects in U.S...

...Foreign currency contracts and financial futures add to the growing lists of speculative investments...

...In both countries, the gap between the richest and poorest citizens is substantially less than it is in our nation...

...Yet Carbide accomplished its feat without adding a dollar to its assets...

...They tend to be concerned about long-term goals simply because they are closer to their company-involved in its management, familiar with its work force, committed to the product or process they are developing...

...Instead of enlarging the economic pie, we are busy reassigning the slices...

...Faced with the alternatives of investing corporate earnings in new plants, equipment, or research (risky propositions whose payoffs are likely to be in the distant future) or undertaking a distribution to shareholders (who would rather pay a low capital gains tax on appreciation of shares than a high income tax on dividends), corporate managers instead see considerable attraction in snapping up profitable, well-run companies with established market positions...

...They point to the high underlying value of the assets being purchased relative to their price on the stock market...

...The average term of office for today’s chief executive officers is only four years-and, as one president of a machine tool company said recently, “A chief executive plots his career first and his capital budget second...

...An ever-larger portion of our economic activity is focused on rearranging industrial assets rather than on increasing their size...

...But Ford and Chrysler chose to stick with what was selling at the time (Ford even considered advertising itself as the “Home of the Whopper...

...investors and managers often can bail out long before...

...Still other fertile fields of asset-rearranging involve the manipulation of tax laws or international rates of exchange...

...In 1978, 2,106 acquisitions were announced, valued at $34 billion, a 54 percent increase over the $22 billion reported in 1977...

...Usually this is accomplished by influencing the government to reslice the pie by subsidy or taxation, but not always...

...They are the consultants who plot acquisition campaigns and the lobbyists skilled at obtaining government subsidies...

...Instead of productentrepreneurs, we have spawned a nation of paper-entrepreneurs, who by now embody our most original thinking and energetic wheeling and dealing...

...The clearest example is in the field of labor-management relations...

...For example, Union Carbide recently increased its first quarter profits by $217.3 million-a healthy jump that added $3.28 to each share of its stock...

...If you are going to encourage a long-run growth, for example, debt-financing has a great advantage, since as long as a corporation meets its interest payments, it is free to sacrifice short-term profits for long-term productivity...

...Again, Japan has some lessons ?or us...

...GM chose to hedge its bets with a modest (though ultimately inadequate) “downsizing” program...

...And they are able to pursue those goals, at the expense of immediate gains, because they are not playing with anyone’s money but their own...

...An exception to this general rule are the stockholders of many small or closely-held enterprises...

...We have also seen, over the years, that frequently these proposals simply stimulate more assetrearranging...

...Of course, by the time the bottom dropped out and Ford began laying off workers by the thousands, the mastermind of its bigcar strategy, former Ford president Lee Iacocca, had moved on to better things at Chrysler, where he could give his undivided attention to lobbying for government loans to save a company from the same long-term problems he had left behind a t Ford...

...tight-money policies designed t o fight inflation further dampen new investment...

...Out of a recent graduating class of 721 a t the Harvard Business School, a grand total of seven reported that they had gone on to start ventures of their own...

...That would give the shareholders the benefit of the premium to reinvest at market prices, and free the corporations from the demands of those shareholders most likely to insist on immediate gains...

...On closer inspection, some acquiring companies have built houses of cards...

...The most obvious example of truncated corporate vision, of course, occurred in 1975, in the aftermath ofa recessionand an oil crisis, when American automobile manufacturers planned their new product lines...

...Out of every 10,OOO citizens in Japan, for example, only one is a lawyer and three are accountants...

...Second, that increase will be taxed at the lower capital gains rate, while dividends are taxed as ordinary income...

...The individual stockholder will not profit from these beneficial “multiplier” effects of his original investment, so he will tend to ignore them, sticking with the safe investment in an existing company that promises “profit now...

...Blue-collar employees are still paying the heaviest price for our decline, followed closely by small business...

...An ever larger portion of our economic activity is focused on rearranging industrial assets rather than on increasing their size...

...Our current obsession with asset-rearranging harms productivity in three related ways: 1. Short-term payouts: Improvements in productivity often depend on investment strategies geared to the long term...

...The same incentives could be given to individual shareholders themselves, in which case corporations with extra cash could be encouraged to buy back their stock rather than acquire a target company at a premium...

...There, as the industrial equivalent of a lawyer, he can plot mergers and tax shelters without ever getting his hands dirty actually turning out a product...

...Surely that reflects a shift toward hard-headed productive values...

...The Japanese government's ability to channel investment into very large-scale integrated circuits, for example, has enabled firms in that industry to avoid equity markets and aim for longterm growth...

...A typical hotshot Bschool graduate wouldn’t be caught dead supervising production for a steel company, and he’s even less likely to try to start his own business...

...Paper entrepreneurialism promises the best financial rewards, the greatest employment security, and the highest social status...

...While graduate programs in law and accounting are booming, science programs are floundering-again a contrast with other industrialized nations...

...Employees must live with the consequences of declining long-term productivity within an industry and a region...

...It may be tempting to conclude that our problems stem in a simple manner from too many restrictions on free enterprise or on the accumulation of wealth...

...products, which may reflect a smaller investment in quality control...

...The development of the internal combustion engine, electronics, xerography, and semiconductors each depended on a quarter century or more of trial and error...

...So they are under tremendous pressure to demonstrate the short-term earnings that potential clients look for...

...Likewise, in the other areas where the tax laws currently encourage speculation in old assets, we could be more discriminating, and target the tax breaks to apply only to fresh investments...

...Instead, these tax breaks could be given only to those who invest in new buildings, creating the additional housing needed to ease our current shortage...

...The pace of this game has been accelerating...

...But when two corporations, with their platoons of lawyers, grind each other down in court, is any socially useful product created...

...The U.S...

...Only when an entire industry faces collapse, as in autos and steel, d o labor and management begin to recognize their common interests- and by then it is usually too late...

...industries have lower research and development budgets, smaller or less modern plants, lower capacity...

...A corporation’s earnings could be immediately taxed as income to shareholders (without the capital gains break) unless the earnings were “rolled over” by the corporation into new investment...

...This dramatic increase in corporate asset-trading is usually explained by the simple fact that many corporate shares are selling below book value...

...Schemes of employee ownership and participation not only appear to improve productivity over the short term, but they may also improve prospects for long-run growth, since employees typically have a higher stake in the continuing viability of an enterprise than do either managers or investors...

...Suppose instead he put his money into a research and development company that was trying to produce a new product or a new manufacturing method...

...But the game of rearranging industrial assets can involve many plays beyond the conglomerate merger...

...There is a good argument that, even without the intervention of the portfolio managers, stockholders as a group tend to take a relatively short-term view of their investments compared with the value of those investments to society...

...Accelerated depreciation allowances, for example, may end up giving corporations extra cash to spend on another round of acquisitions...

...By any number of measurements, including the total amount of money, effort, and media attention devoted to each, the ratio of asset-rearrangers to asset-enlargers in our economy is running at about 2 to 1. The most obvious example is the continuing rage of mergers...

...Independence” to today’s business graduate means working for the Boston Consulting Group instead of for GM...

...here only 70 are engineers or scientists...

...A whole new field of consultancy has grown up in recent years, “earnings management,” which consists almost entirely of such strategic use of accounting conventions-redistributing income from good years to bad, recognizing profits in advance of sales, and similar innovative techniques...

...The industrial Midwest is growing poorer while the Southwest is gaining in wealth...

...So why not limit the tax breaks to corporate earnings that actually are reinvested in new production, equipment, or research and development...

...Simply put, the structure of our economy- its underlying organization, the incentives it offers-has discouraged longterm growth in favor of short-term paper profits...

...On the management side, the overall picture is similar...

...We have seen a variety of quick-fixes for our economic troubles proposed over the years, and more are being offered every day, from across-the-board income tax cuts, to indiscriminate depreciation write- offs, t o protectionist tariffs...

...The result is likely to be a breakdown in cooperation between unions and management, possibly including crippling rounds of strikes, that will ensure there will be even less product to spread around...

...Commercialization often requires the development of large-scale production facilities, distribution and sales networks, and quality control systems...

...Profits Now’ I do not want to suggest that all efforts directed a t rearranging corporate assets are necessarily wasteful...

...Whom you hear less and less of are the pie-enlargers-the engineers and inventors who create better products at less cost, and the entrepreneurs and workers who translate those ideas into new factories, new jobs, and ultimately into goods and services that people want to buy...

...The benefits to him would be proportionately greater, though they would come at a later date...

...To discourage rearranging, the Federal Reserve could establish guidelines that would make it more costly for banks to provide easy credit for speculation and conglomerate acquisition...

...3 . Divisiveness: In an economy based on asset-rearranging, corporations, unions, industries and individuals are pitted against one another in the desperate attempt to obtain a share of a stable or shrinking pie...

...But I’m forgetting something, you saythe recent boom in business school attendance...

...Meanwhile, our best minds are increasingly drawn to the piedividing professions of law, finance, and accounting, and away from pieenlarging professions like engineering and science...

...The circle is a vicious one: as the economy begins to decline, each group seeks to preserve its standard of living, but it can do so only by appropriating a portion of the declining wealth of another group...

...And there are a variety of mechanisms for stimulating more of the smaller, privately-held enterprises that are most likely to see new ideas through t o fruition...

...This money otherwise could have been spent on new factories and other productive uses...

...They are the accountants who manipulate tax laws and depreciation rules to produce glowing-or at least presentable-annual reports...

...But all the long-range trends indicated a growing shortage of fuel and a growing demand for smaller cars...

...They are the financiers who think up new varieties of debentures or new mutual funds...

...Since futures trading is a “zero-sum” game, the investor will make money on one of the contracts and lose the same amount of money on the other...

...To stimulate long-term investment, businesses could be freed from the impatient demands of stockholders through various government incentives that reduced their need to go to the stock market for financing...

...Don’t count on it...

...Automakers had the choice: tool up for big cars and make some quick bucks, or tool up for smaller cars and profit over the long run...

...It is interesting that in Japan trade unions are among the most vocal advocates of long-term investment strategies that emphasize productivity and growth...

...Securities analysts and brokers likewise hope to show profits by correctly guessing the short termfluctuation of price-earnings multiples instead of the long-term potential for growth...

...Look around you, and you can see the rearrangers hard at work, prospering...

...They speak of gains from “synergy”: the dynamic effects of pooled management upon what were formerly independent firms, making the whole greater than the sum of the parts...

...And despite all the claims for “synergy,” there is very little evidence to suggest that mergers have on the average enhanced the basic profitability of merging enterprises...

...Securities fraud, patent infringement, antitrust, product liabilitythese are the growth fields of American business...

...The accounting charges, according to Wall Street analyst Thorton O’glove, “will have no impact on cash flow or distributable income...

...Research aimed at developing fundamentally new technologies is apt to go slowly, yielding little or no profit for many years...

...These managers must do more than invest for the future-they must also attract and keep clients...

...As mentioned above, corporations currently have a strong incentive to retain and reinvest their earnings because of two tax breaks built into the structure of our revenue code: First, dividends are taxed as income to shareholders when they are paid out, but if a corporation reinvests, the increase in the value of its stock will only be taxed when the shareholder sells his shares...

...In the U.S., 20 are lawyers and 40 accountants...

...They are the corporate executives, trained in law and finance, who hire all of the above, and the lawyers whose briefcases bulge with the statutes, opinions, depositions, interrogatories, motions, and prospecti necessary to carry out their strategies...

...The result is a “brain drain” away from innovation in production or distribution...

...The incentive for management to reinvest that is created by these provisions would be fine if corporations put their money into new productive assets instead of buying up old assets, like other firms...

...Silver and treasury bill futures, for example, are often used in a profitable maneuver known as the “tax straddle,” in which an investor buys a futures contract and simultaneously sells an identical contract...

...Some are blatantly speculative-somebody wins only to the extent that somebody else loses...

...These divisions would not loom so large in an economy that was expanding...

...But the attempt to restore an expanding economy will only be crippled to the extent that citizens see themselves primarily as members of different warring groups-blue collar or white collar, small business, investor or consumer, Frostbelt or Sunbelt A Little Discrimination How are we to break out of the downward spiral of asset rearranging...

...We could begin by asking ourselves the question: which strategies will stimulate more paper, and which more product...

...To the extent that they allocate capital more efficiently to where it can be most productive, or smooth out what would otherwise be sudden changes in supply and demand, they make our economy perform better...