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Guest Column/Ananya Mukherjee-Reed

Misplaced Faith: Corporate profits do not mean India's gain

Since the onset of economic liberalisation, the corporate sector’s importance as an economic agent has become evident. While there are different ways in which corporations function within an economy, countries like India seem to prefer a British or United States style corporate capitalism rather than the German, Japanese or Swedish models.

The central premise of the US/British model is its belief in the private corporate sector’s efficacy in generating macroeconomics growth, provided state intervention is minimised. Minimum intervention ensures corporate sector profitability, which in turn ensures a feasible macroeconomics growth rate. As is well known, the roots of this model lie in neo-classical economic theory, which is not concerned with the macro-level growth or national economic development per se. It sees macroeconomic growths as a simple derivative of micro-level activity.

This model’s flaws, when applied to national economic development, have long come to light. Neither the US nor the United Kingdom has achieved the growth rates of the East Asian tigers. Conversely, East Asia’s firm level profitability has been significantly lower than its counterparts in the West. Many developing countries have shown higher rates of firm level responsibility than in East Asia.

Their macroeconomic growth rates, however, can hardly be compared. As an International Finance Corporation study shows, while the ratio of post-tax profits to net worth of Indian firms was in the range of 18 to 20 per cent. During the same period -- 1980-88 -- India’s industrial growth rate stood at about 5.4 per cent while South Korea recorded an average annual growth rate of 13 per cent. The contrast with more pronounced in the 1960s, the era of miracle growth in Korea and a deep recession in India.

The UK provides a further example of the corporate profitability national economic growth paradox. A Sunday Times survey of April 1990 asked: “How can a country which has 28 of the top 50 European companies be in such a parlous state? Even P-E International (authors of the survey) were perplexed.” According to the survey, British firms performed way above either European firms in terms of profitability. Yet, in the same period, the UK’s economic growth was negative -- and lower than France, Germany and the Netherlands, all of which recorded positive growth rates.

How can this paradox be explained? Is there a serious incompatibility between micro-level growth? If so, why? And if so, how far can hopes be pinned on current policies which seek to ensure corporate profitability above all else?

Once one is ready to step outside the framework of neoclassical economics, the incompatibility between micro-level profits and macro-level growth can be explained. But certain caveats are in order. First, overall economic growth or even the industrial growth rate is not determined by corporate productivity alone. This is especially true of countries like India, where agriculture dominates the economy.

Some might argue a large section of industry is unorganised, and unable to achieve the economies of scale conducive to growth. While these are points in question, they should not take away from the fact the corporate sector, especially its largest faction, is responsible for a significant portion of industrial output; it controls the way this output is generated and its impact on the national economy.

With these caveats in mind, one can examine the conditions when corporate profitability may become incompatible with economic growth. One answer was provided by the renowned economist, Joan Robinson, as far back as in 1932. Her thesis was that if the industrial structure is dominated by a few oligopolistic producers, economic growth must necessarily stagnate. Oligopolistic profits can only be realised by restricting output. Through this and the creation of artificial scarcity, prices are pushed up, and oligopolistic -- or monopolistic -- profits derived. Output restriction will in turn mean excess capacities, high unemployment and depressed incomes of non-profit earning classes forming the majority.

In South Korea, growth has occurred despite an acutely oligopolistic structure. This is because the South Korean state, while consciously creating oligopolies, also preempted the unwanted effects of oligopolistic production. It forced large firms to take lower level of competitive profits by maximising production. Growth was not the result of unmitigated profiteering, but of forcing firms to maximise the volume of output produced.

This stress on maximising production and resources use and thereby capturing market shares is in fact the classic Japanese strategy. In contrast to the US/UK model where the maximisation of the shareholder value, or more simply, profit maximisation, is the benchmark of corporate performance, the Japanese focus more on market shares. To achieve a sustained growth in market shares, they in turn invest in technology.

The Massachusetts Institute of Technology Commission on Industrial Productivity has noted: “One key factor in Japanese success was superior engineering. Another was the willingness to invest heavily in both product development and process development for more than two decades while cash returns were low and growing too slowly... Over the same period many American firms were actually ceding products and functions to foreign competitors and diversifying into less risky and more profitable are as such as car rentals and financial services, unrelated to their original lines of work.”

The British follow an entirely different path toward corporate growth. For instance, the famous Yorkshire businessman, James Hanson, was held in the 1980s -- Margaret Thatcher’s era -- as a paragon of British business and awarded peerages. He became particularly noted for “commitment to his shareholders” and ability to acquire companies that continuously maximise shareholder value. The strategy to accomplish this did not, however, contain the growth and expansion of the business acquired. Rather it came “from closing factories, from shedding labour, from pension holiday’s and appropriating surpluses in pension funds, from avoiding stamp duty on purchases by shuffling assets internationally, by tax evasion through the use of 26 Panamanian companies, etc.”

It is evident why this approach to profiteering is inimical to national economic growth. Corporation profits come at the cost of curtailed production, unemployment, layoffs or the canalisation of investment to unproductive areas. In India’s own post-liberalisation obsession with corporate profitability, investment has flown to areas yielding high returns but not adding to real productive capacity. In liberalisation’s initial years, substantial amounts raised from financial institutions, banks and public offerings went to wasteful speculative activities like real estate, commodities, currencies or other financial instruments.

The returns were registered as a sudden rise in the companies’ income under the “other income” category. As far as the maximisation of shareholder value is concerned, this does not pose a problem. If small shareholders are not adequately informed of the way their monies are invested and the uncertainties thereof, there is a good chance they will invest greater amounts. It was largely such luring of small depositors that constituted the so-called stock market in post-liberalisation India; that this did not result in any sustainable rise in industrial investment has become evident.

Corporate profitability is necessary for survival of business, but not sufficient for macroeconomics growth which occurs only if profitability is engendered through a genuine, iterative process of productive investment. The question for developing countries is: how to ensure the macroeconomic relevance of investments within an ideology that abhors all controls on investors and producers?

Reformers have offered two answers. First, “opening up” the economy to foreign competition. As Indian conglomerates “wake up and smell the coffee,” prices will crash and high quality products will flood the market. The naiveté of this neo-liberal position is astounding. Yes, competition may ensue in the short run. But in the long run monopolisation will recur, with foreign firms in monopoly positions and Indian firms capable of competing will enter into collusive arrangements with them. At best it would result in an oligopoly similar to the one that has historically existed in India.

Second, a lot of faith has been placed on good corporate governance. Again, the discussion on the subject in India has so far followed the rather restricted US/UK discourses. So far, it has involved the problems of increasing the accountability of boards of directors, transparency of accounting procedures and so on. Though useful, these fall short of raising the question as to what role corporations should play in development. For that to happen, we urgently need to modify what seems an unquestioned commitment to the freedom of private enterprise.

The author teaches economics at York University, Toronto, Canada