The new economy will give high market valuations only to some companies.
Many business models are changing rapidly in the New Economy. The traditional companies, weighed down by plant and equipment, devote the bulk of their capital to producing goods rather than selling customer satisfaction. In the New Economy, companies will be emphasising speed of change to market conditions by devoting the bulk of their human capital towards market relationships and flexible supply chains.
The high market capitalisations are going to go to those companies that follow the new business model with minimal capital expediture, minimal inventory and mass customisation.
Incremental Productivity will be the key measure in the New Economy.
I think that the macroeconomic variables that will need monitoring will also change in the New Economy. The key measure will be incremental productivity. And future interest movements will be governed by this measure. If incremental productivity increases then interest rates will have to be lowered to facilitate higher consumption. If incremental productivity starts falling, then interest rates will have to be increased to give a stretch to capital employed. And attempting to keep interest rates down without incremental productivity will be a big sin.
Fallacies of some new developments.
There are a few fallacies about some current changes which I would like to underscore. Equity has become a quasi-currency. This has become so because of the widespread use of stock options as compensation for services rendered by labour. Therefore equity becomes just like another currency which can be encashed. Imagine the Indian economy which is around $400 billion growing at 7% compounded. It will be around $800 billion by 2010 in real terms. If the Indian economy is $800 billion and there is one company like Infosys which has a market capitalisation of $10 trillion at that time, as I mentioned in my last column, then what kind of monetary policy and economic management will the country need? Come to the basic statements that are being mentioned by some of my learned friends which is that the high-technology increase is geometrical whilst the other sectors are rising arithmetically. When I think about the economic consequences of the market capitalisation of securities as a currency increasing geometrically, whereas the incremental productivity of physical output for which there is a demand rising arithmetically, I wonder about the magnitude of the inflation that an economy can witness. So equity as a quasi-currency is unsustainable in the long run.
NAV based capital markets are damaging society.
Let me go on about some of the other changes that I’m seeing. For instance, I read about genomics and genetic engineering. The forecast is that someone who is 25 today is likely to live to 92. Someone who’s born today will have a likely average age of 132 years. And then there’s going to be a multiplicity of careers. Some careers will abruptly get broken and people will have to move into new ones. Then you will have to prepare yourself for those long years of your lifetime and thus you are going to need your savings to create a buffer. Are today’s capital markets looking at the long term or are we still totally NAV(net asset value) based. Everything in capital markets is NAV based today. Even among open-ended funds the crucial question is how have I performed vis-à-vis someone else’s NAV or the benchmark index. The question that should be asked is whether we are looking at our social responsibilities. The function of the stock exchange is not only to have a market. Ultimately it’s a social instrument for the good of the society. And if we forget this good of the society, what can happen? Let’s look at communism. What a lofty ideal it was that there should be equality. What happened to all the states that followed this philosophy? What has happened to socialism? Their lofty ideals have failed because there was no productivity. They forgot that there was a cost of capital and that even if capital comes apparently free, ultimately a price has to be paid. They thus disappeared.
The paradigm shift that I’m seeing in the capital markets is what Peter Drucker has noted- that the financial markets have not innovated anything in the past 50 years. So the financial markets will have to be their own destroyers and their own creators. Thus the key question to my mind is whether the economic environment will permit the free markets to function in the manner they do. Warren Buffett has noted that on an average the profits of American companies is $330 billion out of which $120 billion is taken away by intermediaries. So are the financial markets doing what their function is- to allocate capital- or are they going into an orgy of greed. The question then boils down to whether mutual funds that are open-ended really benefit society or do we need a different kind of instrument, namely, retirement funds which can take a longer term view. Their benchmark should thus become of what they are going to give their unitholders when they turn 92.
The 2As and 3Ds of the New Economy.
There is a final change in the New Economy that I want to write about. The New Economy comprises of 2As and 3Ds. The two As stand for Access and Attention- it means getting hold of your customer so that he doesn’t go away. The 3Ds are Disruption, Discontinuity and Destructive Creation. Companies that are not able to cope in this environment of accelerated change will not survive. Society will be technology driven but the biggest beneficiary of this technology will be society and the users and not the players who are creating technology because they will be subject to the 3Ds. Bill Gates has mentioned that technology is a messy affair with lots of wrong experiments and sudden turns. It is a network of possibilities. Technology happens, it cannot be planned. And one must have the character to dwell in disorder to participate in it.
Economies will prosper in the coming two decades but the fruits of that progress will go to those companies that are using technology, not creating it.