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Productivity Not Profits

Summary: 

The 2011 Occupy Wall Street protests provide a context to better explain the solutions we recommend to fund unpredictable R&D+. The Wall Street protester complaints are confused. This article clarifies the issue for mainstream observers and suggests improvements based on our R&D solution.

Over long periods of time, small differences in rates of productivity growth compound, like interest in a bank account, and can make an enormous difference to a society's prosperity. Nothing contributes more to reduction of poverty, to increases in leisure, and to the country's ability to finance education, public health, environment and the arts. Alan Blinder and William Baumol (1993). Economics: Principles and Policy, Harcourt Brace Jovanovich, San Diego, p. 778.

Productivity not profits.

If you can't sustain a growing rate of industrial productivity in a nation-state then you can't sustain a great nation. Let the economy tank and you open up quarters for popular discontent and single-issue political solutions. 'Drill Baby Drill' or 'Universal Health Insurance' become politically attractive siren songs – providing geographically stable jobs to a population desperate for any relief to their personal economic distress. Over long periods of time small, steady losses in industrial productivity undermine an economy to the point where the population is reduced to fighting amongst itself for a piece of an ever-smaller economic pie. It's a dangerous time, engendering the rise of divisive political philosophies and partisan platforms.

Profits are a very poor surrogate measure for productivity, even over the long run.

  • Profits allow management to give the appearance of productivity while they mortgage the future. It's easy to manipulate profitability for up to a decade: cut back steadily on R&D expenditures, outsource core capabilities, etc.
  • Profits allow lucky managers to pillage their firms until their luck runs out. Their tenure happened to start when the labors of previous managers came to fruition, the market shifted in their favor, etc. They were in the right place at the right time, and use this fluke to claim the right to set the future direction and leadership for the firm, a direction and leadership that favors their private benefits at the expense of the firm's shareholders.
  • Profits allow poor managers to reset the clock periodically: a general economic downturn is used as an excuse to reset the baseline for growth. A thousand little accounting tweaks and reserves exploited over the prior decade to give the appearance of growth can now be reversed under the cover of a general restructuring.

Profits are an artificial contrivance conjured up by the accounting and financial professions. In contrast, productivity can be made concrete and unambiguous by basing its measure on the extent to which consumers reach into their own wallets to purchase a firm's goods and services.

Today we undervalue productivity and overvalue profits. If I have a firm that is highly productive but can only pay 4% dividends then I lose out to firms who are unproductive but can pay 5% dividends. It's easy to pay 5% dividends. I take in $100 in investments and each year I pay out $5 in dividends. There's no productivity from the $100, but I don't plan on being around long enough for that fact to become obvious. As a productive firm I have no choice but to play the numbers game and as a result overall capital productivity suffers. Worse, firm management gets rewarded for being good at gamesmanship and not for productivity. Today we allow bad investment behaviors+ to drive out the good.

The ideal investor is informed about the importance of productivity. Unfortunately we have too many uninformed investors with too much excess capital.1 If you're getting 5% as an uninformed investor then how am I going to sleep (or justify to my boss) when I'm only getting 4%? This was the logic behind the 2008 global financial collapse. How do I not purchase securitized mortgages when my competition is doing so and making lots of money? Worse, with integrated financial markets uninformed investors prop up business practices that put all productive firms at risk (e.g., Credit Default Swaps). We can't fix the problem by just letting stupid investors fail.

The fix is twofold:

  • Develop unambiguous, independent measures of a firm's productivity
  • Institute draconian penalties for those who discount the importance of productivity when investing (e.g., intermediaries, investees)

Neither of these exist today. Both are extremely complex to design and implement. But at least they allow us to better inform the public debate.2

Firm productivity is not formulaic. There are no worthwhile econometric models for quantifying a firm's productivity.3 Firm productivity is only quasi-objective. To name a few key variables, we track operational productivity, risk taking, the current industrial phase, market conditions, management capabilities, etc. Any productivity rating for a firm must include both quantitative and qualitative results, and forward projections.4 There can be no one-size-fits-all+ solution for measuring productivity.

Productivity is long term. Investors are short term. We shouldn't (overly) penalize investors for not tracking or seeking productivity. Instead we penalize intermediaries (e.g., Investment Banks, NYSE, and NASDAQ) and firms receiving the investment dollars. Managers and owners of these institutions must have a substantial stake-in-the-game and this stake must be 'at risk' until productivity using the investor's dollar can be shown to have passed the test of time.5 Productivity must replace profits in decisions to 'list' and 'delist' a firm's stock on public exchanges.

We get exciting theater when we argue about CEO greed, putting profits before people, exporting jobs overseas, corporate tax dodges, wealth disparities, unfair foreign (read wascally Chinese) competition, currency manipulations or the occasional corporate scandal. If I can get you riled up over these media-grabbing but distracting side issues then you'll not stop to think about what's really undermining the wealth and greatness of the nation.

Real productivity is tough, so many firm managers and investment intermediaries welcome excuses for poor productivity. In trying to stop what might go wrong we put in place protections ensuring we do less right. Managers hide behind the excuse of 'I followed the rules' rather than taking risks and having to face the consequences when those risks go south. The media, politicians, businessmen, academia and bankers are all complicit in this game. Don't let them take your eyes off the ball.

In matters of economic growth and prosperity, industrial productivity is all that matters. If you want to march on Wall Street carrying a placard, then the slogan should read: Productivity not Profits!

  • 1. The Me Generation.
  • 2. We have instituted these fixes for our Investible Units+. But Investible Units are 100-150 person single-focus firms where it is easier to wrap your mind around suitable measures of productivity. See Independent Evaluation Defined.
  • 3. The various flavors of these models merely rework numbers from the same sources as the accounting statements we're trying to replace.
  • 4. See Concept and Measurement of Productivity for a good summary of the challenges of measuring productivity, key being protections against mortgaging the future+, and results that stand the test of time. It's not straightforward. For example, should pharmaceutical firms who today are defunding R&D be lauded for getting prepared for life in a Phase 3 industry, or should they be vilified for killing off future product development?
  • 5. The investor's dollar includes profits generated using that dollar. The firm must either show it can productively employ profits earned or it must be incented to distribute them to investors. 
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Reba Tull
Offline
Joined: 03/30/2011
Too simplistic

One Share - One Vote still allows insiders to rig investor votes in a manner that gives them disporportionate private benefits.

You haven't addressed Derivative Investment Vehicles+ which make it beneficial for contrarian investors to bet against the success of a firm. Profits vs. Productivity doesn't matter when sophisticated investors can profit by trashing measures of a firm's productivity. As discussed, they'll borrow money before a big investor vote, buy voting shares, vote to trash productivity, sell the shares, and then subsequently they reap windfall+ profits by selling the firm's shares short (or less obviously, by holding shares in a competitor's firm).

The best we can do is to identify management and investor actions that quash productivity and then deal with them on a one-off basis. There can be no one-size-fits-all+ solution to the problem of stagnate productivity.