A couple of years ago Austrian chamber of commerce had an advertising campaign promoting: „Does economy well, all of us are doing well!“. And somehow this made sense to most of us. A well doing economy provides jobs and reduces unemployment, companies are paying taxes on profits and have motivation to invest to create more jobs and pay more taxes. A very simplified picture but it shows the principle quite well.
So identifying the benefits of high profits and high cash flows is easy: It’s about stability and safety for entrepreneurs as well as for employees, it’s about taking a responsible role in society and contributing a share of the profit to the public, it’s about investing in human resources and infrastructure, etc. I don’t want to go into the details of that because you can read any aspect of this thinking from economists of the 20th century like Friedman, Hayek and many, many others.
To identify the downside of profit and free cash flow on society we have to dig a little bit deeper and understand the nature of a capitalistic and competition driven systems:
- What is the idea of competition? To win!
- What means to win in an market environment? To conquer the market and ideally create a monopoly.
- What to do with a monopoly? To control the price and the margin of the offer!
- What is the downside on society? To lose efficiency by losing the best offer!
We realize these tendencies and an increasing number of oligopoly structures in plenty of industries where we have seen and still see rapid market consolidation. Examples are telecom, steel, oil&gas, mining, banking, food, etc. The effect is that the consumer is losing buying power through the increased margin of the offer. And to increase margin and profitability is a necessary procedure to increase the profits and the cash flow. There’s an exchange of money and the higher the margin, the worse the deal becomes for the consumer and the better for the entrepreneur.
If we consider that the industries where we see the highest pace of consolidation are mostly providing commodity goods as food, petrol, telecom and banking services, we will see that most of these offers are at the very bottom of Maslow’s pyramid. Needs which have to be fulfilled at very beginning when you get your monthly pay cheque. And this means that the high profit and stable cash flows of these industries drain money out of individuals, markets and society.
A great (although slightly populistic) illustration of this tendency is the development of the wealth of the Forbes-List-billionaires compared with the development of private debt in Europe and US. Both increased significantly over the last few years and the development is accelerating.
This acceleration is stimulated by a second very negative impact on society in our „Create Profit and Cash Approach“:
To produce profit and cash you have two options: To create revenue at a high margin and to save cost. If you are an excellent manager you will have an eye on both. The matter about the margin we have already addressed.
Let’s have a look on the cost. In most of organizations the biggest portion of operating expenses is labour cost. The cash you pay to your employees and on employment taxes. And for any manager this is the easiest approach to increase profits short term: to reduce labour cost. Beside the impact on the individual which gets paid less or gets laid off, this has an enormous downside on society. The increased efficiency is eating our society.
These workers will spend less in the consumer-markets and this progress will force companies to become even more efficient. It’s a self-fulfilling downward spiral! If the workers are laid off the increase of public unemployment cost and and the cost of securing social security rise. When the cost of unemployment and social security rose, taxation will rise as well. And this forces companies again to become more efficient. With the catalyst of the previously described market consolidation – which are always „synergy and cost reduction driven“ – we create a rapidly moving downward spiral.
The ultimate problem of this development is that the whole capitalistic system we are living in is based on consumer markets. Consumption is the fuel of our present global society. And we are reaching a phase in European and American history where we are already monitoring a decrease in private spending and in these cases where spending is still happening it is often based on high private debt and high risk.
The subprime-mortgage-crisis of 2008 is an excellent example how fragile the balance of private debt and consumption and its financing already is. During the crisis it became clear that a huge percentage of all the US house owners cannot effort their lifestyle. For the real estate markets this means that the consumer market they face today is nothing else than a fiction created by the necessity of banks to sell loans and mortgages. Today we know that approximately 20 percent of all the house owners in the Untied States do neither have the credit rating nor the liquidity to purchase the real estate they are „owning“. This is an artificial market which is artificially stabilized. But it is neither healthy nor sustainable. It is a symptom of our „live-now-pay-tomorrow“ society which is visible on individual, entrepreneurial and public level. The problem we might face is: Tomorrow is coming for sure and there might be significant corrections.
Summarizing these arguments we can say that profits always carry an inherent problem of distribution. The profit of an entity is always on the cost of another entity. And through an imbalance of market power we face more and more the problem that the system gets out of balance.
Increasing the efficiency of labour cost means nothing else than changing the distribution of created value from the employee to the company. Increasing taxes means nothing else than changing the distribution of the gross domestic product.
In a darwinistic system – as capitalism is by its nature – this means that over the time the distribution of wealth is accumulating with the strong entities. The ones who are positioned better to enforce their interest are succeeding in this competition for profit and cash.
And this creates an increase of inequality within society which is a natural threat for peace and freedom. I consider Arab Spring, Occupy Wall Street and even Islamic State or the German Pegida movement as mainly driven by inequality and economical imbalance. And I consider these movements as the first signs of a much bigger threat: an increase of social frictions and a decrease of freedom to ensure future profits.
When I grew up in Austria – which through it’s geographic and historical exposure to the iron gate and eastern Europe was always highly western oriented – it was very clear to all of us: Capitalism comes hand in hand with freedom. The paradigm was there’s no capitalism without democracy. But meanwhile we know – learned on the extraordinary successful example of China – that this paradigm is not just not true, but enormously wrong! The opposite is the case. Capitalism without the burden of democratic structures is much more efficient and therefore more profitable. If we consider global competition as given, if we assume that social frictions are on the brink we can consider a decrease of personal freedom as a proper approach to keep stability in an increasingly imbalanced system. Capitalism is not known for fairness but for efficiency.
Accordingly we can assume that if we continue our run for profits long enough and enforce our capitalistic believes we have to give up our ideas of freedom and equality. It’s a trade and from a holistic perspective we might realize that we are having much to much human beings on this planet to run the system efficient. The cost of keeping the global masses calm are already today overwhelming in comparison to the increase of public wealth and productivity.
Latest since Adam Smith it is clear to everybody that the perfect market is an illusion and it needs regulation to keep them under control. Today we know that there are imperfections which accelerate the development that the markets are eating themselves:
First we developed a fully globalized economy during the last decades without building the necessary political environment to set global regulations. The decision processes of global acting companies are much faster than the ones of national administration and international organizations that we face hardly any effective regulation today. The global discontinuity of taxation approaches is a good example to illustrate that.
The second and much more frightening aspect that is in the nature of competition that it creates winners and losers. The ones who make the profit and the ones who make the loss. Out of the fact that the position of the winners is strengthened over time it is a matter of fact that the position of the losers is weakened. And just like in a tennis tournament like Wimbledon you start with a broad base of players and by the ongoing of the tournament more and more players will be eliminated.
With tennis this is not a big issue since there is a next tournament beginning the next. But within global economic competition there is hardly a next chance. If money and power is once accumulated it becomes (like Thomas Piketty explained perfectly in his book Capital) a kind of self-fulfilling prophecy and becomes its own quality: the talent of capital.
Concluding the question what the societal impacts of producing growing profits and cash are, we can state that it is leading to an increased imbalance within societal stakeholders and an increased risk of social friction.
The profit-oriented system in itself must lead to a collapse because either the profiting entities realize that a further increase of efficiency has to be reached on the cost of the masses. Or the masses realize that profits are always created on their cost and stand up against the system (which is already increasingly happening). This implies a higher level of control and repression of the masses and most probably future profits and social stability will be ensured either through an George Orwell or Aldous Huxley approach.
We know through history and by empiric experience of pseudo-marxistic trial-societies that an equal society with a fair distribution of resources is and will stay an utopia because of the people themselves. It is inherent part of evolution and an important driver of human development being competitive and aiming for individual growth. Nobody can eliminate this natural drive. Out of this we face the paradox situation that nobody considers it as fair if everybody is treated equally. And it is less important what people have as long it is more than what the neighbors have. This is a major paradoxon among all beings, not just humans.
Knowing these societal downsides of optimizing profits and cash flows we identify another critical downside: Although we know we are heading for the edge nobody can stop the development. As long as we are caught in competition no manager or leader can exit this downward train first. The motivation or excuse is always the same: If we don’t do it, our competitors will do it for sure! And so it becomes a rat race to the obvious wrong direction.