Wednesday, June 10, 2009

The Perils of Hyper-competition

On Monday June 1st, General Motors, the doyen of the American auto industry filed for bankruptcy. Shockwaves went through not only the US but also the world economy. Commentaries abound on the cause of the demise of such a big and powerful player in the global auto industry. Hopefully for Malaysians we can learn some important lessons, not the least on how to prevent our own national car company from meeting the same fate.

Angela Merkel, the German Chancellor, put the blame squarely on `mismanagement’, which may mean anything you want it to. Others attribute GM’s fall to its inability to come up with effective strategies against low-cost auto manufacturers from overseas, namely from Japan and Korea. Some put the blame on the unions which allegedly was the stumbling block against efforts to reduce huge labour costs which included pension liabilities and health-care costs. Some blame the American government for not supporting the company in its tough battle against foreign competition, through either greater subsidies or the imposition of higher tariff barriers. And yet others blame the American consumers for fickle-mindedness and lacking in patriotism in their buying decisions.

However, on deeper examination, one will realize that the aforesaid ‘causes’ are rather simplistic and does not address the complexity of the problem. For example, if we put the blame totally on management, we ignore the fact that the GM management has been trying for decades to increase the company’s competitiveness. It took measures such as absorbing Toyota's manufacturing methods, improving car styling and design, investing in hybrid technology, integrating the company’s operations and centralizing management to reduce costs and persuading the United Auto Workers (UAW) to agree to cost cuts. So much so that by early 2008, analysts concluded that GM had successfully transformed itself.

And the unions? Are they responsible for making GM uncompetitive by their demands for improved pay, working conditions and benefits? Who else would do this for the workers if not their unions? Moreover, many of the requests put forward were inarguably reasonable and necessary in order that members get living wages which are able to meet life’s basic needs.

Blaming the American government for not helping GM in its struggle against foreign competition betrays a lack of understanding of the nature of international business. US trade policy seeks to ensure that international trade remains free from both tariff and non-tariff barriers. Tariffs on imported cars or subsidies to GM will undermine US government’s efforts to encourage other countries to remove trade barriers. Furthermore, member countries of the WTO are agreement-bound to refrain from taking protectionist measures. Breaching the agreement can damage trading links with other nations.

Also, if the American government is considered obligated to rescue GM, the next logical question is why only GM needs to be supported and not another company or another industry which is also suffering from international competition. This is why Malaysians must be very careful when they call on their government to support Proton.

The essential truth is that GM actually is a victim of `hyper-competition’ in the car industry. Competition is good to the extent that it leads to the efficient operation of the market mechanism resulting in benefits such as the efficient use of resources and improvements in goods and services being offered to the customer. However, beyond a certain level where competition gets too intense, dysfunctional outcomes will follow. Competitors will behave ruthlessly and the losses suffered by the losing parties will no longer be optimal to society.

As an analogy, let us imagine two men wrestling in a ring according to the rules of Greco-Roman wrestling. They will do their utmost to defeat each other but at the end of the match, there is no physical injury to either wrestler other than a bruised ego. But what if the spectators decided they want a more exciting competition between the fighters and decided to throw swords and knives into the ring and force the fighters to use them? Greco-Roman wrestling will turn into mortal combat like those of the ancient Roman gladiators in the coliseums. The defeated one dies whilst the winner survives but with serious injuries.

The fatal mistake was to give competitors weapons which they in the first place did not need. The weapons of modern day corporate competitors come in the form of loans obtained from the lending industry. A few hundred years ago, business concerns competed using their own money and therefore the level of competition was relatively low. The overall outcomes of the forces of competition were positive and that was the main reason Joseph Schumpeter came up with the notion of `Creative Destruction’ in describing the benefits of competition regulated by a functioning market system. But with the legalization of usury by the Europeans, the financial industry began to grow. Thus began the throwing of `knives’ into the hands of business competitors. The lending industry is now huge and they are now throwing samurai swords, axes, and even bazookas and RPGs into the ring for business competitors to use to fight each other. So it should not surprise anyone to see GM lying on its back in the ring, mortally injured, whilst in the other corner we can see Toyota sitting on the floor looking dazed with horrific body wounds and some limbs missing. For those who are unaware, Toyota recently announced its worst ever annual loss of 436.94 billion yen for the full 2008 fiscal year and a projected a net loss of 550 billion yen for the following fiscal year.

The combat is unending as other gladiators from Korea, who during the 1997 crisis also nearly died from horrific injuries but were given mouth-to-mouth resuscitations, are now back, looking energetic, with new financial `weapons’ in hand. So don’t be surprised if in the coming rounds we see Toyota meeting the same fate as GM. The question to ask of ourselves is how much weaponry are Malaysian taxpayers willing to supply to our own gladiator Proton and when it eventually succumbs to vicious competition, what will be the extent of the injuries i.e. how much money and how many jobs will be lost? Or should we start telling humanity that the competitive situation is unsustainable, untenable and dysfunctional and that we should go back to organizing Greco-Roman wrestling rather than allowing the gladiatorial fight-to-the-death series to continue?

Monday, June 1, 2009

Lurching Towards Disaster: Between Ignorant Masses and Self-Interested leaders

On 24th May 2009, Robert Zoellick, the President of the World Bank, issued a warning that the current global economic crisis could very well lead to serious social upheavals. Mr. Zoellick is highly concerned with the increasing levels of unemployment in many countries around the world, especially in Eastern Europe where some countries are registering double digit decline in their economies.

Mr. Zoellick is actually not alone in having this worry. Many others also share the worry. However, the fact that it is being highlighted by such an important figure is very significant, especially so when political leaders in many countries are trying to re-assure their voters that the worst may already be over and that they are going to see an upward economic trend in the not too distant future.

Obviously, Mr. Zoellick, unlike politicians in many countries, is genuinely concerned with the future welfare of people. He is therefore asking governments to formulate appropriate policies in preparation for this impending grave and gloomy scenario.

Many political leaders on the other hand are more concerned with their short term political positions rather than with the long term welfare of their societies. As a result they tend to underplay the seriousness of the future economic and unemployment scenarios, fearing that it may negatively affect the perception of the public towards themselves.

To be fair, the reason why politicians behave in this manner is largely due to the expectations of the voters themselves who are more concerned with their own short-term well-being compared to the long term welfare of their societies. In their minds, the bottom line is that politicians must be able to guarantee job security so that they can continue to have money in their pockets and bread on their dinner tables. In other words, their main demand on their political leaders is that they must be able to keep the economic engine moving regardless of what is going on in the world economy.

As a result governments around the world are busy formulating economic stimulus packages despite the fact many of them are actually financially strapped and simply cannot afford them.

Take the case of Britain, one of the countries worst affected by the current financial crisis. The advanced financial system and practices of Britain made it possible for the country’s financial sector to grow relatively faster than others. But an advanced financial system is a double-edged sword. Economic growth that results from such an advanced system also brings with it a high level of indebtedness. In Britain, the debt to GDP ratio was recently estimated to be around 67%. However, due to the policy of the British government which wants to spend itself out of the crisis, the country may need to sell 220 billion pounds ($334 billion) worth of bonds. Budget deficit next year may rise to 175 billion pounds or 12.4% of GDP and the overall debt to GDP may rise to 100%. Largely as a result of this likely scenario, the rating agency Standard & Poor’s has lowered its debt outlook for Britain from “stable” to “negative”, thereby increasing the country costs of borrowing. According to many economists, Britain is in danger of becoming a bankrupt country in the manner of Iceland if its policy makers are not careful.

However, politicians in Britain have little choice if they want to remain in office come the next general election. The current crisis is causing a rapid increase in unemployment. Hundreds of thousands have lost jobs and millions of families are suffering from reduced income. For those still holding jobs, there is a high degree of uncertainty as to whether their jobs are really safe. During this difficult time, voters pin their hopes on government, thinking, falsely of course, that it can take the necessary measures to improve their job security. The politicians themselves, for fear of being voted out of office, are reluctant to admit the reality that, in this respect, they are actually quite powerless. What makes it worse is that opposition politicians are also making false promises that they can do a better job at securing voters’ future.

Under the circumstances, it is therefore unsurprising that governments around the world are unable to resist from behaving irresponsibly and indulge in policies that are extremely risky in the context of the long term future of their countries. Stimulus packages in their billions are announced to reassure the voters that the governments are doing their best to ensure that their countries’ economies are not heading for the doldrums. In reality they are just playing for time by staking the welfare of future generations. The present generation is being hoodwinked into thinking that measures that are being undertaken to solve the crisis do not have risks or costs. In the case of Britain, only the most educated are aware of the magnitude of these risks. But sadly they will never be able to change the direction of policy-making because the short-term position of political leaders is not determined by this small group of educated people but rather by the ignorant masses. Sadly, it is also an undeniable fact that this scenario holds true for many other countries.

But the saddest aspect of the current crisis is the failure by all to recognise the fact that all the measures being undertaken, even if they temporarily succeeds in slowing down economic decline, will not prevent a similar type of crisis from happening again. Moreover such a crisis will likely be on a much bigger scale, just as the current crisis is proving to be much bigger than the great depression of the 1930s. As long as the overall system remains, we all will inexorably lurch towards economic and financial destruction with all the attending consequences.