From the June 2008 issue of Research Magazine • Subscribe!

June 1, 2008

How Will Capitalism Work in 2038?

In the early1990s, I got a job at an organization called Business International. For those who are not readily familiar with the communist ethos, the name of the company was something of a pun -- America's answer to the Communist International, also known as Comintern, a confraternity of national communist parties set up by Lenin in 1919 to promote world revolution.

Headquartered originally on Dag Hammarskjold Plaza a block away from the United Nations building in New York City, Business International was founded with the idea of promoting world capitalism. Or, more precisely, its mission was to bring the heads of America's multinational corporations face to face with political leaders, thinkers and theorists in Western Europe and Asia. It was, in effect, a forum in which Big Business could debate, contemplate and shape the world order.

A few years before me, Barack Obama had a short stint of employment there, after graduating from Columbia University with a degree in political science.

By the time I joined it, however, the previously successful firm was on its last legs. Its business model simply -- and quite suddenly -- stopped working. For some reason, top business executives discovered that they no longer had time on their hands to discuss the fate of the world. On the contrary, they had their hands full running their companies.

The reason was obvious: the emergence of intense international competition, which changed both the mindset and the daily routine of every corporate executive in America. It is the development that shaped the business world over the past three decades, but when it first emerged in the early 1980s it took everyone in corporate board rooms and on Wall Street by surprise.

Eclipse of the OldIn the early post-World War II decades, large American corporations had a near monopoly on their markets both at home and abroad. Or, at worst, they had their markets divvied up among similarly sprawling, placid conglomerates. Market share was stable, business activity was orderly and profit flows were steady and predictable. Out of those stable profits, the companies provided cradle-to-grave, well-paid employment to their unionized workers -- who got their share of the overall pie -- and paid out a steady stream of dividends to their shareholders. The 30 stocks that made up the Dow Jones Industrial Average, as well as shares of hundreds of other American corporations, looked more like bonds than equities as we now know them.

It was an environment in which companies felt little pressure to invest in their business, beyond the usual upkeep and some innovation. Excess cash was spent on acquiring businesses that often had little to do with the company's profile. It is hard to imagine now, but Harvard Business School taught its students not to focus on core business -- which was already doing quite well, thank you -- but build far-flung conglomerates. Gulf & Western was a typical U.S. corporation of that era. Started as a metal stamping business in the 1930s, it began diversifying in the 1960s and at one point had holdings in film and television production, publishing, sports, clothing, tobacco, auto parts and sugar industries.

Then, all of a sudden, thousands of U.S. companies refocused on their core competencies. Their executives shelved their global ambition of shaping the outside world and began keeping their noses to the grindstone.

There has been much debate about what brought this transformation. Was it political climate, deregulation or the realization that the U.S. economy was starting to stagnate? While all three factors played a role, the clearest explanation is the emergence of the entrepreneur. Or, to put it more broadly, the return to America's core individualistic values.

Over the past three decades, entrepreneurs not only have created hundreds of successful new companies, but built dozens of new global brands. As recently as in the 1970s, business school professors claimed that establishing a new global brand was almost impossible and would require massive investment of capital that only a global conglomerate could afford. They pointed out that such brands as Kellogg's, Coca-Cola and Ford were all created in the early years of the 20th century or even before. Yet, in the past three decades, entrepreneurs toiling in their garages with nothing but a couple of credit cards to back them up were able to create truly global brands. Examples range from Apple and Microsoft in the late 1970s to more recent entrants such as Google and MySpace.

Revolutionary ImpulseEven more to the point, the entrepreneurial spirit reemerging in American culture was an agent of what economist Joseph Schumpeter famously called capitalism's "creative destruction" -- or at least creative disruption, because entrepreneurs also shook up American business and changed its old, placid ways. Financial entrepreneurs, those who set up hedge funds and private equity firms, forced corporate executives to focus on their core operations, to cut the fat and to boost profits -- otherwise, they risked seeing their companies taken over by corporate raiders and finding themselves out of a job.

In fact, corporate executives were themselves forced to act and think like entrepreneurs, in part because by giving them stock options boards of directors tied their remuneration to the performance of their companies. In the old days, executives were employees and they identified more closely with other stakeholders, such as labor. Now, their interests became identical to those of their companies' true owners, i.e., their shareholders.

Conventional wisdom associates the entrepreneurial spirit with Silicon Valley and the technology revolution. In reality, more entrepreneurs have probably been active in the financial services industry -- and their impact on the U.S. economy has been even greater. The high-tech revolution in the 1990s occurred only because the creativity of computer and Internet entrepreneurs was harnessed to a financial structure. A funding mechanism was created which allowed them to develop their ideas with the help of "angels," then build companies using a few rounds of venture capital investment and finally reward themselves and their backers by selling shares in the stock market.

This entrepreneurial link-up in the United States was a major factor plunging the Japanese economy into stagnation over the past decade and a half. In the past, Japanese manufacturers used to thrive by taking U.S. patents off the shelf, where they had been gathering dust for years, and applying their engineering expertise in producing them. By the early 1990s, this pipeline completely ran out -- because U.S. inventors were eager to implement their ideas themselves and they had investors willing to fund them.

International ReachJapan has not been able to find a fresh economic model suited to this new reality. To this day, it remains squeezed between the United States as the supplier of new ideas and China as a new global manufacturing hub. Whenever there is talk of a worldwide economic downturn, the Japanese economy is always seen as a weak link and its financial markets suffer the worst sell-off.

Japan is rather an exception than a rule. The entrepreneurial gospel has been spread around the world -- not least by American entrepreneurs. Foreign financial markets have been "discovered" by financial entrepreneurs willing to venture outside the box -- sometimes quite literally, like legendary motorcycle investor Jim Rogers, who traveled 52 countries over two years in search of investment opportunities.

Silicon Valley entrepreneurs, meanwhile, opened up India as a lower-cost outsourcing venue for American high-tech business. Original outsourcing companies were set up by Indian entrepreneurs with U.S. experience, even though they now have plenty of local emulators. The model has spread to other parts of Asia as well.

The world has certainly changed -- in a way, it's a world in which the dream of those who set up the original Business International is being realized. The American business model has triumphed, and it is likely to shape international financial markets over the next 30 years, just as it shaped U.S. markets over the past three decades. However, it was achieved not by underemployed corporate executives discussing weighty matters in smoke-filled boardrooms, but as the result of entrepreneurial activity which is spreading gradually from Silicon Valley and Wall Street to remote corners of the globe.

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Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at abayer@kafanfx.com. His monthly "Global Economy" column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-2008.

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